Thursday, June 11, 2015 Imagine a situation in which the employee of your company’s vendor is injured while performing work for your company under a service agreement. The employee, likely unable to sue his or her own employer due to the exclusive remedy provisions of an applicable state’s workers compensation act, sues your company. Naturally, your company looks to the vendor or its insurer to cover the loss, only to find itself inadequately protected by the vendor service agreement.

Often when negotiating a vendor service agreement, the parties at the bargaining table are primarily concerned with closing the deal. Less focus may be given to the finer points of the agreement, like effectuating a complete transfer of risk to the party more likely to cause harm – the vendor.

If the issue of transferring risk via an indemnity agreement or through liability insurance is considered, the preference of the vendor is to avoid assuming liability for loss or damage unless caused by the vendor’s own negligent acts. An agreement that effectively transfers the risk of the company’s own negligent acts and omissions may be immediately stricken by the vendor as offensive. What most businesses don’t realize, however, is this – unless risk of liability is completely transferred to the vendor, the vendor’s insurance will not typically cover a loss when an accident occurs, leaving both the company and the vendor exposed to an uninsured risk.

There are two methods of transferring risk: indemnity agreements and insurance. An insurance policy is one means of transferring risk, as the insurer, for a premium, accepts the risk of liability in the event of loss, injury, or damage. In fact, a company may require its vendor to procure insurance naming the company as an additional insured to protect against potential liability arising out of the services provided under the agreement. This can be built into the contract price, but the key is to ensure the vendor procures an endorsement insuring the company against the company’s own negligent acts and omissions – i.e., a policy that completely transfers the company’s risk.

In the scenario described above, where the injured employee of a vendor – barred under a state workers compensation statute from asserting claims against its own employer – sues the company for a work-related injury, a policy endorsement insuring the company only when a loss is pleaded to be caused in whole or part by the vendor will not trigger coverage and thus, create an exposure gap for the company.

The company is similarly exposed where the contract contains an indemnity agreement that does not completely transfer the company’s risk. Whether the company’s risk is effectively transferred in a service agreement is jurisdictional, to some degree. Some states have anti-indemnity statutes that apply across the board, or apply to certain industries, like construction or oil and gas. The majority of states, however, simply apply restrictions when interpreting the agreements – requiring the party seeking to transfer liability for its own negligent acts and omissions to a third party to do so in “clear and unequivocal terms.”

In cases involving injuries to the employee of a vendor, an indemnity agreement that does not effectively transfer the company’s risk leaves the company in the position of having to mitigate its exposure by allocating a percentage of fault to the vendor-employer as an empty chair, leaves the company’s own insurance policies exposed, and may – if the company has a large deductible or self-insured retention – impose significant out–of-pocket costs on the company. In fact, in the “injured vendor employee” case, (in most states) the only way to circumvent the workers compensation statutory bar against suing the vendor-employer/subscriber of an injured employee may be through an agreement that completely transfers the company’s risk.

At the end of the day, it is better for both the company and the vendor for the vendor to assume the company’s risk of liability. Having the vendor provide insurance covering both the indemnity obligation and direct coverage to the company by endorsement is paramount to mitigating the company’s risk on the front end and protecting the company’s own insurance policies.