Contract Protection Using Contractual Risk Transfer Techniques

Association of Construction and Development
August 16, 2013 — 1,556 views  

Any contract involves some amount of risk, be it physical or business. Things may not always go according to plan or in some cases, there may not even be a plan to reach the result, and so, risks are ever-present.

When parties enter into a contract, the risks may be assumed by either one of the parties. It is necessary to understand all the risks involved in a contract before signing it. Once understood, necessary steps need to be taken to negotiate so that risks are minimized to a great extent to avoid legal and financial troubles.

Benefits of Contractual Risk Transfer

Contractual risk transfer involves transferring the risk onto other parties through clauses that waive the risks off one of the parties. This ensures that the other party is made legally liable for the risks specified, such as mishaps that may occur during the process of work like accidents or incorrect installations, and after the work has been fulfilled like warranty obligations and losses in case of recalls and so on.

Provisions for Risk Transfer

Transferring risks in a contract is usually done through one or more of the following clauses and/or agreements. A Hold Harmless clause or agreement in a contract states that one of the parties – generally the one controlling the contract, shall be saved from harm for the specified risks or all risks arising from the nature of the work. The sole liability for such risks shall be with the other party. This may even transfer liabilities due to negligence or error by the controlling party and may cover all manner of risks including acts of God. This is why the clauses and agreements should be thoroughly studied to ensure fairness.

Complementing the above provision is the Indemnity agreement which states that one of the parties shall reimburse the other party for any and all damages, regardless of whose fault they arise from. Exculpatory clauses are made to have one of the parties give up one or more of their legal rights, such as the right to take legal action against the other party, on account of losses due to the other party's errors. For example, if the nature of the work is not clear or is hazardous, such clauses may be included to protect the individual.

Insurance and Other Considerations

Making sure that the work and workers are insured is another of the ways to avoid financial repercussions in case things go wrong. The party taking the work must ensure that the party giving the work has adequate insurance that comprehensively covers general liability, product liability, and workers' compensation. These must all be verifiable by a Certificate of Insurance given to the first party by the second party's insurer.

Suppose something does go wrong and the insurer decides that it was the first party that caused the event that led to the damages, the insurer can reclaim some of the damages paid from the first party as subrogation. To avoid such a scenario, a waiver of subrogation needs to be obtained from the insurer that covers all scenarios under which the work is done for the first party.

Association of Construction and Development