Don’t get confused between your obligation to insure and a limitation on your liability

Every commercial transaction carries of risk of liability. It is often wrongly believed that if a party is required to insure a risk up to a specified figure, it must be liable for that risk and its liability is automatically limited to that figure. Any limit on liability is independent of the level of your insurance cover

Your liability to insure and a cap on liability are not the same thing. It is important to recognise the difference between an obligation to insure to a specified amount and a clause limiting a party’s liability under or in connection with the contract.

You can have insurance cover without limiting your liability and you can limit your liability without having insurance. Parties under a contract often (subject to the Unfair Contract Terms Act 1977) agree to limit or exclude the liability they owe to each other. This is of course permitted except in respect of liability for personal injury or death. In the absence of a limitation clause, there is no financial limit on how much a party can claim in respect of damages for direct and indirect losses flowing from the breach. A party wishing to reduce their exposure needs an express limitation on liability.

Professional indemnity (“PI”) Insurance acts as an asset against which claims can be made, but doesn’t stop the claim being greater than your insurance cover or below your excess level. For example, if the contractually agreed PI limit is £500,000 and damages awarded from a breach of contract are for the sum of £750,000, the liable party is liable for the whole £750,000. It is possible that insurance may cover to the sum of £500,000 but any sum above that would have to be met by the breaching party.

In practice, it is often agreed by the parties that the total liability owed to the employer for all matters arising under or in connection with a contract (other than excluded matters such as death and personal injury) is limited to the value of the consultant/contractor/sub-contractor’s PI insurance. For example, had there been a limitation clause in the situation above, limiting a claim to the sum of £500,000, the losing party would not have been personally liable for the outstanding £250,000 in damages. The winning party would have been unable to make a claim for any more than the amount equivalent to the insurance cover.

It is always important to understand the risk allocation when negotiating contracts with the other side. Whether you are the employer or the employed you need to make sure you understand where you stand should a potential claim be pursued.

These notes have been prepared for the purpose of articles only. They should not be regarded as a substitute for taking legal advice.