updated on Home Insurance Uncategorized

Uninsurable Contractual Obligations: Identifying and Avoiding Risky Clauses

Professional services firms in the USA—consultants, architects, IT vendors, and other knowledge-based businesses—commonly rely on Professional Liability Insurance (Errors & Omissions, or E&O) to transfer risk. But certain contractual promises can be effectively uninsurable, leaving firms exposed to catastrophic losses and policy disputes. This guide explains the most dangerous contract clauses, real-world pricing context, state and market considerations (New York, San Francisco, Houston), and practical steps to protect E&O coverage.

Why contractual obligations become uninsurable

Insurance covers accidental or negligent acts. Insurers routinely deny coverage when contracts force a firm to:

  • Assume responsibility for another party’s negligence or willful misconduct (broad-form indemnity).
  • Agree to pay punitive damages, criminal penalties, or intentionally caused harm.
  • Waive subrogation against a party whose negligence caused loss.
  • Accept absolute liability (no-fault) or strict liability beyond professional standards.
  • Promise liquidated damages or pre-set penalties that function like fines.

Insurers view these as transferring risk that cannot be underwritten on regular E&O terms. The result: coverage exclusions, refusal to defend, or skyrocketing premiums.

Common uninsurable clauses — what to watch for

Clause type Why it's risky Typical insurer response How to fix or mitigate
Broad-form indemnity / “hold harmless” for other’s negligence Requires you to indemnify third parties even when they caused the loss Exclusion for indemnity to others or denial of coverage Narrow indemnity to your negligence; add reciprocal indemnity
Waiver of subrogation Prevents insurer from recovering from the party at fault Insurers dislike limitations on recovery; may charge or refuse Limit waiver to named parties; seek insurer consent
Contractual cap incompatible with policy limits Caps that are lower than claim costs or create no-cost defense requirement Coverage disputes; insurer may not cover defense expenses Align contractual cap with E&O limit, or require deductible adjustments
Assumption of punitive or criminal liability Shifts exposure for intentional or illegal acts Uninsurable; policies exclude intentional acts and criminal fines Carve out punitive/criminal liability; maintain explicit exclusions
Liquidated damages / pre-agreed penalties Acts like a statutory fine rather than compensatory damages May be excluded as uninsurable penalty Tie liquidated damages to demonstrable damages or remove outright

Practical examples + pricing context (USA focus: New York, San Francisco, Houston)

Understanding market pricing helps when negotiating contracts. Sample market figures (approximate, market-observed ranges):

  • Freelance consultant / small firm (1–5 professionals) — $1M/$1M limit:

  • Small-to-mid tech or design firm (higher exposure) in San Francisco or New York — $1M/$2M:

  • Mid-size to enterprise firms (complex E&O exposures) in Houston or national operations — $2M+:

These figures underline why absorbing extra contractual risk can quickly turn a manageable premium into an unaffordable exposure.

Red flags during contract review

When reviewing contracts for potential E&O exposure, flag any of the following:

  • “Indemnify and hold harmless the client for any and all claims, including those caused by the client’s own negligence.”
  • “Consultant waives all rights of subrogation against client and its affiliates.”
  • “Consultant shall be responsible for punitive or exemplary damages.”
  • “Liquidated damages of $X per day regardless of causation or client negligence.”
  • “Consultant accepts unlimited liability.”

For a focused checklist, see: Checklist for Reviewing Contracts That Could Impact Professional Liability Insurance (Errors & Omissions) Claims.

How to negotiate and draft insured-friendly language

  • Limit indemnity to your negligence: “Consultant agrees to indemnify Client only to the extent that Consultant’s negligence causes direct, provable damages.”
  • Exclude punitive/criminal liability and consequential damages from indemnity obligations.
  • Require the client to be responsible for third-party negligence or make indemnity reciprocal.
  • Preserve insurer subrogation rights, or obtain written insurer consent for any waiver.
  • Cap liability to a reasonable multiple of fees (e.g., fees paid in the prior 12 months) and align cap with policy limits.

For tailored drafting examples and sample clauses, see: Drafting Contracts to Protect E&O Coverage: Clauses Every Firm Needs.

Insurance-side solutions

  • Seek express “indemnity to others” endorsements — some carriers offer endorsements to clarify whether contractual indemnities are covered (subject to underwriting review).
  • Purchase higher limits or excess/umbrella liability to match contractual caps.
  • Separate contractors’ or subcontractor insurance — shift certain risks down the chain where appropriate.
  • Buy a “contractor’s professional liability” or tailored policy if your work mixes professional and construction exposures.

Learn more about how specific indemnity language affects coverage in: How Indemnity Clauses Affect Professional Liability Insurance (Errors & Omissions) Coverage.

When you’re forced into an uninsurable clause — immediate steps

  1. Notify your broker and insurer before signing; get written confirmation of coverage implications.
  2. Request an amendment: limit the scope of the indemnity, add time/monetary caps, carve out punitive/criminal damages.
  3. Obtain a written waiver from the client that they will assume certain losses themselves.
  4. Escalate to senior management or legal counsel — don’t sign high-transfer clauses for the sake of landing a client without board/partner approval.
  5. If contract cannot be changed, price the risk: increase fees, buy excess coverage, or require a deposit/escrow for potential liquidated damages.

If a contract already forced you into uninsurable exposure, read: What to Do If a Contract Forces You Into an Uninsurable Risk With Professional Liability Insurance (Errors & Omissions).

Quick negotiation checklist (printable)

  • Do indemnities exclude client negligence? — Yes / No
  • Is punitive/criminal liability carved out? — Yes / No
  • Are subrogation rights preserved for insurer? — Yes / No
  • Is the liability cap aligned with E&O limits? — Yes / No
  • Are liquidated damages tied to demonstrable harm? — Yes / No

For a deeper practical checklist aligned to claims handling, see: Checklist for Reviewing Contracts That Could Impact Professional Liability Insurance (Errors & Omissions) Claims.

Conclusion

Uninsurable contractual obligations are a common but avoidable source of catastrophic risk for US professional firms—especially in high-cost markets like New York City, San Francisco, and Houston. Combine prudent contract drafting, proactive negotiation, and clear communication with brokers and insurers to preserve E&O coverage and avoid coverage gaps. When in doubt, require written insurer consent or decline the clause rather than accepting unquantified, uninsurable exposure.

External sources and further reading:

Recommended Articles