The Pitfalls of Relying on a Certificate of Insurance and how your Business can Avoid a Major Headac

Many well-intentioned and skilled business individuals have learned an unfortunately hard lesson: the U.S. legal system’s affinity for litigation, and its insurance laws, are often unkind to informal business practices. Where mutual understandings and informal agreements are standard practice in many countries–in the U.S., written contracts are paramount.

Disputes between business collaborators over insurance coverage or indemnification are frequent topics where this division in business cultures may arise and have the potential to cause serious damage. Below is an important rule to follow when relying on a business collaborator to indemnify your company or secure adequate insurance coverage:

THE RULE

Do not rely on a certificate of insurance as proof of insurance coverage or indemnification for your business. Instead, you must insist on a written contract which details the insurance and/or indemnification arrangement that the parties have mutually agreed upon.

A CAUTIONARY TALE

The following hypothetical may help to explain why this rule is so critical: Company A is a manufacturing business that specializes in the production of wine corks. Company B is another manufacturing business that makes wine bottles and labels. Company A and Company B have a long history of working together, where Company B purchases wine corks from Company A and then sells complete wine packaging products to smaller or mid-sized wineries throughout the U.S. Due to their long-standing and successful relationship, which is built on mutual trust, the two companies rely on an informal agreement where Company B will send Company A a standard purchase order for the amount of corks it will need the following month and Company A will fulfill that order.

Because Company B already has first-rate insurance coverage through Insurance B, the two companies agree over the phone that Company B will indemnify and defend Company A for any lawsuits or claims arising from the sale of their products. Furthermore, Company B will send Company A a certificate of insurance that names Company A as an “additional insured.”

Years go by without any issues, and each year Company B sends Company A an updated certificate of insurance that names Company A as an additional insured. Then, seemingly out of nowhere, Company A and Company B are served with a lawsuit filed by a consumer that was seriously injured when opening a champagne bottle and the wine cork shot directly into her eye.

Company A mistakenly believes that Company B will indemnify Company A and that Insurance B will provide coverage because Company A is listed as an additional insured on the certificate of insurance. Instead, Insurance B denies coverage for Company A, unless and until Company A can provide a separate written agreement which states that Company B agreed to indemnify and defend Company A or add Company A as an additional insured to its policy. Company A is left with no other choice but to hire a separate attorney to defend itself in the litigation and is ultimately forced to cover half of the large $1,000,000 settlement with its own funds; a catastrophic blow to Company A’s operations.

WHY IS A WRITTEN AGREEMENT NECESSARY TO SECURE ADEQUATE COVERAGE AS AN ADDITIONAL INSURED?

Despite the official-sounding title, certificates of insurance are generally issued for informational purposes and typically include language reinforcing that point by clarifying that the certificate is not a contract, that it does not confer nor alter any rights relating to coverage under the policy, and that language in the policy itself dictates who is entitled to coverage.

Standard insurance policies will define “who is an insured” as someone that is listed on the attached “Schedule” that accompanies the policy. The policy will also define an “Additional Insured” as someone with whom the primary insured has a written contract or written agreement to add that person or organization as an additional insured on their policy. This language–coupled with the disclaimers on the certificate of insurance–will usually be successful in denying coverage to any supposed additional insureds that do not have a written contract confirming their status as an additional insured.

PRACTICAL TIPS TO HELP YOU AVOID A DISASTROUS SCENARIO

– Always insist on a written contract to solidify your business relationships and make sure to incorporate your insurance coverage and indemnification arrangement. Not only will this help protect all parties regardless of whether one provides coverage for the other, or if each party is responsible for themselves, but it will also help eliminate other disputes that could arise throughout the course of your business partnership.

– If for some reason an all-encompassing contract is not feasible, you should at least demand a separate written agreement that outlines the insurance and indemnification terms you have agreed upon.

– Follow up your business-calls with written letters or emails that recap or outline any agreements you made or your mutual understandings. This is an effective strategy for two reasons: (1) confusions or disagreements will be discovered early on and can be resolved before they present a more serious problem; (2) it will document the terms of your agreements and provide a record of each parties’ intent and understandings, which can be very useful if a dispute does ultimately arise.

Companies that utilize these helpful tips, and take the above-mentioned cautionary tale to heart, will be significantly more prepared with adequate insurance coverage when litigation inevitably comes knocking on their door.

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Requests for information or insights on the issue discussed in this article may be addressed to kevin.sherman@vallalaw.com. This article is for information purposes only and does not constitute legal advice. The information contained herein may be outdated or incomplete, and shall in no way be taken as an indication of future results. The transmission of this article is not intended to create, nor does its receipt constitute, an attorney-client relationship between preparer and reader. You should not act on the information contained in this article without first seeking the advice of an attorney.