Contractual and Legal Liabilities

In one line

A liability policy pays what the law would have made you pay, not what you promised somebody you would pay.

In the wording a student can write in an exam: every liability policy insures the insured's legal liability, meaning the liability imposed on him by the general law of tort or by a statute; it excludes contractual liability, meaning the additional liability he has assumed under an agreement and which the law would not otherwise have imposed; and the exclusion is worded so that liability which would have attached in the absence of the contract remains covered.

The two kinds of liability

Legal liability, sometimes called common law liability, is liability the law fixes on a person whether he agrees or not. Its sources are the law of tort, principally negligence, nuisance, trespass and the rule of strict liability; statute, such as the Motor Vehicles Act, 1988, the Public Liability Insurance Act, 1991, and the Code on Social Security, 2020; and, occasionally, the law of bailment, which imposes duties on a person who has another's goods.

Contractual liability is liability a person has taken upon himself by agreement. It has two forms and both matter.

The assumption of another's liability, which is an indemnity or hold harmless clause: A agrees to indemnify B against claims arising from the work, including claims for which B alone is to blame.

The enlargement of one's own liability, which is a guarantee or a warranty: A promises a result rather than reasonable care, or accepts liability without the limits the general law would have given him.

The line between them is not the presence of a contract. A contractor working under a contract who negligently drops a girder on a passer by is liable in tort, and that liability is legal liability, notwithstanding that his presence on the site came from a contract. What makes a liability contractual is that the agreement, and not the general law, is what makes him liable.

Why a liability insurer excludes contractual liability

Because the insured, not the insurer, chose it. An insurer rates the risk of a business behaving negligently. It cannot rate a risk the insured creates with a fountain pen after the policy is issued, by signing a contract that makes him answerable for everybody else's mistakes.

Because it defeats subrogation. If the insured has contracted out of his right to sue the party who actually caused the loss, the insurer who pays has nothing to recover, and the standard subrogation condition is breached.

And because it can convert an indemnity into a guarantee. A promise of a result, unlike a duty of reasonable care, is broken by an outcome, and an insurer who paid on that basis would be underwriting the insured's commercial performance rather than his fortuitous liabilities.