The Purpose Of Insurance Clauses In Service Agreements

Among the contract clauses typically found in a services agreement (i.e., an agreement where a contractor agrees to provide services to a client) is one requiring the service provider to carry certain insurance. Service providers who work with large corporate clients will be well acquainted with this type of provision and will very likely already carry insurance policies like general liability, errors and omissions, workers’ compensation, or others depending on the industry.

But plenty of freelancers who work with smaller clients, as well as service providers working with their first large corporate client, are not used to seeing this clause. Or perhaps in the past they’ve seen the clause and simply asked that it be removed from the contract if they don’t carry insurance policies. In fact, it’s not uncommon to hear from freelancers especially that they think insurance clauses are merely “boilerplate” contract terms—by which they usually mean unimportant and included in the contract due to excessive formality.

As it turns out, insurance clauses in services agreement are essential if there is any meaningful risk associated with the services being rendered. If there is risk, both client and service provider face exposure to liability, but the client is often the bigger target because it usually has deeper pockets and is often the party directly selling the thing into which the services are integrated.

Example: Company A is a video game company and they hire a freelancer to create original pieces of music for the soundtrack of one of their games. However, the freelancer misappropriates music from another composer and incorporates it into the soundtrack. The composer whose copyright has been infringed upon then sues the video game company for copyright infringement.

At this point, you might be asking why it’s important for the service provider to carry insurance if the client is the one that’s likely to be sued. The answer lies in a different contract clause, which works in tandem with insurance requirements: namely, the indemnification clause.

Related: Common Contract Clauses: Indemnification

An indemnification clause typically requires the service provider to indemnify (i.e., compensate) the client if the client gets sued because of the service provider’s misbehavior. While an indemnification clause can help the client to shift risk back onto the service provider, the only way it actually works in practice is if the service provider can meet its indemnification obligations. Put differently, there has to be money available to the service provider to compensate the client. That’s where insurance comes in. By requiring the service provider to carry certain insurance policies with certain minimum limits, the client can ensure that it can look to the service provider for compensation if the client is sued as a result of the service provider’s mistake.

Keep in mind when dealing with the issue of insurance that insurance premiums are often less than freelancers may think. If freelancers insist on insurance requirements being waived (especially for basic insurance, like general liability), effectively what they’re saying to the client is that they won’t be able to satisfy their indemnity obligations if the need arises. Businesses should think twice before working with service providers who likely won’t be able to meet their indemnity obligations.