Understand the nuances of contract negotiation to minimize contractual risk.

Managing professional liability risks in construction can be difficult. Although not all-inclusive, the following practices should enhance your risk-management strategy and reduce your long-term exposure to unforeseen professional losses. These points rely on the ability to understand and manage contractual risk, which is arguably the most critical element to managing professional liability loss exposures.

Develop reasonable contracts. One of the most critical elements to risk management is the contract with your client. Although there is pressure to secure high-profile projects, be wary of contracts that are not reasonable in the allocation of risk. The risks should generally reside with the parties most capable of handling and controlling them. This will vary by project type and client. Take note of how contracts with your larger, more sophisticated clients manage and transfer risk and how this varies from contracts with your smaller clients. These clients have more leverage, but they also have more experience. Their legal teams generally integrate contract language with a broad approach to risk transfer downstream.

Most companies are flexible and expect some negotiation of contract language. They may respect you more when you negotiate, particularly if you articulate reasonable arguments for compromise. If a client’s position is rigid with little consideration for your position as a vendor, however, you should carefully consider the relationship. Evaluate the need and expected profitability as compared to the risk of future adversity. If the project is already a stretch for your firm, this type of evaluation is even more critical.

Understand all contractual terms. Evaluate how these terms may affect your position during a claim. Contract clauses regarding professional risks are complex. Be aware of standard of care clauses and indemnity clauses.

Standard of care clauses – Professionals are held to a standard of care that applies to services rendered. A professional services contract will have clauses defining this standard of care. The defined standard of care is a description of how the service professional is expected to perform on the project. The way that a standard of care is addressed in a contract can greatly affect your exposure to risk as the professional services provider or as the contractor with responsibility for professional services.

When reviewing these clauses, note that perfection is not the objective and should not be the standard of care. Many parties will attempt to overreach on this matter, as it can become a pivotal clause in determining the allocation of damages following a loss. Beware of contracts that use language holding the professional service provider to the “highest” standard or that use similar wording. Such terms are ambiguous and should be avoided or negotiated.

An alternative may be to consider references to a “reasonable” standard of care specific to the area in which the professional service provider is performing the work. Consider, for example, an engineering firm designing a bridge. A small bridge in Atlanta, Ga., is not subject to the same needs of an eight-lane bridge in Los Angeles, Calif. Ambiguous or overreaching language may open the professional service provider to litigation and indemnity costs.

Indemnity clauses – Client contracts also typically include broad indemnity clauses that transfer indemnity and, in many cases, defense obligations to the professional services provider. The language in such clauses can vary greatly and may extend beyond coverage provided by professional liability insurance, leaving you with unexpected costs to fund the indemnity obligation. Also, indemnity language may include a requirement to indemnify for each “act, error or omission.” Note that limiting such provisions to negligence (by using wording that refers to a “negligent act, error or omission”) may significantly improve your risk position. Also, failure to address indemnity provisions on this matter may accidentally prejudice favorable language negotiated under the “standard of care” clause, by triggering an indemnity obligation beyond the standard of care required by contract.

Liability insurance doesn’t generally address contractual liability (this differs from a typical commercial general liability policy approach), and insurance carriers do not include clients as “additional insureds” under such policies. In the event that you, as a professional service provider, agree to indemnify for client defense costs for third-party claims, such indemnity obligations may not be a covered peril under your professional liability insurance policy.

Select design partners carefully. In some situations, such as in design-build projects, the contractor and design professional are more aligned than in a traditional design-bid-build structure, and selection of the right partner is important. Often, the relationship between the architect or engineer and the contractor can be a catalyst for errors in the design process.

A collaborative relationship between the designer and contractor can minimize project risk and increase profitability because both experts will have input on various aspects of the job. Some qualities to consider when selecting sub-designers are specialization, alignment of contract terms between the parties and review of résumés of individuals performing and overseeing design.

Seek experienced counsel. Since subtle language modifications can drastically affect contracts, it is important to develop a relationship with an experienced construction contract attorney. Such expertise is also useful in developing and updating your existing contracts, and the knowledge you gain during complex project negotiations may improve your risk position across your customer base. You can also seek advice from your insurance broker.

Understand your insurance policy. Insurance is a contract—the principles of negotiation apply. Like your clients, the first obligation of insurance carrier underwriters is to protect their assets. Therefore, they may not offer coverage terms that match your needs exactly.

Review your insurance policies. Too often, coverage is not reflective of the risks involved in the project and includes coverage gaps for perils you assumed were addressed. It is important that you communicate your risks and that your broker has the knowledge and experience to negotiate on your behalf.

Read key terms, definitions and exclusions. Question language that may be inadequate for your risks. Some exposures are not insurable, but professional coverage extensions may be tailored to address coverage deficiencies. Understand how your policies may affect one another in the event of a claim that involves allegations of both professional services and construction activities performed.