By STEPHEN A. DVORKIN, a partner with Dickstein Shapiro LLP's Insurance Coverage Group who practices out of the firm's New York City office
Does your company sell its products through independent distributors and retailers? If so, those vendors of your products may well have demanded protection against claims and liabilities arising out of the products' actual and alleged defects.
You may understand that your liability insurance policies provide you and your vendors with the appropriate coverage for such claims and liabilities. You may be incorrect for reasons that never occurred to you.
Liability insurance policies are not identical in the coverages for claims and liabilities. Failure to become familiar with the relevant coverages can result in the purchase of a policy that gives your vendor too little protection, or from your perspective, too much. There are two basic ways in which the costs of a vendor's defense, and any ultimate liability, may be borne by your insurer:
-- If your policy contains a vendors' endorsement, the vendor may be an insured under the policy in its own right.
-- Your policy may make your promise to indemnify the vendor of your products an "insured contract," in which case you will be indemnified for the sums you are required to pay in fulfilling that promise.
What are the features of those differing approaches that may make one preferable to the other?
The standard liability policy excludes from coverage most liabilities that are assumed by contract. An indemnity promise that you make to a vendor in furtherance of your trade or business may be outside the ambit of that exclusion, however, and qualify as an "insured contract."
It is important to recognize that insured contract coverage does not make your vendor an insured, but allows you to fulfill your contractual defense and indemnity obligations to that vendor at the insurer's expense, within the policy's limits, and subject to any applicable deductible.
A virtue of this approach is that it gives you a great deal of control. Your indemnity undertaking to the vendor is delimited by your contract with the vendor, and you are therefore assured a role in determining whether the circumstances from which the vendor's liability arose are within that indemnity promise. Vendors coverage does not necessarily assure you the same degree of control over the liability limits of your insurance policy.
A vendors endorsement to your liability insurance policy will make the vendor, itself, an additional insured for purposes of that policy. Under some policies, vendors have to be individually identified to the insurer to enjoy insured vendor status; and, indeed, some policies confer insured vendor status only on those entities expressly identified on a schedule that is annexed to the policies on the date of issuance.
Some policies go farther, still, and confer insured status only on vendors to which the insurer has issued a certificate. Other forms of the vendors endorsement, however, simply confer insured status on vendors, without imposing any formal identification protocol or formalities.
You should understand the full implications of vendors coverage before you purchase a policy that includes it. Products liability coverage is generally subject not only to "per occurrence" or "per claim" limits, but also to aggregate liability limits--meaning that the indemnification of vendors could leave you without available limits to indemnify your own liabilities. To the extent your policy is subject to deductibles, be aware that the payment of those deductibles generally is the responsibility of the "named insured."
In other words, your insurer could indemnify a liability incurred by one of your vendors, and submit an invoice for the deductible amount to you. If the policy is for "fronting" purposes, the matter of vendors' coverage rights should be examined with particular care. You may in that circumstance be asked to reimburse a full policy limit that was expended to satisfy a vendor liability or to settle a claim on a vendor's behalf. Of course, the vendor may have its own insurance policy. In that case, issues may arise respecting the priority of the respective coverage obligations, or rights to contribution.
The matter of control over the indemnity claims presented for coverage under your policies should receive attention as you consider the subject of vendor indemnity. If a vendor is an insured under your policy, that vendor may at least theoretically press (and settle) a coverage claim without even consulting you.
The promiscuous settlement of claims by vendors may simply serve to encourage the filing of additional, "copycat" claims, and may frustrate your efforts to protect your product's reputation and market by vigorously defending all non-meritorious claims. And such concerns may be magnified by changes in your vendor relationships. A former vendor will be less concerned with protecting you and your product's image than will be a vendor with a continuing stake in the product and the commercial relationship. But under your occurrence-based liability policies, such a former vendor may have coverage rights in respect of a claim involving an injury allegedly sustained while the vendor relationship existed.
The scope of vendors coverage could also frustrate your efforts to use limited or conditional indemnification promises as a means of policing vendor sales practices. Put plainly, your policy's vendors coverage could conceivably oblige you to indemnify your vendor against the consequences of conduct that you have made every effort to discourage.
Your company may purposefully have refused to indemnify vendors in respect of certain categories of claims. For example, you may have concluded that claims of injury or damage involving your product would be minimized, if instructions for use were given at the time and point of sale. Acting on that belief, you entered into agreements with retailers of the product in which you agreed to indemnify them against liability for injury caused by the product if they followed your sales protocols, which require the retailer (vendor) to provide product-use counseling or to obtain the customer's written acknowledgment that such counseling was offered but declined. Posit that your company and the vendor are now defendants in a suit in which the negligence alleged includes failure to warn, and in which the evidence establishes that the prescribed use counseling was not offered by the vendor.
If the jury in the case described above finds that the counseling you prescribed had not been provided, you would not be obligated to indemnify under your indemnity agreement with the vendor--and you have advised the vendor that you are reserving your right to refuse indemnity under the agreement. The vendor, however, demands a defense of your insurer, under the vendors endorsement of your liability policy, and the insurer does not believe that it has grounds upon which it may refuse a defense. The vendor then persuades your insurer to settle its liability for the per-occurrence indemnity limit of your policy. The insurer pays, and submits a statement to the policy's named insured--you--for reimbursement of the policy's six-figure deductible. Moreover, since the underlying plaintiff's claim against you and the vendor arose out of the same occurrence, no coverage remains for you under your policy's liability limit. And since the insurer has paid its full limit in settlement, it now terminates payment for your defense in respect to the suit.
The points are not difficult to appreciate. First, you must try to determine how your company's approach to issues respecting indemnification of vendor liabilities squares with the vendors coverage of your policies. If they are even potentially at odds, ask your insurance broker to secure an endorsement ensuring that the scope of the policy's vendors coverage is no broader than your own indemnity undertakings to your vendors.
Second, you should consider the universe of your potentially covered vendors when determining the limits of the products liability insurance you are proposing to purchase. If the limits of a policy under consideration would not satisfy both the needs of your own company and reasonably foreseeable vendor claims, you should reconsider either those limits or the scope of the policy's vendors coverage.
The broader message is that you should look carefully and comprehensively at your efforts to use your insurance policies to indemnify vendor liabilities. As the foregoing discussion may suggest, there are ways in which those efforts can take unexpected turns, with potentially unfortunate consequences. If the matter is approached with a heightened awareness of the issues, and a little care, unpleasant surprises may be avoided.
April 1, 2011
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