Indemnity Doesn’t Cover It All: Why Consultants Still Need Insurance

Introduction

Most standard contracts, including consultancy agreements, contain indemnity clauses. However, while consultancy agreements have these in place to protect consultants, this does not mitigate the need for a consultant to obtain insurance such as professional indemnity cover.

A common mistake consultants make is relying solely on indemnity clauses within their consultancy agreements to allocate risk and protect their liability. While these clauses are important and an essential contractual safeguard, they do not limit a consultant’s exposure to liability.

In practice, indemnity clauses and insurance policies work hand in hand and serve distinct but complementary functions. Consultants who do not have adequate and appropriate insurance in place may face significant financial and legal risks.

This article explores why it is essential that consultants have indemnity clauses in their consultancy agreements but also adequate insurance policies.

Indemnities Only Go So Far

An indemnity clause in a consultancy agreement provides a contractual right to be compensated by the other party for specific losses.

However, the effectiveness of an indemnity clause depends on the indemnifying party’s capacity to satisfy the obligations under the indemnity clause.

For example, if a consultant tries to enforce an indemnity clause against a client but that client becomes insolvent, disputes their liability or lacks sufficient assets to cover the consultant’s losses, the indemnity is of limited practical value.

In comparison, insurance policies offer a direct and independent source of recovery where the consultant can be compensated, while pursuing a client under indemnity or where the indemnity cannot be enforced.

An additional issue that may arise is that indemnity clauses can also be subject to interpretation. This means that depending on the circumstances, the ability to recover losses under an indemnity clause may be limited by:

• The precise wording of the clause;
• Any carve outs or exclusions within the clause or consultancy agreement as a whole;
• Statutory restrictions. For example, there are limitations on what type of conduct can be indemnified such as misleading or deceptive conduct (under the Competition and Consumer Act 2010 (Cth)); and/or
• Judicial scrutiny. This is particularly relevant if a clause is ambiguous or deemed unreasonable.

While insurance policies are also subject to terms and exclusions, they are designed specifically to respond to defined risks and are interpreted within an established regulatory framework. As such, it is important that the correct insurance for the services provided is obtained.

The Cost of An Indemnity Clause

A disadvantage of indemnity clauses is that they typically operate on a reimbursement basis and do not typically provide immediate funding for costs.

As such, consultants may be required to incur substantial expenses upfront before the indemnity clause can be enforced.

Alternatively, professional indemnity insurance typically covers costs (particularly legal defence costs) as they arise. For consultants, this can reduce cash flow pressures and ensure access to legal representation from the outset or for the payment of other costs (depending on coverage).

Third Party Claims

Another disadvantage of indemnity clauses as the sole remedy for consultants is that they are typically limited to the contractual relationship they relate to (ie. to the parties in the consultancy agreement).

This is particularly relevant as consultants may still face claims from third parties who are not bound by the consultancy agreement and the indemnity clause contained in it.

For example, a consultant may be exposed to negligence claims from end users, stakeholders, or other parties affected by their work. Insurance typically provides broader protection against such external claims that may not be covered by an indemnity clause.

Concurrent and Proportionate Liability

Even where there is an indemnity clause that may be enforced by a consultant, a consultant may retain concurrent liability.

Concurrent liability is a legal principle that allows a party to pursue legal action against multiple parties for the same incident.

Additionally, proportionate liability regimes in Australia may apportion responsibility among multiple parties.

Both matters mean that consultants can remain exposed to a share of the loss irrespective of any contractual arrangements (ie. irrespective of any indemnity clauses), whereas insurance policies can provide recourse and protection in these circumstances (depending on the policy and its coverage).

Insurance as an Expectation and Requirement

While we always recommend that consultants obtain the necessary insurance as a legal safeguard and to complement any indemnity clause, obtaining professional indemnity insurance is often also a commercial expectation.

Clients often require evidence of insurance held by a consultant as a condition of engaging with them. Where a consultant cannot provide this evidence, clients may be concerned regarding their credibility, it may limit a consultant’s opportunities and, in some circumstances, where obtaining insurance is a condition of a contract, exposes a consultant to contractual breaches.

In addition, certain industries require professional indemnity insurance to be obtained and maintained as a regulatory or licensing requirement.

Even where obtaining and maintaining professional indemnity insurance is not a requirement, industry standards often see this as part of prudent risk management.

Conclusion

While indemnity clauses in consultancy agreements are a valuable tool, they are not a substitute for insurance and should not be the only risk allocation measure in place for a consultant.

Indemnity clauses must be enforced (which is a cost a consultant must incur) to recoup a consultant’s losses but they rely on the financial capacity of the other party and depend on the specific circumstances of a claim.

Comparatively, insurance provides a separate mechanism for managing risk, covering costs and addressing liabilities that fall outside the indemnity clause and the consultancy agreement. Insurance also is often considered a more reliable mechanism than an indemnity clause.

Consultants should adopt a comprehensive risk management strategy that includes both carefully drafted indemnities and appropriate insurance coverage.

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