Contractual Risk Transfer: An Overview & Key Terms

Contractual Risk Transfer: An Overview & Key Terms

Examining and managing risk exposures is one of the keys to long-term success for businesses of all sizes. However, when you work with parties such as contractors, renters, component suppliers and service providers, you may be held accountable for their actions or negligence. Since your regular risk management procedures and insurance policies generally don’t cover others, you could be found liable for huge losses.

The best protection in these situations is to shift risk and liability away from your business and onto other parties. Thankfully, you can do this when you draft a formal business contract by including provisions, clauses and other text that determine exactly who is liable for specific scenarios and losses. This is generally referred to as contractual risk transfer and can include a wide range of provisions on liability. For example, a business could agree to be responsible for losses only when employees or customers are on the premises.

Properly worded contracts are legally binding in court and can help protect your business in the event of a loss or dispute. Additionally, contracts can contain insurance requirements, waivers and other types of risk transfer that give your business legal counsel or direct financial compensation.

Although contractual risk transfer is an effective way to protect your bottom line when working with partners and other parties, the practice itself may expose your business to significant risks. Many states have laws that require specific legal language in order to make contractual risk transfer enforceable, and some states have outlawed specific types of contractual risk transfer altogether.

Legal Language Overview

Contracts and other legal documents are read by many different individuals and tt is essential for them to be written in a way to ensure they will be interpreted and enforced in a clear and consistent way. For this reason, words and phrases included in contracts are often interpreted literally; their meaning can differ greatly from informal, conversational language.

For example, think about the definition of the word “should.” When a manager tells an employee that they “should” be in the office by a certain time, the employee has a general understanding that this is a job expectation. However, because the literal definition of “should” states that the action is only probable and not guaranteed, including “should” in a legal document could cause readers to interpret its meaning in a number of different ways. Instead, most legal documents use clearer language to outline expectations, such as “must,” “will” and “shall.”

Key Terms for Contractual Risk Transfer


Liability represents the legal responsibility for a party’s acts or omissions. Legal proceedings involving liability focus on finding the party that was ultimately responsible for a loss, injury or other damage. Then, any relevant contracts are examined to see if any liability was transferred to another party and if those risk transfer provisions are relevant to the situation.

It's also important to note that courts often consider vicarious liability when investigating a case. Under this form of liability, a party can be responsible for a loss they did not cause if they have a special legal relationship to the party who was ultimately at fault. For example, a person could sue an entire business if a single employee’s negligence leads to their injury.


Negligence is a failure to exercise the care toward an individual or situation that a normal, responsible person would take. Although negligence is accidental in nature, a negligent party can still be held responsible for a loss or damage. Most states have laws that prohibit or limit the transfer of liability that results from one party’s own negligence.

There are a few different types of negligence with important distinctions:

•   Gross negligence: An extreme form of negligence that is still accidental in nature but also shows a reckless disregard for the safety or lives of others. Many contractual risk transfer provisions contain exclusions for gross negligence.

•   Sole negligence: Negligence that can be attributed entirely to a single person or party. Sole negligence is extremely difficult to prove because any involvement whatsoever by another party would qualify as a separate type of negligence. Many states have outlawed contractual provisions that contain sole negligence exclusions in order to protect parties that don’t understand sole negligence and accept additional risk without their knowledge.

•   Joint or contributory negligence: A situation where multiple people or parties are simultaneously negligent for a loss, injury or other damage. During a lawsuit, a court may find that multiple parties were negligent and assign different amounts of liability to each party. However, state laws concerning this form of negligence vary greatly.


Diligence is the amount of reasonable care or attention that a normal, responsible person would take in any given situation. A party may attempt to avoid liability for a loss by proving that they were diligent and took reasonable steps to avoid damage or transfer responsibility for the situation to another reasonable person.


Indemnify means the act of one party agreeing to provide some form of compensation for the loss, damage or liability of another party under one or more specific circumstances. This is one of the most common and broadest forms of contractual risk transfer as the party that compensates for a loss takes on some of the other party’s financial risk.

Three additional terms are often used when discussing this process:

•   Indemnity: The actual compensation that’s exchanged when one party indemnifies another. The form of compensation may vary depending on the specific wording used in different indemnity clauses.

•   Indemnitor: The party that promises compensation through an indemnity provision. This party takes on additional risk by offering the reimbursement in a contract.

•   Indemnitee: The party that will receive compensation through an indemnity provision. This party has transferred part of their risk elsewhere by getting a promise of reimbursement through the indemnity provision.

Hold Harmless

When used in a contract, hold harmless refers to the act of one party protecting another party from losses and liability. Although some experts believe that the terms indemnify and hold harmless can be used interchangeably, not everyone agrees. Courts generally find that hold harmless is a broader term that refers to protection against both liability and losses, while indemnify only protects against losses by promising compensation after damage has already occurred. However, both terms are often included in indemnity provisions in order to offer more protection and avoid confusion.

Duty to Defend

A duty to defend is the promise to provide for a legal defense or transfer funds to hire counsel. Many contracts include a duty to defend provision in which one party promises to accept responsibility for any costs or work related to lawsuits.

Insured Contract

An insured contract is a term used to provide partial or full exceptions to the contractual liability exclusion in most commercial general liability (CGL) insurance policies. Most CGL policies don’t provide coverage for damage that comes from one party’s agreement to take on extra liability since this extra risk wasn’t considered during the insurance underwriting process. However, if the extra liability was a part of a contract, an insurer may label the extra liability as part of an insured contract and provide coverage.


Subrogation is the legal ability of a person or group to use the rights of another when resolving debt or an insurance claim. When talking about contracts, subrogation usually refers to an insurance company that’s trying to recover their losses from a loss that it paid out. For example, if an insurance company pays for one of its policyholder’s losses, it can legally use that person’s right to sue the at-fault party to try to recover the damages.

Waivers of subrogation are a common form of contractual risk transfer where the parties forming a contract deny this right to insurers. As a result, insurance premiums may go up.

We’re Here to Help with Contractual Risk

The risk mitigation experts at CBIZ can help you understand your organization’s risk with contracts and make sure your business is covered in the case of a legal event. Connect with a member of our team for more information on this unique risk. 

This information should not be considered legal advice. Contact legal counsel for advice before you agree to a contract with other parties.

Contractual Risk Transfer: An Overview & Key Terms people looking over contract.jpgContractual risk transfer is an effective way to protect your bottom line, but it may expose your company to additional risks. Get details on what contractual risk transfer is and key terms to understanding it....2020-01-10T22:58:41-05:00

Contractual risk transfer is an effective way to protect your bottom line, but it may expose your company to additional risks. Get details on what contractual risk transfer is and key terms to understanding it.

Regulatory, Compliance, & LegislativeAudit & Assurance ServicesProperty & Casualty InsuranceYes