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Mark Grossman

Insurance For Technology Contracts

2 February 1999

Software development and other technology-related contracts often include provisions that significantly limit the seller's liability. If you're the buyer, you need to know that your seller could and should have insurance that protects them if their product doesn't function as expected and causes you damage. If you're a software or website developer, computer consultant or otherwise involved in the computer industry, you should consider errors and omissions insurance. From your perspective, it's a safety net.

The Negotiation Dynamic

While every contract negotiation is different, one common element in the computer contracting process is that the seller of computer services (software developers, computer consultants, etc.) want a strong limitation of liability clause in the contract. A typical provision might read something like this: "The developer's liability and the buyer's exclusive remedy for damages from any cause whatsoever relating to the subject matter of this Agreement shall be limited to the price of the software."

Of course, the savvy buyer wants no part of this. The buyer might point out that they're paying for a product and relying on the seller's expertise. If the product fails, it could cause damage far beyond the value of the software.

Let's take this scenario as an example. What if the seller is being charged with developing software that's central to the operation of the buyer's business. In fact, it's clear that if the software fails, it would severely disrupt the day-to-day operation of the buyer's business. The buyer rightfully feels that it's unfair that - no matter what happens, no matter how bad the final product is and no matter how much they lose - the seller's responsibility ends with a refund.

Now, the seller has an entirely different perspective. (Somehow, I'm sure that doesn't surprise you.) The developer's concern is that the loss that its product could cause the buyer is totally disproportionate to the price of the software.

As someone who's been involved in these types of negotiations many times and has represented both sides of this type of negotiation at one time or another, I see that the problem is that both sides are right.

Representing the buyer, I've said such things as "Let me get this straight. We're paying you $350,000 for you to develop this product and you feel that it's right for you simply not to be responsible if things go sour. A refund wouldn't even come close to compensating my client for their losses if you screw this up."

Then, when representing a software developer, I've responded to that argument by saying things such as "While we recognize that $350,000 is a significant amount to pay us, we can't accept the responsibility for the almost limitless damage that might ensue if things don't work as expected. Software and computer systems are inherently complex and subject to unexpected failures and complexities. It's up to you as the buyer to set up backup systems and procedures to mitigate your losses if the system fails."


Getting Beyond the Impasse

One possible solution to this problem is for the developer or consultant to have errors and omissions insurance. This could be a source for damage payments to the buyer if the product or service complete breaks down. It's something the parties need to consider early in a negotiation because this may impact the contract price since the policy premiums could be significant.

Errors and omissions insurance (an E and O policy) is what's often referred to as "malpractice insurance." A good policy covers things like negligence, constructive fraud, fraudulent concealment, consumer fraud, negligent misrepresentation, libel, slander, copyright and trademark infringement, and breaches of contract including those that are implied in fact or by law.

When you buy these policies, you need to ask many questions and have your attorney review the policy language. While coverage for negligence is common, you'll find it more difficult to find some of these other coverages. Probably one of the more difficult coverages to find is the one for breaches of contract. Still, you may be able to obtain this; it's important to have. It could save your business.

Beyond the specific coverages, which will vary between policies, you also need to consider other variances. For example, you want a policy that provides "first-dollar defense" coverage. That means that the insurance will pay your attorney from the outset, including any retainer. You want to be sure that after you pay any deductible, the policy pays all ongoing attorney's fees and any settlement or judgment, up to the policy limit.

You want to contemplate whom you want to cover. If appropriate, make sure that the policy covers partners, directors, executive officers, employees and independent contractors. You might also look for coverage for individuals who have left the company, but only for their actions while with your company.

Finally, consider any geographic limitations that your policy might have. Is it limited to coverage within the United States? That's fine unless you have international business.

Some other Considerations

In deciding whether to purchase E and O insurance, you might want to consider what it tells a potential buyer about your services, if early in your sales presentation, you tell her that you have this coverage. You might want to include a copy of your Certificate of Insurance in your sales materials. Just that document alone labels you as a cut above the pack.

Here's a trap for the unwary. Watch out for policies that exclude coverage for projects started before the insurance is in force. If you need that coverage, discuss it with your agent.

When considering the policy limits that you need, you should consider the attorney's fees that the policy may cover. In a complex dispute over a technology project, attorney's fees can easily exceed $50,000 and stop who knows where.

Insurance companies are now extremely aware of the Year 2000 computer problem. You will want to inquire about how the policy will deal with Year 2000 issues.

Consider purchasing a policy with the largest deductible that you can afford to lose. A basic philosophical point with insurance is that you should only insure what you can't afford to lose. If you can afford to take a large hit, then take a large deductible. This will probably significantly reduce your premium.

Most E and O policies are "claims-made" policies. This means that they only cover you for claims that you make against the policy while it's in force. Therefore, if you commit malpractice in 1999, but the mistake isn't discovered until 2001, you'll generally only be covered if you still have insurance in 2001 and then only if it specifically covers prior acts committed in 1999.

"Claims-made" policies can be traps for those not familiar with insurance because in our personal lives, most policies are "occurrence" policies. For example, if you have car insurance on the day that you cause an accident, you're covered for it even if you don't make a claim until a year after the policy expires.


If you're a buyer of computer products and services, knowing that your seller has E and O insurance should provide you with some reassurance. It also allows you to be more demanding when negotiating limitations of liability provisions. You might aim at the policy limits as the limit rather than the price of the product or service.

If you're a seller, you can accept more responsibility for your actions knowing that if the unanticipated happens, you have insurance to protect you. You may find that potential buyers of your goods and services are impressed by your demonstration in financial responsibility. You may find that your premiums are more than paid for by the business that you're getting that you couldn't get before.

Insurance For Technology Contracts is republished from
Mark Grossman
Mark Grossman