Does business insurance cover breach of contract?
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When you agree to do business with a client, it’s important to have a signed contract detailing the arrangement between the two parties. This document sets clear expectations about each party’s responsibilities and provides important legal protection for your business.
Successful contracts include key details, such as:
- Scope of work
- Payments
- Deliverables
- Deadlines
- Materials, supplies, and other relevant information
If either party fails to honor the terms of the contract, they might be sued for breach of contract. Even if you’re not at fault, an accusation of contract negligence could damage your reputation and your bottom line.
Here’s what you need to know about breach of contract claims and how you can protect yourself from expensive lawsuits.
- What is a breach of contract?
- What happens if your client sues for breach of contract?
- What insurance could protect you from breach of contract lawsuits?
- Who should get breach of contract insurance coverage?
- Is bad faith considered a breach of contract insurance claim?
- How do I avoid accusations of breach of contract?
- How do I get breach of contract insurance?
What is a breach of contract?
A breach of contract occurs when one party fails to fulfill their contractual obligations. These claims can stem from missed deadlines, errors, service failures, and other negligent acts.
What are the most common types of breach of contract?
Not all contract breaches look the same. Each varies in timing, severity, client impact, and legal implications. The most common types are:
Actual breach (Timing)
An actual breach happens when one party fails to fulfill their contractual obligations by the deadline. The non-breaching party can likely sue for damages and cancel the contract.
For example, a catering company is supposed to deliver 150 boxed lunches for a medical facility conference, but they never arrive. The facility can sue the caterer for damages, including the last-minute fees for rush delivery on replacement meals.
Anticipatory breach (Timing)
With an anticipatory breach, one party informs another ahead of the deadline that it won’t fulfill its contractual obligations on time. The non-breaching party can immediately terminate the contract and start looking for an alternative solution.
Imagine a food manufacturer has a materials shortage and won’t be able to deliver a bakery’s supplies by the promised date. The bakery owner can immediately cancel their contract, find another supplier, and sue the breaching party for damages.
Material breach (Severity)
As the most serious type of breach, a material breach is when one party fails to deliver on the fundamental terms of the contract, essentially defeating the purpose of the agreement. Whether the work is unusable or never completed, the non-breaching party can terminate the contract and sue for damages.
Let's say a small clothing boutique hires a web developer to build their new e-commerce site ahead of the holiday season. The developer accepts the deposit but fails to launch the site by the agreed-upon date, causing the retailer to lose out on substantial online sales during their busiest time of the year.
The boutique can terminate the contract and sue for damages, including lost revenue and their deposit.
Minor breach (Severity)
Also known as a partial breach, a minor breach happens when a small part of the contract isn’t fulfilled, but the main purpose is met. The non-breaching party can sue for damages, but the contract stays intact.
For instance, a flooring installer is contracted to complete a new restaurant's dining room floor by a specified date. The installation was completed two days late, causing the restaurant’s opening night to be slightly delayed.
The owner can sue the flooring service company for lost revenue caused by the delay, but still must pay for the work.
What happens if your client sues for breach of contract?
Whether you’re a general contractor, an accountant, or a florist, if your company enters into a business agreement with another party, you can be sued for breach of contract.
These lawsuits can result in hefty financial penalties. Types of damages typically awarded to clients include:
- Restitution: You have to pay back any money your client paid you.
- Compensatory damages: You must pay your client any money they might have lost due to your breach. This could be actual damages or an estimate of future losses, such as if they lost a client due to the breach.
- Specific performance: You need to follow through on the terms of the contract. This usually applies when money isn’t adequate compensation for what was lost, like unique property in a real estate transaction.
- Punitive damages: If your breach of contract is particularly egregious, you may be required to pay extra damages as punishment.
Depending on the state, you could also be ordered to pay the other party’s attorneys' fees and court costs.
A breach of contract occurs when a party to an agreement doesn’t fulfill their contractual obligations.
What insurance could protect you from breach of contract lawsuits?
Professional liability insurance, also called errors and omissions (E&O) insurance, protects small businesses from most breach of contract claims related to:
- Mistakes and oversights
- Negligence
- Service failures
- Budget overruns
- Missed deadlines
- Incomplete work
However, most standard professional liability policies exclude breach of contract, meaning it typically needs to be added as an endorsement to your policy. If you’re sued for breach of contract, this coverage helps with legal defense costs, including attorney’s fees and any settlements or judgments.
It’s also important to note that this coverage doesn’t protect against:
- Intentional wrongdoing excluded: Claims over fraudulent, malicious, or dishonest breaches of contract are generally excluded from insurance coverage.
- Claims-made restrictions: Professional liability insurance is a claims-made policy, meaning your claim will only be covered while the policy is active.
Who should get breach of contract insurance coverage?
Business owners aren’t legally required to have breach of contract insurance, but it’s recommended for any company that enters into a business agreement. Some clients may even require proof of professional liability coverage before signing a contract with your business.
Breach of contract insurance is essential for many industries, including:
Professional services
Lawyers, event planners, security guards, and other professional service providers can be sued for incomplete work, missed due dates, and other oversights. Breach of contract insurance will cover their legal defense and any damages owed.
Consulting
If a client believes a consultant's advice, services, or deliverables caused their business to lose money, they might sue for breach of contract. Professional liability insurance can help pay for the consultant’s lawsuit expenses.
Architecture & engineering
Interior designers, architects, engineers, and other building design professionals are at risk of lawsuits over mistakes, misunderstandings, or failure to meet deadlines. Professional liability coverage will handle policyholders’ reputational repair and lawsuit costs.
Real estate
Most landlords, agents, mortgage brokers, and other real estate professionals can be sued for failure to perform their duties or disclose crucial details, and other accusations of negligence. A professional liability insurance policy will pay for legal fees and PR management.
Technology
Cybersecurity contractors, web designers, software developers, and other IT and technology professionals facing software failures, improper integrations, and missed deliverables should consider purchasing tech professional liability coverage, more commonly referred to as tech E&O insurance.
By bundling errors and omissions insurance with cyber insurance, tech E&O can be a more cost-effective option than buying each policy separately. It helps protect technology companies against claims of financial loss, service failures, and breaches of contract, including Service Level Agreement (SLA) violations.
Is bad faith considered a breach of contract insurance claim?
Although bad faith claims and breach of contract claims can stem from the same contract, they have different legal implications.
Breach of contract is a failure to fulfill a contractual obligation. Bad faith, also called a breach of the implied covenant of good faith and fair dealing, is a more serious claim involving misrepresentation, dishonesty, or unreasonable misconduct.
Let's say a dental office hires a contractor to renovate their office space, with a signed contract specifying materials, a completion date, and the total price.
- A breach of contract occurs if the contractor uses cheaper materials than those specified in the contract.
- A bad faith claim could arise if the contractor deliberately or recklessly misrepresented the materials being used while billing for the higher-quality ones specified in the contract or continued to accept payments with no intention of completing the project.
In some industries, such as insurance, breach of faith is treated as a tort rather than a contract claim. This distinction is important because tort treatment can open the door to extra-contractual damages like punitive damages.
For example, a homeowner files a property damage claim with their insurance company after a severe storm damages their roof.
- An insurance breach of contract occurs when the insurer denies a valid claim due to a misunderstanding of what the policy covers.
- A bad faith claim could arise if the insurer deliberately or recklessly ignored evidence of the storm damage leading to a claim denial, unreasonably delayed payment, or misrepresented the policy terms to avoid paying out.
How do I avoid accusations of breach of contract?
Having professional liability insurance is a valuable part of your risk management strategy, but there are additional business practices you can follow to reduce breach of contract cases, including:
1. Draft a detailed contract
Make sure your client contract details exactly what’s expected of all parties, from the work you’ll deliver to roles and responsibilities, to deadlines and payment schedules.
You may want to include:
- A hold harmless clause or limited liability disclaimer, which shifts certain contractual risks away from your business. Contractual liability insurance, typically added to a general liability policy, can protect your business from these additional obligations.
- An arbitration clause that requires the parties to resolve any contract disputes through an arbitration process.
- A “force majeure” or “act of God” clause that suspends the contract if an event beyond your or your client’s control interferes with your ability to proceed.
You may also want to consult a contract lawyer for legal advice on the best provisions to include in your agreements, based on your profession.
2. Document everything
As a small business owner, good recordkeeping is critical to track financial progress, prepare for tax season, and protect yourself in case of a lawsuit.
If you’re sued for breach of contract, you can enhance your defense by having copies of:
- The signed contract
- Relevant email and text conversations
- Receipts and order forms
- Invoices and timesheets
3. Don’t overpromise
It may be tempting to offer your clients the world, but the best way to honor a contract and earn customers’ trust is by setting realistic expectations from the beginning. Providing practical budgets, achievable deadlines, and reasonable deliverables will give you the time and space to fulfill your contractual obligations at the level your clients expect.
4. Communicate with clients
At the start of every project, take the time to discuss communication plans with your clients, discussing important details like:
- Understanding their preferred method of communication
- Scheduling regular project updates
- Providing tools so they can track progress, spending, and important updates
If you’re concerned that a project is running over budget or falling behind schedule, you need to let your clients know as soon as possible. With a proactive approach, you can often revise a contract and avoid a business dispute.
How do I get breach of contract insurance?
Insureon helps small business owners get affordable insurance coverage from top-rated U.S. insurance carriers.
Get free quotes by filling out our easy online application. You can also speak with a licensed insurance agent if you have questions about which types of insurance policies meet your small business needs.
Once you find the right policies for your small business, you can begin coverage in less than 24 hours and get a certificate of insurance (COI) for your small business.
