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Outsourcing – malpractice risk management perils concerning subcontractor’s indemnification provisions.

indemnification

by Rickard Jorgensen, FCII, ARM, ACIArb.

We have received several inquiries from CPAGold™ members about QBE’s coverage position when it comes to the use of sub-contractors for the provision of professional services to clients. The CPAGold™ policy is comprehensive and contains a broad definition of who is covered via DEFINITIONS 8,28 wherein its states:

8.28 You and/or your means only the following:

 ….

8.28.4 any of your present or former temporary or leased personnel, or a present or former subcontractor engaged by you, but only while acting on your behalf;

my underline.

Subject to the full CPAGold™ policy, this wording grants affirmative coverage for a subcontractor working for a CPAGold™ member.

It is best to evidence this arrangement and ensure that all fees paid by clients run through the firm to meet the other coverage “triggers” in the policy.

However, a problem has recently arisen in connection with the agreements requested by the subcontracts that contain some various onerous provisions.

One common sub-contractor (for individual tax returns) presented several of our clients with a very difficult agreement. The following is the highlights of the sections of the agreement which are the most problematic:

9) LIMITATIONS AND DISCLAIMERS 

  1. Quality and Performance of Services. The entire risk as to the quality and performance of the Services, if any, is with the Customer. The Company does not warrant that: (i) the Services will meet the requirements of Customer or operate in combinations which may be selected for use by Customer, (ii) the provision of Services will be uninterrupted or error free; (iii) defects in the Services will be corrected; (iv) the equipment used by Customer with the Services will operate or function correctly; or (v) that the Services conform to any performance specifications.

…Effectively the subcontractor is saying –  you have to check our work and it’s not our problem.

And

d. Liability Limitations. IF CUSTOMER SHOULD BECOME ENTITLED TO CLAIM DAMAGES FROM THE COMPANY (INCLUDING WITHOUT LIMITATION, FOR INDEMNITY, BREACH OF CONTRACT, NEGLIGENCE, OR OTHER TORT CLAIM), THE COMPANY WILL BE LIABLE ONLY FOR THE AMOUNT OF CUSTOMER’S ACTUAL DIRECT DAMAGES UP TO THE AMOUNT THAT CUSTOMER PAID THE COMPANY IN THE TWELVE (12) MONTHS PRECEDING THE DATE THE CLAIM AROSE FOR THE SERVICES THAT ARE THE SUBJECT OF THE CLAIM. IN NO EVENT, HOWEVER, WILL THE COMPANY BE LIABLE TO CUSTOMER IN THE AGGREGATE FOR MORE THAN THE AMOUNT PAID BY CUSTOMER TO THE COMPANY OR FOR ANY LOST PROFITS, LOSS OF BUSINESS, LOSS OF USE, LOST SAVINGS, OR OTHER CONSEQUENTIAL, SPECIAL, INCIDENTAL, INDIRECT, EXEMPLARY, OR PUNITIVE DAMAGES, EVEN IF THE COMPANY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES. BECAUSE SOME STATES DO NOT ALLOW LIMITATIONS ON IMPLIED WARRANTIES OR THE EXCLUSION OR LIMITATION OF INCIDENTAL OR CONSEQUENTIAL DAMAGES, THE ABOVE LIMITATIONS O R EXCLUSIONS IN THIS SECTION 9 MAY NOT APPLY TO YOU.

…this caps subcontractor’s liability to fees paid in the past twelve months

And

10) INDEMNIFICATION 

1. Indemnification.

(i) By Customer. Customer shall defend, indemnify, and hold the Company harmless from and against any and all third party claims, demands, liabilities, damages, losses, and out-of-pocket expenses, including reasonable attorneys’ fees, including without limitation all claims made by Customer’s clients, and those claims caused by or arising out of: (A) Customer’s use of the Services; (B) Customer’s breach of any of its obligations, representations, and/or warranties under this Agreement.

… if there is a claim against the subcontractor, the CPA firm has to indemnify the subcontractor.

(ii) By the Company. Subject to the limitations provided in Section 9 above, the Company shall defend, indemnify, and hold the other Party harmless from and against all third party claims, demands, liabilities, damages, losses, and out-of-pocket expenses, including reasonable attorneys’ fees, caused by or arising out of (i) the Company’s breach of any of its obligations, representations, and/or under this Agreement, and (ii) an allegation that the use of the Subscription Services as permitted hereunder infringes any valid copyright, patent, trade secret, or any other proprietary right of any third party, provided that the Company shall have no obligations under Section 10(a)(ii)(ii) in the event that the subject infringement arises as a result of (a) any use of the Services in a manner other than as specified in this Agreement; (b) any use of the Services in combination with other products, equipment, devices, software, systems or data not supplied by the Company to the extent such claim is directed against such combination; or (c) any alteration, modification or customization of the Services made by any party other than the Company or the Company’s authorized representative if such infringement would not have occurred without such modification or combination. This Section 10(a)(ii) states the exclusive remedy of Customer, and Company’s sole basis for liability, for any claims of intellectual property infringement pursuant to this Agreement.

…relates to intellectual property.

  1. Payment. Amounts payable by the Indemnitor to the Indemnitee in respect of any claims hereunder shall be payable by the Indemnitor as incurred by the Indemnitee.

…pay the indemnity to the subcontractor promptly.

  1. Procedure. Neither party (the “Indemnifying Party”) shall have liability under this Section 10 unless the other party (the “Indemnified Party”) (a) promptly notifies the Indemnifying Party of the relevant claim, demand, liability damage, expense, loss or fee (each a “Claim”), (b) gives the Indemnifying Party full and complete authority, information and assistance to defend such Claim, and (c) gives the Indemnifying Party sole control of the defense of such Claim and all negotiations for the compromise or settlement thereof (provided such settlement or compromise does not require the Indemnified Party to pay any money, take any action, or admit any wrongdoing).

This is a pretty unbalanced agreement and is skewed in the favor of the subcontractor and limits their exposure to liability to fees paid.  If this was an engagement letter presented to a client for services to be performed we don’t think it would be acceptable.

Additionally, this agreement could hinder an insurer’s ability to defend a claim so it is highly unlikely that ANY professional liability insurance would agree to abide by the terms of this. In fact, to a certain degree this agreement shifts the responsibility for the subcontractor’s professional negligence to the CPA.

Not all subcontractors agreements are the same but I expect the foregoing will illustrate common clauses.  Of course, this subcontractor agreement should be reviewed by outside counsel but our immediate reaction of DO NOT sign it without substantial revisions and balancing of the provisions. In addition, the subcontractors should provide evidence of professional liability insurance that fully covers the CPA firm. This should be as comprehensive and offer limits of liability, equal to the coverage the CPA firm currently has in place.

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Jorgensen & Company are not attorneys and do not offer any form of legal advice. Consult with appropriately qualified local counsel for more assistance. Rickard Jorgensen is President and Chief Underwriting Officer for the CPAGold™ program and may be contacted at (201) 345 2440 or rjorgensen@jorgensenandcompany.com.

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