Hausmann Group November 29, 2017 8 min read

There’s Risk in Them Thar Contracts (or Lack Thereof)!

If data is the new oil, as one article from The Economist states, then coding is the new construction. If carpenters, bricklayers, and ironworkers built (literally) this country, then developers, network engineers, and computer scientists are building the systems we need for the future. And while the apps, devices, and insights the digital economy produces create billions of dollars in growth and impact billions of lives, one could argue that this in an industry in need of maturation.

subcontractor risk in IT industry

Case in point: how the industry treats its contractual risk relationship with its subcontractors. Too often, digital economy businesses (like software companies, IT consulting firms, web developers, etc) that subcontract out work fail to transfer their risk properly to their 1099 subcontractors (some call them freelancers; really, they’re small business owners and should be treated as such). They also often fail to ensure that the subcontractor (again: read ‘business owner’) is carrying proper insurance coverage to their business activities.

If we look at the construction industry, there is a well-accepted understanding that the risk of a loss should be transferred down the contractual chain until it reaches the level of the party performing the requested work. For example, a building owner hires a general contractor (GC) to add an addition to their building; the owner will contractually pass the risk of loss onto the GC since they are now responsible for the work. That GC, likely, will subcontract out some of that work to a subcontractor; the GC will then pass the risk for that portion of the work, that was given to them by the owner, onto the subcontractor since the subcontractor is the party closest to and most able to control the work and, therefore, the risk.

The reason for doing this is obvious: say a loss occurs (scaffolding, erected by a subcontractor, collapses and injures a third party who incidentally was walking near the scaffolding). Should the owner be responsible for paying for these injuries? They could be sued by the injured person, but they didn’t have anything to do with the setup, maintenance, or use of the scaffolding. But, since they properly executed a contract which passed the risk onto the GC, they can seek defense for the suit under the GC’s insurance policy. But wait? Didn’t the GC also pass the risk onto the subcontractor? Yes they did, so they in turn can also seek defense under the subcontractor’s insurance policy (along with the owner, since the subcontractor had to assume their liability as well). Thus, the party who was responsible for the injury (the subcontractor who improperly installed the scaffolding) is responsible for indemnifying all affected parties (the injured person, the owner, and the GC).

Alright. Let’s take this example out of the 20th century and bring it into the 21st. Say you run a company that offers consulting and web development services. A major client signs you to a project to design and develop a webpage for a high-profile launch of a new product. Some of the work to be done requires a coding language that you do not specialize in, so you decide to subcontract out that portion of the work to a specialist you know.

All appears to be going well until the day of the product launch; despite many rounds of testing & quality control, the new website fails to perform on launch day. Key features are slow & buggy, videos that are supposed to play don’t load properly, and visitor traffic is a fraction of what it was projected to be due to the site’s issues being picked up by media outlets. Your specialist tries & tries to figure out what went wrong, but after many days of rework, the problem hasn’t been corrected and it appears a major rebuild is in order.

Here’s where things get hairy: your client serves you with a lawsuit alleging negligence and breach of contract for failing to deliver a functional website by the agreed upon date. And while the portion of the project you completed worked as intended, it’s clear that the portion that required the specialist is the root of the issue. If you haven’t a) transferred that risk to your subcontractor via a properly executed contract, and b) ensured that they carry proper insurance to fund their indemnity obligations in that contract, then you could be left holding the bag for their negligence.

To avoid this issue, you should ensure that any work that you subcontract out is detailed in a written & executed contract, that hold harmless/indemnity agreements are included in that contract (see your attorney for more details on this), and that your subcontractors are carrying the proper insurance to cover their indemnity obligations in that contract.

Simply put: if you’re hiring someone to provide IT services, of any kind, for you or your client, then you need to ensure that they are carrying insurance that covers their IT activities (technology errors/omissions liability coverage and cyber liability, for starters).

The new economy has a lot that it can learn from the economies that built our country (and vice versa!). This seems like a great place to start.

Talk to your Property & Casualty Consultant to learn more. We’re here to help.

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