Types of Liability Explained: Contractual versus Statutory Liability
What is Liability?
Liability is a legal term that refers to the obligation to pay for damage caused to another person (natural or legal), both directly and indirectly. Liability is an essential part of contracts between parties - including project contracts in the freelance business. After all, someone has to pay for any damage that may occur in a business relationship. However, even without contractual provisions, freelancers can be held liable.
Definition: Direct and Indirect Losses
The term 'direct loss' or 'immediate loss' refers to damage that is directly caused by an act. Example: You are asked to program software for sending e-mails, but the software malfunctions and sends many more letters than expected. The direct - immediate - damage in this case is the additional postage and shipping costs caused by the incorrect mailing.
Now suppose that the letters sent by mistake are invoices sent twice, and this leads to customers calling their suppliers, who now have to spend both staff and marketing costs to prevent damage to their reputation. This would be the indirect loss resulting from the actual loss. In principle, you have to pay for both direct and indirect loss. By the way: This example is not made up entirely out of thin air - in a real damage case, an IT service provider's numerical error actually resulted in a claim for damages of €14,000.
Types of Damage
In general, the following types of damage can occur:
- Personal injury: As the name suggests, this is when a person is injured.
- Property damage: This is damage to property or premises.
- Financial loss: This is purely financial loss.
Statutory Liability Explained
Statutory liability, also known as third party liability, is the legal obligation of the person who caused the damage to compensate the injured party. Put simply, if you break something, the law says you have to pay for it.
Statutory liability is based on the principle of "no law, no liability". Therefore, if you want to claim damages, you have to be able to prove that there is a legal basis for your claim. If a claim has no legal basis in liability or arises from other contractual obligations, no compensation is payable.
Statutory liability summarised.
Cover for Statutory Liability
Claims based on statutory liability can be covered by liability insurance. The situation is usually different for contractual liability - most liability insurance policies do not cover this. However, exali's Professional Indemnity Insurance covers not only claims based on statutory liability, but also claims based on contractual liability.
Contractual liability explained
Contractual liability is based on what the parties have agreed in their contract. In theory, it makes no difference whether the contract was made in writing or verbally, but in the event of a claim it is easier to prove written agreements than verbal ones. The following agreements are often found in contracts
Increased Liability: Contract Determines Liability
With contractual liability, freelancers and self-employed people contractually agree to pay damages in addition to their statutory liability if contractually agreed obligations (e.g. a service level agreement) are not met. In simple terms, if self-employed workers do not deliver exactly what they have contracted to do, they have to pay - even if they are not legally obliged to do so. Because self-employed persons are much more liable under such contractual clauses than they would be under the law, this is referred to as increased liability.
Unlike statutory liability, contractual liability is not based on laws but on contractual agreements and promises of performance.
Poor Performance
If you do not fulfil your contractual obligations properly - i.e. the work you deliver contains mistakes or does not include elements that were previously agreed - this is called poor performance.
A practical example would be You have been hired as an IT freelancer to program a web form. Unfortunately, you make a mistake, which means that the entire advertising campaign does not work. In this case, you have provided a defective service. This example happened to an IT freelancer in a real exali damage event. You can read about the case here: IT freelancer ruins advertising
Non-performance
Non-performance is exactly what it sounds like: The contractual obligation has not been fulfilled. This can also be the case if you fail to meet a contractually agreed deadline.
We also have a practical example of this: an agency was supposed to update a company's webshop system. However, it turned out that the client's ideas were not as easy to implement as expected, and after the agency was unable to meet not only the original specifications but also several agreed deadlines, the company eventually withdrew from the contract. In the following article you will find out how Professional Indemnity stepped in: Web Shop Project Fail
Comprehensive Coverage with Professional Indemnity Insurance through exali:
Freelancers often have no choice or negotiating leverage to reject liability-increasing provisions in contracts. As self-employed, they are often in a weaker negotiating position. In order to provide you with comprehensive protection as a freelancer or self-employed person, exali's Professional Indemnity Insurance not only offers insurance protection for claims arising from statutory liability, but also from contractual liability.
With the integrated passive legal expenses insurance, the insurer also takes care of the clarification of claims for damages. This means In the event of a claim, the insurer investigates, at its own expense, whether the claim is justified. Unjustified claims will be defended on your behalf and justified claims will be settled. Professional Indemnity Insurance through exali offers tailor-made insurance solutions for freelancers and the self-employed in a wide range of sectors, such as IT and engineering, media or consulting.
Strict Liability
In addition, freelancers and the self-employed may be obliged by contractual clauses to be liable regardless of fault (for example, under a service level agreement). In simple terms, freelancers agree by contract to be liable even if they are not directly at fault for failing to deliver a contractually agreed service.
A practical example:
Let's say you are working as an IT service provider for a company and you have a service level agreement that you will be available for IT problems during business hours. Now there is an unexpected power failure that brings down the entire Internet in your company and you are unable to access an important and time-critical email from one of your customers. You are still liable for failing to meet your contractual obligation to respond.
Lump sum Damages: Damages Do Not Always Need To Be Verifiable
Damages are usually paid for proven losses that have actually occurred. This is not the case with liquidated damages, which are now included in many contracts. Here, the amount of damages is not based on the actual damage. When the contract is concluded, the two parties agree on the amount to be paid if the contractually agreed services are not provided or are provided late.
In practice, a contract could, for example, provide for a lump sum compensation if freelancers do not fulfil the contract on time. In this way, the freelancer would have to pay 10 per cent of the contract value as liquidated damages for each week of delay, without the client having to prove that the delay actually caused it damage of this amount.
Liquidated Damages in Project Contracts
So-called indemnities are common in project contracts, especially in the IT and media sectors. These considerably reduce liability compared to statutory liability. An indemnity means that the freelancer agrees in advance in the contract to be liable for any damage that may occur in connection with the service provided - without having to negotiate with the client about the latter's contributory negligence.
In practice, this means that the client passes on any claims arising from the service provided directly to the freelancer. The freelancer then has to negotiate directly with those claiming compensation. Without an indemnity, clients would have to deal with the claimants first and then try to recover the damages, if justified and paid, from the self-employed (recourse). For the self-employed, this increases the risk of being held directly liable - even if they were not solely responsible for the damage.
Can Contractual Liability be Insured?
As already mentioned, claims for damages arising from statutory liability are covered by most liability insurance providers. However, contractual liability is not so straightforward: a large proportion of insurers refuse to cover contractual liability in excess of statutory liability. The reason for this is that it is more difficult for the insurer to calculate the risks assumed through the additional agreements made.
This is not the case with exali's Professional Indemnity Insurance: here, contractual liability is included in a consumer-friendly way - so that you, as a freelancer or self-employed person, do not suffer any disadvantages just because you have to fulfil the wishes of your business partners.