Consider this, a client requests that you manufacture them a product according to certain specifications which are outlined in a contract. Unfortunately when you complete the order and deliver the goods, your client realizes that the product is missing a functioning piece, and therefore doesn't meet the specifications set out in the contract. They demand the product be fixed, but because of mistakes during production there are some required parts missing which must be re-ordered. This means it won’t be ready on time for shipping their order for the original timeline.
Your client had structured purchase orders on the understanding that the product would be complete. They have therefore missed their shipping deadline and lost sales which cannot be recouped. The end result of this unfortunate circumstance is your client sues you, as this product was guaranteed to be complete to certain specifications and timelines.
You might assume that your Commercial General Liability (CGL) policy would cover claims such as the one in the above example. However, it is unlikely to provide any coverage because of two exclusions found within most of these policies:
1. Damage to impaired property
2. Property not physically injured
Put simply - this means unless there's bodily injury or property damage, the CGL policy will not provide coverage for this loss. To protect against product failure resulting in financial loss to a third party, you will need to add a form of professional liability coverage called Manufacturers Errors & Omissions (E&O) coverage.
Manufacturers E&O is a form of professional liability insurance that covers a production mistake or negligence that results in financial loss to a third party (without bodily injury or property damage). Below are some examples of damages that would be covered under a Manufacturers E&O policy:
If your clients allege that your product failed or that you were negligent in providing the services you had agreed in a contract, they may seek to recoup their financial loss through litigation. This will create a significant burden of legal expenses, as well as potential damages in the form of a settlement if you lose the case. Even if there are no grounds for the lawsuit, you would still be saddled with the legal costs to defend yourself. This is why Manufacturers E&O insurance is so important, as it will provide coverage for not only the legal defense costs, but also the resulting settlement if you do lose the case. Additionally, there are opportunity costs that will be saved by having the insurance company handle the day-to-day legal proceedings. Had you not been insured, managing all the legal proceedings with your own lawyer would be a significant distraction from your normal business operations.
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A California contractor bond is a surety bond that protects clients financially, ensuring contractors fulfill their obligations.