Key Takeaways

  • An errors and omissions clause helps limit liability in service contracts by clearly outlining the scope of responsibility and potential damages.
  • Errors and omissions insurance (also called professional liability insurance) covers legal defense, settlements, and judgments related to service-based mistakes or omissions.
  • Coverage options include tail coverage, prior acts coverage, hammer clauses, and duty to defend provisions.
  • Contracts should avoid vague E&O clauses and instead include clear damage caps, exclusions for lost profits, and specific terms for liability.
  • Adding claims examples and standard clause elements can help clarify how E&O clauses function in practice.

An errors and omissions clause (E&O) included in your company's contracts helps ensure that your company and its workers are protected against claims or lawsuits made by clients for inadequately performed professional services, including errors, omissions, or failure to perform professional services.

What Is Errors & Omissions Insurance?

Error and omissions coverage ensures financial losses due to perceived errors or oversights of the insured party. Another term for errors and omission coverage is professional liability insurance (PLI), and it is similar to malpractice insurance used in the medical industry.

Businesses that need this insurance coverage are those that offer professional services to their customers, such as those in the financial, investment, and banking sectors, the legal industry, and real estate. There is also an increased need for errors and omissions coverage in the information technology industry, because IT affects the infrastructure of most businesses.

In addition, some regulatory organizations, such as the Financial Industry Regulatory Authority (FINRA) might require a company to have E&O insurance.

Who Needs Errors and Omissions Insurance?

Businesses in various industries rely on professional expertise, and even a minor mistake can lead to major financial loss or reputational harm. Errors and omissions insurance is especially critical for:

  • Consultants and advisors (e.g., management, business, or marketing consultants)
  • Legal professionals and accountants
  • Real estate agents and mortgage brokers
  • Software developers and IT firms
  • Architects and engineers
  • Insurance and financial advisors

These industries face increased risk of client disputes over miscommunication, delays, or professional negligence. In some cases, industry regulations or client contracts may require proof of E&O insurance.

What Is Covered by Errors & Omissions Insurance?

The benefits of your error and omissions coverage will vary depending on the policy and issuing insurance company. In general, most insurance providers cover judgments, defense costs, and settlements up to a specified amount.

However, when you select an insurance policy for your company, you should review the language carefully and verify that it specifies certain protections, such as:

  • A duty to defend clause specifying that your insurance carrier must support you and provide an effective defense for your business. In most cases, the insurance company provides you with a qualified attorney instead of using one that you select.
  • A hammer clause, also known as a “consent to settle” or “cooperation” clause, specifying that your insurance carrier must defend you in court even if a settlement opportunity is available. This clause should also specify that your approval is required before your insurer can settle a claim out of court. Note that this clause may limit your insurance provider's losses on the settlement amount through the date that you don't agree to settle.
  • Tail coverage protects your company against mistakes or omissions that occurred during the coverage period, even if the claim isn't filed until after the policy expires. This extended coverage is particularly good if you change carriers. Some insurance providers offer “bilateral tail coverage,” which allows you to purchase tail coverage regardless of who canceled the policy.
  • Prior acts coverage is like tail coverage but protects your company from claims filed during the coverage period, even if the events or actions that caused the financial loss occurred before the coverage period.

Because all insurance policies have a limit on coverage, depending on the size of your company, you might want to consider an umbrella liability insurance policy that covers any gaps in your errors and omissions coverage.

Common Errors and Omissions Claims

Understanding real-world E&O claims can help businesses better evaluate their risks. Common examples include:

  • Real estate: A broker fails to disclose property defects, leading to legal action by the buyer.
  • IT services: A software developer delivers a product with critical bugs, causing financial losses for the client.
  • Consulting: A management consultant provides flawed financial analysis, resulting in client overinvestment.
  • Legal services: An attorney misses a critical filing deadline, negatively impacting a client’s case.
  • Marketing agencies: A misprint in promotional materials leads to reputational and financial damage for the client.

These scenarios underscore the importance of well-drafted contracts and comprehensive insurance coverage.

What Should You Include in Your Company's Contracts?

In addition to insuring your business with professional liability insurance, consider adding an errors and omissions clause to your company's contracts as a means of setting customer expectations. Errors and omissions clauses are most effective when prepared by a lawyer and supported with a professional liability insurance policy. This is because, even with a clear, well-written E&O clause, a customer can still claim that they suffered money damages and file a lawsuit and a court may find you liable for the loss.

Avoid including a broad or vague errors and omissions clause in your company's contracts. These clauses should be extremely specific to avoid misinterpretation. Many well-written errors and omissions clauses will include stipulations that:

  • Limit the amount of damages the customer can claim against your company. For example, an error and omissions clause might specify that your business can't be sued for an amount greater than what was received for providing the services.
  • Disallows lawsuits for perceived lost profits by the client. For example, in the information technology industry, if a client's website goes down because of an error your company makes or an action that your company does not take, the client might feel you are responsible for any lost profits they incurred during the period of time that their website was unavailable.

Key Elements of an Effective Errors and Omissions Clause

A well-drafted errors and omissions clause clearly defines each party’s responsibilities and sets enforceable boundaries. Common elements include:

  • Scope of services: Defines the specific deliverables and performance standards expected.
  • Limitation of liability: Caps the total damages recoverable, often limited to the total fees paid under the agreement.
  • Exclusion of consequential damages: Disclaims liability for indirect losses such as lost profits or reputational harm.
  • Time limitation: Specifies how long after service delivery a client may bring a claim (e.g., within 12 months).
  • Mitigation obligation: Requires the client to take reasonable steps to limit their own losses.

Clarity in these terms helps manage expectations and reduces the likelihood of disputes.

Best Practices for Using an Errors and Omissions Clause

To maximize protection and minimize legal exposure, businesses should:

  • Ensure consistency between E&O insurance policy language and contract clauses.
  • Consult legal counsel to tailor the clause to specific services and industry risks.
  • Use plain language to avoid ambiguity that could be interpreted unfavorably in court.
  • Update clauses regularly to reflect changes in services, regulations, or risk exposure.

When paired with E&O insurance, a strong clause reinforces your legal safeguards and reassures clients of your professionalism and accountability.

Frequently Asked Questions

1. What is the purpose of an errors and omissions clause? An errors and omissions clause helps limit a service provider’s liability for claims arising from professional mistakes, oversights, or failures to perform.

2. Is an errors and omissions clause legally enforceable? Yes, if clearly drafted, specific in scope, and not unconscionable, E&O clauses are typically enforceable in court.

3. Does E&O insurance cover intentional misconduct? No, E&O policies generally exclude claims resulting from fraud, criminal acts, or intentional wrongdoing.

4. Can I use a standard E&O clause in all contracts? While a base clause can be reused, it should be customized for each client agreement to match the services and risks involved.

5. Do freelancers and small businesses need E&O insurance? Yes, even solo professionals and small businesses can face costly claims. E&O insurance provides essential financial and legal protection.

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