Shift Happens: Contracts Reassign Risk of Loss with Good Reason

legal columnist addresses liability and shifting risk


Absent a written agreement allocating the risk of loss, our legal system assigns responsibility for a loss to the party who causes it. We expect the “guilty” party to pay.

Perhaps the single most important issue in industry contracts, therefore, is risk allocation, or which party, security provider or subscriber, pays in the event of a loss. Risk allocation is paramount because the industry provides systems and services to help subscribers protect their assets. And the potential downside for a security provider can be catastrophic: ranging from fire to professional thieves making off with everything. If you own a security company, this is what most likely keeps you up at night.

Historically, the industry’s approach to the allocation of risk is an exception to the rule that the party at fault pays. Rather than accepting liability for wrongful conduct, the industry re-allocates the risk of loss through contract, shifting liability from the “guilty” security provider to the “innocent” subscriber. If your company uses a typical industry contract, I bet you’ve had more than one conversation about how your contract is unfair. Truth is, these sorts of risk-shifting clauses are enforceable, especially between commercial parties.

To make it even more difficult, the industry must constantly sell itself as a provider of increasingly effective systems and services. (The implicit concern being: “Why then, do we need to re-allocate the risk of loss; it all works, doesn’t it?”) Understandably, security providers are eager to get business. Couple that with the fact that industry contracts require the innocent subscriber to bear the risk of losses caused by a culpable security services provider and you can end up with a real uphill battle.

Fundamentally, however, allocating loss in security contracts has nothing to do with what’s fair and everything to do with the economics of making security goods and services affordable to subscribers.

First, there’s nothing improper about re-allocating the risk of loss in this manner. It’s done in other industries, including cable TV, construction, equipment leasing, property leasing, Internet-related services and telecommunications. It simply doesn’t make any sense for a service provider to put his business at risk in providing goods or services to any particular subscriber, especially for $50 a month.

Second, a security system is just one of a number of important components in any subscriber’s overall risk management programs and the system and the services are intended to reduce (not eliminate) a subscriber’s risk of loss. No security provider can guarantee that their system is infallible and will always detect and report every condition in a timely and effective manner.

Third, given the potential for catastrophic loss, it makes no sense for a security provider to put the company at risk in one transaction.

Fourth, insurance is a necessary component of any risk management scheme. Subscribers are in the best position to determine the appropriate amount of insurance. You should require your subscribers to insure against the risk of loss.

Subscribers understand these principals (at least they do before a loss) and no rational subscriber would admit to relying solely on a security system to mitigate their risk of loss. Rather, most, if not all, subscribers would include a number of other risk management tools to limit their potential risk of loss. We’ll talk about the role insurance plays in subscriber contracts in an upcoming column. In the meantime, check out my blog and send me your comments on these and other law-related issues at http://www.securityinfowatch.com/blogs/LegalWatch.

 

Eric Pritchard, SD&I’s legal columnist, is a partner in Kleinbard Bell & Brecker LLP, Philadelphia, a commercial law firm with a national practice in the electronic security and life safety industries.