How Contractual Risk Transfer can Lower Costs Across Your Business

When it comes to keeping your business running, handshake deals won’t cut it – not in court, not with your insurance company and not with the bank.

• If you have a contractor who has verbally promised you a lot of work down the line, the lender doesn’t care until it’s in writing. 
• If you have a subcontractor who swears up and down that they’ll be careful on the jobsite and they’ll take responsibility for anything that goes wrong, that makes no difference in the cost of your insurance until it’s in writing. 
• If you have an agreement between yourself and another business that you both agree on, the courts won’t even entertain it unless it’s in writing.

Look at the case of Castle Restoration, LLC v. Castle Restoration & Construction, Inc. I’ll call the first company CR and the second CRC to try to limit confusion.

In 2012, the owners of CRC agreed to sell their business to the owner of CR, who paid $100,000 at closing and agreed to pay $1.1 million in monthly installments. They drew up a contract with all the details, everyone signed and everyone was happy. 

For a while. 

Shortly after signing the agreement, the owners of both companies decided to change the plan a bit. CRC was still in the middle of a few projects, so CR offered to handle their work-in-progress to offset some of what they owed CRC.

Seems pretty standard, right? 

The only problem is that they didn’t write their followup agreement down, and thus, none of it mattered. When the matter ended up in court, both parties agreed that there was an oral agreement – but that’s where any agreement ended.

When CR missed their first payment, CRC sued and CR countered.

That was in 2012. When the case was finally settled ten years later, the court said the signed contract stood. Their oral agreement was deemed invalid and unenforceable. 

At the core of good contractual risk transfer, you must have one element: a contract. If that’s missing, nothing else matters. 

I’ve heard countless stories from people who chose to forego a contract because they were doing business with someone they trusted. Inevitably, these arrangements often go south at some point. 

“Handshake agreements” between friends/family are either formalized into a legal contract or result in a lawsuit when enough money is on the line. It’s not that the parties turn greedy in every case, as much as it is a matter of each party protecting their interests. 

Here’s the thing: If you go into business with your brother, you’re actually doing him a favor by drawing up a contract and asking him to review it with a lawyer. Sure, you’re watching out for yourself, but you’re also watching out for him. 

It feels strange when it’s family, but it’s the best way to ensure you’re on the same page from the start. Business conflicts are one of the easiest ways to permanently ruin a relationship – no matter how deep your ties.

While contracts can do a lot to save personal relationships, I want to look at the impact that good contractual risk transfer can have on multiple areas of your business, as well.

Cut Your Insurance Costs

As I write this in late 2024, we’re in a pretty rough market for insurance. Costs are rising, terms and conditions are decreasing, and underwriters are under a lot of pressure to limit risk as much as possible.

When your insurance company evaluates your company to set your premiums, they look at everything, from top to bottom. 

Is your safety equipment up to date? How often do you hold safety training sessions? What is your record like? Have you ever been sued? What is your reputation like? 

Then they turn to your contracts to see how much risk your company has assumed. If they don’t see sufficient risk transfer, they’ll either deny you or boost your premium.

At the end of the day, if something happens, your insurance carrier would prefer to either a) not have to do anything, or b) pay as little money as possible – in that order. If your contracts protect your business, then they also protect your insurance company, and your premium will reflect that.

Insurance companies are going to be looking for indemnification clauses and clear language that specifies exactly how risk will flow.

Build a Failproof Business Continuity Plan

In addition to lowering insurance premiums, good contractual risk transfer can protect your business from shutting its doors for good. 

In my earlier article, “4 Critical Factors of Business Continuity Planning,” I shared the real-life story of ABC Manufacturing (I changed their name). You can read it, but here’s the Cliffs Notes version:

A massive fire destroyed ABC Manufacturing’s headquarters. They had great insurance that kicked in and paid for everything, including their lost revenue. They rebuilt everything within a year. 

The problem was that 75% of their revenue came from one client, and that one client didn’t like the idea of their sole manufacturer shutting down for months at a time. Before ABC could get back up and running, this client jumped ship for a competitor. To make matters worse, their competitor poached two of ABC’s top people. 

In the end, even with insurance that covered everything, ABC shut their doors permanently six months after reopening.

With a little more foresight – and good contractual risk transfer – ABC could still be in business today. One example would be to create a contract with a competitor stipulating that they will take over manufacturing in the event of a disaster. You see a lot of companies create similar contracts that are mutually beneficial where competitors commit to helping each other.

(On top of that, building such an agreement is another way you can decrease your insurance premium.)

Protect Your Perpetuation Plan

Imagine that you and your friend form a company with a valuation of $1 million. You both own 50%. You take out $500,000 in life insurance on each other. At first you have a handshake agreement, but you think better of it and put everything in writing. 

Fifteen years later, you still both own 50%, and the business is worth $10 million. That’s great!

Then your partner dies suddenly. 

You still have your $500,000 life insurance policies in place, so you receive some compensation. Only now his wife and their estate planning attorney expect you to buy their half of the business at its current valuation, and you only have enough to cover 10% of the cost.

That’s a big problem and we see it all too frequently. In this scenario, most business owners will end up selling to a third party. The only other option is to beg, borrow and steal to figure out how to pay off the exiting partner’s estate. 

Unplanned exits like this can be especially problematic. Everything can change in a moment without good contractual risk transfer.

Getting everything in writing and updating your contracts frequently could literally save you millions of dollars. 

(Again, if an insurance company sees you setting up a proper perpetuation plan like this, your premium will go even lower.)

Solidify Your Safety Standards

Contractual agreements are a major building block of how construction companies operate. Risk flows in every direction between owners, contractors and subcontractors. When something happens, fingers will start pointing and you want to minimize the chance that they’ll be pointing at you.

Safety standards are your teflon when blame comes your way. Build them into your contracts and then enforce them. 

For instance, if you require subcontractors to have a specific type of insurance, don’t just take their word for it, require a copy of their policy for your records. Or if you require that their safety equipment be fairly new, send someone to do an audit of their equipment. 

In construction, everything flows uphill. If something bad happens, someone is going to have to pay the piper, and you don’t want it to be you.

(At the risk of sounding like a broken record, solidifying your safety standards through contractual agreements will lower your insurance premiums even further.)

Are You Sufficiently Transferring Risk Away from Your Company?

Handshakes are great. Trust is a great quality. But when it comes to matters that could shutter your business, write it down. You’ll be glad you did.

If you want help considering contractual risk transfer from a holistic perspective, contact us today.