What is Conditional Contract Insurance?
Conditional contract insurance is a type of insurance policy that protects a party’s interest in a conditional contract for the purchase or sale of land. These policies may insure either the buyer or the seller, however they are far more common for the buyer. If the contract falls through due to a claim covered by the insurance , the insurer is liable to indemnify the insured against any resulting financial loss they have incurred.
The existence of the policy may allow the insured to pursue their rights under the contract, however insurance can also be placed so that the right to pursue the indemnity is assigned to the vendor. The insurance still remains a policy of indemnity and not a policy of reimbursement or surety.
Key Characteristics of Conditional Contract Insurance
The primary features of a conditional contract within the context of insurance are based around one essential condition that must be satisfied. The general structure of a conditional contract insurance policy states that the insurer will only provide cover for losses which arise from a specific risk once the policy holder has obtained an insurable interest for the contract covered by the policy. In other words, an insurance policy will not be permitted to come into force if the party looking for cover from losses covered by the policy does not have an interest in the matter at hand (i.e. the assets covered by the policy). To become an insured party under a contract of insurance, the person seeking insurance must be able to demonstrate that s/he would suffer a loss as a result of a risk covered by the contract. Once a party has reached a conditional contract of insurance in relation to a property or item, that party is not regarded as the legal owner of the listed item until the specific condition has been met.
An example of a condition which parties may be required to make in order to bring a conditional contract of insurance into effect include payment of an upfront deposit, as well as the requirement to satisfy certain conditions specified under the contract of sale. As such, any insurance contract which requires the insured party to satisfy a condition before the obligation to run under it will not apply, is regarded as a conditional contract of insurance.
Case Studies of Conditional Contract Insurance in Action
Conditional contract insurance, especially for residential property purchases, has seen substantial use over the years and it is a practice across buyer-side legal, real estate and mortgage professionals to advise on it as a possibility to clients.
Let us examine some examples of typical conditions found in conditional contracts and other contracts for sale in Canada and the USA, as well as a couple of examples of successful claims, which clarify the reasoning behind the decision of the buyer to enter into a contract subject to a condition, and the decision of the insurance company to approve or decline an indemnity claim thereunder.
Example 1: Property Services Contract
In a recent claim for indemnification, the buyers and sellers entered into a contract for sale subject to the condition that the buyer could obtain a mortgage for the purchase of the property. The condition was intended to ensure that the buyer would be able to finance the purchase of the property due to a lack of sufficient funds. The buyer then filed a claim with his mortgage professional, who in turn submitted a claim for indemnification under the conditional contract insurance policy. The insurance company agreed to pay out the indemnity claim in favour of the buyer for his out of pocket costs, including paying his deposit back to him.
In this instance, the parties made the decision to enter into a conditional contract for a variety of reasons, including securing the deal while searching for appropriate financing, and also having the correct contractual language to ensure that the buyer obtained full compensation for out of pocket costs related to the failed deal.
Example 2: New Build Purchase Contract
In another situation, the purchaser entered into a new build purchase contract. The purchase contract had the standard conditions incorporated into it, including a condition subsequent for financing. The buyer made arrangements to see approval from his financial services provider for his new home purchase loan. The purchaser then failed to close and the builder sought indemnification under the conditional contract insurance policy. The insurance company declined the claim, agreeing that the purchaser failed to close his new home purchase agreement out of his own indiscretion, and so won’t need to be compensated by the conditional contract insurer.
The decision of the insurance company here was based on the conditional contract language agreed to by the buyer and the seller, but also the contractual relationship between the purchaser and his financial service provider. When the buyer failed to close due to insufficient capital, which he later obtained after the purchaser alleged defects, the claim for indemnity payment under the conditional contract insurance policy was denied.
Advantages and Disadvantages of Conditional Contract Insurance
Conditional contract insurance comes with a mixture of clear benefits and potential downsides. Conditional contracts recognize a greater number of variables than standard insurance contracts do, which means that they can cover a more comprehensive range of situations on a proportionate basis. Buying conditional contract insurance means that pay-outs are made only when certain conditions are met. In some cases, this reduces the likelihood of claims being rejected, and it also ensures that a claim is only paid in the agreed proportion. This remains true even when compared with parts of an insurance contract that might have been excluded from cover. A conditional contract insurance policy is usually expressed as a share of profit, which is highly flexible and therefore highly useful. However, the flexibility of conditional contract insurance is also a potential downside. Many insurance companies offer certain levels of "off-the-shelf" insurance policies, offering cover for the most common situations. Conditional contract insurance, on the other hand, must be tailored to fit the needs of the policyholder, often at greater expense. The sheer volume of inaccuracies that have caused conditional contract insurance to be rejected means that it is not easily understood, even among those who sell it – let alone policyholders themselves. The complex nature of conditional contract insurance also make them potentially difficult to administer, regardless of how tightly the issuing company is regulated. With any insurance policy, you must check the terms and conditions carefully to make sure that you fully understand how it works, and how much you would receive if you needed to make a claim. Take the time to read the small print, and make sure that you are entirely comfortable with any exclusions that might apply.
Legal Implications of Conditional Contracts
In addition to matters that may ‘bite’ in the property or construction contract, you will need to ensure that the conditional contract insurance policy meets the legal requirements of the contract. Most if not all insurance policies will contain a list of exclusions as the basis upon which coverage can be denied and so your whole insurance policy may turn on a correct understanding of what is covered and the exclusions. Particular attention should be paid to: a. insuring that the exclusions are either not relevant to the actual risk to be insured, or that you have sufficient coverage available to offset the particular risk; or b. appointing a person to ensure that the event triggering the opportunity for a claim is actually covered by the policy. There may also be procedural steps which need to be taken regardless of your position as an insured person or entity or whether the person with the real interest in the subject matter of the contract is likely to be covered – this will usually be set out in clauses headed ‘Obligations of the Insured’ or similar.
Additional Common Disputes Whilst the disputes close in the property contract will often be determined as described above, it is possible and probable that certain issues will arise with respect to insurance commitments. For example , in a ‘normal’ property contract appropriate levels of insurance may be able to be taken out by the owner / developer which may be left behind with the previous or new owner or principal contractor upon completion. In a conditional sale contract it may not be as easy or as practical to do this. Similarly, whilst the owner / developer is expected to insure the subject matter of any ‘normal’ property contract, and unless you specifically negotiate otherwise it may not be expected of the seller in a conditional contract. There will often be a contractual obligation lurking behind such an outcome but it needs to be carefully considered. An example of the negotiation of the insurance issue can be found in the case of Inghams Enterprises Pty Limited v The Land Trustee of the Port Moresby No. 134 Special Purpose Fund [(2007) QCA 208] where the Court of Appeal considered the obligations of the seller of vacant land under a purely conditional sale contract. The parties were at odds as to what version of the contract applied – it was agreed between the parties that the later version reflected the true bargain of the parties. However, in the Court’s view, whilst there were significant differences between the conditional sale contract before the court and the prior version, they were ‘not such as to make the bargain inconceivable or impracticable’. Accordingly, in the court’s view the judge below had erred in granting summary judgment on the basis that the relevant contract was not struck by the doctrine of unconscionable dealing.
Negotiating Strategies for Conditional Contract Insurance
When negotiating the terms of conditional contract insurance, these are some of the key areas to focus on:
1. Commencement date
One aspect that can catch people out is having the insurance commence on the date that we issue the certificate of currency rather than on the date of exchange of the contract. The problematic situation is that the purchaser is only insured from the day we issue the certificate of currency following receipt of the policy premium and the contract. A contract may require a substantial period of time to go unconditional. For example it may be for longer than 6 weeks. In such a case we would merely be covering the period by issuing an endorsement covering the risk during the period the due diligence is being undertaken but once the contract is ready the insurance should issue with a commencement date of the date of the contract rather than the date on which we are issuing the certificate of currency.
3. Material change
There is a carve out for material change to the risk. In particular if the contract is rescinded or at least halts after due diligence as a consequence of the prospective purchaser being subjected to unanticipated material detriment then the cancellation for convenience option may be excluded.
4. Casualty or development
There should be a clear obligation for the insurer to insure casualty situations and new developments (for example construction of a building or excavation) should not be excluded by default. In particular new development should be specifically listed as a category of expansion which is to be covered.
5. Length of cover
The period of cover is very important. It is common for the period to coincide with the settlement period. It is better to have a longer settlement period for due diligence which will reduce the premium. Rather than the settlement period the term of the contract; from the date of exchange to settlement should form the basis for the period of the contract. The more frequently a contract has ALTA or WHA provisions the more valuable it is and often a contract will have a clause requiring a change of use or for the operator to comply with new requirements. It is important that the transfer covers these possibilities. While the longer the period of cover the better it is valid to have shorter period to reduce the premium but then the matter is to ensure that the insurer agrees to renew the policy (at the election of the insured).
6. Choice of legal venue
Always negotiate that the insurer accepts the courts in Australia. International insurance markets often require disputes to be resolved overseas which is inappropriate given the Australian environment.
Future Developments in Conditional Contract Insurance
Notwithstanding those limitations, a number of future trends in the use of conditional contract insurance and developments may be starved of the light of day and further details may not be disclosed by reason of The City Code on Takeovers and Mergers (the "Takeover Code") which imposes strict requirements on parties to a takeover offer, and their advisers. This is all the more the case as the market for conditional contract insurance is still relatively nascent and developing. It is clear that there is, and will continue to be, activity in the use of such insurances where it is believed that they can provide an answer to a deal that may otherwise not proceed.
In addition to the potential for development in the use of conditional contract insurance in the context of public offers, future developments in other forms of contingent risks may create demand for such insurance. For instance, in the private M&A market there has been growth in the use of policies insuring breach of warranties given by sellers to buyers. In addition, greater use is being made of transaction liability policies , such as representations and warranties and tax liability policies, to allocate contingent risk in private M&A transactions and with it the potential to insure the associated policy risk. In the same way that information insurance can now provide valuable protection in the context of a public offer, so might it be in a private M&A deal.
Automation and artificial intelligence ("AI") have been on the agenda for some time in the world of finance. That said, it is still somewhat hard to see precisely how AI will impact upon conditional contract insurance. For any such insurance to be binding, an insurer will need to be persuaded that it is insuring a real risk, not an expected outcome. Value is therefore placed on the information disclosed to the insurer. That said, and notwithstanding the absence of clear evidence that AI will be used to underwrite these risks, technology such as electronic data rooms, predictive analytics and sophisticated data capture tools will no doubt increase the efficiency of the process and thereby attract more interest in this sector.