Deep dive: startups, contracts, cyber insurance and more

This is a guest post from Irena Ducic of Embroker, a digital insurance company.  As small businesses or startups grow, so do their needs for expanding their networks of business partners and collaborators. In order to stimulate and accelerate growth, business relationships are formed, partnerships are forged and third-parties are hired to help provide value…

Photo courtesy of Embroker
Photo courtesy of Embroker

This is a guest post from Irena Ducic of Embroker, a digital insurance company. 

As small businesses or startups grow, so do their needs for expanding their networks of business partners and collaborators. In order to stimulate and accelerate growth, business relationships are formed, partnerships are forged and third-parties are hired to help provide value in areas of the business in which there are currently no in-house solutions. 

The introduction of these types of business relationships almost always includes some type of contract that makes the cooperation official and stipulates the terms of the work that is being worked on collaboratively.

Whether you are entering into a business partnership with a new vendor or providing a new client with a guaranteed delivery time for your product or services, you will, more likely than not, be signing a legally binding document with that party.

What happens when you don’t meet those contractual obligations for one reason or another?

Breach of Contract

A contract is a legally binding agreement between two or more parties. There are three components to every contract: an offer, acceptance and consideration. One side makes an offer that the other side accepts, and they both receive some type of benefit in that arrangement. A breach of contract happens when one side fails to fulfill its obligations stated in the agreement or when the other side feels as if the contract hasn’t been fully honored.

There are four types of contract breaches:

  • A minor breach is a partial breach of contract that happens when one party fulfills their side of the deal but still violates some small part of the contract. This is usually a detail that doesn’t cancel the entire agreement but can still be easily fixed.
  • A material breach is considered one of the most severe violations since it means that one party failed to hold up its end of the deal and has directly violated contract terms.
  • A fundamental breach means that the breach of contract is so substantial that it practically cancels the contract and the injured party is usually inclined to seek damages in court.
  • An anticipatory breach happens when the breaching party informs the other side that they won’t complete their end of the contract in time. Sometimes they fail to notify the breached side, who can then take action when it becomes evident that such a breach will occur.

The two parties can often agree to settle minor contract breaches without formal claims. However, more severe violations usually result in lawsuits that can either be settled outside the courtroom or result in a potentially long, drawn-out, expensive legal battle. In either case, the party that has breached the contract will almost certainly end up losing a significant amount of money as a result. 

Why Are Startups Often Exposed to Breaches of Contract?

As a young company, a startup must often work with larger and better-established companies in order to get their products or services to a larger audience. In such situations, the larger company often has all of the leverage when putting together a contract. 

The bigger players tend to protect their interests by adding indemnification clauses to contracts and transferring a majority of the liabilities to the startup. This leaves startups susceptible to third-party claims from customers for failing to provide adequate products or services, even if they are not directly to blame for the alleged shortcomings. 

Startups are also more exposed due to the fast-moving nature of their business. Priorities shift rapidly in an early-stage startup. Employees tend to take several roles in the company, leaving them with less time or attention to devote to everything they do, which could lead to an oversight in contractual obligations. Also, if one person leaves the startup and it fails to find a replacement quickly, they could end up failing to fulfill contractual duties simply because they don’t have enough manpower to handle the workload.

How Can Insurance Mitigate Contractual Risks?

Startups rely heavily on technology and conduct most of their operations online, even more so in the light of the current global pandemic. Transferring processes to the online world has made it easier for companies to maintain operational efficiency. Client communication is also mostly virtual; that means that contracts are also being signed online more than ever. This reliance on technology is a double-edged sword as it speeds up processes considerably but also exposes startups to certain risks that come with the territory.

Numerous factors can lead to a startup’s inability to fulfill the terms of a contract they agreed on with a customer, vendor, or a partner. More often than not, those factors include some kind of a tech malfunction or malicious interference from the online world. Luckily, there is a way for startups to transfer some of these risks to a third-party, the insurer. Let’s look at policies that can help cover breach of contract claims if and when they arise.

Technology Errors and Omissions Insurance: Tech E&O is a policy that indemnifies professional service providers from consequences of unintentional errors or oversights. When you start working with a new client, you both ensure that you have a detailed contract in place outlining all your obligations towards them. Should you fail to meet all the agreed requirements because of an error or omission, your client can sue you for contractual breach and negligence. A client can sue you even if they simply think that you are not living up to the service standards they expected from you.

A tech E&O policy is tied to the professional services you provide, including those related to your software or digital product. It covers both liability and property losses linked to your product’s performance. If your clients think that your product or services are not satisfying their expectations, they can decide to sue for compensation on a contractual basis. A Tech E&O policy would kick in in such cases to cover costs related to these types of lawsuits.

Cyber Liability Insurance: A cyber insurance policy covers your costs in the case that you fall victim to a cyberattack or a data breach that could impact you and your clients and partners. It reimburses the costs of computer forensics, data loss and recovery, and credit monitoring, as well as potential legal costs, awarded damages or settlements if a claim is filed by the affected parties.

Let’s say your company suffered a data breach in which the attackers stole confidential client information. You would be held liable for the incident and your clients could sue you for failing to protect the data with which they entrusted you. You would also be liable for a breach of contract since you agreed to protect their personal information the moment you started collecting it.

Furthermore, a cyberattack can also unexpectedly put your company out of business for a long time, causing you to miss your contractual deadlines. That’s why it’s important to ensure that your insurance policy covers damages related to breached contracts resulting from your temporary inability to operate after a cybercrime. Also, if you are in the business of outsourcing IT or data services, or cloud storage space, team up with your underwriter to design a policy that would best mitigate those risks as well. 

The Takeaway

Breach of contract claims regularly lead to stressful and lengthy lawsuits. They often result in massive legal costs, financial hardships, public relations nightmares and distractions that can stifle the growth of even the most promising high-growth startups. 

That’s why it’s imperative for startups to not only make sure that they are managing their contracts responsibly and analyze all potential risks, but also protect themselves from potentially crippling financial losses by securing the right business insurance policies. 

Irena Ducic is a Growth Marketer at Embroker, a digital insurance company reinventing how businesses ensure they can take the risks they need to grow. Irena is a philologist by education and a great admirer of language and its value to all things marketing.

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