Liability insurance for consulting firms:  beware of the classification of indemnities paid to a dissatisfied customer !

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Publié le 23/01/2025 par Jérôme Goy

INSURANCE LAW

The Paris Commercial Court has drawn all the consequences from a certain body of case law and from the – always tricky – drafting of professional liability insurance policies for consulting firms. The case in question was the classic case of a client of an (IT) consulting firm who was dissatisfied with the services provided by the firm. The ensuing dispute, brought before the Versailles Court of Appeal, resulted in the termination of the service contract and the restitution of the consulting firm’s entire remuneration, including that portion corresponding to the period prior to the dispute.

The said consulting firm failed to obtain cover from its professional liability insurer because of (i) the wording of the insurance contract and (ii) the way in which the facts were described by the Court of Appeal.

1. Reasons relating to insurance law

The judge dismissed the insured’s claims for two alternative reasons: firstly, the conditions for the application of “professional liability” cover had not been met, and secondly, the clause excluding reimbursement of the market price was applicable.

The court clearly states that the loss suffered by the consulting firm does not fall within the scope of professional liability and is therefore not covered by the insurance policy. In its words, “The purpose of a ‘professional liability’ insurance policy is not to compensate the insured for the absence of remuneration for a contract that has been poorly executed due to the insured’s own fault”. Accord to the court, this position is established case law: the restitution of the price following the cancellation of the contract does not constitute a loss, so that the professional liability policy does not apply.

The conditions for professional liability coverage are therefore not met.

The case also concerned the applicability of a clause excluding coverage for “reimbursement of the market price”, a common exclusion in this type of insurance policy.

In this case, the Versailles Court of Appeal rescinded the contract and ordered the consulting firm to reimburse the full price: reimbursement of the contract price is therefore the legal form of the customer’s compensation. In the final analysis, this may be seen as a purely semantic issue, since the economic aim pursued by the parties is obvious: to compensate for the loss suffered through the total and unilateral reimbursement of the sums paid, while the services provided, albeit imperfect, remain for the benefit of the customer.

As we can see, the qualification of the financial compensation is the key to the dispute.

2. Reasons relating to professional civil liability

At first glance, it may seem very easy to identify the professional civil liability specifically covered by the insurance policy of the same name. It’s the professional’s obligation to compensate its client for loss resulting from wrongdoing committed in the exercise of the professional’s activity.

In reality, this can be difficult when the professional liability is contractual, and the damage suffered by the client results from the absence, delay or poor quality of performance under the contract. This was indeed the case here. The Versailles Court of Appeal ruled that the consulting firm had committed a breach of contract by failing to deliver the solution it had undertaken to integrate into the client company’s system, on time and within budget. The service had been provided late and incompletely, leading the customer to abandon the project.

The difficulty lies in the fact that in such a case, unlike extra-contractual liability, two types of loss can arise. The first, which is always present, consists of having paid in vain for services which did not enable the client to achieve the objective set. This is known as intrinsic or consubstantial loss. The second loss, which is merely possible, relates to the consequences of the uselessness of the services for the client’s business (e.g. loss of orders). This is known as extrinsic or consequential damage. Proving its existence and extent is a tricky business.

If the disappointed client wants only to recover the sums paid in vain (the intrinsic loss), the situation presents two possibilities: the client can obtain this result by suing for liability, or instead by requesting that the contract be rescinded. These two routes, which are analytically distinct, can overlap considerably in practice.

All it takes is for the judge to grant the request for rescission, while departing slightly from its logic. Instead of mechanically drawing the consequences of the retroactive elimination of an imperfectly performed bilateral contract by ordering reciprocal restitution, he sometimes deprives the party at fault of restitution. In so doing, from an economic point of view, such a modified rescission imposes a cost on the defaulting party and leaves the victim compensated, in exactly the same way as an action for intrinsic damages would have done.

By formally requesting rescission of the poorly performed contract and restitution of the sums paid, the consulting firm’s client achieved precisely this result. The Versailles Court of Appeal rescinded the contract to the exclusive detriment of the consulting firm, but limited the restitution to the price paid. Thus, in economic terms, the intrinsic loss is compensated and the service company is burdened.

Should the professional liability policy apply to requested rescission when the granted rescission economically produces the effect of reparation?

The Commercial Court refused. Faced with a claim expressly qualified as a claim for rescission and restitution, the court was also sensitive to the fact that, in its view, granting the benefit of the insurance to the professional would constitute an incentive for poor performance of services.

While this argument is understandable, it also raises a major difficulty. Ultimately, the scope of professional liability coverage will depend entirely on the legal and strategic choices made by disappointed clients of the insured professional. Whenever, in order to avoid the risks of a civil liability action, the client strives to obtain compensation for intrinsic loss by opting for rescission and automatic restitution of the price paid, they will be depriving their professional service provider of its insurance, regardless of the reasons why this professional was unable to satisfy the client.

It’s hard to see how professionals could protect themselves against this risk.

The subtlety lies in the fact that it would be possible to escape such a qualification. We would therefore strongly advise all parties, and in particular consulting firms, to:

1. to pay the utmost attention to the terms of their insurance coverage. The subject is omnipresent, and imperfectly resolved by the practice of insurance contracts;
2. in the event of a liability claim, to assess as soon as possible and in detail the potential legal qualification of the claim, and therefore the insurance cover, or not…

 

January 2025

Gilles Pillet – ESCP Business School Professor
Jérôme Goy – Associate, Enthémis