If your business engages sub-contractors or consultants to perform part of a project or service, you could be held responsible to the Principal or a third party for their mistakes, even if you did nothing wrong yourself. Many businesses only discover this exposure when a claim arrives. Understanding how this risk arises and checking that your professional indemnity policy actually covers it is one of the most important steps you can take to protect your business.

How the Risk Arises

When a head contractor or primary consultant takes on a project, they typically sign a contract with the Principal (the client) and take on full responsibility for delivering the work. They then engage sub-contractors or specialist consultants to perform parts of that work on their behalf.

The problem is that the head contractor’s contract with the Principal usually makes them responsible for the entire scope, including the parts done by sub-contractors. So when a sub-contractor makes an error, the Principal looks to the head contractor to fix it and pay any resulting losses. The head contractor is then left trying to recover what they have paid from the sub-contractor. If the issue is in court, legal costs can add up quickly, not including any damages awarded.

This chain of liability is well established in Australian law. In December 2024, the High Court of Australia confirmed in the Pafburn case that a head building contractor cannot use proportionate liability defences under the Civil Liability Act to shift blame to sub-contractors when sued under the Design and Building Practitioners Act. In other words, the head contractor bears the full loss first and then must chase the sub-contractor for recovery separately.

The Insurance Gap: What Many Policies Do Not Cover

This is where the real problem lies. Most standard professional indemnity policies cover the named insured firm, its directors, employees and, in some cases, people working in roles similar to employees. Sub-contractors who are genuinely independent businesses operating under their own contracts are not automatically covered by the principal firm’s policy.

Two specific gaps are common:

• Contractual liability: where the head contractor has contractually assumed responsibility to the Principal for the acts of their sub-contractors, some policies exclude or limit cover for this ‘assumed’ liability unless the policy has been specifically extended to cover it. Without this extension, the policy may decline to respond to the very claims most likely to arise.

• Sub-contractor errors as the source of the claim: even where the head contractor is the named insured, if the actual negligence was committed by the sub-contractor, some policy wordings may not extend to cover the head contractor’s resulting liability, particularly where the sub-contractor is operating as a separate and independent business rather than under close supervision. 

What This Looks Like in Practice

⚠ Claim Example: IT consultancy, data breach caused by sub-contracted developer

A technology consultancy engages a freelance developer as a sub-contractor to build a client’s system. The developer introduces a security vulnerability. The client suffers a data breach.

The client sues the primary consultancy under their engagement contract. The consultancy’s professional indemnity policy covers their own acts and omissions, but the policy has not been extended to cover liability arising from independently contracted third parties. A coverage dispute with their insurer follows, adding legal costs and delay on top of the underlying claim.

 Managing the Risk

There are two complementary ways to manage this exposure: through contract, and through insurance.

Through your contracts:

• Require every sub-contractor and consultant to hold their own professional indemnity (and public liability) insurance with adequate limits before they start work. Specify this in your sub-contract agreement.
• Obtain a Certificate of Currency from every sub-contractor and keep it on file. Check that it is current throughout the engagement, not just at the start.
• Include a deed of indemnity or contractual indemnity clause in sub-contractor agreements that requires the sub-contractor to indemnify you for losses arising from their acts, errors or omissions.
• Check that the sub-contractor’s policy limit is adequate relative to the scope of their work and the value of the project. A sub-contractor carrying $500,000 in PI cover on a $5 million project creates a gap.
   

Through your insurance:

• Review your PI policy to confirm whether it extends to cover your liability for sub-contractor acts and errors, and whether the contractual liability you have assumed under your head contract is covered.
• Ask your adviser if the policy responds where the actual negligence was committed by a sub-contractor rather than your own staff.
• Consider a specific sub-contractor or contractual liability extension if your standard policy does not provide this cover automatically. Your insurance adviser can tailor an extension for you that fills the gap.
• Ensure your policy limit is adequate to cover not just your own work but the full scope of the project, including sub-contracted portions for which you may be held responsible.

Talk to Your Insurance Adviser

A professional review of your policy wording against your actual contract obligations, before a claim arises, takes very little time and can save significant cost and disruption. Your Insurance Advisernet broker can review your current PI cover, identify any gaps in relation to sub-contractor liability, and recommend appropriate solutions.
Contact your Insurance Advisernet adviser today.
 

General Advice Warning 
This communication including any weblinks or attachments is for information purposes only. It is not a recommendation or opinion, your personal or individual objectives, financial situation or needs have not been taken into account. This communication is not intended to be a constitute personal advice. We strongly recommend that you consider the suitability of this information, in respect of your own personal objectives, financial situation and needs before acting on it. This document is also not a Product Disclosure Statement (PDS) or a policy wording, nor is it a summary of a particular product’s features or terms of any insurance product. If you are interested in discussing this information or acquiring an insurance product, you should contact your insurance adviser to obtain and carefully consider any relevant PDS or policy wording before deciding whether to purchase any insurance product.