Understanding and Planning for Contingent Liabilities

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The term contingent liability can sound daunting if it is not understood in its simplest form. It can also cause financial devastation if it is not planned for. Therefore, before entering into any contract all parties should understand the types of contingent liabilities that could occur and plan for meeting the financial obligations should the liability actually come into being.

Defining Contingent Liability:

Initially, the definition of a contingent liability is elementary. It is a liability that might or might not happen, depending upon the happening or not happening of a future event.

The Necessity of Predictability:

To secure an accurate financial plan to protect against the cost of a contingent liability coming into being, it is important to be able to make some predictions about contingent liabilities;

  • In the instance that the future event is likely to occur and the cost of the liability can be determined, the monies should be set aside as a “debit” by the party that would be responsible for paying out the cost of the liability.
  • If the event is difficult to predict, then the corresponding cost can be more difficult to calculate. This will require the responsible party to use experienced experts to calculate the probability of the event happening, or not.
  • Finally, if the happening of the event that might cause the additional liability to occur is highly unlikely, the party who would be financially responsible for payment to the injured party, would not necessarily need to put a debit on their books to show the potential cost and loss.

Areas Where Contingent Liability Might Arise:

There are several areas where a contingent liability might arise out of an original contract. In these instances, it is extremely important that the language of the contract defines possible contingent liabilities. In addition, there should also be language regarding the remedies that will be available to the injured party in the instance that a future event happens that triggers damage. Contingent liability can occur in the following circumstances:

  1. Warranty Issues: When a business promises that a product or service will be of a particular calibre, the business is responsible for the product or service to meet the expected standard. If the standard is not met, the warranty is broken and the business may owe the customer for any loss or damages that occurred as a result thereof.
  2. Indemnity: This type of loss is one in which compensation must be given in the instance of a specific loss i.e. one party will cover the loss of the other if a certain event occurs. An example of this might be if a delivery is late and the receiver loses sales on the item because they cannot deliver on a contract they have entered into with another party. When a specific loss occurs the party experiencing the loss must be compensated.
  3. Guarantee: If the parties require a third party to agree to cover any losses by an unfulfilled contractual obligation, this person/entity is considered a guarantor. In the event that a future loss happens and damages occur, the third party will be the one to provide compensation to the injured party. An example of this is a loan. If the lender feels the lone holder might not make the payments, the lender can require the loan holder to secure a co-signer for the loan. Hence, if the borrower defaults, the co-signer will make the payments to the lender.

The most important things to remember about contracts that might include contingent liabilities are the following:

  • Read all contracts, including the fine print, carefully to understand what types of contingent liabilities could arise and know what your rights would be in the event that the contract is not fully performed
  • If you are a business that will be required to make payments on contingent liabilities, review your finances and be sure to allow for the losses on your balance sheets
  • Make sure that when you are taking into account the types and possibilities of contingent liabilities arising, you consult various professionals with the experience to guide you in predicting the possibility of foreseen and unforeseen future events.

If you find yourself in need of assistance with this or any other legal issue, please contact the law offices of Owen Hodge Lawyers. At Owen Hodge, we are always happy to assist clients in understanding the full ramifications of any and all of your legal needs. Please feel free to call us at your earliest convenience to schedule a consultation at 1800 770 780.


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