Five Things You Should Know About Warehouse Legal Liability Insurance

The growth in e-commerce that has occurred in the U.S. over the past decade has only been compounded due to the COVID-19 pandemic. Companies are increasingly looking to add new warehouses and distribution centers throughout the country to have the capability of delivering goods to their customers within 1-2 days, one of the many consequences of the Amazon Effect. To shorten delivery times and optimize their supply chains, many companies increasingly rely on outsourced third-party warehouse providers, commonly referred to as third-party logistics providers or “3PL’s.” Outsourcing warehouse operations to a 3PL is often a new endeavor not only for the company’s supply chain team, but also for their business, legal, and risk management leaders. Warehousing agreements can be long and complex, and often contain terms that are not common in other procurement or vendor contracts that the company may be used to. One such critical issue is the warehouse’s liability for loss or damage to goods that occurs while the goods are in storage and the corresponding insurance to cover such a loss. This insurance is known as warehouse legal liability (“WLL”) insurance. In this article I will cover five of the most important things you need to know about WLL insurance, whether you are the customer or warehouse operator.  

[Throughout this article I will use “warehouse” and “warehouse operator” interchangeably to refer to a third-party logistics company operating one or more warehouses for a customer.] 

1. A warehouse operator’s liability for loss or damage to stored goods is determined based on a negligence standard.  The Uniform Commercial Code (the “UCC”), a version of which all U.S. states have adopted, provides that a warehouse is only liable for loss or damage to goods that is “caused by its failure to exercise care with regard to the goods that a reasonably careful person would exercise under similar circumstances. However, unless otherwise agreed, the warehouse is not liable for damages that could not have been avoided by the exercise of that care.” (See UCC 7-204(a)).  Further, a warehouse can limit its liability for loss or damage via contract: “Damages may be limited by a term in the warehouse receipt or storage agreement limiting the amount of liability in case of loss or damage beyond which the warehouse is not liable.” (See UCC 7-204(b)).

Most sophisticated warehouse operators require signed warehouse services agreements, or at the very least have standard terms and conditions referenced on a warehouse receipt that is issued to a customer. A standard warehouse contract incorporates the UCC liability standard and has one or more limitations on the warehouse operator’s liability for lost or damaged goods. Therefore, as a practical matter a warehouse operator’s liability will usually be determined per the terms of an applicable contract that closely mirrors the standards set out in the UCC.  

Crucially, under this liability standard warehouse operators are not liable for loss or damage to goods caused by events beyond their control, such as floods, windstorms, earthquakes, and other similar “force majeure” events. Companies storing their goods with a third-party warehouse operator should not mistakenly expect that the warehouse will be legally responsible for any and all loss or damage to those goods while in storage. Instead, the warehouse operator will generally only be responsible for losses caused by its negligence in operating the warehouse. For example, if a California wildfire destroys a warehouse, including the $50 million dollars of customer’s inventory stored inside, the warehouse is generally not responsible for such a loss. On the other hand, a warehouse may very well be liable for inventory loss caused by a fire that spreads throughout the warehouse due to the operator’s poor maintenance of its sprinkler system.

This can be confusing for customers who may be more familiar with the liability standards imposed on transportation carriers, which are typically more akin to strict liability. Under the Carmack Amendment for example, a motor carrier is presumed liable for any loss or damage that occurs while the goods are in its custody unless it can prove that one of a few limited exceptions applies. This is not the case for warehouse operators. 

The issue is complicated further if a warehouse operator provides services to a customer that comprises both storage and transportation services. For example, assume that a 3PL provides transportation and cross-docking services to a particular customer. The 3PL transports the goods to a warehouse, unloads the goods into the facility, re-loads those goods into a different outbound trailer, and then transports the goods to their final destination. If some of the goods are lost or damaged while sitting in the warehouse, did that damage occur while the goods were “in transit” or “in storage”? At first it may seem obvious that the damage occurred “in storage” since it happened within the warehouse. However, what if the cargo had not yet reached the final destination specified on the bill of lading and was only sitting in the warehouse for an hour – is that still storage? Maybe the storage was simply “incidental to” the transportation and for the 3PL’s convenience, and therefore, legally speaking, the goods were always in transit. The answers to these questions are beyond the scope of this article and should be discussed with the company’s insurance broker and legal counsel. However, these distinctions do have practical implications – liability standards for carriers (strict liability) differ from those of a warehouse (negligence), the transportation contract terms may differ from the warehouse contract terms, and the cargo and WLL policies may respond to a claim differently. 

2. WLL insurance is not the same thing as property insurance. Now that we understand the legal standards placed on warehouse operators by law and under most contracts, let’s look at what WLL insurance actually covers. Just as many companies mistakenly believe that warehouse operators are liable for any losses occurring during storage, many also assume that WLL insurance is the same type of coverage as standard “all risks” property insurance. This is incorrect.  

Property insurance is first party coverage, meaning the insurance covers damage to property that the insured company owns. Moreover, property insurance typically covers a range of causes, including losses caused by natural catastrophic events. On the other hand, WLL insurance is third party liability coverage, so the insurance only covers the insured’s legal liability for damage to property owned by others. WLL insurance does not cover the customer’s goods, it covers the warehouse’s liability for the goods. Now you can see the critical links between the first two points: (i) WLL insurance only covers the warehouse operator’s legal liability for goods, (ii) the warehouse operator’s legal liability for goods is determined by the warehouse contract, and (iii) the warehouse contract almost always contains a negligence standard and monetary cap on the operator’s liability. Therefore, the terms of warehouse contract are key in determining the extent of WLL coverage for any specific claim.

This leads to difficult and sometimes surprising claims situations for both the warehouse operator and customer. If the warehouse is not legally liable for a loss, as determined by the contract, or its liability is limited to less than the total actual loss, this can leave the customer (and/or the customer’s insurer) holding the bag for any gap. The warehouse is then in the unenviable position of choosing to either pay for the claim out of pocket or abide by the contractual terms (putting the customer relationship at risk). Indeed, if the customer and warehouse operator are on good business terms, then the warehouse operator may face a somewhat paradoxical position of wanting to be determined legally liable for a claim in order to trigger coverage and payment to its customer, while in the background its insurer is attempting to defend the warehouse from liability. 

Since a warehouse operator’s liability is limited via contract, it is important that customers have their own “all risks” property insurance on the full value of its goods to cover losses that are outside the scope of the warehouse’s legal liability. Some customers try to insist on their warehouse operators providing such coverage, and a few warehouses may reluctantly agree if there is a significant business justification. However, I would caution customers that such an agreement may not actually be in its best interest. 

First, I think it is a dangerous risk management philosophy for a customer to forgo property insurance in exchange for requiring the warehouse operator to carry the coverage instead. Too many things can go wrong, leaving the customer uninsured with millions of dollars of inventory at risk. 

Secondly, even if the customer and warehouse structured the policy such that the customer is an actual named insured on the warehouse’s policy (which would give the customer more control over maintaining the coverage), then any claim payout the customer receives under that policy likely would have to be disclosed on the customer’s future loss run report, even though the warehouse was the primary named insured on the policy. The customer could not avoid a claim on its property affecting its future property loss runs. If the customer is especially concerned about higher future premium costs due to a loss, it could try to address these costs in the contract in other ways, perhaps through a liquidated damages provision that is triggered if the warehouse causes a loss above a certain threshold.   

Finally, the warehouse operator will almost certainly charge the customer for having to obtain insurance that is broader than its standard coverage, perhaps even at a markup, whether this cost is an explicit line item or “baked in” to the warehouse’s rates in other ways. So the customer ends up paying for the insurance anyways, possibly even more than if it had acquired the insurance on its own. On this issue, the juice is not worth the squeeze in my opinion, and customers are better off having their own property coverage for any loss outside of the warehouse’s scope of liability.

3. Contractual minimum limits of insurance are not the same as a cap on liability.  Warehouse services agreements often have two different provisions that the “uninitiated” may believe limits the warehouse operator’s liability for loss or damage to goods. First, contracts usually contain an insurance provision that sets forth the types and limits of insurance that the warehouse is required to maintain during the term of the contract. Second, most contracts also contain a limitation on the warehouse’s liability for loss or damage to goods to a capped monetary amount.* These two clauses are not the same thing. Many people, especially non-attorneys, mistakenly think that putting a minimum WLL insurance limit in a warehouse contract (or a cargo liability insurance limit in a transportation contract) necessarily limits the warehouse’s legal liability to that insurance limit. This is not true unless the limitation of liability clause in the contract is explicitly linked to the WLL insurance provision. Standing alone, an insurance provision only dictates how much insurance the warehouse must have – it does not limit the warehouse’s actual liability. Absent language to the contrary, the amount of the warehouse’s liability is always determined by the limitation of liability provision in the contract (if there is one), regardless of what the insurance provision states.** 

Let’s look at a few examples. 

Example A.  Assume a contract requires the warehouse to have a minimum of $1,000,000 in WLL insurance, but the contract contains no language limiting the warehouse’s liability to the WLL minimum limit or any other amount. If the warehouse operator later damages $5,000,000 of its customer’s goods, the warehouse is legally liable for the full $5,000,000, despite only being required to have $1,000,000 in WLL insurance. 

Example B.  Assume a contract requires a $10,000,000 minimum WLL limit, but the contract also contains a limitation of liability clause limiting the warehouse’s liability to $2,000,000 per occurrence. A claim occurs and the total loss is $8,000,000. In this scenario, the warehouse is only contractually liable for $2,000,000, and so the WLL insurance will only cover up to that $2,000,000 contractual liability, even if the warehouse actually had a WLL policy with limits of $10,000,000 or more. The $10,000,000 minimum insurance requirement was simply a statement about how much insurance the warehouse was required to have; it says nothing about the warehouse’s actual liability to the customer for this particular claim. The customer’s own property insurance should step in to cover the remaining $6,000,000 gap. 

Therefore, on the warehouse operator’s side it is important to always “thread the needle” between the insurance clause and limitations clause if the intent is to limit the warehouse’s liability to the amount of required WLL insurance. On the customer side, it is important to understand the interplay between these two provisions and not mistakenly think it is protected by a WLL insurance limit that is superseded by a limitation of liability clause located elsewhere in the contract. The amount of the monetary cap on the operator’s liability for lost or damaged goods is often a heavily-negotiated point.

[*For simplicity I refer to the limit of liability as a simple monetary cap. In reality, the warehouse contract may contain multiple provisions having the effect of limiting the warehouse’s liability, including a per unit or per pound limit and a valuation clause limiting the warehouse’s liability to manufactured cost rather than retail value or some higher valuation.]

[**Of course, “always” does not actually mean always. There are cases of courts “creating” a limitation of liability where one does not explicitly exist in the contract, by referring to contractual insurance limit requirements contained elsewhere in a contract. This has occurred in the context of transportation claims and possibly other scenarios. While this is not at all the majority rule, customers who do not want to be surprised by a limitation they did not agree to should work with their legal counsel to insert language into the insurance provision of the contract stating that the insurance limits are not intended to limit the service provider’s liability assumed elsewhere in the contract.] 

4. The customer should not be an “Additional Insured” on the warehouse’s WLL policy. Customers often ask that the warehouse operator add the customer as an Additional Insured (“AI”) to one or more of the warehouse’s insurance policies, including the WLL policy. Customers should not request to be added as an AI to the WLL policy, and warehousemen should not agree to such a request. Being an AI on an insurance policy essentially makes the AI company an insured under the policy, subject to the terms and conditions on the AI endorsement. However, as we have seen, the WLL policy only responds to a claim when an insured is legally liable to a third party; it is not first party coverage for property owned by an insured. If a customer and the warehousemen are both insureds under the WLL policy, then who is the third party to whom they are legally liable in order to trigger coverage? Not only is the customer being an AI on the WLL policy not necessary for the coverage to work as intended, doing so can actually complicate the claims process and preclude coverage.

[Under the same rationale, shippers should also not ask to be an AI on their broker’s or carrier’s cargo liability insurance policy.]

5.  Understand and follow the WLL insurer’s underwriting requirements. The WLL insurer will often place certain requirements on the insured that the warehouse must comply with during the policy period in order to maintain coverage. These could include: 

• Providing a monthly, quarterly, or annual statement of value as to the amount of inventory stored at each warehouse facility. 
• Reporting customer contracts for pre-approval or within a specified period of time after being signed. 
• Obtaining approval of material deviations from the warehouse operator’s standard contractual terms. 
• Allowing risk engineer assessments at randomized warehouse locations so that the insurer can assess and provide recommendations to mitigate the warehouse operator’s risk of a loss. 

Perhaps most important, when an insurer first underwrites WLL coverage for a new insured, the insurer often requires the insured to submit its standard warehouse services contract template and its existing customer contracts. This allows the insurer to assess the warehouse operator’s contractual exposure. Upon issuing WLL coverage, insurers also typically set some “ground rules” that the insured must follow when contracting with new customers going forward. It is imperative that the warehouse understand and follow these contract requirements, since failure to do so could result in the insurer limiting or outright denying coverage on a future claim. 

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I hope that you find this first post useful. As is necessary with articles like this, the information is generalized and does not cover every possible scenario. Exceptions and nuance will always exist. However, the key takeaways still stand. WLL insurance covers a warehouse operator’s legal liability, which is determined by the warehouse contract, the terms of which will usually only place liability on the warehouse operator if it acted unreasonably. The warehouse’s liability will be capped as per the contract’s limitation of liability provision, and customers should ensure that they have property insurance on their goods to fill the gaps from losses that are outside the scope of the warehouse’s legal liability. The above discussion is specifically regarding warehouse operations in the United States. Other jurisdictions impose different legal standards on warehouse operators, and the standard insurance coverage may also differ.

If you have any comments or questions about this post, or recommendations for future topics, please feel free to reach out to me at keith@logisticslaw.net. 

Keith Waters

December 30, 2021