Defective design – Contractors All Risks or Professional Indemnity
Contractors All Risks (CAR)
CAR policies meet the cost of repairing physical damage to the contract works during the period up to Practical Completion. Because cover is arranged on an “All Risks” basis, the insured merely has to demonstrate that the works have been damaged and quantify his loss. It is then down to the insurer to either meet the claim, or to demonstrate that the cover does not apply; because either the particular cause of the loss is excluded, or because the insured has done something to render the policy invalid. All CAR policies have some kind of exclusion relating to defective design, workmanship, or materials. However, the wording of these exclusions differs. Many policies will only exclude the cost of repairing or replacing the defective elements of the works, but will cover the damage to other parts of the works that result from the defect. (The LEG2 or DE3 exclusion).
Increasingly, insureds are buying wider cover, whereby in return for an increased uninsured excess and premium, the policy covers the total cost of repairing the damage. This includes the defective elements, and solely excludes the cost of improvements to the original design, workmanship and/or materials. (The LEG3 or DE5 exclusion).
Once Practical Completion takes place however, prime responsibility for loss or damage to the works passes from the contractor to the owner. The bulk of the cover provided under the CAR policy ceases at that point – including damage resulting from defective design. Depending on the individual policy wording, it is possible that some residual cover will remain during the subsequent 12 or 24 months defects liability period, but this is likely to be restricted to one or more of:
- Claims resulting from dealing with outstanding remaining works and snagging matters, and/or
- Claims resulting from work undertaken during the period prior to Practical Completion, but where the damage occurs during the defects liability period. (Claims during this period resulting from defective design, materials, and workmanship will be subject to the same exclusions as those occurring prior to Practical Completion)
Generally speaking, the CAR policy will only meet the direct cost of repairing the damage. It is possible to extend the policy to cover some additional costs that are incurred as a direct consequence of the damage e.g. the cost of debris removal, and the cost of overtime payments to employees to attempt to get the construction programme back on track. It won’t however meet the cost of any compensation that the Design & Build contractor or any other professional must pay to the owner, or any other party, as a result of the project being late in achieving handover; as a result of defective design or materials specification. Nor will it provide any protection if the owner incurs any financial loss after Practical Completion and brings a claim for compensation against the Design & Build contractor.
Professional Indemnity (PI)
Design & Build contractors and other Construction professionals are exposed to claims for compensation from their clients; if the client can demonstrate that it has sustained financial loss as a result of negligent advice provided by the relevant professional. In England and Wales if the contract is signed under seal, the relevant professional is potentially “on the hook” for claims brought against it by their clients, for up to 12 years after Practical Completion.1
As mentioned above, the bulk of the cover under the CAR policy will fall away upon Practical Completion, with more restricted cover available during the subsequent defects liability period. However, no cover will be provided thereafter, and even if it is possible to recover the cost of repairing the damage to the contract works under the CAR policy, it will not provide the Design & Build contractor or the other relevant construction professional with protection against the cost of any compensation that it has to pay to the owner who may incur significant additional costs in maintaining the building or moving out temporarily whilst repairs are undertaken. It is possible however for the Design & Build contractor or other construction professional to transfer this risk to insurers under a PI policy.
PI policies will however only provide protection to Design & Build contractors in cases where the claim is the result of a shortcoming in the professional activities e.g. inadequate skill and care in relation to the design or the materials specification. The PI policy will not respond, and will usually specifically exclude claims resulting from defective workmanship. In many cases when a problem with a building first comes to light it may initially not be clear whether the loss results from workmanship (where the PI policy won’t ultimately respond) or from a potentially insured professional activity.
Where Design & Build contractors arrange PI insurance it is common for the policy to be subject to a very significant excess, and also for the policy to specifically exclude any losses where cover is first available to the Design & Build contractor elsewhere. Accordingly, in rare cases where in theory there may be duplication of cover, the CAR policy will normally respond in the first instance.