Professional Risks - Construction Part 2 June 2015 Are you covered? Coverage issues for construction professionals Part 2 In this two part guide we will be looking at issues that frequently arise when considering whether a professional indemnity policy responds to a claim against a construction professional. In Part 1 we looked at whether there is cover. In particular we considered: Prior claims when will a new claim fall within an existing notification? The obligation to notify circumstances Aggregation Insolvency of the insured In Part 2 we look at issues affecting the scope of cover, including: Contractual liability / fitness for purpose warranty Asbestos Defence and Settlement (ie without consent) LADs Mitigation costs Workmanship / Supervision
Professional Risks Construction Part 2 June 2015 2 Contractual liability / fitness for purpose warranty The level of responsibility that an insured assumes when entering into a contract with a client is an important issue for the insured to consider as it may have important implications for professional indemnity insurance cover. Where the insured has agreed a fitness for purpose obligation in a contract, (for example where an architect expressly agrees that that the design he produces is suitable for a specific use) a higher duty is placed on the insured. So, for example, no negligence needs to be proved as the insured might be liable even if it has not been negligent. Gap in cover Some professional indemnity insurance policies contain an exclusion for liability in respect of claims arising from fitness for purpose contractual obligations. Insureds therefore need to be careful when assuming absolute design obligations, otherwise they may be left with a gap in cover and insurers may not meet the costs of defending such a claim. Some policies are even invalidated if an insured enters a fitness for purpose obligation (although from our experience that is fairly rare). The insured should review its contractual obligations carefully and ensure that it can comply with any specific obligations undertaken. Insureds can avoid a fitness for purpose obligation by entering into contracts which only requires them to use reasonable care and skill. Insureds should also take time to understand exactly what their professional indemnity insurance policy provides cover for and liaise with insurers at an early stage to ensure they understand how the policy will respond in the event of a claim. Asbestos Professional indemnity insurance policies will often contain an exclusion clause providing that insurers will not cover claims or losses arising out of, or in any way involving asbestos. Some of these clauses fully exclude liability whilst others may limit liability subject to a cap. The RICS minimum policy wording excludes insurers liability for any claim resulting from the presence or release or possible presence or release of asbestos. However, this is expressly subject to two provisos which state that the asbestos exclusion will not apply to any claim caused by a negligent act/error/ omission in the conduct of the insured s professional business (as defined in the policy) provided that: 1. the claim has been properly notified; 2. insurers shall not be liable for any claim (a) directly or indirectly arising from asbestos surveys carried out by the insured and (b) arising out of or in any way involving bodily injury. Further, the maximum amount payable in respect of such claims is limited to an indemnity limit for asbestos (which is not additional to and does not increase the indemnity limit for claims). When negotiating limitations of liability in a contract with a client, insureds should check their professional indemnity insurance policy and identify whether there are any exclusions relating to asbestos claims. Limitations of liability included in a contract should reflect the insured s professional indemnity insurance as the insured may have difficulties in meeting any liability greater than its professional indemnity insurance. Defence and Settlement (without consent) It is common for professional indemnity insurance policies to contain a provision prohibiting the insured from incurring defence costs, admitting liability or attempting to settle a claim without the consent of the insurer (usually qualified with the requirement that the insurer s consent shall not be unreasonably withheld). In the event the insured instructs lawyers directly without insurer s consent, the insurer will not be liable to indemnify the insured for any defence costs incurred (unless an agreement is reached). Further, in the event the insured admits liability or attempts to settle a claim without insurer s consent the insured may find itself in a position where it cannot recover an indemnity under the policy. Insurers usually want to instruct lawyers from their panel of law firms (which consist of law firms that insurers instruct on a regular basis and have agreed rates with) to act in the defence of a claim against an insured. This gives the insurers a significant measure of control over the claim and may reduce the cost of legal proceedings. It is therefore very important that the insured does not incur any defence costs without liaising with the insurer first. Insureds should also be mindful of commenting on their liability to other parties when faced with a claim and should ensure that instructions are obtained from their insurers/panel lawyers in the first instance,
Professional Risks Construction Part 2 June 2015 3 particularly prior to any meetings with the claimants and/or settlement discussions. Liquidated and Ascertained Damages Contractual clauses requiring parties to pay pre-determined damages in the event of breach or delay are used to focus the parties on completing projects on time. Liquidated or ascertained damages (LADs) are amounts which the parties agree, when entering into the contract, will be paid as damages in the event of breach or delay. The starting point is that in order to be enforceable the LADs must represent a genuine pre-estimate of a party s losses in the event of breach, rather than amount to a contractual penalty: Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd (1915). The Courts also recognise that LADs serve a commercial purpose by bringing certainty to the parties respective contractual positions and giving them a common expectation of the financial consequences of any breach, and if the terms are negotiated by experienced contracting parties or their solicitors then they can be difficult to challenge: see, for example, El Makdessi v Cavendish Square Holdings BV [2013]. The general law principle is reflected in the wording of many professional indemnity insurance policies, which often cover LADs provided that they represent a fair and reasonable estimate of damages which would be recovered against the Insured. However, recent case law indicates that commercial considerations are featuring more prominently in the Court s assessment of whether a LAD clause is enforceable or constitutes a contractual penalty. In Parkingeye Limited v Beavis [2015] the Court of Appeal ruled that a 75 parking charge which was levied after a 2-hour free period expired was enforceable, notwithstanding the fact that that sum did not reflect the likely loss to the car park operator (given that the parking space would otherwise have been empty) or the length of the offending motorist s overstay. What is notable about Parkingeye is the Court s analysis of the commercial context in which the car park was operated, and its acceptance of the fact that the operator would suffer indirect and reputational losses if the car park was not effectively managed and individual motorists routinely overstayed. As such, although the Court acknowledged that the principle objective of the 75 parking charge was, strictly, punitive (in that it was intended to be a deterrent for overstaying), the operator s broader commercial considerations justified levying those charges. The charge was not therefore manifestly excessive, extravagant or unconscionable, and was enforceable. It remains to be seen whether, in construction contracts, the enforceability of LADs will be assessed by reference to the broader commercial objectives of only one of the contracting parties (as in Parkingeye) and the potential implications of multiple breaches, rather than a genuine pre-estimate of loss based solely on the two contracting parties expectations. The El Makdessi and Parkingeye cases are both subject to appeal, and will be heard by way of a conjoined hearing on 21 July 2015. Avoid specifying LADs which do not represent a genuine pre-estimate of loss or are so high that they would not be regarded as commercially justifiable. Ensure that the parties commercial rationale for agreeing LADs is noted and recorded during negotiations. Mitigation costs Liability insurance policies frequently provide indemnity for mitigation costs if an insured can show that the costs claimed were intended to avoid or reduce third party claims which would otherwise be indemnified under the policy. Typical policy wording includes: Insurers will indemnify the Insured for loss, costs or expense incurred by the Insured with the prior consent of Insurers in taking action to mitigate a loss or potential loss, which if such action was not to be taken, the loss or potential loss could reasonably be expected to be the subject of a legal liability claim against the Insured. In Standard Life Assurance Ltd v Ace European Group [2012] the Court of Appeal considered whether substantial payments made by Standard Life to investors who had suffered losses, in order to avoid and reduce the potential claims against it and to avoid further damage to its brand, were indemnifiable. Standard Life claimed indemnity for payments of 100m under its insurance policy on the grounds that the sum constituted payment of loss, costs or expenses reasonably and necessarily incurred in taking action to avoid a third party claim or to reduce a third party claim. ACE contended that payments which had been made in order to protect Standard Life s reputation were not indemnifiable, or that an apportionment exercise should be carried out to determine the payments made in order to reduce claims (which would be indemnified) and those made to protect Standard Life s reputation (not indemnified). The Court of Appeal held that the 100m payment was a cost and/or
Professional Risks Construction Part 2 June 2015 4 a payment of loss, and that the purpose of the payment was irrelevant if its intended effect was to avoid or reduce one or more third party claims which were otherwise covered by the policy. Furthermore, the Court did not accept that an apportionment exercise was appropriate in the context of a liability insurance policy. It should also be noted that professional indemnity policies normally require insurers prior consent to incurring mitigation costs. The requirement for prior consent is often contained within the insuring clause itself and the obligation to obtain insurers prior consent to expenditure therefore constitutes a strict precondition to indemnity (as opposed to an obligation contained in the policy s terms and conditions, which might be ameliorated by an inadvertent breach clause, or require insurers to first demonstrate prejudice). Costs incurred or payments made by an insured which have the dual purpose of averting a potential claim and minimising the damage to an insured s reputation may be indemnified under a policy s mitigation costs provisions. Whether a payment is made with the intention of averting a potential claim will be judged at the time the payment is made, so sums which are specifically earmarked for a non-indemnified purpose might not be regarded as being made for the dual purpose of averting a potential claim. The policy is also likely to require insurers prior consent to any expenditure. An architect s responsibility for supervision of workmanship The typical duties of an architect involve the provision and coordination of drawings and the supervision and inspection as the works proceed. An architect is not normally expected or required to become involved in manual labour operations or production techniques. The extent of the duty of an architect to supervise and inspect has been addressed in detail by the Courts, but in all cases the extent of the architect s duty depends on the terms of the contract and the circumstances of the project, which are infinitely variable: see for example East Ham Corporation v Sunley [1966] and Corfield v Grant (1992). The usual duties of an architect are reflected in the wording of professional indemnity policies which often exclude liability arising from workmanship. A typical policy might exclude liability arising out of defective workmanship by or on behalf of the Insured, defective materials, manual labour operations, or any defective materials, workmanship or production techniques used in the actual manufacture of any product, save where liability is otherwise indemnifiable and arises from negligent design or negligent specification of materials. Construction claims frequently involve allegations of negligent design as well as poor workmanship, and it is not uncommon for a claimant to assert that the architect was negligent for having failed to detect bad workmanship on the part of a contractor. In what circumstances might an architect s duties in respect of design extend to identifying issues regarding defects in workmanship? An architect has an obligation to ensure that the contractors who are responsible for implementing the designs, and for supervising that implementation, can do so by the exercise of the skill and care ordinarily to be expected of them: see Equitable Debenture Assets Corporation Ltd v William Moss Group Ltd (1984). Consequently, a design may be negligent for lacking buildability if the work cannot be carried out by the exercise of care and skill ordinarily expected on site or would demand exceptional skill or working in difficult conditions. A design may also lack supervisability if the work needs to be carried out in a way which makes supervision difficult. In those circumstances, the Courts may well regard a claim against the architect as encompassing losses flowing from defective workmanship. In relation to an architect s obligation to supervise the works generally, the Courts recognise that the architect will not always be present on site, and it is appropriate for the architect to rely on the supervision provided by the clerk of works. The architect must also review the design throughout the life of the construction process itself in order to implement any changes which might be required as the works progress: Brickfield Properties v Newton [1971]. An architect should ensure that his or her designs are capable of being properly implemented and supervised by the party who is intended to carry out the works, and keep those designs under review as works progress. An architect could face liability in relation to claims involving defective workmanship if those defects were caused or contributed to by the architect s negligent design.
Professional Risks Construction Part 2 June 2015 5 Key contacts Emily Monastiriotis Partner T: +44 (0) 20 7788 2319 E: emily.monastiriotis@ Sushma MacGeoch Partner T: +44 (0) 207 788 2320 E: sushma.macgeoch@ Belinda Fox Managing Associate T: +44 (0)2380 208 155 E: belinda.fox@ Jonathan Spencer Associate T: +44 (0)207 788 2343 E: jonathan.spencer@ www. This communication is provided for general information only and does not constitute legal or other professional advice. You should consult a suitably qualified lawyer on any specific legal problem or matter.