With the long term rise of design and build contracting, some commentators in the insurance industry also point to an increase in cases where a design and build insurer refuses cover in the event of a claim. This clearly affects the contractor, but employers need to be careful too, as the absence of insurance coverage may seriously limit their financial recovery.
What can an employer do to protect its position?
While an employer can impose contractual obligations requiring a contractor to comply with its design and build insurance policy, there are several practical steps it can take to protect its position at every stage of a project. Examples include:
Consider the project structure
Certain types of project structure carry inherent problems for design and building insurance. These should be addressed while the project is being planned. For example:
- Partnering encourages the contractor to accept responsibility early, thereby saving everyone money in the long run. However, any admission of liability by a contractor may prejudice the insurer and jeopardise coverage. The employer should ensure in advance that the contractor is aware of this issue and has addressed it with its insurer.
- Problems can arise when the employer and contractor are associated companies or part of the same joint venture (such as the special purpose vehicle in a PFI project). Design and build insurance may not respond if the contractor has a common shareholding with the claimant, and this must be clarified before the start of the project.
Be careful about fitness for purose
In the absence of a contractual provision to the contrary, a design and build contractor must usually complete the works so that they are fit for their intended purpose. However, insurers invariably exclude fitness for purpose obligations from their coverage. In light of this, most building contracts expressly reduce the contractor’s duties (for example, to a reasonable skill and care obligation in connection with design). Despite this, building contracts sometimes include other wording that, arguably, imposes a fitness for purpose obligation “by the back door”. For instance, the employer may ask the contractor to warrant that the completed works will comply with:
- The employer’s requirements.
- A performance specification.
An employer should take care when imposing that type of obligation in a design and build contract and consider how this might affect the contractor’s insurance coverage. This is not always easy, as the employer must balance its desire to ensure that the completed works fulfill its requirements against the danger of imposing an uninsurable obligation. (For an illustration of the problems that can arise, see Blog posts, Reasonable skill and care vs fitness for purpose and Contractual chestnuts: fitness for purpose.)
Check the work
Most design and build insurance policies recognise that the contractor will sub-contract many of its duties under the building contract, but insist that the contractor supervises the tasks it delegates. A contractor can easily underestimate that duty, particularly when it sub-contracts a specialist task, such as piling or mechanical and electrical work. To the extent that the employer (or its project manager) is monitoring the project, it should check that the contractor is indeed supervising the work.
Check the paperwork
Most building contracts require the contractor to provide the employer with evidence that it is maintaining insurance in accordance with the building contract. An employer should never assume that its contractor is complying with its insurance obligations and should exercise its contractual right to check regularly. This applies no matter how large and reputable the contractor.
Prompt the contractor to comply
In most cases, the employer will not know the precise terms of a contractor’s insurance policy, as the insurer insists on confidentiality. Despite this, the employer should remind the contractor of the need to comply with its obligations in situations where an insurance implication is self-evident. Most importantly, if the employer notifies the contractor of defect in the works or a potential claim, it should remind the contractor to notify its insurer. (For an illustration of the dangers of failing to notify, see Blog post, Keeping your insurers onside.)
Obtain a comprehensive suite of collateral warranties or third party rights
A contractor’s lack of insurance coverage may prompt an employer to look elsewhere to maximise its financial recovery. Having a comprehensive suite of collateral warranties or third party rights from all professional consultants and major sub-contractors is key in such situations. The employer should ensure that it includes a requirement for collateral warranties or third party rights in the building contract and that the contractor complies with that obligation.