Professional Indemnity Insurance in Construction Contracts
What is Professional Indemnity Insurance?
PI provides cover for liabilities arising from professional negligence. Any consultant or contractor / sub-contractor (collectively, “Insureds”) with design responsibility or whose duties include a substantial design element will usually be contractually required to purchase PI. It may also provide cover for a range of other exposures:
- Including defective surveying services
- Project management and contract administration
- Some policies may also offer limited cover against liability for pollution and contamination claims
PI cover is usually expected to be maintained throughout the entire period of the Insured’s potential liability under a contract or appointment. The level of cover required will generally be specified within the contract or appointment. The Insured will usually be required to produce evidence that PI of the required level is in place. Whilst the client will want the security of knowing there is adequate insurance to cover any claim which it might ultimately have, it is equally in the interests of the Insured to ensure adequate PI is in place from the outset. Not only would a failure to do so leave it in breach of contract (exposing it to a claim for damages), but, most significantly, inadequate insurance leaves it potentially exposed to uninsured claims.
Workmanship
PI is intended to cover negligent professional services. It will not generally cover defective workmanship or manual operations, unless specifically included within the definition of insured services and activities. In fact, such activities will often be the subject of express exclusions under a PI policy.
This is a fundamental feature of PI. There can be a fine distinction between workmanship and design when ascertaining what has caused a particular defect. Particularly in design and build situations, the contractor must bear in mind that, unless expressly provided for in its policy, pure workmanship issues for which it may be liable will not be covered.
Standard of care
This is the degree of care and caution that an Insured must exercise under its contract. This sets a benchmark for the quality of services which the Insured must provide.
The standard of care will either be ‘reasonable skill and care’, or otherwise ‘fitness for purpose’. The former sets a lower benchmark and requires the use of only reasonable skill and care when performing services. Fitness for purpose, on the other hand, means that, once completed, the project will be fit for its intended use. This is a higher standard because the Insured effectively guarantees that its design will be suitable for the project’s intended use.
Importantly, an Insured which agrees to a fitness for purpose obligation may have difficulties recovering under its PI policy, even if it has acted negligently. Some PI policies will expressly exclude all cover on a project where a fitness for purpose obligation is imposed. With that in mind in particular, Insureds should be very careful before signing up to such an onerous standard of care.
Onerous contract terms
As with all commercial arrangements, strength of bargaining position plays a key role when negotiating contracts. Important and influential clients will often seek to impose onerous contractual requirements in recognition of wider commercial opportunities.
PII policies will often exclude from cover losses arising from onerous contract terms to the extent the associated liability exceeds what would otherwise have been the party’s liability at law. The rationale behind that is that whilst an Insured can contract on whatever commercial terms it likes, Insurers should not be required to indemnify it for liabilities flowing from such consequent voluntary assumption of risk.
A common example of this is contractual Liquidated and Ascertained Damages (“LADs”), which are a common feature of construction contracts. These are a purely contractual remedy, not being a measure of actual loss or damage. An Insured’s liability for LADs is not typically covered under PI policies.
Novation
Novation agreements are common in construction projects. A novation is a tripartite agreement by which an existing contract between A and B is discharged and a new contract is made between A and C, usually on the same terms as the first.
For example, a developer will commonly engage an architect to assist at planning and / or tender stage. If entering into a design and build arrangement, the contract may require that the architect (and potentially other members of the developer’s professional team) is novated to the design and build contractor – i.e. the contractor will enter into a direct appointment with the architect, supplanting the former contract between the architect and developer. The architect will then, as a result, take on responsibility to the design and build contractor for its design, including for work already undertaken for the developer (depending upon the precise wording of the novation). The design and build contractor takes on ultimate design liability to the developer.
PI policies will often require design and build contractors, as a condition to cover being provided, to take reasonable steps to satisfy themselves of the capabilities of the novated consultant and the adequacy of the design for which they take on liability. This can require interrogation of the design, potentially through an independent third party consultant.
Collateral warranties
Defective design of an Insured could cause different losses to parties with differing interests in a construction project. A collateral warranty is a contract between a party with an interest in the project and a separate party involved in the project’s design, management or construction. The Insured usually warrants to the interested third party that it has complied with its appointment or contract, giving that third party a direct contractual route to recovery against it in the event of a claim.
PI policies can include strict requirements in relation to collateral warranties. They will often extend cover to collateral warranties only where the effect of the warranty is not to make the Insured liable to any greater degree than would otherwise have been the case under its original appointment. The contractual / statutory limitation period during which the Insured may be liable for any breach of its contractual obligations is a good example of this issue in practice. The warranty should not have the effect of extending the limitation period beyond that which would otherwise apply to the contract.
Notification
As with all liability covers, PI policies usually include strict obligations to notify insurers if and when a claim or circumstance arises. Given the fast-moving and often contentious nature of construction projects, Insured parties should ensure they are familiar with the precise notification requirements under their policy and that they at all times comply with them.
A particular feature of construction contracts is Adjudication, which is a short-form dispute resolution mechanism specific to the construction industry. This process operates in extremely tight timescales, and can produce a binding decision within as little as 28 days. PI policies will often (necessarily) contain substantially shortened notification requirements where a Notice of Adjudication is received. Insureds should pay particular attention to those, as they will need to act quickly – often as a condition to cover being provided under their policy.
Credit:
Stephen McLellan – Associate
DAC Beachcroft LLP
