The Sky is the limit: Developments in relation to damage under CAR policies
On 16 December 2024 the Court of Appeal delivered judgment in the case of (1) Sky UK Ltd and (2) Mace Limited vs Riverstone Managing Agency Ltd and Others, a decision which will provide welcome clarity to the construction community, as well as being of interest to the insurance market more widely in terms of its analysis of the nature of an indemnity policy. The judgment discusses a number of important points, notably the rights of insured parties under a Construction All Risks (“CAR”) policy to recover in respect of “deterioration and development damage” which occurred after the policy period as a result of damage which had occurred during the policy period.
The factual background
The claims were in respect of extensive water damage to the roof of Sky's global headquarters building in West London, which was constructed for Sky in 2014 to 2016 by Mace as main contractor under a JCT 2011 Design and Build Contract dated 17 March 2014. Sky and Mace were named insureds under the Policy.
The roof was comprised of 472 wooden cassettes, into a substantial number of which water had entered before final waterproofing had taken place and had remained for periods of construction, leading to wetting and, so Sky and Mace alleged, irreversible swelling and structural decay by the end of the period of insurance (or “POI”, which ran from commencement of the project to one year after practical completion).
In the period between expiry of the POI and the drying out works (which arrested any further damage) the condition of the timber already damaged had worsened, and moisture had spread to other parts of the roof construction. The Court of Appeal termed these types of damage as “deterioration damage”; i.e. damage, such as further swelling, in parts of the timber already damaged, and “development damage”; i.e. damage to additional, previously undamaged timber by way of spread.
It is important to note, as the Court of Appeal stated, that the vast majority of water ingress had occurred during the POI and there was little, if any, ingress after the POI. Secondly, there was no allegation by the defendant insurers that Sky or Mace had failed to mitigate their loss prior to the hearing, given the complexity of designing, agreeing and implementing a remedial scheme.
The underlying decision
In the underlying decision, HHJ Pelling held that Sky was only entitled to damage which had occurred during the POI, and not development or deterioration damage which occurred thereafter. In reaching this decision, the Judge relied on the House of Lords decision in Wasa International Insurance Co Ltd v Lexington Insurance Co [2009] and statements in that decision that in a policy covering losses occurring during a policy period, the cover does not extend to damage occurring before or after the policy period.
The Judge had found that the entry of moisture into the cassettes during the POI was a tangible physical change to the cassettes as long as the presence of water, if left unremedied, would affect the structural strength, stability or functionality of the cassettes during the POI.
The arguments on appeal
All of the parties were granted permission to appeal on numerous grounds, but in this article we discuss the primary point of contention, which was whether Sky could claim for deterioration and development damage.
On this point, the cover identified in the insuring clause of the policy was in respect of “damage to Property Insured occurring during the Period of Insurance” and insurers argued that damage occurring after the POI was not covered. Insurers relied on the decision in Wasa as authority for the proposition that, under “time policies”, the cover is in respect of damage occurring during the period of cover, and not occurring before or after.
In summary, Sky and Mace’s arguments in reply were that:
- An insurance claim is a claim for unliquidated damages and, as such, the measure of recovery is for all the loss suffered by reason of the insured peril occurring during the POI, including loss caused after the POI.
- The Policy contained a Basis of Settlement clause, as below, and the measure of recovery contended for was supported by the underlined words in the clause:
“Basis of Settlement
In settlement of claims under this Section of the Contract of Insurance the Insurers shall, subject to the terms and conditions of the Contract of Insurance, indemnify the Insured on the basis of the full cost of repairing, reinstating or replacing property lost or damaged (including the costs of any additional operational testing, commissioning as a result of the physical loss or damage which is indemnifiable hereunder) even though such costs may vary from the original construction costs …."
The Court of Appeal decision
Development and deterioration damage
Lord Justice Popplewell delivered the leading judgment, which was rooted in the principle, long established in the authorities, that a contract of insurance is a contract of indemnity, often described as a contract to hold someone harmless. Such a contract was not, however, a promise by the insurer to pay money upon the happening of the insured event, but rather a promise to hold harmless, i.e. a promise that the insured will not suffer the damage in the first place. This promise to hold harmless was the insurer’s primary obligation and, when breached, it was under a secondary obligation to pay damages for breach of the primary obligation.
In light of this, damages payable under an insurance policy fell to be assessed on the basis of established common law principles as to foreseeability, remoteness and mitigation that applied to any other contract; namely damages to put the innocent party in the position it would have been but for the breach, subject to express terms in the policy modifying the general position (e.g. limits or deductibles, exclusions such as for consequential loss or if caused by certain perils), but only if such modification was excluded by clear wording.
Lord Justice Popplewell found that the temporal limit in the insuring clause was insufficiently clear to modify the ordinary rule that insurers were liable to pay the reasonably foreseeable costs of remedying development and deterioration damage.
This conclusion was supported by the wording of the Basis of Settlement clause.
Further, Lord Justice Popplewell found that the authorities, including the House of Lords’ decision in Wasa was distinguishable on the facts, predominantly because it did not relate to development or deterioration damage of the type suffered in this case.
Investigation Costs
Mace also claimed the costs of “lifting the lid”, namely the upper surface of the cassettes in the roof upslope above the gutters, as reasonable investigation costs. The trial Judge, at first instance, denied these costs as being recoverable under the Policy and characterised them as “speculative opening up works”. Additionally, the Judge found that any investigation costs not revealing physical damage would not be recoverable under the CAR Policy.
Nevertheless, based on the normal common law principles that apply to contractual damages claim, aimed at putting the innocent party back in the position it was before the breach (to hold harmless), the Court of Appeal found that reasonable costs of investigation were recoverable if they were reasonably incurred in determining how to remediate the insured damage which has occurred. This was the case, even if the result of the investigation may be to identify the absence of damage in certain areas.
Meaning of physical damage
On a separate point, the Court of Appeal also rejected insurers’ appeal in relation to the meaning of “damage”, and upheld the trial Judge’s findings that damage meant any change to the physical nature of tangible property which impaired its value or usefulness to its owner or operator. There was no need for the physical change to compromise the performance of an individual cassette, as insurers argued.
Retained Liability
The Policy contained a deductible (or “Retained Liability”) of £150,000 “any one event but this will only apply to those claims which are recoverable under DE5…”. It was common ground that the claim was recoverable under DE5 by reason of defective design being a proximate cause, and the trial Judge had found therefore that a single deductible of £150,000 applied to the whole of the claim, as opposed to applying separately in respect of damage to each cassette.
The Court of Appeal also upheld the trial Judge’s findings on this point that, based on the long established authorities, an event refers to the cause of the damage, and not the damage itself, supported by the fact that the deductible was specifically linked to the cause of the loss being defective design.
Comment
As the Court of Appeal stated, on the principal point of contention, the fact that development and deterioration damage was recoverable, would accord with business common sense. In the context of a major construction claim, an insured party would reasonably expect to be compensated for the consequences of insured damage which occurred during the policy period, to a part of the works already damaged (deterioration) or to some other part of the building not yet damaged (development), after this period had expired, in the absence of any policy terms limiting recovery. This is especially so in relation to complex claims where a remediation scheme may not be finalised until sometime after expiry of the policy period, and where the state of the building may deteriorate in the meantime.
Of course, development or deterioration damage would be unlikely to be covered under a buildings policy, since this would exclude damage which first occurred prior to the building policy period, meaning the Court of Appeal judgment is crucial in helping insureds to transfer this risk to the insurance market.
The outcome is consistent with the approach taken in recent cases on non-damage business interruption claims, that provided the policy “trigger” occurs within the indemnity period, the totality of loss is covered including that which continued to be suffered after the policy period (UnipolSai Assicurazioni SPA v Covea Insurance plc [2024]).
The Court of Appeal decision will therefore be welcomed by employers and contractors alike. It remains to be seen whether permission to appeal to the Supreme Court is granted.
Authors
Will someone think of the Lenders? Co-insurance issues for funders
Recent Court decisions such as Sky UK Ltd & Mace Ltd v Riverstone Managing Agency Ltd (which we wrote about previously in more detail here) have discussed “Project Insurance” policies taken out by employers in relation to construction projects, confirming the principles by which contractors, sub-contractors and other consultants may become insured under these policies. However, such policies normally also name lenders as insured parties (either specifically by name, or by general description) and in this article we discuss how these principles apply to lenders and what lenders need to do to ensure they are entitled to claim under the policies.
By way of recap, a Project Policy or OCIP normally covers insured parties in respect of physical damage to the “works”, as well as providing third party liability cover (both in respect of negligence and “non-negligence” under JCT 6.5.1). The employer, and/or any lenders, will frequently also want the policy to provide Delay in Start Up cover, which covers financial loss in the event that practical completion is delayed by damage[1] to the works.
A policy will normally define the “Principal Insured” as the employer, being the party who contracts with insurers when the policy is taken out. As I say, contractors, sub-contractors and lenders may also be named under the policy although, as was stated by Eyre J in RFU v Clark Smith Partnership [2022]:
“Being named as an insured does not without more make a person a party to the insurance contract. A person who is named as an insured but who is not otherwise a party to the insurance contract does not become a party to the contract simply by reason of having been named in it. That person remains a third party unless and until it becomes a party in a way recognised as constituting it in law a party to the insurance contract or obtains the benefit of the policy in question in some other way. … Similarly, the editors of Colinvaux rightly say at 15-018 “the mere fact that a policy states that it covers the interests of named or identifiable third parties does not of itself give those third parties the right to enforce the contract or to rely upon its terms (e.g. the benefit of a waiver of subrogation clause)”.
Where a third party insured, such as a contractor or lender, becomes an insured by agreement between an insurer and a Principal or contractual insured, the existence and scope of the cover the third party insured enjoys under the policy depends on the intention of the parties to be gathered from the terms of the Policy and the terms of any contract between the contractual assured and the relevant third party insured.
In a construction context, the Courts have stated that a third party insured contractor can become a party to the policy:
- If the employer taking out the policy is authorised to insure on the third party’s behalf (the “agency” route); or
- On the basis there is a standing offer from the project insurers to insure persons described in the policy such as “Main Contractor” or “Sub-Contractor”, which offer is capable of being accepted by those persons upon execution of a building contract, provided it is not inconsistent with the standing offer (this was the approach which the Court said was relevant in Haberdashers’ Aske Federation Trust Ltd v Lakehouse Contracts Ltd).
Whether a (sub) contractor becomes insured because of agency principles or accepting a standing offer, as well as looking at the policy, it will therefore be necessary to look at the (sub) contract to determine the extent to which the (sub) contractor is entitled to claim, and also to determine the extent to which the (sub) contractor will benefit from a waiver of subrogation.
For similar reasons, a lender will not be insured under a project policy where that policy has been arranged by a principal insured, unless the lender has provided authority to the principal insured to arrange insurance on its behalf and, even then, the lender will only be insured to the extent of the authority provided (even if the cover provided under the policy is wider than the authority provided).
In many cases, this will not cause any issues for a lender to a development finance project since the loan agreement with the borrower will authorise the borrower to arrange insurance in respect of the works, naming the lender as co-insured and first loss payee. Where the borrower is the principal or contracting insured in these circumstances, it will have the requisite authority to insure and the lender will be insured to the extent that the policy reflects the authority.
However, if for some reason the borrower is not the contracting insured, the lender may need to grant authority to the contracting insured via means other than the loan agreement. Further, if the lender wants to benefit from certain bespoke coverage not normally catered for in standard LMA facility agreement drafting (such as DSU cover), it will need to ensure that the principal insured is specifically authorised to obtain such cover on its behalf, and to the extent required.
A final point to note is that these principles will also apply where lenders are looking to be insured under other types of insurance policy in addition to project policies, which the lender has not taken out directly with insurers, such as latent defects or rights of light policies.
Christopher Ives is a Partner at Fenchurch Law
[1] Policies normally contain certain non-damage triggers as well, such as murder, suicide and disease.