Webinar - Insurance for Design Mistakes: a PI CAR Case Study
Agenda
This session focuses on the interplay/overlaps between CAR and PI policies in the context of a case study concerning a defectively designed roof which is damaged leading to various losses and claims against the policyholder. In particular, the session provides practical guidance on how the policyholder may approach claims under any CAR and PI policy in tandem including the strategic choices and implications.
Speakers
David Pryce, Managing Partner
Rob Goodship, Senior Associate
The Good, the Bad & the Ugly: 100 cases every policyholder needs to know. #16 (The Good). Technology Holdings Ltd v IAG New Zealand Ltd [2008]
Welcome to the latest in the series of blogs from Fenchurch Law: 100 cases every policyholder needs to know. An opinionated and practical guide to the most important insurance decisions relating to the London / English insurance markets, all looked at from a pro-policyholder perspective.
Some cases are correctly decided and positive for policyholders. We celebrate those cases as The Good.
Some cases are, in our view, bad for policyholders, wrongly decided, and in need of being overturned. We highlight those decisions as The Bad.
Other cases are bad for policyholders but seem (even to our policyholder-tinted eyes) to be correctly decided. Those cases can trip up even the most honest policyholder with the most genuine claim. We put the hazard lights on those cases as The Ugly.
#16 (The Good)
The Good
In another useful decision for policyholders under CAR policies (see our earlier article regarding ‘The Orjula’), but also damage policies generally, the High Court of New Zealand found (at para 65 of its judgment) that damage (as distinct from physical damage) can be established by one of more of:
a) a material risk to insured property which did not exist before the relevant event;
b) an event which rendered the insured property not fit for its intended use; and/ or
c) the possibility of malfunction during use as a result of the relevant event, which would require the insured property to be dismantled to determine the risk.
Whilst this authority isn’t binding on an English court, it would certainly be persuasive and the last category in particular is helpful to policyholders seeking cover for damage, as the mere possibility of malfunction which itself has not occurred would trigger cover under a policy responding to damage based on this authority.
The decision
The claimant supplied credit card terminals to retailers, 2,051 of which were stored in a basement that flooded on 7 February 2005. All of the containers in which the terminals were stored came into contact with flood water (but only around a quarter of the terminals themselves), and all containers were exposed to increased humidity. The claimant claimed under its Business Assets insurance policy (“the Policy”) for loss or damage to all of the terminals, the insuring clause in the Policy stating:
If during the Period of Insurance specified in the Schedule there happens Loss or Damage unintended and unforeseen by the Insured, except as may be excluded, to the PROPERTY AND EXPENSES INSURED, then the Insurers will indemnify the Insured in respect of such Loss or Damage as expressed in the BASIS OF LOSS SETTLEMENT and in addition the Insurers will indemnify the Insured in the manner and to the extent separately stated herein.
Despite being capitalised terms, Loss and Damage were not defined in the Policy. The claimant’s claim was accepted in relation to the terminals which came into direct contact with flood water, but insurers declined cover for the remaining terminals on the basis that they were neither lost nor damaged.
The court was asked to consider whether the insuring clause had been triggered in relation to the other terminals stored in the basement, essentially whether they were damaged because the manufacturer of the terminals had withdrawn its warranty and / or because the operator of the terminals’ intended network had refused to permit those units to be connected because of the risk that they would malfunction.
The claimant relied on expert evidence which included that it was standard industry practice for manufacturers to dismantle terminals returned to it to ensure their continued security and reliability following suspected damage. This, coupled with the low cost of producing terminals compared with the higher cost to dismantle, meant that terminals were often written off/ disposed of rather than being repaired.
The court’s analysis included a discussion concerning the difference between “physical damage” on the one hand and “damage” on the other, and concluded that the parties had intended the Policy to have the wider, unqualified damage cover, as opposed to cover being restricted to physical damage.
There was a detailed discussion of the damage authorities, including Transfield and Quorum AS, but most notably Ranicar v Frigmobile Pty Ltd, which the court regarded as the leading authority on “damage” in an insurance context. That case concerned scallops which could no longer be exported as they were temporarily and accidentally stored above -18 degrees Celsius, with that change in temperature being enough to constitute the physical change required to trigger cover for damage under the relevant insurance policy. The court in Ranicar held that whereas “physical damage” may require a permanent and irreversible change in physical condition, “damage” could occur when an adverse change in physical condition was both transient and reversible.
Deciding the Technology Holdings case, Woodhouse J (quoting a leading insurance text) said that the essence of Ranicar in relation to damage was that “it is normally sufficient if the damage is in the form of diminution in value or functionality”, but that element was not enough by itself – for damage something must happen to the property itself followed by the impairment in value or usefulness.
Applying Ranicar to the terminals which did not directly come into contact with flood water, Woodhouse J said that:
“…there was an occurrence – the flooding – which was unintended and unforeseen by the insured and which happened to the property. Following this event, which may or may not be similar to the temperature rise in Ranicar, the plaintiff found it could not sell the units. For the reasons discussed, I am satisfied that, if the plaintiff cannot prove that the units were “physically damaged”, there nevertheless will have been “damage to the property” for the purposes of the plaintiff’s Business Assets insurance policy if the plaintiff can establish the following: Because the units were stored in premises affected by flooding the units would malfunction during use in the network on a date earlier than the date on which the units would normally be withdrawn from use and in consequence they are not fit for their intended use”.
Comment
In addition to helping to cement Ranicar’s status as a leading authority on damage in the insurance context, it arguably goes one step further by holding that the mere possibility of malfunction was sufficient to constitute damage where that risk impacting on value or usefulness. The logic of the decision is sound, and merely extends existing principles rather than taking an entirely new approach, and the decision is certainly Good for policyholders.
Rob Goodship is a Senior Associate at Fenchurch Law
Webinar - Defects Exclusions under CAR policies
Agenda
Defects Exclusions give rise to a variety of difficult issues. This webinar will address some of those, including the overlapping concepts of inherent vice, defective condition, damage, and physical damage, as well as considering how to determine the value of what is excluded by the most commonly used clauses.
David Pryce is the Managing Partner of Fenchurch Law
(De)sign of the Times: Blurred Lines on Build Performance Liabilities
Design requirements are at the heart of any construction contract, and the precise formulation of applicable standards is crucial to evaluation of risk. Recent trends indicate that designers in the UK construction industry are assuming increasing levels of liability on build performance, with significant implications for coverage under professional indemnity insurance.
In Arbitration Appeal No 1 of 2021 [2021] CSOH 41, the Scottish Court of Session recently considered the interpretation of deemed design liability clauses, and upheld a provision imposing responsibility on a consultant for designs pre-dating its appointment and which had been proposed without its involvement. Whilst similar clauses may be given a narrower interpretation in a multi-disciplinary design context involving several third party consultants, the scope of such provisions should be carefully considered at the outset, to limit exposure and potential uninsured loss.
Reasonable Skill & Care vs. Fitness for Purpose
A contractor or professional with design responsibility should exercise reasonable skill and care, based on standards expected of an ordinary skilled person performing and professing to have that special skill, so that liability will not arise unless they have acted negligently.
Express contract terms often impose more onerous fit for purpose type obligations, providing a warranty that the works will conform to specified employer requirements. Liability arising from a higher contractual standard than that imposed by ordinary common law, including certification of compliance with specified design, will usually fall outside the scope of cover under professional indemnity insurance.
Strict liability can be implied in relation to design elements of work under a design and build contract (Viking Grain Storage v TH White Installations (1985) 3 Con. L.R. 52); or where the contractor is informed of the purpose for which the works are required and the employer relies upon the contractor’s skill and judgement (Greaves v Baynham Meikle [1975] 1 W.L.R. 1095).
Industry standard forms address the issue in different ways, with JCT contracts requiring reasonable skill and care, whilst all FIDIC contracts impose some degree of fitness for purpose obligation. This divergence in part reflects the usual approach in different industry sectors, with design and construction contracts for energy or infrastructure projects typically including output specifications capable of measurement through testing, as compared with the performance standard ordinarily assumed by an architect or other professional designer in the real estate development sector.
Conflicting Standards
In MT Højgaard v E.ON [2017] UKSC 59, the Supreme Court considered a contract containing both a reasonable skill and care obligation, and a warranty ‘tucked away’ in a technical schedule requiring a service life of 20 years. The latter took precedence, in circumstances where wind turbine foundations designed and installed by the defendant in accordance with the claimant’s requirements and certifying authority’s specification began to fail during the defects period, due to a subsequently identified error in a value in the authority’s specification. The case demonstrates that a contractor can be found to assume the risk if they have agreed to work to a design which would render the item incapable of meeting the performance criteria.
An obligation to ensure that works constructed in accordance with the build design “shall meet the requirements described in the Specification” may be construed as imposing strict liability, notwithstanding the designer having separately undertaken to exercise reasonable skill and care (Costain v Charles Haswell & Partners [2009] EWHC 3140). This depends on the particular contract wording, however, and conversely a design and build contract requiring a consultant to comply with a specific design, alongside an obligation to act with reasonable skill and care, may be construed on the basis that the obligation to comply with the specification is to be read as expressly or impliedly subject to the reasonable skill and care provision (MW High Tech Projects v Haase Environmental Consulting [2015] EWHC 152).
For complex contracts incorporating schedules from multiple sources, a priority of documents provision may be helpful to deal with potential inconsistencies.
Implementation of Design
Following on from the decision in SSE Generation v Hochtief Solutions [2018] CSIH 26, we are seeing an increase in professional indemnity disputes based on a distinction between preparation and implementation of design, with reference to the scope of ‘professional activities’ defined in the policy and declared in the proposal form.
In SSE Generation, a design and build contractor was held liable under the NEC2 contract for costs of repairing a tunnel collapse at the Glendoe hydroelectric power scheme in Scotland, due to breach of contract requirements on appropriate support for erodible rock encountered in a fault zone. The court decided by a majority that Hochtief could not rely on a limitation of liability for design defects, despite having exercised reasonable skill and care in preparing the design statement, as the damage was caused by implementation of design.
This conclusion was reached in light of specific contract terms and the interface between design and its implementation is highly fact sensitive (Bellefield Computer Services Ltd v E Turner & Sons Ltd [2002] EWCA Civ 1823), particularly in cases involving complex construction and engineering decisions.
Design Life
Construction contracts often require completed works to deliver a specified minimum ‘design life’.
The meaning of this concept was considered in Blackpool B.C. v Volkerfitzpatrick [2020] EWHC 1523, a case concerning alleged premature corrosion to a tram depot situated in a seafront location. The court referred to relevant British Standards on service life planning and structural design in concluding that an acceptable level of not “unusually onerous” maintenance is a key ingredient of performance expectations for individual parts of a building, and a specified design life implies that “major repairs” should not be needed during that period. The extent of standard maintenance will be a matter of fact and degree, which could be addressed in O&M manuals produced by the contractor.
Depending on the words used in the contract, several discrete obligations may be separately imposed and cumulatively applied to the design life and quality of particular components within a complex structure (125 OBS (Nominees1) v Lend Lease Construction [2017] EWHC 25).
Conclusion
In view of ongoing hard market conditions, policyholders are understandably reluctant to accept requirements outside the scope of conventional insurance cover, with extensive negotiation on design risk allocation at the pre-contract stage often resulting in a form of compromise wording.
The nuanced approach adopted in recent court rulings demonstrates a blurring of lines between the traditional reasonable skill and care vs. fitness for purpose dichotomy, acknowledging that different standards can apply to various aspects of design under a single contract.
Designers should exercise particular caution in relation to deeming provisions in appointment documents and standard form contracts, imposing liability for plans initially developed by the employer or third parties.
To avoid ambiguity, contractors and consultants should expressly exclude fitness for purpose obligations where possible, and consider inclusion of contract terms defining the output of building design, with reference to intended maintenance procedures. Where exclusion of fitness for purpose obligations cannot be agreed, policyholders should talk to their brokers and insurers to obtain clarity about the extent to which any onerous contractual obligations are covered by their professional indemnity insurance.
Amy Lacey is a Partner at Fenchurch Law.
Weathering the Hard Market: is your CAR Policy Watertight?
The increasing prevalence of water damage losses on construction projects, combined with hard market conditions, has led to a rise in disputes over insurance policy response for these types of events. Claims in consequence of cascading water from burst pipes or adverse weather conditions often give rise to disagreements over the occurrence and timing of ‘damage’, in order to trigger coverage under contract works policies, and a number of standard exclusion clauses may impact upon the level of protection.
Insuring Clauses
The legal test for damage requires proof of physical change to insured property, adversely affecting its value or usefulness. Authorities demonstrate a distinction between policies requiring ‘damage’ - which includes transient or reversible changes if time and money has been spent dealing with the problem (Ranicar v Frigmobile; The Orjula) - as opposed to policies with a ‘physical damage’ trigger, which may not respond in the absence of a permanent alteration in condition (Transfield Constructions v GIO).
The need for coverage in respect of temporary changes is particularly important in water damage scenarios, where the insured property could dry out relatively quickly. Insurers might suggest that no lasting damage remains, even if the policyholder has been put to considerable expense and inconvenience through a water ingress event, especially where guarantees relating to electrical elements of contract works may be invalidated.
It is sufficient for physical change to have occurred at a microscopic level, detectable only through careful examination using advanced inspection techniques, such as accumulation of dust on carpets (Hunter v Canary Wharf) or increased brittleness and liability to early degradation of a pastel painting following exposure to high temperatures (Quorum v Schramm). Accumulations of water can result in physical changes to insured property in the form of rot or fungal spores, especially in close proximity to timber elements, although expert assistance may be required to identify the presence of this type of damage.
Exclusions from Cover
Contract works policies typically exclude cover for damage resulting from changes in the water table level, and may refer to fungus or rot alongside other naturally occurring processes as part of a gradual deterioration exclusion.
Another key aspect of the policy wording determining the scope of protection for water damage events are relevant defects exclusion clauses. Contract works insurance usually contains a standard defects exclusion based on the DE or LEG suite of options, offering different levels of coverage for cost of repair associated with defective design, workmanship or materials. Failed connections in water systems may involve a combination of design or workmanship problems, and the proximate cause of loss will often need to be identified to determine policy response.
DE5 or LEG3 usually provide the broadest coverage for losses in consequence of defects, to include costs incurred to gain access to property damaged as a result of defects, and excluding only the cost of improvements. Some policies provide an option as to application of DE5 or DE3 / LEG3 or LEG2, at the policyholder’s option at the claims stage, allowing flexibility to determine which alternative produces the most favourable outcome with knowledge of the particular circumstances arising.
Some standard exclusion clauses (such as DE4) provide cover for damage to ‘other property’ caused by defects, but not the defective ‘part’ itself, which often leads to disputes over divisibility of insured property between defective and non-defective parts. In general terms, the courts will look to the commercial reality of whether a particular aspect of the development would be viewed by contracting parties as a separate package or phase of works (Seele Austria).
The aggregation wording in the policy may also impact upon coverage for complex aspects of contract works, such as structures formed from separate sections or modular elements, with the possibility of insurers arguing that multiple ‘losses’ have occurred for purposes of the limits of indemnity and deductible.
Policy Conditions
Careful consideration should be given to policy conditions requiring particular steps to be taken in relation to risk mitigation and claims handling.
In order to establish breach of a ‘reasonable precautions’ condition, the insurer must prove recklessness i.e. the insured subjectively appreciated the risk but didn’t care or ignored it; mere negligence will not suffice (Sofi v Prudential). This is distinguishable from policy requirements imposing positive continuing obligations on insureds to take specific actions, such as unoccupied buildings conditions. The recklessness threshold will not apply where there is “a highly defined and circumscribed set of particular safeguards which have to be put in place” (Aspen Insurance v Sangster).
Insurers are increasingly focused on water damage risk management procedures as part of the underwriting process, and may include specific provisions in the policy requiring compliance with e.g. CIREG best practice guidelines. The inclusion of ‘conditions precedent’ should be resisted, with use of appropriate ‘best endeavours’ type language especially if works on site involve third party sub-contractors, so that compliance with the condition is not entirely within the policyholder’s control.
Conclusion
Advice should be sought from specialist brokers on potential improvements to the scope of insurance for contract works, with particular reference to the trigger for coverage, exclusion clauses and policy conditions. When a loss does occur it is important to investigate and document the condition of insured property without delay following a water damage incident, with expert input if required, to minimise the prospect of insurance disputes.
Amy Lacey is a Partner at Fenchurch Law
‘Deliberate acts’ exclusion disapplied: Supreme Court decision on Public Liability
The Supreme Court has rejected attempts by an insurer to rely upon an exclusion clause under a public liability policy, in a case arising from the death of a customer following an assault by door staff at a bar in Aberdeen.
The security company’s insurance provided cover for accidental injury or death, but excluded "deliberate acts wilful neglect or default". The policy was governed by English law and there was no suggestion of any difference in approach under the law of this jurisdiction or Scotland in relation to the issues on appeal. The customer’s widow claimed against the insurer pursuant to the Third Party (Rights against Insurers) Act 2010, following liquidation of the security company employer, based on vicarious liability for wrongful acts of its employees.
The Supreme Court held that a “deliberate act” was something carried out with the intention of producing the insured outcome i.e. in this case, acts intended to cause injury. In reaching this conclusion, their Lordships recognised the commercial context of the policy to cover the business of “Manned Guarding and Door Security Contractors”, including unintended consequences of incidents at the bar door, which commonly involve deliberate physical acts. If every intentionally performed act was classed as deliberate for purposes of the exclusion, there would be no coverage for many accidental injuries the policy was designed to insure.
The same was true if “wilful neglect or default” was construed as extending the exclusion clause to acts embarked upon with reckless disregard for the consequences, in the sense of proceeding despite a known risk of injury, or not caring if such a risk may arise. Interpreting the exemption in that way would seriously limit the cover provided and lead to a “commercially unlikely exclusion, given the nature of the [insured]’s business”.
There was no determination in the earlier proceedings of intention to injure, or even recklessness, and it is not the role of appellate courts to make findings of fact. Following ejection from the bar due to intoxication, the customer hit out at security staff and was taken in a neck hold for up to three minutes, resulting in death from asphyxiation. In sentencing remarks, Lady Wolffe found that the employee’s actions were: “badly executed, not badly motivated … you believed you were acting in defence of your fellow door stewards and to minimise the danger you felt Mr Grant posed to others.”
The insurer was therefore unable to avoid liability. Following a series of pro-policyholder decisions, this appears to be another example of the Supreme Court’s willingness to take account of public policy considerations to avoid stripping insurance contracts of much of their content, and confirms that exclusion clauses will be construed based on the words used in their “documentary, factual and commercial context”, in accordance with principles set out in Wood v Capita Insurance Services Ltd [2017].
The decision is helpful for policyholders in demonstrating that conscious performance of an act with intention to cause insured damage must be established, in order to trigger a deliberate acts exclusion, and mere recklessness will not suffice. Whilst recklessness will be enough to prove breach of a reasonable precautions condition (Fraser v Furman [1967]), insurers face a higher evidential threshold in relation to ‘deliberate acts’.
Burnett or Grant v International Insurance Company of Hanover Ltd [2021] UKSC 12
https://www.supremecourt.uk/cases/docs/uksc-2019-0121-judgment.pdf
Amy Lacey is a partner at Fenchurch Law
The Good, the Bad & the Ugly: #13 (The Bad). Haberdashers’ Aske’s Federation Trust & v Lakehouse Contracts
Welcome to the latest in the series of blogs from Fenchurch Law: 100 cases every policyholder needs to know. An opinionated and practical guide to the most important insurance decisions relating to the London / English insurance markets, all looked at from a pro-policyholder perspective.
Some cases are correctly decided and positive for policyholders. We celebrate those cases as The Good.
Some cases are, in our view, bad for policyholders, wrongly decided, and in need of being overturned. We highlight those decisions as The Bad.
Other cases are bad for policyholders but seem (even to our policyholder-tinted eyes) to be correctly decided. Those cases can trip up even the most honest policyholder with the most genuine claim. We put the hazard lights on those cases as The Ugly.
At Fenchurch Law we love the insurance market. But we love policyholders just a little bit more.
#13 (The Bad)
Haberdashers’ Aske’s Federation Trust Ltd & others v (1) Lakehouse Contracts Ltd & (2) Cambridge Polymer Roofing Ltd [2018] EWHC 588 (TCC)
This case arose from fire damage to a school during construction works. The main contractor (“Lakehouse”) settled proceedings brought by the claimants for £8.75million, paid by the project insurers, and sought to recover £5million from its roofing sub-contractor (“CPR”), being the limit of indemnity under a separate CAR/liability policy taken out by CPR in accordance with express terms of the building contract.
The court was required to determine as a preliminary issue whether CPR was covered under the project policy, which included Lakehouse and its sub-contractors as insureds, and agreement of insurers by endorsement to “waive all rights of subrogation which they may have or acquire against any insured party”. The court held that CPR was not insured under the project policy, given the clear intention expressed in the sub-contract for CPR to take out and rely on its own insurance cover.
In reaching this conclusion, the Judge considered competing theories as to how a sub-contractor may obtain the benefit of project insurance, i.e. (1) the main insured acting as agent, with its conduct subsequently ratified by the sub-contractor (this was considered problematic as sub-contractors would not necessarily have been ascertained at the time of policy inception, nor be able to ratify if they had no insurable interest as yet); (2) a “standing offer” by project insurers to provide cover for members of a defined group; or (3) acceptance by the sub-contractor’s conduct that it would become an insured under the project policy. The standing offer rationale was considered to be the most appropriate.
An appeal was listed in January 2019 but the case settled before the hearing. Given a number of difficulties with the first instance decision, it is unfortunate that the opportunity for further debate and clarification in the Court of Appeal was missed on this occasion.
The Haberdashers judgment seems unfair in terms of a windfall for project insurers, who receive premium based on cover for sub-contractors of any tier, despite sub-contracts likely imposing additional insurance obligations. It is impossible for insurers to accurately rate their exposure on this basis, without knowing at the time of writing the project policy what limits a future (as yet unidentified) sub-contractor may or may not take out.
It seems odd that terms of a contract between third parties should determine who is insured under a pre-existing project policy. The decision effectively confines the scope of project insurers’ standing offer to provision of cover for “sub-contractors who have not agreed to obtain their own insurance” but such a limitation was nowhere to be found in the terms of the project policy.
Given the express waiver of subrogation rights, the reasoning seems inconsistent with the Supreme Court majority view in Gard Marine - that a strong presumption applies in favour of an implied term precluding claims between co-insureds (even if the contract contains an express warranty from the defendant to protect insured property); and the effect of co-insurance is to exclude - as opposed to discharge - liability as between co-insureds. On this reasoning Lakehouse would have no liability to the claimants, which suggests that there is no basis on which a back-to-back claim could be pursued against CPR.
The subrogated claim against CPR was limited to £5million and the Judge suggested (obiter) that project insurers would not have been able to recover the full loss, i.e. the additional £3.75million settlement sum, as it was surely not anticipated that CPR would bear any additional uninsured loss where there was project insurance in place with a higher limit. This was not fully explained in the judgment and begs the question of whether a hybrid situation could arise whereby a sub-contractor is not co-insured up to the limit of its own separate cover, but in excess of that level, becomes insured by the project policy. Further peculiarities as to apportionment of liability could arise where a mismatch occurs between the scope of cover under a project policy and the sub-contractor’s liability insurance, giving rise to significant uncertainties for policyholders and insurers alike.
In our view, the decision in Haberdashers is a bad one. We prefer the approach adopted by the Court of Appeal in Rathbone Brothers v Novae, to the effect that an overlapping insurance situation may arise, even where one policy was specifically intended to cover the loss in question.
Debate as to whether, and in what circumstances, primacy should be given to express allocation of risk within a construction contract as opposed to inferences drawn from the existence of a project policy is likely to continue. Even if a contractor is presumed to fall within the definition of insured parties under a project policy, it should ensure that risk allocation and insurance provisions in its construction contract(s) are consistent, for example by specifying that any separate insurance required to be taken out by the contractor should operate in excess of the project cover, to minimise the prospect of subrogated claims.
Amy Lacey is a partner at Fenchurch Law.
The Good, the Bad & the Ugly: 100 cases every policyholder needs to know. #12 (The Ugly). Tesco Stores Ltd v Constable & Ors
Welcome to the latest in the series of blogs from Fenchurch Law: 100 cases every policyholder needs to know. An opinionated and practical guide to the most important insurance decisions relating to the London / English insurance markets, all looked at from a pro-policyholder perspective.
Some cases are correctly decided and positive for policyholders. We celebrate those cases as The Good.
Some cases are, in our view, bad for policyholders, wrongly decided, and in need of being overturned. We highlight those decisions as The Bad.
Other cases are bad for policyholders but seem (even to our policyholder-tinted eyes) to be correctly decided. Those cases can trip up even the most honest policyholder with the most genuine claim. We put the hazard lights on those cases as The Ugly.
At Fenchurch Law we love the insurance market. But we love policyholders just a little bit more.
#12 (The Ugly)
Tesco Stores Ltd v Constable & Ors [2008] EWCA Civ 362
The case considered the scope of the cover provided by a “contractual liability” extension in a third party liability (“TPL”) policy (“the Policy”).
The claim by Tesco against its TPL insurers arose out of the collapse of a railway tunnel which had been built for Tesco in order to accommodate the construction of a new supermarket on top. The railway line was owned by Network Rail, but the trains were operated by Chiltern Railways (“Chiltern”). Luckily no one was injured by the collapse, but the track owned by Network Rail was damaged. No property owned by Chiltern was damaged, but as a result of the damage to the track it suffered a significant loss of profits due to the interruption of its services.
Tesco had entered into a Deed of Covenant (the “Deed”) with Chiltern, under which Tesco agreed to indemnity Chiltern for losses caused by the construction work for the new supermarket, including loss of profits. Following the collapse Chiltern made a substantial claim against Tesco under the Deed for its lost profits. Tesco, in turn, sought indemnity for its liability to Chiltern under its TPL policy.
Ordinarily, TPL policies cover policyholders for claims in tort by third parties, and are triggered by damage to or interference with property, or by bodily injury. TPL policies don’t ordinarily cover contractual claims, or claims for pure economic loss. The insuring clause in the Policy was in standard terms, and provided that:
“The insurer will indemnify [Tesco] against all sums for which [Tesco] shall be liable at law for damages in respect of:
- Death of or bodily injury to or illness or disease of any person;
- loss of damage to material property;
- obstruction, loss of amenities, trespass, nuisance or any like cause.”
However, the Policy also contained the following extension, headed “Contractual Liability”, which said that the Policy would cover “liability under a contract or agreement…which would not have attached in the absence of such contract” (“the Extension”).
On its face the Extension appeared to significantly increase the scope of the cover provided by the Policy. As Chiltern’s claim against Tesco was a contractual claim which wouldn’t have attached in the absence of the Deed, Tesco (not entirely unreasonably) assumed the Extension meant that the Policy would cover Tesco’s liability to Chiltern. Tesco’s TPL insurers disagreed, and the point was ultimately determined by the Court of Appeal.
The Court of Appeal made clear that the Extension was not a separate insuring clause, and that in order for the Extension to apply it was necessary for Tesco to demonstrate that the claim for which it sought indemnity fell within the insuring clause of the Policy in the first place. Whilst the Court of Appeal was satisfied that the phrase “liable at law for damages” in the insuring clause was sufficiently wide to encompass contractual claims, unfortunately for Tesco the Court took the view that the remainder of the insuring clause made clear that the Policy was intended to respond only to the types of liability that would ordinarily be covered by a TPL policy because: (i) each of the types of loss referred to in the sub-paragraphs of the insuring clause would all give rise to ordinary tort claims; and (ii) the causation phrase “in respect of” meant “for”, rather than something looser such as “in connection with” so that the loss covered by the Policy had to have been directly caused by one of those standard tort types of loss, and not just be more loosely connected to it.
It was not, therefore, sufficient that Chiltern’s loss of profits was related to damage to someone else (Network Rail)’s property. The Court of Appeal decided that the Extension did no more than provide cover for contractual liabilities which were co-extensive with Tesco’s tortious liabilities. As Tesco had no tortious liability to third parties (such as Chiltern) for loss of profits, the Policy therefore didn’t respond.
We can’t criticise the reasoning of the Court of Appeal in Tesco, and we don’t suggest that the case was wrongly decided. However, the decision is problematic for policyholders for two reasons. Firstly, from a policyholder’s point of view the Extension doesn’t “do what it says on the tin”, and it would not be obvious to a policyholder that a contractual liability extension needs to be read carefully alongside a different clause in the policy altogether in order for its meaning to be understood. Secondly, when combined with standard TPL insuring clauses, contractual liability extensions don’t actually provide much additional benefit, so that the apparent benefit is in reality something of an illusion.
However, the Court of Appeal’s reasoning does point to two potential “fixes” to the problem, from the policyholder’s perspective, in both cases by amending the insuring clause. The first fix is to include in the list of the types of loss covered by the Policy something other than losses that would result from ordinary tort claims. That may seem too radical an approach for a TPL policy (although wordings do exist which take approach), and so an approach that may be easier for policyholders to achieve would be to replace the phrase “in respect of” in the insuring clause with something something looser, like “in connection with”, or “in any way related to”. That would allow TPL policies to give full effect to contractual liability extensions, so that they cover contractual liabilities which are connected to property damage (and so not entirely unrelated to what a TPL policy is intended to do), but which aren’t directly caused by property damage. Had Tesco’s policy been drafted in that way, the contractual liability extension would then have covered Tesco’s liability for Chiltern’s loss of profits claim.
Authors
Rob Goodship, Senior Associate
Toby Nabarro, Associate
Webinar - Traps for Contractors and their Brokers
Practical issues to be aware of for those dealing with CAR and Contract Works policies, including the correct trigger for damage, when a defect may constitute damage and an overview of the two leading suites of defect exclusion clauses.
Rob Goodship is a Senior Associate at Fenchurch Law
You have to be pulling my LEG(3)
An unwelcome consequence of the London Market’s preference for including arbitration clauses in most types of commercial insurance policies, is that disputes regarding the meaning of clauses in those policies are frequently resolved in private, rather than in a public forum where the decision of a Court could assist policyholders and insurers in avoiding similar disputes in the future.
In a Construction All Risks context, insurers’ preference for arbitration clauses has had the remarkable effect that in the nearly 25 years since the London Engineering Group (“LEG”) first introduced its suite of defects exclusions, there has not been a single Court decision, anywhere in the world, on the meaning of the defects exclusion which LEG intended to be the most favourable for policyholders: LEG3.
So, if there are no reported cases on LEG3 then where can one look for guidance? The current (2nd) edition of Paul Reed QC’s excellent book “Construction All Risks” doesn’t consider LEG3 in any detail. Whilst we understand that the omission will be corrected in the forthcoming 3rd edition, at present Mr Reed’s book refers to LEG3 as being an equivalent of the most favourable of the “DE” defects exclusions: DE5. That equivalence, however, is not accepted in all parts of the insurance market.
As noted in an article published by Iftikhar Ali of DWF in 2019, the absence of the word “additional” from LEG3 (as opposed to DE5, which explicitly excludes “additional costs of improvement”) has encouraged some to interpret LEG3 as excluding all costs which relate to works which have the effect of improving the original works. If this interpretation was correct then it would produce particularly harsh results for policyholders where the contract works have suffered damage as a result of defects in design, as in one sense all remedial works carried out according to a different design must necessarily be an improvement if the remedial works are defect-free as a result. For that reason Mr Ali (correctly in our view) reaches the view that such an interpretation, whilst consistent with a literal reading of LEG3, would be “a commercial nonsense”. Unfortunately, in our experience, that does not always prevent insurers from running the argument, to the surprise and disappointment of any policyholder or broker who is familiar with how the market ordinarily approaches the clause.
Whilst other texts and commentaries are consistent with the guidance notes produced by the London Engineering Group itself, that LEG3 was intended by the underwriters who drafted it to provide the “the widest form of cover, for physical damage caused by defects”, none of the texts or commentaries discuss how, precisely, one should determine: (i) what constitutes an improvement for the purposes of LEG3; and (ii) what cost is thereby excluded. This article attempts to address that gap.
What is an improvement for the purposes of LEG3?
For the purposes of this article the relevant part of LEG3 provides that:
“the cost of replacement or rectification which is hereby excluded is that cost incurred to improve the original material workmanship design plan or specification” (our emphasis).
It seems to us that for remedial works to constitute an improvement as compared with the original works:
- The remedial works must be different in some way from the original works; and
- That difference must be more than an equally valid way of performing the works, and must produce a tangible benefit (for instance an improved factor of safety, or a longer design life, or superior functionality - in all cases as compared with the original works as completed, as opposed to the outcome desired by the employer).
The requirement for the difference to produce a tangible benefit in order to constitute an “improvement” is important. The fact that remedial works are different to the original works does not on its own mean that they are an improvement, even if the remedial works are more expensive.
In the context of a Construction All Risks claim, if an insurer cannot identify a tangible benefit produced by the remedial works as compared with the original works, then it will not be able to show that the remedial works are an improvement, and any difference in cost between the remedial works and the original works will be irrelevant, and should not result in a deduction under LEG3. It is only if the insurer is able to identify a tangible benefit produced by a way in which the remedial works are different from the original works that one is required to consider what cost is thereby excluded by LEG3.
What cost is excluded?
Once one has a taken a view not just on how the remedial works are different from the original works, but also in what way that difference relates to a tangible benefit (i.e. what is the “improvement”), one can then try to identify the cost that relates to that improvement. Pausing there, it is of course entirely possible that there may be no “cost” of improvement, because a policyholder may find a different way of approaching the remedial works which, although producing a tangible benefit as compared with the original works, is nevertheless cheaper than the original works. In that situation whilst there is an “improvement”, there would be no “cost incurred to improve”, but rather a saving.
Any other interpretation would be precisely the “commercial nonsense” referred to by Mr Ali, and we doubt that there is a single CAR underwriter who, when writing a risk, would want to encourage their policyholder to carry out remedial works more expensively than a cheaper and better alternative if one was available.
Assuming, then, that remedial works are both an improvement, and are more expensive than the original works, it seems to us that the “cost incurred to improve” can then be identified in one of the two following ways.
Item by item comparisons
Depending on the facts, it may be possible to identify excluded costs on an item by item basis. For instance, there will be occasions when:
- Some elements of the remedial works are different to the original works, but produce no tangible benefit (“Differences”);
- Some elements of the remedial works are exactly the same as the original works; and
- Some elements of the remedial works are different to the original works, and do produce a tangible benefit (“Improvements”).
In that situation, the Differences may occasionally be cheaper than the comparable items of the original works. However, there wouldn’t be any justification, in our view, for offsetting any such savings against the cost of the Improvements if those were more expensive than comparable items of the original works. Rather, the cost excluded by LEG3 in that situation would be the un-discounted difference in cost between the Improvements, and the comparable items of the original works.
Equally, if the Differences are more expensive than the comparable items of the original works we can see no justification for excluding the difference in cost relating to them: what is excluded by LEG3 remains the difference in cost between the Improvements, and the comparable items of the original works.
It should be obvious, we hope, that any differences in cost which relate to elements of the remedial works which are exactly the same as the original works, are unaffected by LEG3.
The approach of separating Differences and Improvements should, in our view, be applied not only to separate items of work, but where required by the facts can also be used to identify the excluded costs where individual items of work may contain both Differences and Improvements.
Items of work containing both Differences and Improvements
How this would work in practice in relation to individual items of work can be illustrated by considering a length of steel pipe which was under-specified, has suffered damage by becoming deformed under expected pressure, and has been replaced by thicker steel pipe. In that situation:
- There is a difference between the original works and the remedial works, in that a thicker steel pipe has been used in the remedial works; and
- The fact that the steel pipe used in the remedial works is thicker than that used in the original works produces a tangible benefit, in that is more robust and less likely to become deformed under expected pressure (i.e. the pipework constitutes an Improvement in that it is thicker).
Suppose the thicker steel pipe used in the remedial works is more expensive for two reasons:
- Because more steel has been used to make it thicker; and
- Because the cost of steel has increased since the original works were carried out.
In that situation LEG3 would only exclude the cost of making the pipe thicker by using more steel, as it is only that cost which is related to the way in which the thicker steel pipe is superior to the original steel pipe. The increased material cost is not related to the way in which the thicker steel pipe is superior to the original steel pipe, and so that difference in cost is not, in our view, excluded by LEG3.
Holistic comparisons
There will be other occasions where individual items of remedial work cannot sensibly be compared with any items of the original works (for instance, where the remedial works follow a substantially re-designed scheme). In that situation it will be necessary to compare the overall (remedial and original) schemes with each other.
Even in that situation, however, care needs to be taken not simply to subtract the cost of the original works from the cost of the remedial works in order to identify the cost excluded by LEG3, because that would risk including Differences (i.e. which don’t relate to the way in which the remedial works improve the original works). Rather, the cost of any Differences (e.g. fluctuations in material costs), need to be identified and disregarded.
Ordinarily the most appropriate way to do so in order to produce a reliable holistic comparison, is to compare the cost of the remedial works against not the cost of the original works, but against the cost that would have been incurred if the original works had been re-performed (in exactly the same way) following the occurrence of damage instead of the remedial works which were actually done.
Authors:
Rob Goodship, Associate Partner
