MASTER BUILDER, July-August 2016:
We’ve previously published articles regarding Professional Indemnity insurance (PI) as the risks to builders entering into design and construct (D&C) contracts often are not recognised and understood,
What makes it all the more concerning, is that the advice being given by some insurance brokers, who are supposed to understand builders’ risks, is inaccurate in relation to how the ‘outsourcing’ of this aspect of the contract is treated by the Courts. Some builders are being advised that PI insurance is not required if the design aspect is being outsourced or signed off by an external party. That is not totally correct.
Let’s look at a real life example.
A very large builder signed a D&C contract with a principal. The design component was 100 per cent outsourced to another party. Several months after the commencement of the project, it became clear that the design was faulty, resulting in ongoing losses that are now well into the millions of dollars. The failure happened years ago and rectification is still ongoing.
Millions of dollars have been spent to (1) mitigate the loss and (2) rectify the failure. The party responsible for the design (remember this was outsourced by the builder) isn’t taking responsibility for the issue, so no rectification work has been done by the design contractor nor has any compensation been paid to the builder for the faulty design.
So who is at fault? The entire design was outsourced, so the design contractor (and the design contractor’s insurance) should respond correct? In theory, yes, but what if they don’t? What if they deny liability, or don’t have the correct insurance in place, have used up the limit of their liability, or they’ve since gone into administration? The legal proceedings to recover from the design contractor could take years and even then, the full amount may never be recovered (if anything is recovered at all).\
What happens in the meantime? Is the principal going to wait while the builder takes the design contractor to court? Does the project go on hold indetinitely while this is dragged through the courts? The answer to that is clear. The principal wants its project completed on time and in accordance with its requirements.
In this example above, what’s happening in the meantime is exactly that. The principal doesn’t care that the builder outsourced the design. Its contract to design and construct the building is with the builder, not the design contractor. The principal wants its building finished and the builder has to finish it or be in breach of contract. This means all the mitigation and re-design works are at the expense of the builder.
‘Step in’ the builder’s PI insurer. While the builder did not do the design, it is responsible for the design under the contract, making it responsible for design faults and rectitication of those faults. Fortunately, the builder’s insurer has granted indemnity, and direct costs associated with the failure and rectification are being paid.
Several lessons come out of this example.
- It’s essential to always check that your external consultants, designers, engineers, etc have PI insurance. If there is a design issue, the first port of call will be an action against the consultant and hopefully it (and/or its insurance policy) will respond. But it is critical that when signing D&C contracts, builders must hold PI insurance to protect themselves from claims such as in the example above.
- Is your broker one of those advising you that you don’t need PI insurance? If so, you should consider the advice you’re receiving carefully, as the above example shows you could be putting your business at serious risk.
- Further, it is critical that the right Pi policy is put in place with the correct extensions and endorsements. Some PI policies will not respond to the builder’s claim for mitigation and rectification costs.