Building contractors are increasingly taking on a design liability, either by employing their own designers in-house or by assuming a liability when sub-contracting out the design element. This is called Design & Construct (or Design & Build) and it requires a specific type of professional indemnity (PI) insurance cover.
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Read our Guide to Design & Construct Insurance
Whether you are a new-start business or already buying professional indemnity insurance, our guide covers the following key points:
- What is Design and Construct (D&C) Professional Indemnity Insurance
- What does a D&C policy typically cover
- Examples of work covered by this insurance
- Examples of Design and Construct claims
- Collateral Warranties
- The 'claims made' policy wording
What is Design and Construct Professional Indemnity Insurance?
Contractors are increasingly taking on a design liability by employing their own in-house professionals or by assuming a liability when they sub-contract out the design element.
When you undertake contracts on a design and construct basis it is you who will be the client's target in the event of a design related problem. Even if a claim is ultimately the responsibility of another party, the costs of redirecting the liability can be high and success is far from guaranteed. You will be responsible regardless of your ability to enforce an action against the negligent party. This is where a Design & Construct (or Design & Build) PI insurance policy comes in - protecting your finances and your relationship with your client.
Many clients now expect even the smallest of construction firms and contractors to hold this important class of insurance.
What Does a D&C Policy Cover?
The cover afforded by a PI policy depends on the wording of the policy itself, any endorsements etc. A typical policy will cover you against any sum (up to the limit of indemnity) which you are legally liable to pay arising from any claim made during the period of insurance by reason of negligence or breach of duty arising from the conduct of your professional business. Whether the policy only covers claims for negligence (in contract or tort) or is wider and covers breach of professional duty or civil liability depends on the wording. Fitness for purpose obligations or indemnities are often specifically excluded, as are liquidated damages.
Cover will typically include:
- Claims made against the Insured arising from
- Breach of professional duty
- Any negligent act error or omission
- Dishonesty of employees
- Libel or slander
- Loss of or damage to documents
- Prosecution defence costs - no excess applicable
- Collateral Warranties
- Costs and expenses taken to mitigate a loss
- Compensation for court attendance
- Defence costs (lawyers, court costs, experts etc.) inclusive of the Indemnity Limit
- Aggregate limit of indemnity
Examples of Work Covered by Design and Construct
- Full blown design and build - this is where the contractor does everything using its own employees i.e. all the design work, the supervision of construction and the building work. The professional exposures are the same as a consultant within the construction industry.
- Contingent design and build - This is where the contractor takes on the contractual responsibility for the design but sub contracts out such work to others. The design work would be carried out by firms of architects and engineers who should carry their own professional indemnity. In view of the fact that insurers should be able to recover payments from those professionals who have carried out the negligent work, (any payments made emanating from their negligence) this is regarded as lower risk. It is vital here that the contractor ensures that any consultants it employs carry, and continue to carry, PI insurance.
- Pure contracting - This is where the contractor purely builds from the designs and under the supervision of other professionals who have been appointed directly by the client. This is considered by insurers as low risk work but is not without its dangers. See 'Hidden Exposures' below.
- Hidden exposures - Frequently contractors who offer no design services at all are being asked to carry professional indemnity. A question they often ask is 'what risks do I face if I offer no professional services. The answer is that there are some risks:
- Design alterations: any firm involved in building anything will nearly always need to 'tweak' the plans a little in order to make them work. You could call this 'buildability' and the problem is that a small alteration here could have a larger knock-on effect, thus causing a real problem later in the job. A real liability can arise if plans are altered.
- Design checking services: often firms, formally or informally, double check designs to ensure they work. Failure to do so can lead to a claim.
- Temporary works: scaffolding, access roads, perimeter fencing, storage facilities are often part and parcel of a contract but are not designed and are left to the contractor. Such works can be expensive and can go wrong leading to further expense and consequential loss.
- Unsuitability of materials: Contractors may erroneously utilise materials that do not meet the specifications and have not been agreed. This can be very expensive if the materials prove not to be fit for the purpose intended.
- Duty to warn: a duty to warn the client of any problems or errors that the contractor might become aware of is sometimes included in the contract. Failure to warn when one is aware could lead to a liability and a claim under a PI policy.
- Fees - Sometimes a contractor earns fees (as opposed to turnover which is the correct description for the three categories above). They might project manage for other contractors or carry out other professional functions such as design or quantity surveying. These activities would be rated the same as a professional firm carrying them out.
Examples of Design and Construct Claims
Professional negligence claims are surprisingly common in the construction world. Claims can be extremely costly, even when the designer is not at fault. We’ve selected some examples of claims under design and construct policies that we feel most firms involved in this sector will relate to, whether they are a small or large business.
1. Background - Contractors provided their client with a design and build service in respect of the construction of a quarry conveyor belt, capable of carrying tonnes of material. The design of the system was subcontracted out to specialists. When the conveyor belt machinery failed, substantial damage was caused. Outcome - Although the subcontractor was blamed for poor design, the claim was settled against the main contractor for £75,000.
2. Background - A shop-fitting contractor was verbally instructed by their client's project engineer not to use galvanised steel which was in the their agreed specification, due to the lack of time available. The client subsequently they had never authorised this change in specification and there was nothing was in writing and sued for negligence. Outcome - The claim was for over £150,000 and although the claim was successfully defended, significant defence costs were paid for under their D&C policy.
3. Background - Contractors were instructed in the role of project managers on an existing but uncompleted development where there had been a problem due to the bankruptcy of the original contractors. The project involved restarting the development i.e getting the project back on track and utilising the previous designs, but with a new professional team. Allegations of negligence arose concerning the duplication of work carried out by the original team and the new team, This led to an over-run on the contract budget. Outcome - Insurers appointed specialist solicitors to act for the contractors. Outcome - A settlement of £126,000 was agreed plus defence costs of £36,000.
4. Background - The contractor was employed on a design and build basis to construct a hotel and the design works were subcontracted to a firm of architects. Clear design errors became apparent during the construction of the hotel, leading to various rectification costs and long delays. The architect had also ceased trading during the construction process. The architect’s professional indemnity insurance failed to respond and so the contractor was left responsible for their clients losses. Outcome - Solicitors were appointed to investigate and deal with the claim. The contractors's D&C policy paid £700,000 plus defence costs of £150,000.
Collateral Warranties
These are contractual agreements between parties who otherwise might not be in a contractual arrangement. In the case of a contractor it is unlikely he will have a contractual relationship with the purchaser of the building or the eventual tenant. It is possible that the building is funded by a bank or some other financial institution and again the contractor is unlikely to have a contractual relationship.
A Collateral Warranty creates a contractual relationship between the contractor and these parties which reflects the responsibilities that the contractor has to his client. These agreements can also be assigned meaning that their benefits can be passed on from one owner or tenant to the next. Very often they only stop when the limitation period expires and this is likely to be 12 years after the date of practical completion. So now the contractor can be pursued by parties other than his client. PI Insurers generally take the view that they will accept claims arising from sensibly worded agreements. Insurers regard the acceptance of contractual liability beyond that normally owed by a professional to be beyond the intention of a PI policy. Therefore, unreasonable agreements could have very damaging effects on professionals, leaving them without cover.
Most PI policies address the issue of collateral warranties by clearly setting out the limits beyond which cover will not apply. This should avoid the need to submit each and every agreement for sanction by the insurer. Some of the more restricted policies offer very little cover in connection with this type of agreement.
Of course, the 'claims made' (see Claims Made section below) nature of professional indemnity insurance causes a difficulty here. If a contractor signs up to a collateral warranty having reassured themself that it is within the scope of his PI cover, what happens when they change insurer? Or what if the insurer changes the wording?
Careful consideration also needs to be given in cases where a collateral warranty requires you to carry a limit of indemnity higher than you normally would, as you will be committing yourself to carry a higher level of cover for the duration of the contract (usually 12 years) this can add significant costs to the PI premiums.
'Claims made' policy wording
PI policies are annually renewable and are underwritten on a 'claims made' basis, in contrast to many other types of insurance. This means that the insurers who pay the claim are those providing cover when the claim, or a circumstances which might give rise to a claim, is first notified to insurers, rather than when the work was undertaken or the mistake made. The significance of this can be seen: the cover might be wider when a contract is entered into than when a claim is made. Cover only operates from the retroactive date.
Indeed, you may have entered into contracts in the past which are not fully covered by your current insurance, or which you can only cover on payment of an additional premium. When negotiating with clients therefore, you will want to avoid agreeing to potential liabilities for which you might not be able to get insurance in the future. This might mean restricting the services you provide, or excluding or limiting liability. If you take on liabilities which in the event are not covered by insurance, both you and your client are likely to suffer.
You will also want to check the insurance clause in any contract, and include caveats such as 'provided that such insurance is available at reasonable commercial rates'. A further example of the effect of a claims made policy is that if a claim is made against a retired professional who is no longer covered by a current insurance policy, there will be no insurance for that claim. On retirement therefore, you need to ensure that insurance is maintained - either under your former firm's policy or your own run-off policy.
This guidance note is intended for information purposes only. It is not and does not purport to be legal advice or specific insurance advice. Whilst all care was taken to ensure its accuracy at the time of writing it is not to be regarded as a substitute for specific advice. If you require specific advice, please contact your brokers or call us on 0345 251 4000. This guidance note shall not be reproduced in any form without our prior permission. © All copyright is owned by Professional Indemnity Insurance Brokers Ltd.