08 December 2023
Case Study:
Construction Defects
The insurance coverage provided for “defects” and how it applies to claims scenarios is one of the core areas of our business as construction insurance advisors and brokers, and one of the most complex. When disputed cases come to court, there is much interest in how these are interpreted, and there have been two recent cases; one in the US and one in the UK, which we provide high-level details of below.
Construction / Erection All Risks (CAR) insurance is termed Builder’s Risk Insurance in the US, but the subject matter is the same. In the legal cases below, we will use their respective regional terms. These policies are designed to insure damage to the construction works. If damage is not caused by fire or natural perils such as storm, flood or earthquake, then in a very high percentage of cases, other losses are caused by defects of some kind, hence why this element of cover has the focus that it does.
We typically think of defects applying to construction in terms of:
- Defects in the design
- Defects in the plans or specifications
- Defects in the materials
- Defects in the workmanship; the way in which the project works have been executed.
It is important to consider that CAR insurance cover is only provided for damage and not purely for the existence of a defect. Once you get into the finer details of a claim it is also important to consider the variation in cover available for each project party relating to the fact that some of the above defects may well have manifested outside of the construction period, and/or away from the project site.
In light of all of the above, there are a range of defects exclusions designed to define and tier the level of cover provided by insurers; from LEG1 to LEG3, DE1 to DE5 and other insurer-produced policy wording clauses/covers. DE simply stands for “Defects Exclusion” and this suite of clauses was created in the early 1980s. The LEG (London Engineering Group) clauses were created in the mid-1990s to address the perceived slightly differing approach that defects clauses needed to take to align with the larger engineering risks and the associated supply/warranty agreements which accompany them.
All of the above is outside the scope of this update but please get in touch if you’d like more details on defects clauses, how they are applied to CAR insurance policies, and the impact that this may have on your contract agreements and other required insurances.
Sky UK Limited & Mace Limited v Riverstone Managing Agency Limited & Others [2023] EWHC 1207 (Comm)
The claim in this case related to the remedial works required to be carried out to the roof at Sky Central; BskyB’s flagship building, housing over 3,500 employees. The building also features Europe’s largest flat timber roof.
The roof comprised 472 prefabricated wooden “cassettes” supported on glue laminated timber beams. These were installed between December 2014 and May 2015 and subsequently suffered water ingress following substantial rainfall pending completion of the permanent waterproofing. Although attempts were previously made to dry out the cassettes, these were only partially successful. At the time of coming to court there was some debate around the remediation approach, and the sum that would be required to remediate the issue but all options were in excess of GBP100m.
The policy had DE5 coverage, being the widest standard cover available to the claimant. DE5 only excludes improvement/betterment costs but the exact application of the clause was not a subject for debate here. The case primarily focussed on whether damage had occurred, and the number of incidents (given that multi applications of the policy deductible would have a major impact on the claim amount). It is beyond the scope of this brief update to comment on discussions around the timing of the events and the rights to insurance coverage under the construction contract terms, and these do not affect the core consideration of the coverage for damage.
The judge determined that physical damage occurred once water entered the roof cassettes on the basis that “the entry of moisture into the cassettes during the Period of Insurance is in my view a tangible physical change to the cassette as long as the presence of the water, if left unattended, would affect the structural stability, strength or functionality or useable life of the cassettes during the Period of Insurance or would do so if left unremedied”.
The applicable number of deductibles and what defines the “component part” is an increasingly discussed element of cover in light of the increased usage of modular units in modern construction and so the judge’s approach to this element was a topic of much focus. The insurers were suggesting that the damage to each of the 472 cassettes was a separate “event” and hence a deductible would apply to each. The insured was claiming for one event – the decision not to use a temporary waterproofing system during installation of the roof cassettes. Ultimately the judge ruled in favour of the insured with one single deductible applying to the claim, relating this to the language of the DE5 clause. Mr Justice Pelling said that, in this policy, when recovering a claim under DE5, the “single unifying event must be an error or omission in the design plan specification materials or workmanship of the property Insured that has suffered damage as a result of such defect”.
South Capitol Bridgebuilders v Lexington Insurance Company, No. 21-cv-1436, 2023 US Dist. LEXIS 176573 (D.D.C. Sep 29, 2023)
Meanwhile, in the United States the legal interpretation of another defects case has become a source of increasing interest in the industry.
The Frederick Douglas Memorial Bridge in Washington DC is a 490m long, 6 traffic lane through-type arch bridge consisting of three sets of white arches with concrete abutments and piers that formed the subject matter of this CAR claim. Construction took place between 2018 and 2021 and South Capital Bridgebuilders (SCB) were the appointed contractor and responsible for procuring the CAR coverage for the project.
In order to ensure even placement of the concrete within the formwork, workers were required to vibrate the mix so as to ensure uniform distribution. However, errors were made during this process and as a result there were significant and visible deficiencies in the structure known as “voiding” and “honeycombing”. As a result, SCB needed to replace substantial sections of these support structures and subsequently claimed for the costs under the CAR policy which contained a LEG3 clause; offering the widest form of coverage aligned to DE5 above.
This case revolved around the interpretation of “damage” which is often a complex and controversial topic when it comes to concrete mixes, as seen in Skanska Construction UK Ltd v Egger (Barony) Ltd, following which the original 1996 drafted LEG3 clause was updated to LEG3/06, to include reference to damage being defined as a “patent detrimental change in the physical condition of the insured property”.
In this latest case LEG3/06 was the applicable clause on the policy and there was no further damage definition within the core CAR policy wording. As a consequence the judge, operating under Illinois law, referred to Black’s Legal Dictionary and determined that there had been “a bad effect on something” – namely the decreased load-bearing capacity of the bridge - and therefore cover was granted. Further to this, the court referenced the wording of the LEG3 clause; noting their view that “it was undoubtedly obvious or apparent that there was a detrimental change in condition.”
Some of the assumptions and comments made within this case have concerned insurers. The transition of a correctly mixed concrete mix to a deficient cured product may be a subject for debate in many jurisdictions but in this case the judge provided a wide definition of damage so as to include any “bad effect” on the construction works. Not only did this interpretation make the CAR damage claim a certainty for the claimant but it also could have wider ramifications if the subject matter of a CAR policy is interpreted to go beyond physical damage and respond to any “bad effect” on the project works. In this case there certainly appears to have been some drafting issues that could have been easily remedied; namely the omission to define “damage” which is the critical trigger for cover under the policy, and the replacement of only part of the original policy defects exclusion. LEG3/06 replaced Exclusion C) only whilst Exclusion B) remained part of the policy and still contained an exclusion for faulty or defective workmanship; a “scrivener’s error” as the judge described it.
In both of the above cases, it is important to consider that each ruling location of law and jurisdiction may interpret each case differently. Therefore the cases should not be considered to apply worldwide, but they inform our knowledge and expectations if and when future cases do come to court. In light of insurers’ concerns above, it is clear that there will be a negative reaction from the insurance market especially with regards to US projects; it is important that your broker understands the issues on both sides and can work with all parties to come to the optimal solution for you for existing and future placements.
The US case also reminds us of the importance to ensure that the correct care and attention is put into bespoke policy drafting by a competent professional insurance advisor to ensure clarity of coverage and contract certainty.
If you would like to discuss this matter or anything else in more detail, please get in touch.
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