Contractors often run into problems regarding professional indemnity insurance as they don't appreciate what cover is required. Appointing a specialist insurance broker is a good place to start, says Craig Smith

Contractors who enter into building contracts on a design and build basis commonly encounter problems regarding professional indemnity (PI) insurance. This is largely due to most contractors failing to appreciate what cover is required. These problems can be eased if contractors appoint a specialist insurance broker and openly discuss their requirements. After all, brokers can only procure insurance based on the information provided.

In many cases, design and build contractors do not undertake any design themselves. Design is either handled by professional consultants or by specialist sub-contractors, both of whom should maintain their own professional indemnity insurance. As such, design and build contractors often don't have their own design staff.

Notwithstanding this, the fact remains that the contractor has entered into a contract which makes them responsible for all design, even though it is carried out by others. This concept is reflected by the standard forms of design and build contract and extended further by bespoke schedules of amendments drafted by solicitors acting for the employer. Such amendments often seek to impose fitness for purpose obligations on the contractor.

Reasonable skill
This presents a problem for the contractor in that its PI policy only covers the contractor for the common law duty of care obligation of "reasonable skill and care". As such, the contractor could be found to have exercised reasonable skill and care but failed to achieve the higher fitness for purpose obligation, leaving the contractor uninsured for that higher duty.

Although 'design and build' contractors require PI insurance, the policy does not cover 'build' problems, that is, defective workmanship or materials.

Such risks may instead be covered by the contractors' all risks insurance policy. The professional indemnity insurance cover only extends to the professional activities of the contractor in terms of its design responsibilities, such as design, professional supervision and certifying. This is described as "professional activities" in the operative provisions of the policy.

It is possible for a dispute to arise over what constitutes design. For example, the technical documents incorporated into the design and build contract, such as a specification, often require the contractor to design as well as specify materials. Circumstances may arise where it becomes difficult to distinguish between damage caused by design and damage caused by a failure of materials.

Provided the contractor exercised reasonable skill and care in the design and in the selection of materials, the PI policy will not pay out. Instead, the contractor will either need to claim on a product liability insurance policy or claim against a policy taken out by the specialist sub-contractor or manufacturers. However, if the cause of the problem is unclear, PI insurers could pay out on a claim where the cause involved a failure of materials.

In light of the fact that many design and build contractors do not undertake design themselves, design and build PI policies commonly cover the legal liability of the contractor for work of its sub-contractors or sub-consultants. This is essential where the contractor is undertaking no design itself and is therefore devolving all of its design responsibility.

Obtain confirmation
It is, however, normally a condition of the sub-contractor extension that the contractor ensures that the sub-contractor or sub-consultant has adequate PI cover. In many cases, the contractor may be under an obligation to obtain confirmation of the sub-contractors PI insurance on an annual basis.

This is extremely important for a contractor, not just because it is a condition of its own PI policy but because the contractor needs to see that the sub-contractor or sub-consultant is insured, and therefore worth pursuing in the event of a problem. The contractor is likely to be the first port of call in the event of a claim by the employer.

The contractor will want to join the relevant sub-contractor or sub-consultant into any action so that the contractor's insurer does not pay out on a claim which should be directed elsewhere. If the contractor is diligent in its appointment of sub-contractors or sub-consultants, it should always be possible to pass the claim to an insured party further down the chain, provided of course that the negligent party is still trading and has maintained adequate cover to reflect its design responsibility.

Despite the introduction of the Contracts (Rights of Third Parties) Act (1999), collateral warranties remain a major feature with all construction parties. Many insurers have adopted a collateral warranty extension. However, this is unlikely to cover all warranty requirements and contractors need to check warranties carefully to see that it does not take them outside of the protection offered by their policy. Most insurers are not interested in reviewing or approving collateral warranties; the volume of documentation would be disproportionate.

However, disclosure of such warranties still remains a requirement under the duty of utmost good faith. In practice, contractors should discuss collateral warranties with their brokers and/or solicitors if they have any concerns.

Some professional indemnity insurance brokers are prepared to review and comment on proposed collateral warranties for their clients to see that the obligations are consistent with the protection offered under the policy.

As with bespoke schedules of amendments to building contracts, bespoke collateral warranties present a problem to 'design and build' contractors.

Such warranties are drafted from an employer's perspective and pay little regard to the contractors PI policy. Although a fitness for purpose obligation or an indemnity provision may give the beneficiary under a warranty some comfort, it should be remembered that such obligations are worthless if they take the contractor outside of the cover of its policy.

It is after all in the employer's interest to see that the contactor has an insured risk rather than one which is uninsured and could potentially put the contractor into insolvency. Unfortunately for contractors and insurers, employers are unlikely to abandon bespoke forms of contract and warranties any time soon. IT

Craig Smith is with Hugh James Solicitors