Construction claims - Lumbermens Mutual Casualty Company v Bovis Lend Lease Limited

The recent decision of Mr Justice Colman in the Commercial Court in Lumbermens Mutual Casualty Company v Bovis Lend Lease Limited provides some salutary lessons for those advising contractors on the settlement of construction claims and for those setting up contractor's professional indemnity policies and handling claims under them.

The dispute between Bovis Lend Lease and their Insurers arose out of the settlement of a separate action between Bovis and Braehead Glasgow Limited in relation to the final account for the construction of a retail and leisure centre in Glasgow. To cut a very long story short, Bovis had claimed £37,778,266 from Braehead and Braehead had promptly counterclaimed, in the alternative, £103,594,367 or £75,770,225. A settlement was ultimately achieved on the basis of a payment by Braehead to Bovis of £15 million in full and final settlement of all disputes under the building contract. Some of these disputes related to allegations covered under Bovis' PI cover; others arguably did not. The method of calculation of the £15 million figure was not identified in the settlement agreement. Bovis then sought to recover £19,463,221 from their professional indemnity insurers on the basis of an assessment by their solicitors of the value of the insured element of the counterclaim brought by Braehead. The PI Insurers promptly issued declaratory proceedings in the Commercial Court by maintaining that they had no liability to pay any part of the £19,463,221 claimed.

Directions were given under declaratory proceedings for a hearing of preliminary issues. In very broad terms, the first two issues revolved around whether the Settlement Agreement reached with Braehead had any relevance at all to the ascertainment of Bovis' loss. The third and fourth issues related to the proper interpretation of the insuring clause.

Colman J's decision was as follows:

An Insured under a liability policy needs to establish three constituents before he can show that the Insurer is under an obligation to indemnify the Insured in respect of particular sums paid in settlement of a liability to a third party. These were as follows:

"Firstly, there has to have occurred an eventuality which has rendered the Insured liable to a third party. Secondly, the eventuality and the consequent liability has to be within the scope of the cover provided by the policy. Thirdly, it must be established that such liability has caused loss to the Insured of an amount within the scope of the contractual indemnity"

Colman J found that where a settlement was entered into which did not distinguish between insured and uninsured heads of claim the settlement agreement itself was of no evidential value to the ascertainment of indemnifiable liability under the policy. Rather, it was incumbent on the Insured to establish that he did in fact have a liability to the relevant third party in respect of insured heads of claim and the amount of the damages properly payable in respect of such liability.

Bovis' policy contained two separate operative clauses. Insuring clause 1 covered Bovis in respect of liability arising in respect of claims made "as a result of any neglect, error or omission" in the performance of the insured activities. Insuring clause 2 of the policy provided breach of warranty and fitness for purpose cover, but only (per Memorandum 7 (i) of the Policy) where the relevant contract was disclosed to Insurers by means of an annual declaration to be made by the Insured prior to the expiry of the period of insurance. (No such declaration was made in respect of the Braehead contract).

Colman J construed these clauses in the following way:

Cover in respect of "neglect, error or omission" extended beyond mere negligence but did not embrace deliberate acts or omissions by the Insured. This followed a relatively conventional line of authority including George Wimpey & Co Limited v DV Poole.

Proper construction of Insuring Clause 1 read together with Insuring Clause 2 was, however, that the latter was intended to apply to any claim for breach of contract and the former to "liabilities which may arise independently of constituting a breach of contract". Colman J then gave an example of how Insuring Clause 1 was to work in the following scenario:

"… If the Assured can be sued in tort for non-deliberate neglect or error or omission or for non-deliberate breach of warranty of authority without formulating the claim as one for breach of any contract between the Assured and a third party, there will be cover under Clause 1, subject to the other provisions of the policy"

Because, as a matter of fact, Bovis had not declared the Braehead contract in accordance with Memorandum 7(i) of the Policy there was no cover under Insuring Clause 2 and, to the extent that the liability arose exclusively as a result of Clause 2.5.2.5 as a building contract (which attested to the fitness or suitability of any work or materials used for the works), the claim was unsustainable under the policy because it could not be brought independently of the contract.

There are clearly some lessons to be learnt from this Judgment.

The first is that if one is a contractor who wishes to keep open the possibility of passing part of the financial cost of a settlement of a claim which includes insured and uninsured elements to PI Insurers it is vital that Insurers are pulled into the process of evaluating the claim and are tied into a specific contribution to any settlement ultimately achieved with the Claimant. If it proves impossible to tie the Insurers into the deal an attempt could be made to agree with the Claimant an agreed split of the settlement sum between covered and non-covered heads of claim. This is, however, very much a second best option for the following reasons:

• The Claimant will inevitably extract a price for such an arrangement: there is no reason from the perspective of his claim why such an apportionment should be needed.
• It is clear from Colman J's evidence that the allocation will need to be verifiable. This means that it must be supported either by a plausible assessment of the insured element which is agreed by both Claimant Insured or by other evidence (which may, at the time of settlement, only be in the possession of the Claimant).

If no deal on apportionment to insured and uninsured heads of loss is struck

with the Claimant it looks very much from Colman J's judgment as though the Insured is well and truly snookered. There will be no judgment, award or final adjudication, the settlement agreement will not trigger an entitlement to indemnity and it does not even appear that there is scope for the Insured to bring home his claim by showing that, but for the settlement, the claim against him would have succeeded. On the face of it this appears a pretty unjust result.

The decision also has significant implications for the drafting of design & construct professional indemnity policies.

The first point is that in spite of the fact that there has been authority in existence for decades to the effect that the formulation "neglect, error or omission" extends beyond mere negligence, professional indemnity insurers have consistently included it in policy wordings that are not intended to extend this far. In part this has been the result of broker pressure in a soft market but there is no real justification for the practice being perpetuated in the current hard one.

The second point is that while the "two part" drafting of Bovis' operative clause is somewhat unusual, there is a good prospect that Colman J's logic in the interpretation of Insuring Clause 1 (covering "neglect, error or omission") would also extend to such a clause that existed in isolation without a second insuring provision which gave the Insured cover in respect of fitness for purpose obligations under specific contracts by annual declaration. If that logic was to be applied, the practical effect would be to limit the Insured's right of indemnity to claims that could otherwise be brought in tort or for breach of statutory duty and that would effectively rule out the possibility of indemnification in respect of claims for pure economic loss.

It has to be said that construing a simple "neglect, error or omission" insuring clause so as to exclude pure economic loss would be contrary to what most current UK PI Insurers would regard as the mutual contractual intent. It is frequently stated that one of the features of professional indemnity cover is specifically that it does provide a measure of protection in respect of contractual claims for pure economic loss, albeit not contractual claims which are brought on the basis of the breach of an express contractual warranty or guarantee. If, in any given policy going forward, the intention is to cover claims for pure economic loss but to exclude claims brought solely on the basis of a breach of a strict obligation of fitness for purpose those advising the Insured on policy wordings do need to pay considerable attention to revisions to the standard wordings to make that intention clear.

The decision of Colman J is subject to appeal.