Defect and damage in contractors all-risk insurance: recent developments

Stephen Tester comments

CAR policies that follow the London Market model commonly contain exclusions
in respect of damage resulting from deficiencies in design materials
specification and workmanship. There is then a myriad of different wordings
which give back cover to the Insured for consequential damage over and above
the cost of rectifying the particular defect which has caused the problem.
The basic objective here is to exclude the risk of underwriting the
contractor's design and workmanship - the former being more appropriately
the subject of a professional indemnity policy and the latter being
uninsurable.

Five variations on this theme (the DE(1995) exclusions) are set out below.
Although alternatives DE1 (1995) and DE2 (1995) are the broadest exclusions
it is unusual in a major project to find anything less favourable to the
Insured than DE3 (1995). Before deciding whether it is worth paying the
additional premium that Insurers will demand for the narrower DE5 (1995)
exclusion (which broadly covers only the additional cost of upgrading the
design following the discovery of a design deficiency) it is necessary to
assess precisely how much protection is provided by a policy that contains
the DE3 (1995) exclusion.

Rather more by luck than judgment (because the Court found that the use of
the word 'part' in previous authorities was a mere coincidence of
expression) some assistance has been provided in this respect by the
decision of the Court of Appeal in The Nukila in 1998. This case involved
spudcans on the base of the legs of a drilling platform operating in the
Ardjuna field in the Java Sea. The purpose of the spudcans was to enable
the platform to sit squarely and firmly on the sea bed. There was a problem
with the welding in the spudcans which ultimately manifested itself in
cracks in the welds themselves which gradually spread into the column of the
legs and then into the top plate, internal diaphragms and bulkheads of the
spudcans. The Court of Appeal, reversing the decision of Tuckey J at first
instance, found that there had been damage to the legs of the platform (as
opposed to a latent defect becoming patent) and that this was sufficient to
resolve the case in favour of the Insured. If and insofar as it was
relevant to decide whether the welds formed a different and distinct part of
the construction from the elements close to them the finding was that the
welds constituted a separate part. The Court of Appeal rejected a test
applied at first instance which assessed whether a part was separate by
deciding whether it performed a separate function within the whole.

If the Nukila decision is indicative of the attitude of the Courts towards a
claim of this sort it is likely that clauses such as DE3 (1995) will be
construed narrowly against the Insurers.

Our own view, in light of the Nukila decision, is that DE4 (1995) provides
little in the way of additional protection to the Insured over and above DE3
(1995).

It should be noted that Exclusion DE5 (1995) gives rise to a number of
problems of construction all of its own. In particular it is unclear
whether the additional costs of rectifying a design extend to the cost of
gaining access to and replacing the defective
element and making good afterwards even if these overlap with the costs of
dealing with consequential damage. The decision of the Court of Appeal in
the Wayne Tank case might provide some authority for the suggestion that
they do.

The practical problems of interpretation posed by the DE Exclusions have
caused the London Engineering Group to issue a further exclusion the effect
of which is to require the adjuster to assess the costs that would have been
incurred if the design deficiency had been discovered immediately before it
caused damage. Although we have certain views about the extent to which
this clause achieves its basic purpose this may have the merit of providing
a workable formula in at least some of the more problematic cases.

Perhaps the best practical guidance that can be given to an insured when
looking at the operative clause and the design exclusion for contract works
cover is to analyse precisely what is required. In particular:

• Is there a particular type of loss that he wants to cover?
• If so can it be covered specifically if there is any doubt about whether it constitutes damage?
• Are the consultants who are likely to be instructed already adequately protected by their professional indemnity insurance against the risk of claims for negligent design (in which case there must be questions as to the value of paying the additional premium for the wider DE5 (1995) type protection). De Wordings (1995) Outright defect exclusion DE 1 (1995) This policy excludes loss of or damage to the Property Insured due to defective design plan specification materials or workmanship. Extended defective condition exclusion DE 2 (1995) This policy excludes loss of or damage to and the cost necessary to replace repair or rectify: Property Insured which is in a defective condition due to a defect in design plan specification materials or workmanship of such Property Insured or any part thereof Property Insured which relies for its support or stability on (a) above Property Insured lost or damaged to enable the replacement repair or rectification of Property Insured excluded by (a) and (b) above Exclusion (a) and (b) above shall not apply to other Property Insured which is free of the defective condition but is damaged in consequence thereof. For the purpose of the Policy and not merely this Exclusion the Property Insured shall not be regarded as lost or damaged solely by virtue of the existence of any defect in design plan specification materials or workmanship in the Property Insured or any part thereof. Limited defective condition exclusion DE 3 (1995) This policy excludes loss of or damage to and the cost necessary to replace, repair or rectify. Property Insured which is in a defective condition due to a defect in design plan specification materials or workmanship of such Property Insured or any part thereof. Property Insured lost or damaged to enable the replacement repair or rectification of Property Insured excluded by (a) above. Exclusion (a) above shall not apply to other Property Insured which is free of the defective condition but is damaged in consequence thereof. For the purposes of the Policy and not merely this Exclusion the Property Insured shall not be regarded as lost or damaged solely by virtue of the existence of any defect in design plan specification materials or workmanship in the Property Insured or any part thereof. Defective part exclusion DE 4 (1995) This Policy excludes loss of or damage to and the cost necessary to replace, repair or rectify: Any component part or individual item of the Property Insured which is defective in design plan specification material or workmanship. Property Insured lost or damaged to enable the replacement repair or rectification of Property Insured excluded by (a) above. Exclusion (a) above shall not apply to other parts or items of Property Insured which are free from defect but are damaged in consequence thereof. For the purpose of the Policy and not merely this Exclusion the Property Insured shall not be regarded as lost or damaged solely by virtue of the existence of any defect in design plan specification materials or workmanship in the Property Insured or any part thereof. Design improvement exclusion DE 5 (1995) This Policy excludes: The cost necessary to replace repair or rectify any Property Insured which is defective in design plan specification materials or workmanship. Loss or damage to the Property Insured caused to enable replacement repair or rectification of such defective Property Insured. But should damage to the Property Insured which is free of such defective condition (other than damage as defined in (b) above) result from such a defect this exclusion shall be limited to the costs of additional work resulting from and the additional costs of improvements to the original design plan specification materials or workmanship. For the purpose of the policy and not merely this Exclusion the Property Insured shall not be regarded as lost or damaged solely by virtue of the existence of any defect in design plan specification materials or workmanship in the Property Insured or any part thereof.