This article was produced by Olswang LLP, which joined with CMS on 1 May 2017.
I mentioned in my last blog on the Latent Damage Act that I was seeing an increase in interest in latent defects insurance. This interest is coming from both buyers who are expecting policies to be in place when they purchase new or nearly new buildings and developers who are putting these in place (in addition third party rights (“TPRs”) and/or collateral warranties) in order to make their developments more attractive to future purchasers.
I thought it would therefore be helpful to provide a summary of what this type of insurance generally covers and what it doesn’t.
As my previous blog explained, latent defects are defects that aren’t immediately apparent in a building and which cannot be discovered by reasonable inspection. Taking out specific insurance cover against these types of defects provides you with protection (up to the level specified in your policy (usually the reinstatement value of the building)) for certain types of inherent defects discovered after practical completion of a development has been reached. The benefits are straightforward. Firstly, it is a no-fault policy so if a defect exists and is covered under the policy, you simply notify the insurers. This contrasts with TPRs/collateral warranties where you’ll need to spend time and money proving that a contractor/consultant’s terms of contract have been breached in order to begin to reach a position where the defect can be remedied. In addition, the cover is usually freely assignable and can be passed on to future owners during the policy period (usually between 10 and 12 years). TPRs/collateral warranties can include restrictions on the number of assignments they allow. Finally (and perhaps most importantly) the reassurance of having an insurer’s covenant strength as back up may be more comfort than that of the contractor/consultant. This must be particularly the case in the current climate where there have been a number of high profile administrations and where some of the biggest contractors are having well-documented financial difficulties. The value of a comprehensive set of third party rights/collateral warranties can be significantly devalued if certain members are insolvent.
However, there are also some significant drawbacks to latent defects insurance policies, not least the fact that only certain types of losses are included as part of the policy. A typical latent defects insurance policy will cover defects to the structure/building envelope only, so if a defect is discovered that isn’t structural (such as a mechanical and electrical fault) this will often not be covered. Aesthetic defects such as staining to cladding or general poor performance of the building will also not be covered. Also, whilst there can be specific (tightly drafted) ‘add-on’ policies that you can purchase to cover some consequential losses, these will not otherwise be covered. These could include loss of rent, relocation costs or loss of profit and, depending on the nature of the building, these can be extremely high. This contrasts with the protection that you’d usually get from a standard set of third party rights or collateral warranty, which will usually cover all types of losses stemming from the breach in contract.
The ease of making a claim under a latent defects insurance policy very clearly makes a strong argument for taking a policy out if you can. But, a developer or purchaser should be aware that there may well be significant gaps in their construction protection if they don’t also have a back-up of a comprehensive set of third party rights/collateral warranties in place as well.
