Legal Update: A Practical Guide to Construction Insurance ClaimsSep012004
The basic concept of construction insurance is simple. Insurance transfers the risk of defined unforeseen events from the contractor to its insurers.
However, a combination of poor drafting, a failure to ensure that the insurance contract reflects the construction contract and an increasingly complex legal background has often resulted in construction insurance claims becoming something of a mystery. This article attempts to solve that mystery and provides a simple practical approach to identify valid insurance claims.
This article is of particular relevance to insolvency practitioners who are required to review the merits of construction insurance claims, to contractors and to those involved in the insurance industry.
The starting point is the insurance contract. 1 It sounds a little obvious, but an insurance contract is exactly that – a contract. It is therefore generally subject to normal contract law principles. 2 The words used should generally be given their ordinary meaning and policies are increasingly interpreted in the light of their commercial objectives.
However a little caution is required when reviewing any policy. This is because:
- the language used is often very stylized and therefore difficult;
- certain words used might have a specific or a legal meaning; and
- terms, which might otherwise have a normal meaning, may be expressly defined in the policy. Any express definitions will prevail.
A Typical Insuring Clause
The exact scope of what is covered by a policy will vary from contract to contract and in practice there is no standard construction insurance policy. The following though is what might be described as a fairly typical insuring clause for the construction phase of a project used in Hong Kong:
The Insurers shall indemnify the Insured in respect of loss of or damage to the Insured Property described in the Schedule whilst at Site during the Period of Insurance arising from any cause whatsoever not hereinafter excluded.
The use of certain phrases, such as ‘from any cause whatsoever’ and ‘in respect of’ suggests that the policy provides wide coverage which is to the benefit of the contractor. The burden of proof will also assist the contractor. This is because it is the contractor who has the burden of proving that his claim falls within the fairly wide words of the insuring clause but it is the insurer who bears the burden of proving that an exception applies.3 It is common for the exceptions to be more precisely drafted.
However there are two main points that act as limitations on the extent of the insurance cover:
- The insuring clause set out above expressly covers only loss and damage – it does not cover, for example, defects – this is discussed in detail below.
- The policy does not cover any matter which is ‘not hereinafter excluded’ and it is the detail of the exclusions, which must be reviewed carefully.
The starting point with any insurance claim is to identify the cause of the loss. This is sometimes harder that it seems as any particular loss might have more than one cause. For instance, assume that some electrical components, which have been delivered to site but not yet installed, are damaged by a particularly heavy storm, rain water from which has managed to seep into the building. Is the cause of the damage, water or the storm? The policy might respond differently to both. Further is it possible that the damage was caused by a failure to properly protect the components? The true cause of the loss for the purposes of an insurance claim is not the last cause but the dominant or effective cause. 4 Where there are two causes and it is not possible to identify a single dominant cause, the loss will be covered by the policy if one of the causes is insured. 5 However if one cause is expressly covered and the other is expressly excluded, the loss will be excluded. 6 On a practical level, it is vital to ensure that the cause of the loss can be identified and objectively proved. In construction cases, this might require expert evidence. If so, the earlier this is obtained, the better. Do not leave it until litigation has started before instructing an expert. The submission of a good expert report could in itself convince insurers to pay the claim and the costs of litigation avoided.
What is Covered?
As we have already seen, construction insurance policies typically cover loss of or damage to the Insured Property. Loss and damage should be considered separately.
Although the word ‘loss’ can have a wide meaning and can cover financial loss or loss of use, generally ‘loss of the Insured Property’ will mean physical loss in the sense that part of the Insured Property that was physically present, is not now. Again, whether loss has a wider meaning will depend upon the exact words of the insuring clause.
Sometimes the word ‘loss’ is used in one sense for the insuring clause covering the construction period and used in a different sense for the insuring clause covering the defects liability or maintenance period.
Damage or Defect
Whether the Insured Property can be considered ‘damaged’ or ‘defective’ is one of the main areas of dispute under construction insurance policies.
As the Court of Appeal explained in Skanska v Egger 7, physical loss and damage is to be distinguished from defects in design, work, workmanship, materials and goods for which the contractor is expressly responsible for under the contract.
Skanska attempted to argue that the obligation on Egger to insure the Works, ‘against all loss and damage from whatever cause for which the Contractor is responsible under the contract’ extended to an obligation to insure for damage caused by defects in the floor slab. The court considered the nature of the construction contract and the commercial purpose of the insurance and found against Skanska. The court held that the obligation to insure under the contract in question only required Egger to insure for accidents and mishaps on site (ie damage) which would normally fall to the contractor to repair under the general obligation to take care of the works. It did not extend to an obligation to insure for defects.
Generally insurers include a specific exclusion in insurance contracts which seek to exclude defects in design, materials and workmanship. These exclusions need to be drafted and reviewed carefully, particularly where, as is regularly the case, the extent of the exclusions themselves is limited or subject to further exceptions. For instance, the defective workmanship exclusion could be worded to exclude defective works but not damage to other parts of the Insured Property caused by defective workmanship. Further questions could remain as to whether loss or damage caused by other categories of defects, such as defects in the specification are included or excluded.
The fact that insurance contracts allow claims resulting from defects which causes damage to other parts of the Insured Property has lead to arguments, which have divided the works into smaller and smaller parts. Some of these arguments have been successful. 8 However the courts have warned against the artificial division of parts of the works 9 and the contractors’ arguments have taken a serious dent with the case of Bacardi-Martini Beverages Ltd v Thomas Hardy Packaging Ltd 10 Although this is not a construction case, the principles are generally applicable.
In the Bacardi case, Bacardi had subcontracted the bottling of Bacardi Breezers to Thomas Hardy. Bacardi supplied most of the constituent ingredients, although Thomas Hardy was required to supply CO2, which it bought from Messer. Unfortunately Messer supplied CO2 contaminated with benzene, which was inadvertently introduced into the Bacardi Breezers. Once the contamination was discovered, the drinks were recalled and losses in excess of GBP 2 million were sustained.
The contract between Thomas Hardy and Messer included a limitation of liability clause which sought to limit Messer’s liability for physical damage to property to GBP 500,000. In an action for breach of contract, Messer attempted to rely on the exclusion clause by arguing that the introduction of benzene damaged the concentrate mixture. The English Court of Appeal decided that the exclusion clauses did not apply. The court stated that although it might be possible to speak of the mix of Bacardi concentrate as having been damaged by being admixed with the CO2 contaminated with benzene, the more natural view is that the mix of concentrate and water ceased to exist and the finished product came into existence at the moment of such admixture. What resulted was not damaged concentrate and water but a defective new product.
The Bacardi case could be subject to criticism. For instance, what would the position be if a separate ingredient was added to the concentrate purely by mistake or what if the concentrate was deliberately contaminated and the contamination was discovered prior to the completion of the manufacturing process?
However the Skanska and Bacardi cases can be seen to evidence a trend. These cases in effect apply the reasoning in Murphy v Brentwood 11 in which the House of Lords decided against an application of the complex structure theory – ie that one part of a building could be damaged by another part.
For insurance claims, until the trend established by the Bacardi case is reversed, in order to establish a claim for damage to property caused by a defect, claimants should ensure that they can identify a clear demarcation between the defective property and the damaged property.
1. The phrase ‘insurance policy’ will be used in this article to mean the contract, but it should be remembered that other documents are likely to comprise the whole contract and at the very least, it will be necessary to review the policy with any schedules and endorsements.
2. Drinkwater v Corp of the London Assurance (1767) 2 Wils 363
3. Hercules Ins Co v Hunter (1836) 14 S. 1137
4. Bovis Construction Co v Commercial Union Assce Co  1 Lloyds Rep 416
5. Miss Jay Jay  1 Lloyds Rep 32
6. Wayne Tank and Pump Co v Employers’ Liability Assurance Corporation  QB 57
7.  BLR 236
8. see Graham Evans v Vanguard Insurance Co Ltd (1986) 4 ANZ Ins Cas
9. see Skanska v Egger  BLR 238 para 33
10.  2 Lloyds Rep 379
11.  AC 398