Onerous Contractual Requirements with Regard to Insurance – How can Contractors and Employers avoid Potential Conflicts
This is a synopsis of a talk given to the Lighthouse Club on 17 October 2005.
Increasing costs of insurance and increasing demands from employers have led to some very practical difficulties for contractors. This paper will set out some main underlying themes and then discuss two specific provisions which are currently causing problems for contractors.
There is a view that insurance is an unnecessary evil. Insurance is something you don’t really want, don’t think you need but you are required to obtain.
You might not even know who the insurers are. You might know the name of your broker, but not the insurer or anyone who works there. Worse still, you might not even know what you have bought. There are difficulties in first obtaining a copy of the insurance policy and then in reading and understanding it.
This somewhat pessimistic introduction leads into the two main messages of this paper.
1. Insurance is part of a Risk Management Plan
First, insurance is neither unnecessary nor evil. It is essential. For the employer, it ensures that the contractual indemnities are backed by a financial institution that can afford to pay. For the contractor, it provides the necessary degree of protection to ensure that he has the means to pay in the event that fire sweeps through the site.
But insurance can be so much more. It’s an effective way of managing the risks that you accept under your construction contracts. However you cannot manage your risks until after you have thought about what they are. Before buying any commercial insurance, you need to give some prior thought as to what you want to buy and why. Your insurance requirements need to be considered as part of your overall strategy for risk management and should not stand alone outside of a risk management policy. Insurance requirements also need to be reviewed regularly. Using standard contract wording, without any thought as to whether it is still relevant, is bound to end up in a dispute of some kind.
2. Insurers as Subcontractors
Second – Insurers are an important service provider. Although a contractor is reliant on the expert advice from his broker, you would not normally subcontract with a company that you do not know, even if they were recommended to you. Why should insurers be treated any differently? They are subcontractors like any other. The only difference is that they are not subcontractors for work, but for services, the service of paying for risks.
As with any other commercial relationship, you need to get to know insurers and build a relationship with them. The more you do that, the more likely it is that claims will be paid promptly and that difficult claims will be reviewed more favourably. Changing insurers frequently to obtain a short term benefit of a cheaper price might in the long run be a mistake.
Inter-relationship between the Construction Contract and the Insurance Contract
Unlike many other subcontract arrangements however, the insurance relationship is triangular. Provision of insurance is equally important to contractor and employer alike and contracts invariably require insurance to be purchased in joint names. Employers have a significant interest in ensuring that the contractor obtains insurance. This explains why contract provisions relating to insurance are both lengthy and onerous.
One critical issue is to ensure that there is clarity in the contract drafting. Although onerous contracts may cause disputes, unclear contracts are bound to. In my view, from a dispute avoidance point of view, it is better to be clear and onerous, than unclear.
A good illustration of a dispute caused by a lack of clarity can be found in the English Court of Appeal decision in Skanska v Egger (2002). Skanska was employed by Egger to design and construct a wood chipboard factory in Scotland. The contract was similar to the English JCT form and included usual provisions requiring defects to be made good and containing the usual care of the works provisions.
The contract however required Egger, the Employer, to insure the works for ‘all loss or damage from any cause’.
Egger bought insurance from Eagle Star, which excluded liability for all defects There were defects in the floor slab. Skanska could not claim under the insurance, so they sued Egger on the basis that the contract required Egger to insure for ‘all loss or damage from any cause’ and this included damage caused by defects in the floor slab and that Egger had failed to procure the required insurance. Skanska won at first instance but lost on appeal. The Court of Appeal decided that:
- The insurance provision should be interpreted in the light of the care of the works provision. The care of the works provision required the contractor to take care to avoid ‘accidents and mishaps’.
- Secondly the Court of Appeal decided that there was a clear distinction between damage, which should be covered by insurance, and defects and that the cracks in the floor slabs were in reality no more than the manifestation of a defect.
Particular Problems – Principal Controlled Insurance
The Skanska decision relates to a Principal Controlled Insurance taken out by the employer for the whole project. These types of policies have been popular in Hong Kong in recent years and both the KCRC and the MTRC have used them. The drafting of the contract provisions does require attention to detail.
The Skanska dispute could have been avoided if the contract provisions relating to insurance, required the employer to obtain insurance in a known or specified form and if a copy of the policy was attached to the contract. This is the approach adopted by the KCRC.
It is also important to ensure that issues such as who pays the deductible relating to any claim are clearly spelt out.
Specific Examples of Onerous Provisions
There are two issues which are hot topics currently in the construction industry.
1. Employees Compensation
The first issue concerns common provisions within private form contracts relating to EC insurance. Section 40(1) of the Employees Compensation Ordinance states that no employer shall employ any employee unless there is a policy of Employees Compensation Insurance in place. The maximum penalty for failing to comply with this provision is 2 years in jail.
There are special provisions in the Ordinance relating to construction work and the principal contractor can take out insurance for his employees and all of the employees of subcontractors within a limit of indemnity of HK$ 200 million per event.
Employers may wish to ensure that the contractor does have insurance in place. An injured worker could attempt to sue the employer and the employer will want to know that the insurance is available to pay any claim and his legal costs. Employers may also want to monitor that claims are made properly.
Difficulties can arise however when the insurance requirements cannot be performed or where the insurance required is simply not available. There is an example of this which is currently causing a degree of confusion in the private sector. The general specification relating to EC insurance in private form contracts often includes the following provision:
The Policies shall be issued on an unlimited liability basis in respect of claims arising at Common Law
There is a certain logic in this provision. The logic is that under cl 18 of the old Standard Form Building Contract (or clause 20 in the 2005 edition), the contractor is required to indemnify the employer in respect of any claims arising from employees liability. There is no limitation of liability in the contractual indemnity and therefore logic could suggest that the insurance should also be unlimited.
The difficulty is that unlimited EC insurance is not available in Hong Kong.
Contractors could and presumably do simply ignore this provision. However if the contractor does not buy the insurance required by the contract, then he will be in breach of contract. Contractors could argue that in practice, this does not matter as no damage flows from the inability to provide insurance. The employer is able to rely upon the contractual indemnity anyway. So what does it matter? The response is three fold.
- The purpose of this talk is to provide assistance in avoiding disputes and by the time you have got as far as a discussion about whether the contractor has complied with its insurance requirements, a dispute of some sort is inevitable.
- What if the insurance becomes available? Everything has a price. Is this a risk that contractors can ignore?
- What if the contract has a wide definition of a variation to include all obligations under the contract? If the contractor cannot obtain unlimited liability insurance and he is instructed to obtain insurance complying with the Ordinance, does that bring the variations provision into operation and allow the Contract Manager to make a reasonable assessment of the amount to be deducted from the Contract Sum? This raises interesting questions over the definition of a variation and also the powers of the Contract Manager.
So what should employers do? There are a number of preliminary points to make.
- It is sometimes thought that the requirement to provide insurance of specified limits acts as a general limit of liability. This is not the case. The contractual liability to indemnify the employer and the obligation to insure are separate self standing provisions.
- The contractual requirements for unlimited liability seem completely out of proportion to the level of risk. The highest pay out for a personal injury in Hong Kong is about HK$ 25 million. Eight record breaking injuries are needed within the same incident to come close to the statutory limit. There may be situations where the statutory limit of HK$ 200 million is not enough. These incidences are likely to be rare, but in any event require a proper risk assessment.
- The approach taken with third party liability insurance is different. Invariably, the provisions relating to third party liability insurance specify a limit of indemnity.
The current cost of employee compensation insurance has forced Legco to consider whether it should reform the law by establishing a central state body to provide all employees compensation insurance. This proposal was not accepted and the current plan is for the Government to establish a ‘residual scheme’ for employers who find it hard to buy EC insurance on the open market. This is due to come into operation from next year. The current proposals for the residual scheme will not assist in resolving the problem which contractors currently face in being required to buy unlimited liability EC insurance.
2. Professional Indemnity cover
The second type of insurance cover which is causing contractors difficulties is the requirements in Government Contracts to obtain professional indemnity cover. The Hong Kong Government requirements on professional indemnity insurance are outlined in Technical Circular 6/2003. This requires design consultants, independent checking engineers and contractors undertaking design to obtain insurance to cover their liability for design generally for the construction period and a further 6 years.
The clause reserves the Government’s right to approve the terms of the insurance and the identity of the insurers. The right to approve the insurance arrangements is a sensible tool for the Government, although a certain degree of care must be taken to ensure that it is used properly.
Two problems commonly arise in practice with professional indemnity insurance.
Delays can occur at various stages in the chain. Any delay in obtaining professional indemnity insurance can be critical and the longer the delay the more difficult it can be to buy the insurance. I have been told that delays of longer than a month can be fatal.
An extreme example and a potential warning to employers can be found in the Australian case of Burch v Shire of Yarra Ranges (2004). The facts were that a contractor was required to obtain public liability insurance which had to be approved by the Contract Manager. The contractor failed to obtain any public liability policy but his failure was excused by the Victorian Supreme Court because the Contract Manager had not made the insurance requirements clear.
The court concluded that it was unknown whether the policy would have covered the risks which gave rise to the damage and the contractor was excused his failure to obtain insurance. The resolution of this problem is of course better contract administration. The approval of any insurance policy should be carried out at a very early stage.
2.Six Year Period
The second issue stems from a requirement that contractors provide design liability insurance for a period of six years in one policy. The advantages of doing this for Government are obvious. It means that there is no need to check each year whether insurance has been put into place.
However a 6 year policy is difficult to get. The difficulty is being compounded by the fact that the standard special condition requires professional indemnity cover for all design and this would include temporary works.
The Government have commissioned brokers JLT to report on its professional indemnity requirements. I understand that JLT is producing a questionnaire for comments from the industry.
In June this year, the Hong Kong Government issued technical circular 7/2005. This outlines the Government’s insurance requirements for contract works and third party liability insurance arrangements. This circular attaches a very useful insurance provision. It is a multi-tiered clause.
- The first tier states that the contractor must provide insurance in terms similar to a specimen cover attached to the contract. A copy policy is attached to the circular. This addresses the need for clarity.
- The second tier states that the terms of the insurance and the insurers themselves need to be approved by the Employer. The approval process can lead to difficulties, but it is a useful provision for employers if it is used appropriately.
- The third tier is the commercial compromise. It states that if it becomes impractical for the Contractor to procure the required insurance, the employer may accept modified terms as may be proposed by the contractor. The terms of any modified arrangements need to be agreed. Once an agreement has been put into place, the rate for the insurance in the Bill of Quantities is adjusted and obviously the Contract Sum is affected. This clause therefore allows for adjustments to the insurance provisions if the insurance market changes.
To recap, insurance needs to be seen as one tool within the overall risk management programme. If the employer wishes to interfere with the contractor’s insurance arrangements, then any requirements need to be both clear and workable. There is little point in including contract provisions which cannot be complied with. The main benefit of insurance which is to manage risk for the benefit of the project overall can be lost. A little time and thought at the outset of the project can save a lot of pain on the end.