Over recent weeks we have heard an increasing number of construction companies “unable” to obtain insurance cover for their contractual commitments. Contractors and consultants alike have either been declined cover entirely or offered restricted terms or increased premiums. As the client, lender or warranty beneficiary: what can you do now, and how can you protect yourself on future projects?
The answer to the first question is, I’m afraid, a classic lawyer’s answer: “it depends”. This is not a disingenuous response but an honest one. The provision of PI insurance and performance bonds are not governed by statute but by the terms of the relevant contract, and the solutions to these problems are more likely to be found around the meeting table than in the Courts.
Let us first consider the terms of the most commonly used contracts, appointments and warranties to better understand the rights of clients etc when coverage is not provided.
Most bespoke schedules of amendments, consultant appointments and collateral warranties (whether from a contractor, consultant or sub-contractor and whatever the interest of the beneficiary) contain standard wording requiring the warrantor to maintain PI to a certain level for a certain amount of time, and to provide evidence of the same on reasonable request. The following wording is commonly also used (“Contractor” is used in this example but the wording is commonly found in sub-contractor and consultant documents):
“The Contractor shall immediately inform the Beneficiary if the Contractor’s required professional indemnity insurance ceases to be available at commercially reasonable rates and terms, so that the Contractor and the Beneficiary can discuss how best to protect the respective positions of the Beneficiary and the Contractor regarding the Works and the Property, without that insurance.”
A well drafted appointment/warranty will also include the following wording:
“Any increased or additional premium required by insurers because of the Contractor’s claims record or other acts, omissions, matters or things particular to the Contractor shall be deemed to be within commercially reasonable rates.”
Whilst some documents define “commercially reasonable rates”, often by reference to a percentage increase on the premium paid in the year the document is signed, many leave “commercially reasonable” open to interpretation. Such interpretation would follow usual rules, considering the ordinary meaning of the words with regard to the context in which they were agreed between the parties.
In practical terms
An understanding of the legal position is important as background information and to inform discussion, but the solution to any such problem is likely to be purely commercial. The starting point will always be communication. It is important to be open with clients and explain the issue and provide evidence of increased premiums and efforts made to comply with contractual obligations.
It is unlikely that clients will jump to offer to directly contribute to increased premiums, not least because, one assumes, the consultant’s/contractor’s other clients would also benefit from the maintenance of coverage. Why should one pay for the benefit of all: this is the world of private contracting after all. Further, since clearly consultants/contractors will not seek to double recover, - and thus asking for a contribution in a fair way would be a tricky task.
If the required level of cover is no longer affordable, the likely outcome is that the parties will agree to a lower level of cover or to accepting certain exclusions (for example, it is extremely difficult in the current market to get cover for cladding) both of which should lower premium costs.
As a side note, some contracts, appointments and warranties also require the insured to maintain a policy with no higher level of policy excess than they currently have at the time of entering into the first contract/appointment. Whilst this wording is clearly intended to ensure that the benefit of the insurance policy kicks in suitably early in terms of the level of claims, opting for a higher excess is one way to lower premiums and so should remain available as an option in a tightening insurance market.
The situation with Performance Bonds is similar but different.
Firstly, the required terms of the Bond are usually appended to the building contract and of course a Performance Bond is a project specific product that usually expires at Practical Completion: annual renewal for 12 years is simply not an issue.
Secondly, many contracts provide express provisions setting out what will happen if the contractor does not provide a Performance Bond. Some make the provision of the Performance Bond a condition precedent to payment. Others allow the employer to withhold monies at a certain rate until it effectively self-insures by holding an amount equal to 10% of the contract sum.
However, in certain circumstances one can imagine that the negative impact on the contractor’s cashflow from what is effectively additional retention could prejudice the contractor’s solvency and thus the project. The irony of this should not be lost.
As Performance Bonds are project specific products and a one time purchase, the contractor should be able to include the price for provision in their tender submission. Including the Performance Bond cost as a line item really helps the parties to discuss the cost/risk allocation and to consider whether or not the Performance Bond really is required. Where a bespoke Bond is required, the parties may find a standard ABI bond cheaper to procure. For many projects, the ABI wording will be perfectly sufficient although a decision to move from a bespoke to an ABI bond should not be taken lightly.
Where the parties, as part of tender discussions, find that the cost of a Performance Bond is higher than expected, they may wish to discuss alternatives which could be anything from increased retention to a Parent Company Guarantee.
Once tender negotiations are concluded and the contract is signed, provision of the Performance Bond becomes a contractual obligation and therefore the parties should ensure that the consequences of a failure to provide evidence that the bond is in place are clearly outlined in contract documentation.