In September 2017, the UK construction industry contracted for the first time in over a year. With Brexit delaying some investment plans, there is also a degree of uncertainty in the industry, and, of course, the risk that some construction companies may be forced into insolvency. This blog post considers some practical implications from an insurance angle.

Protection

The risk of sub-contractor insolvency is carried by the contractor, and protection is key. Therefore, at the outset of a project, it is important for the contractor to carry out appropriate financial due diligence on its supply chain. Performance bonds can be procured, or a parent company guarantee from the sub-contractor’s ultimate holding company.

It is now also commonplace for sub-contractors to provide collateral warranties in favour of employers, or other third parties such as a funder (albeit, a collateral warranty is only as robust as the contract to which it relates).

Insolvency of the sub-contractor

In the event of insolvency, if works are outstanding contractors may want to consider termination of the subcontract (so long as the contractor has a contractual right to terminate as a result of the sub-contractor’s insolvency). Calls could be made on any bonds available, and the contractor may wish to contact any guarantor to complete or procure the completion of outstanding works.

Insurance considerations

Professional indemnity policies usually exclude cover for losses in connection with any claims arising out of, or attributable to, the insolvency of an insured (eg a claim for unpaid work on a construction project as a result of an insured’s insolvency). In the recent High Court decision of Crowden v QBE Insurance, it was held that an insolvency exclusion in a professional indemnity policy applied. In reaching the decision, the judge found that the insolvency did not need to be the proximate cause, albeit that it had to “stand out as a contributing factor” to the claim. More on this decision can be found in our article here.

However, if a negligence claim is brought against a sub-contractor (eg for defective design) and the sub-contractor is already insolvent, the claim could still be covered on the basis that the insolvency had no bearing on the sub-contractor’s negligence. This will depend on the facts of the case, and will be subject to other policy terms and conditions.

Where the sub-contractor is insolvent, a third party can bring a claim directly against a sub-contractor’s insurers in accordance with the Third Parties (Rights Against Insurers) Act 2010 (which came into force in August 2016). This is a major change from the 1930 Act, where the insured’s liability had to be established before a claim could be brought (eg by a judgment or arbitration award). The third party will, however, still need to establish the insured’s liability in the action against the insurer, albeit now only in one set of proceedings. Further, third party claimants are still subject to the same policy terms and conditions that would have applied to the insured.

Comment

Speculators may say that given the uncertainty in the construction market, and the easier route to pursuing insurers under the 2010 Act, there will be a surge in construction related insurance claims. That said, insurers will have the ability to scrutinise claims and contest liability at an earlier stage, which could reduce the number of speculative claims.