Insurers and insureds do not bear the risk of a contractor becoming insolvent when undertaking insured repair work. The insurer’s only obligation is to pay its appointed contractor and not any subcontractors engaged by that party.

Background

The English High Court’s decision in AJ Building and Plastering Ltd v Turner1 is a timely reminder of this principle. This case concerns a mandate issued by an insured homeowner to a subcontractor that was engaged to carry out repairs to a property (Mandate). The relevant property was damaged and the insurer confirmed coverage for the reconstruction works. The insurer engaged a contractor to complete the works who, in turn, appointed a subcontractor.

The insurer paid the contractor for the works but the contractor went into administration before it had paid the subcontractor. As such, the subcontractor sought to recover its loss from the insured. The subcontractors attempted to rely on the Mandate to claim payment.

The Mandate contained the following key terms:

  • "[The insured] hereby agrees to employ [the subcontractor] to undertake the works as detailed in their estimate/schedule of works.
  • [The insured] authorises our insurance company to make payment direct to [the subcontractor] upon completion.
  • [The insured] understands that I/we remain responsible for payment of any policy excess or any monies due for work authorised by me/us, which is not paid by my/our insurer.

The subcontractor submitted that the Mandate created an obligation on the homeowners to pay them for the entire amount of the reconstruction works. The homeowners argued that the Mandate only obliged them to pay for any amount falling within the excess/deductible of the policy or any uncovered additional works.

Decision

The Court held that the subcontractor could not rely on the Mandate to recover payment for the insured works.

The Court recognised that, without the Mandate, the insured was liable only for any amount not covered by the insurance (such as the amount falling within the excess/deductible), even if the insurer or the insurer’s contractor becomes insolvent. This was the position reflected in Brown & Davis Ltd v Galbraith2.

In the present case, the Court found that the Mandate did not change this legal position. Based on the facts, the language of the Mandate (especially the third clause noted above) could not be interpreted to mean that the subcontractor was entitled to claim payment from the insured for any part of the insured works, as:

  • the insured had signed the Mandate without knowing or negotiating the price of the works, only knowing that the price would be met by its insurer;
  • the insurer had chosen the subcontractor for the works; and
  • it was not in accordance with commercial sense to have the insured bear the risk of the insurer’s appointed contractor becoming insolvent, especially as the insured did not know that the contractor even existed and was unaware of the contractual arrangements “behind the scenes” between the insurer, contractor and subcontractor.

The Court further stated that the insurer’s payment to the contractor discharged the responsibility to pay for the insured works, even though the insured remained liable for any uncovered part of the works. Accordingly, the Court denied the subcontractor’s claim against the homeowner.

What it means to you

The case has potentially significant consequences for both insureds and insurers.

For insureds, it affirms the general principle that the insured would not be required to bear the cost of works covered under an insurance policy, even if an insurer or its contractor becomes insolvent. However, a differently worded “mandate” may produce different results. It follows that insureds should be careful not to accept liability for any insured works when entering into any mandate or similar contract.

For insurers, the decision underscores that an insurer does not assume any risk if an appointed contractor goes into administration. This highlights the benefit of an insurer engaging a single contractor to undertake any insured works and allowing that contractor to appoint any subcontractors that may be necessary. In that way, the insurer will not be liable if the contractor goes bust or fails to pay a subcontractor.