by Roger Grover
The legal relationship between the producers of a building and its future owners and occupiers is a problematic one. On the emergence of a latent defect, the building’s designers and builders can suddenly seem legally and financially very remote from the new owner or tenant.
Such a situation appears particularly burdensome to foreign tenants, who may be both unfamiliar with the obligations of the full repairing lease and much more familiar with continental-style decennial insurance for latent defects. In a competitive market, a new development which has decennial latent defects cover in place should have an edge over the development without it.
The warranty route
Commonsense suggests that owners and occupiers should not have to bear the often huge remedial costs resulting from the actions of a negligent consultant or contractor. The attempt to recover these costs through tort has always been expensive, time-consuming and uncertain; with the recent House of Lords’ decision in Murphy v Brentwood District Council it has become still more difficult.
Not surprisingly, the result of this difficulty has been the explosion of the collateral warranty industry. In creating a contractual relationship where otherwise none would exist, third parties have sought to provide a legal route through which they can recover the costs resulting from a latent defect — in theory.
In practice the problems associated with collateral warranties are well known to many in the construction industry, usually through first-hand experience. Their negotiation generates huge legal fees and consumes much expensive management time. They frequently seek to impose obligations which go far beyond those that have been owed by consultants at common law and may constitute agreements with any number of unknown third parties. They require the establishment of liability before recovery.
Most important, however, as the deteriorating construction industry is likely to bring out in stark relief, contracts of any kind are only as good as the assets or insurances of the firms who sign them. Consultants who sign without the approval of their professional indemnity insurers are taking a substantial risk. Furthermore, under the “claims made” system of PI insurance, approval today is no guarantee of cover in the future. This article is not the place for a detailed consideration of “claims made” insurance, but for any reader who may be relying on PI insurance to back a warranty, ask your broker to explain “claims made” and its potential implications for continuity of cover — and if you still feel comfortable, ask him to explain it again! As the claims come in and contractors and consultants suffer financially in a depressed market, some collateral warranties will prove to be not worth the paper they are written on.
An alternative approach
The Wren Insurance Association was not set up to counter collateral warranties. But it was established specifically to provide its members with stable and continuing cover, and its approach to warranties has been guided by considerations of long-term insurability. Recognising the unsatisfactory and worsening commercial conflict over warranties the Wren began, some months ago, to seek an alternative solution. The clues had been given in October 1988 with NEDO’s publication of its “BUILD” guidelines, and in February 1990 with the European Commission’s final report on the construction industries of its member states. Both reports recommend the implementation of latent defects insurance negotiated by the developer at the outset of a development.
The Wren asked brokers the Miller Insurance Group to develop a facility along these lines for the benefit of the clients of Wren members. Miller also put in place a separate, parallel facility where owners and occupiers could insure themselves against economic losses arising as a direct consequence of a latent defect. Both facilities, which are underwritten in Lloyd’s and the company market, are now available for buildings designed by Wren’s members. We believe that this represents a significant advance in long-term construction industry relationships.
Latent defects insurance
The latent defects insurance will respond to loss which occurs as a result of a design or construction problem. Broadly, cover is provided for the costs of repairing, renewing and strengthening the structural and weatherproofing elements of the building, although the detailed extent will be agreed with the underwriters. Also covered are the costs of debris removal and professional fees.
The cover does not require proof of fault. It is non-cancellable and fully assignable. It covers the building, not the consultants or contractor involved. It extends for 10 years from the date of practical completion, with the payment of a one-off premium. As underwriters’ statistics indicate that 95% of latent defects will manifest themselves within 10 years, decennial cover provides realistic, thorough protection.
The benefit of the policy is for building developers, owners, their funders and subsequent owners and occupiers: it does not benefit the designers and builders, against whom the insurers may invoke their rights of recourse. On a case-by-case basis, however, these rights of subrogation against the professional team may be waived, if that is what the parties want.
In each case where the insurance is required, the project will be subject to a technical survey enabling the underwriters to monitor the design and construction quality of the job.
Carried out by an independent adviser, appointed by the underwriters following consultation with the developers and professional team, the survey will not unduly impinge on the specifications and programme of the design team, nor on the budgetary plans of the developer.
At present cover is automatically available for projects in the UK and Ireland with a contract value of up to £30m: the underwriters will, however, consider larger developments and overseas projects. The cost of such cover varies considerably from building to building, but is typically in the range of 0.5% to 1.5% of contract value.
Consequential loss insurance
The consequential loss insurance may be purchased with or without the latent defects cover. It responds to the economic losses resulting from a building being rendered unfit to occupy as a result of a latent defect in structure or weatherproofing, which is a standard exclusion from normal business interruption policies. It makes good the effects of loss of earnings (either rent or revenue) and additional expenses incurred. Again the underwriters require a form of technical audit, but this occurs after practical completion and is less exacting than that for latent defects. In order for the yearly premium to be established, an appraisal of the occupier’s business will also be undertaken. Costs are generally in the region of 0.5% to 1.5% of the sum insured chosen by the occupier.
From the point of view of Wren members’ clients who do not wish to purchase latent defects cover, the key feature of the consequential loss facility is that it will sit happily alongside Wren-insured warranties to provide an attractive package to the end-user of the building.
Wider advantages
So, apart from the protection offered to building owners and occupiers, what are the wider advantages?
In a softening letting market a building with these facilities in place will have a distinct competitive advantage, particularly in the eyes of major foreign purchasers and tenants.
The insurances provide “no-fault” compensation, responding to the problem when it occurs rather than at the end of a long, expensive and uncertain legal process.
Most significantly, perhaps, they should release developers and the professional team from the worst excesses of collateral warranty negotiation — with all the attendant time, expense and potential conflict — and enable them to concentrate on the job in hand. That is, the production of commercially attractive, high-quality buildings for satisfied end-users.
