Like many industries, the design and construction industry is in a period
of great transformation. The growth of design-build as a construction method
is one aspect of this transformation. As design-build grows in popularity, construction
and design firms are realigning, changing their services, forming new partnerships,
and repositioning themselves in response to changing market conditions. While
these changes present new and exciting opportunities for contractors, it must
be understood that in taking on responsibility for design, in addition to construction,
they also take on new risks. Failing to realize the extent of their responsibilities and liabilities as a design-builder can
be a devastating oversight.
Agents and brokers need to understand the risks their design and construction
clients face when performing as design-builders, or participating in design-build
joint ventures, to advise them on their additional coverage needs. The commercial
general liability (CGL) insurance policy is not adequate to cover the expanded
liabilities design-build contractors assume. Contractors professional liability
is needed for that exposure. This article will identify some of the professional
liability coverage issues contractors must consider in devising a comprehensive
risk and insurance program.
Risk Transfer Not Enough
Typically, a construction contractor venturing into design-build will do
so with the intention of subcontracting the design of the project to a separate
entity. Often, these contractors (and their agents) mistakenly assume that by
hiring a licensed design professional, they have shifted the design risk away.
Unfortunately, that is not the case. Even where the contract with the design
professional contains all the right risk transfer provisions (indemnity agreements,
waivers of subrogation, and insurance requirements), the design-build contractor
still bears a significant degree of risk.
Contractors should not rely exclusively on hold harmless or other contract
provisions to protect them from design liability for the following reasons.
- The hold harmless provision could be held to be unenforceable. Many
states have strict rules regarding the shifting of liability for one's own
negligence to another party, and failure to conform to these rules may invalidate
the provision.
- The design firm may not be in business when the claim is filed. Since
professional liability insurance is written on a claims-made basis, it is
likely that no coverage would exist at that time.
- Architects and engineers' errors and omissions insurance typically does
not cover contractual liability, such as that assumed in a hold harmless
provision, unless such liability would have attached in the absence of a
contract or agreement. Rather, coverage under these policies is limited
to damages that are the result of "professional negligence," which is a
much different standard of care than the design-builder typically provides
to the project owner. Even if the policy will respond, most design firms
carry relatively low limits of insurance and have limited tangible assets
that could be used to satisfy indemnity obligations if the insurance proves
inadequate.
Because the design-builder's obligation to the project owner is not relieved
by the inability to collect for design damages from the design subconsultant,
design-build contractors should purchase their own professional liability coverage
for their design-build liabilities.
Contractors Professional Liability Insurance
Contractors professional liability insurance was introduced in the late 1990s
as a specialized coverage to address contractors' vicarious and/or direct liability
for design errors or omissions. Contractors professional liability (CPL) insurance
can be written on an annual basis to cover all of a contractor's operations
or on a project-specific basis.
Many of the first generation CPL policies were little more than an architects
and engineer's errors and omissions policy with a different name and did not
always match up to contractors' coverage needs. For example, most of the original
forms covered only contingent liability and did not cover a contractor's direct
liability for professional services.
The second generation of forms, most of which bear a post-2000 edition date,
are more tailored to contractors' professional liability needs, but they still
do not cover all of the incremental design-build exposures. By learning more
about this specialized coverage, agents and brokers can help their contractor
clients assess their professional liability exposure and obtain appropriate
coverage. This article addresses a few of the key coverage issues contractors
should consider in buying professional liability coverage.
Definition of "Professional Services"
The policy's definition of "professional services" is a key determinant of
the scope of coverage. Some forms specifically define the services that are
covered, while others allow the insured to participate in defining it. In the
former case, the definition may omit certain services provided by many contractors,
especially those involved in complicated design-build construction. For example,
facility management, program management, providing of construction computer
software, and leasing of personnel to others for their expertise are activities
not covered by most standard definitions.
Defining professional services on a case-by-case basis (by reference to an
endorsement, the application or the declarations page) allows each insured contractor
to shape the coverage to correspond to its activities. However, contractors
also run the risk of failing to include some activity, which creates an unintended
coverage gap. It is imperative that the contractor provide an exhaustive list
of all services it performs that could even remotely be considered professional
in nature. Some insurers will agree to a broader scope of services than others,
depending on their comfort with the contractor's qualifications to provide certain
services.
Many policies use a combination of these two methods, including a standard
definition of "professional services" (i.e., architectural, engineering, landscaping,
surveying, and sometimes construction management) and extending that definition
to also include any other services listed on an attached endorsement to the
policy.
Direct versus Contingent Liability
Another important consideration in the definition of covered services is
whether the policy covers the insured's own provision of professional services
(direct liability), those provided on its behalf (contingent or vicarious liability),
or both. Most of the major markets' forms (including Zurich, AIG, CNA, and ECS)
provide coverage for both direct and contingent liability, but contractors should
confirm this before purchasing a professional liability policy. Even where all
design work is contracted to others, design-build contractors could be sued
directly for damages arising out of a design subcontractor's work (failure to
properly supervise, negligence in hiring an incompetent design professional,
etc.), therefore, they need coverage for both exposures.
Joint Venture Coverage
Joint ventures between contractors and design professionals are a common
approach to providing full design-build services with respect to a project.
Contractors should pay close attention to the scope of coverage a policy provides
for joint ventures. Some CPL policies automatically include the named insured's
joint ventures as insureds, but most cover only those joint ventures that are
specifically listed on the policy. Where joint venture coverage is provided,
it is typically limited to the named insured's liability arising out of its
participation in the joint venture. Joint venture partners are not covered for
their liability arising out of the project.
Where joint ventures must be listed on the policy to be covered, contractors
should be careful to add such them before any services are performed. Further,
due to the claims-made coverage trigger, past joint ventures must be carried
over as insureds on renewal policies for coverage to remain in force with respect
to these ventures. Some insurance professionals recommend changing "joint ventures"
to "co-ventures" to cover a wider array of business relationships in construction
projects. However, to avoid exposing their limits to unintended persons or entities,
this term should be clearly defined in the policy.
Exclusions
CPL policy exclusions vary widely in number and scope from one form to the
next. However, some exclusions present greater coverage concerns than others.
Some of the more troublesome exclusions can sometimes be modified or deleted
by endorsement. Where they cannot, contractors need to understand the limitations
of the coverage and have contingency plans for how these risks will be funded.
Performance Guarantees. Virtually every CPL
policy contains an exclusion for "express warranties or guarantees." Consequently,
contractors who provide guarantees regarding their work in excess of what is
required by law (i.e., the legal standard of care, typically a "negligence"
standard) have no coverage for costs associated with the failure to fulfill
such promises. Unfortunately, many owners have come to expect these types of
guarantees in design-build contracts. In fact, the ability to obtain such guarantees
and transfer the risk of nonperformance to the design-builder is one reason
for the growth in this form of construction.
In the soft market of the 1990s, a few insurers would occasionally delete
this exclusion, but that possibility seems to have evaporated in the current
market. Nevertheless, contractors should request that the exclusion be modified
to provide coverage for liability it would have had in the absence of such warranties
or guarantees. This prevents the insurer from applying the exclusion when negligence
can be established.
Faulty Workmanship. Most CPL policies exclude
damage arising out of faulty workmanship. For the most part, faulty work is
considered an uninsurable business risk that contractors must retain. Further,
the quality of the work is considered a construction risk versus a design risk.
Nevertheless, some CPL policies preserve coverage for faulty workmanship that
is the result of a negligent act, error, or omission in the performance of professional
services. The fact that a design error produces faulty work does not eliminate
coverage.
Damage to Owned Property Exclusion. The wording
of the exclusion for damage to real and/or personal property can present problems
for design-build contractors. The intent of the exclusion is to preclude what
is more of a "first-party" property coverage from the policy. However, language
such as "property occupied by, or in the care, custody or control of the insured,"
should raise a red flag for design-build contractors.
Unlike a typical design professional, design-build contractors are likely
to be performing work at the construction site. Insurers could use this exclusion
to deny coverage for damage to the facility under construction, or other property
on site, on the grounds that it was "occupied" by the insured or in the insured's
"care, custody or control."
Most second-generation CPL forms have addressed this problem by either removing
the exclusion altogether or removing the phrase "occupied by or in the care,
custody or control" of the insured contractor. Alternatively, some policies
may merely provide an exception to the exclusion for a "construction site occupied
by the insured." Contractors should closely examine these provisions and request
the appropriate modifications to clarify that coverage applies in such situations.
Insurers should be willing to accommodate this request.
Contractual Liability. Like their architect
and engineers (A/E) professional liability counterparts, some contractors professional
liability policies exclude all contractually assumed liabilities. While this
generally works for design professionals, contractors commonly agree to indemnify
owners for damages arising out of their work under the contract, including the
providing of professional services. Because A/E policies typically do not cover
contractual liabilities, attempts to shift this risk to a design-subconsultant
may be unreliable.
Some CPL insurers policies preserve coverage for liability assumed in insured
contracts. The definition of "insured contracts" varies from one policy to another,
but in no instance is it as broad as its CGL counterpart. A sample definition
of "insured contract" is provided in Figure 1. Note that, unlike the CGL policy,
this definition does not allow for the indemnification of another for that party's
sole negligence. Unless the contractor agrees to a broad form indemnification
agreement, this limitation does not represent a big problem.
| FIGURE 1 Sample CPL "Insured Contract" Definition INSURED CONTRACT means that part of any contract or agreement under
which the NAMED INSURED assumes tort liability of the INSURED's client
to pay for compensatory damages to persons other than an INSURED, because
of BODILY INJURY or PROPERTY DAMAGE resulting from an act, error, or
omission (…). However, INSURED CONTRACT does not include any tortious
conduct that otherwise would not be covered under this Policy, nor if
the tortious conduct was solely that of the person or persons for whom
such liability under the INSURED CONTRACT was assumed. For the purposes
of this definition, INSURED shall exclude any employee of the NAMED
INSURED, solely while acting in their professional capacity on the behalf
of the NAMED INSURED. Source: Professional and Pollution
Liability Policy - General Contractors, Form GIC-PPLGCCP (5/01), Greenwich
Insurance Company (marketed by ECS Underwriting, Inc.). |
Some CPL insurers may be willing to provide expanded contractual liability
coverage by endorsement on either a case-by-case or blanket basis. At a minimum,
the exclusion should clarify that it does not apply to liability that would
have existed in the absence of a contact. This prevents the insurer from denying
coverage for liability based on the insured's negligence on the grounds that
the insured had agreed to be responsible for its own negligence.
Waiver of Subrogation
Unlike most professional liability policies, most CPL policies allow the
named insured to waive its rights of recovery (and thus the insurer's right
to subrogation) to some extent. A few contain blanket waiver of subrogation
provisions that merely prohibit the insured from doing anything after a loss
(or claim) to prejudice the insurer's rights of subrogation. By implication
(and successfully tested in the courts), this type of provision does allow the
insured to waive its right of recovery prior to a loss.
More common, however, is a limited waiver of subrogation provision in which
the insurer agrees not to pursue its rights of subrogation against specific
parties - typically, the named insured's clients and/or subcontractors - if
the named insured has agreed to waive such rights prior to loss. (Although the
term "client" is not defined in the policy, this would presumably mean anyone
with whom the insured contracted to provide covered services.)
A sample waiver of subrogation provision is presented in Figure 2. Note that
this provision does not allow the insured contractor to waive subrogation rights
against a design professional, whether the design professional is a client or
a subcontractor, without the insurer's written consent.
| FIGURE 2 Pre-loss Waivers Against Clients or Subcontractors
Allowed The Company agrees to waive this right of subrogation against a client
or subcontractor of the Insured to the extent that the Insured had,
prior to a Claim, a written agreement to waive such rights; however,
with respect to Coverage A [Professional Liability], no waiver of subrogation
may be granted without the written consent of the Company where the
client or subcontractor is a design professional. Source: Contractor's Professional
and Pollution Liability Insurance, Form # 77355 (12/00), CI1256, American
International Specialty Lines Insurance Company |
Although the waiver of subrogation provisions found in CPL policies is broader
than those included in most other types of professional liability policies,
they are more restrictive than what contractors are used to under other types
of policies. Contractors who are unaware of the more restrictive provisions
in the professional liability policy may unknowingly execute waivers that jeopardize
their professional liability insurance coverage. To avoid forfeiting their rights
to coverage, contractors should either attempt to negotiate a waiver of subrogation
provision that conforms to the requirements of their contracts or adapt their
contracts to conform to the requirements of the policy.
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