Most construction professionals will be familiar with the concept of contracts and collateral warranties. However, many see them as formalities needed to satisfy a client, and don't fully appreciate the potential implications of signing up to onerous contractual terms, including boundaries of coverage offered by professional indemnity insurance (PII) policies.
Why contracts are needed
Contracts come in many types. They can be described as an appointment agreement, a letter of appointment, a sub-contract, a consultant agreement, a professional services contract, and many more.
They can also take many forms. Often, contracts will be in a form prepared by the professional's client, sometimes having been drafted by lawyers, and sometimes based on an old contract that the professional's client uses for every project. There are also “off-the-shelf” forms of contract, such as those available from the Joint Contracts Tribunal (JCT), the New Engineering Contract (NEC), and the Construction Industry Council (CIC). Some professional bodies produce their own standard forms of contract, such as RIBA or ACE.
Whatever the contract is called and whatever form it takes, its primary purpose will be to set out the obligations of the parties. For the construction professional this will typically revolve around the services to be performed, processes to be followed, and standards to be met. For the professional's client, the contract would typically deal with their obligations regarding payment and the giving of instructions.
Why collateral warranties are needed
Collateral warranties are another form of contract, and they act to extend a construction professional's liability to a third party. This is typically a party that has an interest in the project, such as a funder, purchaser, or tenant.
Without a collateral warranty the third party would struggle to bring a claim against the construction professional, as it was not the third party who engaged the professional to perform the services.
Professional indemnity insurance and contracts
Subject to specific policy terms, PII is fundamentally intended to provide coverage for negligent performance of professional services, to the extent that the insured would have been liable under the general laws of the country. PII policies typically and consistently available in the UK PII market do not provide coverage for liability that exists solely because of a contractual term where that liability would not otherwise have existed under law.
Additional loss for which a construction professional is liable solely because of a contractual term is likely to be loss which is not covered by PII. For instance, if the contract requires a professional to perform their services to a higher standard than is required under the general law of the country, or if the professional gives a guarantee that the outcome of their services will meet certain specifications, then there is a risk that the professional will be liable despite not being negligent. In this case, PII will not provide full coverage.
Other problematic terms include liquidated or delay damages, rights of set-off, indemnities, and representations, all of which may act to increase liability beyond what it would have been in the absence of these terms and therefore create a risk of uninsured loss.
Professional indemnity insurance and collateral warranties
While PII generally provides coverage for collateral warranties, subject to the contractual liability exclusion described above, it additionally only does so on the basis of an exclusion of any liability that is any greater or longer lasting under the collateral warranty than the liability that would exist under the construction professional's appointment.
This matches the general purpose of a collateral warranty, which is to extend a professional's liability to a third person, not to create additional liability beyond that purpose.
The importance of undertaking a contract review
In the event that something goes wrong and a professional's client or a beneficiary of a collateral warranty seeks to bring a claim against the professional, they will not only seek to bring a claim for negligence, but they will also seek to strengthen their claim by referring to the terms of the contract.
If the professional has not reviewed the contract or collateral warranty then they may have signed up to terms that significantly increase their liability and that will not be covered by PII, which can have serious implications.
In addition, contract reviews can also highlight where risk management measures are missing. For example, financial caps on liability and net contribution clauses can help to limit the professional's potential liability, reducing the likelihood that a claim would exceed the level of PII coverage that the professional holds.
When it comes to reviewing your contracts, here are some things to look out for:
Does the contract contain a clause which makes the performance of your services subject to your obligation to exercise reasonable skill and care? If not, then you may be held to a higher standard than is covered by PII.
Is there a financial cap on your liability? If not, your liability may be potentially unlimited.
Does the time limit of liability clause exclude the ordinary operation of the Limitations Act 1980? This may lead to your liability being extended.
Does the contract contain indemnities or representations? These can increase your liability and increase the risk of uninsured loss.
Are you guaranteeing that the outcome of your services will be fit for purpose? PII typically does not provide full coverage for fitness for purpose guarantees.
Are you guaranteeing outcomes rather than your behaviour? Express guarantees are typically excluded under PII.
Are you required to maintain insurance to cover “all your liabilities” under a contract? It is generally not possible to obtain insurance to cover all potential liabilities under a contract.
Does the contract contain liquidated or delay damages? PII typically does not cover pre-agreed compensation amounts.
Please note that this list is not exhaustive. Keep an eye on our insights page for future articles in relation to contractual liability.
For further information, please visit our Lockton for Architects & Engineers page, or contact:
Nick Rains, Profin Advisory Contracts & Technical