Articles

Introduction

Insurance, especially all-risks insurance policies, are almost a must-have for all major construction projects these days. Despite the ubiquitous nature of insurance policies in the construction sector, there is still a lack of proper understanding of insurance concepts. Often, insureds may not be familiar with the extent of coverage, or may not be well-versed with how insurance claims are dealt with.

The purpose of this article is to provide a high-level overview of the typical coverage of an all-risks insurance policy with respect to damage and/or defects occurring on a construction project.

Typical Coverage

Most all-risk insurance policies for construction projects provide coverage for physical damage that is sudden and unforeseen (so long as the cause of such damage has not been excluded by the policy). ‘Damage’ may seem like a rather straightforward term. Indeed, there is a tendency for lay insureds to equate all losses flowing from everything that was damaged as insured losses. In the process, overlooking the descriptors ‘sudden’ and ‘unforeseen’, who may not fully understand the meaning of these terms.

• The term ‘sudden’ may give the impression that the physical damage has to occur instantaneously (for e.g., within a split second). Thankfully, legal precedents suggest otherwise. The legal definition of ‘sudden’ is slightly more generous. Referring to the Singapore High Court judgment of Pacific Chemicals Pte. Ltd. v MSIG (Insurance) Pte. Ltd. and Another [2012] SGHC 198 (“Pacific Chemicals”), the Singapore Courts determined that ‘sudden’ cannot be limited to an occurrence that happened ‘instantaneously’. Instead, ‘sudden’ should be understood to mean ‘quick’ or ‘rapid’. In other words, there may be more occasions of physical damage that may be covered under the policy.
• The term ‘unforeseen’ has its plain English definition. For some reason, there is an incorrect belief that ‘unforeseen’ is synonymous with ‘unforeseeable’. In Pacific Chemicals, the Singapore Courts confirmed that ‘unforeseen’ and ‘unforeseeable’ are not synonymous. The former refers to a subjective test (in that the insured had failed to foresee the occurrence of the physical damage) whereas the latter refers to an objective test (in that a reasonable insured would have foreseen the occurrence of the physical damage). The two terms are not interchangeable. Where the policy wording provides for ‘unforeseen’, it is sufficient if the insured had subjectively failed to foresee the occurrence of the physical damage.

Limitation to Coverage

Policyholders should pay attention to the limitation to coverage. This is especially so with respect to defects (in other words, physical damage that is the result of defective equipment, material or workmanship). It is not unusual for LEG (London Engineering Group) clauses or DE (Design Exclusion) clauses to appear in policy wordings. There are three types of LEG clauses and five types of DE clauses, ranging from the most restrictive coverage to the broadest coverage. Below, we will examine the LEG clauses and explain the limitations to coverage for each LEG clause.

LEG 1/96

“The Insurer(s) shall not be liable for loss or damage due to defects of material workmanship design plan or specification.”

LEG 1/96 is known as the outright defects exclusion clause. This excludes everything (both the defect itself and the consequences of the defect) from cover.

LEG 2/96

“The Insurer(s) shall not be liable for all costs rendered necessary by defects of material workmanship design plan specification and should damage occur to any portion of the Insured Property containing any of the said defects the cost of replacement or rectification which is hereby excluded is that cost which would have been incurred if replacement or rectification of the Insured Property had been put in hand immediately prior to the said damage. For the purpose of this policy and not merely this exclusion it is understood and agreed that any portion of the Insured Property shall not be regarded as damaged solely by virtue of the existence of any defect of material workmanship design plan or specification.”

LEG 2/96 is known as the consequences defects wording clause. It is more generous compared to LEG 1/96, in that only the hypothetical cost to remedy the defect prior to the damage is excluded. In the Ontario case of PCL Constructors Canada Inc. v. Allianz Global Risks US Insurance Co. [2014] ONSC 7480, the Courts described LEG 2/96 as a ‘deeming clause’ that provides special treatment for damage caused by defects. But, what does this mean?

To illustrate what is meant by LEG 2/96, we look at another Canadian case – Acciona Infrastructure Canada Inc. v Allianz Global Risks US Insurance Co. [2014] BCSC 1568 and [2015] BCCA 347. In this case, the insured sought indemnification for ‘over-deflection’ of concrete slabs (which resulted in significant repairs and rectification to bring the concrete slabs in line with project requirements). Insurers rejected the claim on the basis that the LEG 2/96 clause excluded the cost of repair or rectification of the slabs. The British Columbia Court (at Trial and upheld by the Court of Appeal) found that the physical damage to the concrete slabs were the result of defective workmanship. Be that as it may, insurers were liable for the cost of repairing the damage (and the only deduction that may be made by insurers was the cost of remedying the defect at the point in time just before the damage occurred) because the policy wording included the LEG 2/96 clause.

LEG 3/06

“The Insurer(s) shall not be liable for All costs rendered necessary by defects of material workmanship design plan or specification and should damage (which for the purposes of this exclusion shall include any patent detrimental change in the physical condition of the Insured Property) occur to any portion of the Insured Property containing any of the said defects the cost of replacement or rectification which is hereby excluded is that cost incurred to improve the original material workmanship design plan or specification. For the purpose of the policy and not merely this exclusion it is understood and agreed that any portion of the Insured Property shall not be regarded as damaged solely by virtue of the existence of any defect of material workmanship design plan or specification.”

LEG 3/06 is known as the improvement defects wording clause. The wording of this clause was modified from the 1996 version in 2006, due to concerns in the insurance community about the application of LEG 3/96 following the English Court of Appeal case Skanska Construction Ltd v Egger (Borony) Ltd [2003] Lloyd’s Rep IR 479. Within the insurance community, it was contemplated that the previous wording had to be modified so as to reflect the underwriters’ true intentions that LEG 3/06 provides the widest form of cover for physical damage caused by defects. For the longest time, whilst we understood the broad scope of cover accorded by LEG 3/06, there were no legal precedents on its application. This changed somewhat after the South Capitol Bridgebuilders v Lexington Insurance Company judgment (Case No.: 21 cv-1436) issued on 29 September 2023. In this case, there was honeycombing of concrete due to insufficient vibration. The District Court of the District of Columbia determined that honeycombing of concrete constituted physical damage. It then proceeded to apply Illinois law to interpret the LEG 3/06 clause. Unfortunately, instead of providing an interpretation of how LEG/06 was to be applied, the Court simply determined that the LEG 3/06 wording was ambiguous and had to be construed against the insurer (despite LEG 3/06 being a standard form clause).

As there was no real interpretation of how LEG 3/06 was to be applied, the sceptics amongst us may be of the opinion that we are left none the wiser. That said, the optimists amongst us may be of the view that the lack of legal precedents with respect to LEG 3/06 may be an indication that insurers have been according the widest form of cover to claims containing the LEG 3/06 clause.

Negligence / Reasonable Precautions?

In addition to limitation to coverage, it is not uncommon for all-risks insurance policies to include a willful negligence clause (or reasonable precautions clause).

• With respect to willful negligence clauses, it is important to note that mere negligence will not be captured by such clauses. The use of ‘willful’ indicates that a negligent act or omission needs to encompass an element of reckless disregard before such action or omission may be deemed to be ‘willful’.
• With respect to reasonable precautions clauses, it is again important to note that mere negligence will not be captured by such clauses. Why not? Because the coverage of all-risks policies would effectively be wiped out if they exclude the very liability that they were intended to cover. In the English case of Fraser v Furman [1967] 1 WLR 898, the Courts suggested that there should be an element of ‘recklessness’ in such clauses even though they do not specify for ‘recklessness’.

In other words, even though the insurance policy may appear to impose strict requirements on the level of care expected of an insured, such strict requirements may not have much of an impact when determining the liability of insurers to indemnify for sudden and unforeseen physical damage.

Final Words

It is hoped that this article will provide the basic foundation to a good understanding of one’s all-risks policy. If (or when) faced with a claim event in future, having an understanding of one’s policy will put insureds in good stead in dealing with the claim and managing one’s expectations with respect to indemnification of the claim.

Contributed by:

Sinyee Ong - Counsel, Chua & Partners LLP