Problems, Set in Concrete: The Insurance Implications of Defective Concrete Claims
Many risk managers in construction can be forgiven for overlooking risk issues regarding concrete applications, whether sourcing ingredients or in the design/installation.?Concrete is one of the more understood and ubiquitous substances in construction, even as far back as the time of the Roman Empire.?The ancient Romans did not worry about the insurance risk aspects of concrete, but, judging by recent global claim activity, risk managers should be thinking about this significant issue including how to control such risks, as well as how and when insurance policies should respond to claims.?
Even a basic building material such as concrete can cause catastrophic consequences when it fails. This article will thus look at some real world, and severe, issues regarding such losses and will examine the policy response of the two main insurance policies:?Construction All Risk (CAR) and Construction Professional Indemnity (PI) policies.
CAR Issues
From a CAR policy perspective, concrete defect issues trigger problematic coverage issues.?Generally, CAR policies, as their names suggests, offer comprehensive “all risk” 1st party protection against loss or damage in respect of the contract works, construction plant, equipment and machinery, as well as against third-party claims for property damage or bodily injury arising in connection with construction.?Normally the policies will have language that is broad and covers “all sums” arising out of “loss or physical damage to the property insured.”?However, despite the status of these polices as “all-risk” polices there are still basic requirements that need to be met to obtain coverage and, of course, there are exclusions that can also act to negate coverage.??
Fortuitous damage
With defect issues in concrete applications, the first coverage issue is usually the issue of “damage.”?CAR policies require damage to the works, plant or equipment.?In light of this, some insurers have argued that where the concrete defect is design or installation related, it does not qualify as fortuitous as it is not accidental and, thus, not “damage”.?The argument is, essentially, that “concrete is concrete;” meaning that, once poured, hardened and cured, it is acting the way concrete is supposed to act; no accidental damage has occurred.?The fact that the concrete is in the wrong shape, or thickness, or strength, has not altered its makeup or “damaged” it in any way or damaged any other part of the works.??In support of this argument insurers have often cited the appellate case of Pilkington United Kingdom Limited vs.?CGU Insurance PLC, [2004] EWCA Civ. 23 (BAILII).?In that case, involving glass windows, the England and Wales Court of Appeal held that a CAR policy requires “physical damage caused by the commodity for which purpose a defect in the commodity is not itself sufficient and that the loss claimed must be a loss resulting from physical loss or damage to physical property . . . .”
Insureds, for their part, have attacked this damage issue with some degree of success.?To begin with, concrete applications are usually an integral and structural portion of any construction project and can easily be distinguished from cases such as the Pilkington matter involving less structural parts of the works at issue.?Where a collapse of concrete has occurred and damage to works follows, the situation is easily distinguishable and, in our opinion, clearly amounts to damage under a CAR policy.??Even apart from this severe situation, the defect in concrete will usually manifest itself physically in some way, such as cracking, spalling, deflecting, or honeycombing.?Further, most concrete applications require internal support such as rebar, or are affixed to structural steel.?Once hardened, said rebar or steel has now been damaged in that it is imprisoned in the defective concrete and cannot be re-used.
Accordingly, insureds have successfully argued that these physical manifestations are damage under the policy and that such damage is “accidental” as the results were unintended.???Recently, Canadian courts had just such an issue and decided, decisively, in insureds’ favour in the matter of Accionia Infrastructure Canada v. Allianz Global Risks US Insurance Company, [2014] BCSC 1568 (CanLII).??In the Accionia matter a defect in concrete application for a hospital construction project led to an overly severe deflection, necessitating remedial measures.?The deflection caused cracks and caused the supporting rebar to stretch “beyond its flexural yield point resulting in permanent deformity.”?The Court held that this fell squarely within the perils of the policy and that this result was obviously fortuitous/damage.
Defect Exclusions
One might argue that the answer of whether concrete defects qualify as damage under the perils of a CAR policy seems to be self-evident.?However, the analysis gets thornier when one considers the various policies’ defect exclusions. ?Generally, CAR policies will contain some kind of exclusion for the repair of a defect in either a construction material or in the design or application of such construction material.?There are three types of exclusions which are standard and originate from the London Engineering Group (“LEG”).?The first (“LEG 1”) is an outright exclusion for all loss or damage due to defect.?The second (Leg 2”) is a bit more complex and reads:
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.?
Essentially, the way this has been interpreted is to have the effect of ensuring that any damage to works, plant, materials or machinery caused by the defect is covered but not any of the work necessary to repair the defect itself or, of course, the defect itself.
The third exclusion (“LEG 3”) is a much narrower exclusion (has broader coverage for the insured) and reads as follows:
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.[1]
The effect here is that most damages except, purely, for the rectification of the defect itself and any changes/improvements to the original design, plan or specification, are covered.
The Accionia court offers us an excellent analysis of the LEG 2 defect issue as it applies to concrete defects.?The issue in that matter was, again, over-deflection.?The deflection led to an undue stress on the concrete itself as well as the rebar/structure within.?Once this occurred, reasoned the court, the damage, within the policy definition, was established and the only costs excluded under LEG 2 were those costs that would have been incurred, just prior to the damage, to correct any deflection.?In the court’s opinion, these costs would have been negligible.?The result was insurer liability for the cost of repairing the damage, but with a minor deduction for the cost of remedying the defect right at the moment in time before the damage occurred.
The conclusion to be reached is that, when faced with a denial by insurers on a CAR policy under LEG2, clients should examine such a denial closely and examine the factual basis of the loss.?Assuming no catastrophic event questions that should be asked and raised to argue against such a denial are:?did any physical damage manifest (cracks, spalling, honeycombing) or was any structural steel affected or internal fixation support such as rebar).?If so, It can be reasonably argued, under the Accionia decision, that all costs subsequent to the damage are recoverable under the policy with a deduction only for the notional costs of the repair of the defect itself prior to the damage occurring.
Construction PI Issues
Construction PI policies present different issues but, on the whole, these policies respond to claims against a construction professional/contractor for claims in negligent design/engineering or construction. ?This is because PI policies, by their very nature, are designed to cover situations where a construction professional is claimed to be negligent.?The general grant of coverage reads, as an example, as follows:
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Professional Liability
The Insurer will pay, on behalf of an insured, all Loss resulting from any Claim against an Insured for civil liability arising from Professional Services.
“Claim” is generally defined as any demand for monetary or other damages arising out of a “wrongful act”?(act error or omission to act) arising out of “professional services.?“Professional services” are, like they sound, those professional services performed by the others under contract.???
Accordingly, if the insured was required to make sure the concrete was properly designed for its function, or was of the proper strength and type, including the testing and supervision of its mixing and/or installation, then a failure to do so properly may lead to a claim against that professional which would, as an initial matter, likely fall under the coverage.?
Of course, the above analysis is based on the assumption that the scope of professional services under the insured’s contract includes concrete (design, inspection, installation) and/or that the cement installation is not otherwise excluded.?For example, in the matter of Baulderstone Hornibrook Engineering Pty Ltd v Gordian Runoff Ltd, [2006] NSWSC 223, Baulderstone Hornibrook Engineering (“BHE”) acted as engineers for the Sydney Airport third runway project.?After construction had ended it was discovered that the seawall, and other water facing structures (the “Walls”) were losing compacted sand from erosion.?BHE settled with the principals of the project, with whom it had contracted for provision of engineering services, and then sought reimbursement from their PI policy.
The primary issue in Baulderstone was the cause of the loss of sand from the Walls. The Walls themselves were constructed with prefabricated concrete facing panels. The joints between the panels were then sealed with a geotextile through which water, but not sand, could flow. Behind the concrete panels was sand backfill, which was required under the contract to be compacted to a uniform 80% density.?The design of the Walls was carried out by Connell Wagner and the fill under another subcontractor Reinforced Earth, also under subcontract with BHE. ?
BHE asserted that the design by the subcontractors was negligent in that they used the wrong geotextile. The insurers took the position that the design was not negligent and that the loss of sand was due to defects in the construction of the sand backfill. In particular, it was asserted that the construction was defective because the sand was not compacted to the required density.
The court found that BHE's liability to the principal did not arise from the failure to give proper engineering instructions as to the construction process.?The liability of BHE to the principal arose from the construction work of BHE.??The policy had a specific exclusion for construction work which thus limited the coverage to only engineering services.?As such, insurers were able to deny coverage under the specific exclusion of construction services, which would otherwise have been covered.?The total loss to the insured was AU$65M.
Generally speaking, assuming there are no exclusions such as in the Baulderstone matter, or other problems with professional services, most of the claimed loss would be covered as loss is usually defined fairly broadly.?However, loss of fees, or other contractual loss, is usually not included in the definition of loss; nor are taxes, fines and penalties.?Insureds must be cognizant of the fact that certain portions of the loss, even assuming coverage, might still fall outside of coverage.
Lastly, insureds in PI situations involving concrete, as with all PI matters, must also be wary of warranties in any contract.?The PI policy is mostly intended to cover negligence in the provision of professional services and any warranty that goes beyond reasonable standards of due care for similar professionals can run afoul of this type of exclusion.?Hence, a specific warranty as to quality, or fitness for explicit specifications under contract (and not just general fitness for use) of the concrete should be avoided where possible.?
The takeaway here is twofold:?1) ensure that the contract of work and the PI insurance track each other as far as professional services are concerned; and 2) avoid specific warranties that might be outside coverage if violated.?Additionally, the usual rules, PI or CAR, that insureds should avoid settling or entering into any agreements to correct work or pay unless they have informed insurers and received consent (or a waiver thereof), with the proviso that the insured is always under a duty to mitigate damages under the policy and should make emergency repairs to stabilize a situation and hold down losses until insurers can become involved.?
How should clients address the risk going forward??
Additional Insurance Products
There are additional policy approaches to defect issues, such as efficacy insurance.?This product may also be useful as it is designed to cover situations where a product fails to perform its intended function. Lastly, a “latent defect” insurance policy might also be useful. This insurance can help to cover the cost of repairs or rebuilding if structural damage appears well after the completion. ??
Alexander Damon Rosati
[1] There are other, similar exclusions, such as the Defect Exclusions, also from the London/EU market (the “DE Exclusions”).?For the purposes of the discussion here we will focus on the LEG 2 exclusion rather than the LEG 1 absolute exclusion and LEG 3, the more limited exclusion.???