Construction PI Update: Alarm Bells Extended for D&C PI Underwriters

Design & Construction Professional Indemnity (D&C PI) policies are intended to cover liability flowing from breaches of professional services, such as design, drafting and project management. They are not intended to provide cover for defective building work due to workmanship issues.

In the context of higher construction costs, and lower profit margins, builders and developers faced with statutory liability claims under the Home Building Act 1989 (NSW) (HBA) have looked increasingly to their D&C PI policies to seek cover for these statutory claims. More recently, builders (and consultants) have also grappled with claims under the Design and Building Practitioners Act 2020 (NSW) (DBPA).

Insurers are often faced with the difficult question of whether cover is available under these policies for HBA or DBPA type claims, especially in circumstances where the claim has not arisen from the developer or builder providing professional services.

Last year, the Federal Court of Australia in FKP Commercial Developments Pty Limited v Zurich Australian Insurance Limited [2022] FCA 862 (FKP No.1) determined that in order for the insuring clause of a D&C PI Policy to be triggered, allowing cover under it, there must be a link between an underlying cause of action and the provision of professional services by an insured. In doing so, the Court in FKP No. 1 declared that the cover being sought by the FKP Parties under the D&C PI Policy issued by Zurich (Policy) was unavailable. Our previous article on FKP No.1 can be accessed here.

A further question was subsequently raised and decided in FKP Commercial Developments Pty Limited v Zurich Australian Insurance Limited (No 2) [2023] FCA 582 (FKP No.2). The question dealt with the interpretation of the “Consultants, Subcontractors and Agents” clause 3 extension in the Policy.

Background

FKP Commercial Developments Pty Ltd (FKP Commercial) and FKP Constructions Pty Ltd (FKP Constructions) (together the FKP Parties) were the insured under the Policy.

In separate proceedings, Strata Plan 84298 (Owners), the owners two apartment buildings located in Rosebery, NSW (Buildings), claimed damages from the FKP Parties as defendants (Separate Proceeding). The Owners claimed damages against the FKP Parties for alleged defects that existed in the common property of the Buildings and alleged that the FKP Parties were in breach of the statutory warranties under the HBA. The Owners further alleged that the FKP Parties owed a common law or statutory duty of care under the DBPA to the Owners.

The FKP Parties sought indemnity from Zurich under the Policy in respect of any liability it might have to Owners in the Separate Proceeding.

Operation of clause 3

In FKP No.2, the Court was asked to determine the availability of cover for the FKP Parties under clause 3 of the extension within the Policy that provided that:

Extensions of cover

Cover is automatically provided, and on the same terms and in the same manner as in the Insuring Clause (except as expressly stated), for the extensions of cover described below. Each extension of cover is subject to all the other provisions of this policy, including any additional terms stipulated in connection with it…
…

1. Consultants, Subcontractors and Agents

We agree to indemnify the insured for loss resulting from any claim arising from the conduct of any consultants, sub-contractors or agents of the insured for which the insured is legally liable in the provision of the professional services. No indemnity is available to the consultants, sub-contractors or agents. 

(our emphasis)

Zurich’s position

The outcome of FKP No.2 was essentially determined by the Court’s interpretation of clause 3, and in particular, the phrase “for which the insured is legally liable in the provision of the professional services.”

At its core, Zurich’s position was that for the Policy to respond, even under the clause 3 extension, the claim against the insured must arise from the provision of a professional service.

Zurich submitted:^[1]

1. that the preamble to the extensions of cover section in the Policy refers to cover being provided on the same terms and in the same manner as in the insuring clause;
    
2. that extensions have to be read in light of their place in the Policy wording, and operate within the framework of the insuring clause rather than operating independently of the insuring clause;
    
3. that the Policy is a design and construct professional indemnity policy, that included a carefully structured definition of “professional services”, that indicates that building contractor activity is not part of the covered activities;
    
4. that clause 3 provides coverage for the insured where it breaches a professional services obligation and where the relevant conduct giving rise to the breach is not its own personal conduct but the conduct of an agent or sub-contractor; and
    
5. that the construction advanced by the FKP Parties (see below) would create radically wide cover which could not be rationally explained as an extension to the insuring clause or to any professional indemnity cover.

FKP’s position

The FKP Parties’ position (which was greatly assisted by the Court’s findings regarding the interpretation of clause 3 in FKP No.1) was that for a claim to be covered under clause 3, the claim against the insured does not need to arise from the insured’s provision of professional services. Instead, what is required, is that the insured is “…legally liable for the conduct in its provision of the professional services, irrespective of the source of the legal liability.” ^[2]

Outcome and implications

The Court ultimately preferred the FKP Parties’ position that the claim didn’t need to arise because of the FKP Parties providing professional services, and concluded that cover was available to the FKP Parties under clause 3.

In arriving at its decision, the Court determined that, based on the agreed facts, the defective building services provided by third-party subcontractors caused the defects. That lead to claims against the FKP Parties pursuant to the HBA and the DBPA, even though the claims against the FKP Parties did not arise from the provision of professional services.

As such, the FKP parties were entitled to cover because they incurred a liability in the provision of professional services, as opposed to the claims themselves arising from the insured’s provision of a professional service.

 In this case, the professional services provided by the FKP Parties included “…that FKP Constructions sub-contracted the whole of the design and construction works it was obliged to perform under the head contract with FKP Commercial to sub-contractors, but that FKP Constructions maintained its role as project manager and construction manager”^[3] and those services are expressly included in the definition of “professional services” under the Policy.

Interestingly, in deciding that the claim against the FKP Parties in the Separate Proceedings fell within the meaning of clause 3, the Court appears to have dealt with FKP Commercial and FKP Constructions as a single entity and not as individual insureds under the Policy. This could mean that FKP Commercial is covered under the Policy in circumstances where, on the agreed facts, it has no contractual link to the sub-contractors whose conduct has given rise to the claim.

Key Takeaways

• Cover may be available to insureds under certain D&C PI policy extensions where the claim does not arise from the provision of a professional service by an insured (e.g. the claim arises due to the conduct of a third-party) but an insured nevertheless has incurred a liability in the provision of its professional service;
   
• From an underwriting perspective, insurers will need to ensure that any extensions included in their D&C PI Policies are narrow, and sufficiently linked to the insuring clause or limited to the provision of professional services so as to avoid providing unintentional cover for claims which were never intended to be covered under the policy;
   
• Insurers should also ensure that their policies contain the appropriate exclusions to guard against the extended cover which may arise under a policy extension, for example a D&C PI Policy could contain a clearly worded exclusion, beyond the definition of profession services, which specifically excludes cover for claims not intended to be covered under the policy, such as those relating to workmanship defects; and
   
• This case is highly fact dependent and will likely be the subject of an appeal. It was determined based on some specific policy wording and with the assistance of some agreed facts. All policy wordings will be slightly different. Workmanship and other exclusions will still apply under D&C PI Policies. 

[1] FKP Commercial Developments Pty Limited v Zurich Australian Insurance Limited (No 2) [2023] FCA 582 at [20] and [21]. 

[2] Ibid at [15] 

[3] Ibid at [19]