The key to a successful construction project is the correct apportionment and management of risk, and an essential feature in the consideration of the risk matrix is the effective use of insurance. In construction contracts around the world, legislation may impose mandatory insurance cover to be taken out by specified parties in the project, while other risks are left open to the parties to deal with as a matter of contract between themselves.

Legislation which may govern the contractual relationship between the parties to the construction contract may indirectly affect insurers and the parties may not necessarily have the protection they anticipate in relation to cover they thought was being provided by the wording of the contract.

The Scheme for Construction Contracts (England and Wales) Regulations 1998

In 1994, the Latham report introduced the concept of statutory adjudication for disputes arising out of construction contracts. The aim was to resolve construction disputes swiftly during the course of the contract.

In 1996, the Housing Grants, Construction and Regeneration Act 1966 was introduced and section 108 in Part II converted Latham's compulsory adjudication idea into law. The rules relating to such adjudications were introduced by The Scheme for Construction Contracts (England and Wales) Regulations 1998 by the exercise of powers conferred on the Secretary of State by the Act.

There are two main areas of concern for insurers which arise out of the legislation. First is the speed of the process. A decision from the adjudicator is to be given within 28 days of a party giving notice of adjudication. This speed provides a party seeking adjudication with the potential to ambush the other, having spent a considerable period preparing for the adjudication themselves. The second area of concern for insurers is the risk of a decision which is clearly wrong but in respect of which they may have to make payment until such time as it is overturned by an arbitral award, with the added risk that the party to whom payment is made goes into liquidation before the arbitration takes place.

The recent Court of Appeal case of Bouygues (UK) Ltd vs Dahl-Jensen (UK) Ltd clearly illustrates this risk.

Dahl-Jensen was a sub-contractor to Bouygues. The sub-contract provided for adjudication and arbitration. Retention of 5% was withheld, of which half was to be released 30 days after the completion certificate under the main contract and the rest after the certificate of making good defects.

Dahl-Jensen's employment was terminated for failing to proceed diligently with the work and Bouygues arranged for the works to be completed by others. Dahl-Jensen referred claims for delay and disruption, additional work and wrongful termination to adjudication, and it was agreed that Bouygues' claims for overpayment, liquidated damages and post-termination losses should be treated as a counterclaim in the adjudication.

The adjudicator held that Dahl-Jensen's employment had been validly terminated and, after considering each element of the claim and counterclaim, awarded Dahl-Jensen £200,000. In doing so, he gave credit to Dahl-Jensen for the whole retention, even though it had not yet fallen due. Had he not done so, there would have been a net decision for payment of £150,000 in favour of Bouygues.

Dahl-Jensen went into voluntary liquidation a day before the adjudicator issued his decision. Bouygues sought a declaration from the court in relation to this error and, in response, the liquidator then applied to the court for summary judgment to enforce the adjudicator's decision. Dyson J. ordered summary judgment.

The adjudicator had made a mistake but, according to Dyson J., it was a mistake in his calculations on the disputes that were referred to him, not a mistaken decision to deal with the issue of retention which was outside his jurisdiction.

“It is inherent in the scheme that injustices will occur, because from time to time, adjudicators will make mistakes. Sometimes those mistakes will be glaringly obvious and disastrous in their consequences for the losing party. The victims of mistakes will usually be able to recoup their losses by subsequent arbitration or litigation, and possibly even by subsequent adjudication. Sometimes they will not be able to do so, where, for example, there is intervening insolvency, either of the victim or of the fortunate beneficiary of the mistake.”

It was common ground between the parties that the retention was not yet due and that the adjudicator had made an error or mistake and, as a result, he awarded £200,000 to Dahl-Jensen.

In a letter written after his decision, the adjudicator stated that his calculations reflected his intentions and that his decision did not contain a clerical error or mistake. Bouygues therefore submitted that, if the release of retention was not a genuine slip, it must have been outside the adjudicator's jurisdiction. Alternatively, it was an inadvertent excess of jurisdiction in that he did intend to rule on the issue of retention and decided it should be released, unaware that this issue had not been referred to him by the parties.

Dahl-Jensen argued that the adjudicator's letter could be construed as saying that the inclusion of retention was not a mistake he was entitled to review, ie. it was not a clerical mistake or error.

The Court of Appeal upheld Dyson J and dismissed the appeal.

Dahl-Jensen's liquidator had sought summary judgment for the amount of the adjudicator's award. Under Civil Procedure Rules Part 24, the court may order summary judgment if the defendant has no real prospects of success in its defence and there is no other reason why the case ought not to be disposed of before a full trial. However, this was not an ordinary case. Since Dahl-Jensen was in liquidation, the position was governed by the Insolvency Rules 1986 and Bouygues had a statutory right to set-off pending determination of proof of debt and any appeal therefrom.

As a result, the court granted a stay of execution as requested by Bouygues to extend until the expiry of Bouygues' time for appeal against the liquidator's decision on its proof of debt in the liquidation or the outcome of any appeal. While Dahl-Jensen went into liquidation before payment was made, the situation would have been quite different if the money had been paid before.

Joint insureds

In the Court of Appeal case of Deepak Fertilisers & Petrochemicals Ltd vs Davy McKee (London) Ltd (1999) 1A; ER (Comm) 69, the court considered the extent of the joint names policy procured by the employer for the benefit of the head contractor and sub-contractors.

A term of the contract between Deepak and Davy required Deepak to take out: “.. transit and storage-cum-erection insurance against the risk in transit from the time of transfer of ownership of imported items to site and during the period of the storage, erection and commissioning of the plant. Deepak shall name Davy as an additional insured under policy(ies) and shall cause the insurer to waive the right to subrogation under the policy(ies)”. Davy was to be co-insured on the policy. A further term of the contract provided that: “DEEPAK ... shall cause DAVY to be named as co-insured in all policies of insurance effected in respect of the Plant all rights of subrogation against DAVY being waived.”

Once the plant had been commissioned, Deepak transferred the insurance of the plant to its conventional property insurance policy. Davy were not named as co-insured under this policy but the court considered what the position would have been if it had been.

A year after the plant was commissioned, there was an explosion resulting in substantial damage. Deepak sued Davy. A number of preliminary issues were tried, including whether Davy had a defence on the basis that the action against Davy was one of subrogation founded upon a contract of insurance, the benefit of which flows to Davy.

It is now well established that a sub-contractor has an insurable interest in the whole of the works and not just his own contribution to those works, on the basis that, if the operation is halted for any reason, the sub-contractor will lose the benefit of the agreement for his services. The main effect of this is to confer upon the sub-contractor the benefit of subrogation immunity in the event that his own fault is the cause of any damage to the works (see, for example, Petrofina (UK) Ltd vs Magnaload Ltd (1984) 25 BLR 37).

In this case, the Court of Appeal held that Davy had an insurable interest until completion of the work because it might lose the opportunity to do the work and to be remunerated for it if the property or structure were damaged or destroyed by any of the “all risks” covered by the policy. However, thereafter Davy would only suffer loss if the damage was the result of a breach of contract on its part and in the normal course of events a contractor would take out liability or professional indemnity insurance to protect against this. The court held that Davy had no insurable interest in the plant following completion, the co-insurance term was not effective and they lost the immunity from subrogation claims.

Iain Black is a partner of Masons solicitors, London. E-mail: iain.black@masons.com