i-law

Construction Insurance and UK Construction Contracts

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CHAPTER 1

Introduction to UK construction industry

General

 1.1 In 2014, the construction industry in the United Kingdom contributed £103 billion to economic output, 6.5% of the total gross value added of the economy.1 This represents a rise of 9.5% in real terms on 2013: the largest increase since at least 1990. In the same period, construction accounted for 2.1 million jobs or 6.3% of all jobs. There can be no doubt as to the continued and growing importance of the construction industry to the UK economy. Outside these shores, the standard form JCT, NEC3 and FIDIC contracts remain the contracts of choice, often being subject to the laws of England and Wales. Contractors based in the United Kingdom undertake projects across the world: it is not possible to determine with any accuracy the contribution to the global economy, but it is clear that the contribution is both substantial and significant. 1.2 This raises the question as to what the construction industry comprises. Broadly speaking the market can be divided into housing, infrastructure, industrial and commercial sectors, with individual projects being undertaken on a private, public or public/private basis. Yet, this is a simplistic division as construction projects touch on every aspect of daily life, from the properties in which we live and work; the infrastructure (both in terms of plant and services) that provides us with water, electricity and gas; the transport networks (road, rail, airports, sea ports) that we use for work and pleasure and which ferry to our doors that which we consume: each involves construction and a construction contract. Everything in the built environment around us and more or less everything we use in daily life at some point would have made use of something built by the UK construction industry. Against that background, the risks that parties to construction contracts face, the ramifications of breach or failure; and identifying where the insuring obligations fall are matters that are often taken for granted or not analysed with sufficient detail until something goes awry. 1.3 As no two construction projects are ever the same, it is necessary to consider the individual characteristics of each project and to consider the risks at each stage of the process. Even on the most straightforward project where defects arise there is usually a debate as to whether the same is due to an error in design or workmanship and, accordingly, the identity of the ‘proper’ defendant. In turn, that requires

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a potential claimant to identify the causative breach. This inevitably leads to the question of whether the putative defendant is insured in respect of his act or omission. The stark reality is that insurance and construction contracts go together hand-in-hand. 1.4 Broadly speaking, there are two categories of insurance effected in relation to construction projects as between employer and contractor:
  • (1) liability insurance, for example public liability insurance and employer’s liability arising from claims for loss or damage;
  • (2) property insurance, for example, insurance of the contract works and any material, equipment and machinery associated with it.
1.5 In addition, the professional teams, and the building construction teams engaged in the design and construction of the project will take out appropriate professional indemnity insurance to cover their design liabilities and risk of carrying out negligent design whether in contract, tort, common law or statutory liabilities. 1.6 As between contractor and employer, the majority of building and engineering contracts deal with insurance matters on a broadly similar basis. The contractor is generally responsible for loss or damage to the contract works during the construction period and is responsible for repairing or reinstating them in the event of loss or damage. The contractor is usually obliged to insure the works to the satisfaction of the employer, very often using a policy which is held in the joint names of both the contractor and the employer. In addition, the employer needs to be protected against claims arising against the contractor, either by the contractor’s employees or by third parties, so, to that end, the contractor usually indemnifies the employer under the contract against such claims arising. Consequently, the contractor frequently arranges the employer’s liability and public liability insurance. 1.7 However, on very large projects, the practice is often reversed and it is often the employer who insures in the joint names of the employer and the contractor (there are normally cost savings and reduced insurance premiums because of the employer’s status). Sometimes this reversal of positions is taken into larger building contracts and, in such cases, it is not unusual to find the employer being responsible for effecting and maintaining the insurances.

Valuation methods

 1.8 In order to identify the form of contract most suited to a particular project, it is necessary to consider the method of procurement that is to be adopted by the employer and to identify and assess the options and risks associated with each.

Lump Sum contracts

 1.9 In this form, the contractor agrees a fixed price to execute certain defined building works. The figure is usually arrived at by way of the bill of quantities and is agreed at the time of contract formulation when the work is also commenced. All

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the main forms of building contract are considered to be lump sum contracts, even though they contain provisions for the adjustment of the sum for such things as fluctuations and variations. This is because the contractor agrees to undertake the defined contract works for a fixed price.

Measurement Contracts

 1.10 The contract sum for a measurement contract (also known as a re-measurement contract) is not finalised until the project is completed. The process involves the employer (usually through his consultants) preparing as part of the tender documents a bill of quantities where quantities are estimated rather than finalised. The contractor prices against each item in the bill, providing a unit rate in respect of each bill item. During the project the actual quantity of works in respect of each item in the bill is measured and the quantity agreed, to which the contractual rate is applied to build up the final contract value. Accordingly, at the outset there is a contract sum that is not a finalised figure and is subject to the works being re-measured at completion. As such, by definition it cannot be a lump sum contract. 1.11 Where works are instructed in respect of which there is no applicable rate, the contractor can build up new rates or “star rates”, which will then be used in the valuation of the works.

Cost Contracts

 1.12 With a cost contract there is no binding, pre-agreed sum contract sum. The contractor is entitled to be paid whatever the work(s) actually cost(s), together with an additional payment normally called a management fee, which should cover its profit and overheads. An example is the JCT Prime Cost Contract 2011. This form of contract is often adopted where the employer requires an early start on site such that there is insufficient opportunity to prepare a detailed design and bill of quantities against which a contractor can price. 1.13 There are four common variations:
  • (1) Cost plus a percentage: the contractor is paid the actual cost of work reasonably incurred, plus a fee which is a percentage of the actual cost.
  • (2) Cost plus fixed fee: the fee is a fixed lump sum and so the contractor has an incentive to complete.
  • (3) Cost plus fluctuating fee: an estimate of the total cost is made and the fee varies according to actual cost.
  • (4) Target cost based on the bill of quantities and compared with actual adjusted target cost. If the actual cost shows a saving (or an increase), the fee is increased (or reduced) appropriately.

Procurement Methods

 1.14 The four most commonly used methods of procurement are considered below.

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Traditional/Conventional

Approach and Standard Form

 1.15 This form of procurement has been standard practice since the mid-nineteenth century. There are two defining features of the traditional/conventional method of procurement:
  • (a) The employer will engage a professional team to prepare a full package of documents (usually comprising a specification, drawings, contract particulars that set out the particulars of the contract to be entered into and any amendments to those contract terms, bill of quantities (where appropriate) and, if they have been obtained, copies of any ground investigation or soil reports). That package of information is then supplied by the employer to those contractors who are to be invited to submit a tender in respect of the works described in the tender documents.
  • (b) It follows that the design process is separate from the construction process, and usually the contractor will have no responsibilities as regards design.
1.16 Traditional/conventional contracts can be priced either on a lump sum, measurement or cost reimbursement basis. 1.17 Examples of a standard form of contract appropriate to the traditional method of procurement within the JCT 2011 Suite of contracts are the JCT Minor Works Contract 2011 (MW2011), JCT Standard Building Contract 2011 (with or without quantities (SBC/Q 2011 or SBC/XQ 2011), Standard Building Contract With Approximate Quantities (SBC/AQ 2011) and the Prime Cost Building Contract (PCC2011).

Responsibility and Risk

 1.18 Due to the fact that a full package of documents needs to be supplied as part of the tender process, time needs to be available for those documents to be adequately prepared. Experience shows that where employers seek to rush this phase, errors are inevitably made either as to design or specification or both. This also means that the project life tends to be longer as the design and construction phases are undertaken sequentially by different entities. However, because the employer appoints the consultants that undertake the design - whether architect or engineer - it means that the employer retains full control over the design process. 1.19 Furthermore, because the invitation to tender is usually sent to a number of contractors, there is a competitive tendering process such that the employer can be confident that he is getting a good price for the works. Where there is no competitive tender it is common for there to be a negotiated contract price, again providing for certainty as to the project cost (although the cost can be increased or decreased later in the event that works are varied). 1.20 Subject to the terms of the contract, the contractor is responsible for supplying the labour and materials necessary to complete the works and accordingly for the quality of goods and workmanship. As he does not (usually) bear design responsibility,2 he

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is not generally responsible for design - unless the errors in the design are so obvious and/or so affect the buildability and/or safety of the finished project that it would be reasonable for a contractor to bring the same to the attention of the employer. 1.21 It follows that the risk of the adequacy of the design rests with the employer (as between him and the contractor); although in the event that there is a deficiency in the design the employer will have recourse against his professional team.

Design and Build/Contractor’s Design Portion/Turn Key

Approach and Standard Form

 1.22 In this method of procurement the contractor is responsible for undertaking both the design (or some element of the design) and the construction of the works for an agreed lump sum price. It is a matter for the employer as to whether the whole project will be procured on a design and build basis, or whether only certain elements will be. It follows that this method of procurement provides flexibility and can be particularly useful where one element of the works involves a proprietary system or element. 1.23 Where the contract is on a full design and build basis, the employer will engage a professional team to undertake outline design (often also securing planning permission) and an outline specification which forms the “employer’s requirements”. Whilst this will not be as detailed or as time consuming as the pre-tender process under the traditional method, again sufficient time needs to be allowed for this process to be undertaken. 1.24 Thereafter, the contractor is responsible for undertaking the detailed design so as to produce a final product that meets the employer’s requirements as defined. In order to evaluate tenders that are submitted, contractors are usually required to provide detailed “contractor’s proposals” that set out how the contractor intends to fulfil the design brief. Again, sufficient time needs to be allowed for this process to be completed so the employer has comfort that its employer’s requirements have been met. It is vital that the employer’s advisers consider the contractor’s proposals with care so as to ensure no mismatch between the two. 1.25 Whether at the stage of preparing the contractor’s proposals, or during the detailed design during the works, a contractor will often subcontract out the design to specialist subcontractors - for example in relation to the mechanical and electrical elements of the works. However, the contractor remains responsible for the design visà-vis the employer. In many instances the contractor will engage the employer’s consultants under a novation agreement, thereby ensuring continuity of design process. 1.26 An example of the standard forms of contract appropriate to this form of procurement is the JCT Design and Build Contract 2011 (DB2011). 1.27 It is also open to an employer to procure works on the basis of a turnkey contract, where a contractor offers to build in accordance with his own standard design: in this scenario the employer has little if any design input at all3: he relies upon the contractor both for design and construction of the finished project.

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 1.28 The alternative to a full design and build/turnkey contract is where there is a “contractor’s design portion” (“CDP”) where the detailed design of a defined element (or elements) of the works is the responsibility of the contractor, as is ensuring compatibility between the CDP and the rest of the works. In this scenario, an example of an appropriate standard form would be the JCT Standard form of Contract with Contractors Design 2011, or the Intermediate Form of Contract with Contractor’s Design 2011.

Responsibility and risk

 1.29 Subject to the terms of the contract, the contractor will be responsible for ensuring the adequacy of his design (or that portion of the design that he is responsible for) and in this respect he is likely to have the same responsibility as an architect or engineer would have to the employer. However, most of the standard form contracts carve out responsibility where there is a deficiency in the employer’s requirements that results in loss or damage being suffered; although this is often subject to a requirement that the contractor notify any such deficiency once detected so as to minimise the consequences of the said deficiency. 1.30 Unlike the traditional method, an employer does not retain finite control over the design; once the contract is let the detailed design is a matter for the contractor. It will be a matter for individual employers as to the degree of control they wish to retain. 1.31 The contractor will also be responsible for ensuring the quality of goods and workmanship that he supplies. As such, in the event of any deficiency in the design of the works (or the contractor’s design portion as applicable), the contractor will bear the cost of remedying the same. In the event that the contractor has subcontracted the design (or any element thereof) he may have a claim down the line against the actual designer - subject to an insurance provision that prevents the subrogation of such claims. 1.32 From the employer’s perspective the design and build or turnkey contracts offer the most certainty as to price and in the event of a defect in the works, there is (save for any deficiency in the employer’s requirements) only one “target”: the contractor. Thus, any difficulties in identifying whether it is a design or workmanship issue fall away. The caveat is that the liabilities in respect of design and workmanship are likely to be different, depending on the terms of the contract. Furthermore, as design and build contracts are lump sum contracts the employer has certainty as to price, subject to any variations that may be instructed. As such, design and build contracts are a relatively low risk option for an employer.

Management

Approach and standard form

 1.33 Management procurement takes two forms:
  • (1) Management Contracts
  • (2) Construction Management.
1.34 Both methods involve the construction works being undertaken by a series of package contractors, which the main contractor is responsible for managing. Unlike

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the other forms of procurement, the main contractor does not undertake the physical works himself; instead he is paid to manage the projects. The management contractor’s role is more akin to a consultant and he is required to assist the employer in seeking to keep the costs of the development within budget, co-ordinating the organisation of the work, and enforcing the obligations of various works contractors under the works contracts. To these ends the management contractor liaises with the employer’s existing professionals and is on the same level as them within the consultancy team. 1.35 Where the project is to be procured by way of a management contractor, the employer appoints a professional team that will undertake the design of the works (whether on an outline or finite basis) and a management contractor whose role is to manage the works. However, the management contractor appoints each of the works contractors with each being accountable to the management contractor (rather than to the employer). This also means that the management contractor is liable to pay the works contractor. However, where the works contractors undertake any design, they are responsible to the employer in respect of that design, rather than to the management contractor. That said, it is possible to procure on the basis that the management contractor is responsible for design team as well: this is commonly referred to as a “design and manage” contract. 1.36 The most common standard form is the JCT Management Contract 2011 edition. 1.37 With construction management, the employer contracts with the architect (or engineer) in respect of design; he contracts directly with each of the trades contractors in respect of the works and the “construction manager” is just that: an individual (or company) engaged to manage the works. As with management construction the construction manager does not undertake any physical works. The construction manager manages the works, whilst the employer directs them. 1.38 The most common form of management contracts is the JCT Management Building Contract (MC2011).4

Responsibility and risk

 1.39 From the foregoing it will be apparent that the employer bears the lion’s share of the risk in respect of management procurement as regards time and cost. However, the employer retains control over matters of design and quality throughout the project through its professional team. It is particularly suitable where the works involve specialist design elements that can be let as discrete works packages. It is a low risk option for the management contractor and the construction manager given the limited role which is to be performed.

Integrated

Approach and standard form

 1.40 Also known as partnering or collaborative procurement, integrated procurement has become increasingly popular in recent years. It was developed in response

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to Sir Michael Latham’s report, ‘Constructing the Team’ published in 1994, which criticised the traditional procurement methods.5 The objective of integrated procurement is to address the employer’s objectives as regards time, budget and quality: the focus is upon procurement as a team activity to achieve the best outcome. Collaborative procurement encourages openness and trust between parties to a contract, resolving issues as and when they arise, rather than protecting positions with a weather eye on future claims and dispute. 1.41 Partnering can be adopted for a one-off project (“project partnering”), or the parties can enter into a framework agreement that provides for the collaborative approach to be adopted over time or in respect of a number of projects (“strategic partnering”). The concept behind collaborative partnering means that the longer the time period over which the parties work together, the greater the rewards will be as relationships are built, improvements and savings identified and risk and benefit managed. 1.42 The JCT has developed, in accordance with Constructing Excellence, the JCT - Constructing Excellence Contract which can be can be used to procure a range of construction services. It is designed for use in partnering and “where participants wish to engender collaborative and integrated working practices”. A further popular form of partnering agreement is the Project Partnering Contract 2000 (PPC20006). However, many organisations, such as local authorities, have developed their own approaches, which are tailored to specific organisational needs.

Responsibility and risk

 1.43 The fundamental principle of collaborative procurement is that risk is minimised and responsibility shared as appropriate to the particular project.

Contract forms

 1.44 Leaving to one side bespoke contracts developed for individual projects, there are now three main suites of contracts available for contracting parties to choose from:7
  • Joint Contracts Tribunal (“JCT”) Suite, the current edition being that issued in 2011;8
  • The New Engineering Contract or “NEC” Suite, the current edition being the 2013 edition;9

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    FIDIC (Fédération Internationale des Ingénieurs - Conseils): as addressed below, the main suite of contracts were re-published in 1999 with the Gold Book being re-published in 2011.10
1.45 In addition, contracts have been produced by the ICHEME and IMECHE that address the specific issues that arise in chemical and mechanical engineering projects. 1.46 Each of the projects produced by these bodies has been developed so as to provide a comprehensive contract that seeks to balance responsibility, risk and liability. They have been streamlined in the light of judgments and statutory developments. Thus, care should be taken when adopting a standardised text of amendments to ensure that these matters remain balanced. 1.47 The provisions as regards risk, indemnities and insurance particular to these projects are considered in detail below.

Consultancy agreements and collateral warranties

 1.48 As well as determining the appropriate method of pricing and procurement, an employer needs to consider whether his interests are safeguarded as regards the services provided by the professionals involved in the project, where those professionals have not provided services direct to the employer. This issue is addressed by requiring the relevant professional to enter into a collateral warranty for the benefit of the employer. Similarly, funders, purchasers, freeholders and tenants may need to consider whether they have a right of recourse against both contractor and design professionals given the rule against recovery in cases of pure economic loss.11 1.49 It is now a common expectation that all consultants, together with the relevant contractors and subcontractors, will enter into contracts that give direct rights to the ultimate beneficiaries of the development (the identity of the beneficiaries may not yet be known, but they may comprise lenders to the development, and purchasers or tenants of the completed development). However, it is equally common that those collateral warranties are not executed; that can give rise to disputes as to the party that bears responsibility for the failure to procure the collateral warranties.

1 House of Commons Briefing Paper “Construction Industry: Statistics and Policy” 6 August 2015, Chris Rhodes.

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