Caps: they’re the height of fashion

Like them or loathe them, financial caps appear to be on the increase. These are clauses in contracts that limit a firm’s liability for its breach. But what impact can professional indemnity (PI) insurance have on a cap?

This question has come under the spotlight in Shepherd Homes’ legal action against Encia, its civil engineering contractor. Shepherd is claiming that Encia’s defective piling design resulted in cracking. For its part, Encia is blaming its piling subcontractor, Green Piling.

In short, it is the usual Punch and Judy show, which, at the time of writing, is due to appear in court shortly.

More pertinent to the rest of us was a preliminary issue put to the court relating to a cap on liability in Green Piling’s appointment. This limited the firm’s liability for any damage or loss to the contract price, being, at the most, about £250,000.

In Encia’s view this fell miserably short of its own liability to Shepherd Homes, which is potentially an eye-watering £10m.

Encia claimed that the cap fell foul of the Unfair Contract Terms Act 1977, as it had not been sufficiently drawn to its attention. Encia also felt misled by discussions as to the level of Green Piling’s PI cover, which was £1m. After all, it protested, what would be the relevance of talking about Green Piling’s £1m cover if Encia would never be able to claim more than £250,000 from it?

It is a common misconception that the level of insurance cover held by a party will be available in respect of every individual claim against it. That is not the case if the insurance is in the aggregate (as was Green Piling’s).

Even if it is on an each-and-every-claim basis, then, depending on the precise terms of the insured’s policy, claims from two different sources that relate to the same error (for instance, one from the client and another through a warranty) may be a single “claim” under the policy terms, so allowing the insured only one bite at the applicable insurance level.

None of this escaped Mr Justice Christopher Clarke. He pointed out that the £1m aggregate PI cover may have to be divided among a number of claims, and so is in no way contradictory to a cap per claim in the appointment at a considerably lower figure.

A misconception that is common is that the level of insurance cover held by a party will be available in respect of every individual claim against it. That is not the case

Moreover, he noted that the cap was not hidden in any way, nor very unusual. So it did not fall foul of the act.

Another common misconception over caps and insurance cover is that clients often believe they can heap more onerous liabilities at the door of a consultant as a “trade-off” for accepting a cap in its appointment at the level of its PI cover.

The large fly in the ointment here is that it is the insurers, ultimately, that will be picking up the tab, or at least the lion’s share of it. They will hardly be persuaded to cover more onerous liabilities by a cap at the level of insurance: they would have nothing to gain. And they would view a cap over the level of insurance as neither better nor worse, as the additional sum would have to be borne by the insured (which, no doubt, would have its own view on the point).

Only a cap at significantly below the level of insurance is likely to have any appeal from the insurer’s perspective.

However, even then, it is dangerous for the insured to rely upon it as total protection because, for example, of the reasons given previously of potential aggregate cover or multiple claims being deemed a single “claim” under its particular PI policy, potentially resulting in its overall liability shooting right through its insurance level.

Those that are insured may wish to consider making the cap itself apply as a total limit on all its liabilities (including through warranties), but this will hardly

be appealing to potential claimants, which may present their claim when the pot is empty. Also, it may still not catch all claims, such as third-party claims in tort.

All this should be borne in mind when calculating the appropriate level of cap to apply to a contract. It is by no means as straightforward as some would have you believe.