Risky business

In nationwide research carried out last month by law firm Weightmans, the overwhelming response from construction industry professionals was that the sector faces increasing levels of risk. Professionals are seeking to identify any historical problems, and commissioning contractual reviews to tackle inappropriate allocation of risk.

80% of those who responded complained that contractual obligations are becoming more onerous and complex. The vast majority of those questioned said that they carried out regular checks to ensure that the evolving profile of their business dovetails with its insurance requirements.

Many respondents indicated that adopting a tough approach in negotiations was an important way in which to limit exposure, and the majority of those at the sharp end of those negotiations were aware of the scope of their insurance cover.

In an environment in which professionals are increasingly under pressure to sign up to complex contractual provisions which may exceed or breach their insurance cover, many respondents referred to the existence of contractual contingencies or internal insurance type funds to address uninsured scenarios, though over a quarter suggested that such uninsurable risks were simply ignored.

Over one third of those interviewed thought that there would be casualties in the sector as a result of escalating risk issues. The reality seems to be that although risk is recognised and tackled, ultimately the decision about whether to proceed with a project with a high risk profile is a commercial one.

The risk landscape in construction could be transformed by ensuring that risk management is at the forefront of the process

It is also clear that what can be best described as an “it will be alright on the night” mentality is still perceived to prevail in the industry - a natural consequence of some of the other trends that were highlighted, and consistent with a philosophy that commercial considerations generally outweigh risk-awareness issues.

The findings conveyed some uncertainty around the impact of insurance and in particular the extent to which cover may be compromised by the nature of the prevailing contractual arrangements on a project.

A contractual liability that is incurred when obligations are accepted that go beyond the scope of the exercise of due skill and care is usually excluded from professional indemnity policies.

Common contractual liability exclusions include fitness-for-purpose guarantees or liquidated damages obligations. However, it is common for the provision of collateral warranties to be permitted under the terms of a professional indemnity policy – subject to conditions.

The research also indicated that construction professionals may not be fully aware of the importance of insurance and its relevance to project contractual arrangements.

Evidence for this is found in the revelation from respondents that many do not have a system in place for ensuring that there is no conflict between trading terms and conditions and insurance provisions.

Ironically, this means that avoidable problems arise, despite the heightened concern about risk and the prediction that businesses will fail as a result of it.

The economic upturn will lead to an increase in the use of collateral warranties and other contractual mechanisms to transfer and limit risk – and that is what we are seeing.

It is vital that construction professionals are aware of these contractual mechanisms, how they work, their positive and negative implications, and how they may impact upon insurance.

We have noticed an increasing trend for professionals to be asked to accept contractual terms which could compromise or exceed their insurance cover.

Fitness-for-purpose guarantees and performance warranties are more common, as are clauses requiring work to be done to the “satisfaction” of the client. Such clauses are likely to be in breach of the provisions of a standard professional indemnity policy.

Construction professionals must ensure that there is a clear awareness of what is insured and what is not, in order to make informed decisions about risks to be taken, and how they can be managed and mitigated.

The risk landscape in the construction arena could be transformed by ensuring that risk and its management is at the forefront of the process.

If a relatively modest investment is made early on in a project to ensure that contractual mechanisms do not transfer unnecessary risk burdens, that contracts are executed by the appropriate parties and that their provisions do not undermine insurance cover, many costly disputes with other parties involved on the project and insurers, could be avoided, and the costs of defending or settling a costly and disruptive dispute could be saved.

Mike Grant is head of the professional risk team at Weightmans