Indemnity for contractors arising from sub-contractor’s conduct in the course of construction works

On Friday 1st December the Full Court of the Federal Court released its decision on Zurich Australian Insurance Ltd v FKP Commercial Developments Pty Ltd [2023] FCAFC 188. The case can be read in full here.

The decision considers the definition of “professional services” as they apply under a design and construction professional indemnity policy (“D&C Policy”). The issue to be determined was whether a head contractor may be indemnified for a subcontractor’s conduct in the course of construction work.

FKP Commercial Developments Pty Ltd (“Developer”) was the developer and FKP Constructions Pty Ltd (“Contractor” and collectively “FKP”) was the head contractor for works involving two residential and commercial apartment buildings at Rosebery, New South Wales. The registered proprietor is the Owners’ Corporation of Strata Plan No 84298 (“OC”).

The scope of the Contractor’s role was amongst other things, project, and construction management. All design and construction works were delegated by the Contractor to third-party consultants and sub-contractors.

Both the Developer and Contractor were named insureds under the Policy issued by Zurich Australian Insurance Ltd (“Zurich”). Collectively the Developer and Contractor were sued by the OC in the Supreme Court of New South Wales (the “OC Proceedings”) – the proceedings were settled, however, an interlocutory application was filed as to whether FKP was entitled to indemnity under its D&C Policy for the conduct of its sub-contractors and sub-consultants in the course of construction works.

In determining coverage, consideration was given to both the insuring clause and Extension 3 of the Policy.

The insuring clause stated:

We agree to indemnify the insured against loss incurred as a result of any claim for civil liability first made against the insured and notified to us during the period of insurance, based on the insured’s provision of the professional services.

Extension 3 stated:

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.

Initially, it was accepted that the insuring clause would not apply to the claim, however, extension 3 did because it did not require that the claim arising from such conduct be caused by the insured’s provision of professional services. That clause requires only that the insured is legally liable for the conduct in its provision of professional services, irrespective of the source of the legal liability. (emphasis added).

Extension 3 requires that the consultants and subcontractors were engaged by the insured. Further, the professional services performed by them were causative of the loss, subject of the claim.

The insurer argued that the services performed by the sub-contractors were not professional services but constituted “construction work”. They also submitted that the use of the prepositional phrase “in the provision of professional services” limited “legal liability” for the subcontractors’ professional services only”.

The Court rejected this proposition and found that a broad ordinary and natural meaning of extension 3 intended to provide cover. The relevant professional services to enliven cover were those of “project management services” that were provided by the Contractor. It followed that Contractor’s legal liability sounded in the conduct of its subcontractors, relevantly those under the Home Building Act 1989 (NSW) and at general law.[1] The Court recognised that in the context of legislation governing building projects (including the statutory warranties relied on by the Owners Corporation) developers and contractors are exposed to liability for the conduct of their subcontractors, even where the developer or contractor performs no more than a project management (i.e. professional services) role.

Key takeaways
  1. Depending on the language of the policy an insured builder may likely have the benefit of cover under a design and construction professional indemnity policy for its liability that sounds as a result of construction works undertaken by its sub-contractor.

  2. Insurers may now look to tighten policy wordings by narrowing policy extensions. For instance, to tie the indemnity in the extension to only respond to liabilities directly from the provision of professional services. We have also seen some insurer’s definitions of professional services significantly, so as to limit any exposure to “construction related” activities including any hands on “project and construction management”.

  3. Developers and contractors should seek clarification as to the extent of cover under their D&C Policy. Consideration should be given in the course of contracting to upstream and downstream undertakings. The extent to which any of these undertakings prejudice their insurers or expose them to uninsured liability.

  4. When looking downstream, developers and contractors must ensure that appropriate indemnities are sought from subconsultants for liabilities arising from their work or services. Where this does not exist or there is no formal agreement in place, in the event of a claim, the developer or contractor may be unable to rely on that indemnity to support a subrogated claim against the subconsultant liable for the claim.

[1] In the underlying proceedings, fundamentally, FKP owed the Owners Corporation a duty of care under both the common law and s 37 of the Design and Building Practitioners Act 2020 (NSW). That Act states that a person who carries out construction work has a duty to exercise reasonable care to avoid economic loss caused by any defects. It follows that in carrying out the residential work FKP may have breached that duty of care in causing or permitting the defects and/or non-complying work to be present in the common property.

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