INSURANCE BUILDING PROTECTION INTO PROFESSIONAL RISK THE OPERATION OF PROFESSIONAL INDEMNITY INSURANCE IN CONSTRUCTION

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1 INSURANCE BUILDING PROTECTION INTO PROFESSIONAL RISK THE OPERATION OF PROFESSIONAL INDEMNITY INSURANCE IN CONSTRUCTION Adeline Pang, Lawyer Freehills, Melbourne The purpose of this article is to look at the challenges that are being faced by professionals operating within the construction industry and a consideration as to whether professional indemnity insurance is adequate in providing protection. The article begins by providing a general overview of the types of insurance that are commonly used on construction projects. It then outlines briefly the nature of professional indemnity insurance and considers how professional indemnity insurance operates within the construction environment. The article considers the identity of construction professionals and the scope of activities undertaken by construction professionals that can be taken to constitute professional services, in light of these being dynamic concepts. It looks also at the change in the roles and the activities that construction professionals are increasingly being required to perform in the course of a project and whether these activities would ordinarily fall outside the scope of the indemnity provided by professional liability insurance and are consequently uninsurable risks. INTRODUCTION Insurance plays a vital role in the management of risks within the construction industry and as a conduit of enabling risk transfer. An area that is of increasing concern is the risk management challenges being faced by construction professionals, such as architects, engineers and project managers, in the construction environ. This article looks at the types of risks and the potential liability that are of greater frequency, confronting construction professionals. A principal method (and sometimes the sole method) by which a construction professional s liability can be managed is through the use of professional indemnity insurance (PI insurance). As the size and complexity of construction projects increases, construction professionals are increasingly being required to play multiple roles and in accepting risks that would normally fall outside of their traditional tasks. This translates into a greater need for the use of PI insurance as a means of mitigating and providing indemnity for professional risks. One of the challenges that is being faced by construction professionals is the adequacy of their professional indemnity cover to provide protection in respect of the activities that a construction professional undertakes on a construction project. INSURANCE ON CONSTRUCTION PROJECTS To understand the operation of PI insurance in the construction landscape, it is necessary first to look at the types of policies that are ordinarily required on a project. In order to manage the variety of risks confronted by parties on a construction project, a number of policies are usually taken out. The core construction insurance policies required relate to works, public liability and professional indemnity. CONTRACT WORKS INSURANCE Insurance of the works or contract works insurance is an occurrence based form of policy. It is intended to provide protection upon the occurrence risk of damage or destruction of the works during the construction period. Traditionally, contract works insurance was provided to insure 6 AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #116 SEPTEMBER/OCTOBER 2007

2 against the consequences of some form of disaster happening to the works such as fire or earthquake. From a commercial perspective, it was thought that catastrophic damage to the works would often be beyond the means of a contractor to remedy. Therefore, insurance was required to protect both the owner and the contractor from such an eventuality. Over the years however, contract works insurance has been expanded to cover loss or damage caused by risks beyond the limited category of disaster which it was originally intended to cover. It now provides for insurance against damage to the physical loss or damage to the project property and the contract works from the commencement of the work to practical completion. 1 Contract works insurance generally contains exclusions in respect of faulty materials and cannot be used by contractors to obtain insurance in respect of defective workmanship. 2 PUBLIC LIABILITY INSURANCE Public liability insurance is an occurrence based form of insurance which provides insurance to the insured in respect of claims brought by third parties for damage to property or injuries to persons. Public liability insurance triggers upon the happening of an event causing personal injury or property damage. However, public liability insurance does not provide cover in respect of damage to contract works (as this is otherwise covered by contract works insurance). It also excludes cover for damages caused by breach of professional duty. 3 PROFESSIONAL INDEMNITY INSURANCE The third type of core policy is professional indemnity insurance. PI Insurance is a liability based claims made policy and is usually required to cover the activities of architects, engineers and other construction professionals on a project. PI insurance normally insures a party against a claim made for (and notified) of loss or damage occasioned by a failure to exercise reasonable care resulting in a legal liability to pay. 4 While PI insurance provides cover for a failure to exercise reasonable care in the performance of professional activities, it also contains an exclusion for claims resulting from defective workmanship, that is, negligence in actual construction. 5 Where the contract works or property are damaged or personal injury occurs during the carrying out of the contract works, this will usually fall under the cover provided by one of the three core insurance policies. However, as all three policies contain an exclusion in respect of faulty workmanship, any claims resulting from negligent construction is an excluded claim to which neither of these policies will respond. Therefore, a main area of risk which remains uninsured is negligent construction. This stems from the commercial position that negligent construction is an uninsurable risk which is more suitably borne by the contractor as it represents a genuine trade risk. 6 This may be due in part to the fact that traditionally a contractor is not a professional and is therefore not capable of obtaining PI insurance. The construction industry has often been acknowledged as a high risk industry. There are a number of means by which risks on construction projects can be allocated and managed, one of which is through the use of insurance. AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #116 SEPTEMBER/OCTOBER

3 LEGISLATIVE REQUIREMENTS FOR INSURANCE The importance of insurance in mitigating risk within the construction industry can be recognised through legislation mandating insurance within certain sectors of the construction industry and also by parliament s attempt to otherwise limit the exposure of insurers to liability through introduction of proportionate liability legislation. Mandatory insurance regime In Victoria, the Building Act 1993 requires certain categories of building practitioners to carry insurance. A building practitioner is defined in the Building Act to include a building surveyor, building inspector, quantity surveyor, engineer, draftsperson and builder. Accordingly, it is compulsory for building practitioners to obtain the following types of insurance prior to entering into building work : Category of building practitioner Insurance 7 Building surveyor professional indemnity insurance Building inspector professional indemnity insurance Quantity surveyor professional indemnity insurance Engineer (civil, mechanical, electrical and fire safety) professional indemnity insurance Draftsperson: building design (architectural, interior and services) professional indemnity insurance Commercial builder structural defects/builders indemnity insurance Builder: demolisher, erector or supervisor (temporary structures) public liability insurance Domestic builder builders warranty insurance The Ministerial Order 8 provides that compulsory PI insurance for a building practitioner is required to cover the conduct of the building practitioner as a building surveyor, quantity surveyor, engineer or draftsperson, including any reasonably related professional activities. The policy is required also to specify a limit of indemnity of either: where defence cost is included in the limit not less than $1.5 million for any one claim, and in the aggregate for all claims during any one period of insurance; and where defence costs is not included in the limit: not less than $1 million for any one claim and in the aggregate for all claims during any one period of insurance; and not less than $500,000 for any one claim and in the aggregate for all claims during any one period of insurance in respect of defence costs. 9 While builders are not required per se to carry PI insurance, the Building Act does mandate the provision of a limited form of indemnity insurance in respect of structural defects. Structural defects insurance provides cover in respect of a builder s civil liability arising out of the discovery of a latent structural defect. Structural defect is defined to mean any defect in structural works attributable to defective design, defective or faulty workmanship and/or defective materials but only if it results in: the closing of the building or parts of the building by a regulatory authority; the prevention of continued practical use of the building or parts of the building; destruction of the building or physical damage to the building or part thereof; [and/or] threat of imminent collapse that may reasonably be considered to cause destruction of or physical damage to the building. 10 Structural defects insurance is a statutory exception to the general position that claims arising out of defective workmanship or material is excluded from cover under the core insurance policies usually taken out in respect of construction projects. 11 Proportionate liability legislation Due to the voracity of litigation within the construction industry, proportionate liability was introduced into Victoria as a means of minimising the deep pocket syndrome. The deep pocket syndrome refers to the practice where plaintiffs targeted the defendants with the deepest pockets against whom they would commence their actions. Often the parties with the deepest pockets would be parties who were insured and increasingly insurers were finding themselves embroiled in litigation where they were at risk of paying the entire portion of the plaintiff s damages in instances where the insured party may not have been the major cause of the loss incurred. While the deep pocket syndrome is by no means unique to the construction industry, due to the common occurrence of multiple party liability in building disputes, its effect was more pronounced and lead to concern in the construction industry as to the cost of insurance. To alleviate this concern, in 1993 proportionate liability was introduced in respect of building actions by way of s 131 of the Building Act AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #116 SEPTEMBER/OCTOBER 2007

4 Subsequently, in early 2001 the collapse of one of the largest insurers in Australia, HIH Insurance Group, and the increase in the premium of liability insurance, led to government response (at both the state and federal level) 13 and in Victoria the Wrongs and Limitation of Actions Act (Insurance Reform) 2003 (Vic) (WLA Act) was assented to on 16 June The WLA Act introduced uniform proportionate liability reforms to Victoria for all claims arising out of property damage or economic loss. 14 CONTRACTUAL REQUIREMENTS FOR INSURANCE Insurance on construction projects have become such a matter of course that the requirement for insurance has become entrenched in construction contracts. Standard form contracts now provide for the provision of insurance. The Australian Standard Form Consultancy Agreement AS provides at cl 10 that: 10.1 Professional Indemnity Insurance Before the consultant commences carrying out the services, the consultant shall effect a professional indemnity insurance policy for the services covered in the contract with a total aggregate cover of not less than the sum stated in Item 15(a). The policy shall include provisions for one automatic reinstatement of the sum insured and for loss of documents. The policy and such level of cover shall be maintained until the consultant completes carrying out the services and thereafter for a period as stated in Item 15(b). 15 Similarly, the Australian Standard Form Design and Construct Contract AS provides at cl 21 that where a contractor has taken on both design and construct obligations, it is also required to take out professional indemnity insurance. 21. Professional Indemnity Insurance Before the contractor commences work under the contract, the contractor shall effect a professional indemnity insurance policy with a total aggregate cover of not less than the sum stated in Annexure Part A or, if no amount is stated, the amount of $1,000,000. The policy and level of such cover shall be maintained until the final certificate is issued pursuant to clause 42.6 and thereafter for a period as is stated in Annexure Part A. The contractor shall ensure that every cnsultant, if within a category stated in Annexure Part A, is insured for professional indemnity with a cover not less than the sum stated in Annexure Part A. Each consultant s policy shall be maintained until the final certificate is issued pursuant to clause 42.6 and thereafter for a period as is stated in Annexure Part A. 16 There are a number of factors that are of note in the contractual requirement for insurance. Consultants are under a contractual obligation to take out insurance which meets the following criterions: Insurance is required to be provided from commencement (of works or services) to a specified period after the relevant works or services are completed. This specified period is generally six years which is reflective of the long tailed nature of PI insurance and provides that the works or services remain insured until the expiry of the six year limitation period for a contractual or tortious action. 17 The value of insurance cover provided will need to reflect the value of the project works (and the potential quantum of damages which may be caused through a consultant s negligence actions) as opposed to the value of the consultancy services provided. PI Insurance is required to provide cover in respect of claims arising out of the carrying out of the services provided by the consultant under the contract. Failure of the consultant to comply with any of these insurance requirements will amount to a breach of contract entitling the owner to sue for damages. Often a failure to comply with the insurance requirements of the contract will also amount to a substantial breach which will entitle the owner to terminate the contract. HISTORY OF PROFESSIONAL INDEMNITY INSURANCE At common law, a duty of care is placed on professionals to exercise due skill care and diligence in the performance of their professional activities. Whether a person will be held to owe a duty of care will therefore depend on the characterisation of a person as a professional and the meaning of professional activities. PI insurance was developed to provide indemnity to a professional in respect of a failure to take reasonable care in the performance of professional activities or services. It therefore generally responds to provide indemnity in respect of claims arising out of negligence, as defined from time to time, by the common law. 18 PI insurance is a claims driven policy which operates in respect of claims made during the period of policy cover. It insures AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #116 SEPTEMBER/OCTOBER

5 Recently, there has been an increasing trend for courts to expand the category of people that are held to owe a duty of care in order to reflect the changing modern environment. There has also been an increasing trend to widen the acts and/ or omissions that have been held to fall within the scope of a duty of care. a party against a claim made for (and notified) loss or damage occasioned by a failure to exercise reasonable care resulting in a legal obligation to pay. PI Insurance, generally speaking, responds in respect of negligence caused by professional activities. 19 The meaning of professional activities will generally depend upon the definition of those words in a PI Insurance policy. In the case of a designer, this will usually mean design activities. Although professional services is a contractually defined term within a PI policy, some light can be shed on the characterisation of an activity as being within the professional realm by an analysis of common law consideration of this term. 20 Recently, there has been an increasing trend for courts to expand the category of people that are held to owe a duty of care in order to reflect the changing modern environment. There has also been an increasing trend to widen the acts and/or omissions that have been held to fall within the scope of a duty of care. This article examines how these increased categories of negligence may potentially affect professional indemnity insurance in the construction context. As the manner in which a PI policy operates will depend on the definitions of professional and professional activity, it is therefore appropriate to analyse the manner in which the courts have recently interpreted these two concepts. WHO IS A CONSTRUCTION PROFESSIONAL? While professionals have in the past been viewed as those belonging to an established profession, the concept of a professional is not a static concept but one capable of change over time. There are a number of cases where the concept of a construction professional has been the subject of judicial comment. A professional has been held as one who possesses special knowledge which is attained after study and application, as distinguished from mere skill. 21 The meaning of profession has also been said to be:... an occupation requiring either purely intellectual skill or of manual skill controlled, as painting and sculpture, or surgery, by the intellectual skill of the operator as distinguished from an occupation which is substantially the production or sale of commodities. 22 It should however be noted that even the court s definition of the characterisation of a professional can also be the subject of change over time. In FAI General Insurance Co Ltd v Gold Coast City Council 23 it was observed that:... the meaning of a professional will of course vary with context. Professional however, connotes pertaining or appropriate to a profession, engaged in one of the learned professions. 24 It is therefore perhaps unsurprising that Kirby P (as he then was) observed that the term professional in the context of professional indemnity insurance today is very broad and that professional services involve no more than advice and services of a skilful character according to an established discipline.25 OPENING UP PROFESSIONAL TO NON TRADITIONAL CATEGORIES While only architects and engineers have traditionally been viewed as professionals, 26 the 10 AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #116 SEPTEMBER/OCTOBER 2007

6 definition of professional has in recent times been broadened to encompass new categories of construction professionals. This has been due in part to judicial development in the law of negligence in recent times. Historically, the concept of negligence could be said to have originated from the view that professionals, as members of a learned and skilled calling, had a duty in the performance of their professional services to exercise due skill and care. It is for this reason that professionals were recognised as having a concurrent duty in tort as well as in contract. 27 As the concept of negligence has evolved over the years to recognise new categories of occupations as owing this concurrent tortious duty, so has the availability of PI insurance expanded to meet these modern categories of professionals. Accordingly, the concept of a construction professional has now been extended to encapsulate a variety of what are arguably non traditional professions. Building surveyors are now recognised as being a class of construction professional. The case of Moorabool Shire Council v Taitapanui, 28 involved a negligence claim for economic loss before the Victorian Court of Appeal as against a building surveyor. The claim was brought by the subsequent purchasers of a property, the Taitapanuis alleging a failure by the building surveyor to take reasonable care in issuing a building permit. In that case, the court observed that: It was not in debate that Mellis, as a building surveyor, was required to hold, and must have held, professional indemnity insurance. Neither was it in dispute that he was appropriately qualified, and that he was a registered building practitioner. Thus far, it can be said that in 1996 and 1997, just as is now the case, for a building surveyor to have been registered under the Act such person was required to be skilled by study and experience, and to hold professional indemnity insurance. 29 Recently, in the English case of Great Eastern Hotel Company Ltd v John Laing Construction Ltd, 30 the position of a construction manager was considered by the English court. The case involved John Laing Construction Ltd, who was engaged under a construction management contract in respect of refurbishment and extension works by the Eastern Hotel Company (EHC). In considering the claim in negligence brought by EHC against the construction managers, the court stated that the construction manager owed EHC an obligation to exercise care, skill and diligence to the degree of a professional carrying out similar services. 31 Similarly project managers were recognised as being a class of construction professionals. In Toomey v Scolaro s Concrete Constructions Pty Ltd, 32 the role of a project manager was regarded as a professional for the purposes of reviewing an exclusion for professional liability in a public liability policy of insurance. The judge in that case noted that while the position of a project manager as a professional may be one of recent origin, the categories of professions should not be regarded as being closed and confined to traditional learned professions. 33 THE POSITION OF THE CONTRACTOR The traditional project delivery model provides that an architect or engineer would provide the design services while actual construction is carried out by the contractor. However, as the complexity of project increases and new construction models are introduced, design responsibilities have become more fragmented. Project owners are now requiring contractors to take on additional design and/or construction management activities and, with greater frequency, are looking at contractors to provide a single point of responsibility for design and construction liability. Typically, contractors are usually not required to take out professional indemnity insurance, since contractors are not recognised as being a class of professional, and negligent construction is not an area to which PI Insurance will usually respond. 34 An exception to this is when a contractor has taken on both design and construction responsibilities. In this case, the contractor will be required to take out PI insurance but only in respect of design obligations. As the lines of responsibility between design firms and contractors merge, contractors are assuming non traditional risks for which their usual core policies (such as Contractor s All Risk Insurance) fail to provide coverage. 35 In addition, as construction methods and practices are becoming increasingly more complex and technical, contractors and builders as an occupation body are becoming increasingly more regulated and subjected to legislatively prescribed standards of conduct. 36 It is suggested that PI Policy has become as essential to a contractor as it is to an architect or an engineer. 37 A question therefore arises as to whether a contractor can be considered to be a professional. AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #116 SEPTEMBER/OCTOBER

7 Contractors have generally been regarded as a category that is not considered to attract the title of professional. In the English case of Dominion Chain Co Ltd v Eastern Construction Co Pty Ltd, the court observed that: Neither a contractor nor a builder professes skills in a calling within the meaning of the principle I have applied in the case of engineers and architects. As a result, under the principle, there is no duty on them to take care, either arising from an implied contractual duty depending solely on the relationship brought about by the contract of employment or arising concurrently in tort from that relationship. 38 The Dominion Chain case professes the view that as a contractor is not a member of an occupation which can be distinguished from its requirement of obtaining skill through study or an established discipline, contractors cannot be considered to be a class of professional. The position of the contractor was recently discussed by the High Court in the case of Bryan v Maloney. 39 In Bryan v Maloney, the subsequent purchasers of a house suffered financial loss due to the negligence of the builder in constructing a house with inadequate footings. In bringing an action in negligence against the builder, the High Court 40 had to determine whether a builder owed a duty, in the construction of a house, to exercise reasonable care to subsequent purchasers. While Bryan v Maloney was concerned with the duty of care owed by a builder, the High Court in its reasoning readily equated the position of a builder to that of the professional architect in Voli v Inglewood Shire Council. 41 The court seized upon Justice Windeyer s dicta that the principles of the law of negligence as stated in Donaghue v Stevenson, 42 were applicable to define the ordinary liabilities of any man who follows a skilled calling. 43 The court by its analogous treatment to the duty of an architect and by referring to the builder as a professional builder, indicated a readiness to regard a builder as falling within the category of professional. The case of NRMA Insurance Ltd v AW Edwards Pty Ltd, 44 again involved a consideration as to whether a duty of care was owed by the contractor. In this case, the potential for a contractor to be regarded as a professional, with analogous references to that of an architect or engineer was acknowledged by the court. Kirby P noted that: Even if the duty of care expressed in the cases is confined to a professional or quasi professional relationship, it is far from plain that the detailed facts of the instant case might not bring the parties into such a relationship, properly understood in the modern context. It is true that theirs is not a relationship which was professional in the traditional sense of that term. Assuming such a distinction to be viable, it is, nonetheless, arguable that, with modern complex building contracts, involving hydraulic engineers, architects and highly skilled builders, the principles earlier developed for the traditional professions, may also apply, giving rise to a tortious liability under the general law. 45 The judicial perception of the contractor is perhaps a reflection of the manner in which a builder s role has over time evolved in construction projects. While contractors are now capable of obtaining PI Policy in respect of their professional activities the policy will usually be restricted to activities which are considered to be performed in a professional capacity. Accordingly, while PI insurance is obtainable by a contractor, it will only provide cover for liabilities arising out of a failure to exercise reasonable care in design, project management or even construction management. However, negligence arising from actual construction still remains an uninsurable risk. 46 Furthermore, the services the subject of cover under a PI policy will depend upon the actual wording of the policy. Accordingly, the professional activities of a contractor (or any other construction professional for that matter) the subject of indemnity will depend on whether the professional s policy provides coverage in respect of those activities. This is important as the question of whether a policy will respond is dependent upon the classification of the act or omission the subject of the alleged negligence as falling within the confines of professional activity. If it falls outside the scope of this definition, then it is not a claim to which the professional indemnity policy will respond. This was recently illustrated in the case of Baulderstone Hornibrook v Gordian Runoff Ltd 47 (discussed below). THE MEANING OF PROFESSIONAL ACTIVITES OR SERVICES PI insurance is designed to provide indemnity to a professional for claims arising out of negligence in the conduct of professional activities. The distinction between professional and non professional activities was illustrated in the case of Solicitors Liability Committee v Gray and Winter 48 where the Federal Court held that a solicitor s PI policy has to 12 AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #116 SEPTEMBER/OCTOBER 2007

8 be construed so as to provide indemnity in respect of activities having some nexus to the professional functions of the solicitor only, as opposed to what the court referred to as entrepreneurial activity. A PI policy is a contract between the construction professional and the insurer. Therefore, the meaning of professional activities is largely dependent on its definition in the relevant contract for PI insurance. However, even where the term is contractually defined, there may nevertheless be some ambiguity in the exact scope of professional activities to which the policy responds. If, for example, the PI policy for an engineer defines professional services as those services ordinarily provided by an engineer in the course of its practice, then the common law will need to be applied to determine the services falling within the ordinary practice of an engineer. For this reason, judicial consideration of professional services and its derivative terms are useful to determine how its meaning can be elucidated on a case by case basis. Chemetics International Ltd v Commercial Union Assurance of Canada (1984) 11 DLR (4th) 754 In Chemetics International Ltd v Commercial Union Assurance, 49 the British Columbia Court of Appeal considered the meaning of professional services in the context of an exclusion clause which stated that the policy excludes liability for claims in respect of errors or omissions in the rendering of professional services. Chemetics was engaged to design and construct an oxygen bleach plant. Clause 1.3 of the relevant contract required Chemetics to provide training to owners/ operators in the operation of the plant. As part of these services, Chemetics was required to provide an operating manual. Subsequently, during operation of the plant, the room was damaged due to overfilling of the tower. The owners of the plant then brought a claim against Chemetics on the basis that the damage was due to failure by Chemetics personnel in providing the operating manual to warn the operators of this risk. The insurers argued that although this claim would otherwise be insurable under Chemetics policy, it falls within the exclusion clause, as the writing and provision of the operating manual amounted to professional services within the meaning of the policy. The court held that while Chemetics was under a contractual duty under cl 1.3 to provide operating instructions, both orally and in the manual, the provision of these instructions do not amount to the rendering of professional services. 50 While the Chemetic s personnel who provided the cl 1.3 services was a qualified engineer, 51 professional qualifications are not determinative as to whether the services amount to professional services. The court emphasised that it is not the qualifications of the person providing the services which is determinative of whether the services amounted to professional services but rather, the nature of the actual services provided. In this instance, the provision of cl 1.3 services could have easily been provided by a technician experienced in the operation of plants in general and knowledgeable as to the operating characteristics of this particular plant, as opposed to services which can only be provided by an engineer. Services within the meaning of professional services in this case refer to those services normally expected to be provided only by a professional engineer, such as the design of the plant. This case highlights that it cannot be assumed that all services performed by a construction professional will necessarily amount to the provision of professional services caught under the construction professional s PI policy. While no doubt a broad component of the contractual services provided by a construction professional is likely to be characterised as professional services, there must still be consideration as to whether the particular service can be characterised as being in the professional capacity. GIO General Ltd v Newcastle City Council (1996) 38 NSWLR 558 GIO General Ltd v Newcastle City Council 52 looked at the meaning of professional services within the context of a council s professional activities. Newcastle City Council had issued a Certificate of Structural Soundness for the Newcastle Workers Cooperative Club despite an expert report stating that there was a serious defect in the building. Council s power to issue structural certificates in respect of buildings was founded in s 311 of the Local Government Act which required council to examine building plans and satisfy itself that the proposed construction was in accordance with various statutory requirements before granting approval. Shortly thereafter the building collapsed. When the club brought a claim alleging that council s negligent certification had resulted in the damages suffered, council sought indemnification under its policy for insurance from GIO General. The policy of insurance provided council with cover against claims in respect of public liability, AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #116 SEPTEMBER/OCTOBER

9 product liability and professional liability. However, council s claim was refused by GIO General on the grounds that it neither fell within the public liability or professional liability insuring clauses. In support of its refusal to indemnify on the grounds of professional liability, the insurer argued that as council s ability to issue structural building certificates was founded on statute, council s claim could not be classified as having been incurred in the performance of a professional activity. Rather, it was incurred in the exercise of council s statutory powers. 53 Accordingly, it is not a claim to which the professional liability insuring clause will respond. While Kirby P 54 agreed that council s claim did not fall within the confines of the public liability insuring clause, he did not agree with the insurer s argument that council s certification activities could not be regarded as the provision of professional, (but) statutory, services falling outside the operation of the professional liability clause. The relevant parts of the policy relating to professional liability were: Exclusion 16 which provided that all claims in respect of the rendering or failure to render professional advice or service by the Insured or any error or omission connected therewith may only be brought pursuant to cl (c) Professional Liability ; 55 and The insuring clause at cl (c) which provided that:... a claim or claims made against the insured during the period of insurance arising out of any negligent act, error or omission committed or alleged to have been committed, by the insured in the conduct of the insured s business as specified in the Schedule. 56 Kirby P observed that those activities which constitute an exercise by council of its statutory power and those acts which are within its professional capacity are not mutually exclusive events. Accordingly, while council s ability to check and issue a structural certification was in the exercise of its statutory powers, it was also carried out in council s professional capacity as those activities fell within the meaning of professional activities as applied to councils. His reasoning appears to have been based on the characterisation of the nature of the services being provided by council as professional. He states: The relevant activities conducted by the respondent must be examined to see whether, in their nature, they are properly characterised as professional. The source of the respondent s duties to perform the activities, although a relevant circumstance, is not definitive. 57 Since professional services in respect of a municipal council involved no more than the giving of advice and services of a skilful nature according to an established discipline, 58 in the current context the examination and analysis of building proposals with a view to granting consent can properly be characterised as the provision of a service of a skilful nature according to a discipline. Kirby P again emphasised on this point, when he noted that the council officers alleged to have performed the negligent act being professionally qualified engineers is not determinative of the issue. The real question is to be centred on whether the services (the subject of the negligent activity) could properly be characterised as professional services. 14 AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #116 SEPTEMBER/OCTOBER 2007 Toomey v Scolaro s Concrete Constructions Pty Ltd (2002) 12 ANZ Ins Cas In Toomey v Scolaro s Concrete Constructions Pty Ltd (No 5), 59 Justice Eames in the Victorian Supreme Court considered the meaning of professional services as applying to a project manager again in the context of an exclusion in a public liability policy of insurance. The plaintiff, Toomey, was injured when he fell over the balustrade rail during the course of works for the construction of an apartment building. The tenth defendant, Hudson Conway Management Ltd (HCML), was found to owe a duty of care to Toomey and was one of nine defendants found liable by the court for the loss, damage and injuries suffered by Toomey. HCML had brought third party proceedings in a claim for indemnity under a public liability insurance policy against the insurer, Royal & Sun Alliance Insurance Australia Ltd. Eames J was required to consider whether HCML s liability to Toomey was covered under its public liability policy of insurance. The public liability policy relevantly provided an exclusion clause which stated that claims arising out of any breach of duty owed in a professional capacity by any of the Persons Insured is excluded from operation of the policy. 60 Although Eames J ultimately based his decision of HCML s entitlement to indemnity under the public liability policy on the basis that the action the subject of the plaintiff s claim failed to fall within the definition of business as defined in the HCML policy, his Honour nevertheless turned to a consideration of whether, assuming that the activities of the defendant did fall within the meaning of business (as defined in its public liability policy), the claim would nevertheless be

10 caught out by the exclusion clause as being incurred by HCML while acting in a professional capacity. It should be noted from the outset that Eames J made a distinction as to the interpretation of professional services forming the subject of an exclusion clause in a public liability policy, as opposed to professional services as forming the basis of an insuring clause under a professional liability policy. In the former, the definition of professional services should be construed narrowly as it operated as an exclusion. 61 In the latter however, professional services should be read broadly as it was in the context of an inclusive insuring clause. Eames J noted that, in order to fall within the exclusion, a two tiered approach was required. The first question was whether HCML owed Toomey a duty of care. Secondly, if so, was the duty owed in a professional capacity? On the first question, Eames J held that HCML did owe a duty of care to Toomey. He then went on to consider whether HCML s liability arose out of a duty owed in a professional capacity. While HCML acted as a project manager in respect of the development, this was an internal role more closely aligned to protecting the owner s interest in respect of the development and is distinct from the role carried out by companies carrying on a business as project managers. Notably, HCML did not hold itself out to perform project management roles other than for companies within HCML s group of companies. Neither was HCML paid a fee commensurate with its project management activities. Accordingly, Eames J formed the view that HCML (through the actions of its employee, James) was not acting in a professional capacity as a project manager. In giving reasons for his judgment, he observed that: James had trade skills and experience in the building industry but he was not a qualified surveyor or building inspector. In responding to the knowledge of the low balustrade I do not accept that he was performing professional functions, even employing the broad terms adopted by Kirby P. 62 A number of observations as to what constitutes professional services can be drawn from Eames J s judgment in Toomey v Scolaro: If the person performing the services possesses formal professional qualifications, this may be relevant (but not determinative) of the question whether the services were performed in a professional capacity. 63 The specific actions giving rise to the liability must be examined in order to determine whether it was performed in a professional capacity. For this reason: The actions of an entirely unprofessional kind by an employee, which take place in a professional organisation, might nonetheless be held to have arisen in a professional capacity, and likewise, in an organisation which would be regarded as engaged in industrial and not professional pursuits, the activities of an employee at any given moment might well be characterised as constituting a professional service sufficient to demonstrate that liability of the employer arose by breach of duty in a professional capacity. 64 His Honour s comment above reinforces the position that not all acts of a professional are constituted to be within his or her professional capacity. Specific consideration of the act (or omission) giving rise to the claim for indemnity is required, to determine whether the activity has any real nexus to a professional s practice. 65 This is also a recurring principle coming out of the cases discussed above. Baulderstone Hornibrook Engineering Pty Ltd v Gordian Runoff Ltd (2006) 14 ANZ Ins Cas The importance in determining whether an activity can be characterised as professional services was recently highlighted in the case of Baulderstone Hornibrook Engineering Pty Ltd v Gordian Runoff Ltd. 66 The case involved the design and construction of a runway at the Sydney Kingsford Smith Airport by Baulderstone Hornibrook. After the project was completed, defects were discovered in respect of sand loss occurring from the earth seawall and millstream wall. Baulderstone Hornibrook had settled the claim brought by the airport owners. It then sought indemnification of the claim under its professional indemnity insurance policy. One of the key issues in the case was a question of whether the defect resulted from defective design or defective construction. The insurers argued that as the defect resulted from negligent construction rather than negligent design, the claim was not capable of being indemnified under the relevant policy. The policy provides for indemnification where Baulderstone acting as: building or project owners and contractors and designers; or contractors and designers; or building or project owners and designers, incurs loss, damage or expense arising from professional activities. AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #116 SEPTEMBER/OCTOBER

11 Professional activities is defined as engineering, project management, surveying, designing, geotechnical, environmental monitoring, construction management and certification activities. The policy also provides a specific exclusion in respect of claims arising out of construction work performed by or on behalf of Baulderstone. Einstein J held that while designing, engineering, project management and construction management are all relevant professional activities (as defined within the policy), the carrying out of the construction of the reinforced earth wall is not an activity that is within the field of a consultant engineer, and therefore not an activity within the scope of the professional activities insured. The issue in this case was not substantially about whether the particular activity causing the damage fell within the definition of professional activity. Rather it was an evidentiary question as to the cause of the damage. If the activity causing the loss was due to construction of the seawall, there was no argument that this then fell outside the scope of the PI policy. Various expert evidence was submitted in respect of the actual cause of the damage. Ultimately, Einstein J held that the damage was caused by the defective construction of the seawall. However, in reaching his decision, Einstein J made the following observations towards the characterisation of a professional service : It is necessary for the activities which have caused the loss to be analysed in order to identify the nature of the services which are provided. 67 Not all services are professional. 68 Services are only professional if they are of a skilful character according to an established discipline. 69 This case reinforces a number of insurance issues that are distinctive to the construction industry. Properly defining the scope of professional services Developers and owners are increasingly looking at a single point of responsibility for construction projects. Accordingly, where parties are taking on multiple roles on a project, such as design, construction and/or project management roles, attention should be paid to ensure that those services are included within the scope of professional services under the relevant consultant s PI policy. Failure to do so will result in the consultant being devoid from insurance cover in respect of its claim. There is also the risk that claims incurred in providing professional services may fall within a gap in the insurance policies taken out by a consultant if not properly defined, and therefore fail to be insured at all. As some of the cases discussed above illustrate, 70 typically claims incurred in the performance of professional services will be excluded in a public liability policy. However, as Eames J had observed, the meaning of professional services in the context of a public liability policy exclusion clause may differ from professional services as defined in a PI insurance policy. 71 This can result in the anomalous situation of a claim, which would otherwise be covered by a consultant s public liability policy being excluded on the basis that it was incurred in the performance of professional services. Simultaneously, the same claim may be excluded under that consultant s professional liability insurance on the grounds that it fails to fall within professional services as defined in the PI insurance. An example of this is a claim incurred in the provision of project management services by an engineer consultant. As project management services are arguably the provision of services of a skilful nature according to an established discipline, 72 it can potentially be characterised as professional services and therefore be excluded from cover under the public liability policy. If, however, the PI policy taken out by the engineer refers to professional services only in respect of engineering design, then the provision of project management services will not fall within the definition of professional services for the purposes of the professional indemnity policy and will be excluded from cover under this policy. The cause of the claim In Baulderstone Hornibrook v Gordian,73 a large portion of Justice Einstein s judgment was devoted to determining the actual cause of the damage. This highlights a problem which, due to the number of parties involved, is perhaps more prevalent in construction than in other industries. In a number of cases, the cause of the damage may not always be evident from the outset. This creates a difficulty for both the insured to properly identify the insurance policy responding to the claim and for the insurer to properly determine whether indemnity should be granted. 16 AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #116 SEPTEMBER/OCTOBER 2007

12 For example, in Baulderstone Hornibrook v Gordian Runoff 74 much turned on the evidence given by the parties experts in respect of the cause of the damage. In other situations, the damage may have been caused by more than one party, being for example, a combination of careless construction and defective design. In this situation, there are practical difficulties for the parties involved in apportioning blame between the various parties, which may ultimately result in costly litigation. 75 CHALLENGES TO MANAGING PROFESSIONAL RISK IN THE CONSTRUCTION ENVIRON The cases discussed above serve as a warning to ensure that care is taken to properly manage professional risk through the effective use of PI insurance. As the definitions of professional and professional risk are dynamic concepts that evolve over time, and given the diverse nature of projects which parties are likely to be involved in, construction professionals should take care when renewing PI policies to ensure that they are insured (to the extent possible) in respect of all professional activities they undertake. There are, however, other factors which construction professionals should account for in order to properly manage and control professional risk. UNINSURABLE PROFESSIONAL RISKS Increasingly, owners and developers are, through the use of contractual mechanisms, requiring a greater shift in professional risk onto construction professions (such as a design and construct contractor or a design consultant). The danger in this is that while the principal has successfully managed to shift the risk onto the contractor/consultant, this risk may not necessarily be insurable under the PI policy. There are a number of contractual mechanisms which can result in uninsurable professional risk being borne by construction professionals. Imposition of a higher contractual standard The contract may require the construction professional to provide a warranty that the building or facility being developed will be fit for its purpose or use. Alternatively, the contract may require the construction professional to perform its services in accordance with best industry standard, world s best practice or to the highest degree of skill, care and diligence. The cover provided by PI insurance is usually tailored to respond to professional liability of the insured, to the extent imposed by common law. Accordingly, where a higher contractual standard is imposed, this will usually fall outside the operation of the PI policy. This is particularly so since most PI policies provide specifically for an exclusion against claims incurred through imposition of a contractual duty. 76 From a practical perspective, while a claim pleaded on a fitness for purpose or a higher contractual duty basis would generally be easier to prove than a negligence claim if the success of the claim will depend on the construction professional having access to insurance proceeds then it would be advisable to frame a claim in negligence to ensure that it is indemnified by the construction professional s PI policy. As the definitions of professional and professional risk are dynamic concepts that evolve over time, and given the diverse nature of projects which parties are likely to be involved in, construction professionals should take care when renewing PI policies to ensure that they are insured (to the extent possible) in respect of all professional activities they undertake. AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #116 SEPTEMBER/OCTOBER