In the construction industry, firms serving as general contractors, at-risk or agency construction managers, or as the prime entity on design-build projects need to recognize their design liability exposures and cover them with an innovative and flexible coverage form that addresses their professional liability exposures.
A contractor can obtain coverage for its design services through a tailored professional liability insurance policy provided by Victor and CNA. The policy is designed specifically to protect contractors who provide design services directly or through subcontractors or joint ventures from potential claims arising from errors, omissions, or negligence in their services.
Professional liability (PL) insurance for contractors typically covers legal defense costs, settlements, and judgments related to claims alleging professional negligence, design errors, or faulty workmanship resulting from designed and constructed elements of a project. PL insurance can help protect contractors from financial losses resulting from claims made by clients or third parties due to design-related issues. It is also critical that if the contractor has a minority ownership interest in the project, PL coverage should be available to respond to claims.
General liability insurance coverage excludes design liability exposures
While commercial general liability (CGL) insurance provides coverage for a wide range of risks and liabilities that can arise during construction projects—it typically includes coverage for property damage, bodily injury, and personal injury claims—such a policy excludes design liability exposures. While the coverage for a contractor's failure to recognize faulty design and subsequent faulty workmanship when a subcontractor provides both design and construction can vary depending on the specific terms and conditions of the contractor's CGL policy, coverage for the deleterious effects of faulty design can be more complex.
Because CGL policies typically exclude coverage for design-related errors or omissions, if the faulty design by the subcontractor is the primary cause of the property damage or bodily injury, the contractor's CGL policy will not cover the exposure. A PL insurance policy clearly covers this exposure.
Coverage for failure to detect faulty workmanship
When a subcontractor is responsible for the design and construction management of an element of the project, the subcontractor’s policy should provide coverage. The contractor, however, also has coverage for its responsibility to detect faulty workmanship resulting from the subcontractor’s design and construction obligations. It is important for contractors to carefully review their insurance policies to determine if they include design services in the coverage. Policies may have specific exclusions or limitations related to design services, so it is crucial to work with an insurance professional to understand the scope of coverage and any potential gaps.
To address this potential gap in coverage, contractors should consider obtaining PL insurance. PL insurance covers design-related errors, omissions, and negligence. The policy can provide coverage for claims arising from faulty design, including the contractor's failure to recognize design issues.
Rectification coverage in contractor policy
Rectification expense coverage is often a supplementary coverage included in a contractor's PL policy. It provides coverage to the contractor for a circumstance for which a claim may reasonably be expected to arise. Under this coverage, the contractor can be reimbursed by the insurer for its reasonable rectification expenses arising from its efforts to minimize any potential liability arising from a design defect circumstance. It is important to note that the insured contractor must get insurer approval prior to incurring any rectification expense.
While rectification coverage in a contractor’s CGL policy might be designed to cover the expenses incurred to rectify any mistakes, defects, or errors in the contractor's workmanship or the materials or systems used in construction, the PL policy addresses design liability leading to a need for rectification of the problems resulting from negligent design.
Under a contractor’s PL policy, rectification coverage typically includes the cost of labor, materials, and any additional expenses required to rectify the impact of the defective design. This coverage is important because it helps contractors mitigate the financial risks associated with potential errors or defects in their work caused by their performance of design or their subcontracted delegated design obligations.
Protective gap coverage for design liability exposures
One type of coverage that is often added to a contractor's PL policy is designed to provide additional protection for the contractor when there is a gap or discrepancy between the coverage provided by the contractor's primary PL policy and the coverage provided by any subcontractors or other parties involved in the project. The protective gap coverage is “designed to reimburse the insured contractor in excess of any recoverable insurance and any self-insured retention for a protective gap demand that arises out of a negligent act, error, or omission in the rendering of professional services by the party responsible.”
Under a contractor's PL policy, the primary coverage is typically provided by the contractor's own policy. However, there may be situations where the contractor is held liable for the actions or omissions of design firms, design-build subcontractors, or other parties involved in the project. In such cases, the contractor's primary policy may not provide coverage for these additional liabilities. Protective gap coverage helps to fill this gap by extending coverage to the contractor for liabilities arising from the actions or omissions of subcontractors or other parties. It provides an extra layer of protection and ensures that the contractor is adequately covered for all potential liabilities that may arise during the project.
As noted above, an important point to keep in mind with respect to protective gap coverage is that it applies on an excess basis, over any recoverable insurance, such as that of design firms or design-build subcontractors. Thus, any claims made against the design firms or design-build subcontractors must be settled for the protective gap coverage to apply.
Coverage for joint ventures with design firms
On design-build projects, there is often a shared risk by contractors and design firms by forming a joint venture specific to the project. Unless the joint venture can obtain PL insurance, the exposures of both parties to the entire cost of design liability has to be insured by each firm through coverage that recognizes the joint and several nature of design liability for the project (each party can be held fully liable for the costs, losses, and damages to the client or a third party resulting from construction based on negligently performed professional services). It is critical that the coverage provided by each party’s professional liability insurance covers the specific entity for its exposure to professional liability claims caused by its negligence in the performance of professional services and the negligence of its joint venturer because of the shared liability.
Increasingly, contractors are providing a wider range of services on projects of complexity. Whether through design assistance during the preliminary stages of a project, delegated design leading to construction, or management of subcontractors who provide both design and construction services, contractors are assuming exposures that are outside of the coverage of CGL insurance policies. Prudent contractors should be increasing their protections through the inclusion of PL insurance coverage as part of their risk management strategy.