The Relationship between Construciton All Risks Insurance and Contractual Liability

This article was produced by Olswang LLP, which joined with CMS on 1 May 2017.

Insurance plays a key role in mitigating risks on a construction project. However, whether or not a party is responsible for a loss will depend on the contract terms.

Insurance can fulfil one of two purposes. On one hand, it can safeguard the liability of one or more insured parties. Take professional indemnity insurance, for instance. If a consultant is negligent, it still attracts the blame but often its insurer will end up writing the cheque.

Contrarily, a risk purposely passed on to insurers negates the need for either party to bear its burden. With integrated project insurance project participants look to the insurance rather than to each other when things go wrong.

That remains a nascent product, though, so it’s in relation to construction all risks (CAR) policies that the contrasting approaches have been most evident. CAR insurance protects against damage in permanent and temporary works, as well as for the contractor’s plant and equipment. Typically taken out in the joint names of the parties, the effect is that, once it has paid out to one co-insured, the insurer cannot then subrogate against and recoup from any other that might be responsible.

Recently, the Court of Session’s Outer House was invited to revisit the relationship between contractual provisions and CAR insurance in SSE Generation Ltd v Hochtief Solutions AG and another. Hochtief had been commissioned to design and build the Glendoe hydropower scheme above Loch Ness under an NEC2 ECC contract. Unfortunately, less than a year after opening, part of the headrace tunnel – which carries water from the reservoir to the turbines – collapsed following a rockfall.

Almost three years were needed to build a bypass tunnel and restore the station to full operation. Amidst all this, contractor and employer squabbled as to who was liable.

SSE Generation wished to recover repair costs and lost earnings from electricity generation for the period the plant was closed. This amounted to over £130 million but Hochtief denied fault. Furthermore, it submitted that its employer should look to the CAR policy to recover its losses.

The contractor argued that the requirement in clause 83.1 of the agreement to indemnify the employer for contractor’s risks was supplanted by an obligation to maintain CAR insurance under clause 84. The policy was in joint names and, consequently, there was a general rule of law or an implied term that the parties would not sue each other in respect of an insured loss.

That didn’t wash at all. Lord Woolman considered the two to be discrete obligations. He underlined this by pointing to a special Z clause which limited the parties’ respective liabilities to the tender price. Why bother with a cap if the intention was only ever to rely on the insurance, he asked. SSE Generation was allowed to proceed with its claim against Hochtief.

The case is a reminder of the courts’ stance that contract interpretation takes precedence when deciding where liabilities rest between the parties, regardless of the terms of any insurance. Engineering forms from FIDIC and IMechE are unambiguous on the issue but the clarification of the NEC2’s position is helpful for those contracts, such as the IChemE’s, which are less distinct.