Rob Bates, Partner, unpacks the subtle but crucial distinction between covered contractor error and excluded defective workmanship – examining how LEG defect clauses apply in renewable energy claims, and where the boundary between damage and defect is most clearly defined.
Many years ago, at the start of my career as a claims adjuster at GCube, I thought I’d discovered an applicable exclusion that everyone else had missed. The claim was caused by contractor error – i.e. negligence – and the policy had an exclusion for ‘defective workmanship’.
Armed with little more than a recent pass in the Lloyds test, I ambled over to my manager and said “surely, ‘defective workmanship’ means they installed it badly, so this claim must be denied. The contractor accidentally put a loop in these offshore wind cables, and now they’re damaged”.
My manager smiled wryly, saying, “nice try – but contractor error is a covered peril. It’s the whole reason people buy construction insurance!”
This is an example of where the plain reading of insurance policy language can lead to the wrong conclusions. But where, exactly, is the line between contractor error, which is covered, and defects, which are not?
The renewable energy insurance market has long relied on the London Engineering Group (LEG) exclusions to define and delimit cover for defects. There are three levels of cover:
- LEG 1/96 – no cover for defects.
- LEG 2/96 – no cover for the defects themselves, but resultant damage to non-defective property is covered. The way the clause works is to exclude all costs that would have been incurred had you been able to remedy the defect ‘immediately prior’ to damage. This ‘time bar’ neatly avoids having to distinguish between defective parts and non-defective parts, which can get messy – one person’s part is another person’s part of a part, and so on. But it has the (unintended?) effect of functioning like an exclusion for access costs, particularly in an offshore environment, because sometimes the (hypothetical) cost to remedy a defect prior to damage can be very similar to the (real world) cost of fixing damage. This is a complex area, and coverage will be determined by the facts of the case; suffice to say, for our purposes here, that LEG 2 provides some measure of coverage for resultant damage arising out of defects.
- LEG 3/96 or LEG 3/06 – defects are covered, but any costs to improve the original design, materials, workmanship and so on, are still excluded.1
These exclusions often present issues for insureds trying to understand the coverage they’re offered. This issue of ‘defective workmanship’ frequently arises, because our clients – typically developers, or owners – have a contractual obligation to provide insurance for their contractor who won’t accept a policy that excludes negligence. Onsite contractor errors are one of the most common causes of losses in construction, and negligence is a covered peril – as my former manager pointed out. But what’s the difference between this kind of covered negligence, and the kind that’s excluded?
The answer, we believe, depends on whether the ‘defective workmanship’ results in a physical defect that then leads to damage, or whether you’ve jumped straight to damage. An example might help explain. If, through poor technique, a contractor installing solar panels damages one while fixing it to the mounting structure, while it could be described as ‘defective workmanship’, there’s no intermediate stage of ‘defectiveness’ – you’ve gone straight to damage. That’s covered negligence. If, however, they install the panel badly such that it will suffer damage in future, then you’re within the scope of the LEG clauses once damage actually occurs. You need there to be a physical defect before you can grapple with the LEG clauses – otherwise, it’s just a physical damage event.
This begs the question – what’s the difference between a defect, and damage? Damage must involve adverse physical alteration or change, while a defect is simply a ‘state of affairs’. If a wind turbine blade arrives at site, and to all concerned seems fine, but the bonding was done poorly at the factory, that blade is defective, but not damaged (yet); if delamination then occurs, it’s experienced a negative change, and therefore considered damaged, and we would look to the LEG clauses to determine coverage. As far as the policy is concerned, the blade was ‘always already’ defective – no negative change took place, because as soon as the bonding activity began, you had a defective blade, and you didn’t have a blade at all before that activity began.
These thought experiments can help our clients figure out exactly what’s covered under their policies before disputes arise. No one (apart from lawyers!) wants to spend thousands of hours (and dollars) stuck in court, arguing over the precise meaning of policy wordings – better to partner with an experienced wholesale and reinsurance broker who can advise on likely outcomes early, transfer risks in cost-effective way and, ultimately, negotiate on your behalf to get the maximum fair recovery under the policy.
- The LEG 3/06 version just adds a short definition of damage: ‘any patent detrimental change in the physical condition of the Insured Property’. ↩︎