NEWS / Affiliate / Are you insuring your sub-contractors more than you thought?

Affiliate
Network Rail

30 AUG 2017

ARE YOU INSURING YOUR SUB-CONTRACTORS MORE THAN YOU THOUGHT?

Potential for an insurance shortfall against a major claim

There are many reasons why you may be in the position of sub-contracting work. One of the common reasons is that you may be seeking expert assistance for a particular aspect of work. 

If you employ sub-contractors your firm is nevertheless the first port of call for a claim, and it would be for you to make recoveries from your sub-contractor. This remains true even if the sub-contractor is the expert in a particular area than you. The fact that they may have been joined to the project for their expertise, and are responsible for a loss does not mean that contractual responsibility will skip over a link in the contract chain. 

It may be the case that a collateral warranty has been obtained between the client and the sub-contractor. This is helpful in that a direct contractual link is established, and it may be the case that your client would claim against the sub-contractor without bringing a claim against your firm. It should be noted however that this does not have to be the case. The existence of a collateral warranty does not mean that the client is obliged to bring a claim under it, no matter how much fairer this may appear to be. There is also nothing to prevent the client bringing a claim against you under your contract, and a claim against the sub-contractor under the collateral warranty.

As such your firm may well be facing a claim in respect of your breach of contract because of your sub-contractor’s work. If your professional indemnity (PI) insurers pay a claim on your behalf, and then cannot recover all or part of the claim from your sub-contractor, the amounts outstanding will remain on your claims history. This can affect your premiums and even the availability of PI insurance, despite the error having been made by someone else.

Underlining this uncomfortable reality is the pressure professionals sometimes face to appoint firms rather than the client do it themselves. The client may be looking for a single point (or at least fewer points) of responsibility, and therefore a simplified structure from their point of view if they wish to bring a liability claim.

To get a grip on the implications of claims arising from sub-contracted work it is important to remember that the claim against your firm is not the same as your claim against your sub-contractor. They are two distinct claims, and they do not automatically trigger or mirror one another.

From a liability and insurance risk management perspective, if you employ sub-contractors it is therefore important that:

  • you retain full rights of recovery from them
  • that they are required to hold their own PI insurance 
  • that it is for an adequate limit of indemnity, with no unusual exclusions or high excesses
  • that it is maintained for a sufficient period of time (i.e. the same length of time that you are liable under your contract with your client) 

These elements can be dealt with in your contract with the sub-contractor, and this should as a minimum be “back to back” with your own – which is to say that the obligations that they owe to you are at least as extensive as those which you owe to your own client.  

The intention is that any claim against you should as seamlessly as possible be passed to your sub-contractor if they are ultimately responsible for the problem. The back to back contract is intended to prevent a gap between the claim against you, and your claim against the sub-contractor. 

The PI points are intended that there are resources to pay your claim against the sub-contractor; the legal rights created by the contract are hollow if there are no assets available to pay the claim.

PI is on a claim made basis, which means that it is the policy to which a claim or circumstance is notified which deals with the matter, rather than the policy which is in force when the work was performed or when the damage occurred. 

This point is very important when it is considered that your firm may not be facing a claim as soon as damage is discovered or occurs. Moreover, your claim against the sub-contractor does not have to be made as soon as a claim is made against you, and therefore may be further removed from the date of the project or the date of the damage.

It is therefore an error only to consider the sub-contractor’s PI policy held at the time they are appointed. This policy is largely irrelevant as mistakes often do not come to light immediately, and if they do, it is less likely that they will cause a substantial loss as they can be rectified. It is future policies of insurance which are more likely to be relevant if a problem arises, and very easily those many years after the project concludes.

If the sub-contractor reduces their PI cover in future years, then at the point when they notify your claim against them to their insurer the cover may be substantially less than when they were appointed. As such there is potential for an insurance shortfall against a major claim made against you.

This is the reason for introducing a contractual obligation into their appointment stating that they will carry PI insurance of a certain limit (£2m for example) and for a set period (typically 6 or 12 years from Practical Completion).

A key safeguard is to establish a register of sub-contractors and note the date that their PI insurance expires. An annual check can then be carried out that the sub-contractor is continuing to arrange PI insurance and at the required level. 

The longevity of the firm can also be considered – the intent being to try to avoid firms who will hide behind limited company status and wind themselves up. Every effort should be made to contract with persons who take their contractual obligations seriously (ie if they say they will arrange £2m PI for 12 years, they will do so).

The above considerations and suggestions require a certain formality and rigour in the approach to sub-contracting; the contract with the sub-contractor must be in writing and would usually go beyond an exchange of communications regarding fee and scope of services. 

This is at odds with a situation which often arises where a firm may pass work to a trusted contact, often at times of under-capacity, or on the basis of very longstanding relationships. Here there is often a degree of informality, such that there is not a written contract, and questions of liability and insurance are often viewed with reluctance. A conscious decision needs to be made in respect of these relationships whether your firm wants to retain rights of recovery if a mistake is made, or whether the reality is that you wish the matter to be treated solely within your own insurance.

If the former, greater degree of formality is required in order to safeguard those rights. 

If the latter, then a further step with PI insurers is required. The policy needs to be endorsed that the insurers waive their subrogation rights against the sub-contractor. The same idea is sometimes expressed that the sub-contractor will be deemed an employee of the insured firm. This means that the insurer waives its right to bring a claim against the sub-contractor, and consequently the “buck stops” with the original firm. 

You should not assume that this has happened, and an explicit enquiry needs to be made with your insurers, their agreement to the waiver obtained, and it be evidenced in the form of an endorsement to the insurance (unless explicit wording regarding a waiver of subrogation rights at the election of the firm is already contained in the policy wording - but this is unusual).

A firm anxious to be covered under another’s PI insurance should also ensure that this has happened. An assurance that they are covered by their employing firm’s PI insurance is otherwise ineffective, no matter how sincerely intended. Bearing in mind the claims made basis of PI insurance, it is also necessary to ensure that this endorsement is repeated in future policies, or the waiver will no longer apply. 

Finally, a word about proposal forms, as sub-contracted work does need to be disclosed. It is not the case that the work is zero risk (for the reasons explained above) and it does represent a risk of a claim to your insurer. More happily, it also presents a lesser risk on the basis that the insurer has at least a chance of making a recovery from the sub-contractor, and particularly if the steps outlined above are followed. From this point of view, it attracts a discounted rating in the calculation of premium, and therefore if you disclose your contract and fees, but not the sub-contracted element, you may be doing yourself a disservice at renewal.

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James  Burgoyne

James Burgoyne

Director - Claims & Technical

Jim joined Brunel in 2009 and heads up the Technical and Claims Department. As well as representing Brunel on the ACE PII panel, he writes occasional pieces for us on insurance, risk and associated topics.

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