Challenges facing the Middle East construction industry: performance bonds – part two
Saudi Arabia: Changes in the construction liability regime and the introduction of a mandatory inherent defects insurance scheme
Market Insight 13 January 2022 13 January 2022
Projects & Construction
As part of Vision 2030 the Kingdom of Saudi Arabia has embarked on an unprecedented national infrastructure and development program. The objective of the program is to diversify the Kingdom’s economy from oil through structural reforms, liberalisation and by attracting foreign investment. To facilitate the development program’s ambitious objectives, the Kingdom is implementing various new laws that deal with issues that are likely to arise when the program is actualised.
The legal changes are fundamental to supporting the Kingdom's bold vision, in particular the complex “giga” projects on which the Vision 2030 development program is grounded.
Contractors, consultants and investors involved in construction projects in the Kingdom should be aware that there have been several legal changes that do not appear to have drawn much attention despite the likely significant impact on construction projects. The changes are wide ranging. The most fundamental with respect to construction is perhaps the introduction of laws and regulations creating a “no-fault” liability regime for construction projects, and which transfers certain construction risks to a new mandatory insurance scheme.
This update introduces the laws and regulations that have resulted in the recent introduction of both a decennial no-fault liability regime and a mandatory inherent defects insurance scheme. It will be apparent that the changes are likely to have a significant positive impact for project owners. In particular, the insurance scheme will ensure that it will no longer be necessary to pursue litigation that may last many years before project owners are able to finance remedial works. For contractors, design, and supervision consultants, the changes will clarify the circumstances in which they may be held liable as a matter of law and will, with certain qualifying projects, require the involvement of a new party (an inspection service) during the construction phase. This will no doubt impact on project administration. While the risk of liability may be expanded, it can be expected that greater value will in future be placed on the quality of work, particularly where it is necessary to ensure that the works are signed-off to the satisfaction of insurers prior to handover.
What has changed through the introduction of the Saudi decennial no-fault liability regime?
Most jurisdictions in the GCC impose joint liability on contractors, design and supervision consultants - for a period of ten years following completion - in circumstances where a building suffers total, or partial collapse, or if there is a defect in the building that threatens its stability and safety. This is often referred to as “decennial liability”.
The liability arises as a matter of law based on, effectively, an implied warranty / guarantee that completed buildings will be free of substantial defects for 10 years. Employers seeking to recover damages to remedy defective work therefore do not need to prove the loss was caused by a workmanship error by the contractor, or through the design consultant’s negligence, the employer simply has to prove that a state of affairs exists, say a partial collapse, that triggers the liability.
Up until relatively recently Saudi Arabia has not imposed decennial liability. This meant that contractors and consultants operated in the Kingdom without the risk of no-fault liability (besides for government projects). Construction and design disputes that resulted from the discovery of defects following completion were therefore resolved solely based on the terms of the parties’ contract. This no longer remains the case.
How does decennial liability arise as a matter of law in Saudi Arabia?
The Saudi Building Code Application Law (the SBCAL) - approved by Royal Decree on 24 January 2017 and amended on 18 September 2019 - sets out the legal principles that give rise to decennial liabilities in KSA.
Article 29 (1) of the Implementing Regulations of the SBCAL - approved by Royal Decree on 28 June 2018 and amended on 31 October 2019 - provides for decennial liability and states the following:
The Supervising designer who supervising the implementation of the construction and the contractor shall be jointly responsible for compensating the owner for ten years - from the date of issuance of the occupancy certificate – for the total or partial demolition of the buildings they constructed or the facilities they built and for every hidden defect that threatens the durability and safety of the building.
For design only consultants, Article 29 (3) states that:
An accredited designer shall be responsible for design defects if its work is limited to drawing up the design only, without supervising the implementation.
To whom does the decennial liability scheme apply and when is the liability triggered?
Article 29 provides that the law applies to:
(a) supervising designers (consultants);
(b) designers in respect of defects in their design (if their work was limited to design); and
The categorization of a party as, say, a supervising designer is determined based on the role played by such party and how it is registered with the authorities when the building permit is issued. It is therefore not simply a question of considering the specifics of the work undertaken.
Article 29 confirms that the liability is engaged in circumstances, where following the issuance of an occupancy certificate, there is a total or partial collapse or where there is a “hidden” (i.e. latent and / or inherent) defect that affects the durability and safety of a building. The liability is therefore triggered by a state of affairs and the parties can be held jointly liable, irrespective of whether a specific party’s “fault” gave rise to the state of affairs.
What type of works does the law apply to?
Article 2 of the SBCAL, states that:
The code shall apply to all construction works in the public and private sectors, including the design, implementation, operation, maintenance and amendment of the building, and also applies to existing buildings in the event of their restoration, change in use, expansion or modification.
The Saudi decennial liability regime therefore applies to:
(d) all types of construction works;
(e) construction works in both the private and public sectors;
(f) newly constructed buildings and the restoration / modification of existing buildings.
The new inherent defects insurance (IDI) scheme
Decennial liability needs to be proved, generally through a contested court process, before a building owner is entitled to damages that can be applied to the payment of remedial works. The event triggering the liability may occur up to ten years after the work was handed over and legal proceedings may then take another couple of years before an enforceable judgment is handed down. It is therefore often the case that when the liability is confirmed by a judgment, recoveries are no longer possible as the contractors or designers no longer exist or no longer have assets in the relevant jurisdiction.
Saudi Arabia has apparently recognised that, notwithstanding the in-principle possibility of recovering through the courts, in practice its often difficult to timeously make a recovery for purposes of financing remedial works. In the circumstances, and in contrast to the other GCC states, the Kingdom has introduced a mandatory insurance scheme that apparently seeks to provide adequate financing for remedial works to be carried out before any decennial liability has been determined or decided on by a court.
The IDI scheme ensures that if any project suffers a triggering event (that is broadly the same as which would give rise to decennial liability), the building’s owner will receive an indemnity from insurers to finance the costs of remediating the defective work. In effect, therefore, the risk of inherent defects that give rise to decennial liabilities will be transferred from the owner / developer to insurers.
How has the IDI scheme been legally recognised?
Cabinet Resolution No. (509), dated June 2018, requires “contractors in non-governmental sector projects” to purchase IDI, and the IDI scheme has been effective for all “qualifying projects” from 2 May 2020.
Initially the IDI scheme is limited to new residential projects, but it is the stated intention of the Ministry of Municipality and Rural Affairs is to implement the IDI scheme in phases, so it can be expected that further categories of buildings will be added to the list of “qualifying projects”.
The Ministry of Municipality and Rural Affairs has announced that from 1 July 2021 various requirements will need to be satisfied prior to issuing of a building permit. One of the requirements is to provide a copy of an inherent defects policy. It is understood no building permits will be issued without the authorities being satisfied that such requirement has been satisfied.
Features of the IDI scheme
The IDI scheme is regulated by the Saudi Central Bank (SAMA), the Kingdom’s financial services and insurance regulator. Only approved Saudi Arabian licensed insurance companies are entitled to underwrite policies for the IDI scheme.
SAMA has published a mandatory policy wording for the IDI scheme, which is based on a well-known international wording. The key aspects of the policy wording and features of the insurance coverage are that:
(g) the insured is indemnified against the cost of repairing, replacing and / or strengthening the premises following the discovery of an “Inherent Defect” (as defined) that causes either:
- physical damage to the premises; or
- the threat of imminent collapse;
(h) in addition to the cost of repair, an indemnity may also be advanced in respect of (i) cost arising from demolition and removal of debris; (ii) further professional fees; and (iii) the costs arising from the use of improved materials or different working methods due to changes in law;
(i)the period of insurance is 10 years, which commences and is contingent upon:
- payment of the premium;
- a “Certificate of Practical Completion” being issued;
- the issuance of a “Certificate of Approval” by the “Technical Inspection Service”; and
- the insurers issuing an endorsement confirming the cover is operative;
(j) a “Technical Inspection Service” (an independent consultant) is to be appointed by the insurer (at the insured’s expense) to review the plans, specifications, bills of quantity etc. in relation to the design of the works and to inspect it during construction (in effect to act as the insurer’s eyes and ears). Coverage is contingent upon the “Technical Inspection Service’s” certification of the project;
(k) expressly excluded from the indemnity, amongst other matters, are (i) the cost of defective non-structural works, equipment, fixtures and fittings and external works; and (ii) economic losses; and
(l) the insurer’s right of subrogation is expressly recognised.
The mandatory IDI policy therefore provides “first party” cover for the costs incurred in repairing physical damage or preventing the threat of imminent collapse due to an Inherent Defect. Further, if no waiver of subrogation is agreed and given the express recognition of the insurer’s right of subrogation, the insurer will be entitled (and is likely) to seek to recover from the consultant and / or contractor to the extent of any indemnity payment.
The IDI policy consequently not a decennial liability policy, but rather ensures that financing is available to remedy defects that would ordinarily be excluded from cover under property all risks insurance policies.
What are the main “take-away” points?
Entities undertaking construction, design and/or the supervision of construction in the Kingdom stand to potentially be held jointly responsible and liable to compensate owners for what happens within ten years from the date of the issuance of an occupancy certificate, for all types of construction works in both the private and public sectors (i.e. decennial liability).
To commence work on “qualifying projects” in the Kingdom it will be necessary to provide the authorities with a copy of an IDI insurance policy issued by a Saudi Arabian insurer to receive a building permit.
During the project the works and designs will be inspected on behalf of insurers by an independent Technical Inspection Service. The Technical Inspection Service will need to issue a certificate of approval before the IDI policy incepts.
In the event an inherent defect is discovered following handover, insurers will fund the remedial works. However, it can be expected that insurers will then bring a subrogated recovery claim in respect of the indemnity paid. Insurers’ cause of action in such circumstances is likely to be founded on the legal principles that give rise to decennial liability.