May 10, 2018

Dispute avoidance: disentangling UAE project design claims

Traditionally, construction and engineering insurance covers for onshore projects seek to provide property or income protection. At the most basic level, the works (and limited number of liabilities) are ordinarily insured pursuant to Erection All Risks ("EAR") policies. EAR policies generally cover all risk of damage to the works, unless specifically excluded. Typical exclusions include damage or defects caused by negligent design and the cost of correcting negligent workmanship.

In the last decade, the UAE market has become far more aware of the risks arising from defective design in complex infrastructure projects. It has become more common in large projects to see EAR covers with write backs, to various degrees, for loss or damage caused by, say, defective design. These are commonly based on the wordings prepared by the London Engineering Group (i.e. the LEG2 or LEG3 exclusions).    

Due to UAE regulatory and local employer requirements, in parallel to the developments with respect to EAR covers, another form of cover that has become commonly procured for large EPC infrastructure projects is Single Project Professional Indemnity (“SPPI”) insurance. The purpose of an SPPI policy is to indemnify insureds on a project for losses arising from liabilities linked to the insured project, and caused by the failure in the performance of "professional obligations", typically negligent design and supervision.

The purpose of an SPPI policy is therefore to provide an indemnity against liability for third party claims, in contrast to the purpose of first party EAR cover which is to indemnify against the cost of repairing or replacing damaged property. An insurer’s liability under each is therefore triggered by different things: by a third party claim for which there is liability in a SPPI policy and by damage in a first party EAR policy.

In view of the different risks insured by EAR and SPPI covers, it should be straightforward to establish which, if any, policy should respond. Nevertheless, where the so-called "root cause" is suggested to be defective design, it appears that the lines become blurred. Invariably, where projects have both an EAR cover with LEG3 and an SPPI policy, insureds consider they have effectively obtained what can be considered a guarantee for the design of the project works, and that one or other policy must respond. This misunderstanding invariably leads to difficult claims and conflicts about which (if any) policy should respond.

The solution to avoid such conflicts is for adjusters and claims underwriters to simply consider whether the "loss" they are considering is a first party loss, or a third party loss. EAR policies cover insured first party losses that can be determined as a matter of fact, whereas SPPI policies solely insure third party losses that arise on the basis of the principles of legal liability. The fact that there may be a defect in the works caused by design is therefore only the start of the inquiry with design claims. The inquiry also requires a consideration as to whether there is damage and, if not, whether there is a third party liability to which the SPPI policy responds.

In theory this would appear straightforward, but in practice it is currently the most common dispute we see where design issues are noted on UAE projects.