Co-authored insight by Aon and Clyde & Co.

With design and build contracts on the rise in the U.S., we look at what lessons contractors are learning from experiences in the U.K., particularly around fitness for purpose provisions and professional liability (called ‘professional indemnity’ outside of U.S. and Canada) insurance claims. The U.S. equivalent of a fitness for purpose provision, namely that a project will be ‘free from defects’, is catching some U.S. contractors off guard. It is important that contractors in the U.S. market understand the risk they are signing up for when entering design-build contracts.

What is the Position in the U.K.?

These days design-build contracts are commonplace in the U.K. The JCT Design & Build contract form is widely executed, albeit amended to suit the specific requirements of individual projects. Prior to this evolution, generally speaking, an employer would engage a design team to undertake the design of a project and then would subsequently engage a contractor to construct the project. Under this more traditional model of engagement, the design risk would sit with the employer and the design consultant, and the construction risk would sit with the contractor.

As time has moved on, to allow a more streamlined approach, the industry has shifted towards the design and build form of contract, under which the contractor takes on some (or all) of the design responsibility and risk. This has allowed the contractor to have more input into the design to drive efficiency and save cost. However, it has also meant that some or all the design risk which previously sat with the employer and designer now sits with the contractor, unless the contractor successfully ‘passes down’ those contractual terms to the design consultant.

Under the JCT Design & Build contract form, the responsibility generally sits with both the contractor and the designer, as part of the contractor’s proposals and the employer’s requirements. When it comes to design, the contractor has an overall reasonable skill and care obligation, akin to that of a designer, i.e., the design must be to the standard of a competent professional experienced in that type of work. A contractor also has express obligations to comply with the law and any statutory requirements, such as building regulations.

The JCT Design & Build contract works to avoid the implication of a fitness for purpose provision. However, this can arise in any event if such a provision is included in the employer’s requirements. Such provisions are more regularly tabled during periods where the balance of negotiating power is tilted in the favour of the employer, such as the years following the global financial crisis. An example of a fitness for purpose provision is as follows:

The fit for purpose obligation may also be in disguise. For example, clauses where the consultant warrants that the works comply with the particular performance specifications. The obligation on a contractor to ensure a project is ‘fit for purpose’ is a strict obligation and is a far more onerous duty than a reasonable skill and care duty. This is because whether something is ‘fit for purpose’ is quite often subjective and difficult to quantify. Conversely, reasonable skill and care is a lower standard and does not require the contractor to reach a particular result, as long as the contractor exercised reasonable skill and care in providing the services (although even when designing at the cutting edge a contractor is expected to design with all due circumspection).

If both provisions are present in a design-build contract, a contractor will be faced with conflicting obligations.

This very issue was considered in the UK case of MT Højgaard A/S v E.ON Climate & Renewables U.K. Robin Rigg East Limited and another.* The Supreme Court in this case found a contractor to be in breach of its contractual obligations (in that the contractor breached the fitness for purpose provision) regardless of the fact the contractor was not negligent and had exercised reasonable skill and care.

MT Højgaard (the contractor) had been engaged by E.ON to design, manufacture and install the foundation structures for 60 offshore wind turbines. The contractor was required to submit the foundation designs in accordance with an international standard published by Det Norske Veritas, DNV-OS-J101 (J101). This standard in fact contained a serious error (of which the contractor could not reasonably have known) which produced incorrect equations. The contractor was also obligated to ensure the foundations had a lifespan of 20 years (this was a strict/fit for purpose obligation). Shortly after completion of the works, the foundations failed, resulting in remediation costs of EUR26.5m.

In the first instance (in the Technology and Construction Court (TCC)) it was held that the contractor was responsible for the remedial works as it had breached the fitness for purpose obligation of a 20-year design life. The Court of Appeal overturned this decision. On further appeal to the Supreme Court, the TCC’s original decision was unanimously upheld.

This is a case where the contractor was found to have been free of negligence, however liability was nonetheless established. Although there were apparently two conflicting provisions – reasonable skill and care and fitness for purpose – the court found the more onerous provision should prevail, namely the fitness for purpose strict obligation to ensure a design life of 20 years. It is worth noting that that the Supreme Court’s obiter comments were that the obligation was to prepare a design that would have a lifetime of 20 years. It was disinclined to view the obligation as an absolute warranty of actual performance for that period, not least because, due to the forces of nature, a lifetime of any specified period could never in practice be guaranteed.

The decision in MT Højgaard was later applied in Blackpool Borough Council v Volkerfitzpatrick Limited [2020] EWHC 1523 (TCC), where the Judge held that the obligation was a strict one: the Works Information required the production of a design that was capable of achieving 25-year life. If the design failed to do so, Volkerfitzpatrick and its specialist steel sub-contractor Caunton would be in breach of contract, even if they had exercised all due care (and thus would not have been liable in negligence). Clyde & Co LLP acted for Caunton in the case whose defence that the design would in fact achieve the specified 25-year period was completely successful. On the evidence there was no breach of any obligation, strict or otherwise.

The question then becomes, what insurance cover is available to design-build contractors in circumstances where a contractor has not breached its duty to carry out the services with reasonable skill and care, but has, however, breached a fitness for purpose provision. Ordinarily, a contractor’s professional liability insurance policy will provide cover for a breach of reasonable skill and care but cover is not generally available for breach of a strict obligation/contractual promise, such as a warranty that the project will be fit for purpose (unless the professional is also negligent – see further below). This means, in circumstances where there is a contractual claim for breach of a fitness for purpose obligation and no allegations of negligence are made against the insured contractor or such allegations are defendable, there is likely to be no insurance cover available.

The situation is not confined to design life obligations. Following the tragedy at Grenfell Tower in London, there has been much concern about fire safety deficiencies in large scale projects and where liability may fall, with contractors and construction professionals such as architects, engineers and building control/fire experts all potential targets for losses that some estimate could exceed GBP20bn. Designers will invariably try to argue that fire-safety designs are not negligent because a reasonable body of professional opinion was using the same designs and that is the standard by which they should be judged. We don’t address the merit of such arguments here, other than to say that, from a defence perspective, these arguments become academic where fitness for purpose obligations also exist. However, the rub is that, if there is indeed a fitness for purpose breach but without negligence, liability will land on the professional who then faces a lack of professional liability cover. In addition, policy exclusions/restrictions for fire safety are now ubiquitous. Such exclusions/ restrictions in the U.K. generally restrict cover for claims arising from fire safety to liability which arises out of negligence and would therefore negate the effect of any general fitness for purpose extension.

U.S. Position

The position in the U.S. is evolving as design-build contracts are becoming more commonplace. Similarly, when an employer and contractor enter a design-build contract, some or all of the design risk will shift to the contractor, who would often then seek to pass some or all of those contractual terms down to the designer. Likewise, similar scenarios can arise whereby a fitness for purpose type provision is included in the design-build contract and the contractor finds itself under more onerous design obligations than it would otherwise have expected.

The wording in the U.S., however, is slightly different. Rather than ‘fit for purpose’, it is common to see ‘free from defects.’ An example of a design-build warranty is as follows:

Contractors and insurers in the US should be aware that, similarly, ‘free from defects’ can create a situation where there is a gap in professional indemnity insurance cover for insured contractors. As is the case in the U.K., professional liability policies will generally not provide cover for a breach of a strict obligation. In circumstances where there is a breach of the design-builder warranty, and there are no allegations of negligence, it is unlikely cover will be available under the design-build contractor’s professional liability insurance policy.

To avoid this scenario, it is imperative that design-build contractors are aware of the type of wording used in the design-build contract. Any wording that requires the contractor to warrant that the completed works will comply with the employer’s requirements and/or any performance specification may create the same onerous obligation as a fitness for purpose provision. This is especially so in circumstances where the specific purpose of a project is not clearly expressly defined in the contractual documents.

In the U.S., it should be noted that there has been a recent rise in the use of rectification policies. Whilst at a cost, they are being considered more now that design-build projects are becoming the norm (especially on large projects). First-party insurance generally covers the costs which a contractor, or a design professional that has assumed responsibility for construction, incurs in correcting a design defect that is discovered after the construction is put in place but before it actually results in a professional liability claim. With this coverage in place, a contractor, or a design professional that has assumed responsibility for construction, likely has access to the funding to correct the error and keep the project moving without having to file a claim and establish negligence. Proponents argue that it can help resolve a circumstance faster and without creating animosity between the insured and their client.

When Will Fitness for Purpose Be Covered Under a Professional Liability Policy?

As design-build procurement has evolved in the U.K., so has the relevant professional liability insurance cover and we often see cover for fitness for purpose written back into the professional liability policy by way of an extension, but it should be noted that this cover is generally not available currently for risks situated in North America. An example of the type of wording that might be seen in a policy extension is as follows:

On the above wording, for a fitness for purpose claim to be eligible for coverage under the policy (i.e., not be excluded) a contractor would need to ensure that the contractual documents clearly and expressly define the intended purpose of the works. Contractors should ensure the definition is agreed to by all parties and there is no ambiguity in the language used.

The second proviso above at (ii) requires the design/specification to accord with conventionally accepted practice at the time the design was undertaken. The Insured will need to ensure that the relevant State of the Art Defence is included in its appointment. The irony is that if a State-of-the-Art Defence is included and the insured complied with conventionally accepted practice so as to trigger that defence then the insured wouldn’t be liable and wouldn’t need the policy indemnity. Conversely if the insured hasn’t complied with conventional practice, then a State-of-the-Art-Defence isn’t going to help.

In addition to the above-mentioned limitations of market standard fitness for purpose extensions, typically liability arising out of ground conditions and process engineering would also be specifically carved out of fitness for purpose extensions.

The reality is, it remains rare to see a claim in which a contractor breaches a fitness for purpose provision and yet the works were carried out with reasonable skill and care. This may go some way towards explaining why fitness for purpose extensions largely survived within policy wordings during the recent hard market conditions in the U.K. If a specific design does not work, it is surely more likely than not that the contractor was negligent (though MT Højgaard is an example of when a contractor can be in breach of the fitness for purpose obligation despite not being negligent). In any event, we are seeing these extensions written back into policies in the UK and anticipate similar extensions will also appear in U.S. policies in due course.

Key Takeaway Points for Contractors

• Careful consideration should be taken when entering a design and build contract to ensure the contractor is aware of any fitness for purpose type warranties, noting that the phrase ‘fitness for purpose’ will not always be used. Strict contractual promises will likely not be eligible for cover under a typical professional liability policy unless the insured is also negligent (where cover is written back in). Contractors should be mindful of the wording used in the appointment document and the employer’s requirements.
• Contractors should seek to clarify whether and how technical schedules and other contract documents (often with hundreds of pages) affect overall obligations in their general contract design conditions.
• Be mindful that contractors may still be liable even if not held to have been negligent and that fitness for purpose obligations will likely prevail over the duty to act with reasonable care and skill.
• Insured professionals should study their insurance policies to ensure that they understand how their professional liability cover is intended to respond to fitness for purpose claims. Care should be taken to ensure that fitness for purpose extensions are drafted so to extend cover beyond the main insuring clauses and that contractual liability exclusions are subordinate to them.
• When doing so, insureds would be well advised to focus on the natural and ordinary meaning of the contract wording. There is a clear line of authority in the U.K. that the courts are increasingly inclined to interpret contract provisions at face value.
• In circumstances where cover is written back into a professional liability policy for a ‘fitness for purpose’ or a ‘free from defects’ warranty by way of an extension or endorsement, contractors should be aware that the terms ‘free from defects’ and ‘fitness for purpose’ are difficult to quantify; it is a subjective standard and rarely defined in the design and build contract or the employer’s requirements. This can lead to protracted disputes and costly litigation. It is good practice for contractors to ensure the purpose of the works is clearly and expressly defined in the contractual documents, so as to avoid any ambiguity.

Richard Moody, Global Construction Professional Liability Lead – Clyde & Co LLP, contributed to the article. Clyde & Co LLP is a leading global legal solutions provider and market leader in the Construction and Insurance sectors. Closely connected globally, our local experts are committed to delivering commercial solutions, understanding business challenges and policyholders’ needs, positively representing client brands and managing the expectations of market stakeholders. Clyde & Co LLP accepts no responsibility for loss occasioned to any person acting or refraining from acting as a result of material contained in this summary.