Consultant Anne Wright offers some guidance to lenders on what to look out for in respect of professional indemnity insurance from their borrower’s professional and construction teams.

It will be of no surprise that since 2018 the insurance market has hardened across most lines, with increased premiums and market capacity dwindling.

The insurance market is cyclical, however, and additional economic factors have undoubtedly affected this, such as the vast number of claims following Grenfell in 2017 and high number of insolvencies during the pandemic. It is reported that the UK PII market has approximately halved, and some insurers have withdrawn from the market altogether.

Key risks are becoming increasingly difficult to place for everyone.

In the construction industry, it is now common to find that contractors and professional consultants do not hold (or are struggling to obtain) professional indemnity insurance (PII) at the level and on the terms that either were originally negotiated and agreed with their employers and employers’ funders, or are simply not now obtainable at the outset of a development financing.

Insurers are issuing PII policies that are subject to greater exclusions and/or sub-limits in relation to (in particular) combustibility cladding and fire-safety claims. The fact that PII coverage is being restricted at a time when contractors and professional consultants need it the most is concerning. In some cases, it may lead to insolvency, as fire and cladding claims are high value – combined with the fact that larger contractors in particular, are more likely to face more than one claim in respect of their projects at any given time.

Given the current economic constraints impacting the construction industry, even greater scrutiny is needed at the initial stage of a development financing by all lender professionals.

Notwithstanding the PII market and other economic factors facing the construction industry, there are some practical steps that can be considered by lenders and borrowers to better protect against these risks:

• Consider instructing a greater in-depth enquiry into the financial standing of contractors and key designer professional team tenderers, prior to any offer or lending facility is awarded. In recent more economically stable years, the use of outside investigation agencies has been less frequent, but these agencies should perhaps be considered again and more widely, as a prerequisite to an offer of finance.
• Monitoring Surveyors appointed by lenders should require evidence of PII levels and terms as soon as instructed and be asked to comment on whether the same are appropriate for the project as against what is available in the market – and from whom. Due diligence conducted either in house or by external lawyers should not only ensure that each project participant carries the correct level of PII by reference to broker’s letters or certificates, but also that the same are actually “on foot” and live, and that it has not either initially or over time been varied by endorsement and/or excluded risks.
• Insurances underwritten outside the UK market are also being offered in the alternative by professional consultants and contractors. It will be necessary to verify therefore whether the same is acceptable as a matter of jurisdiction and whether it is possible to pursue a claim in the English courts.
• It is crucial to make sure provision is made in the construction documentation for early notice of changes in coverage to be given by the project participants to the lender’s Monitoring Surveyor so that action can be taken to limit any potential risk gap as soon as it is made known either with the assistance of the employer borrower’s own insurers or by assistance being given as to what might alternatively be available in the market. Contractor and Professional Team Collateral Warranties in favour of the lender are now more important than ever and should be prepared and executed carefully by reference to a market standard principle agreement of which it is collateral.
• The terms of both the principle agreements and collateral warranties should be considered in light of what might be requested for inclusion of a “net contribution” provision. In the event that the employer borrower has defects claim against an under-insured or non-insured contractor and/or professional consultant the employer – and necessarily the lender – may be able to spread its risk by joining those who may be responsible (consultants, subcontractors, design consultants) to the claim. Net contribution provisions limit this more general law of “contributory negligence” in such circumstances and should therefore be resisted.
• Parent Company Guarantees with an appropriately long liability could potentially come to the rescue too – suggest that one is asked for if available. Performance Guarantees could also be considered, although they are of limited use as the UK market rarely provides guarantee cover on an on-demand basis leading to the employer/lender waiting a very long time to have its claim even considered.
• Lastly, it may be worthwhile exploring whether “decennial” (ten-year latent defects) insurance can be taken out with an insurance broker. This needs to be thought about at the very outset, however, and is generally restricted to new developments or infrastructure projects.

It is important to remember that PII does not cover insolvency or poor workmanship and even if adequate PII is in place it will only covers a claim for negligent professional services provided to the employer. PII is not a solution for all things that may go wrong on a project therefore but increasingly lenders are requiring to place it increased reliance on this type of insurance.