It was 5:30 a.m. on a Saturday, and Stan Appleman, a Southeast-based general contractor, sat in his office sorting through papers. He typically used this time for his weekly ritual to reflect on his business, a practice started after the financial crisis almost bankrupt his 25-year-old construction company. He would start by reviewing a quote by Warren Buffett: “You don’t know who is swimming naked until the tide goes out.” However, this day was different, and his mind was focused on a denied professional liability claim.
Stan is like so many successful construction business owners. He built his company from the ground up through hard work, dedication to the trade, the ability to hire and retain the best talent and the commitment to do well by his customers. He was particularly proud of his reputation as a true professional.
He shook his head as he read the letter from his insurance company: “Mr. Appleman, we regret to inform you that there is no coverage under your general liability policy for the above referenced claim, as the claim relates to matters of professional liability and damages that are not otherwise covered by this policy.”
The “ball field” project, on which the claim was made, was a prestigious one. This was a $10 million project for the design and construction of the double-A team’s artificial turf field and drainage systems at their new stadium. The owner had personally approached Stan and asked him to bid under a design-build contract.
However, after Stan won the job, the owner decided to use a design firm with which he had a long-term relationship to conduct the design. The format of delivery would continue to be “design-build,” but this architect-engineer would be substituted and utilized as a sub to Stan’s firm.
Stan agreed to proceed and went through the normal practice of requiring $1 million in professional liability from the subcontracted design firm. He continued to self-insure the professional exposure for his firm, as he had no engineers on staff and assumed he didn’t take professional risk. He had heard others speak of the coverage, but it seemed expensive, and he had always managed the exposure down to his subcontractors.
The project commenced and was completed on schedule. It was a success—or so Stan thought until he received a demand letter from the owner, followed by press outlining problems with the field.
After the design and construction of the field, significant problems with drainage began to occur. The field retained more water than expected based on the design specifications, and it was not usable until repairs could be made. This forced the owner to delay opening and not utilize the field for scheduled play. A substitute facility was selected, but the owner suffered significant financial loss. The owner filed a claim for “economic” damages, among others, and for the replacement of the field and drainage system. The damages sought were in excess of $12 million.
Stan was devastated. He expected that his general liability policy would deal with this but was now in a position with no coverage and the potential for the claim to put him out of business. His head dropped as he continued to read this detailed response by the general liability carrier regarding the reasons his claim was not covered:
- The nature of the subject loss relates to “professional services” performed by you or on your behalf for the design of the “ball field.” Based on exclusion Y of the subject policy, there is no coverage for the subject loss.
- The damages sought under the subject claim do not involve allegations of “bodily injury” or “property damage” as defined by the subject insurance policy. The damages are economic in nature and lack actual “property damage” to trigger the subject policy insuring agreements. Based on this, there is no coverage for the subject loss.
- We recommend that you contact your professional liability insurance carrier and place them on notice of the pending claim. With respect to the general liability policy, there is no coverage for the subject claim, and we will close our file on this matter.
To make matters worse, the design firm was out of business and failed to renew their professional liability policy. Even if they had, it was only for $1 million in coverage, and the pending demands were more than $12 million, which could not be absorbed by Stan’s company.
How to Avoid this Scenario
The insuring agreements within contractors professional liability insurance policies typically cover damages for claims resulting from an “actual or alleged act, error or omission in the rendering of professional services.” For some contractors, identifying and understanding exposures to professional loss may seem straightforward. Others may not even know that a professional exposure exists. Often it is not until after a claim is made alleging a professional error that these issues become a contractor’s concern.
Errors and omissions coverage for architects and engineers is a coverage with which anyone in the construction industry is familiar. Core differences between this coverage and commercial general liability policies are that with errors and omissions coverage, only professional services are covered, and covered damages in such policies are not limited to bodily injury and property damage. The fact that almost any type of economic damage can be alleged as a result of a professional service means that much farther-reaching types of losses are covered. This is important since claims from project owners can allege loss of revenue or increased project costs that result from project delays and costs for re-work.
Professional liability exposures for contractors are not as easily identified because the scope of services can differ on each project and can depend on whether services are performed in house or subcontracted. Contractor and construction manager involvement in project design can blur the lines between design and construction activities, opening potential professional liabilities that would not exist in a standard construction-only contract.
Under a typical design-build contract, the general contractor has ultimate responsibility for design errors discovered during and after completion of a project. Whether the design services are performed in house or by a sub-design firm, the GC is contractually obligated to the owner to remedy an issue. Many times there is not a formal claim or demand from the owner if the design error was discovered by the contractor during the course of construction. It can be in the best interest of all parties to fix the problem to prevent a larger issue in the future. These scenarios do not generally result in a “claim” or “demand” from an owner to remedy the error, and they can be denied by the contractor’s professional liability policy unless rectification/mitigation of loss coverage is included within the insurance policy and all appropriate steps are taken to involve the insurer. If the GC alleges that it was a sub-design firm’s error, it will likely make a claim against that firm’s policy. If the policy is not sufficient to cover the claim, the GC could be left with the remainder of the loss, unless there is protective indemnity coverage included within the GC’s professional liability policy which could reimburse them for the balance.
Given the complex nature of claims involving professional and design services, particular attention needs to be made in structuring insurance policies to address all potential scenarios.
Prior to this experience, Stan didn’t fully understand how such a significant claim could arise and create so much exposure to his company. He knew now that he could have controlled these risks if he had acted earlier. Now, as he read Mr. Buffett’s quote again, he knew that it was he who was swimming naked, and the tide was now out.