Insurances, Bonds and

Collateral Warranties
Every Construction
Project is Prone to
Risks..
The complex nature of the construction industry
increase the amount of risks.

What is a risk?
Let us think of some
construction relate risks

5 Minute
exercise
What are some of the risks likely to
affect your construction project?
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How do we ensure all the risks
identified are managed?
KEY QUESTIONS INCLUDE

Are we able to manage all these risks?

Which of these risks can we control?
How do we ensure we are focussing on the
most important risks?
Is it better to transfer our risks to someone
else?
What measures can we put in place to
prevent such risks?
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Risk Management
Risk management
the process of actively managing risks that may develop during
the life of a project from inception to completion
a process to identify, evaluate, avoid, mitigate, allocate,
control and manage risks and opportunities
Risk Management
Insurances, Bonds and Collateral Warranties serve as
means to manage risks that are likely to occur on projects.
Each one of these has a specific aspect covered (We aim to discuss
all of these by the end of the lecture.
NEC and Risk
Management
 Risk Management under
NEC
Begins with a Risk Register (11.2(14)):

More about this later

Project Risk Register
How does the type of project
determine risk management?
Choose right main
option for you
A - Priced contract with activity schedule
B - Priced contract with bill of quantities
C - Target contract with activity schedule
D - Target contract with bill of quantities
E - Cost reimbursable contract
F - Management contract
NEC Contracts and financial
risk distribution
Choose right secondary
options
Eg X2 without it, the Contractor takes the risk of
changes in the law
 Ensure specific risks are
correctly allocated
Compensation events are events which, if they do
not arise from the Contractors fault, entitle
Contractor to be compensated for effect on the
Prices, Key Dates and Completion Date
the only such events
Hence all risks not to be taken and priced by the
Contractor should be made compensation events
under the contract
compensation events
where?
19 in subclause 60.1
3 in main Options B & D re quantities
Also in some secondary Options
May be additional compensation events in secondary
Option Z the additional conditions of contract
Compensation events
examples (Cl.60.1)
(1) PM gives instruction changing the Works Information
(2) Employer does not allow access to part of the Site
(3) Employer does not provide something
(5) Default by Employer or Others
(12) Contractor encounters certain physical conditions
(13) A weather measurement is recorded, less frequently
than once in ten years
(14) An event which is an Employer's risk stated in this
contract (stated in Cl 80.1)
Who understands the preferred
risk allocation for your project?
NEC drafting panel?
You?!
NEC contracts start with a fair allocation of risk but can
only provide a starting point for risk allocation.
(But go easy on the Z clauses!)
Eg : flooding
Not an explicit compensation event under ECC
Hence might add in via Option Z
The additional conditions of contract are add as
Clause 60.1(20):
The level in the River Wet where it crosses the
boundaries of the Site at the north side of the Site rises
above 24 m AOD.
Risk Register
In Contract Data - from both Employer (Part 2) and
Contractor (Part 2):
The following matters will be included in the Risk
Register:
..
Risk Register (Cl 11.2
(14))
The Risk Register is a register of the risks which are listed
in the Contract Data and the risks which the Project
Manager or the Contractor has notified as an early
warning matter
So the Risk Register is a post-contract risk
management tool and NOT a place for risk
allocation
Risk Register definition
(Cl 11.2 (14))
It includes a
description of the risk and
a description of the actions which are to be taken to avoid
or reduce the risk
the (project) risk register (if there is one) is not the same
as the (NEC3) Risk Register

Includes Early Warning

Early warning (Cl 16)
Vital part of ECC reciprocal obligations to both notify
and solve
Contractor and PM give an early warning aware of a
matter which could
increase the total of the Prices
delay Completion,
delay meeting a Key Date or
impair the performance of the works in use
Contractor may give an early warning by notifying
PM of any other matter which could increase total cost
Beware
It is a condition precedent
There is likely to be a Sanction if not given
Cl 63.5 compensation event assessed as if Contractor
had given early warning
Option C and D Disallowed Cost includes those costs
incurred because no early warning given
Early warning -
continued
PM enters early warning matters in Risk
Register
There may be a risk reduction meeting;
those attending cooperate in making and
considering proposals to avoid or reduce risk,
seeking solutions, deciding actions, updating
Risk Register
PM revises Risk Register to record decisions and
issues
Early warning -
continued
Encourages collaboration and proactive risk
management
Properly managed, it will also help
management of risk
management of change and
processing of compensation events
Risk Register
Risk Register includes a description of the risk and a
description of the actions which are to be taken to
avoid or reduce the risk
Risk Register is a subset of typical project risk
register
The PM updates the Risk Register and may also manage the
(project) risk register!
Issues with Risk
Register
Works best if integrated through the supply chain with
NEC3 contracts and subcontracts
Beware clogging up process with too many risks with low
likelihood and low impact
There is the need for risk quantification to ensure
attention is given to the most important risks
Compensation events -
risk
Allow for risk in
assessment
Assessment ... includes risk allowances for cost and
time for matters which have a significant chance of
occurring (63.6)
The assessment of a compensation event is not revised
if a forecast upon which it is based is shown to
have been wrong. (Cl 65.2)
Work under compensation event carried out under
same risk allocation as original works
Except for stated
assumptions
Only the PM can state assumptions (not forecasts) to
be made in quotations for compensation events (Cl
61.6)
If stated assumptions have to be corrected then PM to
notify a correction
Hence PM manages the level of certainty and risk in
the quotation to suit Employers business needs
NEC ethos supports risk
management
Clarity and simplicity
Flexibility
in choice of options
in clear risk allocation
Stimulus to good management
clear and simple early warning process and Risk Register
PM has the tools to manage risk
Insurance
A construction contract allocates risk between the parties.
It means that the Contractor is liable to the Employer if a
certain loss or damage occurs (or vice versa)
It may then be that the liable party may wish to cover
certain risks by means of insurance
However it may be that the party who is not liable may
still wish/demand that insurance is taken out in order to
assure themselves of payment should the risk occur.
Two kinds of insurance
Liability insurance
E.g. 3rd party insurance for a car driver insures the driver for
damage to another person or their property arising from an
act or omission of the driver
Loss insurance
E.g. fully comprehensive insurance cover for a car driver
will insure the driver as well as the victim
Liability Insurance
Public liability insurance - contractors
Professional Indemnity insurance consultants

Duty of the insurers is to the insured not the victim

Insured must be legally held liable by a court for the insurer to
be brought into the matter (though in reality they are likely to
do so earlier than this)
Ref : Third Parties (Rights Against Insurers) Act 1930

Bradley v Eagle Star insurance Co Ltd. (1989)

Normid Housing Association v Ralph (1988)
Loss Insurance
Insurance against a persons own losses
So a client will require cover for the existing works and any
existing structures
What needs insuring?
People
Those who are working on site or have the right to be on site
Those members of the general public who may be affected by
the carrying out of the works

Property
The works themselves
Adjoining properties
Existing structures i.e. If the contract is for refurbishment or
an extension to an existing property
 JCT SBC/Q 2011Covers
Insurance
Indemnities - Injury to persons and property
Insurance against personal injury and property damage
Insurance liability of the employer
Insurance of the Works
CDP Professional Indemnity Insurance
Joint Fire Code
Bonds and Guarantees
Bonds
Guarantees
Collateral Warranties
Standard collateral warranties
Collateral warranties under JCT Management Building Contract
Collateral warranties under JCT Construction Management Contract
Insurance Documents
Should be checked by the Contractor Administrator or
Employers Agent
Two Stages
Risk of different kinds of loss or damage is allocated
between client and contractor
Then responsibility for insuring against those risks is
imposed.
 Insurance to persons
and property
Personal Injury or death
The Contractor must indemnify the employer against certain kinds of
liability arising out of or in the course of or by reason of the carrying out
of the works. In particular for injury to or death of any person. (cl 6.1
and 6.2)
However the contractors liability is subject to the following qualifications:
In respect of personal injury the contractors liability and indemnity excludes
injury caused by the employer or people under the employers direct control or
by any statutory undertakers acting in pursuance of their statutory rights and
obligations
This does not extend to sub-contractors who remain the responsibility of the
Main Contractor who must make additional insurance provision.
Damage to Property
The contractor must indemnify the employer against
damage to property where it is due to negligence, breach
of statutory duty, omission or default by the contractor or
by someone for whom the contractor is responsible.
The exception then is those people who are the employers
responsibility
The damage must arise out of the carrying out of the
works but excludes the works themselves up to practical
completion (but would include works subject to sectional
completion)
Distinction is drawn between existing structures and
property which is completely separate from the contract.
Damage to property
separate from the contract
Contractor is not liable for damage caused by a specified
peril (e.g. Fire, explosion, flood, burst pipes etc.)
Contractor is liable for negligently causing or permitting
such property to be damaged in other ways such as
impact , subsidence, theft or vandalism
 This means:
That if a person is injured due to the Works, the contractor is
liable unless it is the employers fault.
If property is damaged, the contractor is liable only if it is the
contractors fault
So
A person suffering injury to person or property would usually claim
against the employer who would join the contractor as a third
party in any proceedings.
Duty to Insure
Clauses 6.1 to 6.3 define the scope of the contractors
responsibility to the employer for causing personal injury or
damage to property
Clause 6.4 provides that the contractor shall take out and maintain
certain insurance policies, which will cover these forms of liability.
In the case of damage to property, cover is to be at a financial level
imposed by the employer by means of an entry in the Contract
Particulars.
In practice, this is normally satisfied by a combination of the
contractors public liability and employers liability policies (possibly
along with the third party section of their motor insurance policy)
Contractor must provide evidence that the policies are in force with
the necessary cover
Contractors liability
The contractors liability in respect of personal injury or
death of his employee is covered by the mandatory
employers liability policy that he carries. The
contractors liability in respect of third parties concerning
personal injury and property damage is covered by his
public liability policy.
Joint Names Policy
A joint names policy will indemnify the employer both
against strict liability to third parties and against any
damage to the employers own property (other than the
works or materials on site), resulting from collapse,
subsidence, heave, vibration, withdrawal of support,
lowering of ground water and similar causes.
Contractors responsibility to take out and maintain the
policy at the employers expense.
 Insurance of contract
works in new buildings
This risk is on the contractor as it is his obligation to
complete the contract.
Charon (Finchley) Ltd v Singer Sewing Machine Ltd
This basic legal position is altered by JCT clauses 6.7
6.10 and schedule 3. They maintain a distinction
between two classes of insurable risk
Specified Perils a list of catastrophes which includes damage
from fire, lightning, explosion, storm, tempest, flood, burst
water pipes, earthquake, aircraft and riot.
All Risks Insurance any physical loss or damage to work
executed and site materials with some exceptions such as wear
and tear, design defects, radioactivity or other nuclear-linked
damage, sonic booms or terrorist action.
Also includes impact, subsidence, theft and vandalism
JCT
Offers a choice of two alternatives, these place the
responsibility for taking out all risks insurance in joint
names on either the contractor (insurance option A) or the
Employer (Insurance option B). Such insurance must be
maintained until the issue of the Practical Completion
Certificate.
Whichever of these choices is adopted, it is provided by
clause 6.9 that the party taking out the insurance must see to
it that all sub-contractors are protected from any come-
back action by the insurers. But only for damage resulting
from a specified peril.
Any failure by either party to maintain the required insurance
cover will entitle the other party to insure and charge the cost
to the defaulter.
The difference between
options A and B
The difference between A and B lies in their treatment of
any repair or restoration work which may be necessary
and which is the contractors obligation to carry out.
Where the contractor has insured, payment by the
employer for this work will not exceed what is received
from the insurer,
Where the employer has insured, the contractors work
will be valued as if it were a variation.
Therefore if there is insufficient insurance cover then the
loss will be borne by the party responsible for that under
insurance.
Insurance of existing buildings
and of contract works within them
Where contract is for alterations to or the extension of an
existing structure, then Option C is used
Requires the employer to take out and maintain insurance to
cover damage to both contract works and existing structures
For contract works, Employer insures in joint names on an all
Risks basis, and ensures all subcontractors are protected.
For existing structures the employer only insures against
specified perils and there is no obligation to protect
subcontractors
Where damage is caused to the contract works by an insured
risk, either party may terminate the contract if it would be
just and equitable to do so
Only in the case of very serious damage or destruction
Effect of Insurance on
Liability of Contractor
If a contractor or subcontractor negligently causes
damage (either to the works or to existing structures) of a
kind that falls within the insurance policies described, the
insurance provisions may have a significant effect on
their liability
Cooperative Retail Services Ltd v Taylor Young Partnership
(2002)
Contractor and subcontractor were covered by a joint names insurance policy
Insurance for loss of
liquidated damages
If damage occurs then insurance should cover it, however
the time taken to undertake repairs will cause the
contractor to be granted an extension of time. The
resulting damages the employer might otherwise have
claimed are not covered by these policies.
 Professional Indemnity
Insurance
Construction professionals each have their own insurance policy to
indemnify them against liability for professional negligence. All tend to
operate on the same basic principle
The cover provided will have a financial limit, once that is exceeded then the
professionals own money can be called upon after that the client will suffer the
loss
Professionals are usually required to take out insurance by their relevant
institutions
Covers liability for professional negligence and in that way policies may exclude
liabilities that the professional voluntarily assumes. Eg if an architect guarantees
the suitability of a design, rather than merely exercising reasonable skill and care
Professionals should be aware that payments are made on the basis of when a
claim occurs rather than when the negligent act took place so cover must be
maintained for some years even after death.
 Insurances
Subrogation
Where a loss insurer pays the client in respect
of loss that has been caused by someone
elses fault the insurer is entitled to take over
any legal rights that insured person could have
exercised against the third party responsible.
In such a way the insurer will seek, by suing in
the clients name, to recover from that third
party the amount that has been paid out
Subrogation
No right of subrogation against any
person who is also insured under the
same loss insurance policy.
Under building contracts any loss
insurance policies which the contract
require are taken in joint names of client
and contractor.
Legal effect shown in Petrofina (UK) Ltd v
Magnaload Ltd (1984)
Bonds and Guarantees
This is an arrangement under which the
performance of a contractual duty owed by one
person (A) to another (B) is backed up by a third
party (C). Effectively C promises to pay B a sum
of money if A fails to fulfill their duty
A is the principal debtor
B is the beneficiary
C is the bondsman, surety or guarantor
In Construction
This backup is likely to come from:
Parent Company Guarantee
Payment is guaranteed by other members of the same
company

Bond, provided by a bank or an insurance

company, bonds can be
Conditional
Unconditional
Bonds
In construction bonds are most commonly used
to guarantee
Payment or early release of retention money
A specific obligation e.g. A promise by a sub-
contractor not to withdraw a tender
Performance of the contract in general usually to a
level of 10% of the contract sum
Perar BV v General Surety
and Guarantee Co Ltd. (1994)
When the contractor went into receivership, the contract was
automatically terminated and the court of appeal held that
default meant breach of contract and that the contractors
insolvency did not constitute default and that there was no
longer a contract to be in breach of. Therefore the defendant
was not liable

Paddington Churches Housing Ass v Technical &

General Guarantee Co Ltd (1999)
Collateral Warranties
Contract between Employer & Contractor
Can only sue S/C in tort.
Collateral Warranty bridges that gap.
Need to be careful.
Murphy v Brentwood Council (1990)
NEC core clause 8 80.1
 NEC clause 81.1

fore all risks are the contractors, unless the risk is specifically due to the Employ
 Insurance Cover clause 84

Much more
prescriptive
than JCT.
Insurance policies clause
85
Clause 86 if the contractor does
not insure
Clause 87 insurance by the
Employer