Subcontractors liability: are you covered?

18 July 2023

The Federal Court considers, in a separate question to related proceedings, the connection between the provision of 'professional services' by an Insured, and legal liability arising from the conduct of sub-contractors for the purposes of granting indemnity under a Professional Indemnity policy.

In issue

  • Whether a clause under the ‘Extension of Cover’ section to a Professional Indemnity policy operates to grant indemnity to a head contractor for the conduct of sub-contractors.

The background

These proceedings concerned a coverage dispute under a ‘Design and Construction Professional Indemnity’ insurance policy (the Policy), between FKP Commercial Developments Pty Limited (FKP) and their Insurer Zurich Australian Insurance Limited (Zurich).

FKP sought indemnity under the Policy in respect of potential liability arising from separate proceedings in the Supreme Court of New South Wales. In those separate proceedings, it was alleged that FKP was responsible for numerous defects and non-complaint construction works, and losses arising from breach of statutory warranties under the Home Building Act 1989 (NSW) (the Act). The allegations were made in respect of FKP’s role as principal developer and, through a subsidiary, head contractor of a strata title development in Rosebery, New South Wales. Neither FKP, or its subsidiary, engaged in any design or construction works, instead acting in a construction/project management capacity for sub-contractors hired to complete the development.

In the first instance at the Federal Court, Jagot J (as she then was) found that the Policy did not respond in the circumstances, as the Policy broadly required that liabilities arise from the provision of 'professional services'. Her Honour found that the potential liabilities arising from the Supreme Court proceedings were the result of sub-contractors works, for which FKP was liable, as opposed to arising directly from FKP’s project management. On this distinction, Zurich was successful, with the primary insuring clause held not to apply in the circumstances.

In Orders made on 3 August 2022, pursuant to the above decision, Jagot J held that a separate question be heard and determined. That question is the subject of these proceedings, in which Jackson J delivered judgement on 5 June 2023. In short, for the purpose of determining policy coverage under an ‘Extensions of Cover’ provision, Jackson J considered whether:

  • the whole of the claim made against the Applicants in the OC Proceeding was a “claim arising from the conduct of any consultants, subcontractors or agents of the insured for which the insured is legally liable in the provision of the professional services” within the meaning of clause 3 of the extensions of cover in the Policy.

The decision at trial

In consideration of this question, clause 3 in the ‘Extensions of Cover’ section of the Policy, which FKP asserted extended coverage to the present scenario, was broken into the following components by Jackson J:

  1. Whether the claim constituted by [the Supreme Court] proceedings arises from the conduct of FKP’s sub-contractors;
  2. Whether FKP is legally liable for the conduct of its sub-contractors; and
  3. Whether FKP is legally liable in the provision of the professional services.

It was uncontroversial on the facts that neither FKP, or its subsidiary, were responsible for directly performing any design or construction related works in respect of the development. His Honour readily accepted the factual proposition that all design and construction works at the site were undertaken by sub-contractors engaged by FKP. Hence, any claims made in respect of defective works would invariably be attributable to sub-contractors.

The head development contract between FKP and its subsidiary was taken to be a contract for residential building work for the purpose of the Act. Accordingly, the statutory warranties set out in section 18B(1) of the Act were seen to be implied terms to the head contract. Where the works subject to the Supreme Court proceeding were taken to have been completed by sub-contractors per the above, it followed that the statutory warranties imposed by the Act applied to confer liability upon FKP for the conduct of its sub-contractors where their work led to the claim against FKP.

On the last question, Jackson J (at [19]) found the proper construction of clause 3 'provides indemnity for claims arising from the conduct of any of the insured’s sub-contractors where a substantive element of the factual matrix in which liability arises is the provision by the insured of professional services'. The project and construction management services rendered by FKP satisfy the definition of 'professional services' provided within the relevant policy wording. His Honour agreed with Jagot J, in finding that the origin of legal liability related to the claim is immaterial for the purposes of clause 3. For cover to be extended under this provision, it is necessary only for the Insured to be liable for conduct in respect of its provision of professional services, regardless of the material source of the liability. Accordingly, FKP’s established vicarious liability for the conduct of its subcontractors, and provision of professional services under the head contract were deemed sufficient to establish the final requisite component to enliven clause 3.

Hence, his Honour answered the question in the affirmative, providing FKP with the prospect of having their potential future losses indemnified under the Policy. Zurich was ordered to pay FKP’s costs in respect of the proceedings.

Implications for you

This decision serves as a reminder for Insureds as to the utility of adequately anticipating their insurance needs and adopting appropriate levels of cover accordingly. Despite ultimately finding an avenue through which the policy may respond, litigation may well have been avoided had the Insured effected a more appropriate policy in respect of the reasonably foreseeable risks and liabilities associated with their property development endeavors.

For Insurer’s, this decision is significant in establishing the principle that legal liability need not necessarily arise directly from the provision of 'professional services' by the Insured for the purpose of coverage under a Professional Indemnity policy. It appears sufficient, for the purposes of the policy wording subject to this dispute, for both requisite elements to exist somewhat independently. As such, it is advisable that policy wordings in risk classes affected by this principle, namely Professional Indemnity policies, are reviewed to ensure coverage extends only to the circumstances explicitly intended by the Insurer.

FKP Commercial Developments Pty Limited v Zurich Australian Insurance Limited (No 2) [2023] FCA 582

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