I. INTRODUCTION — THE ROLE OF PROJECT COUNSEL AND SELECTION OF
THE PROJECT DELIVERY SYSTEM
In our role as project counsel for large, complex construction projects, we are often called upon to evaluate and implement a comprehensive project delivery and risk management strategy. Selection of the most appropriate project delivery format typically involves an analysis of legal, timing, funding and other similar constraints.[1] The selection is project specific, and there is no overwhelmingly preferred approach. On many projects, we have used either a design/build or "bridging" design/build[2] methodology because design/build provided the best opportunity for satisfying project goals, especially in light of project specific constraints.[3] For purposes of this paper, it is assumed that the project delivery investigation has been concluded and a design/build project delivery format has been selected. The remainder of this paper will identify the techniques employed to develop an effective risk management and insurance strategy for the design/build project.
II. DEVELOPMENT OF THE RISK MANAGEMENT AND INSURANCE STRATEGY
The development of the risk management and insurance strategy should commence while project delivery discussions are still underway, and should be performed in conjunction with the services of a qualified insurance broker. As project counsel, we normally assist the project owner in its selection of the broker by preparing a Request for Proposal and facilitating the evaluation of the responses. The overall design of the risk management program is premised upon a series of threshold inquiries, including the following:
1. Project size: Is the project, i.e., labor payroll, large enough to justify the economical use of a wrap‑up approach?[4]
2. Jurisdictional legal constraints: Are there legal restrictions or impediments to the use of a particular approach? For example, is the state monopolistic for workers' compensation, thereby compromising the project's ability to implement a cost effective wrap‑up approach? Does legislation preclude the use of contractor default insurance in lieu of traditional bonding? Are certain risk transfers, through indemnification, insurance or otherwise, precluded by law?
3. Owner's risk profile: Does the owner possess the economic wherewithal and/or desire to self-insure or absorb certain risks rather than procure costly front‑end insurance coverage or pay risk transfer fees? For example, if the project is delayed by 10 months, does the owner have the ability to sustain its operations in some alternate fashion so that it can agree to limit the design/builder's exposure for consequential damages (and the associated costs of insurance, contingency reserves and risk transfer fees) or forgo the cost of Delay in Completion Coverage for a builder's risk event, etc.?
4. Project risk requirements, including those imposed by lenders, rating agencies, public stakeholders, etc: Are certain insurance limits and/or coverages required by lenders, rating agencies or authorizing legislation? Does the project risk profile, even on a smaller project, demand enhancement of typical professional liability or other practice policies to protect the owner's or public interest? Do special circumstances dictate particular coverages, e.g., working in the vicinity of a regulated railroad, within a waterway or on a brownfield site?
5. Structure of the design/build entity, and design/builder's financial and pre‑existing risk and insurance profile: Is the design/build entity contractor led, designer led, a joint venture, or a pre‑existing integrated design/build company? In each case, what is the design/builder's existing insurance profile in terms of coverages and limits? What is the design/builder's financial strength and ability to sustain deductible exposure and uninsured risk?
6. Availability and cost associated with various insurance alternatives in the marketplace: To what extent, for what limits, and at what cost are various insurance products currently available in the marketplace? For example, efficacy insurance would typically be evaluated in large industrial construction projects where minimum production requirements are imposed.
As we prepare and negotiate the project "deal" documents (such as the development, lease or operating agreements among the project developer and public stakeholders) and the definitive design and construction agreements, we are continuously integrating elements of the risk management and insurance program. To accomplish this, we create a "risk management matrix" that lists each potential cause of risk and significant loss that is of concern. For each cause of risk, we identify contractual remedies, insurance remedies and process remedies that are incorporated into the project delivery and risk management plan to abate, allocate or transfer the risk in the most efficient and cost‑effective manner possible. The point of this exercise is not to single‑mindedly shift as much risk as possible away from the owner to the design/builder. Whether in a competitive bid or negotiated contract situation, we find onerous front‑end documents that unreasonably shift risk to be counterproductive, usually adding unnecessary expense, disputes and aggravation to the construction process. For this reason, we usually invite the design/builder (and, if appropriate, other project stakeholders) to participate in the development of the risk matrix, including the implementation of "process remedies," such as partnering and on‑site dispute resolution.
Before project commencement, we will often "dress rehearse" the job and test the project risk matrix during a partnering session or project stakeholder meeting. A hypothetical risk event will be suggested (such as the failure of scaffolding due to a combination of questionable engineering and a 60 mph wind), and the parties will review their respective roles and management responsibilities with respect to the event, including a discussion of how contracts, relevant insurance policies and project contingencies respond.
III. STRUCTURING THE
DESIGN/BUILD INSURANCE PROGRAM
A. Traditional vs. Design/Build Format
Before considering specific problems and solutions associated with insuring the design/build project, it is useful, for comparative purposes, to briefly discuss the differences between the traditional general contractor or design‑bid‑build project delivery system[5] and the design/build format, and variations of the risk profile for each.
Under the design‑bid‑build approach, the owner retains a design professional who is responsible for translating the owner's vision, or program, into detailed working Drawings and Specifications, or Construction Documents.[6] Once the drawings are completed, the design professional assists the owner in obtaining competitive bids or proposals, and awarding a contract to a contractor who agrees to complete the work shown in the Construction Documents for a stipulated sum or guaranteed maximum price. During the construction phase, the design professional performs construction administration services, such as site observation and reporting deviations from the Construction Documents to the owner, review and certification of pay applications, review and approval of shop drawings and submittals, responding to requests for information, processing change orders, and determining project completion and administering project closeout.
Under the design/build approach,[7] the design professional responsible for preparing the plans and specifications works directly for the design/build entity as opposed to the owner. There are, however, substantial variations on how this may be accomplished, each of which may impact the risk management and insurance structure. One variable involves the nature of the design/build entity. Some of the possibilities are as follows:
1. Contractor as Design/Builder: The owner contracts with a traditional contractor or construction management firm that, in turn, engages a design professional. There is no privity of contract between the owner and design professional.[8]
2. Design Professional as Design/Builder: The owner contracts with a design professional who, in turn, engages the contractor(s) required to construct the project. There is no privity of contract between the contractors and the owner.[9]
3. Integrated Design/Build Firm: An integrated firm possessing "in‑house" design and construction capability contracts with the owner.
4. Joint Venture or Limited Liability Company: A traditional contractor or construction management firm joins forces with a design professional to provide design/build services.
There is also a wide variation with respect to the "starting point" for the design/build effort. At one extreme, the design/builder may simply be provided with the owner's performance criteria and asked to locate and purchase an appropriate site, finance the project, and design and build the project in accordance with the owner's performance criteria (a so‑called "turnkey" project because the owner's only obligation is to pay the design/builder and "turn the key in the door" at the conclusion of the project). Some entrepreneurial design/builders also assist the owner by maintaining a financial and/or operational interest in the project even after substantial completion. [10] Under a more common approach, the owner will maintain responsibility for the property and project financing, develop specific architectural criteria, and then retain the design/builder to complete the design in accordance with the architectural criteria and complete construction. At the other end of the spectrum, the owner may advance the design through the conclusion of Design Development documents utilizing the services of its own design consultant, thereafter retaining the design/builder to prepare Construction Documents (based upon the Design Development documents prepared by the owner's consultant) and construct the structure. The owner's consultant reviews the Construction Documents for conformance with the Design Development documents, and may provide additional services as the owner's representative during the construction phase, such as site observation and certification of pay applications. This is commonly referred to as the "bridging" approach to design/build.[11]
B. Is the Structure for Insuring a Design/Build Project Fundamentally Different From a Traditional Project?
There are many items on the risk management matrix that are handled in essentially the same fashion, regardless of whether the project utilizes a traditional or design/build format. For example, while every company that performs services on the worksite is normally required to have adequate worker's compensation, employer's liability, and automobile liability coverage, the requirements for coverage, limits and policy terms do not vary based on the project delivery system selected. As discussed below, when utilizing the design/build format, there may be some distinctions associated with the builder's risk policy, but the most significant differences involve the interplay of commercial general liability and professional liability coverages.
Unfortunately, as design/build has become more popular in the past decade, many traditional contractors, and to a lesser extent, design professionals, have assumed the previously unfamiliar role of lead design/builder without recognizing that their normal commercial general liability and/or professional liability policies may be inadequate to address the new challenges that design/build presents.
C. The Owner's Risk Profile and Insurance
Opportunities
From the owner's perspective, there are several risks that are not typically transferred to the other participants involved in the construction process, such as (1) the owner's failure to timely acquire property, raise capital as required, or otherwise satisfy development obligations necessary to commence the construction process; (2) damage or destruction to the structure prior to substantial completion, and the resulting repair and replacement cost and schedule impact; and (3) encountering hazardous materials or other unforeseen conditions. It is normally extraordinarily expensive, if not impossible, to transfer or insure against the risks posed by the first group of listed items, although in rare cases, transfer of those risks from the owner to a "turnkey" design/builder is possible. Risk transfer products, however, may be available for the other categories.
1. Builder's Risk Insurance
A significant concern to the owner is the risk of damage to the structure while under construction due to fire, flood, windstorm, vandalism, or a variety of other perils. This risk is addressed through placement of a builder's risk policy that covers direct physical loss (typically on a replacement cost basis) to the structure, as well as building materials, whether incorporated into the structure, stored on‑site or in transit. The coverage is commonly provided under a "special form" or "all risk" policy, which is defined by its exceptions and exclusions – that is, the policy will protect against all causes of loss that are not specifically excluded.[12] The policy typically provides coverage (and sublimits) for "hard costs" associated with the direct replacement of that which has been damaged or destroyed, as well as "soft costs," such as architectural and engineering fees, testing and inspection service, legal expense, additional insurance premiums, etc., that will also be incurred. While this policy may be purchased by the contractor, it is more frequently purchased by the owner so that the owner may control the cost, scope and limits of the insurance coverages involved. In addition, there are, as discussed in the section below, several endorsements (e.g., "delay in completion" endorsement) that the owner will have a particular interest in procuring.
a. Delay
in Completion, Expediting Expense and Contractor's Extra Expense
The "Delay in Completion" endorsement extends coverage for soft costs, additional expenses and loss of rental income or gross earnings that result from the failure of the project to achieve on‑time completion due to a builder's risk event. This coverage usually involves a substantial deductible period and may not respond to claims for acceleration or premium time required to meet the completion date. However, the policy normally includes a modest sublimit for so‑called "expediting expense," which covers the cost of overtime and other emergency expenses required to restore or replace work that has been damaged. Once the work has been restored, however, "expediting expense" does not cover the cost of accelerating the work of subsequent or "downstream" contractors. This problem can be addressed by expanding "expediting expense" to include "contractor's extra expense" and negotiating a higher "sublimit" for this combined coverage. On particularly time‑sensitive projects, such as a ballpark that must be ready for Opening Day, these coverages are essential.
b. "Ensuing
Loss" From Defective Design or Workmanship
The typical builder's risk policy form will contain a policy exclusion similar to the following:
THIS POLICY DOES NOT INSURE LOSS OR DAMAGE CAUSED BY ANY OF THE FOLLOWING:
Errors, omissions, or defects in:
A. Designs and plans;
B. Specifications; and
C. Materials or workmanship.
Unless direct physical loss or damage by an insured peril ensues, and then this policy will cover for such ensuing loss or damage only.
While
written as an exclusion, the "ensuing loss" clause provides a
significant opportunity for recovery in either the traditional or design/build
context. An actual "case
study" example is as follows:
We have observed at least one similar situation under a design/build contract where professional liability insurance was unavailable due to exhaustion of aggregate limits (see discussion at Section III.D.5.b), and the "ensuing loss" coverage under the builder's risk policy was the only vehicle for recovery of a portion of the substantial loss that resulted from a design error.
The builder's risk policy is normally primary with respect to damage to the project during the course of construction, an intent that is supported contractually by the waiver of subrogation included in most construction contracts (including the AIA forms) and the "waiver of subrogation endorsement" contained in the builder's risk policy. As a result, coverage is effectively provided on a no‑fault basis.
2. Environmental Insurance
Another category of risk that is normally a concern for the owner is the discovery of hazardous materials or other so‑called "pollution conditions" that may be encountered underground, in existing structures, or otherwise on the site, that are either unknown at the commencement of the project or that occur in greater quantities than anticipated based upon initial investigation. This risk can be devastating to the owner because of the substantial remediation expense and delay to the project schedule that may be involved. To limit this exposure, the owner may choose to procure a risk transfer product, such as a Clean‑Up Cost Cap Insurance[13] or a Pollution and Remediation Legal Liability Policy.[14]
D. The
Design/Build Contractor's Risk Profile and Insurance Opportunities
1. Construction and Design
Responsibilities
Under the design‑bid‑build format, the contractor has primary responsibility for "construction means and methods" but takes no responsibility for errors or omissions in plans and specifications prepared by the design professional. Aside from the risk of injury to his own employees (addressed through worker's compensation and employer's liability insurance), the contractor is primarily concerned about loss resulting from bodily injury or property damage sustained by third parties. Indeed, the contractor is typically required to "indemnify and hold harmless" the owner, architect and their agents from losses resulting from the contractor's performance of the work "attributable to bodily injury, sickness, disease or death, or to injury or to destruction of tangible property (other than the work itself) . . . to the extent caused by the negligent acts or omissions" of the contractor or its subcontractors.[15] As discussed in Section III.D.2, the contractor's primary tool to deal with these risks is the commercial general liability (CGL) policy.
Under the traditional design‑bid‑build approach, the architect/engineer has responsibility to perform design services, including preparation of plans and specifications, in accordance with the applicable standard of care and the terms of its contract with the owner. As discussed in Section III.D.4, the risk transfer tool for addressing losses sustained as a result of professional errors or omissions is the architect/engineer's professional liability insurance policy.
2. The Commercial General Liability Policy
The CGL policy is the contractor's primary tool for addressing bodily injury and property loss exposure. It operates on an "occurrence basis," meaning that it will respond to a claim made long after the policy period has expired if the injury or damage occurred while the policy was in effect. Since bodily injury or property damage can occur after substantial completion or conclusion of the normal policy period, most contracts require the contractor to obtain "completed operations coverage" under the CGL policy for an additional period – typically two to five years.
Under the design‑bid‑build format, both the contractor and design professional are normally required to maintain CGL coverage, while the design professional alone is required to maintain professional liability coverage. The fundamental assumption is that the contractor is not undertaking professional design responsibility, other than those incidental design activities directly associated with fulfilling the contractor's "means and methods" responsibilities, such as preparing shop drawings, scaffolding design, etc. To the extent that liability could arise as a result of the contractor's "incidental design" activities, it was generally believed (prior to Harbor v. Omni, discussed below) that the CGL policy was adequate to cover the contractor's risk of bodily injury or property damage. The standard CGL form does not contain a design exclusion; and, if the unendorsed form is used, the policy appears, on its face, to provide coverage for liability arising from incidental professional services provided by the contractor as long as the damages arise from an occurrence and result in bodily injury or property damage. In most cases, however, insurers exclude liability for professional errors or omissions through an endorsement to the policy. Even in the face of such an exclusion, however, it was believed, at one time, that the typical CGL design exclusion did not preclude coverage for "incidental design" activities typically associated with contractor "means and methods." This assumption was fundamentally changed by the decision in Harbor Ins. Co. v. Omni Construction Co.[16]
At the time of the Omni case, the standard professional liability endorsement to the CGL policy was ISO Form CG 22 43.[17] The purpose of this endorsement was to create a clear separation for those activities within the realm of "contractor means and methods," that were thought to be the proper subject of CGL coverage, and the services performed by the architect or his engineering consultants that are normally covered by professional liability insurance. This endorsement was included in the CGL and excess policy maintained by the contractor, Omni Construction Co. Omni was in the process of excavating the site for a new office building and parking garage when settlement damage occurred to an adjacent building owned by Sears. Omni incurred the costs necessary for repair and sought recovery f