Cash is king - insurance is often a poor second

When an insurer fails to pay a claim (repudiates) or becomes insolvent, the contractor suffers the risk.

The necessity to appoint insurance ombudsmen (or the short- and long-term insurance industries has, no doubt, partly arisen from actions by certain insurance companies with an attitude of ‘we don’t pay, we hassle’ (to parody one insurer’s advertising slogan).

The construction industry has had a long and very necessary relationship with the short-term insurance industry as it relies on insurers for protection from a variety of unforeseen risks, which occur frequently. A number of insurance companies also offer ‘upfront performance sureties’, which guarantee the contractor’s performance.

Contractors must understand that insurance cover does not shift liability and is merely a safety net to protect against the insured risk — should it arise.

Contractors must understand that insurance cover does not shift liability and is merely a safety net to protect against the insured risk — should it arise. In Botswana, a main contractor received a 2-million Botswana pula (about us$330 000) performance surety from Mutual and Federal Botswana for the due fulfilment of the sub-contractor’s obligations. When the sub-contractor went into liquidation and the main contractor called on Mutual and Federal to meet its obligations as guarantor under the surety bond, Mutual and Federal refused to make payment. It had no grounds whatsoever for refusing to pay. The conditions of the bond were fulfilled and, legally, it was obliged to pay. The main contractor was obliged to issue summons against Mutual and Federal, which eventually honoured its obligations on the steps of the Court. However no contribution was made to the main contractor’s totally unnecessarily incurred costs of bringing the action to court and no compensation was tendered for depriving the main contractor of rightful entitlement for almost two years. Insurers and banks usually require full collateral security cover for risks insured so, in truth, they charge a fee for very little risk exposure to themselves. In this instance, Mutual and Federal had ‘inadvertently’ omitted to take cover from the sub-contractor before issuing the performance surety. Forgive my cynicism for thinking this might have had some influence on their actions. Needless to say, this particular main contractor no longer accepts performance sureties from Mutual and Federal!

During the week of February 21 to 28 1997, tropical cyclone Lizette swamped Nampula Province in Mozambique. Over a long distance, it severely damaged roads a contractor was about to hand over to Mozambique’s National Directorate of National Roads and Bridges. The storm damage led to an insurance claim that the insurer, also Mutual and Federal, repudiated. The insurer lost the case in the Johannesburg High Court, which found the insurer liable and ordered it to pay to the contractor R2,5-milllon plus whatever value-added tax might have been paid by the contractor. Mutual and Federal appealed and the matter came before the Supreme Court of Appeal. The contractor’s claim was made under an insurance policy that indemnified the contractor and the employer in respect of fortuitous physical destruction or damage.

The contractor sought an indemnity for the repair costs of 101,88 km of roadworks that had sustained storm damage. The insurer raised two defences:

It maintained that proper construction of the building contract leads to the conclusion that the contractor was not liable to repair the roads. It, therefore, did not have an insurable interest in the restoration of the roads and could only validly have insured the works up to the extent of its interest (for loss or damage it was obliged to make good at its own expense).

It maintained that the roads were defectively designed and damage suffered, therefore, fell outside the policy Indemnity.

Because the contractor was not liable for the design, it would not be liable to repair damage due to faulty design. However the damage occurred after a cyclone. It was caused by an unusually heavy downpour. The contractor was, therefore, responsible for the repair of the roads. Any competent independent roads engineer could surely have resolved whether or not the proximate cause of the damage was the cyclone as opposed to failed design.

The insurer’s expert on road construction repeatedly stated that the drainage and other aspects of the construction, such as the wearing layer on the road, should have been designed better. Much stress was placed on flood returns — the statistical frequency a storm of particular severity might be expected to recur should have been calculated and incorporated into the design. Only then would the design not have been defective. In effect, the Insurer’s argument was: if the contractor hoped to be entitled to an indemnity under the policy for storm damage to the works, it was not good enough for it to construct, as it did, the works to the satisfaction of the employer. It had to construct the works to the satisfaction of the insurer! An interesting proposition particularly as the insurer was not a party to the construction contract. However full marks for innovation!

The standard of design demanded by the insurer before it would pay was not clear during the trial. Its expert criticised various aspects of the drainage but did not state the design standard. He thought that the drainage should have been designed to withstand the impact of cyclone Lizette but, as we do not know what the return period of Lizette was, that does not set an ascertainable design standard. Without having established a standard, the insurer could not maintain that the design was defective. And there wasn’t any suggestion that the insurer did not know the nature of the unsophisticated contract works it was insuring. Accordingly, the Supreme Court of Appeal found that it could not, as a prerequisite to accepting liability, demand that the design standard should have been higher than the employer was prepared to pay. And there wasn’t any acceptable evidence that the roads were poorly-designed. The Supreme Court of Appeal dismissed the Insurer’s appeal with costs, including the costs of two counsel.

In the event that the reader might think that Mutual and Federal was singled out unfairly in this article, I might tell you next time how, in November 1993, a firm of consulting engineers, Van Immerzeel and Pohl, was successfully sued by Samancor as a result of alleged negligent supervision of a pipeline it had designed. Some 13 years later, the Supreme Court of Appeal eventually ruled that Santam was obliged to indemnify Van lmmerzeel and Pohl in terms of its PI policy!