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Vast majority of small businesses have no D&O insurance

Figures from Datamonitor’s SME insurance survey, conducted in 2014, suggest that only 23.3% of small and medium-sized businesses have any Directors and Officers cover. This is in stark contrast to large corporate businesses where take up has increased significantly over the past 20 years. Now at almost 100% among FTSE 250 companies, this has been driven by directors themselves, who have refused to take up a directorship without cover in place.

The fact is though that directors of small businesses face exactly the same risks as those in large companies. Without cover in place, these directors are vulnerable in the event of legal action against their business. Even worse, they are unlikely to have the in-house legal resources that their larger counterparts would have, if they were in the same situation.

Read the attached insight report from our insurer partner, Allianz, for more information. If you would like to discuss the insurance needs of your own business, please talk to the specialist D&O team at Arlington, who will help you to put adequate insurance cover in place.

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Legal guidance for building professionals – Standard of care in construction contracts

In summary:

  • It’s important not to overlook contract terms that set out the terms of a project’s delivery as these could form the basis of a dispute.
  • The standard of care refers to how much care a contractor must exercise and sets the benchmark for the quality of service.
  • There are two types of standard of care:
    • Reasonable skill and care
    • Fitness for purpose (more onerous)
  • Reasonable skill and care contracts are more common and require that a contractor demonstrates they have acted with reasonable skill and care when undertaking services.
  • Fitness for purpose contracts require that the project is fit for its intended use when completed.
  • It is less easy to get professional indemnity insurance cover for fitness for purpose contracts and consultants should therefore be very wary of agreeing contract terms that include these.

When a professional consultant or design and build contractor enters into contract, its focus will be on establishing key terms central to any commercial arrangement, such as the scope of work and payment terms.

Along with these are terms which describe the required standard of care to which the relevant services are subject. It is against these terms that delivery will ultimately be assessed and, if a dispute arises, these will set the bar when establishing whether there has been a breach. However, despite the potentially significant implications which accompany these terms, they are often overlooked, until an issue arises.

What is a standard of care?

The standard of care is the degree of care and caution which a professional consultant / design and build contractor must exercise when undertaking its services. It effectively sets a benchmark for the quality of services to be provided.

There are two types of standard of care which are explained below:

  • Reasonable skill and care
  • Fitness for purpose

Reasonable skill and care

In the UK construction industry, reasonable skill and care obligations are usual. To the extent a consultant / contractor can demonstrate that it acted with reasonable skill and care when undertaking its services, it will not be in breach of its obligations. What constitutes reasonable skill and care in a given situation will be assessed against how a reasonable consultant / contractor in the same professional field would have acted.

In the absence of express provision within the parties’ contract, a duty to act with reasonable skill and care will be implied (by virtue of s.13 Supply of Goods and Services Act 1982). It is, however, usual that the contract will address this expressly.  By way of an example, the standard NEC3 Professional Services Contract provides that:

“The Consultant’s obligation is to use the skill and care normally used by professionals providing services similar to the services” (clause 21.1).

Similar wording is used in the JCT Design and Build standard form of contract.

Such provisions reflect the common law test for negligence.  A party will not be found to have been negligent if it has carried out its services to the same standard that another reasonably competent member of its profession would have met. This was confirmed in the case of Bolam -v- Friern Hospital Management Committee [1957] 1 WLR. With that in mind, independent expert evidence is required to support allegations of professional negligence.

Fitness for purpose

This requires that when the project has been completed it is fit for its intended use. Such an obligation is considerably more onerous than one requiring only reasonable skill and care. The consultant / contractor effectively guarantee that its design will be suitable for its intended use. It is rare for a contract or appointment to impose such an obligation.

Express wording will generally be required in order for a fitness for purpose obligation to be applied.  Consultants / contractors should be careful, however, to ensure that no such obligation is implied into their contract. For example, where an employer makes clear that work is to be done to achieve a particular purpose, the work is of a kind that the relevant consultant / contractor holds itself out as performing, and it can be shown that the employer relied upon the skill and judgement of the consultant / contractor, there can be an implied warranty that the completed work would be fit for the notified required purpose.

In the case of Greaves & Co. -v- Baynham Meikle [1975] 1 WLR 1095 CA, structural engineers were appointed to design a warehouse floor which would be suitable for the use of stacker trucks. The floor failed, and the engineers were found liable for having breached an implied warranty that the floor would be reasonably fit for the purpose for which the engineers knew it was required.

Particular care should be taken when contracting under the NEC3 standard form. The core clauses require the contractor to provide its works in accordance with the Works Information. Whilst such an obligation does not expressly refer to fitness for purpose, it is acknowledged that this envisages the works will be designed so as to be suitable for their intended use. Consultants / contractors should be careful to select the relevant option requiring only the use of reasonable skill and care.

Particularly in cases where a fitness for purpose requirement is not expressed specifically in the contract, a consultant / contractor may be unaware that it is taking on extended obligations. The contract should be considered carefully as a whole.

Insurance implications

In addition to potentially extending a party’s obligations, and so its potential liabilities, the applicable standard of care can affect its ability to claim under its professional indemnity insurance policy, in the event an issue arises.  It is common for policies to exclude from cover liabilities arising from onerous contractual provisions – i.e. a duty or obligation going beyond that which would otherwise be implied by common law or statute. The rationale behind this is that whilst an Insured can contract on whatever commercial terms it likes, Insurers should not be required to indemnify it for liabilities flowing from such consequent voluntary assumption of risk.  A fitness for purpose obligation will fall squarely within this category.

Some professional indemnity insurance policies will exclude all cover on a project where a fitness for purpose obligation is imposed.  Alternatively, cover might be limited to such losses as would have been suffered had the usual reasonable skill and care obligation applied, with the Insured liable to meet any additional exposure itself.

Parties should therefore be wary of taking on any fitness for purpose obligations in respect of their works or services.

In order to protect themselves as far as possible, professional consultants / design and build contractors should take reasonable steps including the following when entering into contracts:

  1. Ensure the contract expressly identifies the required standard of care, to avoid uncertainty and / or to avoid a potential situation in which a fitness for purpose obligation is implied.
  2. Be careful to avoid any contractual provisions which might be taken to impose – whether expressly or implied – any fitness for purpose obligation
  3. Require that the applicable standard of care is limited to reasonable skill and care (including by ensuring the correct option is selected when contracting under NEC3). If the employer pushes for fitness for purpose, endeavour to understand why that is required. Given the associated risk and the potential implications in terms of insurance cover, consider ultimately whether such an obligation imposes too great a risk and so would be a deal breaker.
  4. Establish the insurance position, by seeking to understand whether, and if so how, the policy would respond should a fitness for purpose obligation be accepted.
  5. If relevant design work is to be undertaken by a sub-consultant / sub-contractor, consider whether a collateral warranty should be obtained in favour of the employer. By then giving the employer a separate direct contractual right of recourse that may serve to deflect any claim (either in part or entirely).

Parties should be sure not to overlook standard of care requirements in favour of what might appear to be commercially more important contractual provisions. From a liability perspective, these should be at the very top of the contractual checklist.

This article was produced in conjunction with our legal partner, DAC Beachcroft