A Jardine Lloyd Thompson Information Article

DESIGN / BUILD - WHAT IS IT? - WHAT ARE THE IMPLICATIONS?

By Roger A.H. Brett

WHAT IS DESIGN/BUILD?

Design/Build has become in the 1990's the Project delivery system of choice. More than 50% of Construction Projects are using this method of delivery. Overseas, the use of this method of delivery is even higher. More and more Owners are acknowledging the Design/Build delivery approach. It is being used more and more in the public sector. Owners in the Public Sector are now searching for ways that can deliver a proposed facility faster and within the cost restraints required in today's political environment, but still allowing innovation, and maintaining a high quality finished product. The downsizing of Corporations has led to the elimination of various departments within these Corporations. The re-engineering or downsizing of Corporations has also contributed to the growth in the Design/Build method of delivery. Corporations and the Public Sector are no longer able to manage these projects. This has allowed the growth of alternative methods of filling this void. The opportunity now exists for companies to introduce to their owners the "Design/Build" approach to a proposed project. These firms can now demonstrate to their owners the savings in costs, the enhanced creativity, and the team concept that produces better cooperation between the parties involved on the project. It is now generally accepted that Design/Build projects allows for new ideas which in turn produces innovation, implementation of the new ideas and the development of new materials.

WHY DO OWNERS CHOOSE THE DESIGN/BUILD METHOD OF DELIVERY?

• The Owner no longer has to coordinate the Design team and the Contractor. The Design team and the Contractor now have a singular responsibility.
• Construction costs are known earlier on in the contract. 
• Responsibilities can be clearly defined and this in turn can lead to better risk management by the concerned parties. The Owner will be able to cut costs considerably by not having to administer many areas of the contract, as this will now become the responsibility of the Design/Builder team. 
• Ability to shift some of the "Errors and Omissions" liability. In the past the Owner purchases the "drawings" from the Design team and then gives them to the "Contractor" as complete and free from any errors or omissions. With a Design/Build contract it is the Design/Builder who warrants to the Owner that the drawings are complete and free from any errors or omissions. 

RISK MANAGEMENT AREAS TO BE CONSIDERED BY THE DESIGN/BUILDER

• Delays in the project completion date due to risks not typically insured, such as: inability to obtain permits; extreme weather for long periods in time; materials required for the construction are not available. The Owner usually assumed these risks. In a design/build contract the design/builder often guarantees the project completion date with no exceptions for force majeure events. In the past under a conventional project the Contractor would have been granted an extension.
• Warranties of Fitness and Guarantees of Performance and Quality. The Contractor in the past only had to construct the project to the design specifications. Now even if there is no design negligence, the Contractor may have to pay to fix a problem on suitability of the project and may not be able to recover his costs from the design team.
• Consider the use of specialist Insurance markets to transfer some of the risks that arise with design/build projects.
• Make sure you have ownership of the proposed project plans and specifications.
• Check your contract with respect to Indemnification Clauses; Occupational Health and Safety Acts requirements; Waivers of Subrogation; The Limit of Liability Insurance required under the contract; Consider Allocation of Liability or Risk Assumption clauses in lieu of Limitation of Liability clauses; and also check the Contract Law.
• Check that the contract between the Design/Builder and Owner does not have any warrantees and guarantees that relate to the Engineering portion of the contract. There should also be no "warranty of fitness" clause.
• What Insurance is required under the contract and who will provide it. 

In the end it is the responsibility of the "Design/Builder" to understand the "Owner's" bottom line goals and to effectively work together with the Owner in adding the design/build delivery method to their mode of operations.

WHAT CAN THE CONTRACTOR AND DESIGN PROFESSIONAL DO TO REDUCE THEIR EXPOSURE?

When a Contractor joins up with a design team and forms a design/build firm for the purposes of doing a design/build project, he steps between the Owner and the Design team and effectively transfers the Owner's professional liability exposures onto his own shoulders. By doing this, the Contractor creates a number of risks that he should be aware of:

• He should check the design firm's professional liability policy as the policy in force for the design professional provides very limited contractual liability coverage and most likely will not cover any other firm, particularly the Contractor, as an additional insured.
• Most professional liability policies are issued on a "claims made" basis. The average design professional carries a policy with a limit of $1,000,000 or less with an aggregate limit of either $500,000 (if the per claim limit is $250,000) or $1,000,000 (if the per claim limit is $500,000 or $1,000,000). There is a single aggregate limit when the limit per claim is greater than $2,000,000 per claim. Further the limit per claim may be eroded by the defense costs (legal and adjusting costs) if the limit is greater than $1,000,000 per claim. The policy may be covering the general practice of the design professional and the limits may have been eroded by a pending claim arising from work done on another project, and hence there may be no limit available for the proposed project. 
• Ensure that high-risk exposures such as contracts involving Geotechnical or Environmental design are insured under a separate Professional Liability insurance policy.
• Under a design/build project the Design/Builder could be faced with a situation where there is a professional liability policy in place for the project, but could still be faced with a situation of having to bear the costs of fixing a problem. i.e. In the past the owner owed the contractor a "warranty of constructability" in the event that the project is not constructable. Under the conventional method where the Owner contracted separately with the Design Professional and the Contractor, the Owner would have claimed directly against the Design professional. This burden now rests on the shoulders of the Design/Builder.
• Make sure that if you are involved in a design/build project, the contract states that the work designed to date, by any of the design professionals on the design/build team becomes work owned by the design/builder. Losing access to the design drawings could present a major problem down the road.
• Under a design/build project, the design/builder is ultimately responsible to the owner for any error, omission or negligent act in the drawings even if they subcontract some of the design work to another professional design group. Make sure that the Subcontractor carries adequate professional liability insurance limits.
• Design Professionals should stand fast with Contractors and not get pushed into doing questionable redesign to satisfy an Owner or Contractor's budget. The delineation of the roles between the Contractor and the Design Professional must be clearly set out and understood by both parties. There is a tendency, especially during the proposal stage to overlook this aspect of the relationship, it can later be a claims minefield. 
• Try to build into the agreement between the design professional and the contractor, a clause for additional funds in the event that that there is a need for any redesign to be done.
• Where the Design Professional is going to be doing minimal design work, the agreement between the Design Professional and the Contractor should state, that the Design Professional will be doing minimum design.
• It should be noted that the Construction Industry in Canada has prepared a contract for Design/Build projects (CCA14) for the Contractor and the Owner. Some of the Architectural Associations have endorsed this document. However, APEGGA, the CEA and other Provincial Engineering Associations have not endorsed this document due to the warranty clauses found in the agreement. What usually happens is the Contractor passes these warrantees down the line to the design professional. Ideally, two contracts are needed. In Ontario we are seeing two contracts being issued, one for a contract incorporating Project Management and the other for Design/Build contracts.

HOW CAN INSURANCE HELP? 

What Types of Professional Liability Insurance are available?

• Contractor's Professional Liability Insurance
• Architects and Engineer's Professional Liability Insurance with a Design/Build extension endorsement
• Dedicated Project Design/Build Insurance
• Conventional Professional Liability Insurance for Architects and Engineers

Each of the above noted policies is designed to meet a specific need and are briefly described below:

Contractors Professional Liability Insurance is a reasonably new product and was introduced to the Canadian insurance market in October 1997. This policy has been designed for the Contractor who either joint ventures with a design group for the purposes of doing a design/build project or where the Contractor has in-house design professionals and actually does some design and constructs it. With some Insurers, this type of policy will have the deductible applicable to the defense and adjusting costs (i.e. no first dollar defense cover) and the defense costs form part of the selected limit.

Professional Liability Policies are usually triggered by a notice of claim, or a potential claim, being received from the owner or an outside third party. What is not commonly known, is that these policies can be endorsed to allow the policy to respond to a "first party" claim. (i.e. the Named Insured can bring a claim against the policy alleging an error in design but the onus is on the Named Insured to prove that there was an error in the design. Some Insurers are still not prepared to allow these policies to be issued for one-off projects and issue policies on the basis that they cover all the projects the Contractor enters into. However, there are other Insurers that will issue dedicated project policies for Contractors involved in design/build projects. At this point in time most major Canadian insurers do not provide full pollution cover for contractors under these policies, but pollution cover is readily available from Lloyds and USA markets.

Professional Liability Insurance for Architects and Engineers with the Design/Build endorsement extension has been available from Insurers for a number of years now. This policy only provides cover for the design professional team; the Contractor can not be named as a Named Insured under these policies. The intent of the policy is to provide cover for a negligent act, error or omission (some of the USA wordings provide cover for any "Act, Error or Omission") arising out of an error committed by the design professional. The policy conflict of interest exclusion should be read carefully in situations where the Design Professional is contracting out the construction work on behalf of the owner. If the Design Professional is contracting out the construction, this type of policy will only cover errors and omissions by the Design Consultant. The design/build endorsement that is attached to this policy deletes a number of the exclusions presently found under a Design Professional's policy and replaces them with modified exclusions and exclusions more applicable to construction activities. The policy is endorsed to exclude, failure to render professional services or complete construction in a timely manner. There are also exclusions for the following: acquisition of any real estate and the financing of such acquisitions; the securing or failure to secure financing for a project; the preparation or failure to prepare safety precautions and procedures on a project; cost overruns and the providing of estimates or statements of probable construction costs; projects where the design professional does not perform design services but performs construction management services and/or construction; projects where such services are performed by a subsidiary or a related entity. Finally, there is an exclusion for faulty workmanship, construction or work not in accordance with the design of the project. If pollution cover is required, some policies may only provide limited cover. Some USA Insurers will provide full pollution if this cover is required. 

Dedicated Project Design/Build Insurance is available from certain USA Insurers, but the Canadian market place is still reluctant to issue dedicated project policies that cover Contractors as well as Design Professionals. Canadian Insurers should be able to grant an endorsement extension to the policy, that provides cover for reasonable legal fees incurred by the Contractor, in the defense of a claim against the Design Professional, following a judgement by a court of competent jurisdiction or a settlement in accordance with the terms and conditions of the policy provided that the Named Insured is found to be solely liable for the damages.

Conventional Professional Liability Insurance for Architects and Engineers specifically excludes cover for design/build projects and the policy also has an exclusion for any construction that may be done by a related company. These policies can provide the Design Professional with full pollution cover if required.

The writer would pose the following questions for any "Design/Builder's" Risk Manager to ask themselves prior to entering a design/build contract:

KEY RISK MANAGEMENT QUESTIONS

• Who is the owner of the proposed project?
• Is it a public company or a private entity?
• What is the Owner's attitude towards litigation?
• Will you be working with the same decision-makers for the duration of the proposed project?
• Do you know why the owner has selected a design/build method of delivery?
• Do you fully understand the terms, conditions and other requirements of the proposed contract?
• Does your firm have the resources to bid on this project?
• Does your firm have the expertise to fulfill the contract requirements?
• Is the project financing sound?
• Does the owner have the financial capacity to fulfill its responsibilities?
• Should financial guarantees be obtained?
• Is the proposed project schedule realistic or does it appear to be rushed?
• Who are the other participants in the project and what is the contractual relationship?
• Do your current Policies cover you for Joint Ventures and/or financial interests in a project?
• Does the proposed contractor have a history of disputes and litigation?
• Have you checked the Contractor's safety record?
• Have you checked out the Contractor's financial status?
• Does the Contractor have bonding capacity, and is their surety financially strong?
• Are there any unusual physical or construction risks associated with the project?

CONTRACTUAL CONSIDERATIONS

• Is the project scope well defined - but not so well defined that crucial guarantees and warrantees or program criteria can not be met?
• Can all parties determine their liability by reading the contract document?
• Remedies and limit the owner to those remedies?
• Does the contract exclude implied obligations and state that the contract is the entire agreement?
• Does the contract document deal with a variety of limitations regarding time and monetary items? 
• Does the proposed contract state what your obligations are and specify any penalties for loss or damage?
• Will the owner agree to a limitation of liability being put in the contract or to an exclusion for consequential damages? 
• Should the owner default, or if there are delays, does the contract negate consequential loss to you?
• Are claims administration procedures for extras clearly laid out in the contract?
• Does the contract address dispute resolution, and if so, has an effective method been agreed upon?
• Does the contract have any performance guarantees and to what extent are they insurable with professional liability insurance or efficacy insurance?
• Does the contract define who is responsible for arranging and paying for the insurance? (the writer strongly recommends that the Design Professional's Professional Liability Insurance or the Design/Builder's Professional Liability Insurance be arranged by the Design Professional or the Design/Builder and not by the owner, Owners have been known to cut corners with the coverage being provided, in order to cut the cost of the insurance)
• Does the contract define the risks to be covered?
• Does the contract specify the insurance limits and deductibles required?
• Does the contract specify the responsibility for the deductibles?
• Make sure all policies are described in the contract adequately, including valuation requirements.
• Ensure that the contract specifies the duration for which such insurance must be maintained.

INSURANCE CONSIDERATIONS FOR THE CONTRACT

What Policies of Insurance will be required for the Project? (This list is intended as a basic guide as each project will have its own unique requirements)

• Professional Liability Insurance (Design/Build or conventional Design Professional Liability)
• General Liability (possibly a project "wrap-up" liability with extra limits by way of an "Umbrella" policy) 
• Workers' Compensation
• Real and Personal Property Insurance
• Inland Marine Insurance
• Builder's Risk and Course of Construction Insurance
• Coverage for Delayed Completion and Loss of Income
• Auto and Mobile Equipment Insurance
• Specialty Insurance (i.e. Force Majeure and Liquidated Damages) 
• If a foreign project, there are many other exposures (i.e. Political Risks; Kidnap, Ransom and Political Detention; Tax Liabilities Insurance; Contract Ratification etc.)
• Bid Bonds, Performance Bonds and Payment Bonds
• Non owned Aircraft insurance

EXAMPLES OF DESIGN/BUILD CLAIMS

One of the major Insurers writing this class of insurance has advised that three (3) out of every four (4) design/build projects have claims. Approximately 40% of the monies spent on "claims" go to pay legal and adjusting costs and 60% goes towards payment of the actual claim. Some examples of actual claims are as follows:

Claim # 1.

Involves a commercial building of 10 stories. This was a design/build contract led by the Contractor. The Contractor became concerned over project costs and profitability and asked the Structural Engineer to re-design the slabs and columns. Due to the tight schedule for commencement of the work, the redesign process took place very quickly. Upon completion of construction, it was discovered that the structural design was deficient with respect to seismic requirements under the building code. The owner demanded remedial work and the Contractor proceeded against the Design firm. 

The cost to rectify this error was $400,000.

Claim # 2.

This project was an arena project and again was led by the Contractor. The Contractor attempted to construct the facility using plans and specifications, which were prepared by the Design Consultants to allow the Contractor to bid the job. The design documents were incomplete and consequently the Contractor incurred inevitable additional costs. The Contractor is now pursuing the Design Consultants on the basis that they should have advised the Contractor that it would incur additional costs. 

The likely cost to rectify this problem will be $250,000. 

Final Note: 
The Engineer and Contractor should always ensure that there are sufficient contingency funds in the contract price to meet unforeseen problems.

Jardine Lloyd Thompson Canada Inc. is part of the worldwide Jardine Lloyd Thompson Insurance Brokerage Group. Jardine Lloyd Thompson and its subsidiaries specialise in professional liability insurance, handling of professional liability insurance claims and arranging captive insurance companies.

The information contained herein is believed to be accurate, but individual circumstances, local business and insurance practice and the Law can vary extensively and Jardine Lloyd Thompson and its associated and subsidiary companies are not responsible for any errors and omissions or any loss or damage arising from the use of this information. In the event of situations such as are described in this bulletin, the reader should seek legal counsel and specific advice from Jardine Lloyd Thompson or your Insurance Broker.

© 2001 Jardine Lloyd Thompson Canada