CAR insurance: scope of standard form exclusion

The Court of Appeal has considered the scope of a standard defects exclusion clause (known as “DE3”) in a CAR (contractors all risk) insurance policy. The wording of the exclusion distinguishes between property that is defective (for which there is no cover) and property that is free from defective condition.

The court held that loss to property that is in a defective condition is excluded. It is irrelevant whether the insured is responsible for the loss.

Background

The case concerned the construction of a section of the M60 in Manchester. The earthworks subcontractor claimed under its contractor’s all risks policy for damage caused to the works by heavy rainfall. Gerling denied liability under the policy. The High Court confirmed coverage and Gerling appealed. The appeal considered one aspect of the High Court’s decision where it was held that an exclusion clause in the policy should not apply so as to exclude the Insured’s claim. To read our article on the High Court decision click here and go to pages 16-17.

The CAR policy indemnified the contractor against: “… all Damage (meaning Physical Loss, Physical Destruction or Physical Damage) of whatsoever nature sustained during the period of insurance to: a) the Works whether permanent or temporary, materials incorporated or for incorporation therein … and any other property of whatsoever nature … the property of the insured.”

The policy also included the following exclusion clause (which is one of several industry standard wordings):

“This policy excludes loss of or damage to …

a) Property insured which is in a defective condition due to a defect in design plan specification materials or workmanship of such Property insured or any part thereof.

b) …

Exclusion a) above shall not apply to other Property insured which is free of the defective condition that is damaged in consequence thereof.

(Our emphasis added)

Court of Appeal’s decision

Gerling argued that the High Court should have held that the subcontractor’s temporary drainage works (which were installed to protect the earthworks from damage) fell within the scope of “Property insured” for the purposes of the exclusion clause and formed an indivisible part of the damaged works. This would allow the Gerling to argue that the temporary drainage was defective and the loss excluded from cover.

Importantly for the insurance industry (given that the exclusion clause in this case is a standard wording) the Court of Appeal stated that the purpose of the exclusion clause is clear. It prevents insurers from having to pay for the replacement, repair or rectification of property which was already in a defective condition at the time the fortuity covered by the policy occurred. This means that providing the insurer can show that the property was in a defective condition, the exclusion applies. This is irrespective of whether the fortuity was the responsibility of the insured.

The Court of Appeal then went on to consider the wording “Property insured” in the exclusion clause in order to determine whether the temporary drainage works were within the scope of the clause. The court noted:

• There is a distinction in the wording of the exclusion clause between “Property insured which is in a defective condition due to a defect…” and “other property insured which is free of the defective condition that is damaged in consequence thereof”. The effect of the clause is that the part of the works that contains the defect and is damaged will be excluded from cover under the policy (for example a steel frame of a building which collapses due to defective nuts and bolts); however the damage that is caused to the non defective works would be covered under the policy (for example damage to the roof, cladding and brick walls caused by the collapse of the steel frame).
• In this case, the exclusion had to be limited to that part of the works which had suffered damage (i.e. the capping and sub-formation in the earthworks); if that part of the works were wholly or partly defective the exclusion applied. Given that the capping and sub-formation were not inherently defective, the exclusion did not apply and the insured was covered under the policy.
• As for the temporary drainage works, this was used by the insured to protect the earthworks, and a failure in the temporary drainage works (if there was one) could not be characterised as a defect in the condition of the earthworks. The temporary drainage works were outside the scope of the exclusion clause and therefore the exclusion did not apply.
• The court held that if the latter point was wrong, and the temporary drainage works were within the scope of the exclusion for “Property Insured”, there would be a distinction between this property and the earthworks (“other property insured which is free of the defective condition”) so that the exclusion would still not apply to the earthworks because of the limitation. The insured would therefore still be covered for damage to the earthworks.

Comment from Stephen Tester

This case illustrates the difficulties that can arise in applying a so-called “DE3” type exclusion in a CAR policy. The key is to identify the damaged Insured Property in respect of which indemnity is sought and assess whether the defect which has caused the damage to occur is situated in a distinct and independent part of the Insured Property to the damaged property. Deciding whether one element of a building is sufficiently distinct from another for the saving from the exclusion to apply can be very difficult, but it does seem that two construction elements can be sufficiently distinct in spite of the fact that one provides support or protection to the other. The fact that both elements can be seen as parts of a single integrated system does not mean that the exclusion will necessarily apply.

Further reading: CA Blackwell (Contractors) Ltd v Gerling Allegemeine Verischerungs - AG [2007] EWCA Civ 1450