H) Latent Defects Insurance
Latent defects insurance is a form of insurance taken out in respect of specific new-build project to provide cover in the event of an inherent defect in the design, workmanship or materials becoming apparent after practical completion. It indemnifies the insured for the cost up to the total sum insured which is typically the full reinstatement value of the repairs to the damage caused or for repairs to prevent imminent damage by the defect and is typically available for between 6 and 12 years from the date of final certificate or practical completion.
The insured can be any party who has an interest in the completed project such as the Employer or developer, but can also be the funder or an incoming tenant with an obligation to repair under the lease.
The Employer may have appointed the Contractor and professional team directly and have contractual rights as a result, or the funder and tenant may have received collateral warranties. However there are many situations where these aren’t sufficient to protect the beneficiary’s interest such as where they are restrictively drafted with net contribution clauses and limitations on liability or where there are members of the team who simply haven’t provided warranties at all. But most of all, they rely on the client proving breach of contract and seeking redress themselves against the individuals with all the inherent risks and costs associated with it.
With the increasing prevalence of net contribution clauses in warranties, latent defects insurance in contrast provides a single point through which to recover the costs of repairing, replacing and or strengthening the premises following discovery of a latent defect that has caused or is about to cause major damage or destruction to the structure.
The policy typically covers damage to the whole structure caused by an inherent defect in the structure (all internal and external load bearing elements essential to the stability and strength of the premises) as well the non-load bearing fixings and finishing’s necessary for the waterproofing and weatherproofing of the building envelope.
It should be noted that generally latent defects insurance is more limited than a typical collateral warranty as the cover is limited to a maximum sum insured, whereas warranties do not generally contain caps on liability. In addition the policy only covers certain specified losses, whereas warranties generally cover all losses attributable to defective workmanship and/or negligent design. Weighing against this the insurer’s covenant is likely to be stronger than a Contractor’s and in that respect alone insurance may offer greater security than a warranty.
Generally policies covering latent defects do not cover consequential or economic losses arising from the defect other than the costs of repair. Similarly defects to the non-structural parts such as wiring, gas, water, ventilation and heating fixtures, nor internal windows, floor coverings and drains are generally excluded. As such, damage caused by inherent defects in non-structural, non-building envelope parts and those losses suffered due to an inability to trade or damage to items stored on the premises (which could be substantial and in excess of the cost of repairing the premises) would not be covered.
The insurer providing latent defect insurance in Malaysia will either appoint a surveyor to visit the works and certify them on completion, or rely on Employer Consultants certification to determine whether to offer cover. Policies typically penalise those who under insure their property by not fully declaring the build cost. Penalties, known as ‘Average’ provisions calculate the amount by which the premises were under insured and proportionately reduce the amount of any payment made under the policy so it is essential that Employers correctly state the value if they wish to rely upon the insurance to recover costs for latent defects.
Latent Defect insurance typically excludes cover for any defects of which the insured is aware before the certificate of insurance is issued, and any fit out works should be fully notified to the insurer as well as any subsequent modifications, alterations or additions.
Generally with this type of insurance there is an exclusion of cover for the first 12 months after practical completion. This is seen by some as an important exclusion that detracts from the value of the policy. Insurers take the view that the Employer must take care to appoint a Contractor that will be around long enough to rectify defects during this initial period.
The insurer will often have a right to recover any sums it pays to the insured by starting legal action at its own expense in the insured’s name to exercise any right the insured may have to make a recovery from a third-party such as under a collateral warranty. The insured should not do anything that would diminish the insurer’s rights after the policy is taken out and if the insured subsequently recovers any monies which reduce the insured loss (whether before or after the insurer pays out on the claim) it must then account to the insurer for such sums.
Latent defects insurance provides a single point through which to recover the costs of repairing, replacing and or strengthening the premises following discovery of an inherent defect that causes damage or threatens the structure’s imminent collapse, but it typically excludes a variety of non-structural fittings and infrastructure as well as any consequential losses or economic loss. However, providing the limitations and cost are acceptable, and the policy is properly taken out, insurance provides a secure and straightforward alternative to relying on the contractual provisions of warranties, building contracts and appointments.
The Insurance is usually taken out in the name of the developer but is freely assignable to new and subsequent owners, lessees or financiers. Insurers under certain conditions can be prepared to waive subrogation rights against Architects, Engineers, Contractors and others (but not suppliers) on payment of an additional premium and, usually, the imposition of a higher deductible.
Where the insurance is taken out on residential developments it should result in the immediate availability of funds for repairs and minimises disruption to the tenants or purchasers. In addition It meets the insurance requirements being imposed by many financiers and mortgage providers and can be a major advantage to the developer when negotiating a sale or letting. In fact, some major tenants in commercial development are now insisting on the cover being in place.
Employer considering taking out such insurance should do so at an early stage in order to minimise the cost and maximise the benefits. The cost of latent defect Insurance can almost double if the insurance is purchased after the foundations have been started. Employer should consider the insurance as an integral part of the procurement and construction process. It should not be an afterthought purchased only to satisfy funders or tenants. The Employer should ensure that all those working on the project know from the outset that cover is being purchased and they understand the advantages and implications for them and make it clear from the outset if any consequential loss cover is required as this will have a bearing on the market placement.