Insurance cover: Don't attempt the impossible

Although the attitude of insurers to policy interpretation has never been strictly uniform there is no doubt that a harder line has been taken in the past 12 months. As such, many firms are finding their insurers are refusing to cover them because they have failed to meet all the requirements of their policy warranties.

In a recent case of mine, a design-and-build contractor got into a dispute with its insurer as a result of this increasingly tough approach.

In 2007, two men fell through a roof on the contractor’s site. Both were seriously injured and one was paralysed. Although the men had been working under the direction of their employer – a demolition subcontractor – the main contractor was still liable under the health and safety act.

After a criminal prosecution had taken place, the paralysed worker brought a civil claim for damages in excess of £2m against the contractor and subcontractor. The contractor’s insurer agreed to indemnify it and instructed a solicitor to defend the claim. The subcontractor’s insurer, by contrast, refused to cover the claim. It later transpired that it had agreed to insure a gentleman known as Mr Y, who had been a sole trader specialising in demolition, before he become bankrupt. Mr Y persuaded a friend to set up the demolition subcontracting company so he could continue trading, but failed to tell his insurer about this arrangement or, indeed, his bankruptcy. The insurance policy was therefore invalid.

These events had serious repercussions for the main contractor. Its insurance policy included a condition that all its subcontractors had to maintain insurance on terms no less onerous than its own.

Furthermore, this condition was expressed as a warranty, which meant that any breach of it would immediately deprive it of cover not only for the injured man’s claim, but any others as well. Because the subcontractor was not covered for the claim and so was not “maintaining” its insurance, the main contractor was in breach of the warranty.

If the terms laid down by your insurer sound like you need to police the impossible, don’t sign them

The first the main contractor knew of all this was when, in June last year, it received a letter out of the blue from its solicitor (purporting now to be acting for its insurer) declining cover for the claim and advising it that it would have to deal with two applications to set aside a default judgment (which its insurer had negligently allowed to be entered against the contractor) and defend against the injured man’s demands for an immediate payment of £750,000.

A bloody battle between the contractor and its insurer followed. The insurer insisted that the warranty had been breached and that its handling of the matter, although unorthodox, was justified. The contractor maintained it was absurd to expect it to do anything more than carry out reasonable checks that its subcontractors had and were maintaining adequate insurance. It had carried out these checks before hiring the demolition firm but had failed to spot that anything was wrong because the insurance certificate presented to it by Mr Y on the firm’s behalf was misleading. It referred to the insured as the “company named below” and entered the demolition firm’s name in the space.

The main contractor was fortunate to be able to challenge the insurer’s decision, but others in a similar position might not be so lucky.

Contractors rarely verify whether their policies oblige them to retain only subcontractors that have and maintain a specific level of insurance. Even those that are aware of this requirement and check their subcontractors’ insurance policies, as in this case, lack control over the subcontractors’ consequent actions. This means there is no way for a contractor to guarantee its subcontractor’s level of insurance.

The lessons learned from this case are tough ones. Contractors must ensure they always check the details of their subcontractors’ insurance policies, even though those checks might seem onerous and time-consuming. If in doubt, engage the help of a solicitor.

Second, check the terms and conditions of your own policy. If the terms laid down by your insurer sound like you need to police the impossible, don’t sign up to them. I hope this article will prompt a review of existing policy conditions and highlight the pitfalls to avoid upon renewal.