The fourth in the series of articles on collateral warranties looks at what is at stake in negotiations over net contribution clauses and professional indemnity insurance.

The arguments for and against net contribution clauses have already been advanced by Rachel Barnes (18 February) and Ian Insley (26 May). This article simply explains how they work. As before, references to the contractor also apply to consultants.

If a loss is caused by a number of people, each is liable for the whole of it, but the party that actually pays can recover contributions from the others. The effect is that the person paying takes the risk that the others are solvent.

Net contribution clauses try to put the risk of insolvency on the person suffering the loss. The clause usually says that a party that has contributed to the loss shall bear only a fair proportion of it, assuming that others that have also contributed have similarly agreed to pay their share of it.

There is usually an argument over whether there should be a net contribution clause at all. They are unpopular with developers and investors because they affect recovery of losses. However, they are popular with insurers because they reduce their exposure. Assuming that a clause has been agreed in principle, the other argument is over who should contribute. Some clauses put forward by insurers include “all other consultants, contractors, subcontractors and suppliers”. This requires the beneficiary to ensure that it has collateral warranties from all of these people, which is not only unreasonable but almost impossible to organise.

As collateral warranties are usually only provided by designers, the parties named in the clause should be limited to designers. In practical terms, it should be limited to the principal designers and it is usually acceptable if only consultants, as opposed to subcontractor designers, are named.

Should the contractor be named? If the warranty relates to a conventional procurement route, then it is probably reasonable that the contractor should be named. However, if a design-and-build contract is used, one of the purposes of taking collateral warranties from the designers (which will be subcontracted to the contractor) is to give the beneficiary some protection if the contractor becomes insolvent.

Some clauses put forward by insurers say the beneficiary must have warranties from all firms in a project, which is not only unreasonable but almost impossible to organise

If the contractor is included and then becomes insolvent, the protection available from the warranties is reduced. In these circumstances, I believe the contractor should not be included.

Professional indemnity insurance

Collateral warranties usually contain provisions that require the contractor to maintain professional indemnity insurance. The level of cover will be specified and that it shall be maintained for six or 12 years from practical completion, provided that the insurance is available at reasonable rates and on reasonable terms. This proviso is sufficient protection to the contractor and it is not necessary to qualify the requirement by asking it to use best or reasonable endeavours to maintain the insurance.

The contractor will be required to produce evidence that the insurance is being maintained and renewed, but care should be taken here, because many policies only allow the disclosure of a certificate from the contractor’s broker confirming the amount of the insurance, the basis of cover, the amount of any excess and the period covered.

One issue that arises is whether the insurance covers each and every claim or if it is on an aggregate basis. Insurance on an aggregate basis is an overall limit for all claims made in any particular year, so it is possible that there may be no cover for claims made later in the year. Cover for each and every claim means the limit of indemnity applies to each claim. Most people advising beneficiaries resist aggregate insurance.