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11 Jul 19 21:54

The London Engineering Group ("LEG"), a consultative body for insurers of engineering class risks, first published their suite of exclusionary clauses relating to defects in 1996, with LEG 3/06 being revised ten years later. Whilst these clauses have now been with us for nearly a quarter of a century, there is little jurisprudence on their interpretation, and none of them have thus far been cited in case-law in England and Wales.

How confident are we then, that we really understand what each version of this clause is meant to cover and exclude?

Typically, the first requirement in a Construction All Risks policy is there must be otherwise indemnifiable physical damage before any of these exclusions need to be considered. The mere existence of a defect (interpreted to mean contract work which fails to comply with the express and implied descriptions or requirements of the contract) does not, in itself, constitute damage. So, if the Insured knows of a defect that will be expensive to fix, why shouldn't he simply wait for damage to occur then recoup some of his repair expense from his Insurer?  The answer, often, is that the Insured has an accompanying duty to take reasonable precautions to prevent damage occurring, however this will also require a consideration of what is practicable, both in the time available and at a proportionate cost. 


So what do the LEG clauses actually say? 

LEG 1/96 – The 'outright' defects exclusion

"The Insurer(s) shall not be liable for:
 Loss or Damage due to defects of material workmanship design plan or specification"

The meaning here seems pretty clear, but it's also an exclusion seldom in use in the market today as the Insured inevitably looks to obtain at least some cover in respect of damage caused by defects.


LEG 2/96 – The 'consequences' exclusion

"The Insurer(s) shall not be liable for:
All cost rendered necessary by defects of material workmanship design plan or specification and should damage occur to any portion of the Insured Property containing any of the said defects the cost of replacement or rectification which is hereby excluded is that cost which would have been incurred if replacement or rectification of the Insured Property had been put in hand immediately prior to the said damage"

This version looks to exclude only those costs that would have been incurred had the defect been rectified just before the physical damage occurred, with all other costs incurred as a consequence being covered. It requires a hypothetical calculation of the cost of defect rectification and will, in theory, mean that costs to access damage are also excluded – if you would need to incur these same costs to access and rectify the defect. 
 

LEG 3/06 – The 'improvements' exclusion

"The Insurer(s) shall not be liable for:
All costs rendered necessary by defects of material workmanship design plan specification and should damage (which for the purposes of this exclusion shall include any patent detrimental change in the physical condition of the Insured Property) occur to any portion of the Insured Property containing any of the said defects the cost of replacement or rectification which is hereby excluded is that cost incurred to improve the original material workmanship design plan or specification"

LEG 3/06 provides the widest defect cover of the three, excluding only the cost of any "improvements" put into place following the loss. What constitutes an improvement compared to unavoidable betterment is matter of fact and is, to a degree, determined by the circumstances of each specific case, but in some situations (e.g. defective workmanship) there may be no extra-over "cost" of improvement excluded at all. 


Evolution 

From time to time, attempts are made to amend or update the LEG clauses. One example of an amended version of LEG 2/96 which the author has seen in a CAR risk recently is reproduced below: 


LEG 2/96 'Amended' Version

"The Insurer(s) shall not be liable for:
All cost rendered necessary by defects of design, plan or specification and should damage occur to any portion of the Insured Property containing any of the said defects the cost of replacement or rectification which is hereby excluded is that cost which would have been incurred if replacement or rectification of the Insured Property had been put in hand immediately prior to the said damage"
 

In this version, a comma has been inserted after 'design', and the words 'material workmanship' have been removed completely. The impact of this is to remove from the ambit of the exclusion, defects in both materials and workmanship. In that sense, it has become a narrower exclusion – or provides a broader cover if you look at it the other way – than the default LEG 2/96 market clause.

As a matter of good practice, an amended market clause should be highlighted both to the Insured and to the underwriter at the time of placement, depending on who prepares the wording. It may, for example, present a challenge in rating the risk and determining the premium, where pricing models are assessed based on standardized wordings. 


Conclusion

Reimbursing Insureds for costs incurred to reinstate covered physical damage remains the number one priority of Insurers and identifying and isolating from total costs presented those incurred to rectify a defect is a key part of this process. Whilst underwriters and claims may feel confident they know which costs these clauses are designed to cover and exclude the factual analysis of the particular set of loss circumstances can and frequently do lead to uncertainties and the absence of any case law in England and Wales means these types of claims will likely continue to present a challenge for the foreseeable future.


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