Since the introduction of proportionate liability legislation, most design and construct contracts expressly provide that the contractor agrees to be responsible for the acts and omissions of its subcontractors.  The intent, of course, is to allow the principal to seek contractual recourse against the contractor, and not have to establish negligence claims against subcontractors (whom the principal has no contract with).

But how does this type of provision interact with insurance policies required under the contract?

What is proportionate liability?

Proportionate liability is the concept of allocating liability between defendants in proportion to their contribution to the loss of the aggrieved party.

Proportionate liability legislation has been enacted in various formats in each State.  However, in essence, the Courts are able to apportion liability between ‘concurrent wrongdoers’ in claims for economic loss or property damage.

What happened prior to proportionate liability legislation?

Prior to the enactment of proportionate liability legislation in Australia, where two or more defendants were found liable to have caused the same type of loss, each defendant would typically be found to be jointly and severally liable to the plaintiff for the whole amount.  Accordingly, the preferred approach was for a plaintiff to seek recourse against the defendant with the ‘deepest pockets’ (such as professional service providers who typically carry professional indemnity insurance).  Often, one defendant may be insolvent and so the other would be left to pay for the loss.

Contracting out of proportionate liability legislation

In New South Wales, Western Australia and Tasmania there is an express ability to ‘contract out’ of proportionate liability legislation.  Consequently, parties may include a clause in their contract which stipulates that the operation of the relevant proportionate liability legislation is excluded from, and does not apply to, the contract.  Principal-drafted contracts often include such a clause, with the intent of allowing the principal to treat the contractor as a ‘one-stop-shop’ for all of its claims, regardless of the extent to which the contractor’s subcontractors or consultants may have contributed to the loss.  This relieves the principal of the burden of establishing negligence claims against such non-contracted parties.

Interestingly, the contract does not need to expressly refer to the proportionate liability legislation for the parties to be deemed to have contracted out of the proportionate liability legislation.  A judgment in Tasmania (and referred to in relation to a New South Wales case) has held that if the contract contains a provision which is inconsistent with the principles of proportionate liability, this will be sufficient (at least in Tasmania and New South Wales).   For example, if a party agrees to be responsible for the acts and omissions of its subcontractors (a very typical term contained in most design and construct contracts), the parties may have impliedly agreed to “contract out’ of the proportionate liability legislation.  The fact that the parties did not intend to ‘contract out’ of the proportionate liability legislation may be irrelevant.  This implication would not apply in Western Australia where the relevant legislation requires express reference in the contract for the contracting out to be effective.

In Queensland, the proportionate liability legislation provides that it cannot be contracted out of.  All other states are silent concerning whether parties may contract out of the relevant proportional liability legislation (however there are views on each of these – a discussion for another article).

Effect on insurance

Where parties elect to ‘contract out’ of proportionate liability, parties are exposing themselves to greater liability than they otherwise would have been exposed to at law (they are assuming liability that would have been apportioned to another wrongdoer).  Insurance policies refer to this as ‘contractually assumed liability’, and more often than not, expressly exclude such liability (meaning that the policy may not respond as intended).

Insurance policies that contain the usual contractual liability exclusion will only cover an insured for the portion of the loss that a court, under the relevant proportionate liability legislation, attributes to the insured (because that would be the liability that would have attached ‘but for’ the contract).  The additional liability a party voluntarily assumes by ‘contracting out’ of proportionate liability legislation will be excluded from the insurance policy coverage.  The insured will therefore have a ‘gap’ in its insurance coverage.  This will obviously not assist either party to the contract and would be an unintended effect of the decision to include the provision excluding the operation of proportionate liability legislation in the first place.

Accordingly, before executing the next construction contract which excludes the application of proportionate liability legislation, parties (this applies equally for principals and contractors) should confirm the effect of such provisions on the insurance policies relied on by the project.  Whilst the outcome depends very much on the wording of the policy and the drafting of the contractual provisions, there is a real risk that the insurer will not pay a claim if the insured has agreed to contract out and this has extended their legal liability beyond what it would have been at law.