Allens

Construction & Major Projects

Focus: Insured's entitlement to make a construction claim

15 July 2009

In brief: A recent decision by the New South Wales Court of Appeal provides guidance on what constitutes a 'construction contract' for the purposes of the Building and Construction Industry Security of Payment Act 1999 (NSW). The court confirmed that a requirement under an insurance contract that the insured take reasonable steps to protect the subject matter of the policy is not a separate construction contract between the insurer and the insured. Partner Leighton O'Brien (view CV) and Law Graduate Merav Bloch report.

How does it affect you?

  • A critical feature of a construction contract is that the contractor undertakes to carry out work for the principal. An obligation under an insurance contract that the insured take steps to protect the subject matter of the policy is unlikely to satisfy that definition.
  • The practical implication of this finding is that, absent special provisions, an insured cannot claim payment under the Building and Construction Industry Security of Payment Act 1999 (NSW) for construction works carried out in connection with an insurance contract.
  • Both the judge at first instance and the appeal judge recognised that an insurance contract could, in certain circumstances, contain a separate construction contract. Nevertheless, the court gave little indication as to when such circumstances would arise.

Background

Thiess and John Holland (the joint venturers) were members of the consortium that bid successfully for the design and construction of the $1.1 billion Lane Cove Tunnel Project (the project). The joint venturers entered into an insurance contract with various insurance companies, including the respondents, under which the respondents agreed to indemnify the joint venture in respect of the investigation, planning, development, design, construction and commissioning of the project.

In the early hours of 2 November 2005, a portion of the tunnel collapsed, leaving a 10x10-metre crater in a nearby road. The joint venture subsequently made a claim on its insurance for construction works carried out following the collapse. Negotiations between the parties were still continuing on 2 September 2008, when the joint venture purported to serve on its insurers a payment claim under the Building and Construction Industry Security of Payment Act 1999 (NSW) (the Act).

In making its claim, the joint venture relied on clause 18 of the insurance contract, which required it to take all reasonable precautions to safeguard the subject matter of the policy and to prevent loss and damage. The joint venture argued that since 'reasonable precautions' necessarily involved construction work, clause 18 constituted a separate construction contract between the insurers and the insured.

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The decision at first instance

In the Supreme Court of NSW 1, Justice Bergin held that there were two matters to be determined:

  • whether clause 18 of the insurance contract constituted a separate construction contract between the insurers and the insured; and
  • if so, whether it fell within the scope of the Act.

The second question arose in connection with section 7(2) of the Act, which provides that the Act does not apply to a construction contract that forms part of a contract of insurance under which a recognised financial institution undertakes to provide an indemnity for construction work carried out under the construction contract. Assuming that clause 18 constituted a separate construction contract between the insurers and the insured, the question was whether the respondents were 'recognised financial institutions' within the meaning of the section.

Her Honour rejected the argument that clause 18 of the contract constituted a separate construction contract between the insurers and the insured. Justice Bergin placed particular emphasis on s4 of the Act, which defines 'construction contract' as a contract or arrangement under which a party undertakes to carry out construction work for another party.

Her Honour pointed out that 'an important aspect' of that definition is that a party undertakes to perform construction works for another party. This was not the case for parties to an insurance contract.

A second (albeit related) reason given by Justice Bergin was that the relevant clause had to be construed in light of the commercial purpose of the contract, which was to provide an indemnity to the insured, not to procure construction works. As such, her Honour was satisfied that the 'reasonable steps' required by clause 18 were conditions precedent to the indemnity being available, and not a positive obligation or undertaking on the part of the insured.

Having reached this conclusion, it was unnecessary to consider the application of s7(2).

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The Court of Appeal decision

The Court of Appeal2 agreed with Justice Bergin's decision and her reasoning. The court accepted that s7(2) suggested that a construction contract could, in appropriate circumstances, form part of an insurance contract. It was satisfied, however, that this was not such a case.

Justice Macfarlan (with whom Justices Allsop and Sackville agreed) held that whether or not clause 18 constituted a separate promise to undertake construction work could be tested by asking whether the insurers could sue the insured for damages if the insured failed to take reasonable precautions, as required by clause 18. It was clear, in his view, that they could not. To hold otherwise would be to ignore the commercial purpose of the contract and the nature of the dealings between the parties.

For this reason, his Honour agreed with Justice Bergin that the requirement to take reasonable precautions was a condition precedent to the insurer's obligation to indemnify, not a promise or undertaking by the insured to take those precautions. In carrying out the relevant construction works, the joint venturers did not entitle themselves to claim payment under the Act, only to claim payment under the insurance policy.

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Conclusion

This decision clarifies the circumstances in which the Building and Construction Industry Security of Payment Act can be relied upon. Critically, recourse to the Act will only be available if the contractor undertakes to carry out works for the principal. It is not enough that the contractor undertakes to carry out construction works per se. Parties seeking to leave open the possibility of claiming payment under the Act must be careful to frame their contracts accordingly.

Footnotes
  1. Zurich Specialties London Ltd v Thiess Pty Ltd [2008] NSWSC 1010.
  2. Thiess Pty Ltd v Zurich Specialties London Ltd [2009] NSWCA 47.

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