Clients are naturally risk-averse, but excessive demands for professional indemnity cover and reliance letters don’t help anyone, argues the CBRE’s Steve Timbs.
Construction industry consultants will be familiar with the trend of clients passing ever more liability to them. Employers are more aware of risk and naturally feel the urge to transfer it elsewhere. And the tougher competition for contracts means that they can: unlimited liability and open liability are now commonly being sought, and this can create a situation whereby the consultant’s contractual liability becomes disproportionate to the fee and the risk is no longer worth the reward.
Other problematic terms being sought include consequential and indirect loss provisions arising from a breach of duty. These can have significant financial consequences for parties that accept them, as liability can extend to commercial matters such as the loss of rent or a reduction in property value.
As the breadth of liability grows, we are also seeing an increase in the average value of disputes. And as the property market recovers and the size of the average contract increases, this will rise further in the future.
The severity of the situation is exemplified by the recent decisions by insurers RSA and Aviva to withdraw PI insurance for architects, designers and construction professionals, surveyors and valuers – much of the property market.
Will the UK market ever return to fairer practices – such as those elsewhere in Europe? This feels some way off at the moment
In response to these developments, smaller firms, in particular, are turning work away if their professional indemnity (PI) insurance fails to meet the client’s requirements. This means that consultants are being appointed for their ability to bear risk rather than their suitability for the job.
I should add that larger firms are not immune to the problem. At CBRE we experience the issue frequently. Recently a reputable fund manager requested £500m PI liability in return for monitoring a construction project. The development value was just a fifth of the cost of the PI and the job attracted a £75,000 fee. The fund manager seemed to be selecting consultants on the level of liability that they offered, rather than their competence.
Reliance letters
Often we find that reliance letters are also sought. These are quick alternatives to negotiating a detailed collateral warranty, and are intended to make a consultant liable to parties outside its contract, such as a purchaser or funder.
The letter allows a third party, to whom the letter is addressed, to “rely” on the consultant’s advice. In other words, like a collateral warranty, it creates a contractual relationship.
Reliance letters usually cover the following provisions:
- highlight the performance of services, subject to the scope of service and relevant limitations normally included in an appointment document;
- identify a limitation period for reliance, typically six or 12 years;
- grant a licence to use and reproduce the contents of the reports;
- detail the required levels of PI insurance cover and set out aggregate financial limits;
- detail limitations or exclusions on the consultant or supplier’s liability;
- provide a right to assign, which may be limited to one or two onward assignments;
- identify the applicable legal jurisdiction.
In my experience, reliance letters typically arise late in a transaction process, and the amount of time and effort they require from the transacting parties and their legal representatives should not be underestimated. It will often be a protracted process and involve an eventual compromise on the terms that each party will accept.
The benefit of a soundly drawn reliance letter issued early in the due diligence process should be clear, as it allows purchasers and funders to place their confidence in the advice that they
receive and to know from the beginning of the project what is on offer in terms of PI insurance.
Will the UK market ever return to fairer practices – such as those followed elsewhere in Europe, where PI levels are usually restricted to a multiplier of the consideration or fee received? This feels some way off at the moment.
As a starting point, it is important that there is a clear match between the liability levels and the PI provisions that are contained in an appointment letter or subsequent reliance letter. All members of the project team should review their PI insurance and determine what level of risk is realistic in relation to both their reward and their insurance arrangements.
Client confidence
From a client’s perspective, decisions concerning appropriate liability levels should begin with a prudent and realistic assessment of the level of risk likely to flow from the appointment. Once this has been determined then the supplier’s PI insurance cover should be checked to ensure that it corresponds and is free of unusual limitations or broad exclusions. Whenever possible, situations where the liability cap exceeds the available PI cover should be avoided but where this does arise, then a sober assessment of the supplier’s covenant strength should be made.
These basic steps should give a client reasonable confidence that there is something to back up the contractual liability provisions of their suppliers. From a supplier’s viewpoint these steps should also enable a reasonable balance to be achieved between risk and reward.
The danger, of course, is that reliance letters could start developing lengthy disclaimers and limitations and the process of issuing what is today a somewhat informal document, may become considerably more formal; whether that will benefit anyone remains to be seen.
Steve Timbs is executive director of CBRE’s building consultancy team
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