In recent years it has become increasingly common for developments to be carried out by building companies under design and construction (D&C) contracts where they do not perform work themselves and instead rely on consultants and subcontractors. 

This has led to confusion about whether a D&C contractor's PI policy will respond to claims made against them arising from the work of others, in circumstances where the insuring clause of such policies will often require the claim to relate to the insured's professional services. 

The recent decision of the Federal Court in FKP Commercial Developments Pty Limited v Zurich Australian Insurance Limited (No 2) [2023] FCA 582 (FKP v Zurich (No 2)) provides guidance on how courts construe terms in a D&C PI policy and whether the availability of cover is dependant on the existence of a causal relationship between the provision of professional services and legal liability. 

FKP Commercial Developments Pty Limited and FKP Constructions Pty Limited (together, FKP) sought indemnity under a D&C PI policy issued by Zurich (Policy) in relation to a NSW Supreme Court proceeding (OC Proceeding). The OC Proceeding involved allegations that FKP was liable for defective and non-compliant building work that was performed by its sub-contractors. 

At first instance in FKP Commercial Developments Pty Limited v Zurich Australian Insurance Limited [2022] FCA 862 (FKP v Zurich), Justice Jagot considered two questions which were to be heard separately from any other questions in the proceeding:

1. Does the Policy on its proper construction provide that the insured’s sole right to payment of claims expenses prior to final adjudication of the claim is under the Advancement Provision?

2. Is the whole of the claim made against the Applicants in the OC Proceeding a “claim for civil liability...based on the insured’s provision of the professional services” within the meaning of the insuring clause:

(a)    whether FKP Commercial Developments was a developer within the meaning of the Home Building Act to whom the OC was the immediate successor in title;

(b)    whether FKP Constructions entered into a D&C contract with FKP Commercial Developments in the form of the head contract;

(c)    if FKP Constructions sub-contracted the D&C works it was obliged to perform under the head contract and itself performed only project management and construction management services, being services within the definition of ‘professional services’ in the Policy; and

(d)    even if there is no causal connection between the provision of the Professional Services and the defects alleged in the OC Proceeding? 

Jagot J determined that the answer to the first question was "no", and to the second question was "no, in that the asserted facts were not sufficient to engage the insuring clause in the policy". Accordingly, Her Honour found that FKP had no entitlement to indemnity under the insuring clause.

Based on the negative response to question 2, FKP sought to rely on clause 3* of the Extensions of Cover to the Policy (Clause 3). Justice Jagot ordered that a third separate question be heard and determined, which is the subject of the subsequent proceedings; FKP v Zurich (No 2).  

*Clause 3 in the extensions of cover section states: "We agree to indemnify the insured for loss resulting from any claim arising from the conduct of any consultants, sub-contractors or agents of the insured for which the insured is legally liable in the provision of the professional services. No indemnity is available to the consultants, sub-contractors or agents."

The question before the Court in FKP v Zurich (No 2) dealt with whether the claim made against FKP was one "arising from the conduct of any consultants, subcontractors or agents of the insured for which the insured is legally liable in the provision of the professional services” within the meaning of Clause 3. 

Justice Jackman dealt with the separate question by reference to the three components of Clause 3 of the Policy. This article focuses on the third component that was considered by the Court, which is whether FKP is liable in the provision of the professional services. 

The key question before the Court was whether the third limb of Clause 3 required a "causal connection" between the insured's provision of the professional services and legal liability. A causal connection requires there to be a connection between an act and a consequence that in some way follows from that act.  

In FKP v Zurich, Justice Jagot held that Clause 3 did not impose a requirement that the claim be caused by, result from or arise from the insured's provision of professional services, stating that the clause: 

"requires only that the insured is legally liable for the conduct in its provision of the professional services, irrespective of the source of the legal liability". 

In FKP v Zurich (No 2), Justice Jackman took the same approach, relying on the "ordinary and natural meaning" of the words within Clause 3 to conclude that a causal connection between the claim and the insured's provision of professional services was not required. Importantly, His Honour noted that if the parties had intended a causal connection between the insured's legal liability for its sub-contractors and the insured's provision of professional services, they would have incorporated one of the many connecting phrases commonly used in PI policies for that purpose of establishing causation requirements, for instance: 

• "based on";

• "arising from";

• "attributable to"; or 

• "in consequence of".

Further, His Honour agreed with FKP that the prepositional phrase of "in", used in the relevant part of Clause 3 of the Policy (in the provision of), "suggests no more than a broad factual or temporal (but not causative) connection".  

When analysing the construction of the clause, Justice Jackman agreed with Justice Jagot's reasoning that the insuring clause is starkly contrasted with the language in Clause 3. Unlike the insuring clause, Clause 3 does not require the cause of action to depend on the insured's "provision of, or failure to provide, professional services". Instead, Justice Jagot observed that when constructed correctly, Clause 3:

"provides indemnity for claims arising from the conduct of any of the insured's sub-contractors where a substantive element of the factual matrix in which that liability arises is the provision by the insured of professional services".

On this basis, Justice Jackman found that there is no requirement for the sub-contractors' conduct giving rise to the claim to involve the provision of professional services. In finding that cover was available under Clause 3 he stated it is enough that:

• the services performed by FKP (as project manager and construction manager) are expressly included in the definition of "professional services" under the Policy; and

• FKP (as the developer/ head contractor) are legally liable for the conduct of its sub-contractors.

Justice Jackman also emphasised the need to consider the purpose and circumstances of the Policy as a whole. Contrary to Zurich's assertions, Justice Jackman submitted that it is not commercially unreasonable for an insurer to sell an extension to professional liability cover to developers and builders for their liability for the conduct of their sub-contractors, even in circumstances where the developer or builder only performed a project management role. 

A similar question of construction was raised in the case of Suncorp Metway Insurance Ltd v Landridge Pty Ltd [2005] VSCA 223 (Suncorp), which contemplated what was meant by "professional duty" in an insurance policy. In this case, it was held that what is considered a professional duty will depend upon the "characterisation of the overall activity in the context of which the breach occurs", rather than concentration on a specific task. Additionally, it was held that the policy must be construed in the context of the circumstances in which it was formed, which suggests that the fact that a PI policy has been issued to an insured may indicate of itself that the services provided are "professional services". 

Correspondingly, the Federal Court of Appeal in the QBE Opal Tower decision, ruled in favour of QBE, concluding that the whole policy should be considered when construing the meaning of a definition of a word. In this case, the definition of the term "product" was being considered. It was submitted that the literal meaning of a word should not prevail where it would produce a result that is inconsistent with the object and purpose of the policy. This decision demonstrates the Court's tendency to look at the entire policy, as well as the purpose of the policy, to properly construe a term used therein. 

With more and more building companies entering into D&C contracts whereby they use sub-contractors to carry out the works, it is important for both insurers and insureds to understand how the courts may construe certain clauses in a PI policy. In particular, there has been confusion regarding the requirement for a claim to relate to the insured's professional services, and whether this means that a policy will still respond where the work was performed by the sub-contractors, rather than the builder or developer. 

The judgment in FKP v Zurich (No 2) emphasises that construction of the language used in a PI policy and consideration of the circumstances of the policy, may be key to deciding that the insured is or is not covered. In this instance, cover was afforded due to Justice Jackman finding that there was no requirement for the claim to be caused by the insured's provision of professional services, in circumstances where a substantive element of the factual matrix in which the liability arose was the provision of professional services by the insured, and the insured was legally liable for its sub-contractors conduct.  

The judgment of Suncorp and the QBE Opal Tower decision are also useful reminders of the factors emphasised by Courts when construing the meaning of a term in an insurance policy and the importance of considering the context of the policy as a whole.