Major Construction Projects - K&L Gates

Major Construction ProjectsKey Risk and Insurance Strategies

October 6, 2011 – Los Angeles, CA

Hosted By:John R. Cunningham, Senior Vice President, Construction Consulting Practice, Marsh Risk Consulting

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Speakers

Harold DorbinSenior Vice President

Construction Consulting PracticeMarsh Risk Consulting

Frederic J. GiordanoPartner

K&L Gates LLP

Michael D. HastingsProject Risk Practice Leader

Marsh U.S. Construction Practice

Danette M. JonesSenior Vice President

Marsh U.S. Construction Practice

Timothy L. PiercePartner

K&L Gates LLP

Insurance in Context:Construction Risk Management

Michael D. Hastings, Marsh U.S. Construction PracticeDanette M. Jones, Marsh U.S. Construction Practice

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Charles De Gaulle International Airport, Terminal 2EMay 23, 2004, 05:00 GMT

Risk Transfer Is Not Risk Management

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Insurance in Context: Construction Risk Management

Not all risk is insurable There is an interplay between insurable and

uninsurable risk Regardless of insurance in place, loss control and

mitigation is preferable to an insurance settlement Insurers provide their best terms and conditions to

projects where risk is managed

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Identify/Quantify the risk to all stakeholders Determine the most effective methods to control and

mitigate risk Assign/Define contractual responsibilities Determine the coverage and limits necessary to

protect the parties and the work Identify which party is in the best position to provide

each coverage Communicate/Collaborate

Construction Risk Management: Insurance in Context

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The Insurance Industry: What Every Party Should Understand

Insurance companies are for-profit businesses that seek to earn a fair rate of return for the risk they take

Traditional insurance coverages are supported by years of precedence

Insurance rates are supported by years of data Denying a claim can be as expensive as paying it Insurance companies’ financial ratings are

determined by the capital backing the policies they write

Insurance is a heavily regulated industry

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Professional Liability Insurance: What every party must know What it covers

Amounts which the Insured is legally required to pay due to negligent acts, errors, or omissions

Bodily injury, property damage, economic damage

Pitfalls Duty of care Claims made policy Retroactive date/extended reporting period Exhaustion of limit/defense within limit

Enhancements Project-specific professional liability OPPI/CPPI

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General Liability Insurance: What every party must know

What it covers Amounts which the Insured is legally required to pay Bodily Injury or Property Damage caused by accident (including

resulting damage) Personal Injury

Pitfalls Claims arising out of defective construction Completed operations through statute of repose Indemnification/limitations of liability Additional insured for ops and completed ops Anti-indemnification statutes/precedence Wrap-up exclusions

Enhancements Limited professional liability coverage Limited pollution liability coverage

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Environmental Insurance: What every party must know

What it covers Bodily injury, property damage, clean-up costs

Unknown/unexpected release of unknown pollutants Unexpected release of known pollutants Liability associated with transportation and off-site storage

facilities Fund indemnification when land with known pollutants changes

hands

Pitfalls Reliance on CGL endorsement Claims made forms

Enhancements Project-specific CPL, PLL, Cost Cap

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Builders Risk Insurance: What Every Party Must Know

What it covers Direct physical damage to property

Project itself Equipment, materials that will become a part of the project Temporary structures

Delay in Start-Up (DSU) Actual damages Expediting expense

Pitfalls Transition to permanent insurance Sub limits Responsibility for deductibles Who pays what insurer does not? Damage to existing structures Lender requirements Design firm as named insured

Enhancements Project-specific policy forms

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Controlled Insurance Programs: What Every Party Must Know What it covers

General Liability, Excess Liability, and/or Workers Compensation

Job-site claims for owner, general contractor, trade contractors

Pitfalls Geography/operations covered Over-focus on “savings” Completed operations Products liability Deductible pass-throughs Sponsor v. enrollee claims

Enhancements/Benefits Broad/Stable coverage Expedited claims process Supports collaboration

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Controlled Insurance Program: Savings Dilemma

$1 Million Insurance Cost

$500,000 Insurance Cost

$28 Million Materials & Labor$30 Million Materials & Labor

Subcontractor A Subcontractor B

$31 MM Bid

$28.5 MM Bid

Better cost, but lower “savings”

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Controlled Insurance Program: OCIP vs. CCIP

Dramatization

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Identify/Quantify the risk to all stakeholders Determine the most effective methods to control and

mitigate risk Assign/Define contractual responsibilities Determine the coverage and limits necessary to

protect the parties and the work Identify which party is in the best position to provide

each coverage Communicate/Collaborate

Construction Risk Management: Insurance in Context

(Earlier slide intentionally repeated)

Contractual Risk Management for Mega Projects

Timothy L. Pierce, K&L Gates LLP

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I. Dispute Resolution Clauses

Litigation vs. Arbitration International Arbitration Administrator Attorneys Fees Clauses Waiver of Juries Appeal of Arbitration Decision

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Examples of Consequential Damages

Owner – rental expenses, loss of use of income profit, financing, business or reputation, and loss of employees or employee ineffectiveness

Contractor – Home Office overhead, loss of profit on other jobs and losses of financing, business, and reputation

II. Consequential Damages

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Allocation of liability and negotiation of same Waiver of consequential damages except:

To the extent of insurance coverage No waiver for willful conduct No waiver for subcontractor caused Cap on liability

II. Consequential Damages

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III. Allocation of Responsibility for Builders Risk and Uncovered Risk

All risk of loss covered Who has responsibility for uncovered damage

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Pay if Paid Invalid in California Clark v. Safeco – Pay if paid provisions are

unconstitutional and unenforceable in California on private works of improvement Mega Construction – Pay if paid provisions

are unconstitutional and unenforceable on public works of improvement

IV. Pay if Paid vs. Pay When Paid Clauses

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Are Pay if Paid clauses valid in response to a pure contract claim?


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What if Project in New York uses contract adopting law of another state?


K

Project

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A. Handling of subcontractor claims Pay when paid What is a reasonable time Subcontractor pass-through claims Coordinate dispute clause with all

participants


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Owner can shift the burden of unknown conditions to the contractor

– Interstate Contracting v. City of Dallas

– Contract should use explicit language

– Does shifting the costs for unknown conditions help or hurt the owner?

V. Changes To The Work

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– Statutes May Limit Burden Shifting by a Public Owner. For example: California Public Contract Code section

7104: Contracts that involve digging trenches or excavation deeper than four feet “shall” include a clause providing for a change order when unknown conditions are encountered


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Contracts generally provide that:

Change orders and change directives should be in writing

Contractors should be cautious not to perform work unless there is a written change

Changes need to be approved in writing


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Material Acquisition Issues To Consider

Ownership of Material Prior to Use on the Project

Responsibility for Material Escalation Costs

VI. Material Acquisition

Legal Perspective on Insurance Issues

Frederic J. Giordano, K&L Gates, LLP

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Legal Issues

Large construction projects often insure differently that other construction projects Wrap-ups

OCIP CCIP

Subguard policies Project specific policies (for professional liability) More comprehensive builders risk policies

Very few court decisions specifically address the interpretation of these kinds of insurance policies No reported Subguard cases

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Legal Issues (cont.)

Consolidated insurance programs eliminate or reduce some of the legal issues that arise under traditional insurance products. For example: Disputes over additional insured status and coverage

All contractors and subcontractors participate in wrap-up

Ancillary disputes over scope and validity of contractual indemnification

Subrogation and disputes between insureds Professional liability/general liability

EPC systems Availability of sufficient limits

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Legal Issues (cont.)

California recently enacted certain statutes impacting wrap-ups Cal. Civ. Code § 2782.9

Prohibits requiring a participant under a residential wrap-up from defending, indemnifying or holding harmless another for claims covered by the wrap-up.

Cal. Civ. Code § 2782.95 Disclosure requirements for residential wrap-ups

Cal. Civ. Code 2782.96 Disclosure requirements for public works and projects other

than residential construction

Other, significant legal issues exist even under consolidated insurance programs

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The Occurrence IssueMust be an “occurrence” to trigger general liability coverage Occurrence generally defined as “an accident,

including continuous or repeated exposure to conditions, which results in bodily injury or property damage neither expected nor intended from the standpoint of the insured”

On its face would seem to include any property damage

Whether property damage resulting from defective construction remains a hot issue in construction claims

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The Occurrence Issue (cont.)

Significant Variance in Court Interpretation IL, OR, PA, and an increasingly limited number of

other states Allegations of damage only to the building itself are not

property damage and not occurrences E.g., West Bend Mutual Ins. Co. v. The People of the State

of Illinois, 929 N.E.2d 606 (Ill. App. Ct. (1st Dist.) 2010)

FL, IN, TN, TX, and an increasing majority of states Defect in the work can give rise to an occurrence if it

damages other parts of the work E.g., Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242

S.W.3d 1 (Tex. 2007)

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The Occurrence Issue (cont.))

California among states where highest court has not yet addressed the occurrence issue

But see McGranahan v. Ins. Corp. of New York, 544 F. Supp. 2d 1052 (E.D. Cal. 2008) (indicating defective construction may give rise to an occurrence depending on insured’s intent)

Practical Solutions to the Occurrence Issue Start selecting other forum’s law to govern your policy

May not be enforceable in all states Careful that the selected state is favorable on other issues

Make an express change by endorsement (but you should not have to pay for it)

Purchase other insurance products Warranty insurance Surety bonds

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The Occurrence Issue (cont.)

Systematic Solutions to the Occurrence Issue Resolve the issue before the state Supreme Court

Favorable trend Some states have defined “occurrence” by statute

Colo. Rev. Stat. § 13-20-808 “In interpreting a liability insurance policy issued to a construction

professional, a court shall presume that the work of a construction professional that results in property damage, including damage to the work itself or other work, is an accident unless the property damage is intended and expected by the insured.”

Also Arkansas (Ark. Code § 23-79-155), South Carolina (2011 S.C. Act 26, to be codified as S.C. Code § 38-61-70), and Hawaii (Ha. Rev. Stat. § 431:1)

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Reservation of Rights & Conflict of Interests

In California and many other states where an insurer’s and insured’s interests do not fully align Independent counsel is mandated

Law: West's Ann. Cal. Civ. Code § 2860 San Diego Fed Credit Union v. Cumis Ins. Society,

Inc., 162 Cal. App. 3d 358 (1984) Md. Cas. Co. v. Peppers, 355 N.E.2d 24 (Ill. 1976) Public Service Mut. Ins. Co. v. Goldfarb, 425 N.E.2d

810 (N.Y. 1981)

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Reservation of Rights & Conflict of Interests (cont.)

Examples of conflicts: Multiple count complaint, not all counts covered

(fraud/intentional acts) Multiple types of damages, not all covered A potential dispute regarding whether the conduct in

question fell within the covered time period Plaintiff potentially seeking damages in excess of

limits, but demand within limits Vicarious liability v. direct liability

But see Travelers Property v. Centex Homes, 2011 WL 1225982 (N.D. Cal. April 1, 2011)

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What does “independent counsel” mean? You control the defense and strategy of the case;

the insurer pays for it In some states, the case law suggests the insurer

has no right even to have input into the case (practically speaking this may not be a good idea)

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Rates that are reimbursable varies CA – rate the insurer would ordinarily and

customarily pay to panel counsel under Cal. Civ. Code Section 2860

IL – “reasonable rate” Federal decisions clear, reasonable equals what the

market will bear

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Are there consequences if an insurer fails to identify conflict? Yes, later could be stopped from raising coverage

defenses Utica Mut. Ins. Co. v. David Agency Ins., Inc., 327

F.Supp.2d 922 (N.D. Ill. 2004)

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Other General Construction Defect Considerations

Ramifications of when loss occurred or was discoveredProperty policies/builders risk might apply Normally exclude workmanship/design issues But, ensuing loss clause might create coverage

i.e. defect results in other damage to the building Possible to obtain coverage for “cost of making good”

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General Construction Defect Considerations (cont.)

GL is tricky Exclusion for work in progress Completed operations

Insurers drafted it to offer broad coverage and they market it accordingly

Subcontractor exception to “your work” exclusion Carriers have taken a narrower view in court and that

narrower view has on occasion carried the day “Accidental” v. “intentional” property damage

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Insurance Coverage for Delay Claims?

SubguardMay be covered in part under builders risk policies (if purchased)May even be possible under GL policies Often includes language providing coverage

“because of” property damageOften covered under professional liability Consider requiring for GC/CM?

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Claims-Handling Tips

Obtain copies of the policies that cover you or are supposed to cover youMake a timely claim

As soon as reasonably practicable Notice of a claim does not necessarily mean getting sued

Put all the carriers on notice Do not decide what type of claim it is too early Defect might be GL or Builders Risk or Professional

Duty to defend v. duty to indemnify A little bit of duty goes a long way

Don’t accept the first no Some would say to expect it

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Resolving the Claim

Duty of cooperation and reportingMediation and settlement strategiesIn the end Your goal should be to resolve the claim with as

little of your money as possible

Project Governance and Retained Risk Management

Harold Dorbin, Marsh Risk Consulting

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Owner’s Project Perspective

Owners make money from the completed project Project objectives are longer term

On-Stream reliability Usable life Cost of use/operation

Schedule and cost may or may not be critical Project is “the asset” Funding structure Industry/Business needs

Success for the project defined by both Corporate objectives Business justification for project

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Contractor’s Project Perspective

Contractors make money by completing the project Project objectives are usually shorter term

Defined by contract compliance

Longer term objectives are real Execution reputation Technology supplied/experience

Success for the project defined by both Contract compliance Corporate objectives

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Risk RealityIs there more of it or are we just better at identifying it?Technology advances have led to higher risk recognition and elevated the management bar Personal computer and software Forecasting and forensics expectations Execution expectations Global execution and coordination Cost of risk – risks are retained selectively Each project is a unique collection of risks

Project Governance and Mega Projects

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Project Governance Definitions

“Capacity of a management organization to positively influence the project toward a successful outcome”

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Why Mega Projects Are Different

First step is to acknowledge: “Bet the Farm” “Failure Is Not an Option” More developed strategic planning

Delivery method needs risk consideration Resources/Labor availability considerations

“New Sandbox Rules” Every action has a reaction “Not Kansas” anymore

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Systematic (“stage gate”) identification of what is high risk (Yes/No) Define stages in planning/project when key decisions

need to be made Apply specific screening tests at each stage If a “high risk” condition exists

System engages internal experts “risk committee” Defined interaction between project and risk committee Risk committee makes recommendations to project and

executive management – at each stage

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Why Mega Projects Are Different – Example Proposal Decision Flow Chart

Preliminary decision made on Proposal

Level 1, 2, 3

GATE ONE

PM completes Pre RA Form and submits for

comment/approval

Pre RA approve/reject and

comments via procedure 123

Bid/No BidAssessment

LEVEL 1 AND 2

REJECT

END

LEVEL 3

ACCEPT

BID

1 or 2

YES

Proposal LevelConfirmed via procedure

123

Notify Risk Review Group based on Pre RA

Responses

Notify Risk Review Group immediately after bid

decision

Risk Review Group provided the Pre RA & Proposal Documents

PM includes pre-approved Liability Limits,

etc.

Commitment made to providing proposal

PM completes Pre RA Form

NO

LEVEL 3

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~ ~Proposal Management

Plan Updated Proposal Management Plan updated and sent to

RRG

GATE THREE

Gate 3 Risk Checklist Forms completed, all documents

required via Procedure 123 completed

Project Risk Analysis completed and

contingencies defined by procedure 234

Risk Review Group provides remarks to PM

for consideration

PM submits Project Risk Analysis and other bid data

Project Risk Analysis completed and contingencies

determined per procedure 234, then provided to RRG.

Risk Review Group provides recommendations

on specific Risk Action Plans and RA

PM supplies revised Project Risk Analysis and

contingencies to RRG

RRG accepts revised Project Risk Analysis

PM submits contingencies, PRA and other data

Risk Review Group recommends No Proposal

YES

NO

PM determines which RRG recommendations

to include

Do Gate 3 Risk Checklist Forms or updates

to the Procedure 123 Risk Documents require

RRG engagement

PM provides Gate 3 Risk Checklist Forms and all

documents per procedure 123.

YES

NO

Gate 3 Risk Checklist Forms completed, All documents required via Procedure 123 completed

Why Mega Projects Are Different – Example Proposal Decision Flow Chart

Continued

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Define and distinguish compliant from high risk projects at each planning/bidding stage What decision is being made? (ex. bid/no bid,

funding) By when must it be made? What information is necessary to make decision? What is risk to not having all the

information/assuming? Who can make the decision? Are there different criteria for different project

circumstances? (ex. cost of project, criticality to enterprise)

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Define and distinguish compliant from higher risk projects during execution and close out stage Are there key decisions that require executive

management input (i.e. key vendor selection)? By when must it be made? What information is necessary to make decision? What is risk to not having all the information/assuming? Who can make the decision?

What metrics and at what level define when a project is “off the rails”

Project Processes and Mega Projects

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Project processes must align with stage gate requirements Example - if stage gate process requires different

levels of cost estimate accuracy – each level of accuracy must be defined and exhibit: Consistency – able to be repeated producing same outputs

from same set of inputs Accountable – clearly defined and assigned to project

members Transparent – allows others to quickly understand what

decisions have been made, by whom, and with what information

Industry Best Practices (IBP) – all project processes should meet IBP standards

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Having good project processes even on non–high risk projects is critical: Rely on project processes to deliver projects that are

not “high risk” and subject to executive management and risk committee scrutiny

Having consistent, accountable, transparent, and IBP project processes will allow audits and easy testing of project metrics to determine if project eventually becomes “high risk” during planning/bidding phase or in execution

Project Risk Management and Mega Project Governance

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Project Risk Management and Mega Project GovernanceSpending more resources does not guarantee better results: Start project risk management during strategic

development period of project plan/bid Bid screening tools Qualitative techniques to make key project decisions

Expectations from sophisticated project risk management processes cannot be higher than capacity of organization to develop needed information

Utilize a process that: Identifies and prioritizes key project objectives Identifies and tracks risk to all key project objectives Driven by project team and integrates with project controls

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Project Risk Management and Mega Project GovernanceSpending more resources does not guarantee better results (con’t): Simple lessons learned system aids with risk

identification Sort able risk data for easy identification of project specific

risks Project risk management will tell you what worked and what

did not

Linking project risk management with project controls

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Project Risk Management and Mega Project GovernanceGovernance requires effective project risk management inputs at every project stage: Early decisions (funding, bid/no bid) require

preliminary risk assessment What is the impact to the project key objectives of not

having/assuming the data required for the decision? What is the impact if the decision is delayed? What is the impact to the project key objectives of

negative feedback from project controls? Which decision should I make – increase the cost of

the project by accelerating the contractor/subcontractor or allow the schedule to slip?

Wrap Up

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Wrap Up

Owner vs. contractor perspectives on mega projects Changing expectations and standards for project

governance Stage gate processes and aligning project process to

meet objectives Consistent, accountable, transparent, and IBP

procedures Risk committee involvement and value Project risk management – mastering the least

complex system that will support objectives Project lessons learned and project integration are

critical

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Contact Us:

Harold [email protected]

Frederic J. [email protected]

Michael D. [email protected]

Danette M. [email protected]

Timothy L. [email protected]

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K&L Gates includes lawyers practicing out of 38 offices located in North America, Europe, Asia and the Middle East, and represents numerous GLOBAL 500, FORTUNE 100, and FTSE 100 corporations, in addition to growth and middle market companies, entrepreneurs, capital market participants and public sector entities. For more information, visit www.klgates.com.

K&L Gates comprises multiple affiliated entities: a limited liability partnership with the full name K&L Gates LLP qualified in Delaware and maintaining offices throughout the United States, in Berlin and Frankfurt, Germany, in Beijing (K&L Gates LLP Beijing Representative Office), in Brussels, in Dubai, U.A.E., in Shanghai (K&L Gates LLP Shanghai Representative Office), in Tokyo, and in Singapore; a limited liability partnership (also named K&L Gates LLP) incorporated in England and maintaining offices in London and Paris; a Taiwan general partnership (K&L Gates) maintaining an office in Taipei; a Hong Kong general partnership (K&L Gates, Solicitors) maintaining an office in Hong Kong; a Polish limited partnership (K&L Gates Jamka sp.k.) maintaining an office in Warsaw; and a Delaware limited liability company (K&L Gates Holdings, LLC) maintaining an office in Moscow. K&L Gates maintains appropriate registrations in the jurisdictions in which its offices are located. A list of the partners or members in each entity is available for inspection at any K&L Gates office.

K&L Gates has offices in: Anchorage, Austin, Beijing, Berlin, Boston, Brussels, Charlotte, Chicago, Dallas, Doha, Dubai, Fort Worth, Frankfurt, Harrisburg, Hong Kong, London, Los Angeles, Miami, Moscow, Newark, New York, Orange County, Palo Alto, Paris, Pittsburgh, Portland, Raleigh, Research Triangle Park, San Diego, San Francisco, Seattle, Shanghai, Singapore, Spokane/Coeur d’Alene, Taipei, Tokyo, Warsaw, and Washington, D.C.

This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.

©2011 K&L Gates LLP. All Rights Reserved.

This document and any recommendations, analysis, or advice provided by Marsh (collectively, the “Marsh Analysis”) are not intended to be taken as advice regarding any individual situation and should not be relied upon as such. This document contains proprietary, confidential information of Marsh and may not be shared with any third party, including other insurance producers, without Marsh’s prior written consent. Any statements concerning actuarial, tax, accounting, or legal matters are based solely on our experience as insurance brokers and risk consultants and are not to be relied upon as actuarial, accounting, tax, or legal advice, for which you should consult your own professional advisors. Any modeling, analytics, or projections are subject to inherent uncertainty, and the Marsh Analysis could be materially affected if any underlying assumptions, conditions, information, or factors are inaccurate or incomplete or should change. The information contained herein is based on sources we believe reliable, but we make no representation or warranty as to its accuracy. Except as may be set forth in an agreement between you and Marsh, Marsh shall have no obligation to update the Marsh Analysis and shall have no liability to you or any other party with regard to the Marsh Analysis or to any services provided by a third party to you or Marsh. Marsh makes no representation or warranty concerning the application of policy wordings or the financial condition or solvency of insurers or reinsurers. Marsh makes no assurances regarding the availability, cost, or terms of insurance coverage.Marsh is one of the Marsh & McLennan Companies, together with Guy Carpenter, Mercer, and Oliver Wyman.

Copyright 2011 Marsh Inc. All rights reserved.MA11-11092

Major Construction ProjectsKey Risk and Insurance Strategies

October 6, 2011 – Los Angeles, CA

Hosted By:John R. Cunningham, Senior Vice President, Construction Consulting Practice, Marsh Risk Consulting