Building Guarantees: Continuing risks to residents following Manchikalapati v Zurich Insurance (2019)
The interpretation of Building Guarantee insurance: Causes for concern
In the recent decision of the court of Appeal in Manchikalapati v Zurich  EWCA Civ 2163, the court considered the interpretation of a Building Guarantee, the circumstances in which cover arose and how the maximum liability cap operated. Whilst some commentators have welcomed the decision for reinforcing the rules on how contracts are to be interpreted, these principles are already well settled. The application of these principles on the facts of this case have also been welcomed. However, the decision is not without difficulty and further guidance from the Supreme Court would be welcome.
Zurich, trading as ZIP, issued a Building Guarantee to the claimant occupiers of 104 unit residential scheme (the“ BG policy”). Clauses 3.1 and 3.2 of the BG policy provided cover for (i) “..the reasonable cost of rectifying or repairing Major Physical Damage…” caused by the developer’s failure to comply with agreed specified quality standards, and (ii) “…the reasonable cost of rectifying a present or imminent danger to the physical health and safety to occupants…” caused by the failure to comply with specified quality standards and Building Regulations.
The BG policy contained a Maximum Liability Cap (“MLC”) which provided that, “(b)…the maximum amount payable in respect of a New Home shall be the purchase price declared to Us subject to a maximum of £25 million”. However, it went on to provide that where the combined value of all New Homes within a Continuous Development (i.e. Block of Flats) “…exceed £25 million, the total amount payable by Us in respect of all claims in relation to the New Homes and the Continuous Structure shall not exceed £25 million”.
The BG policy also contained the following exclusions:
- That ZIP would not pay for, “…[a]ny sum above Your proportionate share of your reasonable cost of repairing Major Physical Damage to Common parts”; and
- That ZIP would not pay for any claim or contribution where “…cover is available under another insurance policy, or where some other form of compensation or damages is available to You”.
Following completion, ZIP transferred its book of BG policies to another insurer (ZIP retained no interest in the BG book of business and played no active part in the litigation). Serious defects in the building were identified. These included no compartmentalisation (which posed a major fire risk), the lack of fire protection to the structural steelwork and the leakage of sewerage pipes into the car park in the basement.
Insurers refused to meet the estimated cost of the required remedial work (£10.8 million) on the basis that the claims made were not covered by the BG policy. Twenty-six of the flat owners (“the Claimants”) sued insurers under their respective BG policy for the estimated cost of carrying out the required remedial works, although it was accepted that they would not ultimately carry out those remedial works in the region of £9.7 million. The trial judge held that the claims fell within the BG policy but only awarded the claimants the sum of £3.6 million on the basis that the MLC limited the claim to the maximum value of the value of the flats owned by the Claimants. Insurers appealed, and the Claimants cross-appealed on the operation of the MLC.
On appeal the Claimants contended that:
- The MLC did not limit their claims to £3.6 million. The MLP was the value of all homes (not merely the value of homes of occupiers who are pursuing a claim) subject to a maximum of £25 million.
- The policy required insurers to pay for losses falling within the cover without proof of either (i) that the cost of remedial works had been paid, (ii) incurred, or (iii) that the Claimants intended to carry out the required remedial works.
- Defects in the balconies and basement fell within the BG policy cover.
- Condensation damage was within the cover provided by the BG policy when caused by building defects resulting from the developer’s failure to construct building in accordance with the required standards.
Insurers contended that:
- The BG policy did not respond where cost of rectification had not been incurred and paid.
- The MLC was the value of the insured’s home (or the value of several insureds if more than one claim is pursued) up to a maximum of £25 million.
- Neither defects in the balconies or the car park in the basement fell within the BG policy cover.
- Damage caused by condensation did not fall within the BG policy.
The CA restated the principle that, in interpreting a policy of insurance (or indeed any contract), the court considers the natural and ordinary meaning of the words used in their documentary, factual and commercial context. It was not the policy of the court to interpret contracts against insurers. Only in cases where the natural and ordinary meaning of the words used is in doubt will the court interpret a policy against insurers (see the Supreme Court’s decision in Impact Funding Solutions Ltd v Barrington Support Services (2016) and Arnold v Britton (2015)). As the meaning of the MLC was ambiguous, the court interpreted it in a manner it considered to be consistent with, and not repugnant to, the BG policy which, in their view, meant that the Claimants’ interpretation was to be preferred on the meaning of the MLC. In other words, the cap was £10.8 million, being the value of all flats and not merely the value of the Claimants’ flats. A single occupier should have the right to recover damages the entire cost of rectifying defects that amounted to a present and imminent danger to the health and safety of occupants. The limitation in the BG policy that they only be entitled to recover their proportionate share towards such costs only applied to Major Physical Damage to the Common Parts.
The CA further held the BG policy:
- Responded regardless of whether the costs of rectification had been incurred, or whether there was actually an intention to carry out the remedial works. The general rule was that Claimants were free to use the money as they considered fit. The fact that the sums paid out would pay the Claimants’ legal costs was of no relevance.
- Responded regardless of whether the remedial works are carried out. The obligation to pay arises in situations where it remedial works are impossible and situations where there is no intention to carry out such works. The absence of an intention may be relevant to the quantification of loss, but not in situations where a policy responds to the cost of reinstatement and not merely loss.
- The Claimants were not required to pursue a legal claim against third parties before making a claim under the BG policy. The exclusion “…where some other form of compensation or damages is available to You…” only related to claims under statute or under similar types of insurance policy or performance bond, and not claims in tort. Such an interpretation would be contrary to the intention of the policy.
- The BG policy covered the defects in the balconies and the car park. In relation to the latter, Common Parts and attached garages fell within the BG policy, although basements and semi-basements were expressly excluded. The CA held that the general rule was that if a loss fell within the general cover but also within an exclusion, the exclusion would apply. However, as the car park fell within express inclusions (i.e. garage and Common Parts) it fell within the definition of “New Home” and was covered by the insurance policy. The fact that the definition “New Home” did not include basements or semi-basements was irrelevant.
- The exclusion for condensation did not include condensation that resulted from a failure to comply with express requirements of the specified quality standards or Building Regulations, merely condensation caused by ordinary wear and tear.
Whilst providing useful guidance on how contracts and policies of insurance are to be interpreted, this decision follows a line of recent cases on the interpretation of contracts. The court will give effect to the natural and ordinary meaning of words and only apply the contra proferentem rule and interpret a policy against insurers in cases of ambiguity.
Nevertheless, the court’s decision does give rise to cause for concern. Not only does it potentially allow a policyholder or group of policyholders to recover the estimated cost of carrying out necessary remedial works up to the MLC without undertaking to actually carry out the remedial works or to hold the insurance monies received on trust for other occupiers, it leaves them free to ultimately decide not to use the money to carry out the required remedial works at all. This may prevent other occupiers from making claims under their policies, leaving them without a remedy and the inability to remediate defects that cause a risk to health and safety. It could result in a small number of insureds being enriched at the expense of others. This is a difficulty that was highlighted by Mrs Justice Jefford in Hodgson v National House Building Council (2018), but has not been resolved. Rather than provide comfort to occupiers, it should cause some concern.
The guidance of the Supreme Court would be welcome. In the meantime, the Court of Appeal’s decision highlights the importance to review the wording of such polices in the interests of occupiers and the need for the providers of such policies to obtain robust indemnities.