Welcome to today's webinar hosted by Inland Marine Underwriters Association. I'm Lillian Coulson, and I'm pleased to introduce our webinar. Remember, there are two ways to hear the webinar. If you have computer speakers, you may listen to the webinar through your computer internet connection to the webinar in listen-only mode. If you lose your internet connection, you can still listen to the audio portion of today's webinar and follow along with the PDF of the slides by dialing the phone numbers that was emailed to you with the login instructions. While your phones will be muted during the presentation, our presenters will address questions at the end of the presentation. Directions will be provided at that time. To view the presentation full screen, click the full screen icon in the top right-hand corner of your screen. To exit out of full screen mode, simply click the full screen icon one more time. It's important to note that you'll need to toggle out of full screen mode in order to type in your questions. Okay, we're ready to begin the webinar, and there will be a brief pause while we engage the recording. Hello and welcome to today's webinar, Builder's Risk, Defect, Damage, and LEG Concept. Please be aware of the IMUA statement. We are fortunate to have two excellent presenters today, Michael Gibbons and Mark Katz. Michael is a Senior Claims Attorney with Munich REIT's Global Client North America Property Claims Team based in Munich, Germany. In his current role, Michael is responsible for the legal coverage analysis and negotiation of large and complex industrial and other property claims involving Munich REIT's various treaty and facultative reinsurances for specifically global active clients. Michael's experience extends to claims emanating from large builder's risk projects in a number of different fields, including energy and engineering. Michael is an Australian and English qualified attorney. Mark Katz is a partner with Mound, Cotton, Wallen, and Greengrass here in New York City. He is experienced in various areas of complex insurance and regulatory issues. His experience includes first party, third party, and reinsurance coverage disputes involving matters such as property damage, builder's risk and delay in completion, time element, extra expense, and boiler and machinery claims. He has litigated actions involving properties under construction, manufacturing facilities, energy producers, hospitals, warehouses, and various other commercial properties. He is admitted to the New York and New Jersey bars and has litigated in numerous other federal and state courts throughout the United States. Mr. Katz is a graduate of Syracuse University, Maxwell School of Citizenship and Public Affairs, and of Hofstra Law School, where he was the editor of the Hofstra Law Review. Welcome, gentlemen. Thank you and good afternoon. This is Mark Katz, and I'm really very pleased to be here presenting today with Michael Gibbons. I think we'd like to start with some polling questions, which will help us get a sense of who the audience participants are, and we can, you know, better gauge how to go forward with the presentation and various levels of detail. So the first question, which is now up on the screen, has to do with each of your, you know, current roles and professions, so we can, again, get a sense of who we're speaking to and presenting to. And the second slide is so we can gauge a sense of the audience's experience so far with various leg exclusions. So if everybody could take a moment to answer the polls, which I see you're doing now, and once we have the results, we can move forward. So, it looks like we've got a pretty varied group of participants today of various experiences, and about half the group seems to have prior experience with leg exclusions, either in seeing them in insurance policies or perhaps having worked claims with them. And I believe, Michael, you want to pick up and go through the agenda and set the stage for today? Yes, indeed. Well, thank you very much for having me today. Thank you to the IMUA for allowing us to present. So what are we going to talk about today? Well, we're going to talk about a reasonably complex topic, and for that reason, we're going to start from what we call from the ground up, which I'm sure underwriters are very familiar with the term. And the reason why we're doing that is that it's very important that everybody has the same frame of reference when we start talking about the defect clauses themselves. And that frame of reference is essentially the first topic, so how risks are allocated within a building project, the fundamental principles of insurance, such as the definition of damage, fortuity, the indemnity concept, defect versus damage. Once we've set that scene, then we're going to go into the exclusions themselves and talk about them. Past experience has sort of shown that this is really the best way to go about it as if you're reading the leg clauses for the first time, and even if you have read them a few times, those principles of damage and fortuity seem to pop up in your head at different times, and it's really hard to try and understand really where the clauses are coming from. Okay, so the allocation of risks within a building project. So the basic picture is you have an owner that finds a main contractor and they sign a contract that basically says, please build this thing, and while you're at it, can you please get some property damage and DSU insurance. The main contractor then thinks, okay, I need some subcontractors, and they're going to do various things such as design that, build that potentially, and supply these parts that we're going to require. And in doing all of this, the owner has to think about the different risks that his project or the main contractor has to think about the risks that this project is going to encounter. So your classical ones such as fire and NATCAT, property damage, DSU, the insurance obligation, bodily injury, workers' compensation, what if one of the subcontractors goes insolvent, what if there is work that's defective and not fit for purpose, breaches of contract, et cetera. And in the traditional scheme, these risks are spread into different areas. So there's risks that, some of the risks I just mentioned, so project not being built as agreed, rectifying defects, something's not fit for purpose, wear and tear deterioration, delay insolvency, all often have an insurance back to them. So we have liability insurance with the usual suspects, professional indemnity, bonds, warranties, CGL coverage, and workers' compensation. But where we're going to focus today is much more on the property insurance side, the builder's risk side. And that today is almost always an all risks policy of physical damage and DSU that is intended to cover those very fortuitous risks such as NATCAT and fire risks, but also the resultant damage from defects. And that has been the traditional position in the U.S., and that's something that Mark will get into later. But what defect causes are trying to do is they're trying to find a balance between the two concepts of rectifying defects, which is a business risk and should stay a business risk, and the resultant damage from defects, which is what property insurers or builder's risk insurers want to ensure. So I'll hand over to Mark to continue on to all risk property insurance. All right. So the focus of today's seminar, of course, is on builder's risk insurance and particularly the London Engineering Group exclusions that have come to be known as leg one, leg two, and leg three. And before we get there, as Michael said, it will help really to recap a bit. And one of the things that I think it's important to remember as we go forward is that builder's risk insurance is generally written on an all risks basis. So instead of it being named perils, it's all risks. So the starting place for the discussion and really the starting place for analyzing coverage, be it underwriting or on the claim side, is to understand that generally speaking, you will be covering a risk and you need the exclusions in order to modulate what might or might not be covered beyond the initial coverage provided for all risks. So typical U.S. policies provide coverage for all risks of physical loss or damage. And I think everybody in the audience is probably very familiar with that. They provide coverage for sudden physical loss or damage from any cause other than those specifically excluded. So again, the starting point is that absent an exclusion, you're going to be providing coverage for risks of physical loss or damage. One of the concepts that's inherent in all risk coverage, in addition to the express exclusions in the policy, are the notions of fortuity and indemnity, which are sometimes referred to as the unwritten exclusions. So a starting point for this then is what can damage mean? Where do you get to a point of having damage? And under typical U.S. interpretation, the policy would require a physical loss or damage which strongly implies that there was an initial satisfactory state that was changed by some external event into an unsatisfactory state. In the U.K., this same concept has been expressed as damage requires a changed physical state being harmful in the commercial context. And very similarly in Canada, the Canadian courts have held that you need to have an altered physical state or some permanent deformity. Australia, again, very much in line. You need a physical alteration or change, not necessarily permanent or irreparable, which impairs value or usefulness. And the London Engineering Group, in their exclusions, have written that you need to have a patent detrimental change in the physical condition of the insured property. So the common theme in all of this, again, bearing in mind that we're dealing generally with an all risks policy that requires physical loss or damage, is that in most jurisdictions that we deal with and that we encounter, the courts will require some change or alteration to something that was proper to begin with and then became unfit through circumstance or damage. So if you start with a condition of impairment, then there is no change in the physical state, then there is no damage that would be covered by the policy to begin with. There is also the notion of fortuity, which, as I said, is sort of the unwritten exclusion. And most courts have held that a loss does need to be fortuitous in order to be covered by insurance. It has to happen by chance. It can't be a certainty. That fits in with the general concept that insurance policies ensure risks, not certainties. So if something is definitely going to happen, then it really is not an insurable event. You need to have a discrete event that includes some change or alteration in state. So it must at one point in time have been fit and then become unfit. So really, the bright line here in testing fortuity, even under all risk coverage, is that the defect or the manifestation of a defect would not be covered because that was always inherently there and there is no change and there is no risk, which is very different from damage by an ensuing peril, which then is a risk because it might or might not happen from the defect. It also has to happen by chance, as I mentioned. So it cannot be – I think we've got a screen share issue here. Let me take a look. I'm not sure what happened. I'll bring it back up. Sure. Michael, is your screen okay? No, I – I'm bringing it back. I don't know what happened. I don't see it. It's coming back again. Okay. Okay. Here we go. Okay. So, as I was saying, you need to have some fortuitous circumstance that creates a risk. And I don't seem to be able to move forward with changing my slides. Okay. Okay. The – actually, the icon – the bullets are coming on as I do it. Are the bullets coming on as you do it? They weren't, but we can continue from here. I'll see if I continue to have an issue with it. So, in addition to the concept of fortuity, again, you need to have a fortuitous risk. It has to happen by chance. It can't be a certainty. is also the principle of indemnity, which, again, is one of these unwritten exclusions or limitations on coverage even in the all-risk environment. So, the principle of indemnity is that insurance is designed to give the insured back what they had before a fortuitous covered loss. It returns them to the condition immediately before the loss. Generally, the policies limit recovery with materials of like kind and quality, less any betterments. Betterments or an improvement generally are expressly or specifically excluded. And again, that's in keeping with the ultimate goal of insurance, which is to return the insured to the position it was in prior to a fortuitous loss and not to put them in a better position and not to leave them in a worse-off position. Okay. So, thank you, Mark. So, that's – when you're sitting in front of your computer screen, these sort of concepts can get a little heavy after a while. So, I'll just go over them again. So, the first thing we talked about was risk allocation. So, if you remember, we're talking about that balance between that risk of rectifying defects and the insurance coverage of fortuitous damage that we have there. So, there's the allocation of risk to builder's risk policies. Then there's the concept of all risk. You know, it's all perils. Is defect a covered peril? And the traditional concept of that you need an ensuing loss from a separate peril to have coverage. The definition of damage, and this – it's generally similar in the different jurisdictions, but it might not be. And you'll see as we go forward that the leg clauses use the word damage. And apart from the new leg three, do not define what damage means. So, it's up to the local jurisdiction to decide what it means. The principle of fortuity. So, it has to be something that has happened by chance and not something that's expected nor intended. And this is an argument you often see in defect cases or in defect claims where the argument comes across that, well, if it was defective, it was always going to break. Therefore, it's not fortuitous. And the indemnity principle. You get back what you had before and not something better. And I want you to remember the word better as we go forward because you'll see that common word betterment as we go forward. And just on the fortuity question, that argument that I mentioned isn't something that really does hold water when we go forward to the leg clauses themselves. So, what I'm going to do now is a little quiz, but it's a hypothetical quiz. I'll give everybody a chance to answer some questions later on. And it's just to really consolidate what you're really covering in an all-risk policy. So, if you have damage, as per the definition, as a result of a defect, so the defect has caused damage, what is the combined effect, in terms of the claim that you're going to get from it, on coverage in an all-risk policy, so not including exclusions, of needing physical damage, it must be a fortuitous loss, and the indemnity principle. You get back what you had before. And the answer to that is, well, what are you covering? You're covering the cost to repair all physical damage, and that includes the defective part. So, if you don't have an ensuing loss exclusion in there, or a defect exclusion with ensuing loss, you are covering anything that fits the definition of damage, however caused, so including by defects. What you're excluding, through the indemnity principle, are essentially just the costs incurred to improve the original property, so betterment. You're excluding betterment. So, you're covering all damage, and you're excluding betterment. And I want you to remember this slide, if you can, for when we talk about leg three, and see if you can see a difference between the result of leg three, what you would get from leg three, which Mark will talk about, and what you would get if you didn't have leg three in the policy. So, let's talk a bit about where the defect ends and where damage begins, because ultimately that becomes a very important concept in the building risk environment, particularly when dealing with traditional U.S. exclusions and the leg provisions. So, I think most people who are familiar with building risk policies know that there's been a fairly standard set of U.S. exclusions that have been used in policies covering U.S. risks for a very long time. And those exclusions generally require that there be a detrimental change in the physical state of what's being built. So, the purpose of builder's risk insurance is not to be a performance bond or a surety bond, but like commercial property insurance, the purpose is to provide coverage against physical loss or damage to what is being built. So, before you had the leg provisions, which are now starting really to find their way more and more regularly into policies covering U.S. risks. So, before the leg provisions, which we'll get to, these policies generally excluded faulty designer workmanship, but provided coverage for an ensuing loss from an insured peril that results. So, the typical example of the insured peril, which causes separate damage, would be some faulty work performed, for example, by the electrician, and that leads to a fire that then causes fire damage to the building. So, the faulty work by the electrician would not be covered because that's your typical exclusion for faulty designer workmanship. And if that was discovered before anything else happened and needed to be redone, that wouldn't be recoverable under a U.S. policy. But if you then had a fire, now you've got an ensuing loss from an insured peril that causes separate and distinct damage. That's the easy example of the bright line between the defect and the damage that's caused by that defect. And, of course, it's not always so clear-cut, and the lines between them aren't always so bright. Okay. So, as promised, I'm going to give everybody a chance to throw in their two cents and tell me whether you think there is damage in the following examples. So, just remember what Mark just said, that you need damage to occur. And the question is, what do you need, or how great a detrimental change in a physical condition do you need? So, if we could bring out the first polling slide. And the question is, that would be the faulty workmanship one. So, this is a later one, but it doesn't matter. Number three. Can we get the number one? Give me one second. Okay. No problem. No problem. Yeah, that's one. Is that correct? Okay. Yeah, that's it. Okay. So, this is the question. So, faulty workmanship results in the installation of a bent structure. So, I want you to answer, is there damage? Yes or no. So, I'll give you a few seconds to type in. And just remember, there's no right or wrong answer here. Those numbers are climbing, that's great. And you can click Broadcast Results when you're ready. Okay, so the numbers seem to have settled down a little bit, so I'll just broadcast that now. Okay, and as you can see, we've got, what, 62% saying that there is no damage and 37% saying, yes, there is damage. So you can already see that these cases are not going to be clear-cut from the beginning because reasonable people such as yourselves have very different views on the same very basic facts. So if you look at this, I mean, I think the, sort of a hard-line view, you would say that that wouldn't be damage because if it's just bent, nothing has happened. And we're talking about something needs to happen, and you'll remember that principle of fortuity. Okay, so let's bring in the second question now. Okay, so this is the second case. So tests show that paintworks met bonding standards when completed, but two years later they no longer do. And some areas of the paint, about 15%, are visibly peeling and cracking. Is there damage? Yes or no? Okay, so those numbers are coming in, that's great. Again, we're having a similar split as before. Okay, I'll broadcast that now, it seems to have settled down a little bit. So as you can see, now we've got some 63% saying no, there is no damage, and 36% saying yes, there is damage. And guess what? You're all right. Everybody's right. And the reason why everybody's right is that in some areas, you can argue that that 15% that's physically peeled, so we have something that's happened, is damaged. But the parts that have become weaker potentially haven't crossed that line into damage, but potentially they have, and it would really depend on the judge that you have sitting there that day. Okay, can we bring in the third question now? Okay, so this one is, our concrete slab has deflected further than designed. That's right, this is this one. Okay, is there damage? So it's deflected. Designed to deflect a little bit, but it's deflected a lot. Okay, I'll broadcast that, that's settled. So we've got about, again, a very similar split again, so about 60% saying no, there is no damage, and 36% saying yes. Now those of you who are joining from Canada or are aware of what's been happening in the Canadian jurisdiction, there is a case up there that Mark will touch on later, where there was a similar fact situation, but where there was cracks as well on top of just the deflection. So in this case, you can see, okay, at what point is a concrete slab damaged? Do we just have a manifestation of just defective design and workmanship, or has something actually happened that you can call it damage for the purposes of insurance? Okay, the next point on the slide is, I won't do a poll for this one, but you can see, what if you've got microscopic cracks or visible or large cracks in a faulty weld? There are cases on this, or a tunnel wall. At what point can you say that there is damage? Are microscopic cracks just manifesting a problem, whereas large cracks, you know, you've really crossed that line? And that's the question that will need to be answered in these cases. Now the last one, and this is the last question I'll get you to answer. So we've got, this is number four here, yeah, wire brushing of metal, which results, sorry there's an ambulance going by outside, wire brushing of metal, which results in microscopic scratching and leakage occurs, but it's repairable by brushing again with a plastic brush. So if you wire brush metal, what are you expecting to happen? Metal on metal, and you can just polish it again with a plastic brush. Okay, I'm starting to see that the split here is what I would expect, and that is, and I'll just start to broadcast that now, that is about 50-50. And that's a very good question. Do we have fortuity here? If you're brushing metal, I mean, you have to realize that microscopic scratching is going to happen. That's what you do, that's why you wire brush something. And you can just repair it again with a plastic brush. But what happens if that delays your project by several months, and you have to order new parts because the scratching is, it's quicker and cheaper to order new parts in. So these are all very interesting questions that need to be answered in a claim scenario. But what it really boils down to is this graphic here, is this question here. You have a defect that exists in the property, that it begins to manifest itself, and then at some point, and remember these words, it's a matter of fact and degree, at some point it will be considered damage for the purposes of insurance. And that's the big challenge you have with defect exclusions, and that's the balance that defect exclusions are trying to come to. So you're defecting your manifestation, that's your entrepreneurial risk, that's your job to make your defects good again, or that's the contractual obligation. But damage, if something happens that you weren't expecting and that's why you buy insurance, we have damage, we have physical damage, that would be covered. So let's now move on to those defect exclusions, and I'll hand over to Mark to talk about those. Great. Thank you, Michael. So we can now move into talking more specifically about the various types of defect exclusions. And as Michael has walked us through, that metamorphosis between a defect, a manifestation of a defect, and ultimately becoming damage really is the crux of what I think as underwriters you're trying to strike a balance with. And as claims folks, you're trying to really understand when it goes from being something that's excluded to something that might be recoverable under the policy. So under traditional U.S. wording, and we touched on this a bit already, but very typical U.S. wordings come in two main varieties. The first provides that the policy does not insure against the cost of correcting or making good defective design, plan, specifications, or materials of workmanship. However, the exclusion shall not apply to direct physical loss, damage, or destructing resulting from such defective design or specification, et cetera. This is the more narrow of the traditional U.S. exclusions because right off the bat, it doesn't treat defective design or workmanship as a peril, but really treats it as a condition that could exist. So the exclusion doesn't exclude, for example, loss or damage caused by that defective design or workmanship, but instead it simply does not insure against correcting or making good the defective design or workmanship. This particular version of this exclusion does have what is commonly referred to as the ensuing loss provision, and it says if you have a defect but you then have resulting physical loss or damage, then the resulting loss or damage is covered. Now, some have argued that in an exclusion like this, you don't even need the ensuing loss exception to the exclusion because the exclusion never applies to physical loss or damage. It only applies to the cost of correcting or making good. And this, again, is the narrower version of the typical U.S. exclusion. So if the contractor or subcontractor does something bad, makes a mistake, does something that's defective or not up to standard, then the policy won't insure the cost of making that good, and that loss, that risk, should fall on the parties to the contract. The other type of traditional U.S. exclusion is more broad and really treats defective workmanship or material or design as a peril that's capable of not only resulting in a defect but also causing other damage. So a fairly typical version of this exclusion is that the policy will not pay for loss or damage caused by or resulting from faulty or defective workmanship or material, but the exclusion shall not apply to physical damage resulting from such faulty or defective workmanship or material. So, again, the difference between the two is one only excludes the existence or condition of a defect, while the other treats it more as a peril and excludes loss or damage caused by or resulting from that defect. So, again, a traditional U.S. wording, the starting point is that the policy excludes the cost of making good the defect or the damage caused by or resulting from that defect. There's typically an exception to the exclusion that it doesn't preclude coverage for resulting damage that arises from or ensues from that defect, but what is never covered, and this is really a very important factor both in the traditional U.S. wording and as we get into the leg provisions, what's never covered is just the manifestation of a defect or damage to the defective part itself. So if something is installed improperly, such as concrete, and that defect manifests in cracking, while you still don't have loss or damage or anything beyond the existence of a defect, you've just now noticed it or it's manifested in a way, but the damage, if you will, or the manifestation of the damage is still limited to the defective part itself. Again, under traditional U.S. wording, that will not be covered because you have no resulting or ensuing loss. You've just got the manifestation of what already was defective. So if the original loss was considered an ensuing loss, then the exception, in essence, would swallow the exclusion, and U.S. courts have said that that really is not the purpose and that can't be a proper interpretation of the contract. In order for the ensuing loss to be covered, U.S. courts have held you really need a loss that's wholly separate from the defective materials themselves. So it generally requires a separate peril resulting from the defect that causes a different type of damage. And again, pay attention as we go forward that damage to the defective part itself generally will not be covered. There is fairly well-developed U.S. case law on this. There are several decisions by various U.S. courts addressing this issue. And the one theme that you'll see throughout, and I'm not going to walk through each of the various decisions here, but the prevailing theme is that the courts really have required consistently that there be some separate damage from an ensured peril that results from what was initially excluded. So, for example, in acne galvanizing, there was an improper weld in the kettle that held molten zinc. That weld failed. The molten zinc then was released and caused damage to other parts of the facility. The court in that case held that there was no peril separate from and in addition to the excluded peril of the faulty weld. So it all flowed naturally and directly from the improper or defective weld. So without that separate peril, even though you had separate damage, without a separate peril, there was no ensuing or resulting covered loss. Another case that comes up often in what we do here with construction defects is the Lakeela construction case, which is a federal court decision out of New York where the cost to repair the building's foundation that was constructed with defective concrete was held to be excluded because of the faulty or defective workmanship or material exclusion, even though there was a manifestation of a defect because the concrete cracked. But again, the court there held that you need a separate peril and a separate type of damage, not just a manifestation of the defect that is limited to the part itself that's defective. Okay. Thank you, Mark. Well, as you can see, sir, the U.S. jurisdictions seem to have come up and did come up with a reasonably clever way of distinguishing defect from damage in the sense that damage to the defective part was generally excluded and any ensuing damage was covered and ensuing damage had to be caused by separate peril. So the peril was what sort of made that distinction. In the London market and overseas and other jurisdictions as well, that concept hadn't really developed. And so one of the issues that was happening is that they thought, well, if we try to exclude damage to defective property and cover damage to other property, then that's the perfect balance because damage to the defective property, well, that's the contractor's problem. Damage to something else, so the faulty concrete column falls down and damages another part of the property, well, that's fortuitous. That's not part of rectifying the defect. That is fortuitous consequential damage that we want to cover. So it sounds easy, doesn't it? Damage to defective property, not covered. Damage to property free of the defect, covered. That should be easy, right? Well, historically, it hasn't been easy. And to distinguish between defective property and property that's free of the defect, depending on what happens. So the column falling over example, it's reasonably easy. But what if you have a manifestation, excuse me, of cracking? And it affects other parts of the property as well. Did they have the defect in them as well? And that's sort of the age-old question that was trying to be solved when the London Engineering Group got together to form the leg clauses or to write the leg clauses. So the criticisms were, look, we've got a lot of distinctions that we have to make here and they're not easy to make. So defective property, property free of the defect. A manifestation versus damage. The original loss or the defect and the ensuing damages in the U.S. Sometimes that can be very difficult to distinguish. So is there something else we can do to avoid having to make such distinctions? And that's how the leg concept came to be. Right, so now that takes us to the most recent British invasion on U.S. soil, which is the importing of the leg exclusions into U.S. policies covering U.S. risks or even policies issued overseas that cover U.S. risks. I know for myself personally the first time that I saw one of these leg exclusions, even though they've been around since the 1990s. But here in the U.S., the first time I saw one was probably about seven or eight years ago. And it was a policy issued and underwritten out of Spain for a Spanish company that was doing work in the U.S. So it was, again, issued overseas but covering a U.S. risk. And the first time I saw it, I wasn't quite sure what to make of it and I had to read it a bunch of times in order to at least start to formulate an understanding of what it meant. And now, many years later, I've seen it many, many times and courts have started to issue decisions on what they might mean. And it really has deviated to a certain extent from what was the traditional U.S. approach, which I know I've gone through a few times now, so I won't continue to beat that dead horse. But let's talk now about the London Engineering Group exclusions. So what the group tried to do, according to their own mission statement, was to create a consultative body for insurers and reinsurers active in the relevant classes in the London engineering, energy, operational power, and construction markets, or what they generally refer to as the engineering markets. And in the 1990s, they developed these three distinct defects exclusions for use in various applications but predominantly in large infrastructure projects, large builders' risk projects, really. And the three versions of the leg exclusions provide varying degrees of cover and initially, again, adopted by European underwriters, but more recently finding their way into property and construction policies covering U.S. risks. So the three versions are not so surprisingly known as leg one, leg two, and leg three. And the ones we're going to discuss today are the ones that I see most often, which are the 96, the 1996 versions. There have been some updates and tweaks to them over the years, but these are the three that tend to be used most often. Leg 1 is what the London Engineering Group refers to as their model outright defects exclusion. We're not going to spend much time on it today because it really isn't often used, but it essentially drops a blanket on any defect and doesn't cover the defect or any resulting damage. Leg 2 is what they refer to as the model consequences defects wording, which I think is the closest to the traditional U.S. approach of trying to find the balance between the manifestation of a defect and damage flowing from that defect and allowing the insurers to provide coverage only for the resulting damage but not providing coverage for correcting the defect. And Leg 3 is the least restrictive of the exclusions, or another way to put it is provides the most coverage, and we'll get to that and see how that works momentarily. So this is the wording of Leg 2, and it says, all costs rendered necessary by defects of material workmanship, design, plan, specification are excluded and should damage occur to any portion of the insured property containing any of these said defects. The cost of replacement or rectification which is hereby excluded is that cost which would have been incurred if replacement or rectification of the insured property had been put in hand immediately prior to the said damage. So for those of you who are familiar with it, you've seen it before and have had time to sort of digest it. For those who are new to this, I would say take a minute and read it, and it may take more than one reading to really understand the concept here. But essentially, this exclusion has two main parts to it. The first is the exclusion for all costs rendered necessary by the defect. And again, very similar to U.S. wording that says we don't insure loss or damage caused by or resulting from a defect. The second part of this exclusion says, but should damage occur, so again, now you need some damage. It can't just be the manifestation of the defect, but should damage occur to any portion of the insured property containing any of the said defects, what's not insured or what's excluded is the cost that would have been incurred if you had replaced or rectified that damaged property immediately before the damage occurred. So it actually requires a hypothetical determination of what cost would have been incurred immediately prior to damage happening in order to have corrected or rectified what was done improperly to begin with. So for example, if you've got a slab that isn't built with adequate rebar and that slab then collapses, well, you initially wouldn't cover the defective work, but now you have damage occurring to any portion of the insured property. So the slab itself is insured property, it's now been damaged when it collapsed. You now need to hypothetically determine what cost would have been incurred to replace or rectify that slab immediately prior to it collapsing. And that thing gets backed out of the adjustment or backed out from the recovery of what the insured can have under leg two. It could be a lot that gets backed out and very little covered, which we'll go into later, or it could be the reverse. You could wind up having a lot covered and very little backed out depending on the circumstance and what it would take to do the repair. So then the next clause of the leg exclusion, and this also appears in leg three, which you'll see is really very important to the entire concept here, and it says for the purpose of this policy and not merely this exclusion, it is understood and agreed that any portion of the insured property shall not be regarded as damaged solely by virtue of the existence of any defect of material, workmanship, design, plan, or specification. So again, the existence of the defect itself will not be considered damaged. You do need to have some damage occur separate and apart from the defect before you get into any aspect of this exclusion or the ensuing loss portions of this exclusion beyond what's not covered. Then we have leg three, which starts off very similar to leg two, and it excludes all costs rendered necessary by defects of material, workmanship, design, plan, specification, and should damage occur to any portion of the insured property containing any of the said defects, the cost of replacement or rectification, which is hereby excluded, and up until that point it really is the same as leg two. It excludes the defect, but in the event of damage occurring, you have a carve-out to the exclusion, but here, instead of the carve-out being the cost that it would have taken to avoid the damage from happening, all that's excluded under leg three is any cost incurred to improve the original material, workmanship, design, plan, or specification. So in the event of damage occurring beyond the existence of the defect, leg three gives back much more coverage than you would have under leg two. In fact, it arguably covers everything that happens except any costs incurred to improve the original workmanship or design or specification. So if you go back with the same design or the same specification and there is no improvement, then nothing would be carved out, but if there is an improvement, then that part gets backed out of the adjustment. So again, in our concrete slab example, if there's inadequate rebar and it causes a collapse under leg two, you could back out potentially an awful lot because immediately before that collapse, you would have had to have essentially rebuilt the slab in order to have avoided the collapse, and that would be maybe the entire cost of the loss or damage. Under leg three, all you back out is any cost incurred to improve upon the original material or design. So for example, if in rebuilding the slab you use more rebar or a larger rebar or a different specification of concrete, that incremental increase in cost in using more rebar or better rebar will get backed out, but it likely will be very little in the grand scheme of the damage. But again, leg three, just like leg two, says very clearly for the purpose of this policy and not really this exclusion, it is understood and agreed that any portion of the insured property shall not be regarded as damaged solely by virtue of the existence of any defect. So the defect itself, even if you have a manifestation of the defect, will never constitute damage, but should you have damage, then leg three and leg two give back certain amounts of coverage. So again, just to recap, leg one essentially excludes all loss or damage due to the defect. Leg two excludes the cost that would have been incurred if the property was fixed immediately before the loss occurred. And leg three excludes the cost actually incurred to improve on the original design. Now we move on to the key question that leg clauses raise, and that is, what do you do when it comes to a manifestation of a defect? You might remember Mark quoted the second paragraph of the leg two and leg three clauses, which said that property shall not be regarded as damaged solely by virtue of the existence of any defect of material workmanship, etc. So if it's not damaged solely by virtue of the existence of it, the existence of a defect will at some point manifest itself. I mean, you don't know it exists until it does manifest itself in some way, shape or form. But at what point does it go over that line to damage? So you've seen this slide before, and this is the key question that needs to be asked. Now there is a case in the UK, it's called the Nukila case, some of you might have heard of it. It was decided in 1997, now this was shortly after leg two came out, but it wasn't actually a leg two clause, it was a clause that excluded damage caused by defect. So it has a very similar ambit, but the question was, well what is damage? When does the defect become damaged? So what you had here was you had an oil platform, it was a floating oil platform, and the oil platform, if you can think of it, you had like a platform where the people were, and you had three very large steel legs, and at the end of each leg there were boxes called spud cans. I think it's a great name for a box. And the spud cans were used for flotation, so if you emptied the water out of them, then they would float, and if you filled them then it would sink to the right depth and you could then do your oil prospecting. And what happened was, is the welds that joined the legs to the boxes were faulty. They weren't properly profiled. And they, over time, over a period of about 18 months, cracks started to appear. And they were micro cracks at the beginning. And after about two years, they had turned into quite large cracks and they'd spread into the metal of both the boxes and the legs. And so the question was, okay, we definitely had a defect to the hull of the, sorry, yeah, we had a defect in the weld. And the question was, were those cracks, at some point, did they cross that border to damage? And what the court said, and I'll read it out to you, is, if one is considering whether there is damage to the hull, and whether such damage is caused by a latent defect, so if you're wanting to know if something, if a defect causes damage, it follows, logically, that the damage must be something different from something over and above and incrementally greater than the defect itself. So that's the distinction they're making in English cases, in English case law, is that you need something over and above and incrementally greater than the defect itself. So that the manifestation, a simple manifestation of a defect is not enough to be damaged. But then the court very unhelpfully added to that, where the line is to be drawn is a matter of fact and degree. And that's why claims lawyers and external counsel like these types of cases, because it is a matter of fact and degree, and you almost need to argue it in each case. There was another case that came up, and it's called Skanska and Egger, and that was decided in 2005. So the leg clauses were well and truly out in the market, and that question of defect and damage had been settled, to a certain extent, by Nikila. But this wasn't actually an insurance case. What had happened was that Skanska was to construct a chipboard factory for Egger, and there were defects in the floor slab, and it cracked quite significantly. And what had happened is that Skanska had an obligation to buy property insurance, and they had bought property insurance for builders' risk insurance. That included a leg one clause, which is quite rare these days, but back then it existed. And the leg one clause said that all damage as a result of defect is excluded. So the question was, did Skanska comply with its obligation to buy property damage insurance? Because they bought insurance, but it excluded damage as a result of defect. And I won't go through the reasoning of the case, you can read that later, but basically the court said, in this contractual scheme, so it distinguished that we're talking about a contractual obligation to buy insurance, so in this contractual scheme, the mere manifestation of a defect, which the contractor has to make good anyway, does not constitute loss or damage for the purposes of the insurance requirement. And that put the market in a spin, because it was, well, hold on a sec, I mean, we've got some serious cracking going on here, and they're saying it's not damage. And you can read that into the case, but the case was very, very specific on a contractual obligation to buy insurance. They weren't interpreting a defect clause, in that sense. So that's, you might hear of that case being thrown out, and that was the reason why the leg, or the London Engineering Group, brought out a new version of the leg three clause in 2006. Now, thankfully, from what I understand from Mark, in the US you still have the 96 version. You read the 06 version like the plague, and the reason why is that they insert a definition of damage in there that isn't exactly helpful for insurers in terms of coverage. It really opens up what damage can mean. So, the lesson here is that the leg clauses were developed in the UK, and there is a certain tradition in the UK as to, and a reasonably strict one, in terms of latent defects and damage. And the courts were much more insurer-friendly in that. So this clause, the leg two clause, has a sort of a legal backdrop, and that legal backdrop is, if the wording distinguishes damage caused by a defect, which the leg clauses do, then you require something different from something over and above and incrementally greater than the defect itself. You need something else to happen, and we're going back to that principle of fortuity. Something has to happen. It's not just a manifestation or a mere manifestation, it has to happen, and it has to diminish value or usefulness. Now, the question for you as underwriters in the US market is, how are courts going to, with a different tradition, how are they going to interpret the definition of damage and whether this clause is requiring something incrementally greater than the defect itself? And that remains to be seen. So that brings us then back to the leg exclusions and how North American courts might view those as compared to how English courts or European courts might interpret the wordings. And I can tell you, I don't believe there are any US courts that have yet addressed a leg exclusion, although I suspect that some will be happening soon. I know I have got a few matters that are moving in that direction, and I'm sure I'm not the only lawyer in the US that has active litigations involving these clauses. But there is a decision out of Canada that's got a little bit of history to it now that I think is really worth discussing. But before we get there, let's recap a little bit on leg two. So we had talked about the basic notion that it doesn't cover defects, but in the event of damage, it will cover the resulting damage. But you then need to do this hypothetical calculation of what it would have cost to have replaced or remedied the defect before the damage happened. So two different examples, one which we'll get into more is the concrete slab example. If you got a defective concrete slab and the rebar is inadequate and you then have a failure of that slab, well, immediately prior to that failure, it probably would have cost an awful lot to have gone back and remedied that defect. You'd have to pull out the slab, re-pour it with better rebar, and essentially redo everything. So in that instance, the hypothetical will be a very large carve-out from what might be recoverable. But take another example of a plumber that puts in a defective elbow joint in a plumbing system in a high rise. And the elbow isn't properly glued in or soldered in, and it leads to a release of water that causes damage 40 stories down through a nearly complete high rise structure. The cost of correcting that defect, which is just the defectively installed elbow, would be minimal. So you've got a lot of water damage that should result in damage, and you've got very little carve-out in the hypothetical leg two exclusion. Just again, the cost of redoing one elbow in a plumbing system would be probably next to nothing. So that carve-out, the hypothetical in leg two, could be a lot or it could be a little, depending on the facts and circumstances. And that leads us to the ACCIONA decision, ACCIONA versus Allianz, which was decided in 2014 by a Canadian intermediate appellate court. And that involved a builder's risk policy that included a leg two provision, and they were constructing a 500-bed hospital. Some point during construction, the concrete slab exhibited over-deflection through cracking that required extensive remedial measures, like we've been discussing, probably required pulling out and repouring a majority of the slab. The insurers took the position that the loss was excluded under the leg two provision, and that the cost to remedy the defect would be quite high. It was really everything that went into it in order to have prevented the deflection from occurring. So again, essentially repouring and redoing the entire slab. But what the court held was something very different. The court agreed that the over-deflection and cracking of the concrete was the result of defective workmanship and failing to properly support the slabs while curing. And that the damage, so the court did find there was damage, that the damage was the over-deflection and cracking of the concrete, and that that was within the peril insured clause of the policy, and it would constitute fortuitous damage. But when it came to the leg two exclusion and how the court interpreted that is where things really get interesting. So the court ruled that leg two precludes those costs rendered necessary by the defects, but limited to those costs that would have remedied or rectified the defect immediately before any consequential or resulting damage occurred. So in essence, courting the provision, but the court then ruled that the exclusion did not apply to the cost of rectifying or replacing the damaged property itself, but only applied to those costs that would have prevented the damage from happening. And there's really a very significant distinction there. What the court ultimately ruled is that all that would be excluded, all that this hypothetical carve out would remove from coverage, was the minimal extra costs that would have been incurred to properly shore up the slabs while they were curing, as opposed to redoing all of the improper shoring or redoing the slab that ultimately cured defectively. So really a very narrow carve out. Now I personally don't agree with this decision, and I think that the court really interpreted it improperly and unfairly. Because if you look at the wording, what's excluded by leg two, I'll see if I can advance to the next slide. What's excluded by leg two is what's underlined here on the screen. That cost which would have been incurred if replacement or rectification of the insured property had been put in hand immediately prior to the said damage. What the court has now ruled is excluded and limited the exclusion to just the cost that would have prevented the damage from happening. Really very different from the replacement or rectification of the insured property. Once the slab cures improperly, replacing it or rectifying it is a very big job, where adding additional shoring during the curing process really wouldn't take much, which is what the court ruled was excluded. Again, to me, that's not the replacement or rectification of the insured property, that's just the means that would have prevented the collapse from happening, or the failure from happening, or the over deflection from happening. So the court went with really a very narrow interpretation, but again, driven by the facts and circumstances. So here one of the key facts was that it was the failure to properly shore the concrete and the slab during curing that led to the over deflection, which would be very different than a situation where you had improperly constructed slab or under-designed slab. So even though I don't agree with this particular decision and the way the court ruled, I think it's too narrow in its treatment of the exclusion, it still doesn't necessarily carry over to other cases because all of them really are very fact-sensitive and limited to the particular circumstances. Now, a little bit of history on ACCIONA. Allianz appealed this decision to Canada's highest court, the Supreme Court of Canada, and the Supreme Court essentially punted and sent it back down to the Intermediate Appellate Court for further decisions in line with another decision that the Supreme Court had recently issued. And as far as I know, the Intermediate Court has not taken further action on this case yet. The remand or back was only in October, so not a whole lot of time has happened, at least in the world of jurisprudence, between October and now. So I suspect that soon there'll be more developments in the ACCIONA decision, but at the moment that's where things stand. So a few hypotheticals, although I think we've largely covered some of this already, but take the situation where the general contractor on a large high-rise construction project installs rebar per design specifications, but it's later discovered that the design is not sufficient to support the superstructure concrete. But nothing has happened, you just, there is a discovery made that what was done is inadequate. So under typical U.S. wording that requires an ensuing loss and a separate peril, you're not gonna have any coverage. Under leg one, which we haven't read, but again is very strict in what it excludes, there also wouldn't be any coverage. Leg two, which again requires that you have some damage beyond just the defect, again, no coverage there because nothing's happened beyond the defect. And even under leg three, where you have an awful lot of giveback and ultimately a fairly narrow exclusion, you still will have no coverage because again, nothing has happened. There's been no damage beyond the mere existence of a defective slab. But now let's take a different scenario. You've got that same under-designed slab, but now it's failed before the under-design or the defect was detected. So under typical U.S. wording, I still would say you don't have a covered loss because there's no damage separate and apart from the defect caused by a separate peril. Unless you consider gravity to be a peril, all you've got now is the failure of a slab that was defective. Assuming it doesn't cause damage to any other part of the construction project, there is no ensuing loss, separate damage from an insured peril. Leg one would be very much the same. Leg two though gets interesting. And I think there would be some debate as to whether there is or is not coverage under leg two. If you consider just the collapse to be the manifestation of the defect and nothing beyond, then there wouldn't be any coverage because again, even under leg two, which gives back some coverage, you still need damage to occur. And it's expressly stated that the existence of a defect will not be considered damage. But under leg two, if the collapse would be considered to be damage that occurred, then you still exclude the cost which would have been incurred if replacement or rectification of the insured property had been put in hand immediately prior to the damage. So what would it have cost to replace or rectify the defective slab immediately prior to it collapsing? In my interpretation, and what I believe a US court would hold, it would be a large expense of correcting and rectifying the defect in that slab. We know at least one Canadian court disagrees and might rule all it would take would be some extra shoring that might have prevented the slab from collapsing. Leg three, of course, a very, very different story. And under leg three, once you've got damage, everything then is covered with the exception of any improvements or betterments to the original design. So if you've got leg three wording, instead of having a lot that still remains not covered under leg two, which would be all of that extra cost of hypothetically preventing the collapse from happening, under leg three, you're essentially going to cover everything with the possible exception of the incremental additional cost of redesigning or bettering that slab. So again, the example we discussed before, if you need thicker rebar or additional rebar, then you would carve out that cost, but the difference between a 14 gauge and a 12 gauge won't be much, or the difference between having rebar every three feet on center versus every five feet on center, again, won't be much. So the carve out, what remains excluded under leg three is very little, while what remains excluded under leg two is potentially an awful lot. So the key takeaway here is that the difference between leg two and leg three really can be a tremendous difference in terms of what remains excluded in the event that there is damage beyond the mere existence of the defect. Okay, so we've pretty much reached the end of this topic, and I'll turn to some takeaways in a second. But I just wanted to point out that if you're more confused now than you were when this webinar started, don't worry, that's completely normal. And it will take a while to digest these principles, which is one of the reasons why we started with the basic principles and then moved up into the clauses. And hopefully, it's our goal, is that you'll be sitting in the bath somewhere or maybe on a beach in some nice Caribbean resort, and it'll just click, and you'll jump up and be extremely excited that you get it now. You get leg two and you get leg three. And if they could hand out awards for that, I think that would be a good thing too. So maybe we could speak to the regulatory bodies in the US, see if you guys can come up with something. So anyway, before I do the takeaways, I want to use a memory trick that I think is helpful. It's sort of a graphical memory trick to try and at least take something away from what we've told you today. So the memory trick is I want you to imagine that you are standing in a tree house that you've just built yourself. And you look down at your feet and you notice that the floor is just beginning to crack. And you start to furrow your eyebrows because you're thinking, oh, hold on, is that just the manifestation of a defect or is there damage occurring here? And then as you're looking down, you notice that your legs look very different. And on one leg, it's written leg two. And that leg is the leg you've always wanted. The one that had you exercised in all those hours that you had planned to do, that's your hypothetical leg. So that's the hype, you think about the hypothetical cost. It would have, you would have incurred to have a leg like that, all that exercise and effort. And on the other leg, it's just, well, it's your normal leg. And on that leg is written leg three. And that's the, then you think of, well, what's the real cost I actually incurred to have my leg like this? I can certainly calculate that. And then as you look up into the mirror that you've installed there for reasons only known to yourself, you're wearing a hat. And on that hat are written the letters D in capitals, D, E, five, with a star next to it, but potentially even a magic star. And you're feeling, you feel that this hat is quite tight on your head and you're getting a headache. And then you're feeling this headache might be coming from that thought of, you know, have the cracks in my treehouse reached damage level yet? And then you wonder why there's a magic star next to the D, E, five on the hat that you're wearing. And then you look down and there's these magic letters or words written in the floor of your cracking treehouse, which state, which is free of such defective condition. Okay, so I wanna bring you back from the world of the imaginary and take you through our real takeaways for today. So the first one is with leg two, you take all covered damage, you subtract the hypothetical costs of fixing the defect before the damage occurred. So that's your hypothetical leg. It's all about the hypothetical costs that you would have incurred before the damage occurred. Leg three, so your normal leg, is you take all the covered damage and you subtract the actual costs for making the property better, the actual costs of making the property better so that the actual cost you incur to have the legs that you do. The third takeaway is just effective is not damaged. You need damage to occur. So a manifestation of a defect, and you're thinking of those cracks on your treehouse floor, are they damage or is it just a manifestation of a defect? Manifestation of defect cases will give you headaches just like the hat you're wearing with D, E, five written on it. In fact, most defect cases will give you headaches. And the last takeaway is leg three significantly raises exposure. And as I mentioned before, particularly the new version 2006, so be wary of it. And I would advise that you try to use D, E, five if you can. Now, I want you to think back to those magic words. And this is something I discovered subsequent to the talk that we gave last year in San Diego, these words, which is free of such defective condition. If you look online in the different sources, the D, E, five clause takes on different forms depending on where you read or where you get it from. And the D, E, five clause I'm referring to there is one that makes a distinction between defective and non-defective property, which is something much better than what leg three does. And D, E, five is still a little bit narrower than leg three, particularly the new version of it. Okay, well, I think that's it from Mark and myself for today. So I would hand it over to the IMUA hosts to begin the Q&A session. Thank you. At this time, our presenters, Mark Katz and Michael Gibbons will take questions. To ask a question, type it into the text box on the Q&A pod that we have open. And then click the balloon icon next to it and you'll receive it. We'll just wait a few moments for questions to come in. Okay, so the first question is if we could define the acronym DSU, and DSU is delay in startup, which sometimes in the U.S. we more typically refer to as delaying completion. So that would be the delay coverage that's part of a builder's risk policy. We have a question of what constitutes faulty workmanship, process, or completed product. And that's something that at one time was heavily litigated in the U.S., and there was a great debate of whether faulty workmanship was only the result of the workmanship or if it included the process of getting there as well, and most U.S. courts have held that faulty workmanship can be either the process or the product. So if something is done wrong in installation, that's faulty workmanship, and if the end product is defective, that's faulty workmanship as well. We've got a question to please explain further why leg 306 is beware. This is common in Europe, and I can't read the rest, but I think it says it's starting to become more common in the U.S. So in 2006, the London Engineering Group made a modification to leg 3, and I don't have it in front of me, but they essentially tried to, in their words, clarify what was meant by damage and the difference between the manifestation of a defect and damage. And in clarifying it, they really very much further limited the exclusion, and again, I don't have the exact words in front of me, but it reads something like damage is any patent detrimental change in the physical condition of the property, which is, I think, a very, very broad definition of what is meant by damage. So again, the London Engineering Group characterized it as a clarification, sort of suggesting that that's what they always meant, but if it's written into the exclusion and actually part of the leg 306 exclusion, I think it takes away your ability to debate where manifestation ends and where damage begins, or at least really restricts the ability to have that discussion. And by calling damage any patent change, it suggests that even at the microscopic level, even at the tiniest level, you then morph or transition from a defect to damage. You've got a question that, in Canada, we're often asked to provide DE4 coverage. Would this be equivalent to, I don't know if there's a way to expand this, would this be equivalent to leg three? I will confess, I'm not that familiar with the DE provisions. Michael, do you know where DE4 fits on the spectrum? Yes, so DE4, I think, is sort of the machinery type exclusion, if I'm not mistaken, and essentially most of the DE clauses make the distinction between defective and non-defective property. And what DE4 does is it talks about an item or a part of the property, and that can be then hard. So if you're talking about a machine, you know, if there's a defective part that causes damage to non-defective parts, like, well, what's a part of a machine, that's a question that you get often with the DE4 clause. So you don't see it as much anymore, but the DE clauses, like, say, two, three, and four, have a similar ambit to the leg clause. They're a little bit more, so it depends on the case, but they're a little bit more restrictive in that they exclude, say, costs incurred to, you know, to get to the defective part. So you have to damage something to get to the defective part, that would be excluded. Whereas under leg two, that may or may not be excluded. And leg two, as Mark mentioned before, it talks about a hypothetical calculation. So what you're doing is you're subtracting a hypothetical calculation from a real calculation, or a real calculation of what costs were incurred. And if you're doing that, they don't necessarily match. So you're off, the result can be a little bit volatile, whereas DE4 is a little bit more certain. So I think the defect in the DE clauses that was trying to be remedied in the leg clauses was the fact that you had this distinction between defective and non-defective property. So I suppose the short answer is two, three, and four are similar to leg two. But, you know, it's hard to really compare them. But I would say they're quite similar. The next question we have is, what is the statutory timeframe for leg three after policy expiration? And I'll say that that's really a great question. This gets into not just the leg provisions, but really when coverage starts and ends under a builder's risk policy. So the basic notion is that during construction, you're going to have a builder's risk policy in place. And once construction is complete, however that might be defined, you then really should transition into a commercial or risk policy, or a commercial property policy. Because the builder's risk policy is there to provide coverage for direct physical loss or damage during construction, where the commercial property policy will provide coverage during completed operations or during operations. So I don't think it's so much the statutory time of what happens after the policy expires. I think it really is when the damage occurs. So if you have, for example, an improperly installed water valve, and that valve fails after construction is complete six months into operations, the physical loss or damage, the ensuing damage there, which is what would be covered, happens during the all-risk policy, then it would be the responsibility of the all-risk policy to respond, even if the peril that led to the damage started or happened or was inherently built into the construction. And by the same token, if that physical damage happens during the builder's risk policy, then it would be potentially recoverable there. What we do see more in overseas policies, not so much in U.S. policies, is the extension of the warranty provision in the builder's risk policy. And to me, that creates a whole host of issues in trying to determine where, which is a builder's risk loss and which is an all-risk loss when you've got an all-risk policy, commercial property policy in place after construction is complete, but you've got this warranty provision on the builder's risk policy. But again, that raises, I think, a different set of issues. But the main thrust, I think, of the question about the statutory period is, when does the physical damage occur, which is different than when did the defect happen? We've got another question here about, on the hypothetical slab failure example, how would you separate the cost of defective rebar, if it were the causation event, from a well-executed poured concrete? If it's workmanship, and I'm assuming that this would be under leg two, so if I understand the question correctly, it's, if the defective rebar, I don't know if it's defective in the product or if it's defectively installed, but I think what you need to do, again, is this hypothetical slab failure example, but I think what you need to do, again, is this hypothetical analysis of what would it have cost to have done it right the first time? And if it's just defective in its installation, so if it's too high or too low in the slab, meaning it's not that you used too little or that you used the wrong gauge, but it's just placed in there defectively, then I think your carve-out becomes minimal because the cost to have done it right may not be any different than the cost that was incurred to do it improperly. Another question here is, do you think leg clauses will remain in the realm of industrial engineering construction projects, or have you seen these clauses in the construction of more standard commercial property? I've seen them in all sorts of builder's risk policies, so I've seen them not just in industrial and engineering, but also in more traditional construction projects, office buildings, high-rise buildings, big-box stores. So they're really starting to proliferate throughout the U.S. builder's risk policy world. And, in fact, also what I'm seeing is more and more companies seem to be willing to accept those as proposed by the brokers, because I do think it's still something that's broker-driven, where leg three seems to be what everybody is asking for these days, particularly on the large commercial projects. And just to draw a different distinction, while I am seeing it in traditional construction or standard commercial property, it's all on the large commercial property projects, the $100 million office buildings. I'm not seeing it on your more traditional, smaller projects, more of your middle market. The next question is, under the policy with leg three, would then the property policy subrogate against the professional liability policy of the contractor? The problem with subrogation in this entire universe is that, generally, all contractors and subcontractors are also insured under the builder's risk policy. So if you look at the definition of insured, it's generally pretty broad, and we'll cover the owner, the contractor, and all subcontractors. So if it's the contractor that made the mistake, and given the general U.S. rule that you can't subrogate against your own insured, you're not likely to have subrogation opportunities. There is usually an exception for professionals. So if it's a design issue by the architect or engineer, then it's more likely you would have subrogation potential because those professionals typically are not insured under the builder's risk policy. The next question, is there a statute limitation how far back a suit can be filed? If materials used were deemed appropriate when installed and five years later, were no longer appropriate, how far back can suit or claim be filed? Two different issues there. One is a suit under the policy, and most insurance policies, and it varies by jurisdiction in the U.S., but most policies will have a suit limitation provision, and that clause usually starts running from the date of physical loss or damage. So, for example, a typical suit limit provision will say you've got two years to sue from the date of physical loss or damage. So it's not so much when the defect occurred or when the defective workmanship or design was done, but when the resultant physical loss or damage happens, that will start the time to sue for coverage under the policy if there's a dispute for coverage. When you're talking about a suit against a manufacturer of a component part, so, for example, if you have a defective water valve and it's the wrong strength, the wrong tensile strength and fails under pressure, the suit against the manufacturer of that valve will remain viable until the date of the damage. So even if the valve was installed 20 years ago, in most U.S. jurisdictions, you then would still have time to sue from the date of that damage. The next question is how do you view U.S. carriers scripting leg language to match their forms versus using language as written from leg? At least what I'm seeing is that the leg provisions are typically just amended onto the policy by endorsement, and for the most part it's been cut and paste of the London Engineering Group wording. I have seen some examples of carriers adopting that wording and making slight modification just so that it conforms with the other wording in their policy in terms of consistency of terms used. But I haven't seen, at least not yet, any real effort by a U.S. carrier to craft their own wording that mirrors or mimics the leg wording. Next question, which I'll defer to Michael, is can you please explain DE5 again? Okay, so DE5 is the DE causes betterment exclusion. So it's the defect exclusion that only excludes betterment. So it's similar to leg 3 in its ambit, but what it does, if you have the magic words, is it makes a distinction between defective and non-defective property. And it also doesn't define damage like leg 3.06 does. So you've got just the local jurisdiction definition of damage there. So DE5 is the damage as a result of a defect is excluded. Well, only betterment is excluded. So everything else is covered, just betterment is excluded, if there is resulting damage to a non-defective property. The next question is how does leg 3 work in conjunction to rectification coverage on the professional liability policy for the design engineer? And I don't know the answer to that. I'm not that familiar with professional liability policies for design engineers. So I don't know how they might or might not respond. Next question is in the guaranteed maintenance and extended maintenance during the O&M phase of a P3, if the period of indemnity is extended, could you see losses getting triggered for leg 3 under those scenarios during the O&M phase under a CAR policy? And I think the answer is absolutely. And that's where you're going to wind up with this overlap and some debate between the two different carriers, the builder's risk carrier that still has the maintenance period and the all-risk carrier that's on the risk. And you're going to wind up getting into the battle of what is the cause of the loss, whether it is or isn't covered under the builder's risk policy, and then whether it is or is not covered under the operations policy. So I think that having these maintenance periods in there, and I recognize that they're written in a way, so it's really just trying to provide coverage for defects that already existed that then sort of manifest or cause damage, but that flow directly from construction as opposed to operations. But I think it becomes a very blurry world. And you have really great difficulty in parsing between the two. But as far as the period of indemnity, I could absolutely see it becoming extended. Next question is that I mentioned pending U.S. cases. So how far along are any of those and are any rulings pending? I don't have any that are teed up at the moment for rulings. But I do think that we're fast on at least two of them moving in the direction of motions that soon will be before the court. So I would say sometime in the next 12 to 24 months, I would expect rulings, at least on the ones that I'm involved in. Regarding the rebar failure example on slide 38 and 39, would there be coverage under leg two and leg three? Wouldn't there need to be damage separate from the defect for coverage to trigger? Where is the line drawn between defect and damage here? And I think this really kind of sums up the entire difficulty in trying to determine where you go from the manifestation of the defect and into damage. Again, under traditional U.S. wording and traditional U.S. interpretation, if you've got just a failure of the part or the component that was improperly built or designed, many U.S. courts will find that that's nothing more than the defect. That unless you've got a separate peril, meaning, for example, a fire or water damage that flows from the defect, and a separate type of damage, that you don't have an ensuing covered loss. And I would agree with that. And I gave the example of unless you consider gravity to be a peril, and that's something that courts have grappled with a bit. And many courts have said that collapse is not a separate peril because gravity is a force, gravity is not a peril. So I would agree that on both those examples, I think you'd have a pretty good argument in the U.S. that there is no coverage because you don't have any damage. But then in other jurisdictions, courts are a bit more generous, I'd say, and will find that once you've got some real physical impairment, such as a collapse, that they would consider that to be damage. So it really is jurisdiction-specific. It depends on the case law in each jurisdiction, and it really is fact-sensitive as to the scope or extent of the damage that happened. It's also fairly rare that you'll have the collapse of a component part without some resultant damage to another component of the building. So typically, that then would trigger coverage because you've got at least damage to something else that wasn't necessarily defective to begin with. I think we've got time maybe for one or two more questions. So the next one is, currently, when Leg 3 is added to a policy, a higher deductible applies. Is it possible to apply the lower AOP deductible in a loss? And I've seen this done a number of different ways. I've seen, and again, the deductible that applies, whether it be a specific deductible or the all-other-perils deductible, will depend on the peril, not necessarily the type of damage. So I've seen policies that have a specific higher deductible for Leg 3. I've also seen policies that have a sublimate for Leg 3, and I've seen policies that have a sublimate for Leg 3. And once that sublimate's exhausted, you then roll into Leg 2. So the policy has Leg 3 coverage and Leg 2 coverage, but the Leg 3 coverage is limited to a certain dollar amount, and then it rolls over into Leg 3. I'm sorry, then it rolls over into Leg 2. So I've seen it done all different ways. I would certainly suggest that, given the scope of coverage that ultimately is provided by the Leg 3 exclusion, that you consider not just premium, but also deductibles when pricing it. One last question, how should one rate or charge for Leg 3 coverage? I don't know the answer to that. I'm not an underwriter. I don't get involved in rating or charging, and I actually think the IMUA has some prescriptions about discussing rates and fees, so I'm going to pass on that question. Michael, do you have anything to add? No, I mean, I'm on the claims side, so I'm also not an underwriter on that, with the pricing. I think what underwriters I speak to have been seeing is that it's really hard to, like in a soft market, it's more the terms that become softer, and the price might stay the same or is reduced by less. So it's a difficult time for the market, and I think one of the dangers there is that, you know, in order to keep price levels at an acceptable level, you know, much broader coverage is being offered, and the question is whether it's risk-adequate going forward. Yeah, one thing I would add to that is, although these are exclusions, they are the Leg exclusions, you know, to me they really are coverage provisions disguised as exclusions, because at the end of the day, particularly Leg 3 gives back so much coverage that I'm not sure that much remains excluded. Okay, well, just from an Immunogree perspective, we're always, you know, interested in talking to seeding companies, to people for this exchange of information. We feel it benefits us greatly, and it also benefits you guys. So please feel free to contact us at any time if you want to discuss any of these topics. And on behalf of myself and Mt. Cotton, I appreciate everybody's time and attention today. I thank the IMUA for allowing us to make this presentation, and I certainly thank Michael Gibbons for, yet again, allowing me to join him in what really is, I think, a very informative and interesting presentation. Thank you for a very interesting presentation on builders' risk, defect, damage, and Leg. Thank you also to our attendees for your participation and your interesting questions. All attendees will receive a link to an electronic survey. Please take a moment to respond to the survey and provide feedback.

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leg exclusions

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