The case of Skanska Construction UK Ltd (formerly Kvaerner Construction Ltd) v Egger (Barony) Ltd (Skanska Construction)⁴ concerned a floor slab which was completed at the end of October 1997 and shortly thereafter cracks were noticed. Temporary repairs to the slab were made between October 1997 and November 1998, by which time it was clear that the slab would have to be completely replaced.

In that case, the judge concluded in obiter comments that the DE3 exclusion would exclude cover for damage to the floor on the basis that the phrase ‘loss and damage’ could not extend to rectification of the defects in themselves.

It is worthwhile to repeat verbatim what appears at the Court of Appeal judgment:

It was, faintly, argued, before us for the first time, that one of the Respondents’ pleaded particulars of causation would lend itself to an argument that one part of the Works collapsed and damaged another … The argument relates to one plea … of failure by the appellants to sufficiently compact the sub-base material underneath the slab with the sub-base having a typical air void content greater than 15%. It was suggested, on that basis, that one part (the sub-base) collapsed and damaged another part (the slab above it). That argument was not only not raised below, it attempts to divide the indivisible … I see no prospect of any court accepting that the sub-base ‘damaged’ the [rest of the] slab above it within the meaning of clause 22(2).⁵

Two more recent decisions in the UK have however, been determined very much in favour of the insured’s contentions in relation to the operation of a DE3 exclusion.

The first case is that of Seele Austria GmbH & Co KG v Tokio Marine Europe Insurance Ltd.⁶ That case concerned a claim brought against a contract works insurer in relation to damage to windows. Comments made by the Court of Appeal in relation to the wording contained within the DE3 exclusion are significant and are repeated below:

[50] … The precise point at which a line is to be drawn between ‘Insured Property (a)’ which is in a defective condition and ‘other Insured Property’ which is free of the defective condition may be difficult to identify in some cases, particularly where the work being carried out by a single sub-contractor is of a complex nature. However, I think the intention behind the rider was to provide cover in respect of damage accidentally caused in consequence of the defects to parts of the work which in commercial terms are to be regarded as separate and distinct from that part in which the defect exists. For this reason it is not right, in my view, to regard the whole façade as a single item of property for this purpose. In commercial terms, the plasterboard ceilings and the external cladding are each to be regarded as separate items of property …

That case was instructive, and demonstrated a willingness of the courts to make a division between the ‘Property Insured which is in a defective condition’ and ‘other Property Insured which is free of the defective condition’.

The approach in the UK at least, appears to now have been largely settled by the decision of the Court of Appeal in CA Blackwell (Contractors) Ltd v Gerling Allegemeine Verischerungs AG.⁷

That case considered the operation of the DE3 exclusion in the context of a contract to complete earthworks in the construction of part of a motorway.

After the initial earthworks comprising of basic cuttings or embankments, the road was to be constructed of three layers. These were:

·        the sub-formation;

·         the formation, which involved the spreading of imported material known as ‘capping’; and

·        the laying of asphalt layers, which was the responsibility of the main contractor.

The Court of Appeal held that ‘Property Insured’ meant that part of the works which had suffered damage. If that part was wholly or partly defective, the exclusion applied. In that case, the Court said that there was nothing defective about the sub-formation so that part of the works was not defective; nor was there anything intrinsically defective about the condition of the capping (save for a possible issue not herein relevant).

The Court of Appeal said:

… it is I think important to construe the exclusion clause without regard to its application to the facts of this case. Its purpose is clear. It prevents the insurer from having to pay for the replacement, repair or rectification of property which was already in a defective condition at the time the fortuity covered by the policy occurred. If the defect is one of design, plan, specification, materials or workmanship the property would have to be repaired, etc by the contractor or others in any event.

What is important to note is that the exclusion is not of loss or damage caused by defect in workmanship, etc. The cause of the loss or damage is irrelevant. Provided the insurer can show that the property was in a defective condition the exclusion applies … All this is, I think, self-evident from the wording of the exclusion. What is more difficult is to discern how wide the words ‘Property Insured’ are intended to be.⁸

It was submitted by the insurer’s counsel that those words had a very wide meaning and that one should not attempt to ‘divide the indivisible’. That counsel also referred the Court to the cases of Walker Civil Engineering Pty Ltd v Sun Alliance & London Insurance plc,⁹ and Skanska Construction. In relation to this, the Court of Appeal said:

[21]          … [the Walker clause] … was a clause which, unlike the DE3 clause, excluded liability for damage caused by the defect. The court held that ‘part’ did not refer to a part such as a tank but referred to the part of the work being carried out by the contractor. I do not see how this aids the construction of the DE3 clause. Nor do I gain any assistance from the other case relied on … [Skanska Construction], which was concerned with the contractor’s obligation to insure, assumed in its contract with the employer.

The Court of Appeal continued:

[22]          So, returning to the wording of the clause in this case, the first thing to note is that it draws a distinction between ‘Property insured or any part thereof’ and ‘other Property insured’. This suggests, and indeed requires, divisibility. Division is easy in some cases. The Institute report gives the example of a steel framed building with its roof, cladding and dwarf brick walls completed which collapses because the nuts and bolts used in the construction of the steel framework are defective. Under the DE3 wording, damage to the steel framework is excluded but damage to the roof, cladding and dwarf brick walls is covered. I agree that this is the effect of the clause in that sort of case. By analogy, one might argue in this case, that the property Insured refers to the entirety of the earthworks. That cannot be what was intended by this wording. I think it must be restricted to that part of the works which has suffered damage. If that part is wholly or partly defective the exclusion applies.

The Court went on to conclude:

[24]          So how should one apply the exclusion construed in this way to the facts of this case? There was nothing defective about the sub-formation so that part of the works was not defective; nor was there anything intrinsically defective about the condition of the capping …

[25]          But the failure, if there was one, to implement other measures which were designed to protect the capping such as the use of pumps and bowsers and the means to channel and dispose of the water on the verges, cannot be characterised as a defect in the condition of the capping … If I am wrong about this and one can characterise the works contemplated by these measures as property insured and the failure to carry them out made it defective, I would distinguish, as the judge did, between this property and the capping and sub- formation (other property), so that the exclusion does not apply because of the limitation.

Recently in Sky UK Ltd v Riverstone Managing Agency Ltd¹⁰ his Honour Judge Pelling KC sitting as a Judge of the High Court said of DE5 (1995) at [29]:

Although the language is convoluted, the effect of the provision is reasonably clear: if any Property Insured is defective in any of the ways defined in (a), the Policy will not respond unless loss or damage to the defective Property Insured is caused by that defect, in which case the Policy will respond but subject to a more limited exclusion from recoverability of the additional cost of and incidental to any improvements to the original design plan specification materials or workmanship of the relevant defective Property Insured.

And then at [30]:

The reason for this formulation is clear: the purpose of the Policy was to insure against physical loss or damage to Property Insured occurring during the Period of Insurance, not against the existence of any defect in design, plan, specification materials or workmanship in the Property Insured, which is left to be resolved (if at all) by other means including but not necessarily limited to claims against the main contractor or (in an appropriate case) any relevant sub-contractor or consultant.