Congratulations! A contractor has just been awarded a fixed-price lump sum design-build contract for a new project. The award was based on a set of preliminary drawings prepared by a design professional in response to the project proposal. Unfortunately, the design professional failed to correctly identify several design elements required for the contractor to construct the project in accordance with contract requirements. It is financially committed to the owner but is now facing millions of dollars in cost overruns because of these design errors and omissions. Thankfully, the contractor required the design professional to procure a professional liability (PL) policy. But is it worth the paper it is written on?

Design-build contractors are regularly asked to commit to a fixed-price lump sum contract with an owner based on a preliminary design. After award of the project, that preliminary design is further developed into approved construction drawings. But if there are errors or omissions in the preliminary design that prevented the contractor from accurately estimating or scheduling the project, then the contractor may be left with little more than a professional liability insurance policy as a means of recovery. In many cases, contractors are allowing their “prime” or lead designer to provide a minimal amount of coverage (for example, typical professional liability policies are in an amount less than or equal to $5 million dollars) that would not provide adequate compensation for the extent of damages incurred.

Contractors understand that when they engage with a project owner under a design-build delivery method, they are assuming the risk of an adequate and sufficient design to satisfy the owner’s requirements. Except for any owner-provided information on which the design-build construction team can rely, the contractors are typically barred from recovering upstream in the event there are any design errors or omissions. Accordingly, design-build contractors often seek to shift the risk of design errors and omissions downstream to their design professional “subcontractor.” And, like the requirement for subcontractors to obtain and maintain adequate liability insurance through a commercial general liability (CGL) policy, design-build contractors require their design professionals to obtain and maintain adequate professional liability policies. In many cases, however, the design professional offers its contractor an unmodified boilerplate policy, which is likely insufficient to protect against significant errors and omissions and essentially works against the design-build contractor through an inherent eroding policy provision.

Let’s review a few of PL policy specifics that design-build contractors should understand.

1. Project-specific or corporate policy?

Professional liability policies can be specific to the project or written as a corporate policy. If the latter, then design-build contractors need to be aware that the timing of their claim is critical as they, effectively, share the policy amount with anyone else with any other liabilities or costs arising from current or past work of that design professional in the same policy period. And contractors must be mindful of the policy period, any retroactive dates, and any extending reporting periods to ensure a claim arising out of a design error or omission is covered. While a project-specific policy may require additional premiums, it is often worth the expense to ensure dedicated limits for errors or omissions on the specific project. Similarly, design-build contractors should ensure—in either the design contract document or, better yet, as a policy endorsement—that the design professional’s PL policy is primary to any design errors or omissions. Otherwise, it could be construed that such policy sits in excess over the contractor’s PL policy (which it is likely required to obtain to satisfy upstream owner contract requirements).

2. Eroding Policy Limits

One of the most frustrating aspects of a PL policy is the concept of eroding limits—that is, as expenses are incurred (legal, consulting, etc.) to defend against covered claims, the remaining policy limit payable to cover the resultant damages is reduced dollar for dollar. In essence, the more a design-build contractor is forced to pursue recovery against its design professional, the less insurance proceeds that are ultimately recoverable.

Design-build contractors should treat PL policies as separate contracts. Not only does the law treat them as such, but they can be equally as negotiable, and the issues discussed above are just some of those subject to negotiation (albeit likely at a higher premium). Design-build contractors must identify not only the design deliverables required of their design professionals but the expectations and requirements of their PL policy to ensure adequate protection. Any cost increases to obtain or maintain sufficient policy terms can be evaluated against the risk of errors or omissions, and the design professional can help the design-build contractor understand that risk. Often, lump sum fixed-price bids are submitted based on an incomplete design and the design professional is in the best position to identify for the design-build contractor where design risk lies. PL policies are intended to cover errors or omissions and not anticipated design growth, but design-build contractors should not be expected to rely on their own construction contingency to cover insufficient policy limits.

In addition to ensuring sufficient PL protections—through negotiation if necessary—design-build contractors can also require their design professionals to maintain excess funds to satisfy potential liability. This can be done through separate “towers” of coverage, escrow agreements, or proof of adequate capital. There is no simple answer as to how much is required, and too many variables exist to simply apply a percentage of the overall design-build contract amount; however, through risk analysis by the design-build contractor and the design professional, a thorough understanding of the contract and construction requirements and scheduling, and an evaluation of anticipated design growth, the team can reach a better agreement on what constitutes adequate liability protection.