Australia: My PI Policy Will Cover Me For Defective Works, Won´t It? Think Again: The Saga Of Sydney´s Third Runway

Last Updated: 23 October 2008

A recent Court of Appeal decision1 has highlighted the limitations of professional indemnity policies in the building and construction context.

Where did the third runway go?

Between 1992 and 1994 Baulderstone Hornibrook Engineering Pty Ltd (BHE) was the head contractor in the design and construction of the third runway at Sydney Airport. Insurance had been arranged for BHE and its subcontractors by the Federal Airports Corporation (subsequently Sydney Airports Corporation Limited) (the Airport). A number of different insurers were used, providing total cover of approximately $50million. BHE also had its own cover of $20 million.

By 1996, subsidence of the backfill behind the sea wall and millstream walls had occurred. BHE negotiated a settlement with the Airport which involved remedial works costing approximately $65 million.

BHE sought indemnity from its insurer (which accepted liability) and the insurers arranged by the Airport (the Airport's insurers). When the Airport's insurers denied indemnity, principally on the grounds that the policy did not provide cover for negligent construction work – only for design – BHE sued them. The main issue at trial had been whether BHE's failings were of design and engineering (which would have been covered) or construction (which were not).

BHE subcontracted elements of design and engineering to two other firms, but retained some responsibility for design themselves.

Design or construction?

The Court of Appeal upheld Justice Einstein's main conclusions (except on one point as to whether one of the insurers had admitted liability to BHE).

The relevant policy contained a not uncommon exclusion in professional indemnity policies in respect of " work performed involving the means, methods, techniques, sequences, procedures and use of equipment, of any nature whatsoever which are employed by the Insured's contracting staff or others in executing any phase of any Project"

The Court of Appeal endorsed the finding that the proximate cause of the subsidence was BHE's defective construction of the wall and therefore the exclusion applied. The adequate and suitable performance of the compaction of backfill was something which should have been within the knowledge of a competent and experienced contractor and it held that BHE failed to carry out the compaction properly and failed to test it appropriately – hence the inadequate compaction was never discovered (or, at least, not until 1996).

BHE had contended on appeal that the designs prepared by the subcontractors were flawed and were always destined to fail: even if BHE had followed them to the letter, the subsidence would still have occurred. On this basis, it submitted, the error was best categorised as design error as, ultimately, the wall was doomed anyway. The Court of Appeal took the view that even if there were problems with the design, and advice given, by BHE (which, it found, also had design functions) and its two subcontractors, that was not the point and could not form the basis of the decision.

The clause to which this exclusion applied was headed "Professional Activities" and included engineering and design. The Court was not prepared to accept, necessarily, that any failings alleged against the subcontractors could be described as the ... professional activities and duties of an engineer... but that did not matter. Even if the failings in design and engineering would have been covered, BHE was caught squarely by the exclusion clause: the disappearing sand arose out of the construction work being poorly executed. President Allsop drew a comparison of language between "arising out of" and "by reason of", warning that the former is wider than the latter. In this case, the language used was "arising out of".

It did not matter that BHE may also have been a designer and that negligent design would have been covered by the policy. As soon as BHE had failed in one respect which served to activate the exclusion clause, the policy would not respond. This is entirely consistent with the Wayne Tank principle2, as recently explained and approved by the same President Allsop3. If there is an exclusion of liability on one ground, the insurance policy cover cannot be resurrected by the application of another ground that is not excluded.

"Show me the money!" and when to stop asking

The Court also clarified that acceptance of money from one insurer which did not fully cover the loss does not prevent the insured seeking indemnity from another of its insurers. The insured may only receive one indemnity for its loss, but that does not mean that it may only receive it from one source. Essentially, the insured can receive money from as many insurers as it may have, until it has been fully indemnified for the same loss. Once the insured insured is fully indemnified, any remaining insurers may be liable to contribute to the insurers who have already paid out on their policy but they will be discharged insofar as payment to the insured is concerned.

Know your limitations

This decision provides a welcome reminder that professional indemnity policies do not provide absolute protection against all types of loss or liability. Do not expect that, where the fault involves inadequate construction rather than design, cover will be afforded: the policy will not pay for the constructor to rectify its own mistakes. This gap is only partially addressed by public liability cover, which may provide indemnity where inadequate construction gives rise to third party property damage or personal injury.

Parties should also take heed of the warning issued regarding the choice of language: "arising out of" or "by reason of". The risk of an exclusion clause applying is greater when the former is used.

On the bright side, insureds can take comfort that payment from one insurer may not preclude recovery from another insurer until they have been fully indemnified.


1 Baulderstone Hornibrook Engineering Pty Ltd v Gordian Runoff Ltd & Ors [2008] NSWCA 243 (Allsop P, Beazley JA and Campbell JA, 9 October 2008)

2 Wayne Tank and Pump Co Ltd v The Employers' Liability Assurance Corp Ltd [1974] QB 57

3 McCarthy v St Paul International Insurance Co Limited (2007) 157 FCR 402

Wendy Blacker t (02) 9931 4922 e
Ray Giblett t (02) 9931 4833 e
David Slatyer t (07) 3231 1532 e
Jim Demack t (07) 3231 1570 e

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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