It confirms our view that much of the debate about LEG3 and how it operates is really about whether insured property is damaged (covered) or simply in a defective state (not covered) and, while that is something that can only be determined on a case-by-case basis it should be the first consideration for all parties. On the facts here, faulty floors were not damaged floors.
The Case
The parties to the Danish dispute agreed that the contractor had carried out defective work in new build housing by failing to extend an acoustic membrane between two concrete layers all the way to the edge insulation, as required by the project specification. The consequence of this was the two concrete layers became mixed and as a result the impact sound levels between floors were too high.
Section 5.1.1 of the relevant insurance policy required physical damage to occur to the insured property as a result of an "unforeseen event", which was a defined term within the policy. The Court held that, as the contractor knew the soundproof membrane had not actually been extended to the edges as specified, the resulting situation was not an unforeseen event.
The Court also considered the application of clause 5.1.2 – which was a LEG3 term in the 2006 format. It was argued that, if there was physical damage, the expenses incurred to remedy such damage could be described as improvements to the original work. However, the Court held: "The faulty floors cannot be considered to imply that there is physical damage within the meaning of the insurance terms and conditions."
That is, the floors were simply in a defective state – they were not damaged. So, while the case provides no assistance on what might be regarded as improvements, it does serve to illustrate the difference between damaged and defective insured property.
The Court's actual reasoning is set out very shortly, but it's clear that all of the familiar arguments regarding whether damage had occurred as opposed to just property being in a defective state, and the implications of the LEG3 exclusion clause, were canvassed in argument.
Among the arguments advanced by the contractor was that the mingling of the two layers of concrete amounted to “damage”. While this assertion was not rejected specifically by the Court, it is apparent that it was not found attractive. In that respect, the overall finding is consistent with the English "Bacardi Breezer" line of authority.
Danish Legal System
As regards the legal status of the judgment, Kristin Persson, a partner at Advokatfirman Nordia, notes the Danish legal system is based on the civil law tradition, meaning that statutory law constitutes the primary source of law. However, case law also plays an important part, as judicial decisions serve to interpret and clarify statutory provisions. In the present matter, the judgment comes from the second instance, Eastern High Court. Decisions of the High Court do not have precedential effect in the same binding sense as judgments of the Supreme Court. Nonetheless, such decisions are regarded as having persuasive authority and are generally followed by the lower courts, particularly in the absence of guidance from a Supreme Court.
Comment
To place this decision in context, there have been two US decisions (Archer Western v ACE and South Bridge Builders v Lexington) which were of concern to English insurers as they seemed to identify as damaged, works which an English tribunal may have deemed simply defective.
In the later English Court of Appeal decision BSkyB v RiverStone it was reiterated that damage, in so far as English law is concerned, requires a fortuitous change in physical condition which renders the item of insured property less valuable or useful.
So, if something is intrinsically useless or simply faulty by means of poor design or workmanship at the outset, this is not something which would normally be covered under a standard English Contractors All Risks (CAR) policy.
This case serves to emphasise that point – faulty is not damaged. In spite of the fact the contractor here had purchased the most expensive form of CAR cover available, where only improvements would be excluded from cover, they still had to establish physical damage had occurred.
This is consistent with prevailing English law: defective works are not covered in the absence of damage. CAR or builders risk insurance is not liability insurance or warranty coverage – insureds should not regard such cover as a guarantee against design and construction defects.
