The investment process, which the entrepreneur (Investor) enters, is subject to a number of risks. Some of them are obvious and foreseeable, nevertheless there is a group of risks that are completely unpredictable and reveal themselves only at the stage of project implementation.
When providing legal support in many investment processes, I often observe the emergence of significant risks arising from the work of the designer or architect. These risks, are sometimes downplayed even by experienced investors.
The role of the designer in the construction investment process and the risk for the investor.
Implementation of a construction project is not possible without the participation of a designer – an architect.
When entering into negotiations with a designer, the investor must not forget that in addition to the contractual provisions regulating in detail the scope of their work, responsibility and deadlines, it is necessary to include an appropriate provision in the contract regarding the possession of an insurance policy for the designer. This very insurance product, called architect’s or designer’s liability insurance, can prove crucial to the success of an investment when design errors or inaccuracies occur. We often encounter design errors in our practice, resulting in the interruption of the investment chain and giving rise to a number of problems that in extreme cases could even lead to the bankruptcy of the entities involved in the construction process.
The designer’s mistakes lead directly to lost profits for the investor.
In developing a cost estimate, also calculating their own remuneration, the contractor relies heavily precisely on the project, which contains the most significant cost elements. The contractor’s lump-sum fee should be subject to change in the event of design defects, i.e., designer error. In such a case, as a general rule, the general contractor is entitled to claim an increase in the lump sum payment. If the design errors documented, are not in doubt, and the resulting increase in the contractor’s costs due to these errors can be accurately calculated, the investor must bear the burden of such correction, even though it is clearly to their disadvantage. Needless to say, this always has a significant impact on the investor’s budget and return on investment, which are also estimated on a project basis, as they are the resultant of the general contractor’s remuneration and a number of other costs and cost drivers and revenue-generating elements, such as the assumed prices of the units.
The impact of design errors on the cost of a construction project is not limited to an increase in the cost of the general contractor’s salary or additional work and materials. It also has important implications for the investor’s bid to enter into development agreements with prospective buyers during the construction process. In the event of an increase in costs on the part of the investor, they do not have the option to change the price indicated in the
development agreements. This is another component of the investor’s damage, resulting from the designer’s error.
The elements of security – it’s not just the policy, but also the documentation of defects….
In the event of a design error, it becomes necessary to carry out a detailed process of documenting a number of factors. It is certainly mandatory to document that a given cost incurred by the investor, is due to a design defect, and not, for example, improper workmanship or an arbitrary deviation from the design, or an attempt to circumvent executive guidelines, in order to optimize the contractor’s costs. At this point, it should be recalled that the construction process is also fraught with risks related to unreliability in the execution of construction work, or even attempted fraud, which can have serious consequences, not only for the investor but also for future owners of the premises.
Such situations also occur, making it extremely important to meticulously document each case that meets the criterion of error of an act or omission on the part of the designer, as well as to document the damage itself and the causal relationship between them.
An example of such actions or omissions by the designer that will interrupt the established course of investment financing can be, for example, the indication in the design of a type of elements no longer available on the market. In such a situation, the general contractor selects replacements which, while usually not a problem, generates costs for executive changes.
… and a properly negotiated agreement.
In the situation of a legitimate increase in the general contractor’s remuneration, as a result of a design defect, it remains for the investor to claim their damages precisely from the designer. Therefore, the Investor should protect themselves and ensure already at the stage of negotiating the terms of the contract with the designer that the latter has full liability insurance covering design errors. Attention should be paid not only to the provisions of the policy itself, but also to the General Terms and Conditions of Insurance, which should not contain exclusions or limitations of liability that allow the insurer to evade liability to the investor. It is also necessary to include a provision in the contract obliging the designer to carry investor-approved liability insurance not only during the design and construction period of the project, but also during the agreed post-construction period. This is because we encounter in jurisprudence practice the problem of determining the moment when the damage occurred, which can limit the liability of the insurer.
In the context of the issues described above, it is worth discussing the standard statement in construction contracts that the contractor has read the design and has no objections to it. Does such a clause eliminate the contractor’s ability to apply to the investor for an increase in remuneration as a result of the discovery of a design error during the course of the work, if they had previously expressly stated that the design was known to them and had been accepted by them without reservation? Each situation will be considered individually by the court. Of course, there may be extreme interpretations of such standard clauses in contracts with contractors, but an analysis of the case law shows that the mere inclusion of the above clause in a contract with a general contractor does not eliminate their right to make claims arising from a design error. The prevailing view in the case law is that it is indeed the duty of
the general contractor to verify the design, but in doing so, the general contractor cannot be required to have strictly design knowledge. Thus, the contractor should analyze the project with due diligence, but cannot be required to verify it 100 percent. Of course, experienced contractors will catch most of the inaccuracies in the design, but that doesn’t change the fact that requiring the general contractor to have design knowledge is unreasonable. Nevertheless, the Investor, in order to minimize the risk, may make such general provisions in contracts more specific, obliging the contractor to analyze the project in as much detail as possible.
The investment process is fraught with risk for all parties involved. However, risks can be minimized by requiring partners to have adequate insurance. An experienced broker and a lawyer’s perspective will be helpful here, especially in the context of possible future litigation. After all, it is no secret that an insurance company that receives a claim for compensation will analyze the facts in detail and check the validity of the claim. The process of documenting the damage and dialogue with the investor’s partners will play one of the key roles for the payment of any compensation. Therefore, the investor should not neglect to analyze the terms of the policies available to the designers, since it is mainly their interest that these insurance policies are intended to secure in the future.