Structural Defect Insurance: A necessity for Construction Business
A reputable construction firm in India discovered irregularities in a flagship project pertaining to the structure of one of its key buildings just after handover.
The fault occurred when the sub-contracted structural design consultant committed a major error and omission resulting in a faulty load design calculation.
Since this was a complex structure, rectification wasn’t possible. The building had to be demolished and re-built at a cost of INR 9 crore.
As there was no physical damage and the client had taken a deliberate decision to re-construction, the present policy or Contractors All Risk Policy didn’t trigger any claim.
The client sought sanctum under the Professional Indemnity covers of the Structural Design consultant that were required under the terms of their contract.
After a long-drawn (close to two years) legal process, the claim was approved and the client was compensated INR 30 lakhs– grossly inadequate when compared against the overall claim of INR 9 crore.
Since it is not financially viable for the consultant to procure a professional indemnity policy covering the entire value of the construction, they had taken it based on their contract value - INR 30 lakhs. Hence the claim was limited to this project fee.
Could the builder have been better insured? The answer lies in “Structural Defect Insurance.”
What is structural defect?
Structural defect is a major risk which might derail construction firms’ growth and aspirations.
The Real Estate Regulatory Authority Act, or RERA Act, which came into force from May 2017, seeks to protect home-buyers as well as help boost investment in real estate.
RERA Act enforces a strict form of construction liability under civil law known as structural defect liability, making a construction firm liable for post construction defects, also known as inherent or latent defects.
Structural defects include any damage inherent to the building which may be physical in nature or otherwise, and that go undiscovered at the time of handover. This includes faults, breakage, or cracks, appearing over time in elements such as load-bearing columns, walls, slabs, beams etc., which can affect the strength and stability of the building, including the following:
- Defects due to design flaws.
- Defects due to faulty or bad workmanship.
- Defects due to materials used.
- Major cracks in masonry work.
- Any defect found to have resulted from negligence, use of inferior materials, or non-adherence to regulatory codes
Structural Defect Liability is a clause under the RERA Act which mandates:
- The promoter is liable for structural defects for five years from the date of handover of a residential project.
- The Developer is required to rectify any structural defect, defects in workmanship, quality, or provision of services, or any other obligations as per the sale agreement brought to the notice of the promoter within five years.
A recent amendment in the Maharashtra Regional and Town Planning Act, 1966, mandates that the key stakeholders of a construction project will be held liable for structural defects in a building (commercial or residential) discovered within a period of 10 years from the date of handover1.
As per the amendment, stakeholders in a construction project include:
- The builder.
- Architect/ License surveyor.
- Structural Engineer.
- Site Supervision/Site Engineer.
- Construction Company including contractor, sub-contractor.
- Consultants appointed for various activities involved in the construction work.
Further, government sources have been quoted to be saying that the insurance papers requiring this liability to be transferred properly to an insurer would be needed in order for them to process the OC for any building.
How Insurance Helps
To cover the liability of the stakeholders in construction, covers known as Structural Defect Insurance or Inherent Defects Insurance are available.
The scope of such covers may include any inherent defect, inferior workmanship, or defective materials that may appear in the building structure within the tenure of the policy. Such defects which were undiscovered at the time of completion of the project must be covered by the insurer by way of considering the cost to strengthen the structure and restoring to an original or acceptable state.
Main features of the policy:
- The policy period can be extended by up to 10 years.
- This is a first party cover and hence proof of legal liability is not required, eliminating the lengthy legal process which normally causes delays in other comparable policy settlements.
- The policy is freely assignable to future tenants or purchasers, facilitating the formalization of a sale or tenancy agreement.
- The potential risk of insolvency can be mitigated.
- The property sale is enhanced with a valuable guarantee, offering buyers added confidence.
- The developer is better able to command a premium on the selling price by virtue of the warranty they can offer.