The LEG Defect Clauses – Construction Insurance – Watch this Space

A few months ago, the London Engineering Group (LEG) announced that it will be publishing revised LEG clauses later this year to provide greater clarity for the construction insurance market.  The announcement follows the 2023 U.S. Federal Court decision in South Capitol Bridgebuilders v Lexington Insurance in which LEG 3 was described as “ambiguous—egregiously so” and “internally inconsistent and bordering incomprehensible”.  This does not surprise us.  We have encountered similar concerns with LEG 3 in the context of large construction projects in New Zealand. Despite these longstanding issues, the clause remains widely used, making the proposed revisions a welcome development.  

In anticipation of the revised clauses, we’ve looked at what current versions say and possible areas for clarification.

The first clause, LEG 1/96, seems relatively clear.  It is a straight exclusion of damage due to defects.  There is no write-back of cover for resultant damage.  However, the other clauses, LEG 2/96 and LEG 3/06, are more complex, as they attempt to preserve some measure of cover for resultant damage. 

By comparison, LEG 2 and LEG 3 are expressed as excluding ‘costs’ rendered necessary by the defects.  They don’t outright exclude resultant damage.  Instead, where there is damage, the clauses preserve cover for the damage, but exclude certain ‘costs’ relating to the defects.  LEG 2 and LEG 3 describe the excluded costs differently, with LEG 3 generally regarded as providing broader cover.

LEG 2 excludes:

“All costs rendered necessary by defects of material workmanship design plan or specification and should damage occur to any portion of the Insured Property containing any of the said defects the cost of replacement or rectification which is hereby excluded is that cost which would have been incurred if replacement or rectification of the Insured Property had been put in hand immediately prior to the said damage. …” (Difference to LEG 3 highlighted)

LEG 2 requires identification of what it would have cost to repair the defect prior to the event.  This is a hypothetical question, so the excluded sum will necessarily be based on a cost estimate rather than actual costs.  Also, the repair work required immediately prior to the damage may not line up as a neat subset of what is now required after the damage.   In practice, this creates a potential disconnect between what is excluded and what was actually done to repair the property.   

By comparison, LEG 3 excludes:

“All costs rendered necessary by defects of material workmanship, design, plan, or specification and should damage (which for the purposes of this exclusion shall include any patent detrimental change in the physical condition of the Insured Property) occur to any portion of the Insured Property containing any of the said defects, the cost of replacement or rectification which is hereby excluded is that cost incurred to improve the original material workmanship design plan or specification. …” (Difference to LEG 2 highlighted).

LEG 3 moves away from the question of what hypothetically would have happened prior to the damage.  It looks at what costs were actually incurred “to improve” the original defective work or design.  This anchors the exclusion more closely to the actual loss, and avoids the hypothetical exercise required by LEG 2.  However, it introduces a different uncertainty: What constitutes an ‘improvement’?

One interpretation is that the entire cost of correcting the defect is excluded because any compliant repair or replacement is, necessarily, an improvement on defective work.  Another is that only costs associated with enhancements beyond the original contractual requirements are excluded, in much the same way as a deduction for betterment. The clause provides little guidance as to where to draw this line.

Both exclusions conclude with a sentence clarifying that the insured property “shall not be regarded as damaged solely by virtue of the existence of any defect of material workmanship design plan or specification”.  This reinforces the distinction between a ‘defect’ and ‘damage’.  A ‘defect’ is a flaw in the way the work was designed or built in the first place (Corbett v Vero).  ‘Damage’, by contrast, usually requires a physical alteration that impairs value or utility.  The distinction is fundamental because both clauses only preserve cover where there is first ‘damage’, while continuing to exclude certain costs relating to the defect.

The proposed revisions will hopefully address the uncertainties that have troubled courts, insurers and contractors for many years.  In particular, greater clarity around the distinction between defects and damage, and the scope of the costs excluded under LEG 2 and LEG 3, would assist in assessing cover and resolving claims more consistently.  We will be watching with interest to see whether the revised clauses achieve that objective.

andrew durrant is a special counsel at fee langstone