Understanding Defects Exclusions in Construction All Risk Policies

Damage vs. Defect

A defect is not automatically damage. Damage requires a detrimental physical change to the property. A defect may exist without any physical deterioration.

This creates four possible states on a project:

1. Damaged & defective. E.g., a retaining wall fails due to insufficient reinforcement.
2. Damaged & not defective. E.g., compliant works damaged by extreme weather.
3. Not damaged & defective E.g., incorrect fire retardant paint applied but no physical change.
4. Not damaged & not defective – the majority of construction works.

Understanding this separation is essential before looking at how DE and LEG clauses operate.

DE clauses: Five levels of coverage

DE clauses are widely used on building and civil engineering projects. They range from very restrictive to very broad:

• DE1 (Outright defects exclusion). All defect related damage excluded. Rarely used except on basic or high risk placements.
• DE2 (Extended defective condition exclusion). Excludes defective property and anything relying on it for support but covers damage to unrelated works.
• DE3 (Limited defective condition exclusion). Excludes the defective property itself but covers resulting damage to non defective works. A common market baseline.
• DE4 (Defective part exclusion). Only the specific defective component is excluded, not the wider system. Technically broader than DE3 but may not be in practice.
• DE5 (Design improvement exclusion). Covers damage to defective property and excludes only the cost of improving the original design. The broadest DE clause.

LEG Clauses

LEG clauses are common on engineering projects and operate differently:

• LEG 1/96 – Outright exclusion Equivalent to DE1.
• LEG 2/96 – Consequences wording Excludes the cost of the remedial work that would have been required before the damage occurred. Depending on the scenario, this can be narrower or broader than DE3/DE4.
• LEG 3/06 – Improvement wording Covers damage to defective property and excludes only the cost of improving the original design.

Hybrid options and excess structures

Broader defects cover typically attracts higher deductibles. For example, DE3 with a £50,000 excess may provide a better outcome than DE5 with a £250,000 excess.

To address this, many London market CAR policies now allow post loss selection between multiple defects clauses. This gives insureds flexibility to choose the most favourable outcome at claim stage. The broadest hybrid structures typically combine DE5, LEG 2/96 and DE4.

Case laws shaping interpretation

Recent court decisions have challenged long held market assumptions:

• Skanska v Egger (UK) The court suggested (obiter) that even under DE5, the loss might not constitute “damage” but merely the manifestation of a defect. This caused temporary market disruption and led to clarification wording in LEG 3/06.
• South Capitol Bridgebuilders v Lexington (US) A US court held that concrete “honeycombing” was damage, not just a defect. This has prompted a reassessment of LEG 3/06 usage in the US.
• Archer Western v Ace (US) The court again treated defective concrete as “damaged”, reinforcing the shift away from traditional UK interpretations.

These cases highlight that defects exclusions are dynamic and subject to judicial interpretation, sometimes in unexpected ways

Speak to an expert

When something goes wrong on a project, defects exclusions often decide who pays and how much. Small differences in wording, combined with changing case law, can turn an expected insurance recovery into an uninsured cost. Getting the right advice upfront is critical to avoiding delays, disputes, and unexpected losses on complex construction projects.

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