Defects Exclusion (LEG 1/2/3, DE 1–5)

Purpose

All-risks policies for construction and erection risks (CAR/EAR) are intended to cover sudden, unforeseen physical damage, not the cost of defective design, materials or workmanship as such – that risk is addressed through warranty and contract law against designers and contractors. The defects exclusion clauses developed in the London market (the LEG series of the London Engineering Group, and the older DE series) set out, in graduated form, how narrowly or broadly this exclusion is drawn.

Effect and limits

The narrowest, “outright” version (LEG 1/DE 1) excludes all loss or damage arising from a design, material or workmanship defect, including consequential damage to defect-free parts. The “consequences” version (LEG 2, broadly corresponding to DE 3/DE 4) excludes only the hypothetical cost that would have been needed to remedy the defect before the damage occurred, while covering resulting damage to defect-free property. The broadest version (LEG 3, corresponding to DE 5) covers both the defective item and all consequential damage, excluding only the cost of improving on the original defective design.

Negotiation and practice

Because the three tiers imply materially different retained cost for the project owner, policyholders on complex projects often negotiate the ability to select between several defects clauses after a loss has occurred (“post-loss selection”), to obtain the most favourable interpretation in the specific case. Courts have repeatedly clarified the boundaries between the versions, so the precise wording chosen needs careful review in each case.