Professional liability policies often exclude fines, liquidated damages and punitive damages. In a recent ruling, the Swedish Supreme Court held that liquidated damages sustained by an insured’s counter party were covered by a professional liability policy when the counter party claimed damages from the insured corresponding to the liquidated damages. The precedent has answered a question of importance for the insurance and construction industries.
The background of the case no. NJA 2018 p. 834
The construction company Byggdialog AB (“Byggdialog”) was contracted by Bo i Väsby AB (“BVAB”) to build a school. Byggdialog contracted the technical consultancy company Integra Engineering AB (“Integra”) to produce the construction documents for this purpose. Pursuant to the applicable general conditions agreed between Byggdialog and Integra, Integra would be liable for loss caused by a negligent performance of the contract. Byggdialog and BVAB had in turn agreed that Byggdialog was liable to pay liquidated damages for delays in the construction.
Integra did not produce the construction documents in accordance with the contract, which caused a delay in the construction project. Byggdialog was obligated to pay liquidated damages in the amount of 2,700,000 SEK pursuant to its agreement with BVAB and subsequently made a recovery claim against Integra corresponding to this amount.
Integra notified the claim to its insurer under its professional liability policy. However, the insurer declined the claim with reference to the policy exclusion for liquidated damages, which provided that fines, liquidated damages or punitive damages were not covered unless there was such liability for damages covered by the policy regardless of if the claim is labelled fines, liquidated damages or punitive damages.
Integra challenged the insurer’s coverage position and initiated an action in the District Court, which used the procedural possibility to refer a specific issue to the Supreme Court. The issue before the Supreme Court was whether the exclusion clause was applicable in relation to Integra’s claim.
The reasoning of the Supreme Court
The Supreme Court held that the wording of an insurance clause is typically fundamental for its interpretation. However, where the wording does not provide a clear interpretation, guidance can be derived from the systematics of the policy and its other terms and conditions. Other factors, such as the purpose of the clause and what would be an objective and reasonable interpretation may also be relevant.
Since liquidated damages in a contract constitute compensation for loss agreed in advance, the Supreme Court held, with reference to the wording of the first part of the exclusion, that a claim for liquidated damages against the insured was not covered by the policy. However, the Supreme Court further held that the wording of the clause did not include liquidated damages that had been paid in a prior stage in the contract chain and passed forward as a claim for damages against the insured.
Further, the Supreme Court held that liquidated damages typically would be a claim for damages when it is passed forward in the contract chain. Consequently, the Supreme Court considered Byggdialog’s claim against Integra as a claim for damages.
In terms of the purpose of the exclusion, the Supreme Court concluded that it was probable that the insurer desired to exclude compensation for loss that did not have any connection with a real loss and that compensation for liquidated damages can include more than the actual loss sustained. According to the Supreme Court, however, that purpose was not stated clear enough by the wording of the clause.
The Supreme Court also considered other relevant factors when interpreting the exclusion clause. A uniform practice in the industry regarding the exclusion had not been established in the case and the Supreme Court concluded that the insurer could have formulated the exclusion clearer. Furthermore, the Supreme Court concluded that an interpretation where liquidated damages were covered by the insurance was reasonable. For this conclusion the Supreme Court considered that a failure to perform correct construction documents typically can delay a project and lead to penalties for the constructor. Consequently, the Supreme Court found that Integra was entitled to indemnification under the insurance.
The Supreme Court’s ruling answers the important question if liquidated damages that are passed forward through the contract chain can be considered a claim for damages and hence covered by a professional liability policy. Liquidated damages are often included in contracts and may have several purposes. They may prevent breaches of contract; provide a larger compensation when a breach occurs; limit the liability for a breach; and to simplify the process of calculating the loss sustained by a breach of contract (there is no requirement to establish the existence or quantum of a loss).
Since the amount of the liquidated damages will not be determined by the size of an actual loss, the insurer may have difficulties in setting the premium for a professional liability insurance if liquidated damages passed forward are covered by the insurance. The ruling may cause insurance companies to adjust the exclusion clauses for liquidated damages in their professional liability policies. However, construction companies should be aware that they might have a contractual obligation to have an insurance that covers its contractual obligations. A construction company that does not have a professional liability insurance that covers a claim like the one in this present case might not fulfil its contractual obligation. The insurer and insured should discuss these issues.