Latent Defect Insurance or Collateral Warranties – which is the best for commercial properties?

7 May 2024

Latent Defect Insurance or Collateral Warranties – which is the best for commercial properties?

city buildings

Latent Defect Insurance (LDI)

Developers automatically think to obtain a latent defect (LDI) or structural warranty insurance policy when building residential homes. This is so a mortgage can be obtained by purchasers, due to the UK Finance requirement for a 10-year warranty to be in place on homes sold during this period.

But what if you plan to build a commercial, build to rent or mixed-use project?

Commercial projects

There is no requirement for commercial properties to have latent defect insurance, however we do advise the cover is taken out. This offers protection to the property owner, investors, leaseholders, tenants and landlords.

Latent Defect cover provides a wide range of commercial and industrial properties with protection against property damage and water ingress caused by a defect in the design, workmanship or materials.

Cover protects the load bearing structure and waterproof envelope of the building to the full rebuild value (includes index linking each year). The insurance steps in to repair, right up to the full dismantling and rebuilding including the associated professional fees. The insurance term can be 10 or 12 years and sits with the property itself, which means it is freely assignable for the life of the policy.

The policy is written for the benefit of the property, not any individual, and a valid claim will respond without fault. It is also further possible to waive the subrogation rights against the consultants and main contractor for additional premium.

Additional covers are available including loss of rent, business interruption and mechanical and electrical latent defect cover.

Build to Rent

Build to rent schemes are now comfortably in an LDI class of their own and there are a variety of options in the market. These include applying commercial latent defect cover on the whole building, if there is certainty over long term rental, to schemes that operate similarly to a residential latent defect policy. This can offer individual insurance certificates to units should there be a change in strategy during the first 10/12 years.

Mixed use schemes

Residential warranty providers will offer cover on commercial units in a mixed-use block (for example, office and retail units) and they usually stipulate this is the case so 100% of the structure is included within the latent defect policy.

Collateral Warranties

On commercial buildings this option is commonly used. The collateral warranty typically sits between a contractor, sub-contractor or consultant and an interested third-party benefactor, giving them rights to make a legal claim from the warrantor.

Collateral warranties offer less protection than a blanket LDI policy as they require proof of negligence, therefore relying on Professional Indemnity insurance which is written on a claims made basis. If cover is allowed to lapse there may be gaps in cover or the PI can be cancelled altogether. The same risk occurs if the warrantor becomes insolvent.

With a collateral warranty, if a defect does occur, cash flow can be an issue because the money to repair would not be available immediately and a legal challenge could exasperate this problem. There is also the risk that the legal challenge may not go the way you want.

It also must be considered that professional indemnity is very expensive and the aggregate cover limits may not be sufficient, even on an each and every claim basis if the defect is substantial.

A long term thought process.

The front-end cost of latent defect insurance needs to be weighed up against the potential issues that may occur down the line. It certainly offers a secure option for investors and funders in creating a saleable and leasable property. Tenants also feel secure knowing they have protection, and it may make the decision for a tenant signing the lease.

Please contact Samantha Ferneley today by emailing to arrange a meeting to see how we can help your commercial project.