Soft Cost Coverage In a Troubled Economy
March, 2009
Introduction
Soft Cost or Delay in Opening coverage has become increasingly important in these troubled economic times. Understanding the coverage, typical claims, and the factual information that would be helpful to an adjustment of a soft cost claim are of paramount importance.
A typical soft cost provision in a Builder's Risk or Course of Construction coverage form or endorsement provides as follows:
We will pay the actual loss of rental income and soft costs you incur due to a delay in the completion of any building or renovation under construction from the date the construction would have been completed had no loss occurred until the construction is completed, not to exceed the Applicable Limit Of Insurance for Rental Income And Soft Costs shown in the Declarations.
The delay must typically be caused or result from direct physical loss or damage to the building under construction by a peril not otherwise excluded, and the insured must exercise due diligence and dispatch to complete the construction on or as close to schedule as possible.
Some policies also provide soft cost coverage as an additional coverage under a Civil Authority provision. Typical requirements for Civil Authority coverage apply, and, in addition, coverage for soft costs caused by a civil authority prohibiting access to the building under construction will specify that the coverage for soft costs will begin 24 normal business hours after the time when access is prohibited and will apply for a period up to 30 consecutive days after coverage begins or the soft costs loss ends, whichever occurs first.
Soft Cost Claims Analysis
So what are soft costs? They are costs caused by the delay in completion and incurred by a developer or contractor other than normal labor and material for the construction project. Examples of soft costs would be architect and engineering fees, financing fees, legal and accounting fees, additional construction period interest, taxes, insurance, and marketing fees that arise from a delay in the completion of the project due to the physical loss event. Factually, in the event of a loss, the contractor will need to be on the project for an additional period of time. Thus, the aforementioned increased fees and costs are incurred as a result of the delay in opening.
Without additional coverage for soft costs, the typical Course of Construction or Builder's Risk policy would not indemnify for these losses. A basic fire policy covers only direct physical losses caused by a covered or non-excluded peril. Indirect losses such as additional soft costs have long been viewed as "consequential" losses that are not covered under basic property policies. Similarly, business interruption policies that address loss of earnings and extra expenses do not provide indemnification for these types of soft costs.
So the initial inquiry when a claim is first presented becomes whether the insured purchased soft cost coverage at all. Then, the parties must also look to what is the "delay" period for purposes of indemnification. Because the delay period is typically defined as commencing from the anticipated completion date and ending on the actual completion date, the delay period can be equivalent to the physical restoration period. However, other factors can cause a delay in the actual completion of the project. For example, weather conditions, changes in the sequencing of subcontractors, and the availability of materials and supplies can delay completion of the project. Similarly, a careful adjuster must review the progress of the project up to the date of loss to determine whether the project was on schedule and the proffered anticipated completion date is correct.
Expert accountants and construction managers can be used to assist in the analysis of a Soft Cost/Delay in Opening claim. Many documents normally generated in the course of a construction project can be used to analyze a claim. Critical path charts with revisions, construction status reports, and change orders can be used to evidence what the developers and contractors foresaw as the actual completion date up to the date of loss. Original contracts, subcontracts and amendments, along with bid documents and specifications may be helpful. The developer's proposed business plan, loan submissions, and budgets can be informative.
Conclusion
In summary, insured developers and contractors may incur additional expenses relating to delays in opening that have nothing to do with a covered, direct physical loss to a building under construction, especially in these troubled economic times. A careful adjustment must include an inquiry into whether Soft Cost coverage has been purchased, the measurement of any delays actually incurred, and the amount of additional soft costs in excess of what would have been normally incurred. Sophisticated legal counsel, accountants, construction experts, and documentation are available to the adjuster to assist in the handling of soft cost claims.
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