Proportionate liability in construction, engineering, building and property development
In brief – Law reform of proportionate liability provisions to affect principals, contractors and subcontractors
What is proportionate liability? When can it have unintended consequences? How can you circumvent it? How will the proposed reforms to proportionate liability laws affect you?
What is proportionate liability?
Proportionate liability is the principle that where two or more people are concurrently responsible for certain types of economic loss, their liability is limited to the extent that they are responsible for it.
It operates throughout Australia via a patchwork of state and commonwealth legislation and affects a very broad range of claims. These can arise from either a failure to take reasonable care, including negligence claims and some contract and breach of a statutory duty claims, or from misleading and deceptive conduct (including certain claims under ASIC, Corporations and Competition and Consumer legislation).
Proportionate liability trumps contractual allocations of risk
In most jurisdictions, contracting out of proportionate liability is not expressly allowed. This can have important and unintended consequences.
For example, say you engage a builder to construct high rise apartments. The contract states that the builder will fully indemnify you for loss or damage caused by structural failure. The apartments collapse due to the negligence of the builder’s engineer.
As a result of proportionate liability you may not be able to recover any amount from the builder, despite having a contractual indemnity which provides that the builder will assume 100% of your loss. If the engineer becomes insolvent and has inadequate insurance, you may end up wearing the whole bill.
That’s not the least of it.
Proportionate liability trumps contractual indemnities
In most jurisdictions, concurrent wrongdoers cannot rely upon indemnities to avoid proportionate liability.
This can have even more undesirable and unexpected consequences.
For example, say you are engaged to construct a wind farm. You subcontract out the supply of the turbines to a manufacturer and obtain a full indemnity on their performance. When built, the turbines fail to meet outputs. The wind farm operator sues you.
You attempt to pass on the loss to the turbine manufacturer, but are met with a claim that the turbine is faulty because of a part manufactured without reasonable care by a supplier.
Proportionate liability may mean that you can’t recover any amount from the manufacturer, despite having a contractual indemnity which provides that the manufacturer will assume 100% of your loss.
Making proportionate liability work for you
Proportionate liability generally advantages downstream parties (downstream contractors, subcontractors, consultants and suppliers) and disadvantages upstream parties (principals and upstream contractors and subcontractors).
It is therefore not surprising that most companies try to avoid proportionate liability when they are upstream and affirm it when they are downstream.
Where it is in your interests to avoid proportionate liability, it pays to be aware of the main circumvention techniques.
Circumventing proportionate liability by contracting out
One option is to try to contract out of the relevant legislation. This may be more or less successful depending upon where you are located.
For example, NSW, WA and Tasmania allow contracting out. Queensland doesn’t. Other states are silent (hence there is a risk that they will implicitly not allow contracting out).
Accordingly, to increase the prospects of success, the contracting out clause could be located in a contract that provides that it is governed by the laws of NSW, Tasmania or WA.
However, where parties seek to manufacture this outcome artificially by choosing a governing law which permits contracting out even though it does have any connection to the subject matter of the contract, the choice may be unenforceable.
Circumventing proportionate liability by use of indemnities
In WA, NT and Tasmania it is possible for concurrent wrongdoers to use indemnities to avoid proportionate liability by reallocating losses. In NSW, Victoria, Queensland and the ACT it isn’t.
Circumvention by arbitration or expert appraisal
Another option is to compel disputes to arbitration or expert appraisal in the hope that proportionate liability does not apply. This met with some success in one Tasmanian case.
This option will be more likely to work if it is made clear in the dispute resolution clause that the resolver does not have the power to apply the proportionate liability regime.
There is, however, considerable uncertainty as to how and the extent to which proportionate liability applies in an arbitration. This may warrant attention when parties are considering whether to agree to an arbitration clause.
Using a cut-out agreement or deed poll
Take the situation where you are a principal and your claim for defective work against a contractor is met with a defence that the defects were caused by a subcontractor. If you didn't (or can't) contract out of proportionate liability then you may be unable to recover against the contractor. Moreover you may have no cause of action against the subcontractor. A common strategy to avoid this situation is to create legal relationships with persons who may be found to be proportionately liable.
A principal, for example, could enter into a separate "cut out" deed with a subcontractor, whereby the subcontractor promises to the principal that it will exercise due care in carrying out its obligations owed to the head contractor under the subcontract. The principal could then have a direct cause of action against the subcontractor.
The same result can be achieved by requiring the subcontractor to enter into a deed poll in the principal’s favour.
This strategy is powerful because it can be used to link any two project participants, irrespective of whether there would otherwise be any cause of action between them.
It can also be integrated neatly with project documentation or approvals. If necessary, it can also be backed up by securities, including bank guarantees.
Insurance gaps due to proportionate liability
It is important to note that contracting out can affect insurance. Most policies don’t cover contractual liabilities assumed as a result of contracting out of proportionate liability. This is because they generally contain an exclusion to the extent that a party assumes a greater liability than that which would otherwise apply at law.
Take the example of a contractor who is found to be liable for a claim from a principal when, if it had not contracted out of proportionate liability, it would have only been liable for 10% of the claim.
The contractor may get stung when it discovers that 90% of its liability is not covered by insurance. The principal too may be exposed because 90% of its claim could be uninsured.
Solutions to this problem include arranging separate "gap" policies or negotiating existing policies so that they provide coverage.
New legislation affects home builders and developers
As discussed in our earlier article, Changes to home building in NSW have implications for builders, developers, owners corporations and owners, the Home Building Amendment Bill 2011 (NSW) came into effect on 25 October 2011.
Amongst other things, it has exempted claims for breaches of statutory duties under the Home Building Act from proportionate liability.
Typically, this may make life more difficult for builders and developers who are sued by owners corporations or owners and who wish to apportion liability to subcontractors and consultants. They may need to fall back on third party cross-claims and statutory claims for contribution (where available). They may also need to utilise cut-out agreements and deed polls more frequently.
Proposed legislation to resolve inconsistencies between states
The patchwork nature of proportionate liability legislation has lead to significant inconsistencies and ambiguities across Australia.
In an effort to resolve this and address some of the inequities identified above, in September 2011 the Standing Committee of Attorneys-General (SCAG) put forward draft model provisions for a new harmonised law. The draft provisions contemplate:
- prohibiting contracting out except in higher value contracts ($5-10 million plus)
- allowing concurrent wrongdoers to use indemnities to reallocate losses
- allowing a court to take into account the responsibilities of concurrent wrongdoers (whether or not they are notified, parties to the proceedings or have settled)
- clarifying that proportionate liability will apply to arbitrations and external dispute resolution schemes.
Interestingly, it is not clear whether these provisions would have retrospective operation. The Master Builders' Association and Housing Industry Association have already made submissions to SCAG.
Proposed reforms would benefit the construction industry
There are some positives to take away from the proposed changes.
Apart from making the law more certain, they would give parties the freedom to allocate proportionate liability as they see fit, via indemnities and, at least in larger projects, contracting out.
However, whether the proposed changes will help or hinder you will depend upon what you do and which state you are in.
For example, if you are a principal, developer or upstream contractor in NSW, WA or Tasmania then the changes may restrict your current rights to contract out of proportionate liability when dealing with contractors, suppliers and consultants. You may then need to consider the circumvention techniques discussed above.
If you are a contractor, subcontractor, consultant or supplier in NSW, Victoria, Queensland or the ACT, then the changes may give you a new entitlement to avoid concurrent liability using indemnities. You will then need to incorporate appropriate indemnification clauses into your subcontracts in order to take advantage of this new right.
It may be quite some time, however, before agreement is reached in relation to any reform.
Even when it is, developers, builders, contractors and consultants in the construction industry will have to be as vigilant as ever to protect their interests, avoid losses and mitigate risk.