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In brief - Changes will affect many residential building industry standard practices

The new Part 11 to the Strata Schemes Management Act 2015 (the Act) and corresponding changes to the Strata Schemes Management Regulation 2016 (the Regulation) take effect from 1 July 2017 in respect of applicable building contracts executed on or after that date or, where work is performed in the absence of a contract, applicable work performed on or after that date. The legislation does not have retrospective operation.  

Strata defects associated with residential building work focus of new regime

The amendments in Part 11 of the Act and Part 8 of the Regulation create a new regime in relation to identification, rectification and coverage for costs of strata defects associated with residential building work, including:
  • two mandatory inspections by an independent qualified inspector
  • preparation of an interim and final report identifying defects in building works by the independent qualified inspector, and
  • a requirement that the developer provide a building bond to the Secretary of the Department of Finance, Services and Innovation before an occupation certificate is issued, which may be paid to the owners' corporation in whole or in part in respect of the cost to rectify defective building work identified in the final report
These changes will apply to building work carried out on a building, or part of a building, that is part of the parcel of land of a strata scheme (including common property and lots in a strata scheme), being work that is residential building work or used or proposed to be used for mixed use purposes that include residential purposes (Act, Section 191(1)).
 
The changes only apply to work in the above categories carried out for the purpose of, or contemporaneously with, the registration of a strata plan or a strata plan of subdivision of a development lot (Act, Section 191(2)).

Building work subject to Home Building Compensation Fund insurance requirements not affected by changes

The changes do not apply to building work if the work is subject to the requirement to obtain insurance under the Home Building Compensation Fund (Act, Section 191(3)). This means, for example, that the changes will apply to most new "multi-storey" residential buildings, which, by reason of clause 56(1) of the Home Building Regulation 2014 (NSW) are exempt from such insurance requirements.
 
The effect of the changes on many of the standard practices in the residential building industry should not be underestimated. This article identifies seven key issues that should be considered by every developer, builder and financier involved in strata-related residential building work.

1. Rethink the pre-conditions for the achievement of "practical completion" under building contracts

Under the new legislation, a building bond must be provided by the developer to the Secretary "before an occupation certificate is issued under the Environmental Planning and Assessment Act 1979 for any part of a building for which the building work was done" (Act, Section 207(1)). No distinction is made between an interim and a final occupation certificate and the use of the words "any part of a building" suggests that neither an interim nor a final occupation certificate can be issued until the building bond is paid. 
 
The requirement to lodge the building bond before the issue of an occupation certificate effectively interposes a new step along the road to a developer's settlement of sales contracts. Because of the nature of the documentation that the Regulation identifies as being needed to accompany the lodgement of the building bond, a whole range of logistic challenges to conventional industry practices arise. 
 
It is likely that there will be at least two casualties arising from this new regime, namely: the practice of developers in requiring occupation certificates to be provided as a condition of the builder achieving practical completion; and the practice of many builders in seeking to provide "as-built" documentation after the date of practical completion.
 
Clause 52 of the Regulation states that a developer, when giving the Secretary a building bond, must also give the Secretary the following documents and information:
 
  • a lodgment form in the form approved by the Secretary
  • a copy of any written warranties relating to the building work
  • the strata plan number of the strata scheme concerned
  • a copy of any schedule of non-conforming works relating to the building work
  • the street address of any building to which the bond relates
  • a copy of all “issued for construction” and “as-built” drawings and specifications relating to the building work
  • the name and address of the principal certifying authority for any building work to which the bond relates
  • a copy of any schedule of approved samples relating to the building work
  • an address for service for the developer
  • a copy of any development consent or other consents, approvals or certificates issued under the Environmental Planning and Assessment Act and relating to the building work
  • an address for service for the owners' corporation for the strata scheme
  • a copy of any alternative solutions and fire engineering reports, and the applicable assessment and approval by the principal certifying authority, relating to the building work
  • a copy of any documents relevant to the determination of the contract price used to calculate the amount of the building bond
  • a copy of any design certificates relating to the building work
  • a copy of the contract or contracts for the building work between the developer and the builder
  • a copy of Building Code of Australia compliance certificates by each subcontractor for any part of the building work carried out by the subcontractor
  • a copy of specifications for the building work, and any variations
  • a copy of any inspection report obtained by the developer or builder relating to the building work

The breadth of some of the above categories is discussed in successive sections below. 
 
However, developers need to be particularly mindful of exposure to claims for extensions of time and delay damages arising where:
  • the building contract requires the issue of an occupation certificate as a pre-condition to the achievement of practical completion 
  • the builder has done everything on its part to achieve practical completion but cannot do so until the issue of the occupation certificate, and
  • there is a delay on the part of the developer in lodging the building bond resulting in a delay to the issue of the occupation certificate 
Likewise, the oft-requested plea of the builder to permit the provision of "as built" drawings after practical completion appears incapable of being granted given that a copy of "all 'issued for construction' and 'as built' drawings and specifications relating to the building work" now need to accompany the lodgement of the building bond and thereby themselves form a pre-condition for the obtaining of an occupation certificate.   

2. The criteria for establishing the amount of the bond

Section 207(2) of the Act states that "the amount secured by a building bond is to be 2% of the contract price for the building work". The Act leaves the definition of "contract price" to the Regulations, which relevantly state:
 
For the purposes of the definition of contract price … the contract price for building work is the total price paid under all the applicable contracts for the building work as at the date of issue of the occupation certificate.
 
At least three potential issues arise from this definition. 
 
Firstly, the date for determining the amount of the contract price is the date of issue of the occupation certificate. Given that the lodgement of the bond is a pre-condition for, and must therefore necessarily pre-date, the issue of an occupation certificate, there is some element of fiction about the definition that may be overcome when further details about the bond lodgement process are published. Presumably the amount of the bond will equate to an estimate of the contract price as at the date of issue of the occupation certificate. Further guidance will need to be given on this issue.
 
Secondly, the definition of contract price quite clearly uses the word "paid" and not the word "payable", as at the date of issue of the occupation certificate. This leaves open the possibility that the quantum of the building bond may be influenced (by way of a reduction), where a portion of a contract price is not payable to the builder until after an occupation certificate is obtained. 
 
Thirdly, the definition does not appear to align with the process for establishing the "contract price" in circumstances in which there is no written contract for the building work or where the parties to a written building contract are "connected persons" (which, for the purposes of the Regulation, include related bodies corporate and associated entities of the developer). In those circumstances, the "contract price" for building work "is the price set out in a cost report" prepared by a quantity surveyor member of the Australian Institute of Quantity Surveyors or the Royal Institute of Chartered Surveyors and unconnected with the developer and builder. The "cost report" must take into account a range of matters identified in clause 50(3) of the Regulations, none of which relate to any amounts "paid". This process, which will potentially disadvantage developers with "captive" building companies, may also create extra logistic issues at the time of project completion.  

3. Setting the expiry date of the building bond

Clause 51 of the Regulation is headed "Maturity dates for building bonds" and states that a building bond "must be able to be claimed or realised for a period of not less than 2 years and not more than 3 years after the date of the occupation certificate for the building work to which it applies." 
 
Section 209(3) of the Act provides that a building bond must be claimed or realised on the later of:
  • 2 years after the date of completion of building work for which it is given, or
  • within 60 days after the final report on the building work is given to the Secretary by the building inspector
However, it is the developer who controls the timing of the final report. Section 200(1) of the Act requires the developer must, no later than 18 months after completion of the building work, arrange for the building inspector to carry out the final inspection and such inspection must be carried out and the final report provided "not earlier than 21 months and not later than 2 years after the completion of the building work" (section 201(1) of the Act). 
 
By reason of the above, it would appear possible for a developer to procure a building bond with an expiry date of, say, two years and one day after the date of the relevant occupation certificate and arrange for the final inspection and report at the latest permissible time, namely the end of the first year after the completion of the building work. By the time the report is lodged and any review process undertaken, such a building bond would have expired, rendering the whole bonding process otiose.
 
It may be that the Secretary's intervention using discretionary powers under section 212 of the Act could potentially overcome the above scenario by bringing forward the timing for the final inspection, however, it appears to be the case that the current maturity date provisions for the bond permitted under the Regulation are inapt for the corresponding bond realisation processes under the Act.

4. The insolvent developer

The Act does not currently prescribe the form, or list potential providers of, building bonds. It merely states that a building bond may be in one or more of the following forms:
  • a bank guarantee
  • a bond
  • another form of security that is prescribed by the Regulation
The Regulation does not yet provide any further details.
 
The requirement to lodge the building bond places a potentially significant financial hurdle in the way of obtaining the occupation certificate and settling on sales contracts. It comes at a time when, frequently, developers are close to being fully drawn down on funding facilities and project costs may have overrun budget. Unless careful provision has been made for the procurement of the building bond, the obligation to lodge it could exacerbate a developer's financially precarious situation.   
 
The recent New South Wales Supreme Court judgment in Gardez Nominees Pty Limited v NSW Self Insurance Corporation [2016] NSWSC 532 regarding the somewhat invidious position financiers can find themselves in when a developer becomes insolvent prior to the end of a residential building project, is discussed in our earlier article: Neither fish nor fowl - breaches of statutory warranties under the Home Building Act 1989 (NSW) and a mortgagee in possession’s rights, obligations and risks
 
For the purposes of the new Part 11 of the Act, a "developer" is defined as being: 
 
the developer of the strata scheme by whom or on whose behalf building work to which this Part applies was carried out.
 
In light of the reasoning adopted in Gardez, a mortgagee in possession might not be considered a "developer" for these purposes. And yet, no occupation certificate can be obtained until the building bond is lodged. In these circumstances, the burden of lodging the building bond is likely to fall on the financier if it wishes to realise the funds to flow from settlements of sales contracts.
 
Just as developers may consider pushing down to contractors an obligation to provide security commensurate with the building bond regime, financiers may consider placing similar obligations on developers at the time of entry into funding agreements.    

5. The paper trail

The very breadth of the documentation that is to be supplied by the developer to the Secretary at the time the building bond is lodged may give cause for concern. 
 
In particular, the requirements that the developer provide:
 
a copy of any inspection report obtained by the developer or builder relating to the building work 
and 
a copy of any schedule of non-conforming works relating to the building work
 
may cause developers and builders to consider carefully the consequences of their actions and the types of documents that they generate during the course of the project. 
 
For example, it is not uncommon for disputes to arise during the course of building projects and, particularly, in the context of applications by builders for adjudication under applicable security of payment legislation. At times, a builder will allege underpayment and the developer will allege a right to withhold monies on account of the builder's performance of non-conforming or defective works. Under the new legislation it would appear that any defective works reports commissioned by a developer or builder during a project will need to be disclosed to the Secretary and presumably made available to the appointed building inspector and the owners' corporation. Similarly, non-conformance reports generated by consultants and others during the project will also be, prima facie, caught by the disclosure obligations. 
 
A developer's adoption of a rigorous approach to defect identification and management during the course of the project may, ironically, draw particular attention to those particular problems during the interim and final inspection processes required by the Act. 

6. The defects liability period and return of builders' security

The new legislation imposes defect inspection, identification and rectification obligations in a period that falls outside the conventional twelve month defects liability period adopted by many residential building contracts.
 
The regime adopted by the Act is likely to change fundamentally the times at which developers will want to be able to require the builder to attend site and rectify defects and return security to the builder.
 
It is likely that developers will need to give consideration to, in respect of contracts to be entered into on or after 1 July 2017, at least the following courses:
  • extending the defects liability period to run for at least (and possibly a number of months more than) two years from the date upon which an occupation certificate is issued in respect of the works (if later than the date of practical completion)
  • holding sufficient security until the end of the extended defects liability period and ensuring that such security, typically by this stage, 2.5% of the original contract price, is sufficient to cover the amount of the building bond (2% of the contract price as at the date of the occupation certificate)
  • obliging the builder to rectify defects identified in an interim report prepared by a duly appointed building inspector (whether or not the existence of or responsibility for such defects are contested), and
  • ensuring subcontractor warranties are sufficiently robust to permit the developer to direct subcontractors to attend to rectification work in circumstances in which the head contractor is insolvent or uncooperative
 
It should also be noted in passing that although a final inspection report to be prepared under the Act is required to specify how defective building work is to be rectified, interim inspection reports are not required to do so. 
 
This may lead to an anomaly whereby the rectification method adopted by the builder in response to an interim report is disapproved of by the building inspector performing the final report. 
 
Since final reports are required to identify any defective building work arising from the rectification of defective building work identified in the interim report, it would be advisable either for the legislation to be modified to require the building inspector to identify rectification methodologies in the interim report or to expressly permit or encourage liaison between the developer, builder and building inspector in respect of the contents of an interim report. 

7. The new anomaly for reckoning time under the Home Building Act 1989 (NSW)

Prior to the coming into force of the new Part 11 of the Act, section 3B of the Home Building Act (HBA) created a presumption as to the occurrence of "completion of residential building work". This concept is important because it provides the basis for the reckoning of time in which claims for breaches of statutory warranties under Part 2C of the HBA can be made. 
 
Section 3B of the HBA created a rebuttable presumption that the "completion of residential building work" occurred upon "practical completion" of that work, being the earliest of:
 
(a)   the date on which the contractor handed over possession of the work to the owner,
 
(b)   the date on which the contractor last attended the site to carry out work (other than work to remedy any defect that does not affect practical completion),
 
(c)   the date of issue of an occupation certificate under the Environmental Planning and Assessment Act 1979 (NSW) that authorises commencement of the use or occupation of the work,
 
(d)   (in the case of owner-builder work) the date that is 18 months after the issue of the owner-builder permit for the work.
  
The new Act has prompted the introduction of a new section to the HBA (section 3C), which applies to the construction of a new building in a strata scheme. For these purposes, the completion of residential building work is taken to occur on "the date of issue of an occupation certificate that authorises the occupation and use of the whole of the building". 
 
The application of the tests in section 3B and section 3C, respectively, of the HBA has the capacity to lead to different dates constituting the "completion of residential work" for the purposes of the Act depending upon whether the work relates to a new building in a strata scheme or not. Going forward, care will need to be taken to establish the correct date for the purpose of the reckoning of time under the HBA, particularly with respect to the last dates for commencing proceedings for breaches of statutory warranties. 

Further guidance on practical aspects of the legislation needed

These are but a handful of considerations engendered by the imminent application of Part 11 of the Act. Hopefully some more fulsome guidance on the practical aspects of the legislation will be available significantly in advance of its commencement.  

This article has been published by Colin Biggers & Paisley for information and education purposes only and is a general summary of the topic(s) presented. This article is not specific legal or financial advice. Please seek your own legal or financial advice for any questions you may have. All information contained in this article is subject to change. Colin Biggers & Paisley cannot be held responsible for any liability whatsoever, or for any loss howsoever arising from any reliance upon the contents of this article.​

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