Better days ahead for building owners in NSW strata schemes - Landlord & Tenant - Leases

With a quarter of Sydney's Metropolitan residents now living in Strata titled properties¹, the increase in high rise residential developments shows few signs of abating. New legislation, coming into effect at the end of this year, will give these owners greater protection and developers may need to consider changes in the way they do business.

The Strata Schemes Management Act 2015 (the Act) will come into operation across New South Wales in November 2016 and draft regulations are currently being circulated by NSW Fair Trading for comments². This should offer better protection for owners of residential building apartments³. In particular, it addresses a constant bugbear - the defects in these developments.

There has been particular concern recently for the rights of owners' corporations and purchasers in pursuing defect rectification following the High Court's decision in the case of Brookfield Multiplex v Owners Corporation Strata Plan 61288 [2014] HCA 36 (the Brookfield Multiplex Case). The Brookfield Multiplex Case provides that the law will not step in to assist purchasers in respect of latent defects where parties had an agreement articulating the builder's obligations to remedy defects. Owners' corporations (and purchasers of apartments) will either be limited to relying on their contractual protections, or the introduction of legislative reform⁴.

The Act may have a significant impact upon developers⁵ with the introduction of a new defect bond and inspection regime, designed to reduce the incidence of drawn-out disputes for defect rectification. This new regime, however, will only apply to construction contracts entered into after the commencement of the legislation and won't apply retrospectively.

SIGNIFICANT CHANGES FROM A DEVELOPMENT POINT OF VIEW

Developers must now appoint a qualified building inspector to inspect and provide an interim and final report on the building work⁶.
Prior to completion of the building work, developers must provide a building bond (paid into a fund established by the Department of Fair Trading) equal to 2% of the contract price for the purpose of securing payment for rectifying any defective building work identified in the final report⁷.
On the later of two years after the completion of the building work, or within 60 days after the final report is given to the developer, the bond will be either drawn down in favour of the owners' corporation if the final report identifies and estimates the costs of the defective work, or returned to the developer (or the balance of the bond) if there is no defective work identified.
The maturity date for a building bond must not be more than three years⁸.
Importantly, an occupation certificate (as issued under the Environmental Planning and Assessment Act 1979) for any part of the building for which the building work was done will not be issued until the building bond is provided by the Developer, which may impact on the Developer completing its contracts for sale⁹.

Clearly, the NSW Government is attempting to address the need for additional statutory protection for purchasers or unit holders by increasing accountability for developers. The new legislation supplements the statutory warranties provided by the Home Building Act 1989 (NSW) (Home Building Act) and in particular, "multi-storey"¹⁰ developments¹¹. Under the Home Building Act, owners have a period of six years to claim for any 'major defects'. Claims for defects causing physical damage, which fall short of this definition, need to be brought within two years¹².

IMPLICATIONS FOR DEVELOPERS

So how will the draft legislation impact upon developers? It really depends on the way their organisation is structured. Those developers with in-house construction capabilities will have different considerations and may seek to allocate risk differently compared to those who contract with third party builders.

Those contracting with third party builders will seek to extend the defects liability periods until the issue of the final report (which will occur after the two year period), and require builders to provide additional security to cover the 2% defects bond.

Developers with in-house construction subsidiaries may not wish to change their current approaches and risk allocation with their related builder entity. These organisations could seek to pass this added cost on to the individual purchasers of the strata units.

How effective the reforms will be at addressing the issue of post-completion defect rectification remains to be seen. There are obvious practical considerations for all parties to negotiate; will bonds for 2% of the value of the contract sum really be adequate to cover the costs of rectifying all defects? Debateable.

In light of the Brookfield Multiplex Case, or any legislative reform, there is a prudent path. Developers and builders, as well as owners corporations and purchasers should ensure that the terms of the agreement between the parties are clearly set out in the contracts they enter into.

Footnotes

¹ See rolling annual total for high rise residential building approvals chart – Business Insider Australia, "The RBA's warning on Australia's apartment boom', 16 October 2015, David Scutt.

² Comments on the draft Strata Schemes Management Regulation 2016 may be lodged by way of email to < strataconsultation@finance.nsw.gov.au >.

³ Ibid. 2.

⁴ See ' The rise and fall of a builder's duty of care to owners corporations' 10 October 2014 by Anna Ross and Kate Gill-Herdman.

The High Court's reasoning for its decision that the builder did not owe the duty of care alleged by the owners corporation for economic loss caused by latent defects was based on the special circumstances necessary to establish the existence of such a duty of care and the need to establish a certain level of 'vulnerability'. It held that the individual owners of the units purchased (together, forming the owners corporation) were not 'vulnerable' to the required threshold to the economic loss caused by the construction by the builder. The individual owners were in a position to protect themselves contractually when entering into the agreements with the developer, and could have 'exercised [their] contractual wisdom to bargain for protection against the risk of defects'⁴.

⁵ The term 'developer' in the Act has the same meaning given to it in the Home Building Act 1989 (NSW).

⁶ Under Part 11 of the Act, developers now must:

within 12 to 18 months of completion of the building work and with the approval of the owners' corporation, appoint a qualified building inspector (not connected with the developer or the building work) to inspect and report on the building work (interim report); and
if defective building work is identified, within 18 months to 2 years of completion of the building work, arrange for that inspector to carry out a final inspection and provide a final report (final report).

The developer will be responsible for all costs associated with obtaining inspections and reports, and for the purposes of section 210 of the Act, the building bond may be used to meet the costs of an inspection or a report, including any fee for the appointment of a building inspector by the Secretary (if the developer of the Strata scheme is bankrupt or insolvent and the costs of any fee have not been paid). See section 54 of the draft Strata Schemes Management Regulation 2016.

Matters to be specified in the interim report and final report are contained in sections 47 and 48 of the draft Strata Schemes Management Regulation 2016.

⁷ The building bond will be payable irrespective of whether the building work is held to breach the statutory warranties under Part 2C of the Home Building Act, or whether the developer is liable to the owners' corporation or any owner of a lot in respect of that work.

A developer may be subject to a fine of up to $22,000 if it fails to provide the building bond prior to completion of the building work, and an occupation certificate will not be issued until and unless the building bond has been provided (Division 3, Part 11).

⁸ See section 51 of the draft Strata Schemes Management Regulation 2016.

⁹ See section 207 of the Act.

¹⁰ High rise residential buildings which have a rise of more than three storeys and contains two or more separate dwellings.

¹¹ There is a general exemption for construction of new multi-storey residential building, which do not require insurance cover under the Home Building Compensation Fund. See Home Building Compensation Fund Fact Sheet published May 2016 by NSW Fair Trading and Division 6 Exemptions relating to insurance, section 56 of Home Building Regulation 2014..

¹² See section 18E of the Home Building Act.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.