Few issues force politicians to act on dodgy building practices more than reports of 85 percent of new apartments being riddled with defects.
This is especially given that owners of apartments in complexes above three storeys in New South Wales are not covered under home warranty insurance and are left to pursue compensation through the courts.
Not surprisingly, then, when a University of New South Wales report laid bare the facts about the extent of defects in Sydney apartments in 2012, the state felt compelled to act.
The result was a change to the Stata Schemes Management Act which among other reforms to the Act in 2015 saw the introduction of Australia’s first defect bond scheme under which developers of multi-unit residential complexes are required to provide a bond worth two percent of the construction cost to cover defects which become evident during early years of occupancy.
Many agree that the concept of developer bonds is sound. Certainly, it is better than the previous situation which afforded apartment owners little if any protection.
Nonetheless, concerns about the scheme are growing.
To understand these, it is useful to look at how the scheme works.
In a nutshell:
• Prior to an occupation certificate being issued, developers of strata schemes are required to provide the Building Bond Secretary (NSW Fair Trading) with either a bank guarantee or a bond equal to the value of two percent of the value of the construction contract.
• Within twelve months after practical completion, the developer must appoint an inspector.
• No earlier than fifteen months and no later than eighteen months following practical completion, the inspector is required to inspect the building work and produce an interim report outlining any defects (and, if possible, the causes of these).
• Between the time of this report and the issuing of the final report (see point below) the builder and developer have an opportunity to rectify these defects.
• No sooner than 21 months and no less than 24 months (two years) following practical completion, the inspector must issue a final report. This will outline any defects which have not been rectified from the initial report as well as any rectification work which is defective. It must also specify how the defective work identified should be rectified. It cannot, however, include any new defects which were not outlined in the interim report.
• Where defects remain, the owners corporation can call on amounts necessary from the bond to cover the cost of rectification before the remaining bond amounts are repaid to the developer.
Several points should be noted.
First, whilst it is the developer who appoints the inspector, an owners corporation can either accept or refuse the appointment. Where the latter happens, an inspector is appointed by the Secretary.
Second, the inspector must not have been ‘connected’ with the developer over the past two years. This means that they cannot be (or have been) either a family member or an employer/employee of the developer. It also means that the inspector must not have been involved in the design, construction and certification of the building work.
Despite being appointed by the developer, the inspector has a statutory obligation under the Act to behave impartially.
Banjo Stanton, principal solicitor at property and construction law firm Stanton Legal, says the scheme has several issues.
First, having inspectors appointed by developers creates challenges where inspectors are required to act impartially yet are reliant upon developers for generation of income and work.
As for the independence requirements, Stanton says these are inadequate. Provided their relationship finished at least two years ago, there is nothing in the Act to prevent a developer from appointing former staff or business partners as inspectors, he points out.
At any rate, owners and owners corporations will not be privy to discussions between developers and inspectors prior to the latter’s nomination nor will they know about any social or professional connections between developer and inspector.
It should also be noted that there is no requirement under the Act for the building inspector to avoid becoming financially dependent upon any one developer. Thus there is nothing preventing an inspector from relying upon either a single developer or a small number of developers for either their entire income or a substantial portion of their income.
As for the inspectors themselves, Stanton says these are not required to hold any minimum qualifications and have no liability for anything which is considered to have been done in ‘good faith’.
Next, there are the limitations regarding the defects upon which the builder can report. As mentioned above, the final report cannot include defects which were not identified in the initial report. This, Stanton says, could result in an absurd situation whereby defects are uncovered during later inspections, the inspector is not allowed to report on these and any money from the bond which is leftover after covering the cost of initial defect rectification is repaid to the developer despite it being known that there are further defects.
This is especially problematic, Stanton says, considering that more serious and costly defects may not become evident in the fifteen to eighteen month-period post completion during which the initial report is due. Where this happens, owners are unable to claim on the money from the bond in respect of these defects and are left to pursue developers for compensation. Where the developer is a $2 company, doing this is pointless.
Third, Stanton says the scheme provides a ‘mandatory free-kick’ for builders who have already done shoddy work to cover up defects. Whilst the interim report provides a list of defects, it does not provide a scope of repair works. This, he says, provides an opportunity for shoddy builders who have already done poor work and who are not being paid to perform the repairs to essentially cover up poor rectification work.
“One cannot reasonably expert that a builder, who did defective work in the first place and is not a specialist remedial builder, or an independent consultant with extensive defect consulting experience, to be able to identify and execute proper repairs without the guidance of a scope of works from a suitably qualified independent inspector,” Stanton says.
“That is with the builder having the best of intentions. The reality is that in many instances, a builder left to its own devices on what scope of work is to be done, and who is doing repairs for no charge (taking the builder away from paid work), will succumb to the temptation of the cheapest approach of tidying up the finish of the affected area without attempting to fix the cause of the defect.
“That will also in many instances be done a short time prior to the independent’s inspector’s final inspection, compromising the ability of the independent inspector to identify the hidden inadequacies in the repair work. The ‘band-aid’ repair will then avoid the owners corporation being able to claim upon the bond and also ‘walk the owners corporation past’ its 2 year time limit to commence proceedings for the large majority of defects.”
Fourth, whilst the final report must include recommendations on remedial action in respect of any defective work which remains unfixed, it is not required to include any estimate of the costings for the repairs. Instead, the developer and owners corporation must attempt to reach agreement in regard to the costings. Where no agreement is reached, the cost is determined by a quantity surveyor who is appointed by the Building Bond Secretary.
This, Stanton says, is problematic. Owners, he says, will be left to obtain (and pay for) their own evidence in respect of the costs. Many developers will demand an opportunity to have their own experts carry out inspections and prepare competing reports. What will follow is a litigious process which is both costly and time consuming. Further, whilst owners may be able to recoup the costs associated with defects, they will not be able to recoup the costs which are reasonably incurred in progressing their repair cost issues.
Finally, there is nothing under the scheme to prevent developers from selling units without the bond being in place.
To address these issues, Stanton says action is needed on several fronts. Conflict of interest concerns could be resolved by having the government nominate inspectors from a panel rather than these be nominated by the developer. Likewise, the scheme could be adjusted to address defects identified by an inspector in their later inspections as well as in their initial ones. As for the builder cover up issue, Stanton says the interim report should include a scope of work with ‘hold points’ for independently appointed inspections to confirm the adequacy of repair work being done before it can be covered up. Cost issues, meanwhile, could be resolved by having the inspection include a repair cost estimate in the final report. This could be prepared by the inspector or someone nominated by them. Finally, strata plans should not be able to be registered without confirmation that the bond has been lodged.
“One cannot reasonably expert that a builder, who did defective work in the first place and is not a specialist remedial builder, or an independent consultant with extensive defect consulting experience, to be able to identify and execute proper repairs without the guidance of a scope of works from a suitably qualified independent inspector”
Christopher Kerin, legal practitioner director at strata and building defect law firm Kerin Benson Lawyers, agrees that there are issues. He voices concern around two matters: restrictive timeframes and conflicts of interest.
On the former point, Kerin says issues arise in several areas.
First, there is the initial inspection. As noted above, the scheme does not require the developer to have appointed an inspector until twelve months following practical completion. After that, the inspector must produce their interim report not before fifteen months after practical completion and not later than eighteen months following practical completion. This leaves a timeframe of three to six months in which to complete the initial inspection.
For strata schemes involving only a small number of units, Kerin says this is not an issue. With a complex involving three or four hundred apartments, he says the timeframes are severely restrictive.
How the law has dealt with this, he says, is to specify that inspectors did not need to undertake ‘destructive testing’. For example, where there are no access panels, he said, inspectors will not be required to cut new access panels and look around in the ceiling cavity.But if there are access panels, inspectors will be able to poke their head in and peer inside the ceiling cavity.
A consequence, he says, is that focus will likely shift to repairs of a superficial nature and upon items which are incomplete rather than issues of major structural integrity and serious defects. This would include, for instance, issues such as rangehoods not being properly connected, balustrades failing to meet NCC requirements and only one coat of paint being present rather than two.
More expensive items such a water ingress from balconies or leaking roofs, he says, may receive less attention yet be more financially significant for owners.
Once the initial report has been done, Kerin points out that the developer then had a further three to four months under the timeframes outlined earlier in this article to undertake rectification. This too, may create issues. If 300 balustrades in an apartment complex are all found to be less than a metre in height, for example, he says that is unlikely to be rectified within that timeframe.
Beyond this, the timeframes may simply be too short for significant defects to manifest themselves and thus be covered under the scheme. Take for example, water ingress. It takes time, Kerin says, for tiles to tent or membranes to crack. Thus symptoms of this are unlikely to be evident at the time of preparation of the interim report. Given that the final report cannot mention issues which were not raised in the interim report, this means owners may not be able to call on funds from the scheme to cover these types of issues notwithstanding that these are some of the issues which bestow greatest financial detriment upon owners.
To overcome this, Kerin says he would like to see something akin to the ‘major defect’ concept in the Home Building Compensation Fund scheme incorporated into the new scheme. Under the HBCF scheme – which applies to detached housing and single-storey or low-rise multi-residential dwellings of three storeys in height or less – coverage is extended from two years to six years where the issue in question is a major defect. A similar concept, Kerin says, could be applied to the defect bond scheme to effectively extend the scheme’s coverage for apartment owners in respect of major items.
Beyond that, Kerin says conflict of interest issues associated with having developers appoint inspectors are serious. Whilst owners corporations did have the right to refuse an appointment, Kerin says new apartment owners are largely concerned about ‘settling in’ and rarely have the time or expertise to scrutinise the appointment.
Given this, he fears that a ‘cottage industry’ will develop in which inspectors become dependent upon a small number of developers for significant portions of their work. Where this happens, inspectors will inevitably feel pressure to avoid jeopardising their relationships with the developers who appoint them for new jobs.
“I think it will be like building certifiers where a cottage industry will develop where there will be a bunch of people who get work on a repeat basis from developers,” Kerin said.
“They will become economically dependent upon developers providing them with a stream of work.”
“It’s a business model (for inspectors) that is shaped in a particular way. It can only work one way and that is developing a good relationship with the developer.”
New South Wales has introduced Australia’s first defect bond scheme.
Whilst better than nothing, the scheme certainly appears to have a number of issues and challenges.