Submissions by Peter Merity | Peter Merity Building and Construction Lawyers

REFORM OF THE HOME BUILDING ACT 1989

ISSUES PAPER

Submission by Peter Merity

KEY ISSUE 1: HOME BUILDING CONTRACTS -

What aspects of the regulation of home building contracts should be improved and why?

Home Building Contracts Recommendations

Executive Summary

Office of Fair Trading Standard Form Home Building Contract should be amended in certain respects and then versions should be published which are specifically adapted to deal with:

(a) home building contracts,

(b) unit building contracts

(d) cost plus contracts

There should be a general explanatory memorandum for each kind of contract explaining, in plain English, how the contract works

There should be a more detailed explanatory memorandum explaining, in plain English, the significance of each of the clauses in the contract.

The use of these contracts in an unamended form should then be mandatory unless the owner or owners take certain required steps to vary them. This achieves some degree of protection for the home owner without sacrificing freedom of contract.

The contracts should only be allowed to be varied from the standard form if the owner acknowledges in writing that he or she has read and understood the more detailed explanatory memorandum where it deals with the clauses the subject of the variation, or there is an independent lawyer’s certificate that the owner has obtained legal advice on the variation from the standard form, and still wishes to proceed with that variation.

If there is no such acknowledgment or certificate, then the legislation should provide that the builder is to be unable to enforce any of the variations from the standard form against the owner.

Certain fundamental terms such as those in the statutory warranties implied by section 18B of the current should of course not be able to be varied by the parties whatever their wishes as these terms relate to the rights of later purchasers of the property as well.

There should be a 25% cap on the amount to which provisional sums can blow out as a result of the builder’s negligent estimates.

The practice of overcharging in the earlier progress claims, “Front End Loading”, should be prevented.

There should be a liquidated damages clause in the contract imposing a standard rate of liquidated damages.

The length of the defects liability period should be extended to 26 weeks.

There should be adjudication of the progress claim disputes under the 1999 to give rapid and inexpensive resolution of minor disputes.

EXPLANATION OF RECOMMENDATIONS WITH RESPECT TO HOME BUILDING CONTRACTS

RECOMMENDATIONS 1 - 7.

The Need for Fair Standard Form Home Building Contracts

Background - the Vulnerable Nature of Home Owners

Most home owners enter into home building contracts without legal advice despite the often huge amounts of money involved. When I have asked home owners who have later had to come to me for assistance why they entered into these contracts without obtaining legal advice, they has said such things such as: “Since the builder was not legally represented we did not feel we needed legal assistance ourselves, and after all, it was a Standard Form Contract!”

It seems an article of faith with home owners that if a building contract is a “Standard Form Contract” the contract will be perfectly fair and everything will be all right. This is so even where the “Standard Form Contracts” are the standard form contracts of the builder’s industry associations!

The idea that they may safely enter into such contracts no doubt reflects the enormous success that such legislative expedients as the New South Wales Fair Trading Act and the Commonwealth Trade Practices Act have had over the past 40 years. Home owners just cannot believe that, in relation to having a house built, which is the largest consumer transaction of their lives, the law does not adequately protect them.

Home owners are even more at risk when they enter into the builder’s own home building contract. A builder’s “home made” home renovation contract which I recently came across perfectly illustrated this problem. It was imposed on a young couple who later became clients of mine. By that time they and their children had been sleeping on mattresses on the floor for some 18 months longer than the contract contemplated. The work was still incomplete and the builder went to the site only when he wished to do so. He claimed an extension of time for every day in which the weather bureau reports showed even the smallest amount of rain fell, even days when he was not on site and on days after the roof was on and rain would not have affected the progress of the work. He believed that the contract allowed him to do this. Inserted into the definitions was a definition of inclement weather which said that “inclement weather means any weather that, in the opinion of the builder, prevents the work being carried out in the usual manner.”(my italics). This was only one of many such clauses in the contract which gave an unfair advantage to the builder. Although the draftsman of the contract clearly not heard of the contra proferentum rule, these clauses still created a thicket of problems and dealing with them in the ordinary way with litigation was going to generate huge legal costs, costs totally beyond the means of the young couple in question. It would have been much easier to protect the home owners, and indeed the builder might not have “tried it on”, if the contract had not contained these clauses. In dealing with such matters I have often fervently wished that the clients had taken legal advice before contracting.

I have proposed the Office of Fair Trading Home Building Contract as the basic template for the government standard form contracts because it has the following advantages:

It has been around for many years and so is familiar to all participants in the building industry.

It was originally drafted with the input of the two industry associations, the HIA and the MBA, and so it is not easy to argue that it is not fair to both owners and builders.

It is a good contract, needing only some minor amendments by way of fine tuning.

The problem is that home owners will not take legal advice before contracting. They view it as expensive and unnecessary because they have a naive faith in printed forms.

The solution is to give them what they want - a reasonably fair standard form contract which the government makes available for free and which they can amend if they wish but only after they have been made aware of the dangers of leaving the safety shield of the standard form.

RECOMMENDATIONS 8 - 11

Proposed Amendments to The Office of Fair Trading Standard Form Home Building Contract

As well as the need to amend the structure of the contract to deal with the issues peculiar to unit building, home renovation and cost plus contracts, the Office of Fair Trading Home Building Contract has a few problem areas which need attention.

RECOMMENDATION 8 - Provisional Sums

The problem: Often the contract involves the performance of work for which the builder is unable, or unwilling, to fix a price. The most frequent example is where the site must be excavated and the nature of the ground under the site is unknown. The work may require excavation into rock or, in the case of loose soils, there may be a need to pier down to bedrock or if underground water is encountered dewatering may be necessary. In these circumstances it is reasonable that a provisional allowance, that is, an non binding estimate of what the work will cost, will be included in the contract price to provide for those works. That provisional allowance is simply made for budget purposes. The owner must pay the actual cost of the works whatever that turns out to be. Furthermore, if the provisional allowance is inadequate to cover the actual cost of the work, the contracts generally also provide that the owner must pay the builder a further amount, being a percentage of the amount the actual cost exceeds the provisional cost, to cover the builder’s additional overheads and profit.

The provisional allowance will almost invariably be the builder's own estimate Sometimes less scrupulous builders have, when competing for a building job, used this term to reduce the apparent contract price by underestimating the provisional items, knowing that the owner is obliged under the contract to pay the difference between the provisional allowance and the true cost and to pay the builder a percentage of the difference into the bargain. The owner is almost invariably relying on the builder's skill and judgement in such matters.

Further abuse of the provisional allowance provisions: If items which are reasonably predictable are made provisional items, what you get is essentially a Cost Plus Contract. I have known builders to list, in a schedule of provisional sums, provisional allowances for everything such as:

o the initial survey,

o the excavation,

o the piering,

o the foundations,

o the slab,

o the frame,

o the brickwork,

o the gyprocking and internal fit out and

o the tiling.

That is, they have made almost all the contract works into provisional items and thereby insulated themselves from any risk of their estimates being wrong. This is simply a device to change a Lump Sum Contract into a Cost Plus Contract so that the builder does not have to bear the risk that his estimates of the cost of the works are wrong. The problems posed by Cost Plus Contracts are dealt with in more detail below.

The Office of Fair Trading Home Building Contract, is the only one of the Standard Form Contracts which attempts to deal with this issue. It imposes a term in clause 10 which reads as follows:

The contractor warrants that the provisional sums allowed have been estimated with reasonable care and skill and in the light of information necessary and available at the date of the contract and taking into account such factors as a competent and experienced contractor should have taken into account in estimating the provisional sums.

Unfortunately this is not an ideal solution. Since the work has been done, the builder can argue that the owner has the value of it incorporated in his house and so he or she has suffered no loss in that regard. The lawyers for the builder could argue that he or she has suffered no loss at all except in the most extreme case where the owner may be able to prove that he or she would not have entered into the contract at all if the provisional sums had been estimated properly and the difference was beyond the budget and their ability to pay for. Even then the owner must give convincing evidence of the loss which he or she has suffered thereby. This is difficult for the owner to establish and is not discouraging for the contractor. In any event by this stage the owner has almost certainly already run out of money and cannot afford to pay for a lawyer anyway.

The solution is an amendment along these lines:

Where the provisional sums have not been estimated with reasonable care based upon information available to the builder at the time of contracting and, as a result, the increase in the total cost of provisional allowances exceeds 25% of the original provisional allowances, the contractor may only charge the owner an additional 25% for the work.

This will limit the otherwise limitless losses faced by the owner and will be very discouraging for the contractor and might eliminate this kind of abuse altogether. It is not oppressive on the contractor as it does not make him the guarantor of the cost of the item, it merely requires him to have exercised reasonable care with respect to the information available to him at the time of contracting.

RECOMMENDATION 9 - "Front End Loading"

The problem: Another way in which the contract may be used to unfairly impose on the owners is by the misuse of the progress payment schedule in clause 12. Progress payments are generally paid by way of "milestones", or stages, in the construction of the house, such as:

· the excavation stage,

· the piering stage,

· the foundations stage,

· the slab stage,

· the frame stage,

· the window stage

· the brickwork stage,

· the lock up stage

· the gyprocking and internal fit out stage and

· the installation of kitchen and white goods.

The marginal note in Clause 12 of the Office of Fair Trading Home Building Contract says, inter alia, "Progress payments are usually made at specific stages as the work proceeds, These payments, which include GST, should equate to the value of the work done."

What sometimes happens is that the builder produces a progress payment schedule whereby the amounts to be paid for the work exceed the contract value of the work in all but the last progress payment, a practice called “Front End Loading”. This is generally not apparent to the owners who have no experience in relation to the relative value of the various stages of the building works. What then sometimes happens is that, towards the end of the job, the builder begins to lose interest in finishing as he knows that there is no more profit in the job for him. For example, there may be only $5,000.00 left of the contract price to be paid but there may still be $25,000.00 worth of work to do. The builder will often then cease work, particularly if there is no effective liquidated damages clause in the contract, and try to pressure the owners into agreeing to terminate the contract on the basis that he leaves them to complete the work and they do not pay him the last progress payment. This is a considerable problem because if the builder dies, becomes insolvent or disappears, the Home Owners Warranty Insurers will not wish to indemnify the owners for what is, they will claim, a prepayment for work.

There is a further problem when Front End Loading results in the value of the work performed to a certain stage being less than the value ascribed to it in the schedule of payments. A finance provider such as a bank or building society is likely to be unwilling to pay an inflated progress claim.

The solution: To avoid some of these problems I propose a clause along the following lines:

Where part or all of the contract price is to be provided by a third party finance provider with payments being based on the value of the work the subject of the Contractor's progress claim, then the Owner is not in breach if a lesser sum is paid to the Contractor reflecting the extent that the finance provider's reasonable valuation of the works is less than the amount of the progress claim.

This has the benefit of having a reasonably independent third party, not the owner, making an interim decision on whether the progress claim is inflated. Generally the difference is not great and the builder is happy to accept the decision of the bank’s valuer as eventually the bank will pay the whole of the contract price with the final payment. I have indeed known a builder whose invariable practice was to insist that the owners pay their share of contract price to the bank leaving the bank responsible for progress payments. He told me he did this as, in his experience, the bank valuers were always reasonable and paid promptly and he avoided petty disputes as to whether a milestone had been reached because, say, one small toilet window had not been installed for the window stage.

This proposed amendment does not cover the situation where the owners are paying the first two or three payments with the bank paying the rest. There the Office of Fair Trading Home Building Contract requires the home owner to pay the inflated payment claim or dispute the value of the claim under clause 12 of the Office of Fair Trading Home Building Contract. That clause 12 is the only one in all the standard form contracts which allows the owner to withhold, from a progress payment, an amount estimated by the owner, acting reasonably, which is equal to the owner's estimate of the value of the disputed item and provides that the contractor must still carry out its obligations under the contract pending resolution of the dispute. An insertion, into every home building contract of a clause along the lines of clause 12 would go some way towards solving this problem but the personal dynamics between the owner and the builder will result in the builder viewing this kind of action by the owner as a declaration of war whereas the same action by a bank valuer would probably be accepted.

There is an even greater likelihood of problems where the home owner is paying for the whole of the work him or herself. Some of the payments would be covered by this proposed clause but the ones made direct by the owners would not be. Fortunately that is not often the case. Perhaps, as a partial solution the contract should provide that:

The part of the contract price that the home owner is providing should be deposited with the third party finance provider.

Thereby putting the whole issue of payments into the hands of the bank’s valuer where I think everyone would prefer it to be.

RECOMMENDATION 10 - Liquidated Damages

Where the Work is Not Completed in the Time Provided for in the Contract

The problem: The most significant deficiency in the Office of Fair Trading Home‑Building Contract is that it does not provide for liquidated damages for delay by the builder.

The contract provides, in clause 9, that "the work will be done with due diligence and within the time stipulated in the contract, or if no time stipulated, within a reasonable time;" That is, the statutory warranty to that effect is made a formal term of the contract. The clause then goes on to say that the contract period, that is, the time stipulated in the contract, can be extended for listed reasons such as increment weather etc. In the other standard form contracts, a failure by a builder to complete the works within the contract period as properly extended, would give rise to a right to claim liquidated damages. There is however no right to liquidated damages under the Office of Fair Trading Home‑Building Contract.

In the other Standard Form Contracts there is usually a default amount of $1 per day for liquidated damages and the builders seem to be able to persuade home owners that that sum is appropriate. No doubt because it is printed on the form! The contracts in some cases also provide that the liquidated damages may only be claimed after practical completion is achieved. That has the effect of depriving the home owner of any real benefit from the liquidated damages clause as he or she must continue to pay progress payments in full until the last payment, even if the accumulated liquidated damages exceeds the amount remaining in the contract. My experience is that home owners, when negotiating a contract, are in such a state of euphoria that they cannot conceive that there will be any need for liquidated damages and can be persuaded to agree to any token sum.

How to fix a sum for liquidated damages?

In an ideal world the default figure for liquidated damages, unless otherwise agreed, would be the cost of renting equivalent premises in the area of the building in question. This will vary with every contract and consumers cannot be trusted to look after their own interests in that regard and set a reasonable figure. It is necessary to set a figure which would be acceptable by the Courts as not imposing a penalty. I propose a daily rate based on a notional interest on the monies the owners are expending on the project. In effect this would require the builder to pay a commercial rate of interest on the contract price, most of which would already have been paid to the builder by that time.

The solution: It is recommended that a special condition be inserted into the Office of Fair Trading Home‑Building Contract along the following lines:

Should the contractor fail to complete the works in the time for completion as provided for in clauses 6 and 7, the owner shall become entitled to liquidated damages being interest on the contract sum at the rate provided herein for unpaid monies or, failing that, at nine per cent, per day or part thereof until the works are practically completed, which money may be deducted by the owner from progress payments as they fall due and to the extent that such liquidated damages are unpaid, the contract price shall be reduced, and, to the extent that such liquidated damages exceed the balance of the contract sum payable, they shall be a debt recoverable by the owner against the contractor.

RECOMMENDATION 11 The Length of the Defects Liability Period

The problem: The Office of Fair Trading Home‑Building Contract provides in clause 23 that:

The contractor must rectify omissions and defects in the work which become apparent within the period of 13 weeks from the date the work has been completed.

All the Standard Form Contracts provide for a defects liability period of 13 weeks. I was once told by a building inspector that most defects come to light in the first twelve weeks so this is probably just sufficient, but I personally would be more comfortable with 26 weeks. This clause is not a bar. Even after the defects liability period the owner can claim for defective work under the consumer warranties implied by section 18B of the Home Building Act. The defects liability period is usually of significance is the builder had retention monies deducted from progress claims or has provide security as retention is usually payable and the security is usually to be released at the end of the defects liability period.

The solution: I propose a clause as follows:

The contractor must rectify omissions and defects in the work which become apparent within the period of 26 weeks from the date the work has been completed.

RECOMMENDATION 12 The Risk That the Work May Be Defective and Require Expensive Rectification

The problem: Clause 12 of the Office of Fair Trading Home‑Building Contract, alone of all the contracts, allows the owner to withhold, from a progress payment, an amount estimated by the owner, acting reasonably, which is equal to the owner's estimate of the value of the disputed item and provides that the contractor must still carry out its obligations under the contract pending resolution of the dispute. This is a clause which is guaranteed to give rise to problems because it puts too much power into the hands of owners who do not understand building processes and the need to continuously fund building works and who, regrettably, also sometimes just want to retain the last progress payment. At the same time there are many instances where the builder has demanded payment for work not done. Usually the sums involved are not large enough to justify full scale building litigation but as it currently stands, there is no other way to resolve the issue.

The solution: The solution might be the adjudication of the progress claim dispute under the Building and Construction Industry Security of Payment Act 1999 to give rapid resolution. There would need to be special provisions to cover the special vulnerabilities of home building consumers but the scheme as it currently operates provides an ideal forum in terms of time and cost for resolving such disputes.

RECOMMENDATION 13 The Risk That the Work Will Not Conform to the Plans or Specifications

Section 18B provides that there will be implied into every contract to do residential building work:

(a) a warranty that the work will be performed in a proper and workmanlike manner and in accordance with the plans and specifications set out in the contract,

One would think that this would be enough to provide the home owner with an adequate level of protection especially in view of the things that were said by the High Court in Bellgrove v Eldridge [1954] 90 CLR 613. There is, however, an unfortunate tendency for judges and Tribunal members to be dismissive of defects or deviations from plans which are not, in their view, serious.

2. Should the threshold for large contracts be raised from $5000 to $20000?

Yes. For the reasons set out in the Issues Paper

3. Will further regulation of progress payments provide greater clarity and certainty in home building contracts?

Yes. As indicated above, any suite of reforms in this area should include provisions to prevent “Front End Loading” and to prevent a mismatch between the sums payable under the contract and the sums the finance provider must provide under the financing agreement.

4. What items, if any, should be included in the termination clause?

Recommendations - Executive Summary

A fair and reasonable termination clause should cover these things:

For the benefit of the builder, if the owner:

(a) fails to pay any amount by the due date; or

(b) fails to give evidence of ability to pay as requested; or

(d) interferes with our obstructs the progress of the building works; or

(e) fails to give or interferes with the builder’s possession of the site; or

(f) fails to give an instruction or direction required within the time specified; or

(g) fails to produce evidence of title if requested; or

(h) fails to pay any deposit contemplated by the contract; or

(i) becomes bankrupt or, being a corporation, goes into receivership, liquidation or administration;

then the builder should be able to serve a notice of default.

For the benefit of the owner, if the builder:

(a) becomes bankrupt or, being a corporation, goes into receivership, liquidation, administration; or

(b) is unable to complete the contract; or

(c) fails to complete the works in the contract period as extended under this contract, or, if no contract period is agreed, within a reasonable time; or

(d) fails to remedy defective work or replace faulty or unsuitable materials and proceeds with the works such that the cost of remedying the defective work or replacing the faulty or unsuitable materials is made unreasonably more expensive; or

(e) fails to proceed with the building works with all due diligence; or,

(f) fails to proceed with the building works in a competent and workmanlike manner; or,

(g) without reasonable cause suspends the building work before practical completion; or,

(h) without reasonable cause refuses or neglects to comply with any obligations under this contract; or,

(i) deliberately fails to remove or remedy any defective work such that the continuation of the work has or will result in the defective work being built in and/or unable to be rectified without unreasonable additional expense.

then the owner should be able to serve a notice of default.

Immediate Termination in the Case of Defaults Not Capable of Remedy

Certain defaults, such as insolvency, are not capable of remedy and the termination clause should allow for immediate issue of a notice of termination in those cases, noting that, in all cases, any notice of termination must be in writing and must be properly served.

The Need for Reform - Unfair Termination Clauses In Current Industry Standard Form Home Building Contracts

Background

The termination clauses in home building contracts generally operate as notice of default provisions.

Notice of default provisions in a building contract enable an aggrieved party, such as a builder who has not been paid a progress claim, or an owner whose project has taken too long to complete, to serve a notice on the other party complaining of that default. The notice allows the other party the contractually agreed notice period (usually ten working days) to remedy the default specified in the notice. The sting in the tail of the notice is that if the recipient of the notice does not take reasonable steps to remedy the default in the time allowed, the aggrieved party could then serve a notice terminating the contract.

The provisions are necessary because at common law, in order to terminate a building contract which does not expressly make time of the essence with respect to the date of completion, an aggrieved party has to be able to show that the other party has repudiated the contract, that is, the other party has shown by its conduct that it does not intend to carry out the contract at all. This is almost never the case in a building contract where the builder is taking too long to complete the works, because invariably the builder's intention is to carry out the contract, but as and when it suits him to do so. In Laurinda Pty Ltd v Capalaba Park Shopping Centre Pty Ltd

[1989] HCA 23; (1989) 166 CLR 623 at 658‑659, Mason CJ said that there was a difference between evincing an intention to carry out a contract only if and when it suited the party to do so, and evincing an intention to carry it out as and when it suited the party to do it. He said that in the first case, the party intended not to carry the contract out at all, in the event that it did not suit him. Whereas in the second case, the party intended to carry out the contract, but only to carry it out as and when it suited him. It is only if the inference is that the defaulting party intends so to delay performance that the promisee will be substantially deprived of the benefit of the promise, that repudiation can be inferred. Mason CJ said that the inference is not lightly drawn: Progressive Mailing House Pty.Ltd. v. Tabali Pty.Ltd [1985] HCA 14; (1985) 157 CLR 17.

What this means in plain English is that without an effective notice of default clause providing for termination for lack of due diligence, a builder can keep an owner waiting almost indefinitely for his or her house to be completed. It also means that without an effective notice of default clause the owner cannot terminate the contract for other causes unless those causes involve the most extreme misconduct by the builder.

The problem. Regrettably the current edition of the basic home building contract proffered by one of the two builder's associations, the Housing Industry Association's NSW Residential Contract for New Dwellings, no longer provides an owner with a satisfactory notice of default clause.

The provision under the old HIA Standard Home Building Contract Edition 11 used to read:

The Owner may, subject to the following, end this agreement if the contractor:

(a) becomes bankrupt or executes a deed of assignment or arrangement or makes any composition for the benefit of creditors

(b) goes into liquidation, either voluntary or compulsory, or has a receiver or an official manager appointed; or,

(d) fails to proceed with the building works in a competent and workmanlike manner; or,

(e) without reasonable case suspends the building work before practical completion; or,

(f) refuses of neglects to comply with any obligations under this agreement; or,

(g) fails to remove or remedy any defective work (as directed by the warranty insurer) within the time allowed.

As you can see, although it was not perfect, the clause did give the owner a fairly comprehensive set of reasons which he or she could use to terminate the contract.

The Use of the Term “Substantial Breach”

The current equivalent to the old HIA Standard Home Building Contract, the HIA NSW Residential Building Contract for New Dwellings, now reads:

If a party is in substantial breach of this contract the other party may give the party in breach a written notice stating:

details of the breach; and
that, if the breach is not remedied within 10 working days , that party is entitled to end this contract.

This clause appears on the face of it to be fair and reasonable, in that both parties can terminate for persisting substantial breach of the contract. Unfortunately because of other terms in the contract it is anything but fair and reasonable in its effect.

The Use of a Narrow Definition of ‘Substantial Breach” as it Benefits the Owner

The problem is that the definition of a substantial breach by the builder has been greatly narrowed down:

A substantial breach of this contract by the builder includes but is not limited to if the builder:

(a) has its licence canceled;

(b) suspends the carrying out of the building works other than under clause 32.

This causes a problem in that, if for example the problem is one of delay, the owner must establish that the delay in question is a 'substantial breach'. The meaning of the term substantial breach has not been judicially decided in this context but it is almost certain to mean a breach which would, at common law, constitute a repudiation justifying the other party ending the contract. It would seem that, in order to safely use this provision when the breach is that the builder has failed to proceed with due diligence, the owner must first allow the delay to extend to such lengths as would also constitute a repudiation at common law. That could be a very long delay necessary to raise the inference '..that the defaulting party intends so to delay performance that the promisee will be substantially deprived of the benefit of the promise..' Progressive Mailing House Pty.Ltd. v. Tabali Pty Ltd. [1985] HCA 14; (1985) 157 CLR 17, at page 32

The Use of a Broad Definition of ‘Substantial Breach” as it Benefits the Builder

On the other hand the contract provides for a much more extensive list of reasons which the builder can use to terminate the contract:

A substantial breach of this contract by the owner includes but is not limited to if the owner:

(a) fails to pay any amount by the due date;

(b) fails to give evidence of ability to pay as requested;

(d) interferes with our obstructs the progress of the building works;

(e) fails to give or interferes with the builder’s possession of the site;

(f) fails to give an instruction or direction required within the time specified.

These things make it much easier for a builder to terminate the contract should it desire to do so.

Right to Terminate for Insolvency

The old HIA Standard Home Building Contract Edition 11 used to read:

The Owner may, subject to the following, end this agreement if the contractor:

(a) becomes bankrupt or executes a deed of assignment or arrangement or makes any composition for the benefit of creditors

(b) goes into liquidation, either voluntary or compulsory, or has a receiver or an official manager appointed; or,

The current HIA NSW Residential Building Contract for New Dwellings now provides:

The builder may end this contract by giving the owner written notice by certified mail or by personal service if the owner:

(a) being a person, is or becomes bankrupt; or

(b) being a corporation, is or goes into liquidation.

The contract gives no such equivalent right to terminate for insolvency to the owner. This can be a significant problem as the owners have no viable right to terminate the contract on the builder’s insolvency and must await the decision of the liquidator or administrator as to whether it wishes to affirm or reject the building contract. Again the owners can then be left waiting an unconscionably long time.

Unfair Provisions Limiting Owner’s Freedom of Action after Terminating the Building Contract

The problem All of the Lump Sum building contracts provide that if the contract is terminated by the owner, then the owner is to complete the building work and, if the sum of the cost of completion plus the monies paid to the builder to the date of termination is greater than the contract price, then the builder must pay the owner the difference. If the sum of the cost of completion plus the monies paid to the builder to the date of termination is less than the contract price, then the owner must pay the builder the difference. This is a statutory repeal of the provisions of the Rule in Sumpter v Hedges, which admittedly had its unfair aspects, but poses an often impossibly unfair requirement on the home owners to complete the works in accordance with the contract plans or possibly lose the right to claim any restitution. The solution There should be an amendment to the effect that the owner is not bound to complete the works in accordance with the contract plans but may still claim the estimated cost of doing so less the unpaid balance of the contract price.

5. If cost-plus contracts are to be regulated, in what situations should they be allowed and what controls should apply?

Recommendations - Executive Summary

We should insert a section in the Home Building Act in exactly the same terms as section 13 of the Victorian Domestic Building Contracts Act
We should insert a regulation in similar terms to Regulation 11 of the Victorian Domestic Building Contracts Regulation the only difference being that the ban on Cost Plus residential contracts should cut out at $800,000.00 not $500,000.00.
There should be anOffice of Fair Trading Standard Form Home Building Contract being a cost plus contract.
The contracts should only be allowed to be varied from the standard form if the owner acknowledges in writing that he or she has read and understood the more detailed explanatory memorandum where it deals with the clauses the subject of the variation, or there is an independent lawyer’s certificate that the owner has obtained legal advice on the variation, and still wishes to proceed with the variation from the standard form.
If there is no such acknowledgment or certificate, then the legislation should provide that the builder is to be unable to enforce any of the variations from the standard form against the owner.
There should be clauses in the standard form cost plus contract as follows:

The contractor must provide an estimated total cost of the works.

The contractor warrants that the estimated total cost of the works has been estimated with reasonable care and skill and in the light of information necessary and available at the date of the contract and taking into account such factors as a competent and experienced contractor should have taken into account in estimating the provisional sums.The expression reasonable care does not oblige the builder to make any investigations of the site other than a visual inspection

Where the estimated cost has not been estimated with reasonable care based upon information available to the builder at the time of contracting and, as a result, the increase in the total cost of the works exceeds 25% of the original estimated cost, the contractor must carry out the works to completion and may only charge the owner an additional 25% for the work.

Background

Definition of a Cost Plus Contract

A Cost Plus contract is one where, under it, the parties agree that the builder is to be paid the cost of the work done plus a profit percentage.

In any home building project there are going to be risks. The question arises who is going to bear a given risk? The building contract acts as a formula for allocating those risks between the parties.

The golden rule of contractual risk allocation should be that party who should bear the risk of an event occurring is the party who is in the best position to avoid that event occurring.

The Reasons the Industry Standard Form Contracts Are Unacceptable

The two cost plus contracts most in use in New South Wales are:

The Master Builders Association CPC Residential Cost Plus Contract

The Housing Industry Association Cost Plus Contract

In every important respect, these Cost Plus contracts breach the golden rule of contractual risk allocation.

The major risks that arise in a home building contract are:

(a) the risk that the builder may have underestimated his costs and underpriced the job,

(b) the risk that the work may not be completed in the time provided for in the contract

(d) the risk that the work will not conform to the plans or specifications.

You need to look at the contracts to see how they deal with these risks.

MASTER BUILDERS ASSOCIATION COST PLUS CONTRACT CPC RESIDENTIAL

The Risk That the Builder May Have Underestimated His Costs and Underpriced the Job

A Cost Plus contract is usually preceded by an "estimate" of the costs of the works. That estimate is produced by the builder. In my experience this "estimate" is seldom, if ever, included in the contract. That "estimate" is usually a very low one. Often the builder tenders to do the work for a much higher fixed‑price contract and persuades the owners to enter into the Cost Plus contract on the basis that "it will be much cheaper this way."

Schedule 1 of the Master Builders Association Cost Plus Contract provides that, among the costs which the builder is entitled to claim are:

o all wages and other entitlements payable to the builder's employees or payable by reason of such employment...

o the builder's own work....,

o costs of any services ....

o costs of all trade contractors.....

o cost of hired equipment ....

o cost for the use of plant and equipment belonging to the builder....

o the cost of correcting modifying or changing work already completed, which is changed by reason of a variation by the Owner, all which is defective or reasons other than due to materials provided by the Builder or the workmanship of the Builder.

o the cost of complying with any site specific issues such as safety and pollution and waste disposal......

o any other costs or expenses which the builder is liable for or incurs by reason of

carrying out the work including insurance costs......

The essential thing to realise is that every one of these costs, which could be greater or lesser according to the approach and conduct of the builder, will not be borne by the builder. Indeed if the builder is careless and, as a result, these costs increase, the builder will be rewarded for his carelessness by an equivalent increase in his profit, as any increase in the cost of the works is going to increase what he is paid as a percentage of that cost. The structure of the contract is also almost an invitation to fraud in that the builder can exaggerate the hours which he or his employees have spent on the job and unless the owners have someone observing the site at all times, it will be impossible to prove that the hours claimed were not spent on site. I have known of unscrupulous builders arranging for the labour on projects of their own to be entirely paid for by the owners of another site in this way. Even if the builder is not so unscrupulous, he is unlikely to be driving his workers as it is not to his commercial advantage to do so.

With respect to the builder's optimistic estimates of cost, Clause 3(d) provides that:

Contract Represents Entire Agreement

(d) Apart from any terms implied by Statute, the whole of the terms, conditions and warranties of this Contract are set out in the Contract, drawings and specifications (as per Schedule 3) and will not and are not in any way varied or affected by reference to any prior negotiations, stipulations or agreement, whether written or verbal.

What this means is that all the optimistic estimates of costs, and the things that the builder said about the ultimate cost of the works, are not part of the contract.

The Risk That the Work May Not Be Completed in the Time Provided for in the Contract

With respect to the builder's estimates of time, there is no liquidated damages clause in this contract. Although the statutory warranties, which cannot be excluded by contract, give an owner a right to sue if the time taken is greater than the contract time or a reasonable time if no contract time exists, until a court decides that issue, the owner must still pay the builder in full and cannot deduct anything for delays.

The Risk That the Work May Be Defective and Require Expensive Rectification

If you look at paragraph (g) of Schedule 1 you will see that the Builder, under the Contract, is entitled to recover the whole cost of rectifying defective work even if that defective work was performed by the builder's sub contractors or employees under his control. The only exception is where the work was physically performed by the builder himself. With regard to liability for subcontractors, this is an attempt at sidestepping the statutory warranties imposed by section 18B of the Act. Eventually, after consideration by a Court or Tribunal, the clause may fall foul of the prohibition in section 18G, but the drafting gives the builder a considerable bargaining and tactical advantage.

The Risk That the Work Will Not Conform to the Plans Or Specifications

A careful reading of paragraph (g) of Schedule 1 will show that the builder is in a position to argue that the cost of correcting works which have not been built in accordance with plan must also be borne by the owner even if the failure to comply with plan was the fault of the builder. This is again an attempt at sidestepping the statutory warranties imposed by section 18B of the Act. Eventually, again after consideration by a Court or Tribunal, the clause may fall foul of the prohibition in section 18G, but the drafting gives the builder a considerable bargaining and tactical advantage.

Summary of the Master Builders Association Cost Plus Contract

The Master Builders Association and Cost Plus Contract is a contract in which the builder has absolutely no incentive to complete the work in accordance with the plans, or free of defects, or on budget or on time because he suffers no loss if he fails to do so. Indeed if he goes over budget he profits from it.

HOUSING INDUSTRY ASSOCIATION COST PLUS CONTRACT

Let us look at Schedule 2 of the Housing Industry Association Cost Plus Contract.

The Risk That the Builder May Have Underestimated His Costs and Underpriced the Job

If you carefully read that schedule you will see that it has all of the problems that we discussed in the Master Builders Cost Plus Contract. It is perhaps not as well drafted. Otherwise the only difference between the Housing Industry Association Cost Plus Contract and the Master Builders Association Cost Plus Contract is that in the Housing Industry Association Contract there is no Entire Agreement clause. That was probably just a drafting error.

The Risk That the Work May Not Be Completed in the Time Provided for in the Contract

With respect to the builder's estimates of time, there is again no liquidated damages clause in this contract. Although the statutory warranties give an owner a right to sue if the time taken is greater than the contract time or a reasonable time if no contract time exists, until a court decides that issue, the owner must still pay the builder in full and cannot deduct anything for delays.

The Risk That the Work May Be Defective and Require Expensive Rectification

If you look at paragraph (g) of Schedule 1 you will see that essentially the Owners must pay for everything including the cost to rectify defects. There appears to be a drafting error in that it may have been intended in paragraph (g) to exclude, from costs payable by the owner, faulty materials and workmanship the responsibility of the builder when those costs are incurred during the defects liability period. Unfortunately as a result of a drafting or printing error the paragraph was left incomplete and it is not clear what was meant. There is definitely no concession that the builder must bear the costs of rectification of any defects if they are rectified during the construction period of the contract. Again, with regard to liability for defective work, this is an attempt at sidestepping the statutory warranties imposed by section 18B of the Act. Eventually, after consideration by a higher Court, the attempt may fall foul of the prohibition in section 18G, but the drafting gives the builder a considerable bargaining and tactical advantage.

The Risk That the Work Will Not Conform to the Plans Or Specifications

A careful reading of Schedule 1 will show that the builder is in a position to argue that any cost in connection with the works, including the cost of correcting works which have not been built in accordance with plan must also be borne by the owner even if the failure to comply with plan was the fault of the builder.

The Victorian or the Queensland Legislation?

I recommend following the Victorian legislation which allows for slightly more freedom of contract than the Queensland legislation and does not have Courts deciding which costs can and cannot be reasonably calculated. The critical thing is to ensure that the builder has an interest in preventing the cost of the work blowing out excessively.

KEY ISSUE 2: STATUTORY WARRANTIES

6. Should the definition of “completion” include a specific definition for subsequent purchasers?

I recommend that the definition of “completion” for subsequent purchasers, where it cannot be ascertained because of lack of evidence as to the criteria currently used, should be 12 months after the date of the first issue of the HOW Insurance certificate in respect of the building works.

7. Is it necessary to clarify that the principal contractor is ultimately responsible for the statutory warranties to the home owner?

It is not clear what “ultimately responsible” means but a statement of the principle that the principal contractor, ie the licensed builder, is the one liable under the warranties would be a desirable thing.

8. Do you think maintenance schedules should be required for strata schemes and why?

Absolutely. What happens is that the strata scheme committees ignore maintenance for years and then, just before the warranties expire, they are approached by “building consultants” who charge exorbitant fees for an inspection and then promote unjustified claims against the builders for defects which have arisen because of a failure to maintain the building.

9. Should home owners’ obligations relating to maintenance be further clarified in the legislation? Why?

Other than the obligations of strata scheme committees, I do not think so. It is highly likely that the insurance companies will jump on such obligations to attempt to resist every payment under the HOW Insurance, and home owners have the least amount of resources to resist such a legal onslaught. .

10. Should “structural defect” and other terms be further defined in the Act? If so, which ones and what would be the definition?

I would be inclined to follow the Queensland legislation in this regard. Do a list of specific defects and then a general overall definition as proposed in the issues paper to act as a catchall.

11. In what ways could the statutory warranties be improved (if at all)?

The statutory warranties are quite adequate. No need for any change there.

12. Are the statutory warranty defences currently contained in the legislation adequate?

No. The requirement in section 18F that the builder’s warning be in writing is sometimes unfair in its results. Perhaps the defence should be extended to situations where the builder can prove to the satisfaction of the Court that the home owner, or the home owner’s architect, who directed the work be carried out in the matter which gave rise to the problem, was clearly in no doubt about the risks he or she was taking.

KEY ISSUE 3: DISPUTE RESOLUTION

13. Should home owners be required to allow licensees back on site to rectify defects? In what circumstances would this be inappropriate?

Yes. This could greatly reduce the volume of litigation. It would only be inappropriate if the licensee was no longer licensed or insured or there had been threats of violence such that the home owner was in a genuine state of apprehension. There should be a responsibility on anyone ordering a home owner to accept a licensee back on site to ensure that the licensee is not being destructive and is performing work of an acceptable standard.

14. Are complaint inspection advices useful in the dispute resolution process?

Yes. But rectification orders are better.

15. Should a penalty notice offense be created for non-compliance with a rectification order?

Yes. The order should give a reasonable time for compliance and then be enforced by criminal sanctions.

16. Which option, if any, do you support for disputes over $500, 000 and why? Do you have any other suggestions?

17. What are your thoughts about alternative dispute resolution?

Every time a specialist tribunal is set up with the intention of providing cheap and simple dispute resolution the participants and their legal advisors tend to demand that the process be as fair and reasonable as possible, which in the end results in its procedure and determinations being exactly like a Court with all the costs that that entails. Without any criticism of the Members intended, this is what has happened with the Consumer Trader and Tenancy Tribunal Home Building Division. This is a universal trend and is because all the participants are pursuing perfect justice. Unfortunately this has given rise to the legal aphorism that “a building matter is not complete until the legal costs generated by it equal the contract price of the structure in question.” The one exception to this rule is the Security of Payment scheme. Despite the fact that adjudications under that scheme were “quick and dirty”, as one Supreme Court Justice approvingly described them, the results tended to be acceptable to the parties and the dispute very seldom went on to full scale litigation. Indeed the fact that the security of payment scheme made rapid justice available to the less powerful participants in the industry seems to have resulted in a change of behavior in the more powerful participants, such that disputes are now, it seems to the writer, far less frequent and the adjudicators are looking for work.

18. Can the current dispute resolution processes be improved? How?

I recommend a very structured adjudication process for home building matters. Either party can approach an adjudication authority which then nominates the adjudicator who then, if expert evidence of defective work is required, will appoint appropriate an expert or experts who must investigate and report within ten business days, after which the parties have five business days to provide written submissions and a further five days to answer those submissions, after which the adjudicator has a further five business days to issue his or her determination. The whole process can be completed in twenty five business days.

I recommend that it be an entirely non government process as it currently is under the security of payment scheme. Indeed the current adjudication authorities would be the ideal bodies to run the scheme. They have the experience, the administrative machinery and the personnel required to do this. Taking this approach will mean that the establishment of the scheme will cost the State Government almost nothing.

KEY ISSUE 4: OWNER BUILDERS

19. Do you think that owner-builders should be required to take out home warranty insurance at the beginning of the project? Should sub-contractors be required to take out home warranty insurance when working for an owner-builder?

These two issues are interrelated. My response is yes to requiring owner builders to take out home owners warranty insurance at the beginning of the project, for reasons I will deal with below. If that is to be required, then sub- contractors (which I assume in this context refers to Trade Contractors) do not need to take out home owners warranty insurance as the one policy covers all on site.

If, on the other hand, it is decided not to require owner builders immediately to take out home warranty insurance, then each trade contractor whose work is valued over a certain amount should take out insurance.

20. Should the Queensland provisions, or a variation of those provisions, be adopted in NSW? Why?

No. Subsequent purchasers should be protected. Owner builders should insure from the beginning

21. Should the threshold for obtaining an owner-builder permit be increased? If so, to what value and why?

Yes. To the same value as the home owners warranty insurance threshold.

22. Do you have any objection to recognizing a leasehold arrangement as the prescribed interest in the land?

No.

23. Can you see any problems with raising the threshold for the owner builder permit course in line with the current home warranty insurance threshold? If so, what problems arise and how can they be addressed?

No.

24. Do you think a penalty should be introduced for owner builders who commence work prior to obtaining a permit? If so, what penalty do you think is appropriate?

Yes. Demolition of the work done.

25. Will obtaining and an owner builder permit in all the owner’s names close the current loophole? Do you have any other suggestions?

It will help. I suggest that the solution is simply more enforcement of existing law.

26. Do you think that owner builders should not be able to build dual occupancies? Why?

No, they should not be allowed. The whole idea of allowing owner builders to build is that the only person who suffers for the owner builder’s lack of skill and expertise is the owner builder him or herself. Specifically allowing an owner builder to build dual occupancies is against that policy.

KEY SHEET 5: DISCIPLINARY PROVISIONS

27. Do you agree with the possible proposals to prevent phoenix company activity in the building industry? Is there something else that can be done bearing in mind the NSW Fair Trading’s jurisdiction?

Yes to any attempt to prevent phoenix company activity.

28. Should NSW Fair Trading building inspectors be able to issued penalty infringement notices for non-compliance with a rectification order? Do you think that this will improve compliance with the legislation and rectification orders?

Yes to all the above.

Do you think that qualified supervisors should be limited in the number of projects that they can oversee? If so, how many projects would be appropriate?

Yes to the first question. With respect to the second, the proximity of the projects to each other could be important. Seven houses in the same development might be reasonable, but three houses many kilometers apart in the country might not be.

30. Do you think that the current disciplinary provisions provide an effective deterrent from errant conduct?

No.

KEY ISSUE 6: HOME WARRANTY INSURANCE

31. How does the NSW home warranty insurance scheme compare with other jurisdictions? What model do you think would work best and why?

The insurance should be along the lines of the original House Purchasers Insurance provided by the old Builders Licensing Board. That was a government administered first resort scheme to protect people from bad building work and, so long as there was no political interference, it worked.

32. Should new rectification work of a significant value be covered by a further certificate of insurance? Why?

Yes. Two reasons. The subsequent purchaser is protected and the builder has a reason to keep up the standards of the building work because it will be liable to the insurer after a payout.

33. Is there a need for a searchable public register of home warranty insurance policies?

Yes, for many reasons. The builders Licensing Board was able to do this quite easily.

34. Does the current 20% for incomplete work provide enough consumer protection? Should it be increased to 40%? Why?

No. Too tempting for frauds.

35. Do you think the scheme should be renamed? Do you have any suggestions for such a name?

Why bother?

36. Should the current exemption from home warranty insurance requirements for the construction of multi storey buildings be retained? Why?

No. There should be intense concentration on high rise in every way to ensure that purchasers are not left with derelict buildings they cannot live in while builders and developers get off free.

37. Does the high-rise exemption require further clarification? If so, what would you clarify?

The best clarification would be deletion of the exemption altogether.

38. Is the current definition of “storey” in the Act sufficiently clear? Should any changes be made?

The definition of storey is adequate. The best change would be deletion of the exemption altogether.

39. Do you think that section 92B should be repealed? Why?

Absolutely not. It should be dusted off and made functional by redrafting. It was brought in to solve a problem that really does occur quite frequently.

40. What are your thoughts on the current eligibility criteria? Can the process be made easier, keeping in mind that level of risk taken on by the insurer and the possible ramifications on the cost of premiums?

I agree with the proposals for the application of eligibility criteria for HOW insurance. The risk in this area comes from two things - incompetent builders and greedy shareholders. Take the licences away from the first group and require the second group to have their own funds exposed to creditors as was the case in the earlier incarnations of this legislation such as the Builders Licensing Board Act 1971

41. Does the definition of “disappeared” for the purposes of lodging a claim need to be clarified? Do you agree with the proposal put forth in this paper?

I agree with the proposal put forward in the Issues Paper

42. What are your thoughts around home owners being able to purchase top up cover? Is this necessary?

It may not be necessary but it is a very good idea as it will provide a pool of funds which will make it realistically possible for the home owners to have their building rectified and completed. There really is a general social benefit in the building stock in New South Wales being all of a good standard. The enormous economic drain of demolishing and rebuilding houses which have become unusable before the expiration of a reasonable usable life is something which the Government should try to avoid.

PETER MERITY

BUILDING & CONSTRUCTION LAWYERS