Decennial Liability And Decennial Liability Insurance: The Only Road To The Promised Land For The New South Wales Building Crisis

September 2019

229. If a builder has built a house for a man and his work is not strong, and if the house he has built falls in and kills the householder, that builder shall be slain.
230. If the child of the householder be killed, the child of that builder shall be killed.
231. If the slave of the householder be killed, he shall give slave for slave to the householder.
232. If goods have been destroyed, he shall replace all that has been destroyed; and because the house that he built was not made strong, and it has fallen in, he shall restore the fallen house out of his own material.
233. If a builder has built a house for a man, and his work is not done properly and a wall shifts, then that builder shall make that wall good with his own silver

INTRODUCTION

Congratulations! You’ve spent the last year saving a deposit to secure the purchase of an eight-year-old apartment in a Sydney residential high-rise you’ve been eyeing for some time. You’re a subsequent owner and, after settlement, there seem to be structural defects appearing. Celebrations are halted. You turn to the vendor for relief, but they rely on the basic principle of caveat emptor (‘buyer beware’). The vendor has given no warranties or made any representations, fraudulent or negligent, that could give rise to a successful action by you. Would a successful action against the supply side engaged to design and build the tower be likely? As laws currently stand in New South Wales, no.

We’re all familiar with the discovery of latent structural defects at Mascot Tower in June 2019, a ten-year-old building, which led to the evacuation of 132 apartments. The residents are now facing a potential repair bill of $20 million, or $151,500 per apartment, with investigations as to the cause continuing. Six months earlier, in December 2018, Opal Tower with a staggering 392 apartments in Homebush was evacuated when cracks appeared in the foundations and walls throughout the building. In the four months since the mass evacuation, Ecove, the developer of Opal Tower, has spent more than $10 million reimbursing residents for accommodation and living expenses. Together, Opal and Mascot are nicknamed ‘Topple Towers’ but they certainly won’t be the only residential buildings in New South Wales to have structural defects.

In February 2018, The Shergold Weir Report highlighted the “serious compliance failures in recently constructed buildings” and weak oversight by licensing bodies, state regulators, and local governments, making 24 compelling and legitimate recommendations, none of which provides an immediate resolution for the owners of Topple Towers. Not surprisingly, “the first recommendation of that report, and the first recommendation of the Opal Tower inquiry was to do something pretty simple: Make sure that engineers [and other building practitioners] are actually registered, because anyone can call themselves an engineer in NSW. It’s just not regulated at all.”

A year later, on 19 February 2019, the Hon. Anthony Roberts, New South Wales Minister for Planning and Housing, received independent advice from Unisearch Expert Opinion Services as to the causes and extent of the structural damage and proposed rectification of Opal Tower. The final report made five recommendations, all of which were already touched upon in some way by the Shergold Weir Report.

Less than a week after the evacuation of Mascot Tower, a June 2019 joint study by Griffith and Deakin Universities of 212 buildings in three States found more than half of all high-rise blocks have at least one defect, with building fabric and cladding, fire protection, waterproofing, roof and rainwater disposal, and structural and hydraulics issues topping the list. New South Wales buildings are by far the worst with an inconceivable 97% having more than one fault, followed by Victoria with 74% and 71% in Queensland. The plethora of defects unknown within the New South Wales high-rise sector has had the effect of significantly affecting off-the-plan sales on Sydney apartment living.

The numbers speak for themselves. Australian Bureau of Statistics showed approvals for apartments dropped 18.4% in July 2019 and 44.2% over the year, declining for 17 consecutive months. On 7 September 2019, it was reported that the Building Professional Board (‘BPB’) issued 47 penalty infringements totalling $433,000 against 23 certifiers last financial year compared to $47,000 the previous period, nearly a ten-fold increase. In comparison, only five infringements were issued by the BPB in the four years prior and none five years before. BPB recorded 245 complaints, issued 176 warnings and repudiated three accreditations.

On the same day, a Sydney analyst warned that the repair bill for defects in the high-rise sector and the drop in property values could cost the housing market trillions of dollars’ worth of damage if you take into account the value collapse as well as the actual cost of repair. The high-rise sector could be the crack in the Sydney housing market recovery. Developers, owners and funders are screaming from the rafters as they watch their asset value depreciate by the day as more defective residential buildings come to light, and the launch of class actions such as the residents of Opal Tower against the New South Wales Government.

In this paper, we examine latent defects, those defects which are hidden and unobservable, in residential buildings greater than three storeys, which are exempt from the mandatory statutory protections of the Home Building Compensation Scheme (‘Scheme’). The Scheme covers purchasers and subsequent owners for a period of six years for structural defects and two years for non-structural defects in New South Wales.

Then, we focus on the third-party rule, the problems associated with loss, and the legal techniques used over the years to remedy this gap in homeowner protection and since the exemption was announced in 2003. We respectfully suggest the only logical and rational solution to the current residential multi-storey building crisis in New South Wales: decennial liability and decennial liability insurance also known as latent defects insurance (‘LDI’).

Next, a discussion of the origins and operation of decennial liability laws from France and the delayed response by the English construction industry. Consumer confidence in New South Wales high-rise sector is at an all-time low. Fuelled by public outrage and negative press against the supposedly absolved developers, designers and builders of Topple Towers, the State Government announced the birth of New South Wales Building Commissioner and the market’s reaction, the issue of Australia’s first LDI product.

Finally, we conclude with the lessons learned and identify the most viable options available to overcome many of the shortcomings currently perceived and experienced by owners and subsequent purchasers of defective high-rise apartments in New South Wales.

WHAT IS A ‘DEFECT’ AND ‘LATENT DEFECT’?

There is no complete definition of a ‘defect’. The courts have defined it as “a lack or absence of something essential to completeness” and “the concept of a latent defect...means a concealed flaw. What is a flaw? It is the actual defect in the workmanship or design...”. The courts have said that “a defect is not latent if it is discoverable by the exercise of due diligence whether or not due diligence was in fact exercised.”

This raises several questions, not at least, what constitutes due diligence? Does it include an investigation or examination and how would one undertake to relieve oneself of this burden? Today, the nature of the examination solely rests on the contract provisions, current industry laws and practice regarding developers, designers, builders, certifiers, engineers and local councils. Considering poor construction methods, cost cutting on quality materials to maximise profits and questionable certifying protocols, it’s a wonder this crisis has taken this long to reveal itself.

As we see today with many new construction projects suffering from design and construction defects, those that bear the loss (owners, purchasers, tenants and funders) are generally known as third parties who don’t have the necessary contractual links to commence legal proceedings against the original developer, builder or relevant construction professional. The legal obstacles and doctrines of caveat emptor and privity of contract, also known as the third-party rule, where only a party to a contract can sue and be sued on that contract, ensure the party suffering the loss has little recourse under the common law or tort.

PRIVITY OF CONTRACT

The doctrine of privity of contract severely limits the ability of subsequent owners to take effective legal action for defects caused at construction by a builder or consultant. This fundamental problem is one that the law has been grappling with for more than four centuries and continues to be faced every day in commercial life. The rule states that a contract cannot confer rights or impose obligations under it on any person except the parties to it. One of the reasons why a third-party could not sue was “because he was a stranger to the consideration, that is, he had given nothing in return for the promise.”

It was not until the mid-19^th Century that English law clarified the position in Tweddle v Atkinson (1861) 1 B&S 393. The facts revolved around an agreement by the fathers of a bride and groom to pay the groom a sum of money. When the bride’s father failed to pay, the groom sued unsuccessfully. The court held that no stranger to the consideration could take advantage of a contract even though it was made for his benefit. At the time it was followed and acknowledged as authority for the third-party rule. However, in Drive Yourself Hire Co. (London) Ltd v Strutt [1954] 1 QB 250 Lord Denning allowed third parties to enforce contracts expressly made to benefit them by relying on a list of authorities to support his view.

If the law was confusing before these decisions, then it just got a lot worse. Despite attempts by Lord Denning to allow successful actions of third parties to rely on a contract for which they were not a party to, the House of Lords repeatedly reaffirmed the law according to Tweddle, in such cases as Dunlop Pneumatic Tyre Co Ltd v Selfridge & Co Ltd  [1915] AC 847 and Midland Silicones Ltd v Scruttons Ltd [1962] AC 446 with Lord Denning dissenting.

The third-party rule has not been without criticism. English courts have on numerous occasions expressed their reservations but stopped short of returning to the views held by Lord Denning, instead opting for acts of Parliament to remedy this deficiency with the introduction of, the most significant being, the Third Parties (Rights against Insurers) Act 1930, Defective Premises Act 1972 and Contracts (Rights of Third Parties) Act 1999 which all come with their own issues.

In New South Wales our closest equivalent is Part 2C of the Home Building Act 1989 (‘HBA’). Part 2C implies statutory warranties on all residential building works and may be enforced by any owner and successors in title. These warranties take effect from completion of the building works for a period of six years for structural defects and two years for non-structural defects with a six month extension if a building defect becomes apparent during the last six months of the statutory warranty period.

Part 6 of the HBA requires a contractor undertaking residential building works to have mandatory insurance under the Scheme, formerly known as Home Warranty Insurance. However, there are two problems with the HBA. First, what does a subsequent purchaser do when latent structural defects appear after the expiry of the statutory warranty period? Second and more importantly, section 56 of the Home Building Regulation 2014 specifically exempts multi-storey buildings from the mandatory insurance requirements under the HBA, i.e. buildings over three storeys are not covered under the Scheme.

Another example is the Civil Liability (Third Party Claims Against Insurers) Act 2017 (NSW) which replaced the now repealed section 6 of the Law Reform (Miscellaneous Provisions) 1946 (NSW). This Act allows a claimant that has a claim against an insured person with an insurance liability policy to directly proceed against the insurer to recover the amount of the insured liability before a court. A claimant still requires leave to commence proceedings against an insurer (section 5) and has to show that the insurer was on risk under the policy (section 7).

In Margaret Ritchie v Advanced Plumbing and Drains Pty Ltd [2019] NSWSC 1028 the claimant successfully sought leave to proceed against the insurer of Advanced Plumbing, which was in voluntary liquidation. The claimant exercised her statutory right to recover insurance moneys that would have been payable by the insurer under Advanced Plumbing’s policy.

In Zaki v Better Building Constructions Pty Ltd [2017] NSWSC 1522 the court set out the ‘well settled criteria’ in order to obtain leave under section 5: that there is an arguable case against the defendant; there is an arguable case that the insurer’s policy covers that liability; and there is a real possibility that, if the plaintiff obtains judgment against the defendant, the defendant will not be able to meet it. However, leave must be refused if the insurer can establish that it is entitled to disclaim under the policy or under any Act or law. The legal complexities and costs associated with claims under the Civil Liability (Third Party Claims Against Insurers) Act make its operation undesirable and untenable.

Other examples of Australian laws avoiding the third-party rule include the Insurance Contracts Act 1984 (Cth), section 51; Corporations Act 2001 (Cth), section 601AG; Law Reform (Miscellaneous Provisions) Act 1946 (NSW), sections 3 and 5; and the Civil Liability Act 2002 (NSW) but these are of no assistance to owners of structurally defective apartments.

EXCEPTIONS TO THE THIRD-PARTY LOSS PROBLEM

Lawyers have attempted to avoid the third-party rule in a number of situations, some more successful than others. The most relevant and used in construction today by third parties include:

1. Actions in tort
2. Assignment
3. Collateral contracts

ACTIONS IN TORT

Over the years and as a general rule, the courts have found that purchasers and subsequent owners cannot use the law of tort to obtain compensation from a contractor, construction professional or supplier where they don’t have any contractual relationship, except in the case of negligent misstatement. The loss is considered purely economic and therefore outside the scope of this remedy. In order to succeed in tort, negligence must cause personal injury or property damage to an owner as historically established in Donoghue v Stevenson [1932] AC 562.

Some attempts have been made to establish an actionable duty of care for homeowners and owners corporations but those cases are not regarded as good law. The issue was finally put to rest by the High Court of Australia in Brookfield Multiplex Ltd v Owners Corp Strata Plan 61288 [2014] HCA 36. This concerned a 22 storey apartment building in Chatswood built by Brookfield in 1997 under a design and build contract for the owners, Chelsea Apartments Pty Ltd. The building had two strata schemes registered, one for the residential apartments (levels 10 – 22) and the other for commercial serviced apartments (levels 1 – 9). Both owners corporations were subsequent owners of the building.

Five years later, latent defects appeared. The owners corporation for the residential apartments could enforce the statutory warranties under the HBA against Brookfield which promptly settled out of court. The serviced apartments were not covered by the statutory warranties and its owners corporation sued Brookfield for negligence. The Court held that Brookfield did not owe a common law duty of care to the owners corporation of the serviced apartments because it was a subsequent purchaser of a commercial, not residential, building.

Nevertheless, a purchaser may successfully recover damages for negligent misstatement of a construction professional such as an architect, engineer and designer that causes foreseeable economic loss as in Hedley Byrne & Co Limited v Heller & Partners [1964] AC 465. That said, establishing the duty of care is still time consuming, costly and success is not guaranteed.

ASSIGNMENT

Assignment is the unilateral transfer to a third party of a party’s benefits under a contract. Only the benefit of a contract may be assigned to a third party, not burdens, so long as the assignment is absolute, in writing signed by the assignor, and notice is given to the other party to the contract. Strictly speaking this is not a dilution of the third-party rule because the assignee stands in the place of the assignor as a so-called ‘successor in title’ to the assignor.

If burdens are to be assigned, consent of the other party to the contract is required. If the assignment is effective, the assignee stands in the place of the assignor as regards the benefits under that contract. The assignee’s position and claims cannot be better or exceed those recoverable by the original assignor and are subject to prior equities.

There are two limitations to assignment: where the contract prohibits the assignment of contractual rights; and where the law or contract states that the right is incapable of assignment. The prohibition on assignment may be absolute, conditional or partial.

Construction contracts usually contain the right to damages for defective work so that any assignment of this obligation would extend to the assignee unless assignment is expressly prohibited under the contract. Even if assignment is defective or not permitted, the putative assignee may still be able to pursue an action in the name of the assignor but only with their co-operation.

 COLLATERAL WARRANTIES

Collateral warranties are also known as duty of care agreements or letters and are usually supplemental, to another contract. The agreement is entered into by parties that would not normally have a direct contractual relationship associated with a primary contract, a contract which is “collateral” to the primary contract. These agreements extend the primary contract to another party, such as a first purchaser, tenant or subsequent owner, with the obligations owed, for example, by a builder or designer to the developer under the primary construction contract as the law of tort no longer provides an appropriate remedy.

Collateral warranties came into being as a result of a series of high profile cases in the United Kingdom (‘UK’) since the mid-1980s. The two most prominent were given by the House of Lords in D & F Estates Ltd v The Church Commissioners [1988] 41 BLR 1 and Murphy v Brentwood District Council [1990] 50 BLR 1 which held that it was not possible to recover damages for negligence in relation to building defects. Damage to buildings was held to be economic loss which, as previously stated, is not recoverable in tort. Consequently, any claim for defects had to be brought as a claim for breach of contract which made it necessary to establish contractual relationships between parties involved in the building project who are not usually involved in the primary contracts, such as funders, purchasers and tenants.

Important practical consequences arose from these cases which were highlighted in 1990 by David Cornes and Richard Winward in Collateral Warranties – A Practical Guide for the Construction Industry who opined:

“In practice, this means, for example, that a leaseholder of a defectively designed commercial office building will be unable to bring an action in tort against the architect who had been employed by the developer. Collateral warranties seek to fill that gap by creating a contractual relationship between the parties.”

Warranties are usually negotiated and agreed at the time of engaging a designer and builder and are additional to the contractual obligations owed to the client under the primary contract. Technically, it’s not really an exception to the third-party rule because the third-party is a party to the contract although not a party to the primary contract. This is a practical means of circumventing the restrictions on legal remedies arising from the doctrine of privity of contract.

If executed by way of deed these warranties are valid for 12 years from the date of practical completion which, unlike a contract, requires no consideration to render the warranty enforceable. The main problem associated with these warranties is when designers and builders attempt to restrict their liability by inserting particular clauses.

TO WHOM MAY A WARRANTY BE PROVIDED?

In Australia, warranties are usually sought by those who acquire an interest in a commercial development and who would not, in the absence of a warranty, have a contract with those responsible for the design and construction. Warranties are rarely sought in residential projects due to the implied statutory warranties afforded under the HBA. Those requiring warranties can be divided into the following categories: financiers; non-occupiers (including funding purchasers), occupiers (purchaser or tenant); land owners who entered into development agreements; and owners of neighbouring properties who own or occupy dwellings.

 LIMITATIONS OF COLLATERAL WARRANTIES

Any breach of the terms of a warranty will entitle the beneficiary to claim compensation for loss suffered, but this will be heavily dependent on the exclusions and restrictions within the warranty and being able to find a solvent warrantor.

A warranty’s effectiveness to recover loss is significantly impacted by these limitations:

1. ‘Net contribution’ clauses seeking to limit the liability of a warrantor toward the beneficiary by reference to a just and equitable contribution, thereby requiring a warrantor to pay only the loss he has caused. The result is that the injured party must sue all tortfeasors and collect their respective share of the loss from them. This is very impractical and exposes the purchaser to multi-party proceedings at considerable legal cost.
2. ‘No greater liability’ clause where the warranty does not impose a burden which is greater or different to that imposed by the principal contract to which the warranty relates.
3. Caps on liability and damages where the warrantor will only be liable for the costs of repair, renewal and/or reinstatement of the building, especially excluding consequential and economic losses such as loss of profits and loss of income.
4. Assignment of the warranty by the purchaser is limited to twice only. However, the counting may never start if this provision is incorporated in the warranty because every time there is an assignment the assignee steps into the shoes of the assignor and he has the right to make two assignments.
5. Professional indemnity insurance (‘PII’) only allows aggregate cover for a “failure to exercise reasonable skill and care required by the law” or “negligence, errors or omissions” and excludes cover for “fitness for purpose”. Policies are issued annually on a ‘claims made’ basis so there is no indemnity once the policy has expired, or the policy excludes contractually assumed liability, or if the insured becomes insolvent. Any third-party should be cautious as PII is designed to protect the negligent consultant as opposed to providing protection and indemnity for your loss. Although PII is required by most collateral warranties to help back up the indemnities given by the professional consultant, it does not provide direct protection to a third-party until negligence and damages are established.
6. Time and expense in providing warranties, particularly on commercial properties with multiple occupations or purchasers such as office buildings or shopping centres.
7. It will not cover deleterious and harmful materials which usually refers to the publication of Good Practice in Selection of Construction Materials 2011 by the British Council of Offices and Ove Arup & Partners.
8. Insolvency of the warrantor.

WINDOW TRIMMINGS AND BAND-AID SOLUTIONS – RECENT NEW SOUTH WALES REFORMS

The Strata Schemes Management Act 2015 (NSW) was amended in October 2015 to introduce building bonds and mandatory post completion inspections. These amendments commenced on 1 January 2018 and apply to all construction contracts (except building work which falls within the Scheme of Part 6 of the HBA) as follows:

1. Prior to the issue of an occupation certificate, the developer must provide a building bond in the amount of 2% of the contract price for the building work to secure funding for the payment (up to the amount of the bond) of the costs of rectifying defective building work identified, section 207.
2. The mandatory appointment of a building inspector not connected with the developer or one will be appointed for the developer, sections 193 - 198.
3. The appointed building inspector must carry out an inspection between 15 months and 18 months after completion of the building work and provide an interim report to the relevant parties. The original builder must return to undertake any rectification works identified in the interim report prior to final inspection, sections 199, 202, 206.
4. Between 21 months and 24 months after completion of the building work, the building inspector is to carry out a final inspection and prepare a final report identifying any unrectified defective work identified in the interim report. The costs of these inspections and reports are borne solely by the developer, sections 200 – 202, 204.
5. The owners corporation will have a right to use the building bond for fixing any defective building work identified in the final report by the building inspector with any surplus funds to be repaid to the developer, sections 207(3), 210.
6. The building bond must be claimed or realised within 2 years after the date of completion of building work, or within 60 days after the final report on the building work is given by the building inspector, whichever is the later, section 209(3).

These reforms are most welcome and long overdue in addressing the void of the multi-storey insurance exemption but disappointingly fall short of the mark. There is one significant and fundamental flaw with these amendments: what about latent defects arising two years after completion?

If ever there was a time to implement a new system that’s proven its worth the world over by protecting both commercial and residential assets, especially high-rise owners, now would be a perfect opportunity to introduce decennial liability and decennial liability insurance in New South Wales. 

DECENNIAL LIABILITY AND DECENNIAL LIABILITY INSURANCE

WHAT IS ‘DECENNIAL LIABILITY’?

Decennial liability originated from the Napoleonic Civil Code of France in 1804. As a concept, the French Civil Code introduced ‘responsabilite decennale’ or ‘assurance decennale’ to protect building owners who may not have the expertise or technical knowledge to notice defective designs or construction at the point of project delivery, particularly latent defects. It is a strict form of liability to cover the 10-year period following completion of a project imposed on those responsible for the design and construction of buildings and other fixed installations.

In France, decennial liability is a matter of public policy which can’t be excluded contractually or by any means and survives changes in ownership of the building to benefit every subsequent purchaser for the 10-year period.

Being the imperial power, it once was, France spread its system of law including decennial liability across its colonies in Africa, the Middle and Far East. Today, the list of developed and developing nations that have codified decennial liability is impressive and include: Algeria, Angola, Argentina, Bahrain, Belgium, Bolivia, Brazil, Cameroon, Canada, Chile, Colombia, Egypt, Finland, Gabon, Indonesia, Italy, Iraq, Jordan, Kuwait, Lebanon, Mali, Malta, Morocco, Netherlands, Oman, Paraguay, Peru, Philippines, Qatar, Republic of Congo, Romania, Saudi Arabia, Senegal, Spain, Sweden, Syria, Tunisia, and the United Arab Emirates.

In New South Wales, a very loose form of decennial liability is found in the Environmental Planning and Assessment Act 1979, section 6.20 (formerly section 109ZK) which states that “a civil action for loss or damage arising out of or in connection with defective building work cannot be brought more than 10 years after the date of completion of the work” usually from the issue of an occupation certificate.

In Owners Corporation Strata Plan 76841 v Ceerose Pty Ltd & Anor [2016] NSWSC 1545 the court entertained claims of the owners corporation within the 10 year period but would not grant leave to introduce new claims once that period had expired. In Dino Dinov v Allianz Australia Insurance Limited [2017] NSWCA 270 the Court found that the limitation only applied where the parties are both participants in the building industry and the claim arises directly from that relationship.

Section 6.20 expressly states that it does not operate to extend any period of limitation under the HBA as the purpose of the limitation period is to protect participants in the building industry. One must bear in mind that any proposed action under section 6.20 has its own hurdles. The definition of ‘building action’ is determined on a case by case basis bearing in mind the purpose of Part 6 and the context of the dispute. These actions are protracted and costly especially when victory is never guaranteed.

THE FRENCH APPROACH TO ‘DECENNIAL LIABILITY INSURANCE’

As one would expect, when latent defects appeared within the 10-year period many builders had disappeared from the market, for any number of reasons, leaving owners with no defendant and no remedy.

In response, France implemented two changes. Firstly, the Loi Spinetta was introduced in 1978 (as amended in 1983) to protect the interests of owners and subsequent purchasers by expanding the definition of “builders” to include:

1. architects, contractors, technicians, or other persons bound to the building by a contract of hire of work;
2. any person who sells, after completion, a work which he built or had built;
3. any person who, although acting in the capacity of agent for the building owner, performs duties similar to those of a hirer out of work.

Secondly, the French Insurance Code was amended creating an absolute and compulsory obligation on the building owner, contractors and designers to obtain decennial liability insurance known as ‘assurance de responsabilité obligatoire’ to cover the 10-year period. These policies are known as ‘assurance decennale’ for contractors and designers and ‘assurance dommage-ouvrage’ for building owners. Over time, a unified policy was created called ‘la police unique par chantier’ where the developer, designers and builders for a project are all on the same policy.

In France, all parties on the supply side, those who design and those who execute the works, are jointly responsible and must be insured against decennial liability whether the project is a new-build, redevelopment or renovation. Failure to do so attracts a €75,000 fine or up to six months imprisonment. Insurance must be obtained prior to works commencing where premiums are collected under a single one-off payment ranging from 1% to 2% of the total construction cost. French law prohibits any limit on the policy amount in order to cover repair costs in the event of a total or partial collapse of the building, or some latent structural defects that compromise the building’s safety and/or stability. Exemptions are limited but extend to any government agency that constructs buildings or has buildings constructed for their own use.

WHAT DOES IT COVER?

French civil law cases have found the fixing of a structure or installation into the ground to be a deciding factor as to applicability. Despite this there remains some uncertainty about the extent of what is covered by decennial liability. Whilst a structural collapse, whether total or partial, would be clear, the liability has also been extended, in cases where expert evidence has been provided, to defects that posed a threat to the building’s strength and safety.

LDI IN THE UK

In the UK there is no common law or statutory concept of decennial liability. In Constructing the Team Final Report of the Government/Industry Review of Procurement and Contractual Arrangements in the UK Construction Industry July 1994, Sir Michael Latham was scathing of the third-party rule stating that “the current arrangements are inadequate”. The solution, according to Latham, was to exclude joint liability so that “no party would pay for more than their adjudged contribution to the cause of the damage” and implementing compulsory latent defects insurance for 10 years from practical completion through new legislation, similar to the Joint Contracts Tribunal standard contract form provisions on latent defects insurance which would cover economic loss with the cost of the premium to be shared amongst the principal participants in the project. It was suggested for all future commercial, retail and industrial building work, and any public sector schemes.

In the early 1980s the UK insurance market issued decennial liability insurance, known there as LDI, less commonly known as building defect insurance or inherent defect insurance and remains optional today. LDI become increasingly popular from 1989 mainly in answer to the high profile cases of the mid 1980’s and the 1988 publication of Building Users’ Insurance Against Latent Defects a report by the Construction Industry Sector Group of the National Economic Development Council. At the time, there was little take up as premiums were in the order of 1.3% to 1.7% of construction cost in addition to fees and expenses for independent design and building auditors.

LDI was initially offered by two insurers in the UK: Local Authority Building Control and National House Building Council but is now offered by many insurers in the market providing cover for periods of usually between 10 to 12 years from practical completion although longer policies are now available. These policies are non-cancellable and are freely assignable between successive owners and tenants interests are usually noted on the policy. Premiums can either be payable annually prior to completion, or through a single, one-off payment before construction works. Construction industry stakeholders (‘Stakeholders’) flocked to LDI finding it a superior alternative to the Contracts (Rights of Third Parties) Act 1999 and collateral warranties.

Following on, Latham believed that the difference between the UK LDI and the French system is that although neither requires a party to establish liability, the French system is superior because liability is accepted if damage “affects the solidity of access roads, main conduits, foundations, structural elements, enclosing or covering works and fixed equipment”; or “which renders the works unfit for their intended use”, a fitness for purpose test. Further, there is no requirement for any payment of an excess.

Latham found the French dual system of compulsory producers’ decennial insurance and clients' damage insurance an attractive option, but too large a step for the UK at the time. Although Latham’s vision may not be completely realised, insurers and underwriters within the UK have fulfilled his recommendation in releasing LDI products to the market as the risk in not offering LDI greatly prejudices the future of the supply side of the UK construction industry.

WHAT DOES UK LDI COVER?

As the name suggests, basic cover indemnifies an insured against damage to the whole building caused by a latent defect in the structural parts of the edifice. Cover is provided for defects in design, workmanship and materials. LDI is offered on a no fault basis where third parties don’t need to prove negligence or liability of any party. Demand is driven by purchasers where the cost is proportionate and acceptable to the supply side of the industry.

A basic policy covers the structure and the weatherproofing envelope but can be extended to include non-structural elements such as mechanical and electrical defects in HVAC, water systems, lifts, escalators, electrical distribution systems, building management systems and business interruption covering loss of rent, profit or revenue, and the costs of working from alternative premises. Some LDI provide for a built in 5% per annum indexation to account for inflation over the period of the policy.

There is usually an exclusion of cover for the first year after practical completion as the contractor’s defects liability period runs during this period so they should make good any defects. Further, in the first two years any claim is to be remedied by the contractor, failing which, the insurer will step in. Exclusions are quite reasonable and include wilful acts, omissions or negligence of the insured; nuclear exclusions; war, invasion, act of foreign enemy, hostilities; defect prior to the issue of the certificate for practical completion.

All parties benefit from LDI as it reduces the risk of putting up additional costs for repairs on the project. One must be cautious not to misunderstand what is covered under LDI and if significant premiums are involved or excesses (sometimes around 1%) or both. Usually building owners procure LDI prior to commencing construction work and the insurer engages independent engineers and surveyors to monitor construction. Today the cost of LDI in the UK ranges from 0.65% - 1% of the contract price.

HOW DOES UK LDI WORK?

In addition to the premium, the insured must pay for technical auditors to check the design and construction for insurers. The aim is to identify defects prior to practical completion so that these defects are rectified before handover of the building to the owner. There is, inevitably, an element of duplication of fees in the sense that the building owner is paying professionals for the design and then paying another set of professionals to vet the design for insurers. However, it can be argued that this audit process is good for risk management of the design, execution of workmanship, installation, choice of materials and testing.

Further, a latent defect alone will not trigger the policy, there must be actual physical damage or a threat of imminent physical damage before a claim can be made. Consequential loss such as business interruption, loss of rent and loss of profits are available under separate cover. It is still a voluntary scheme which should be reviewed by current policymakers with a view to make such cover compulsory for all newly constructed property. Typically, LDI provides cover up to the full rebuild cost for repairs and for work to prevent imminent damage. Premiums are reducing and therefore, LDI is becoming more prevalent in the UK.

LDI IN AUSTRALIA

Stakeholders patiently waited for the New South Wales Government to respond to the Topple Towers crisis. On 11 February 2019 the Hon. Matt Kean MP, New South Wales Minister for Innovation and Better Regulation issued a media release stating, inter alia, that the plan was to appoint a Building Commissioner who will act as the consolidated building regulator in New South Wales including the responsibility for licensing and auditing practitioners.

On 1 August 2019 The Honourable Gladys Berejiklian MP, New South Wales Premier appointed David Chandler OAM, as the State’s first Building Commissioner, a newly minted role currently with no budget, powers, office or staff to make any serious and immediate impact on the current building crisis. Notwithstanding, Mr Chandler is highly distinguished and respected in the building industry with over 40 years’ experience and is an adjunct professor at the Deans Unit School of Computing, Engineering and Math at Western Sydney University.

Mr Chandler’s credentials are second to none and has a mandate “to bring building reforms including new legislations to be introduced later this year covering mandatory registration of building practitioners, a new duty of care to ease the compensation process for home owners victim to negligent building practitioners, and ensuring all buildings comply with the Building Code of Australia.” Unfortunately, during this period, the government’s response fell short of market expectations, so the market did what it does best: absorb the information, evolve from the current status quo, and resolve by providing a solution to the building crisis. 

On 21 June 2019 Ensurance Limited (‘Ensurance’), an ASX-listed insurance underwriting agency, launched the first LDI product for the Australian market underwritten by Lloyd’s of London sold on an exclusive basis through Ensurance’s network of licensed intermediaries. The product has been met with strong interest and is aimed at all those involved in the supply side of building works. The policy provides 10 years cover upon completion on commercial or residential use of up to $10 million or more on application. This also includes the defects liability and maintenance periods under contract. As expected, there are some underwriting requirements such as managing a compliance program, technical inspections and site audits during the construction phase.

Under this product there is no requirement to establish fault, negligence or liability of the parties to the construction contract. Subject to the terms of the policy, it can be called upon if the insured property suffers physical loss or damage or there is a threat of imminent damage due to latent defects. An excess will apply being the greater of $5,000 or 1% of the contract value but this is negligible compared to the ongoing accommodation and holding costs, defending law suits and class actions, and other expenses the supply side would have to outlay, for example, $10 million paid by Ecove in four months reimbursing owners and residents of Opal Towers. Time consuming, costly and complex litigation is avoided with repairs finalised within weeks as opposed to months and years. There are no restrictions on the number of assignments passing on to future owners, and immediate access to repair funds can minimise business interruption and loss of profits.

The current price of LDI is 1% of construction cost for commercial or residential builds and 1.5% for owner/builder projects with room for discounts when other related policies are procured. Premiums are cheaper if made in a single one-off payment prior to the commencement of works although there is an option for stage payments made throughout the building process where the last payment must be received before completion.

 CONCLUSION: THE ROAD TO THE PROMISED LAND

We have come considerably far from the harsh penalties once declared for the collapse of a building by Babylonian King Hammurabi but the consequences remain the same. Why is it that during construction of a building we insist that contractors are insured under a ‘contractors all-risks’ policy to cover for any loss or damage but following completion we blindly accept that the benefit of a continuation of some form of building insurance is not necessary when a high-rise apartment will be for many the largest single purchase during their life. The irony is that owners are oblivious to latent defects being too trusting of developers and their army of designers and contractors.

Whether in the UK or Australia this paper reveals the non-existent rights of subsequent owner’s and third parties relating to latent defects and only reinforces the urgent need to resolve this issue. Owners and subsequent purchasers grow impatient with Australian law playing catch up, and this is not new. It is evident that the third-party rule has created many injustices over its time, distorting the supply chains liability to effectively nil whilst a disgruntled subsequent purchaser bears the joys of finding a suitable defendant worth suing. The issue is nevertheless complex, not just in a legal and commercial sense, but also at a policy level. But there really are some simple solutions and government needs to step up and finally put this to rest.

These and other concerns were previously raised in the UK in a number of valid critiques by Phillip Britton and Mark Fairweather, “The Walk to Paradise Gardens: Flat-Owners and Building Defects”, May 2009 Society of Construction Law (‘SCL’) 156; Britton and Julian Bailey, “Domestic Bliss or Paradise Lost? Consumer Rights in Construction in England and Australia”, May 2011 SCL 167; Britton, “’Make the Developer get the Job Right’: Remedies for Defects in Residential Construction”, March 2013 SCL D154; Britton, “The State, the Building Codes and the Courts: Prevention or Cure?”, December 2013 SCL D152A; and Britton, “A Stadium and its Defects: Liberty, Loss and the Limitation Period”, June 2019 SCL 217 echoing similar obstacles the residents of Topple Towers and others suffering the same predicament where, not surprisingly, all are found in common law jurisdictions.

Tort law has finally achieved and found the right balance otherwise any deviation from the current position would open the floodgates to countless claims, some legitimate while others not so. Introducing a new statutory duty of care would have a tremendous negative effect on the supply side of the industry with contractors and professionals spending most of their time in disputes or defending claims, leaving them with no time to do what they do best, design and build. The knock-on effects would see unheard of inflation for the cost of property which would exponentially sky-rocket, where in actual fact this is just the industry factoring in costs for future claims and disputes. This would not reflect the true investment value of any property asset.

In concluding remarks on decennial liability insurance in France, Latham observed: “Litigation is avoided in practice by a concordat apportioning responsibility for payment between the insurers. Only about 10 cases a year now go to court. About 85% of cases are settled within 20 working weeks. The cost of insurance has fallen sharply, having originally been high. The estimated aggregate cost of it, as apportioned between the client and construction team, is about 3.5% of the total cost of the project.” This was the cost in France in 1994. Today that cost varies between 1% to 2% of the construction value yet in the UK LDI is around 1% of construction cost.

Other civil law jurisdictions have realised the shortcomings of only decennial liability without the indispensable corresponding insurance. In June 2018 Saudi Arabia introduced a new law for approval making the purchase of insurance mandatory for all construction projects within the private sector. Saudi Arabia has now made decennial liability insurance mandatory and other Gulf Cooperation Council (‘GCC’) states such as the UAE, Kuwait, Qatar, Oman and Bahrain are expected to follow. The process to be implemented by insurers will be like that in France and the UK where independent design and construction consultants review design and inspect the works before and during construction. Higher costs are expected initially but in the long term it will protect the supply side from enormous claims for latent defects especially when many projects in the GCC cost hundreds of millions and more than often, billions of dollars.

Some might suggest that all New South Wales needs to do is enhance the building inspector’s role by simply extending their term to 10 years and undertake further inspection on the fifth, eighth and tenth year after completion or as defects arise. In order to do so the bond would need to be held over the increased term but can be released in increments as time passes without incident so that no less than 1% of the bond is held five years after completion in an interest-bearing account initially for the benefit of an owners corporation. If there are no defects or rectification works, the developer is to be refunded the entire bond and interest no later than 10.5 years after completion. However, the fundamental flaw with this system is that it’s reactive, not proactive, to any realised design and building defects. For that reason, it is not recommended as a continued viable option and should be repealed.

Taking into consideration the concepts, principles and obstacles discussed, this paper recommends the following reforms in New South Wales including the introduction and enhancement of specific legislation affecting the rights of third parties and subsequent owners of property that currently fall outside the Scheme and statutory warranty period under the HBA as follows:

1. For the reasons stated, leave the area of tort law settled without introducing a new statutory duty of care to any group including owners’ corporations or subsequent residential homeowners.
2. Repeal the multi-storey exemption found in section 56 of the Home Building Regulation 2014 (NSW).
3. Increase the period of statutory warranties under the HBA from six years for major structural defects to 10 years keeping minor non-structural defects at two years. Definitions of ‘major defects’ and ‘major elements’ under the HBA to be expanded to include the observations of Latham regarding the superior French system of decennial liability i.e. soil inadequacies, affects the solidity of access roads, main conduits, foundations, structural elements, enclosing or covering works and fixed equipment which renders the works not fit for purpose. Also, the definition of a ‘builder’ should, as far as possible, replicate the French definition to include all parties in the design and construction of a building or structure.
4. Introduce mandatory LDI to apply to all residential and commercial buildings and structures whether a new-build, redevelopment or renovation. Policies should include the usual boiler plate exclusions to liability.
5. For obvious reasons, exemptions to LDI should include industrial works related to mining, oil and gas, chemical installations and any government agency that constructs buildings or has buildings constructed for their own use. Private building companies with no claims history and strong financials should also be exempt if the structure is built solely and intended for their own use.
6. Unlike Latham’s views, LDI should include joint responsibility so that all parties on the construction supply side, whether they design or execute the works, are jointly and severally held responsible. This is consistent with the government’s exclusion of proportionate liability under the Home Building Amendment Act 2011 (NSW) which no longer apply to claims for breach of statutory warranty in residential buildings under the HBA.
7. To ensure effective cover, LDI must be obtained prior to works commencing where, depending on the risk, premiums are collected under a single one-off payment up to 1.5% of the total construction cost. French law prohibits any limit on the policy amount in order to cover repair costs, but this feature is not required or necessary since the cost of construction is more than adequate.
8. Failure to comply with mandatory LDI laws should attract severe financial penalties and/or a period of imprisonment for executives and senior management for repeat transgressions. Financial penalties should include higher premiums, up to 3%, and a commercial freeze on the developer realising the asset in the market until LDI is in place.
9. LDI should be operated and managed privately by the insurers with government oversight. Government regulators should monitor insurers to ensure there is no price gouging, fixing or collusion for LDI products fixing a maximum policy fee of 1.5%, representing the highest risk, of the construction cost. The insured’s premium will be reflective of its claims history for designers, contractors and suppliers engaged; any specialist work required; type of materials utilised; and substantiated reputation in the marketplace.
10. Following on, in order to obtain LDI insurers shall engage independent designers and contractors, at the cost of the developer, to assess any defect or risk in design and construction with site inspections at least every two weeks throughout the construction process without notification or announcement on site to the builder or developer. To ensure independence, these designers and contractors must show that in the last five years they have not been commercially engaged by any of the insured parties on the policy.
11. Together, insurers and the state government are to create an online registry freely available to the public to be updated in real time upon the issue of any LDI where each policy provides a summary including the name of the relevant insurer, date of issue and expiry, insured amount, etc. along with a copy of the policy according to the street address of a building or its title folio identifier. Further, any sale contract must include a copy of the LDI policy otherwise the sale is void.
12. In order to save costs and lower premiums, insurers should introduce a single policy product for the entire supply side on any build obtained prior to the commencement of construction works so that all parties to the project are included on a single policy. The premium can be paid in full prior to construction or in stage payments no later than the date of completion cutting out the need for PII.

With great respect, even if the New South Wales Government implements all 24 recommendations made in the Shergold Weir Report and the five recommendations from the Opal Tower final report today, it will do little if anything to eradicate latent defects in high-rise towers. It is a noble attempt but remains weak on consumer rights; monitoring before and during construction; liability and payment of compensation by the supply side; restoring confidence in the high-rise sector; or providing any guarantee that defects will be rectified without the years and cost of litigation.

Despite the proposed recommendation of laws requiring building designers (architects, engineers and other building practitioners) who provide final designs and/or specifications of elements of buildings to declare that the building plans specify a building which will comply with building regulations, including the Building Code of Australia doesn’t necessarily mean a building or structure will. What is an owner or subsequent purchaser to do with a new registration scheme for currently unregistered designers and commercial builders who intend to make declarations? How will it assist in avoiding disputes, the passage of time whilst liability is determined, costly legal proceedings or the rectification of latent defects?

In relation to the appointment of a Building Commissioner to act as the consolidated building regulator in New South Wales including the responsibility for licensing and auditing practitioners, respectfully one may ask, do we really need more bureaucracy when the Department of Fair Trading, BPB, SafeWork, Environmental Protection Authority, Independent Commission Against Corruption and other government bodies already have the power to investigate and take disciplinary action against designers and builders that engage in improper, rogue or criminal conduct?

Should New South Wales implement the above reforms introducing decennial liability and LDI, property owners and subsequent purchasers of residential or commercial builds will be afforded the highest form of security possible in real estate property. Under the current regime, parties on the supply side of construction may face financial ruin under a judgment for damages in the event of a collapse or even partial collapse of a building. LDI moves the risk from the building owner, designers and builders to the books of an insurer.

Australia prides itself as a nation of forward-thinking advanced people that other nations envy and look to for leadership. In the case of third-party property rights, we are behind by the rest of the world including developing nations who have decennial liability. In some form or another, decennial liability and LDI are successfully in place the world over which undoubtably protects owners and subsequent purchasers of property.

Failure to introduce decennial liability and mandatory LDI in New South Wales, preferably based on the French model with the cost borne by the supply side of the industry, will negatively affect the property market for years to come as developers hold onto depreciating assets and banks refuse to lend because the risks are far too great for purchasers of high-rise apartments that may contain structural latent defects. Decennial liability with mandatory LDI will: be a significant step in restoring confidence in the market; protect consumers from defective work; protect designers and builders from financial ruin; provide a better quality of builds; increase economic activity in New South Wales; significantly reduce disputes and court proceedings; and provide maximum profits for developers.

Unlike the UK in 1994, decennial liability and latent defects insurance is the right step and a win-win for all Stakeholders in New South Wales today.

The contents of this paper is intended to provide a general guide to the subject matter and does not constitute legal advice. Ferrer Lawyers always recommend that you contact our expert advisors experienced in building defects matters. Our trusted team and independent experts are highly respected and will protect your rights and interests. Owners faced with building defects should call (02) 8823 3588 or email us with your enquiry at This email address is being protected from spambots. You need JavaScript enabled to view it. for further information, guidance or assistance.