The Office of Fair Trading has released a report analysing the impact of the proposed strata defects bond which is slated to be introduced in mid-2016, with the commencement of the Strata Schemes Management Act 2015.
A copy of the report can be found here.
What is the strata defect bond?
The strata defect bond will be 2% of the contract price for the construction of the building. It will be retained after completion of the building work. In conjunction with the strata defect bond, the developer will be required to obtain inspection reports at certain times prior to the expiration of 2 years after completion of the building. In certain circumstances, an owners corporation will be able to have recourse to the strata defect bond to rectify defects not rectified by the developer in that period.
How will it operate?
The introduction of a 2% strata defect bond fills a void, where currently there is no insurance protection for schemes greater than 3 storeys. Whilst the scheme sounds promising, it should be considered with caution. The following matters should be noted:
- The report recommends that the inspection reports must have a respected and valued status in Tribunal and Supreme Court proceedings and cannot simply be ignored. It was suggested that the Tribunal and the Supreme Court should have to acknowledge the report and its findings. This would either require those reports to be prepared by “experts” who have adopted the Expert Code of Conduct in both the Tribunal and the Supreme Court, or there would need to be amendments to the legislation which governs proceedings to allow the admissibility of those reports.
- The report includes a survey of the property inspection market to obtain prices of inspections of individual residential units. The nature of the reports which are being contemplated being obtained may be revealed by entities surveyed. The entities approached generally provide pre-purchase inspection reports, and there is a serious question as to quality and usefulness of the reports that will be obtained. It is difficult to imagine how those reports will meet the requirements of a Court.
- Based upon data obtained from the home warranty insurers in 2000 and 2009, it is suggested that a 2% strata defect bond based upon an average cost of a strata residential building of $14 million (ie a bond of $280,000.00) would cover the calculated median claim size. It was suggested that the data indicated that a 2% bond would cover a substantial proportion of the claims that may arise. However, the data used to calculate the size of the possible claim is deficient for 2 reasons:
- the data excludes claims concerning high rise multi-storey buildings, as those schemes were exempt from home warranty insurance from 2003 and such claim data would not be captured; and
- the claims made on the insurance, reflected in the data used, would have been subject to all of the exclusions and limitations under the insurance policy, in particular, we suggest that most claims would have been limited to structural defects only, thereby understating the true claim size.
- It is suggested that the presence of the 2% strata defect bond will reduce the incidence of litigation. The process itself will take approximately 2 years, and indeed it is proposed that the strata defect bond be released or realised after 2 years from the date of completion of the building work. The difficulty is this. The changes made to the Home Building Act 1989 which introduced a 2 year statutory warranty period means that owners corporations must seriously consider commencing legal proceedings before the expiration of the 2 year warranty period, or otherwise its rights in relation to non-major defects will be extinguished. What constitutes non-major defects remains to be seen, but it may very well cover a large range of defects. There is no provision to “stop the clock” in respect of the lapsing of the 2 year warranty period, where a builder and/or developer are attending to the rectification of defects identified in the inspection report. An owners corporation will be compelled to commence proceedings to preserve its rights in respect of the 2 year warranties, thereby potentially negating the benefits of the defect bond process.
- It must be remembered that this scheme is intended to fill the void created by the exemption for home owners warranty insurance for high rise constructions, that is, construction over 3 storeys. In multi-unit developments, each lot will have a certificate of insurance, to which the owners corporation can have access. So for example, in the case of a 20 lot scheme, based upon insurance coverage of $340,000.00 provided by each certificate, an owners corporation would have access to coverage of $6,800,000.00. On the example provided, an owner corporation will only have recourse to a strata defect bond of approximately $280,000.
Will anything change?
The report raises the concern that the cost of the strata defect bond will simply be passed on to the end consumer. That is to say, the developer will simply add the cost of the 2% strata defect bond to the retention moneys that are withheld from the builder, and in turn the builder will simply increase their price to reflect allocation of risk, resulting in higher costs of units for consumers. Effectively, the end result is that the consumer is paying for the cost of rectifying the builder’s defects!
It follows that, disappointingly, the strata defect bond may have very little impact upon the quality of construction in NSW.