Australian Construction Industry Insurance Update - November 2021

In this update, we look at some of the issues affecting the Australian construction industry from an insurance perspective.

Contents

Key take-aways from the Lacrosse decision

The risks facing construction industry SMEs

Cladding Safety Victoria recoveries

Disciplinary proceedings against Victorian building practitioners

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Key take-aways from the Lacrosse decision

To re-cap the decision at first instance, on 29 February 2019, the Victorian Civil and Administrative Tribunal (VCAT) handed down its judgment finding:

1. LU Simon (the Builder) had breached its statutory warranties and was primarily liable to pay damages to the applicants.
2. The Builder had not failed to take reasonable care in its selection of the Alucobest ACP cladding and consequently was entitled to pass through all of its liability to the 3 consultants (Gardner Group Pty Ltd – the building surveyor/certifier, Tanah Merah Pty Ltd (the fire engineer) and Elenberg Fraser Pty Ltd (the architect) (the consultants).
3. Each of the consultants had acted in breach of their consultancy agreements with the Builder.
4. Each of the consultants failed to take reasonable care and were concurrent wrongdoers within s24AH of the Wrongs Act 1958.
5. The consultants were liable to indemnify the Builder for 97% of the assessed damages in the proportions:
   (i) The architect: 25%
   (ii) The fire engineer: 39% (adjusted to 42% on appeal)
   (iii) The building surveyor: 33% (adjusted to 30% on appeal).
6. Jean Francois-Gubitta the Frenchman, whose un-extinguished cigarette butt started the fire, was found liable for the remaining 3%.

All three consultants appealed to the Court of Appeal of Victoria. The Court of Appeal in its decision of 26 March 2021 largely upheld the VCAT decision, finding in favour of the building surveyor on one minor ground. None of the parties have appealed to the High Court of Australia.

Our key take-aways from the Judgment are:

1. ACPs do not comply with the deemed to satisfy (DtS) provisions of the Building Code of Australia

This finding determined the fate of many building and construction consultants defending or facing claims involving the use of ACPs. It means that consultants involved in the design/construction of a building requiring type A construction, that specified, approved, sanctioned or used ACPs may be exposed to liability.

2. Proportionate liability – applicants can plead their claim to attempt to avoid the application of the proportionate liability provisions of the Wrongs Act 1958

In the Court of Appeal decision, the Victorian Court of Appeal aligned itself with the NSW Court of Appeal in determining that the way in which a claim is framed is the starting point for deciding whether a claim is an apportionable claim.

In the VCAT proceeding below, the Applicants argued only a breach of those statutory warranties that did not involve a failure to take reasonable care. No allegation was made by the applicants at the VCAT hearing that the builder had failed to take reasonable care.

Practically what this means is that in a novated contract situation, where a builder under a design and construct contract has engaged consultants – the builder will likely be able to pass through its liability through to the consultants and the insurers will likely wear the hefty damages bill.

3. In considering the liability of consultants, look closely at the terms of the consultancy agreements

Whilst Lacrosse is a guide for the allocation of liability between consultants, it will be the contractual terms in each case, the allocation of risk and the facts, including how non-compliant cladding came to be on the external walls, that is determinative. Lawyers need to investigate these matters early in the case to ascertain the exposure of their client, whether they are a builder or a consultant. What role did they have in ACP being on the building? In terms of a consultant, who retained the consultant and what were they contracted to do?

4. Whether a builder failed to exercise reasonable care must be considered in all the circumstances of the case

In upholding VCAT’s decision that the builder did not fail to take reasonable care, the Court of Appeal set out the relevant factors to be considered and confirmed that whether a builder is a concurrent wrongdoer or contributory negligent needs to be considered in the ‘wider context’.

In determining the ‘wider context’ the terms of the D&C contract between the builder and the developer are relevant. In Lacrosse, the builder had taken on responsibility for the design and the construction of the Lacrosse building to ensure that it complied with all legislative requirements including the BCA. The Tribunal and in turn the Court of Appeal accepted the builder’s evidence that it sought to cover its own shortcomings by engaging highly skilled professionals to direct and supervise its work. It assisted the Tribunal that LU Simon had acted on the advice of the consultants and there was no expert evidence to the effect that the builder had failed to exercise reasonable care.

This means in a novated contract situation, where the builder followed the advice of consultants, they are unlikely to be found to be a concurrent wrongdoer or contributory negligent. However, different contractual relationships and terms may lead to different outcomes.

5. Work to resolve cladding disputes early

The outcome of the appeal means building surveyors cannot rely on the peer professional opinion defence or the C1.12(f) BCA defence. Building Surveyors are usually going to be exposed to liability in cladding cases.

Whilst respondents may have defences that will assist them in relation to apportionment of liability, parties are well advised to look at the bigger picture, the fact that applicants will succeed and to try and work with other parties to resolve these disputes quickly.

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The risks facing construction industry SMEs

SMEs in the construction industry have faced numerous challenges over recent times. The first blow was the hardened PI insurance market and the difficulties this caused for SMEs trying to renew or secure PI cover. Construction based SMEs faced increased premiums, lower caps on cover and in some cases, challenges obtaining cover at all. Then came the pandemic and all the challenges that it brought with it: site numbers capped, working from home mandates for ‘non-essential’ workers, COVID positive cases and the contact tracing and quarantine that comes with a positive case, and COVID-testing. If staying on top of all of those challenges wasn’t enough, the pandemic brought with it various risks for construction-based SMEs.

Supply chain disruption has been an issue faced by the construction industry globally. Unforeseeable disruption to projects carries risks for both contractors and consultants, particularly SMEs which are typically cash poor businesses. Contractors typically carry delay risk and disruption to the supply chain can hinder progress payments to contractors and delay projects, leaving contractors liable for liquidated damages and the like. Disruption to the payments to contractors in turn disrupts payments to sub-contractors and consultants.  

Snap lockdowns across Australia have closed the construction industry for varying periods. These snap lockdowns freeze the income needed by SMEs to pay outgoings including salaries, sub-contractors/consultants and trade costs. The race to recover those losses can lead to increased risks for SMEs as they may look to cut costs elsewhere. Quality Control and Quality Assurance processes may suffer. Staff cuts may lead to less supervision of more junior staff and so on.

The design and construction of buildings involves collaboration between all involved, as well as good inspections and good oversight. These factors, which form the ingredients for successful projects, have been hindered by extended lockdowns and restrictions on site numbers. Restrictions on site numbers can mean inspections have to be undertaken by video or other remote means, meetings between consultants/contractors often have to take place remotely rather than on site, where, in comparison, issues can be inspected, discussed and resolved on the spot or shortly thereafter. These changes in working conditions can leave smaller SMEs, with limited numbers of employees who may already be working at stretched capacity due to COVID infections/close contact isolation requirements, vulnerable to errors/omissions. Defective works can go unnoticed. Deviations from a design can go undetected. And so on.

With Australia now starting to open up, some of these risks will begin to diminish. But we may not see the price that is to be paid for these errors and omissions for some years.  

To read more about the insurance risks for construction SMEs, click here.

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Cladding Safety Victoria recoveries

The Cladding Safety Victoria (CSV) scheme for remediating combustible cladding has now been running for a year, and we have seen some significant changes to the liability and recovery claim environment that are impacting on the professional indemnity insurers of building practitioners.

The CSV scheme commenced in mid-2019 with the Victorian Government allocating AUD600 million in funding over five years to remediate combustible cladding.  The scheme was given statutory force from 1 February 2021 with the commencement of the Cladding Safety Victoria Act 2020 (Vic) which established CSV as a stand-alone statutory authority. 

CSV is responsible for assisting owners of “high risk” buildings to procure remedial works and for funding those works. CSV prioritises remediation projects for funding by risk and readiness to proceed. CSV provides owners with “stage one” funding for the engagement of consultants to prepare a remedial scope of work and tender those works. “Stage two” funding is then provided for the building works. CSV has statutory rights to repayment by the owners and subrogated recovery rights against building practitioners.

The current demand for funding exceeds CSV’s annual budget and its total five-year funding package. There are over 750 applications with CSV for residential building remediation, of which 200 projects are under way and 50 projects are ready to start. Over 170 government buildings have been referred, with 113 projects funded, 50 projects complete and 60 projects ready to start. 

Three matters will be apparent to insurers from the above figures:

1. CSV is currently sitting on some 250 recovery claims, and its success in those recovery claims will determine the number of buildings it can remediate.  CSV is becoming an experienced litigant, and it will purse recovery claims aggressively.
2. The remediation program is expected to stretch out over the full five-year time allocation, so recovery claim activity is expected to remain elevated and steady for at least the next five years. 
3. Owners of “low priority” buildings are likely to drop out of the CSV scheme over time and adopt the usual path of filing their own civil claims in the Courts for anticipated remediation costs.

Due to the remediation bottlenecks discussed above, the limitation period on combustible cladding claims in Victoria has recently been extended to 15 years from the date the occupancy permit was issued. This is an increase from the usual 10-year limitation period applicable to building actions. Fortunately for insurers, the extended limitation period applies prospectively rather than retrospectively. Combustible cladding claims where the ordinary 10-year limitation period would have otherwise expired on or after 16 July 2019 (i.e. where the certificate of occupancy was issued on or after 16 July 2009) can now be issued within 15 years. The date of 16 July 2019 appears to have chosen because it was the date the CSV scheme commenced.

Where CSV provides funding, the Victorian Government has a statutory right of repayment from the owners when the owners make a recovery. This allows owners to pursue their own recovery claims and repay CSV from any recovered funds. This is the preferred method where there are multiple defects. The owners require CSV’s consent to settle the cladding portion of the claim. 

The Government is also subrogated to the owner’s recovery rights against any building practitioners that are liable for the non-compliant façade. The statutory recovery rights “pierce the corporate veil” and extend to the officers of a company at the time of the act or omission that gave rise to the liability. Officers have a statutory defence to a subrogated recovery claim where they can prove that the act or omission of the company occurred without the knowledge or consent of the officer. As insurance limits under professional indemnity insurance policies are eroded, or where cladding exclusions apply, CSV will increasingly look to recovery claims against officers, with a view to triggering directors’ and officers’ liability insurance cover. 

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Disciplinary proceedings against Victorian building practitioners

Some recent and proposed regulatory changes will increase the exposure for insurers for claims that fall within the Inquiry Costs cover available under professional indemnity policies.

Victorian building practitioners are subject to the licencing and disciplinary provisions in the Building Act 1993 (Vic) (Building Act). The disciplinary process commences with the building regulator, the Victorian Building Authority (VBA), issuing a “show cause notice” setting out the alleged grounds for disciplinary action and the proposed penalty. The building practitioner has 14 days to make an oral or a written representation to the VBA showing cause why the proposed disciplinary action should not be taken. The VBA must make its disciplinary decision within 28 of receiving the building practitioner’s representation. The VBA can impose the usual disciplinary sanctions, including suspension or cancellation of registration, and fines of up to AUD27,261 for an individual or AUD136,305 for a company. Building practitioners can request an internal review of the disciplinary decision followed by an independent re-consideration in the Victorian Civil and Administrative Tribunal (VCAT).

The number of show cause notices issued has been steadily increasing over time. In the six months from May to October 2021, the VBA handed down 86 disciplinary decisions. In comparison, 98 show cause notices were issued for the previous year 2019-2020. Building surveyors/certifiers have consistently accounted for around 25% of the show cause notices issued. Internal review is requested in around 20% of cases, with only a handful of cases proceeding to VCAT each year.

In March 2021 the VBA updated its enforcement policy. The VBA also published, for the first time, a stand-alone enforcement policy for combustible cladding breaches. Under these policies, the VBA is to take a more active approach to surveillance, monitoring and enforcement, which explains why disciplinary action is increasing. The policies state that the VBA is to favour suspension, cancellation and imposition of conditions on a building practitioner’s licence, rather than the imposition of pecuniary penalties. The combustible cladding enforcement policy states that the VBA will consider prosecution rather than disciplinary action.

The “show cause” process resolves disciplinary matters quickly and with reduced cost, when compared to the traditional “inquiry” model where an independent panel of practitioners conducts a hearing. However, building practitioners face some significant disadvantages under the Building Act “show cause” regime:

1. There are independence issues because the VBA performs the roles of investigator, prosecutor and decision maker. Further, the VBA decision makers are not building practitioners and lack the professional expertise that an independent panel of peers has in a traditional inquiry. As a result, there is a tendency for the VBA decision makers to substantially affirm what was proposed in the show cause notice. 
2. Re-hearing applications to VCAT attract the ordinary legal costs associated with adversarial litigation. The prospects of success are usually low as VCAT tends to defer to the VBA’s original decision. Further, including multiple charges in the show cause notice can often ensure that the VBA will succeed in proving at least one disciplinary ground in a VCAT re-hearing. Consequently, the VBA will achieve partial “success” for costs purposes, so the building practitioner (or their insurer) will have to bear their own costs of the VCAT proceeding and pay part or all of the VBA’s costs.

Professional indemnity insurance policies typically impose a coverage sub-limit for “inquiry costs” and exclude cover for fines and penalties. The following coverage issues typically arise in disciplinary matters:

1. Whether the insured’s legal costs of prosecuting a VCAT re-hearing are indemnifiable as “inquiry costs”. Policy wordings that provide cover for the insured’s “response” to an inquiry may not cover the legal costs of prosecuting a re-hearing.
2. Whether it is reasonable to incur insured defence costs (and/or an insured liability for the VBAs’ costs) in a contested VCAT re-hearing to obtain a modest reduction in penalty (in particular an uninsured fine). 
3. The inquiry costs sub-limit may be insufficient to cover all of:
   1. the insured’s legal costs (including independent expert and counsel’s fees) of responding to the show cause notice, pursuing internal review, and prosecuting a contested VCAT re-hearing; and
   2. the insured’s liability to pay the VBAs legal costs of the VCAT re-hearing if the insured is unsuccessful.  

Due to the above factors, disciplinary proceedings are often resolved by some form of “plea deal” having regard to the coverage limitations and in attempting to balance the interests of the insured and the insurer.

The Professional Engineers Registration Act 2019 (Vic) (PERA) commenced on 1 July 2021. PERA provides for the compulsory registration of Victorian engineers with Consumer Affairs Victoria (CAV). Engineers who are involved with building work remain subject to the Building Act disciplinary regime. Engineers who practice outside of the building industry are now subject to a new disciplinary regime contained in Part 4 of PERA, which adopts a similar “show cause” process to that in the Building Act but the CAV is the decision maker.

The Building Act and associated Regulations will soon be amended to expand the categories of building practitioners that must be licensed under the Building Act. Under the proposed legislative amendments, trades including carpentry and waterproofing will soon have to be licensed. Once compulsory licensing takes effect, those trades will become subject to the disciplinary regime under the Building Act. Professional indemnity insurers of those trades should carefully consider the level of inquiry costs cover they are providing and the exposures that will follow.

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