November 27, 2019

Market Summary: Construction Professional Indemnity

Since 2017 there has been a rapid withdrawal of professional indemnity insurance capacity from the Australian market, both in the construction sector and generally. The withdrawal has come after a sustained period of unprofitability that has been exacerbated by external events including a Royal Commission into the banking sector and the combustible cladding crisis.

There has been a 40% reduction in capacity from the Lloyd's market alone. In the construction sector, this has led to large increases in premiums, reductions in the overall aggregate limit of insurance policies, limits on specific claims, and the application of "cladding exclusions".

Cladding assessment and remediation

NSW

Private owners of Class 2 (high rise residential) and Class 9 (aged-care, hospitals, schools) buildings must register their building with the NSW Cladding Taskforce if the building façade incorporates aluminium composite panels or insulated cladding systems.

The registration information is provided to Fire and Rescue NSW and Local Councils. The Local Councils can then undertake further investigations and issue fire safety orders for remedial action to address any risks associated with the cladding.

QLD

Private owners of multi-storey buildings that require type A or B fire resisting construction and that were completed before 1 October 2018 were required to register their buildings with the Queensland Building and Construction Commission (QBCC) before 29 March 2019.

Owners who registered were required to engage a qualified building practitioner to complete a more comprehensive assessment and submit it to the QBCC before 31 July 2019.

Owners of registered buildings that have been assessed as having non-compliant combustible cladding must obtain a fire safety risk assessment and remediation plan from a fire safety engineer and submit it to QBCC before 3 May 2021.

VIC, WA, SA, TAS

State Government Cladding Taskforces are proactively undertaking identification and assessment of government and privately owned Class 2 (high rise residential), Class 3 (high rise commercial and hotels) and Class 9 (aged-care, hospitals, schools) buildings.

Buildings with non-compliant combustible external cladding are referred to the Local Council's municipal building surveyor to issue building orders requiring owners to remediate.

In Victoria, the Cladding Taskforce can refer the remediation of extreme and high risk buildings to Cladding Safety Victoria (CSV) for the management and funding of remediation works.  CSV has been given AUD600 million in funding. When CSV arranges and pays for remediation it takes an assignment of the owners' rights to pursue recovery from the designers, certifiers and builders. The recovery arrangements have not yet been finalised, however the prospect of government- funded recoveries poses a significant risk to PI insurers of Victorian building practitioners.

Owners of private buildings in Victoria can also enter into tripartite “cladding rectification agreements” with local councils and lenders who will fund the rectification works, with repayments to be made by each apartment owner that are to be collected through council rates notices over a number of years. To date, owners and lenders have not shown any interest in the cladding rectification agreements. 

BCA amendments and related reforms

Legislation in all States requires building work to be designed and constructed in compliance with the Building Code of Australia (BCA). The BCA was amended on 12 March 2018 (by way of an out-of-cycle amendment to the 2016 edition of the BCA) and again on 1 May 2019 (by the commencement of the 2019 edition of the BCA) to increase fire safety, further restrict the use of combustible materials on building facades and increase sprinkler protection. The Australian Standard for automatic fire sprinklers, AS 2118, was also upgraded in 2017.

The BCA is a performance-based code that prescribes the "Performance Requirements" for the construction of buildings. The Performance Requirements can be met using either a Deemed-to-Satisfy (DTS) Solution or a Performance Solution (Alternative Solution). DTS compliance is achieved by following the prescriptive requirements detailed within each part of the BCA. An Alternative Solution must be shown through an approved assessment method to comply with the relevant Performance Requirements.

The key DTS provisions in the 2019 edition of the BCA relating to the use of combustible cladding can be summarised as follows:

  • The DTS provisions require external walls of Type A (high-rise) and Type B (low-rise) buildings to be constructed wholly of non-combustible materials. A material is "non-combustible" if it passes a combustibility test set out in Australian Standard AS1530.1.
  • The DTS provisions do not require the external walls of Type C buildings (single dwellings) to be constructed from non-combustible materials.
  • There are BCA exemptions and concessions that permit the level of fire resisting construction to be reduced from Type B to Type C in some circumstances, which removes the DTS requirement to use non-combustible facades.
  • Combustible materials may be attached to non-combustible external walls in certain circumstances, provided the fire resistance of the external wall is not compromised.
  • "Bonded laminated materials" are deemed to be non-combustible. Each lamina must be non-combustible when tested under AS1531.1, which means that ACPs with a combustible core cannot meet the definition of a "bonded laminated material".

Alternatively, combustible cladding can be used on a façade with an Alternative Solution that applies an approved assessment method to demonstrate that the fire performance of the façade meets the performance requirements of the BCA.

Evidence of compliance for nominated variations to the DTS provisions is commonly provided in the form of a Fire Engineering Report (FER) prepared by an accredited fire safety engineer. Fire safety engineers are normally appointed to prepare an FER in accordance with the method and process described in the International Fire Engineering Guidelines, which is submitted to the independent regulatory authorities (fire brigade and building surveyor/certifier) for approval.

Typically, the FER will make use of one or more of the following assessment methods permitted by the NCC:

  • verification methods specified by the BCA (including a façade fire test under Australian Standard 5113);
  • comparison with the DTS provisions; and
  • an analysis of the holistic fire safety strategy performed by a registered fire safety engineer using methods agreed during the design process and demonstrating compliance with the acceptance criteria also agreed during the design process.

Most States have now passed regulations prohibiting the issuing of a building approval for a building of Type A or B fire resisting construction where the design incorporates extruded/expanded polystyrene cladding or composite panels with a core of more than 30% polyethelene. These regulations prevent the use of a prohibited product through an Alternative Solution. The regulations prevent remedial works that retain the prohibited products through the use of an Alternative Solution in the remediation design (which would otherwise allow the combustible cladding to remain with the Performance Requirements satisfied through the upgrading of compensatory fire safety systems such as sprinklers).

Most States set by regulation the minimum professional indemnity insurance requirements for designers, certifiers and building surveyors. Due to the unavailability of professional indemnity insurance, most States revised their minimum insurance regulations in 2019 to permit building surveyors/certifiers to hold professional indemnity insurance policies that are endorsed with a cladding exclusion. The State governments are now considering whether the minimum insurance requirements for other designers (such as architects) should also be relaxed to permit cladding exclusions.

Wider legislative reforms

Legislative reform in all States aimed at improving the effectiveness of building compliance and enforcement systems generally has overtaken and subsumed measures directed at improving fire safety and cladding issues.

Following the Grenfell Tower fire in 2017, the Building Ministers Forum (BMF) commissioned an independent expert examination of the compliance and enforcement problems within Australia’s building and construction system. A report by Peter Shergold and Brownyn Weir was delivered in February 2018. The report made 24 recommendations directed at the registration and training of building practitioners; improving supervision; auditing and expertise in the industry; and a need for better documentation.

In March 2019, the BMF prioritised six recommendations from the Shergold and Weir Report for development of a consistent national approach, which were:

  • the registration in each jurisdiction of consistent categories of building designers and certifiers;
  • nationally consistent qualification requirements for each category of building designer and certifier registration;
  • better regulation of private building surveyors to minimise conflicts of interest and improve transparency;
  • development of codes of conduct for private building surveyors;
  • enhancement supervisory powers and mandatory reporting obligations for private building surveyors; and
  • better approval documentation to be prepared by appropriate categories of registered practitioners.

Most States have started introducing legislative reforms directed at the six areas that have been prioritised by the BMF.

The NSW government is conducting an inquiry into building standards, quality and disputes. The inquiry released its interim report on 13 November 2019, which identified 19 areas for priority State government action. The key recommendations are:

  • that legislative reform and policy be directed at ensuring adequate insurance protections for consumers, in particular protections under statutory warranties for residential buildings, professional indemnity insurance and the Home Building Compensation scheme, as well as the Strata Building Bond and Inspection Scheme;
  • the government should defer its current package of legislative reforms until it has consulted with the Insurance Council of Australia and its members to develop appropriate insurance products and facilitate adequate insurance coverage;
  • the introduction of licensing, certification and regulation across all categories of practitioners who actually design and build buildings; and
  • a more centralised approach to the issue of flammable cladding in NSW, including a financial support package to assist buildings to rectify and remove it as a matter of urgency.

Following a public consultation process in October 2019, the NSW Government has recently introduced building reform bills that propose to give effect to the priority recommendations made in the Shergold and Weir Report.

The Design and Building Practitioners Bill 2019 passed the third reading in the lower house on 13 November 2019. Presumably there will be further consultation and amendments to the Bill, in accordance with the inquiry's recommendation, before the Bill is debated in the upper house. The Bill (in its current form) proposes four amendments that will be of particular interest to construction PI insurers:

  • The Bill requires designers to provide a declaration that their design (and any variation during construction) complies with the building code and applicable standards. A principal design practitioner must also be appointed to ensure each aspect of the design is coordinated and covered by appropriate declarations.
  • Builders are required to carry out all work in compliance with the certified design, and to provide a declaration at the occupancy permit stage that the construction so complies.
  • Designers and builders are required to hold professional indemnity insurance that covers them for their declarations of design/construction compliance.
  • The Bill imposes a non-delegable duty of care on a person who carries out construction work to exercise reasonable care to avoid economic loss caused by defects in or related to a building for which the work is done and arising from the work. Contracting out of the duty is not permitted. The duty is not retrospective, and it is subject to limitation periods and to proportionate liability legislation.

The Building and Development Certifiers Regulation 2019 is expected to commence shortly. The Regulation provides legislative support for the Building and Development Certifiers Act 2018 that was passed in 2018 to create a simplified and strengthened certification system.  

It remains to be seen whether other States will follow NSW's lead and reform building legislation to impose similar compliance declaration obligations on designers and builders.

Class actions against manufacturers

Two class action proceedings have been filed in the Federal Court of Australia against the two largest manufacturers and Australian distributors of Aluminium Composite Panels.  

The first Court proceeding is against the German manufacturer and the Australian distributor of the "Alucobond PE" product, 3A Composites GmbH and Halifax Vogel Group Pty Limited. The lead plaintiff is the owners' corporation for the Shore Dolls Point residential apartment building in Dolls Point, Sydney, which was constructed in 2011 and 2012.

The second Court proceeding is against the Australian distributor of the "Vitrabond PE" product, Fairview Architectural Pty Limited. The lead plaintiff is the owners' corporation for the Solis Apartments residential apartment block in Warwick Farm, Sydney, which was constructed in 2014 and 2015.

Both proceedings are funded by IMF Bentham. The current class actions are open to property owners, owners' corporations and long-term lease-holders who have suffered or will suffer financial loss due to the need to remove and replace Alucobond PE or Vitrabond PE cladding products, or take other remedial measures. The class actions seek compensation for owners of residential, commercial, mixed-use, and other non-residential buildings throughout Australia on which the Alucobond/Vitrabond PE product has been used.

Product liability claims are made in both proceedings. It is alleged the manufacturers and distributors supplied goods (the ACP) that breached statutory consumer law guarantees that the goods would be of "acceptable quality", meaning they would be safe, durable, and fit for all the purposes for which goods of that kind are ordinarily supplied.

The manufacturers and distributors are arguing that the supply of the ACP was a business transaction, rather than a supply to a consumer, and thus the consumer law guarantees did not apply to the transaction. The manufacturers also plead that the ACP products were capable of being used or fitted onto buildings by qualified professionals in ways that met the BCA, thus any fault for incorrect use lay with the contractors who put the ACP on to the buildings and certifiers who declared it to be used safely, and not the manufacturers or distributors who disclosed all necessary information to allow the products to be used safely.

It is generally believed that a proportionate liability defence is not available to the manufacturer/distributor in an action for breach of the consumer guarantee of acceptable quality, however this is an issue that will need to be decided in the proceeding.

Pleadings have recently closed in the class action proceedings. Hearings are scheduled during November 2019 to refine the group members and common issues to be decided. Builders, designers and certifiers who are facing cladding rectification claims by owners are now giving consideration to whether they can apportion a share of liability to the product manufacturers or distributors.

It seems probable that if the ACP class actions are successful then there could be similar class actions brought against manufacturers of other combustible façade and external insulation materials such as expanded polystyrene (EPS). However, we are not aware of any plaintiff law firms or litigation funders who are "book-building" at this stage in respect of other façade class actions.

Test cases on compliance of ACPs with BCA

Lacrosse

The trial judgment was given in the Lacrosse Apartments decision in March 2019. The judgment has been digested by the industry stakeholders and the key outcomes have been:

  • The Court decided that ACPs with a combustible core are not "bonded laminated materials" under the definition contained in the BCA in 2012. Consequently, ACPs are not deemed to be non-combustible and cannot be used under DTS provisions on Type A and Type B buildings.
  • The trial judge rejected the building surveyor's defence that he discharged his duty of care by acting in accordance with an established (albeit mistaken) industry belief that ACPs were deemed to be non-combustible.
  • Primary responsibility was apportioned to the fire safety engineer, on the basis fire safety engineers are required, when performing an assessment under the International Fire Engineering Guidelines, to consider and advise about the materials that are proposed to be used on the facade.
  • The builder was found liable to the owners for breach of a consumer protection warranty that was incorporated into the domestic building contract that the building would be constructed in compliance with the BCA. However, the trial judge found that the builder had relied on its design team to supply a compliant design and was thus entitled under its novated consultancy agreements to contribution/indemnity from the designers.

The designers and the building surveyor have filed an appeal in the Victorian Court of Appeal. Written cases have been exchanged. A hearing date is expected to be set in mid-2020.

The Royal Women's Hospital

In March 2018, the builder of the Royal Womens' Hospital in Melbourne, Lendlease, commenced proceedings in the Victorian Supreme Court seeking to recover costs of around AUD10 million that it incurred replacing cladding that is alleged to be non-compliant with the BCA.

Lendlease constructed the hospital between 2006 and 2008. The building regulator identified allegedly non-compliant combustible cladding in 2015. In 2017, Lendlease agreed with the Department of Health that it would replace the cladding at Lendlease's cost. In the proceeding, Lendlease claims against the building surveyor, architect, fire safety engineer and façade contractor.

If this proceeding runs to trial, the Court will need to decide whether the cladding complied with the DTS provisions of the BCA that allows combustible products to be applied as an "attachment or lining" to an external wall. The Court will also have to consider the role and responsibilities of the specialist façade contractor.