Why NSW needs statutory warranty reform

Housing affordability is a national issue that has confounded many for a prolonged period of time. Most of the debate has focused on solving the problem through the supply side and fixing planning constraints. The problem in NSW, however, runs far deeper than that and deserves a deeper analysis.

A regular complaint by residential developers in Sydney is that medium and high density residential projects just don't stack up. The cost of producing new product in Sydney is such that prices must continue to escalate and affordability is consequently worsened. Most would point to the inordinately high regulatory costs imposed through the various taxes and charges on new homes as well as the unacceptably tortuous approval processes. But what isn't typically discussed is that a key part of the problem also lies with the cost of construction.

It would be easy to criticize rising labour costs and other productivity constraints impacting the construction industry but, anecdotally, these issues are not constraining the profitable delivery of apartments in other States such as Victoria. In fact, Melbourne currently has just over 6500 apartments under construction within the CBD or fringe CBD locations, whereas in Sydney the same number is less than a third as much and declining. Labour costs and work practices are essentially the same between these two states, however the average cost of construction, measured on a per square metre basis, is significantly different. Construction rates in Melbourne are often up to 30 percent less when compared to Sydney. That means even if you assumed land values and taxes are the same, the total development cost of an apartment in Sydney is up to 15-20 percent more expensive than in Melbourne, due solely to the cost of construction.

The answer for this is simple - between one third and one half of this extra cost is as a direct result of the operation of the Statutory Warranty provisions under the NSW Home Building Act. These costs are now so great they are being passed through to the consumer.

The NSW Home Building Act has a long and sorry history, having undergone numerous legislative changes over the past decade as a response to such market failures as the collapse of HIH and FAI as insurers of last resort under the Home Warranty insurance scheme and the withdrawal of other providers from this market. The Home Warranty Insurance Scheme is established under the Home Building Act 1989 and commenced on 1 May 1997. It is an integral part of the consumer protection package for home owners having building work undertaken. Part 2C of the HBA details Statutory Warranties to be applied to contracts for residential building work. The scheme needs to be retained but reforms are needed to make it work as it was intended.

What was meant to be a system that ensures strong consumer protections against sub-standard workmanship and the financial failure of residential builders has, unfortunately, been relegated to one that is open to the exploitation of unscrupulous, ambulance-chasing lawyers not unlike the situation that was experienced in NSW under the previous Workers Compensation regime before that legislation was amended. It speaks volumes that few, if any, of the claims currently being pursued under the Statutory Warranties regime are being prosecuted by the top tier legal firms in NSW, rather they are being pursued by a group of smaller law firms.

The system relies entirely on the court system to determine claims that are ultimately in dispute. With a structure that has little consequence resulting from vexatious or ambit claims, over-claiming has become endemic and seen as a legitimate tactic by claimants to force negotiated financial settlements. More often than not the quantum of financial settlement is pursued over the rectification of alleged defective work. The end result is one where disputes are managed by claimants through an expensive and drawn out series of non-binding mediations, exhaustive and expensive discovery processes and a battle of competing consultants.

The consequences have been severe. The whole scheme is legalistic, adversarial and not conciliatory. Legal wrangling can drag on for years costing consumers and builders alike millions of dollars in legal fees. Uncertainty in the definition of structural defects and some active litigation lawyers have distorted the operation of the scheme, whereby builders are needing to provision for vast sums of contingencies to meet future claims. These contingencies are often well in excess of the profit margins they have earned constructing these projects. Most of the settled claims spend their money on legal fees and expert reports and not on rectification works and, in many cases, the items identified for repair don't get repaired. Some strata bodies lose substantial funds pursuing spurious claims. There has been a steady withdrawal of the higher quality and top tier contractors from the residential construction market in NSW. Lower quality residential housing will be built and the void is being filled by companies without the required resources. Some of them are phoenix building firms who won't be around to meet any claims as they will simply fold when the job is done.

It comes as no surprise that homeowners surveyed by the UNSW for the recently released ‘Governing the Compact City’ report are also expressing increasing levels of frustration and anger at the excessive costs, lack of action and financial failure of builders they are experiencing when trying to fix defects.

The scheme is not working as intended.

This is a serious policy issue for NSW. It is not only a major barrier to both investment in the state as well as a key disincentive to tier 1 contractors in residential construction, but has also led to a significant deterioration in consumer protection for residential owners in this state. These problems do not occur in other states with similar schemes.

Reform to the Home Warranties Scheme is an important micro-economic reform. The reform agenda is actually one that seeks to have the scheme work the way it was meant to by protecting the consumer against serious defects and ensuring building problems are fixed in a timely and cost-effective manner. The way this can be achieved is by reinstating a non-legalistic and binding resolution mechanism.

The key reforms being sought are as follows:

  1. The legislation needs to reinstate a proper distinction between latent structural defects and non-structural defects. This will ensure that non-structural or cosmetic defects are dealt with in an appropriate time frame and not become clouded by an excessive passage of time and a lack of building maintenance.
  2. All claims must provide as a necessity the particulars of the claim, ensuring real issues are being dealt with and acting as a deterrent to vexatious or ambit claims. In order to bring a claim the owners should be required to give adequate particulars of each specified defect or class of defect and the nature of rectification claimed. In nearly all other legal actions involving claims for damages there is a requirement that the claimant actually give particulars of what damages have occurred, but no such basic legal onus applies under the Home Warranties Scheme.
  3. A non-litigious and binding process needs to be introduced to ensure real defects are identified and fixed in an appropriate time frame by the builder. In Queensland, for example, experienced building inspectors will attend the site to independently assess all claims for defective work and issue appropriate instructions. Failure to comply with a works order can lead to disqualification of a builder's licence. Whilst similar infrastructure was dismantled many years ago in NSW it will be possible to introduce a panel system of certified private sector building inspectors, approved by the Director General, with the necessary experience and powers to determine claims in NSW. For this to work properly when a claim is made the inspector will attend the property before the expiry of the relevant warranty period and adjudicate on the list of non-structural or structural defects as the case may be under a binding determination.
  4. 2- and 6-year warranty periods for non-structural and latent structural defects respectively with no extensions of time.
  5. The sole remedy should be the rectification of defective work either by the subject contractor or a third party. There is no imperative under the legislation to rectify alleged defects. Rather, financial settlements are often the primary objective in the majority of claims. In fact, in an increasing number of settled claims monies received from builders remains unspent often years after a claim has been settled. This practice is a detriment to the homeowners and is contrary to the intent of the whole scheme.
  6. Claims for defective work are assessed against the building codes, practices and the level of contract specification of the subject building at the time the building was constructed. Materials should be deemed suitable for the purpose for which they are used if they meet the specifications in the relevant contract for residential building work, or in the absence of such specification the materials meet the requirements of the Building Code of Australia.
  7. Requirement that owner's corporations properly maintain their property and provide certificates of adequate maintenance coupled with compulsory 2-year inspections. Often defect claims have resulted from or are obscured by years of reduced or neglected maintenance of a building by the owner's corporation.

It is encouraging that the Minister for Fair Trading, Anthony Roberts, is currently looking at this issue and whilst some changes were made to the Act last year, they did not go far enough or deal with the underlying issues. We encourage the Minister and this Government to see through what will be a campaign based on emotive and misleading arguments against fixing the system.

If reforms are not forthcoming the harsh reality is that tier 1 quality builders will continue to look for other opportunities in other states to deploy their capital because the costs and risks of building residential apartments in NSW are just too great.

George Kostas is Managing Director, Construction + Development, for Brookfield Multiplex Australasia