Upon taking possession and control of an incomplete distressed development asset, a secured financier will more often than not look to complete the project works itself in order to maximise its recovery.
This may necessitate the financier assuming responsibility for the building contract in order to complete the project works or engaging a replacement builder because the original builder may be related to, or an associate of, the defaulting borrower, may itself be insolvent or whose engagement may have already been terminated.
By the very nature of a distressed project and the need to appoint a replacement builder to complete the works, the financier will often be left to bear the ‘cost risk’ of completion of the works. The financier, through its controller, is usually required to engage an incoming builder to complete the project under a ‘cost-plus’ or ‘managing contractor’ method of works delivery. A replacement builder is highly unlikely to assume the cost risk by agreeing to complete the work of a prior builder on a lump (fixed) sum basis.
In both these types of engagement, the cost risk lies with the financier. In order to manage this cost risk and other risks in the completion of the works, financiers and their controllers will assume significant involvement and control over the carrying out of the works.
Design and Building Practitioners Act 2020 (NSW) — Duty of Care
- Section 37 of the Design & Building Practitioner’s Act 2020 (NSW) (DBP Act) imposes a statutory duty on persons who carry out ‘construction work’ to exercise reasonable care to avoid economic loss caused by defects.
- The issue posed in this article is whether it might be held that either, or both of, a financier who enters into possession and control of a distressed site or its appointed insolvency controller who brings the works to completion, are carrying out ‘construction work’ as that term is defined in the DBP Act and thereby subject to the section 37 statutory duty of care.
- Section 37 of the DBP Act provides as follows:
37 Extension of duty of care
(1) A person who carries out construction work has a duty to exercise reasonable care to avoid economic loss caused by defects—
(a) in or related to a building for which the work is done, and
(b) arising from the construction work.
(2) The duty of care is owed to each owner of the land in relation to which the construction work is carried out and to each subsequent owner of the land.
- The extension of this duty of care to subsequent owners of the land means that the benefit of the duty of care owed passes with the subsequent transfer of the land to any new owners.
- This statutory extension of the duty now owed to subsequent owners is a significant departure from the prior common law position.
- Section 37 significantly expands the reach of the duty of care to beyond the High Court confirmation in Brookfield Multiplex v Owners Corporation SP 61288 that no duty of care was owed by builders to developers and future owners in claims for pure economic loss.
- In 2014 in Brookfield Multiplex v Owners Corporation SP 61288 the High Court overturned a New South Wales Court of Appeal decision which had found that a contractor owed a duty of care for pure economic loss for defective work to a successor in title to the developer of a commercial development.
- The new section 37 statutory duty revives the common law duty that existed in New South Wales prior to the decision in Brookfield Multiplex v Owners Corporation SP 61288.
Section 37 duty of care applies to all classes of buildings
- Whilst the DBP Act requirements around building and design practitioner registration and lodgment of compliance declarations and much of the reform in NSW of the construction industry has centred on class 2 buildings (recently expanded to class 3 and 9(c) buildings) it is now settled that the section 37 statutory duty of care owed to owners and all successive owners applies to all buildings (including both residential and commercial buildings).
- Accordingly, financiers and controllers dealing with distressed residential, commercial or industrial developments need to be mindful of the section 37 statutory duty of care.
When might a financier or controller be carrying out ‘construction work’
- ‘Construction work’ is broadly defined in the DBP Act and potentially relevant to financiers and their appointed controllers includes ‘supervising, coordinating, project managing or otherwise having substantive control over the carrying out of any work (our emphasis).
- The NSW Supreme Court[1] has suggested that a developer who ‘is in a position where it is able to control how construction work is carried out’ may have ‘substantive control over the carrying out’ of construction work within the meaning of section 37(1) of the DBP Act.
- It might follow that a financier, or its controller, who is involved in the performance of building work, and where that involvement amounts to supervision of, or control (be it actual control or an ability to exercise control) over the works, may be held to owe a duty to present and subsequent owners of the land, to exercise reasonable care to avoid economic loss caused by defects.
- The liability of a financier or controller under section 37 of the DBP Act has not as yet been considered by the courts.
The duty of care is non-delegable
- Relevant to financiers and controllers in the event that it is held that they owe the section 37 duty of care, is the recent High Court decision in The Owners – Strata Plan No 84674 v Pafburn Pty Ltd where the Court held that:
- the section 37 duty of care was a non-delegable duty of care;
- section 5Q of the Civil Liability Act 2002 (NSW) (CLA) required the liability for breach of the non-delegable section 37 duty of care to be treated as a vicarious liability; and
- the section 37 duty of care is not discharged by the exercise of reasonable care in the selection by a developer of a skilled replacement builder or by the selection by the builder of skilled sub-contractors.
- The Pafburn decision informs that:
- a developer does not discharge its duty of care by the exercise of reasonable care in the selection of the builder; and
- a builder does not discharge its duty of care by the exercise of reasonable care in the selection of skilled sub-contractors.
- If a developer does not discharge its duty of care by the exercise of reasonable care in the selection of the builder, then might the same not follow in the case of a controller exercising reasonable care in the selection of the builder.
Proportionate liability defences not available
- As a result of the High Court finding that the section 37 duty was a non-delegable duty and the liability for breach being a vicarious liability, the Court held that the proportionate liability legislation in Part 4 of the CLA was not available to reduce liability under the section 37 duty of care.
Six key takeaways:
- Even where the financier or receiver have delegated the carrying out of the works to a builder, subsequent owners may still allege that defects were caused in the time when the financier or controller was exercising control, or had the ability to exercise to exercise control, over the carrying out of the construction work.
- If found to have substantive control over the construction works, a financier or controller could be held to owe to the owners and subsequent owners of the land, the non-delegable statutory duty to exercise reasonable care to avoid economic loss caused by defects.
- A financier or controller found liable to an owner or subsequent owner under section 37 of the DBP Act could not raise the CLA proportionate liability defence to limit their liability to an amount reflecting the proportion of the loss that the court considered just having regard to the extent of their responsibility.
- A liable financier or controller would be left to issue cross-claims for contribution or indemnity against others (such as the builder) who it is alleged were responsible for the defects (concurrent wrongdoers).
- In such circumstances, the financier or controller would be assuming not only the costs of bringing the cross claims but also the insolvency risk of the builder well beyond the date of completion of the works, payment of the contract sum in full and the return of any performance security provided by the builder.
- Whilst awaiting judicial guidance to provide further certainty in this area, financiers and controllers tasked with completing a distressed development project must continually and proactively monitor the quality of the works to minimise the likelihood of defects.
[1]The Owners – Strata Plan No 84674 v Pafburn Pty Ltd [2022] NSWSC 659
