Giving Security in Construction Contracts

It is not uncommon in construction contracts for a principal or even a head contractor to insist on security from a contractor or subcontractor. We discuss below the purpose of the security, the different types of security commonly given and what happens when a call on a security is made.

Why is ‘security’ given in a construction contract?

The purpose of security is to provide the principal or head contractor with protection if the contractor or subcontractor fails to fulfil its obligations or defaults in some way on the contract. The principal or head contractor can recoup losses that arise because of the default.

The requirement for security to be provided may also be a sensible precaution for a principal, if a contractor or subcontractor is seeking pre-payment for building materials or goods (such as bathroom or kitchen fittings) that are yet to be used in the construction project.

Similarly, a contractor may be wise to insist that a principal (or head contractor in the case of a subcontractor) provides security for any payment obligations that may be owed to them. This way, the contractor can still obtain payment if the principal fails to pay what is owed. This is especially important if the principal or head contractor is what is commonly referred to as a ‘$2 company’, that is a company without any substantial assets.

Types of security

Depending on the size and scope of the contract there are a number of options that are commonly available for providing security. These include cash, bank guarantees and insurance bonds.

The simplest type of security is ‘retention money’ or a cash security. This is when a party who is paying another party under a construction contract holds a specified sum of money back from progress payment. This is usually a percentage of the amount payable, and is eventually released at practical completion of the contract or at the end of the defects liability period.

Alternatively, bank guarantees and insurance bonds may be used instead of cash. These forms of security essentially amount to types of promises by a third party to pay an amount of money when a specified event occurs. A ‘specified event’ may include such things as a default by the contractor to complete work on time, a default in payments by the principal (if the security is in favour of the contractor) or even something as simple as a demand for payment.

The advantage of bank guarantees and insurance bonds is that they do not impact as significantly on cash flow, for the party giving the guarantee, as a cash security will. However, in order to obtain a bank guarantee or bond the party providing the security is required to pay a fee to the bank or insurer and is likely, in the case of a bank guarantee, to be required to provide some kind of cash deposit or mortgage over real property or some other security.

Insurance bonds operate in a similar manner to a bank guarantee but generally only a fee for the bond is required, and there is no further security such a mortgage. The cost of the fee for an insurance bond will be determined by both the size of the security and the risk (as assessed by the insurer) of the contractor defaulting and the insurance bond being called upon by the principal.

In addition to the guarantees discussed above, a ‘parent company guarantee’ may be required by a principal if a contractor or sub-contractor is part of a wider organisation. The effect of this type of guarantee is that the parent company becomes responsible for any default by the contractor. This can include stepping in and taking over any of the contractor’s obligations in the event of a default. Ordinarily, whichever approach is adopted the liability of the parent company will be subject to an agreed cap.

Another security option is what is colloquially referred to as a ‘letter of comfort’. This type of security is less common and is generally only used when a contractor is not an Australian company or individual and may be offered as evidence of financial standing. However, it is important to realise that letters of comfort are not the same as a bank guarantee or an insurance bond. A letter of comfort may not necessarily give rise to an immediately enforceable legal right on the part of the recipient of the letter and should be treated with considerable caution and care.

What happens when a call on security is made?

Even if unconditional security is given, it is likely that a contract will stipulate restrictions on when the security is able to be called on. Often a contract will be drafted in such a way that calling on a security involves multiple steps. For example, it is usual that the principal will firstly need to show that they have an entitlement to call on the security. Secondly any required notice of the intention to call on the security will need to be given. Finally, any obligation to give notice within a certain period of time needs to be met.

Can a contractor stop a principal from calling on a security?

It is possible to commence court proceedings seeking an order for injunction, to prevent a principal from calling on a security. However, it can often be difficult to obtain orders granting such an injunction unless certain pre-existing conditions are satisfied. These conditions may include that the contract provides for a restriction on the right to call on the security and that there is a genuine dispute between the parties as to whether the principal has an entitlement to claim payment or money from the contractor or subcontractor.

In addition, whether an injunction is granted or not may ultimately turn on the question of where the ‘balance of convenience’ lies. This will be decided by whether or not convenience dictates that the security should not be disturbed until the dispute between contractor and principal is resolved.

Conclusion

The giving and receiving of security is an important part of construction contracts. However, it is important that all parties to the contract understand the scope of the security and any limitations that are imposed on the parties by the contract in relation to both providing, and calling on a security. This understanding is vital for avoiding costly misunderstandings and potential litigation.

If you are considering entering into a contract that provides for security we recommend you seek legal advice before agreeing to any security provisions. We would be happy to discuss the implications of providing or receiving a security with you.

If you or someone you know wants more information or needs help or advice, please contact us on +61 2 9248 3450 or email info@bradburylegal.com.au.

Liquidated damages in construction contracts and the dangers of penalty

The inclusion of a liquidated damages clause in construction contracts is a common way of addressing what consequences will flow from a breach of contract during the life of the contract and when a build is ongoing. However, to be effective they must be well-drafted.

It is therefore important to understand exactly what is meant by this term, particularly if you find yourself in the unfortunate position of being the party in breach under the contract.

What are liquidated damages?

In their simplest form liquidated damages are fixed damages. They are a way of calculating what compensation a party will pay to another party to that contract, if it is in breach of its obligations. The party in breach is known as the defaulting party, and the party not in breach is the non-defaulting party.

A common example of liquidated damages clause is for delay of the contractor. This might be that the contractor will owe the principal $3000 in damages for each day of delay in achieving practical completion.

The exact amount of damages for a breach of contract can often be difficult to calculate at any given moment. Rather than a contract providing for an unquantified amount of damages, a liquidated damages clause fixes the sum of any damages in advance and includes details of the sum to be paid should a breach occur in the contract.

Are liquidated damages the same as agreed damages?

The short answer is ‘yes’. Other terms you may come across, which effectively mean the same thing as ‘liquidated damages’ include ‘pre-estimated damages’, ‘stipulated damages’, ‘liquidated and ascertained damages’ and ‘adjustment of time costs’.

Liquidated damages clauses in construction contracts

Liquidated damages clauses are useful in construction and other commercial contracts because they provide a degree of certainty for all parties as to what will happen should a breach of contract occur. A valid liquidation damages clause will fix the amount recoverable under the contract without the need for costly litigation.

It can sometimes be difficult to quantify the extent of any damage suffered when a build is ongoing. However, a liquidated damages clause will mean that here is no need for the non-defaulting party to undertake the time-consuming and complex process of proving their loss or damage with evidence. The clause also allows both parties to decide in advance exactly what their respective rights and liabilities will be in the event that a breach occurs.

Liquidated damages clauses are particularly relevant for construction contracts because they:

  • Allow the parties to quantify and be clear about risk allocation and their intentions should a breach of contract arise and also allow parties to clearly understand in advance how loss will be calculated should a breach occur;
  • Encourage all parties to comply with their respective contractual obligations in the knowledge that if a breach occurs the clause can be enforced without the need to resort to litigation;
  • Allow a contractor, at the time they are tendering, to factor the price of their exposure (the amount specified for liquidated damages it there is a breach) into their contract price;
  • Allow a contractor to compare the cost of accelerating works in order to achieve practical completion by a required date versus the amount of any liquidated damages sum that becomes due and payable if the date for practical completion is not achieved;
  • Provide a ceiling or cap on a contractor’s liability for damages for specified breaches of contract;
  • Provide a principal with a means to recover damages regardless of the amount of any actual loss; and
  • Do not require the non-defaulting party to mitigate their losses, in contrast to other forms of damages.

What if I want to claim non-liquidated damages?

In rare cases, a liquidated damages clause will mean the right to damages under general law, calculated in court, will be lost. If clear and unambiguous words indicate to a court that the party wanted the liquidated damages to be the entirety of their damages for an event such as delay, then that party will lose their entitlement to general damages. Regardless of actual losses, it will be capped.

As determined early last year in the Victorian tribunal case Leeda Projects Pty Ltd v Zeng, courts will assume that general damages are not excluded by a liquidated damages clause, but they can be persuaded otherwise. In one disastrous example in England, the parties had entered ‘£ nil’ in the liquidated damages clause for delay, and the court found that the surrounding circumstances showed that the parties intended to exclude all damages for delay when using this clause.

Liquidated damages vs. penalties

Understanding the difference between liquidated damages and penalties is vital for any contracting parties. This is because courts will enforce liquidated damages clauses, but they have also made it clear that they will not enforce a clause if it amounts to a penalty clause.

In the eyes of a court, a clause will be a penalty clause where the amount of fixed damages in the contract is not a genuine pre-estimate of loss or damage sustained by the non-defaulting party, or where it does not protect the legitimate commercial interests of the non-defaulting party. Rather, where a provision is a kind of punishment for non-observance of the contract, it will be a penalty.

It is not enough for parties to label a clause ‘liquidated damages’ in the contract, or to state that ‘the parties agree that this is not a penalty clause’. Courts will consider whether in substance it is a penalty.

The factors that determine whether a liquidated damages clause is a de facto penalty clause will vary from build to build and contract to contract. However, the courts have traditionally applied some key tests when considering whether a contractual provision goes beyond liquidated damages and is in fact a penalty.

The first key questions to consider are:

  • Is the amount provided for in the clause ‘extravagant and unconscionable’ when compared with the greatest possible loss that could possibly be shown to result from the particular breach of contract?
  • Does the breach consist solely of non-payment of money which results in a larger sum for damages being required?
  • Does the clause stipulate the same amount is to be paid for different breaches, even if the breaches vary in terms of seriousness?

If the answer to any of these questions is ‘yes’ then it is likely the clause will be a penalty and will not be enforceable.

What if actual loss can’t be quantified?

A clause may be a valid liquidated damages clause even if it is not possible to estimate in advance the actual or true loss that may be suffered. The main consideration is whether the liquidated sum is extravagant. Therefore, it is important to consider carefully the tests above when determining the size and scope of any liquidated damages clauses.

Conclusion

The difference between a reasonable liquidated damages clause and an unenforceable penalty clause can be a difficult line to draw, even when all parties to a contract enter into negotiations with the best of intentions.

Before entering into a contract or agreeing to a liquidated damages clause it is always advisable to seek legal advice to ensure that you understand the full ramifications of the agreement and to check that, if needed, the terms of the contract will be enforceable by you or the other party.

If you or someone you know wants more information or needs help or advice, please contact us on +61 2 9248 3450 or email info@bradburylegal.com.au.

Employees, independent contractors and ‘shams’ in the construction industry

It is common for builders and operators in the construction industry to utilise contractors to carry out specific trade skills such as concreting, plastering, bricklaying and plumbing.

Business operators however, need to be cautious when ‘hiring’ skilled or other labour to ensure that they are not in breach of provisions of the Fair Work Act 2009 (Cth) (the ‘Act’). The Act prohibits a person from misrepresenting ‘employment’ as ‘independent contracting’, otherwise known as ‘sham arrangements’.

These sham arrangements have been predominant in the construction industry and are illegal.

It is important for business operators to understand the difference between an independent contractor and employee.

Example of a sham arrangement

Sham contracting came back to haunt Royans Wagga Pty Ltd in the 2017 case, Putland v Royans Wagga [2017] FCA 910. Royans Wagga was a business primarily running truck repairs. Linda and Shane Putland performed work for Royans Wagga over many years in a call centre, obtaining and passing on information about vehicle accidents to Royans Wagga sales representatives so that repair work could be secured.

If the Putlands could prove that they were employees and not independent contractors, they stood to gain significant back pay and payment in lieu of reasonable notice of termination. Meanwhile Royans Wagga stood down the barrel of a long list of contraventions of the Act and pecuniary penalties. It therefore denied the employer-employee relationship, arguing that the Putlands were independent contractors.

As is often the case, a number of factors pointed towards either relationship. Bromwich J had to balance these factors against each other and arrive at a conclusion.

Is someone an employee or an independent contractor?

The distinction between an employee and independent contractor is not always easy to determine. Generally, the Fair Work Commission or a Court will look behind the label given to the arrangement by the parties to identify the factual substance of the relationship. How one party or both parties view the relationship is not determinative of the issue.

Primarily, an employment relationship is an exchange of labour (time, skill and effort) for remuneration – the employee serves the employer as opposed to carrying on a business in his or her own right.

If the worker is acting as an entrepreneur who owns and operates an enterprise and as a representative of its own business, then it is more likely that the worker is an independent contractor.

The entirety of the relationship is analysed which might consider the following factors:

  • the degree of control that a business operator can exercise over a worker engaged to perform work (whether the control is actually exercised or whether just the potential exists);
  • whether the worker works exclusively for the business operator;
  • the provision of a uniform, business cards, tools etc. from the business operator;
  • whether the worker undertakes work personally or is free to delegate to others;
  • the location of the work;
  • the method of payment for the work performed – whether at an hourly rate or on completion of a specific project, whether wages are paid or there is a commission;
  • the responsibility for acquisition and maintenance of equipment;
  • the creation of goodwill of saleable assets through the work performed;
  • the allocation of risk and profit associated with the work;
  • the degree of integration the worker has with the entity for which it works;
  • the existence of leave, taxation, superannuation payments, etc;
  • how ‘business-like’ is the business of the business operator – are there systems, manuals, invoices etc;
  • the right of the business operator to dictate the place of work, hours of work etc. of the worker

This list is not exhaustive.

In the case above, Royans Wagga required the Putlands to obtain ANBs, it issued tax invoices in lump-sum amounts, it did not deduct income tax, it did not require uniforms to be worn, and it paid others to do work.

On the other side of the scales, the Putlands only worked for Royans Wigans, their telephone and internet accounts were paid by Royans Wigan, they had their office equipment supplied, they did not advertise any business run by themselves, their work led to Royans Wigans accruing goodwill, and they lacked ‘true autonomy’ in their work. Evidence also indicated the managing director of Royans Wigans had authority to control and issued directions and approvals to the Putlands.

Bromwich J decided it was an employee-employer relationship, to Royans Wagga’s significant detriment.

Misrepresenting employment as independent contracting

A business operator is prohibited from offering a person a role as an independent contractor when the relationship between the parties is really one of employer-employee.

Section 357 of the Act states: ‘A person (the employer) that employs, or proposes to employ, an individual must not represent to the individual that the contract of employment under which the individual is, or would be, employed by the employer is a contract for services under which the individual performs, or would perform, work as an independent contractor.’

To take advantage of a sham arrangement, the employer would insist that the ‘contractor’ obtain an Australian Business Number (ABN) and create his or her own business before commencing work. The worker is generally responsible for paying his or her own taxes and insurances.

The worker is treated as an independent contractor and the employer circumvents the obligations that would normally arise from an employer-employee relationship. Consequently, by signing up as an independent contractor, the worker foregoes access to employment entitlements such as payment for annual and sick leave, long service leave, compulsory superannuation contributions and protection from unfair dismissal or termination of employment.

For contractors who are genuinely running a business as a profit-making enterprise this is not problematic. However, in the case of a sham arrangement, the workers may earn a higher hourly rate, but perhaps not conducive to a profit-making enterprise, from which they must pay their own tax, insurance and superannuation. In such circumstances, the sham arrangement results in the employer ‘getting its cake and eating it too’.

Sham arrangements are illegal

It is illegal to inform a someone that he or she is an independent contractor if they are actually an employee. It is also illegal to dismiss an employee or threaten to dismiss an employee for the purpose of ‘re-engaging’ them in predominantly the same work as they performed whilst they were employed.

Similarly, a person must not induce a former employee to carry out the same type of work as when they were employed under the guise of an independent contractor arrangement. Where an employer employs or has at any time employed an individual to perform particular work, the Act also makes it illegal for the employer to make a statement that they know is false in order to persuade the individual to perform substantially the same work as an independent contractor.

Businesses entering sham arrangements risk significant civil penalties and potential claims for back-pay of employee entitlements such as annual leave payments, sick leave and superannuation contributions.

Why do businesses use sham arrangements?

A sham arrangement may result from simple ignorance on the part of the business owner or a desire to minimise costs. A worker may even indicate that he or she is ‘happy’ with the arrangement.

Sham arrangements may be prevalent during the start-up phase of a new business where cashflow is limited and the future success of the enterprise unknown. Conversely, businesses may have been running sham arrangements for some time.

The temptation to use ‘contractors’ instead of employing staff usually flows from a desire to circumvent the financial and other responsibilities that arise from an employment relationship. If the business takes on workers as independent contractors rather than as employees, the business need not comply with nationally-recognised employment conditions, annual leave, sick leave, workers’ compensation or termination processes.

Conclusion

If you are considering engaging workers for your building projects, you should think carefully about the arrangements to determine whether your workers are truly independent contractors or employees. If you are unsure, obtain legal advice.

Failing to do so could lead to significant costs down the line.

Please contact us should you require any further information, on +612 9248 3450 or email info@bradburylegal.com.au

Deal or no deal: electronic signatures and contract law

Of the many changes brought by the digital age to the commercial landscape, one that is overlooked is the act of executing a contract. The days of wet-ink signing ceremonies in boardrooms are on the way out, while clicking a computer mouse a few times is fast becoming the norm. This can lead to situations that will make any company director uneasy.

Williams Group Australia v Crocker

A software system HelloFax enables users to upload their digital signatures to a document if the correct password and username are entered. Director A of a building company sets up usernames and passwords for Directors B and C. The passwords are not changed. Down the track, Director A uses these passwords to execute an application for credit not only in their name but also in the names of Directors B and C. Director A also executes personal guarantees bearing the digital signatures of all the directors. A lending company approves this credit application, and over time a $889,534.35 debt is accrued.

Eventually, the lending company claims the debt from the building company, and from the directors personally. Director C learns that they are being personally sued for hundreds of thousands of dollars.

Of course this was a real case: Williams Group Australia v Crocker [2016] NSWCA 265. One of the parties was going to be left up the proverbial creek without a paddle. If the contract was void then Williams Group Australia’s debts were lost. If the contract was valid, then the innocent director Mr Crocker was going to foot the substantial bill for a contract he didn’t sign.

Digital signatures made basic questions difficult. As Crocker said in evidence: “Well it’s difficult when you’re presented with … your signature that’s electronic to know whether you did or didn’t [sign it]”.

Ultimately Crocker won, as he had not represented that his co-director had authority to sign on his own behalf. Had it been he who set up the signature software, however, it might have been different. And the substantial legal bills undoubtedly soured the victory. A warning shot was fired for all users of digital signatures.

Digital signatures and electronic signatures: some basics

Some quick definitions:

  • Electronic signatures are essentially like traditional handwritten signatures but in electronic form: typing a name into an email, or pasting an image of a signature.
  • Digital signatures use a code attached to an electronic document that identifies and authenticates the signatory. Adobe Sign for PDF files is one example. One party has a ‘private key’, which enables them (and only them) to sign a document. The other another party has a ‘public key’ enabling them to see the signature, but which does not let them edit the signature.

In both types of signature, if a witness is required, they must be present to witness the authentication.

What risks do electronic executions open a company up to?

Of course, there are enormous benefits brought by the rise of digital and electronic signatures. The software keeps a record of who signs and when. They are efficient: signatories don’t need to leave their office, and can almost instantaneously do business with parties on the other side of the globe. However, this rise also brings added complexities.

Two of these must be considered by businesspeople:

  1. Unauthorised use of the signature, or forgery, is now quite easy. Directors must beware of colleagues or fraudulent third parties taking their signature or the digital key. Even though forgery is illegal and renders a contract void, it creates huge problems, especially if the fraudulent party has disappeared with the money. Also, it won’t be forgery where a superior has given a subordinate authority to use the digital signature software; working out whether this has happened is not always easy.
  2. On the other side of the coin, a person may intend to sign a contract, but if the electronic execution is not done according to law, a contract may be deemed unenforceable and the other party can escape its obligations.

The law tries to find a line between a desire for commercial convenience and the desire to prevent forgery. It pays, sometimes in the hundreds of thousands, for signatories to be aware of the law around electronic execution.

A contract is void if the signature is forged, so that it is as if the contract never existed. However, this is no consolation if the forger has disappeared.

So how do I digitally execute my contract properly?

Very generally, the law’s position is not totally different for digital execution as for physical wet-ink execution. Contract law remains the same at its core: there must be an intention shown to make an offer and to accept that offer.

Having said this, there is no short answer to this question. Certain types of contracts, such as for sale of land or for giving someone else your right to sue, have particular requirements and electronic execution might not suffice. Statutes will have different definitions of signature.

Australian governments foresaw the issue of electronic execution at the turn of the century. They enacted the Electronic Transactions Act 1999 (Cth) and the Electronic Transactions Act 2000 (NSW).

These Acts make it clear a transaction, including a contract, is not invalid just because a signature was made electronically. Additionally, if an Act requires someone to give information in writing, this is satisfied by electronic communication so long as this communication is readily accessible and the other person consents to electronic communication.

To meet the requirements of signature by electronic means:

(1) A method must be used to identify the signing party and to indicate the person’s intention;

(2) This method must be as reliable as appropriate for the purpose for which the electronic communication was generated; and

(3) The other party must consent to the use of electronic means to sign a document.

Where the signatory is someone acting on behalf of someone else, e.g. an employee for a corporation:

(4) The signing person must have authority to bind the principal.

The cases confirm this story. Generally, a person must put their name or mark to a document, and the important part is that they must do this “for the purpose of adopting or authenticating the document”. In some contexts, a typed first name at the end of an email suffices to create legal relations between the receiver and the sender.

Businesspeople should be very cautious in relation to witnesses to signatures, as attestation is not apparently protected under these Acts. It is assumed electronic attestation is permitted under law, but this has not been demonstrated yet.

The fourth element: binding a principal

As (4) indicates above, the situation is further complicated for companies or other principals and their agents. The person signing a document must have some form of authority to do sign on the principal’s behalf.

This authority must come from the company. Always the safest form of authority is express actual authority: the company should inform the other party in writing that the agent has the authority to use the electronic signature.

A company may also give the person ostensible authority, such as by providing them a certain title, status and facilities. Common practice is for businesses to put in place an organisational structure that gives the appearance to outsiders that an officer has the authority to bind the principal. For example:

  • Giving an officer the title ‘Manager’ and providing letterheads and business cards gives ostensible authority to the officer.
  • Significant prior dealings in which a person acted on behalf of the company, to its apparent acceptance

Conclusion

In Williams Group Australia v Crocker, if the director Crocker had made some representation that his co-director had authority to sign on his behalf, then he could well have been bound. This ostensible authority might have arisen if Crocker had set up the electronic signature system himself. He was saved by the fact that his co-director had set up the system.

Crocker was also saved by the fact that email notifications that came with use of his digital signature were not detailed enough to inform him of the full circumstances of his signature being used by his co-director. Had they fully informed him of the circumstances and had he done nothing, he may have ‘ratified’ the signature and beared the costs.

The court did not resolve the question of whether a ‘genuine’ electronic signature made without authority is forgery, but hinted that it might be.

The story is not happy for any of the parties. Crocker was still put through the ordeal of expensive legal proceedings. Williams Group Australia faced huge losses.

The case shows that in the digital age, training and rigorous checks and balances are more important than ever in ensuring that employees understand how their signatures are used and who has authority to use them.

And there is no substitute for open communication between the two parties about who has authority and how they will exercise it.

If you or someone you know wants more information or needs help or advice, please contact us on +612 9248 3450 or email info@bradburylegal.com.au

Dealing with variations in building contracts

Variations to the scope of works, or variations to the services to be provided, under a construction project are common in the building industry.

A variation may be requested by either party or arise out of necessity, for example, due to changes required in legislation or because of a latent condition.

When negotiating a variation, it is important to follow the process required under the contract and to ensure that the variation is clearly documented.

What is a variation?

The scope of works to be provided under a building contract will generally be set out in attached specifications, plans, or a service brief, which together form the whole contract.

The scope of works is an integral part of the contract. It identifies those works for which the contractor will ultimately be liable and is the basis from which alterations or additions will be classified a variation. The categorisation of a variation is important as it affects a contractor’s right to claim additional costs and a principal’s obligation to pay them.

The following concepts are relevant in determining what constitutes a variation:

  • The variation must be requested and be something that is not already covered in the scope of works. If there is no request by a principal to vary the scope of works, a contractor will have difficulties in claiming additional costs.
  • Similarly, if higher quality materials are provided than what is specified in the scope of works, a contractor will not have a right to charge for the upgrade unless this was specifically requested.
  • Work that is indispensably necessary to complete the job, although not spelt out in the contract or scope of works, is not a variation. An example of work that is intrinsic to the job is the installation of hinges when hanging doors – although the specifications may not refer to ‘hinges’ per se, it is obvious that the provision and installation of doors cannot be completed without this component.
  • A complete change to the scope of works by the principal is not a variation and may give a contractor a right to terminate the contract.

Dealing with variations

Variations to the scope of works often lead to disputes in the construction industry. It is therefore important that both parties understand the significance of a variation and the processes required for requesting and claiming them.

A principal may require that the contractor undertake more or less work than that provided in the scope of works. Issues can arise where a contractor is not qualified for, or does not have sufficient resources to, undertake the additional work. Similarly, if work falling within the scope of works of a contract with one contractor is given to another contractor, this will be problematic for both parties and may result in a breach of the contract by the principal.

To avoid a potential breach which could allow a contractor to terminate the agreement, principals should ensure that their contracts contain provisions that enable them to request variations to the original scope of works. The contract should identify the circumstances under which a variation might be requested and set out clear processes for varying the scope of works or services.

Principals should also be aware of the difference between a variation and a complete overhaul of the scope of works which may entitle the contractor to terminate the contract.

Contractors should ensure that they will be adequately paid for works additional to the original scope and follow the processes outlined in the contract for applying for modifications.

A variation may be requested by a contractor who needs to carry out additional work to fulfil the scope of works. This may occur where latent conditions arise. Latent conditions are physical conditions on the development site that are materially different to those that would reasonably have been contemplated, notwithstanding a contractor having made all due inspections and investigations of the site.

The contract will generally provide a timeframe during which a contractor may notify the principal of a pending variation. The contractor will typically be required to set out reasons why the variation is required and the costs in carrying out the additional work. The contractor should always obtain approval before undertaking any variations.

Quantum meruit claims

In some circumstances, strict compliance with the variation procedures set out in the contract will not be commercially efficient. The need to make a variation may arise without adequate time to follow due process, particularly when it is necessary to avoid delays or wastage.

Even if they are refused payment for the variation on the basis that the correct process was not followed, a contractor may still have a quantum meruit claim. In this case, the amount of the claim will be a reasonable price for the work carried out by the contractor, often based on industry standards.

A principal that requests and supervises a variation, despite the fact that the formal process was not followed, will be prevented from benefiting from the additional or modified works.

To succeed in a claim, it must be shown that the principal received a benefit, the contractor incurred expenses in doing the work, and that it would be unfair for the principal to retain the benefit without paying for it.

A contractor who refuses to undertake work requested by a principal that falls well outside of the scope of works provided in the contract, may also have a quantum meruit claim. One example of this is work that is unexpected and that does not ordinarily fall within the principal’s area of construction. In this case, if the contract is terminated, the contractor may be paid for the work completed to date.

Conclusion

A clearly defined scope of works and detailed process for dealing with variations must be included in all construction projects.

The scope of works should be sufficiently detailed and cover additional matters that may arise during construction of the project. The clearer the scope of works, the easier it will be for both parties to recognise and deal with a variation.

If you or someone you know wants more information or needs help or advice, please contact us on +612 9248 3450 or email info@bradburylegal.com.au.

The cost of poorly-drafted building contracts

The importance of having in place a written contract is widely accepted in the construction (or any) industry. But are you putting in the time necessary to understand and document your negotiations, so that your rights are properly secured by your building contracts?

An unresolved contractual dispute depletes time and resources and has potential to damage the parties’ reputation and relationship. Disputes have a devastating effect on a building project and if they are not resolved by negotiation between the parties, they will likely escalate to dispute resolution processes, or even to a hearing before a Court.

In many cases, determination of the dispute will turn on the contract between the parties and what it does, or does not, contain. The words of the contract will be scrutinised, and poorly-drafted terms that are unclear or ambiguous can be the undoing of an otherwise valid agreement.

Case study

Incomplete contract terms that lack explanation or process lead to uncertainty. This was the case in Port Macquarie-Hastings Council v Diveva Pty Limited [2017] NSWCA 97.

In 2011, Diveva Pty Limited trading as Mid Coast Road Services entered into a contract for asphalt works with the council, having successfully tendered in 2005 and 2008. The contract contained an ‘option clause’ which merely stated, ‘with a future twelve (12) month option available’.

There were issues regarding one of the projects undertaken by Diveva, with the council claiming that Diveva had failed to comply with certain specifications under the contract. This matter appeared to remain unresolved both at the time when the council notified Diveva that it would not be exercising the option, and when the council advertised for tenders for future works.

In reliance of the contract, Diveva notified the Council that it was exercising the option. It did not take part in any tendering process. No further contract was offered, and Diveva sued the council for breach of contract.

Original proceedings

In the original Supreme Court proceedings, the Council claimed that the option could only be exercised unilaterally by the Council. The Supreme Court disagreed.

The task of the Supreme Court was to determine in whose favour the option worked. In the absence of a clear term in the contract, the Supreme Court was required to look at the overall language used throughout the entire agreement and found that repeated use of the term ‘option’ was a commercial inducement to tenderers.

The Supreme Court determined that, upon its construction, the 2011 agreement ‘conferred an option upon [Diveva] to extend the Agreement for a further 12 month period’. This conclusion was based on the words ‘with a further 12 month option available’ and the meaning of these words determined objectively and within the context of the Agreement.

Hall J considered that the Council could have protected its interests with clear drafting: ‘It would have been open to the Council to simply have said expressly that the option could only be exercised by Council. However, it did not. The Council could have, but did not use the same formulation, as discussed above, “Council reserves the right…” (employed in other sub-clauses in the Agreement) had it wished to make clear that the Council had the right to renew the Agreement for a further 12 month period.’

Diveva was successful and was awarded damages for loss of profits and opportunity.

Appeal

The council appealed to the NSW Court of Appeal, asserting again that the option clause could only be exercised by the Council alone, or at the very least by mutual agreement.

The Court of Appeal arrived at the same conclusion, and the appeal was dismissed. In its judgment, the Court considered that interpretation of the real meaning in the contract relied on the words used and the intent and purpose of the parties.

The Court found that there was an inference throughout the agreement that the council would offer further work to successful tenderers. The words ‘option’ and ‘available’ were used repeatedly in both the agreement and tender request which, according to the Court, deemed the option capable of being exercised by Diveva unilaterally.

The Court also noted that the option clause provided no qualifying matters, hence council’s allegations of the non-complying work would not preclude Diveva from validly exercising the option. But for the disputed works, the Court considered there was a strong likelihood that the council would have entered into a further contract with Diveva, given its track record, previous dealings and knowledge of council works.

Key points

As the option clause referred to in the above case was silent as to the time, method and respective rights of the parties to exercise, the Court was required to determine its true meaning by looking at the intent of the parties and the language used elsewhere in the agreement.

This may have been avoided if the option clause was drafted to provide how and when the option could be exercised, in what circumstances, and by whom. As stated by the Court, had the council required that the option was to be exercised only unilaterally then it was open for it to have included this in the terms.

Keep in mind the following points to ensure that your building contracts can, under tight scrutiny, protect your rights and interests:

  • Your construction contracts should be negotiated, prepared and reviewed with assistance of an experienced construction lawyer. Money spent now can protect your business against loss down the track.
  • Read your construction contracts, highlight the terms that you don’t understand and ask for them to be explained. Ask, ‘what if’, ‘what happens when’, ‘how should’, ‘who might’.
  • Construction projects often comprise several contracts – these need to align and, where relevant, reflect reciprocal obligations and rights. Pay attention to timelines, completion dates, extension and delay clauses and, of course, options.
  • Use precedent contracts carefully – ensure the fields that are likely to vary from build to build are highlighted so that important information can be populated. Don’t rely on the precedent alone – read the entire contract for each project for relevance and completeness.
  • It is easy for important terms to be overlooked or formatting errors to occur when using precedent contracts, particularly if prepared by staff who are unfamiliar with their contents. Appointing a precedent custodian to supervise access to precedent contracts will help minimise some of these issues.

Conclusion

Poorly-drafted contracts can have unforgiving results, and roll-on effects to subsequent building projects.

If you or someone you know wants more information or needs help or advice, please contact us on +612 9248 3450 or email info@bradburylegal.com.au.

Implied conditions & warranties for home building contracts

Following changes to the Home Building Act 1989 (NSW) in early 2015, the statutory insurance scheme that was established to provide compensation for certain defined losses if a builder dies, becomes insolvent, disappears during a build or fails to comply with a money order from a Court or Tribunal was re-named and is now referred to as the Home Building Compensation Fund.

Along with the re-naming of the scheme a number of other changes were made in respect of warranty insurance and implied warranties and conditions in building contracts entered into in NSW. These changes and the issue of implied conditions are discussed in further detail below.

What is covered by warranty insurance under a building insurance contract?

From 15 January 2016 an insurance contract issued in respect of building work in NSW must provide coverage and indemnity for losses or damage sustained by a beneficiary in respect of residential building work which has arisen because of the suspension of a contractor’s licence as a result of non-compliance by the contractor with an order.

Contracts entered into after 15 January 2016 in NSW only cover residential building work that is required under the Act to be covered by a certificate of insurance. This means that work such as built-in furniture and cabinetry which is done as standalone work and not part of a broader residential building contract is now exempt from the mandatory insurance scheme. For many would be renovators and home owners it is relevant to note that this category of work includes kitchen cabinets.

Statutory warranties

Builders must now provide a 2 year post completion warranty for their work. This period rises to 6 years in the case of ‘major defects’. Major defects are defined as being something that is a major element in a building AND which prevents all or part of the building form being either lived in or used for its intended purpose OR which threaten the collapse or destruction of the building as a whole of part of it. The concept of ‘major defects’ replaces the previous 6 year statutory warranty for ‘structural defects’.

Rectification orders may be issued by NSW Fair Trading Inspectors which require completion of rectification work in specified stages and by certain dates. These orders can also include an order for the payment of any money that is due under the contract.

Under the current legislation rectification work is specified as the preferred outcome of any proceedings before a Court or Tribunal for building claims.

Implied conditions and warranties

Section 18B of the Home Building Act 1989 (NSW) provides that all contracts for residential building work in NSW entered into by the holder of a contractor licence or a person required to hold a contractor licence before entering into a contract, will contain the following implied conditions and warranties:

  • All work will be done with due care and skill and in accordance with plans and specifications as set out in the contract;
  • All materials supplied will be good and suitable for the purpose for which they are being used and, unless otherwise specified in the contract, those goods will be new;
  • Work will be done in accordance with the legislation or any other law;
  • Work will be done with due diligence and within the time specified in the contract. If no time period is specified then work will be done ‘within a reasonable time’ ;
  • Where the work under the contract relates to the construction, alteration or additions to a dwelling the work will result in a dwelling that is reasonably fit for occupation as a dwelling (to the extent of the work conducted);
  • Materials used in doing the work will be reasonably fit for the specified purpose or the result being sought, provided the owner for whom the work is done expressly makes known the particular purpose for which the work is required or the result that the owner desires the work to achieve, so as to show that the owner relies on the holder’s or person’s skill and judgment.

These statutory warranties cover both a principal contractor in respect of their relationship with the owner of land on which work is being carried out and are also implied into contracts where the principal contractor has contracted any part of the work to a subcontractor.

What if there has been a breach of a statutory warranty?

Previously the defence available to a builder or contractor to a claim of breach of statutory warranty was that any defective work was carried out on the instructions of the consumer and was done so contrary to the builder or tradesperson’s written advice.

Post 15 January 2016, a builder or tradesperson can also defend this type of claim on the basis that any defective work was carried out as a result of the builder or tradesperson acting on written instructions from a professional engaged by the consumer before the builder or tradesperson commenced work.

The professional in question can be an engineer, surveyor or architect or some other person with appropriate specialist or expert knowledge that was relevant to the building work in question. Critically that expert must be someone who is independent from the builder or tradesperson about whom the claim has been made.

In an ideal world construction projects would progress smoothly and the need to consider issues of insurance and implied conditions would not arise. Unfortunately this is not always the case and knowing where you stand with respect to warranty insurance as well as implied contractual conditions is likely to be an important part of successfully managing any build. It is always a good idea to seek legal advice before a situation becomes problematic as this can avoid costly unpleasant surprises down the track.

If you or someone you know wants more information or needs help or advice, please contact us on +612 9248 3450 or email info@bradburylegal.com.au.

Early release of retention money

Most construction contracts allow for a principal or head contractor to require the other contractor or subcontractor to provide a form of security. The purpose is to protect the principal or head contractor from loss should the other party breach the contact or fail to perform its obligations.

The simplest form of security constitutes the principal withholding a specified sum of money from a contractor / subcontractor’s progress payments. This is known as a retention amount or cash security.

The timing of release of the retention amount after work is completed by the subcontractor is sometimes contentious. Many contracts do not allow release of retention monies until certain events under the head contract are achieved. In this respect, security of payment legislation across all jurisdictions of Australia prohibit ‘pay when paid’ provisions.

In its simplest form, a ‘pay when paid’ provision is a contract term that makes payment to a contractor / subcontractor contingent upon the head contractor or principal being paid. However, the legislation goes further to catch certain other provisions which by their nature, will constitute a ‘pay when paid’ provision.

In Maxcon Constructions Pty Ltd v Vadasz [2018] HCA 5 the High Court took a broad approach in defining a ‘pay when paid’ provision and determined that certain terms tying the release of retention monies to an event under the head contract will constitute a ‘pay when paid’ provision and be void.

The facts

Maxcon Constructions Pty Ltd (Maxcon) (as head contractor) entered into a contract with Mr Vadasz (as subcontractor) for the design and construction of piling for an apartment building.

The contract provided for security in the form of a cash retention of 5% of the contract sum which was to be released to Mr Vadasz once the certificate of occupancy for the building issued.

Mr Vadasz completed the work under the contract and served a payment schedule on Maxcon from which Maxcon deducted retention monies. Mr Vadasz subsequently applied for the matter to be adjudicated and the adjudicator determined that the retention constituted a ‘pay when paid’ provision and was therefore void.

Maxcon appealed, asserting that the adjudicator had made an error.

‘Pay when paid’ provisions void

A ‘pay when paid’ provision is generally defined as a contract term that:

  1. makes the liability of one party to pay money owing to the other contingent upon some payment to the first party by a third party; or
  2. makes the due date for payment from one party to the other party, the due date for payment by the third party to the first party; or
  3. otherwise makes the liability to pay money owing, or the date for payment of that money, contingent or dependent on the operation of another contract.

The Court found that the clause making release of the retention money contingent upon issue of the occupation certificate fell within the third category of ‘pay when paid’ provisions and was therefore void.

In its reasoning the Court considered issue of the occupancy certificate was:

‘…dependent upon certification by the builder, Maxcon, that the building work had been performed in accordance with the issued documents, including the head contract between Maxcon and the owner of the land [and] issue of the certificate depended on completion of the whole project in accordance with the provisions of the head contract.’

In other words, release of the retention monies was essentially contingent upon completion of building work under another contract (i.e. between Maxcon and the landowner).

As a consequence:

‘…the due dates for payment of the retention sum were dependent on something unrelated to Mr Vadasz’s performance.  They were dependent on the operation of another contract – namely, the completion of the head contract, which in turn would have enabled a certificate of occupancy to be issued.’

Conclusion

Clauses in construction contracts that tie the release of retention monies to an event under the head contract and not to the subcontractor’s performance (and other obligations under the contract) will likely constitute a ‘pay when paid’ clause, and be void.

Subcontractors may now be able recover retention monies earlier than once thought.

Principals and head contractors should review contracts to ensure that they are not relying on terms that breach security of payment legislation.

If you or someone you know wants more information or needs help or advice, please contact us on +612 9248 3450 or email info@bradburylegal.com.au.

The Building Code of Australia – compliance issues

The Building Code of Australia (‘BCA’) contains a series of technical provisions that dictate a range of minimum acceptable standards in respect of the design and construction of buildings and various other structures. It is produced and updated by the Australian Building Codes Board on behalf of the Commonwealth Government and all State and Territory governments.

The BCA is found in the first two chapters of the National Construction Code (‘NCC’) and has been in effect since 1 May 2011.

Why do we need a national building code?

The BCA was introduced as a means of ensuring that minimum construction standards around the country were consistent. Compliance with the BCA’s technical requirements is therefore mandatory in all States and Territories.

What does the BCA cover?

The BCA covers a broad range of building and construction related matters including standards for structural adequacy, fire resistance requirements, energy efficiency and sustainability, issues that affect the health and amenity of building occupants and matters concerning access and egress.

How do I know if my building complies with the BCA?

The technical requirements of the BCA are split into two volumes.

In order to ascertain whether your building is compliant, or the steps you need to take to ensure that it becomes compliant, the first thing you need to do is determine which volume your building comes under.

Technical requirements in the BCA depend on which class of building is involved. There are 10 possible classes of buildings and these are divided between the BCA volumes as follows:

  • Volume One – Commercial Buildings – covers requirements for all Class 2 to 9 buildings (commercial buildings) as well as access requirements for persons with a disability (Class 1b and 10a buildings) and Class 10b swimming pools which all have access requirements for people with a disability; and
  • Volume Two – Housing provisions – includes Class 1 and 10a buildings (save and except for access requirements for persons with a disability in Class 1b and 10a buildings), specified Class 10b structures (again, other than access requirements for persons with a disability in Class 10b swimming pools) and Class 10c private bushfire shelters.

Do the same standards apply to domestic and commercial dwellings?

Not surprisingly, the BCA provisions for housing differ significantly from those that apply to commercial buildings. If you are in any doubt as to what volume your construction will be covered by, especially if you are considering a mixed use development, then it is always prudent to seek legal advice prior to embarking on any construction rather than waiting and finding out at the end of construction that minimum standards have not been met.

Does the BCA prescribe all aspects of a build including mandatory materials?

The aim of the BCA is not to dictate that only certain materials or building methods will be permitted to be used if a building is to be compliant. Rather, the BCA is a performance-based building code. This means that the use of alternative materials, designs and even construction methods may be permitted provided the minimum standard requirements of the code are met.

In this way innovative materials and new construction methods can be allowed with designs being tailored to suit a particular build and flexibility of design is allowed provided the intent of the BCA is met. The aim of the BCA is to set minimum standards not to dictate what materials or designs can be used to achieve those standards.

How is compliance with the BCA assessed?

Just as no single building method or material is prescribed as being mandatory by the BCA there is also no single method of assessment applied to determine compliance. Under the BCA there are several acceptable assessment methods available including:

  • Evidence based assessment – which allows for the provision of a report from Registered Testing Authority, a current Certificate of Accreditation or Certificate of Conformity, a certificate prepare by either a professional engineer or some other appropriately qualified person, a current certificate issued by a product certification body provided that body has been accredited by the Joint Accreditation System of Australia and New Zealand or any other form of acceptable documentary evidence that is able to adequately demonstrate suitability for use;
  • Verification methods – including calculations or mathematical models or tests using a technical operation either on site or under suitable laboratory conditions;
  • Alternative method (sometimes referred to as any other method) – alternative methods may be used provided the relevant authority is satisfied that compliance with the BCA has been achieved. In making such a decision an approval authority may have regard to relevant deemed-to-satisfy provisions or verification methods provided for in the BCA;
  • Expert judgment – in situations where tests or modelling calculations are not available the opinion of a technical expert may be acceptable; and
  • Comparison – a comparison is made between the proposed building method and the ‘deemed-to-satisfy’ method set out in the BCA. Provided that it can be demonstrated to the approval authority that the proposed building solution is either equivalent or superior to the ‘deemed-to-satisfy’ provision, then the proposed method or material may be deemed to meet the relevant performance standard.

Although the BCA is designed as a plain English document navigating your way around the BCA does require a certain degree of prior knowledge and skill. If you have any questions or would like assistance in understanding the BCA or ensuring your building complies with the BCA requirements we would be happy to assist.

If you or someone you know wants more information or needs help or advice, please contact us on +612 9248 3450 or email info@bradburylegal.com.au.

Building Defects – Damage to Balconies

Due to the widespread construction of high density apartments and townhouses there has also been an increase in the construction of balconies. Balconies are susceptible to water damage which can lead to damage to the internal elements of the building.

The defective construction of balconies has become an increasingly common dispute affecting owners’ corporations.

In this article we look at some common defects and a case that illustrates the issues facing owners and builders if a dispute arises.

Causes

Defects with balconies can arise as a result of poor architectural design, defective construction by builders or maintenance issues.

For example, an inadequate slope that does not drain water properly, or drains it toward the building can lead to water ponding on the balcony.

When water ponds on a balcony it might bring to light issues with the waterproofing membrane at the door threshold or on the balcony itself. For example, waterproof flashing may have been omitted or damaged during the construction of the balconies.

Finally, balcony leaks might be caused by issues such as render cracking caused by foundation movement as a result of lack of property maintenance.

Disputes in relation to balcony defects can be complicated due to the technical nature of the disputes and often cannot be satisfactorily resolved without expert evidence as to the cause of the defects.

Case Study

The case of Guney & Ors v CFM Property Group Pty Ltd (Domestic Building) [2013] VCAT 514, involved a dispute between 4 owners of townhouse units and the builder of those units, regarding the alleged defective construction of the balconies. The owners alleged that water leaks in the balconies and exterior cladding had occurred.

The parties reached a settlement of the dispute at mediation whereby it was agreed that the builder would rectify the defective balconies within a certain timeframe. The builder failed to undertake the rectification works, stating that he was unable to complete those works due to inclement weather.

The owners pursued their claim before the Victorian Civil and Administrative Tribunal. And each party retained a building consultant who provided expert evidence before the Tribunal.

The Tribunal found that the owners had given the builder ample opportunity to rectify the defective balconies and that it would be unreasonable to require the owners to give the builder a further opportunity. Instead, the Tribunal assessed the owners’ damages as the costs they would incur in engaging an alternative builder to attend to the rectifications.

Conclusion

Building defects can have serious detrimental effects on the use, enjoyment and value a property. It can often be difficult to identify the party responsible for rectifying balcony defects. Without expert legal advice, it is possible that the costs of the defect will be unfairly borne by an incorrect party.

If you or someone you know wants more information or needs help or advice, please contact us on +612 9248 3450 or email info@bradburylegal.com.au.