Australian Construction Industry Insurance Update

Regulations, class actions and State Governments step up

Australia’s recent crisis in residential construction works remains a catalyst for recent developments in the construction and insurance sectors.

Quick links

Legislative reforms: Queensland

Greater powers for the Board of Professional Engineers

There have been a number of important developments for individuals who provide engineering services in Queensland. The engineering industry should be prepared for a number of compliance audits and investigations into non-compliance with the Professional Engineers Act 2002 (Qld) (the Act) to be conducted.

The Building Industry Fairness (Security of Payment) and Other Legislation Amendment Act 2020 granted enhanced investigative and enforcement powers to the Board of Professional Engineers Queensland (BPEQ) under the Act. The BPEQ administers the Act and is responsible for registering engineers and investigating offences against the Act and the conduct of registered engineers.

Amendments to the Act will come into effect from 1 March 2021, and give BPEQ greater investigative powers including:

• Broader grounds and procedures in respect of cancellation and suspension of professional engineer’s registration;
• The ability to conduct compliance audits of registered professional engineers;
• Greater investigatory powers, including general powers of investigators to enter places, search places that have been entered and seize evidence, and to compel the production of a broader range of information and evidence; and
• Ability to impose conditions on a professional engineer’s registration without their consent.

The BPEQ’s enhanced powers now mirror those of the Australian Securities and Investment Commission and other regulatory bodies and it may be that the BPEQ will commence more investigations and subsequent disciplinary proceedings in the Queensland Civil and Administrative Tribunal which are likely to fall within the cover provided by professional indemnity policies.

Legislative reforms: New South Wales

Design and Building Practitioners Regulation 2020 – the public consultation draft

The Design and Building Practitioners Act 2020 (DBP Act) imposed new obligations on design and construction practitioners to be introduced in two stages (see our article on the DBP Act). The first stage took effect in June 2020, in which the DBP Act imposed a retrospective statutory duty of care to avoid economic loss caused by defects or construction work. It applies to professionals who perform “construction work” including builders, product manufacturers and suppliers, and designers.

The second stage of the obligations will commence on 1 July 2021, which includes the introduction of compulsory insurance, declarations to be given by designers and builders to ensure compliance with the Building Code of Australia (BCA), and a comprehensive registration regime for engineers.

On 17 November 2020, the NSW Government released the Design and Building Practitioners Regulation 2020 (NSW) (Regulations) in a public consultation draft form. They are due to commence on 1 July 2021 and are designed to provide greater clarity to the operation of the DBP Act. The Government also released a Regulatory Impact Statement, which provides further context and explores the benefits of the Regulations as proposed.

The Regulations are not in their final form; however, they do offer guidance about how the second stage of obligations under the DBP Act will operate which we summarise below particularly in relation to the proposed regulation of mandatory insurance requirements.

Class 2 Buildings

The Regulations are set to apply to class 2 buildings (typically multi-unit residential buildings) and buildings that contain a class 2 element (such as mixed-use residential and commercial buildings).

With the mixed-use buildings that contain a class 2 element, the reforms will apply to all parts of the building. For example, if a residential class 2 building contains commercial office spaces (class 5), or shops and restaurants (class 6), these are also subject to the reforms. Assuming there is no change to this aspect of the Regulations following the public consultation phase, building practitioners and their insurers will need to be aware of the increased risk profile when undertaking works involving class 2 or mixed-use buildings, and price that risk appropriately.

Mandatory Insurance Requirements

Under the DBP Act, the following practitioners must be “adequately insured” with respect to their declarations and work:

• Registered design practitioners;
• Registered principal design practitioners;
• Registered building practitioners; and
• Registered professional engineers.

Mandatory Insurance – design practitioners and registered engineers (Professionals)

The Regulations specify that Professionals are to be covered by a professional indemnity insurance policy which covers all relevant work and indemnifies against “all liability” incurred, and extends to “…any time since the registered individual first became a design practitioner or principal design practitioner.” ¹

There requirements are extremely wide. Firstly, even in a soft professional indemnity insurance market, it would not be possible for Professionals to obtain cover against all liability. For example, professional indemnity insurance obtained by Professionals in the construction sector is typically encumbered by exclusions such as combustible cladding and product defect exclusions. Secondly, it would be difficult for Professionals to obtain policies that retrospectively provide cover from the time they first undertook the relevant class of work.

However, the Regulations also provide that the Professionals must hold an insurance policy that, in their reasonable opinion, provides an adequate level of indemnity for the liability that could be incurred ². In determining whether an insurance policy provides for an adequate level of indemnity, the Regulations provide that the following criteria ought to be considered:

• The nature and risks associated with the work typically carried out;
• The volume of the work typically carried out;
• The length of time the professional has been registered;
• A reasonable estimate of claims that could be brought against the professional;
• The financial capacity of the professional; and
• Any limits, exceptions, exclusions, terms or conditions of the policy.

The Regulations do not prescribe any minimum limits of indemnity, or any restrictions on exclusions. Rather, Professionals will be expected to use their ‘best endeavours’ to obtain appropriate professional indemnity insurance for their circumstances. This ambiguity could be problematic for insureds where the cover they obtain, falls short of what is required in the Regulations. This could expose insureds to greater risk, as well as brokers seeking to place cover for their clients.

The mandatory insurance requirements for the Professionals will commence on 1 July 2021.

Mandatory Insurance – building practitioners

The Regulations provide that building practitioners must also be covered by an insurance policy that provides for an “adequate level of indemnity” under the same criteria as design practitioners and registered engineers. However, there are some differences.

Firstly, while professional indemnity policies are required for Professionals, the requirement is not extended to building practitioners. Secondly, the mandatory insurance requirements for building practitioners do not commence until 30 June 2023.

Registration regime for engineers

After 1 July 2021, only registered professional engineers, or those under the direct supervision of a registered professional engineer, will be able to carry out professional engineering work in New South Wales. The registration scheme applies to structural, civil, mechanical, fire safety and electrical engineers.

To apply for registration, the engineer will need to make an application to the Department of Customer Service (Department). To determine whether an applicant should be registered the Secretary of the Department may consider various factors including:

• Does the applicant have requisite qualifications, skills, knowledge and experience?
• Has the applicant been suspended, cancelled or disqualified from holding an equivalent registration in another state or territory in Australia?
• Is the applicant an undischarged bankrupt?

If engineers fail to obtain the appropriate registration prior to conducting engineering work, they will not be entitled to payment for the work, and they risk facing a penalty of up to $55,000 for an individual and $165,000 for a company.

Legislative reforms: Victoria

In the first half of 2020, the Victorian Government continued with its legislative response to the building industry issues that were identified in the Victorian Cladding Taskforce reports and the Shergold & Weir “Building Confidence” report that was obtained by the Building Ministers’ Forum in April 2018. There were three significant legislative reforms in late 2020.

1. Cladding Safety Victoria

The Cladding Safety Victoria Act 2020 (Vic) (CSV Act) and associated regulations were enacted on 1 December 2020, which implement changes to the operation of Victoria’s cladding rectification agency, Cladding Safety Victoria (CSV). The key changes are:

• The CSV Act establishes CSV as a separate body corporate; prescribes CSV’s cladding assessment and remediation processes; and gives CSV additional powers. CSV previously operated as a business division of Victoria’s building regulator, the Victorian Building Authority (VBA).
• CSV may provide funding to owners for the rectification of combustible cladding on eligible higher risk residential apartment buildings.
• The 10-year limitation period on building actions is extended to 12 years for certain claims for cladding rectification costs. The extended 12-year limitation period applies where two conditions are met:
  • Firstly, the claim must be a “cladding building action”, which is defined as “a building action in connection with, or otherwise related to, a product or material that is, or could be, a non-compliant or non-conforming external wall cladding product”. The wide definition of “cladding building action” could easily be interpreted by trial Courts as extending the limitation period on proceedings where combustible cladding is one of a number of defects alleged.
  • Secondly, the usual 10-year limitation period must have otherwise expired between 16 July 2019 to 1 December 2021. As a consequence, combustible cladding claims in respect of projects completed between 16 July 2009 and February 2011 that would have been statute barred (at the time this article was published) can now be brought within the limitation period.

CSV retains its statutory rights to recover funds it loans to owners from any building practitioners or consultants who may be liable for the use of non-compliant combustible cladding during development. The statutory right of recovery extends to the company’s officers who held office at the time the cladding was used/approved and who had knowledge of the cladding’s use.

2. Tightening of cladding ban

On 1 February 2021, Victoria’s Planning Minister issued a declaration under the Building Act banning the use of specified combustible facade materials. The declaration prohibits building practitioners from placing aluminium composite panels (ACPs) with a core containing more than 7% combustible materials or expanded polystyrene external insulation panels (EPS) on high rise buildings after 1 February 2021.

Under the previous Ministerial Guideline 14, dated 22 March 2018, building surveyors were directed not issue building permits allowing the use of ACPs with a core containing more than 30% combustible material or EPS on high rise buildings unless the Building Appeals Board had determined that the proposed use of the cladding complied with the fire safety performance requirements of the building code.

The recent declaration removes the discretionary use of combustible products through performance-based solutions that are approved by the Building Appeals Board. Previously, cladding rectification works could allow sections of ACPs or EPS to remain on high rise buildings where it was safe to do so. Under the recent declaration, all ACPs and EPS will need to be removed as part of rectification works, even if it poses no fire safety danger, which will substantially increase the cost of remedial works for many buildings.

3. Engineer registration

The Professional Engineers Registration Act 2019 (Vic) (PERA) that was passed in August 2019 is due to commence on 1 July 2021. PERA introduces a registration scheme for professional engineers that will be phased-in over a two-and-a-half-year period. Engineers who provide professional engineering services in the areas of structural, civil, electrical, mechanical and fire safety engineering will need to register with the Business Licencing Authority (BLA) unless they work under direct supervision or only in accordance with a prescriptive standard. Registration is required to provide professional engineering services in Victoria, or from a location outside Victoria if the services are intended for Victoria.

The BLA has commenced a process to approve assessment schemes. Any organisation can prepare an assessment scheme and apply to the BLA for approval of that scheme. It is expected that registration on Engineers Australia’s “National Engineering Register” will be one such pathway to registration in Victoria.

When the Act commences on 1 July 2021, the registration of engineers engaged in the building industry will transfer from the VBA under the Building Act to the BLA under the PERA. Engineers who are engaged in the building industry will have an endorsement on their PERA registration that will entitle them to practice as a professional engineer in the building industry. Engineers who hold the endorsement will be subject to duties and obligations under the Building Act and PERA.

Future legislative reforms

In November 2020, the Victorian Government established an Expert Panel to lead a comprehensive review of the legislative framework and regulation of Victoria’s building, plumbing and architecture sectors. Legislative reform in Victoria will now be driven by the recommendations of the Expert Panel. The Expert Panel is chaired by Victoria’s Commissioner for Better Regulation and its members include Dame Judith Hackitt who led the UK Government’s inquiry into the Grenfell Tower fire.

The Expert Panel’s work is to be carried out in three stages:

• Stage 1 – Seek stakeholder feedback on options for improving consumer protection; practitioner registration and regulation; regulator powers, roles, responsibilities and structure; and legislative objectives.
• Stage 2 – Seek stakeholder feedback on options for improving building information;
• general duties of care; dispute resolution; and approval processes.
• Stage 3 – Provide recommendations for a new Victorian Building Act.

Class actions against manufacturers of combustible Aluminium Composite Panels (ACP) cladding

Background

There are two class action proceedings on foot in the Federal Court of Australia against manufacturers and Australian distributors of ACPs (Alucobond and Vitrabond).

The lead plaintiffs in each proceeding are the owners’ corporations and apartment owners of residential apartment blocks in NSW. The litigation is funded by Omni Bridgeway. The claims were originally brought under the Australian Consumer Law for breach of the consumer guarantees that the ACPs would be of acceptable and merchantable quality. The claim in the Alucobond class action was amended in February 2020 to add claims for misleading and deceptive conduct in relation to the advertising and promotion of the ACPs.

The class actions are open to property owners, owners’ corporations, commercial building owners and public bodies in Australia that have suffered, or will suffer financial loss due to the need to remove and replace the ACPs (see our article on previous updates to the class actions).

In the Vitrabond proceeding, the Australian supplier, Fairview Architetural Pty Ltd (Fairview), was placed into voluntary administration in July 2020. On 6 November 2020, Fairview entered into a deed of company arrangement (DOCA), which provided for the sale of Fairview’s business to a related entity, with the claims of trade creditors to be paid in full and the owners’ claim in the class action to be preserved to the extent Fairview was insured for the potential liability.

The owners applied for leave to proceed against Fairview while it is subject to the DOCA. The owners argued that Fairview was entitled to cover for the class action claim under a public liability insurance policy issued by AAI/Vero that was in force when the cladding was supplied in 2014/15. Fairview had notified its insurer of the claim, but at the time of the application for leave the insurer had not indicated its position on whether cover was available.

Justice Wigney granted leave for the owners to proceed against Fairview. His Honour issued a written judgment concluding the owners had an arguable case that Fairview’s potential liability in the class action proceeding was covered under the AAI/Vero public liability insurance policy. His Honour considered that it was arguable Fairview’s conduct in supplying the cladding caused property damage because it caused damage to the building to which the cladding was affixed, the damage arising from the need for Owners to remove the cladding and remediate the building. His Honour opined that this argument was supported by the well-known case of Austral Plywoods Pty Limited v FAI General Insurance Co Limited [1992] QCA 4, in which it was held that the affixing of defective plywood to the hull of a vessel physically affected the hull, not only because of the screw holes which were made to affix the plywood, but also because the physical change to the hull caused by the affixing of the defective plywood meant that it was unsuitable for use.

In light of this decision, it is expected that building practitioners who are defending combustible cladding claims may seek to claim under their public liability insurance policies in addition to any professional indemnity insurance policies they may hold.

Queensland and Victoria

The states of Queensland and Victoria have both filed a notice of consent to become group members in the proceeding, which is likely to increase the size of the total claim.

In an ASX announcement by Omni Bridgeway, it was revealed there are likely to be more than 1,000 group members. The estimated total amount of the claims for compensation is likely to exceed $500,000,000.

State Government actions to address the cladding crisis

Queensland

Commencing on 1 October 2018, the Building and Other Legislation (Cladding) Amendment Regulation 2018 (Qld) (Regulation) introduced a new regime for identifying, assessing and regulating the use of combustible cladding materials on external parts of buildings. The Regulation requires owners of particular buildings to undertake an assessment of the material used on the external walls of their building. This will identify which buildings are affected by combustible cladding and whether cladding rectification work is likely to be required to achieve an acceptable level of safety. The owners of buildings which fall within the Regulation are required to register the building on the Queensland Government’s Safer Building website.

The timeframe for the steps to complete the registration and assessment has been extended slightly as below:

• 29 March 2019 – Register buildings and complete the combustible cladding checklist (part 1).
• 31 July 2019 (was 29 May 2019) – Complete the building industry professional statement and complete the combustible cladding checklist (part 2).
• 31 October 2019 (was 27 August 2019) – Engage fire engineer and register their details on the combustible cladding checklist (part 3).
• 3 May 2021 – Complete the building fire safety risk assessment, fire engineer statement and the combustible cladding checklist (part 3).

There have been no other developments on combustible cladding in Queensland and it will be interesting to see what occurs when the fire safety risk assessments and fire engineer statements are completed and owners are then required to rectify any cladding which does not pass the fire safety risk assessment.

New South Wales

The NSW government has recently announced a $1 billion program over the next three years to fast-track the removal of ACPs. Apartment owners who are required to replace ACPs on “high-risk buildings” will be able to access interest-free loans as a part of the program (Project Remediate Loans). There are an estimated 225 “high-risk buildings”. The government has estimated a cost of $4 million per building.

The program was unveiled in the 2020 state budget and is comprised of the following:

• $139 million to establish and offer technical support to owners for the remediation of at-risk buildings;
• $930 million to cover the interest for loans taken out over the next three years by building owners to remove and replace combustible cladding; and
• Project assurance service to be established and coordinated through the Office of the NSW Building Commissioner to work with owners corporations to project manage rectification works. A managing contractor will be appointed to manage and oversee each individual project.

Building owners and strata corporations will be able to apply for the Project Remediate Loans in March 2021, after the Government finalises a financial loan provider. The owners will be contacted directly if their building has already been identified as “high-risk”.

To apply for a Project Remediate Loan, the building must meet the following criteria:

• Be a residential apartment building (Class 2) in NSW (which includes multi-use buildings); and
• Have been confirmed by the Cladding Taskforce and consent authority to have a high-risk combustible cladding façade that requires remediation.

Meanwhile, there is an online form that can be completed, which allows individuals to receive email alerts and updates as further information on the program becomes available.

The Government aims for the work to remove cladding to begin in June 2021. If rectification works are already underway, the owners’ corporation can apply for the Project Remediate Loan, or continue with their own plans. Retrospective assistance is also being considered. There are multiple matters before the New South Wales Courts requesting removal and replacement of the cladding. Project Remediate Loans provide an option to strata corporations to fast-track rectification works, and to crystallise losses in those disputes. This could be particularly useful where strata corporations are subject to a strict removal order. It remains to be seen what the take up of the Project Remediate Loans will be in circumstances where no such order has been made.

Victoria

Rectification of private high rise buildings in Victoria continues to be driven by the Cladding Safety Victoria (CSV) scheme. CSV has $600M in funding and, as noted above, CSV has recently been established as a stand-alone statutory authority and has been given expanded powers that include the power to pursue subrogated recoveries. Proceedings for the recovery of cladding remediation costs funded by CSV are starting to work their way through the Courts.

The scale of CSV’s operations and its impact on construction professional indemnity insurers is shown by some of the figures below:

• CSV has 56 staff and CSV aims to spend $51M on rectification programs during this current financial year.
• Approximately 550 eligible buildings are with CSV for assessment of funding requests.
• CSV has completed work on 11 buildings, and has work under way on 72 others. CSV aims to start work on 200 projects before the middle of this year.

The CSV process can be summarised as follows:

• Eligible buildings are referred to CSV by the cladding audit process. This is usually preceded by a Building Order being issued to the owners requiring remediation of the cladding.
• CSV and the owners enter into a stage one funding agreement, whereby CSV provides a loan to the owners to fund the owner’s expenditure on independent experts to assess the cladding and prepare a remedial scope of works.
• CSV appoints an independent project manager to assist the owners to issue a tender for the remedial works. Pre-qualified builders are permitted to tender for the works.
• The owners engage a builder under a CSV-approved form of design and construction contract to perform the remedial works.
• CSV and the owners enter into a stage two funding agreement, whereby CSV provides a loan to the owners so the owners can pay the building contractor.
• The CSV-appointed independent project manager administers the design and construction contract for the owners.
• The owners pursue recovery of the remediation costs and repay any recovered costs to CSV. Alternatively, CSV pursues a subrogated recovery claim in the name of the owners.

It is too early to draw any conclusions about CSV’s approach to recovery actions. However, it seems likely Courts will accept that CSV’s assessment and competitive tendering process reasonably mitigates the cost of remediating the cladding defects. It is also expected that CSV, as a public authority, will take a robust, “legal-entitlement” approach to recoveries rather than a commercial one. It also remains to be seen how CSV and owners will conduct recovery actions where there are owner losses that are not funded by CSV (such as loss of apartment use or non-cladding defects).

The Victorian Government has recently arranged a professional indemnity insurance policy that provides cover for consultants and building surveyors who are involved in the CSV remediation process. The premium on the policy was reported to have been around $7M, with the policy providing cover for claims made within 10 years. The policy was obtained because CSV was experiencing difficulty finding consultants/building surveyors who would agree to be involved in the remediation works. This was because of the high number of practitioners who had cladding exclusions on their professional indemnity insurance policies.

Concerns for Insurers

New South Wales

• The main concern for insurers is that the DBP Act applies retrospectively. As such, insurers are exposed to new causes of action against professionals that might otherwise have not been pursued. This can create unexpected and long-tail exposures to books of business.
• Insurers might also experience issues arising from works undertaken by unregistered professionals which can lead to fines arising from non-compliance. Insurers might seek to expand their ‘Qualified Person’ endorsements to ensure that their insureds are appropriately registered under the DBP Act.

Victoria

• The extension of the time limit to bring legal claims for the installation of ACPs from 10 years to 12 years under the Cladding Safety Victoria Bill 2020 (Vic) should be on the radar of all insurers with current (and writing future) construction professional indemnity policies providing indemnity to construction professionals operating in Victoria as it extends their liability period for an additional two years.
• In relation to the State Government covering the cost of insurance for service providers, a key unresolved problem is the conflict of interest arising out of the privatisation of building surveyors and certifiers, whereby they are paid by the builders whose work they have to assess.
• The decision in the Fairview case might lead to an increase in cladding related claims under public liability policies.

Concerns for Building Professionals

Many professionals have recently experienced difficulties in obtaining professional indemnity cover in a hard market, resulting in insurance cover that is encumbered by cladding-exclusions and the like.

This issue, together with the ambiguity created by the minimum insurance requirements in the new NSW Regulations will mean that professionals might inadvertently fail to obtain cover that meets the Regulations, leading to additional claims and posing complex renewal issues for brokers.