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Owners Corporation update: Defects in common property and an owners corporation’s rights to compensation

Dec 18, 2014

Owners corporations unfortunately often face having to deal with defects in common property.  Inevitably this leads to the question as to whether the owners corporation and/or its members are able to recover compensation for the costs incurred to rectify the defects.

The obvious targets for that compensation are the developer of the property or its builder.

Rights under Legislation — Owners Corporations Act

Section 68 of the Owners Corporations Act stipulates that the initial owner, (usually the developer), must act honestly and in good faith and with due care and diligence in exercising its rights under the Act and must take reasonable steps to enforce the domestic building contract it has entered into in respect of the land in the plan of subdivision.

Unfortunately the Act also states that those provisions only apply when the initial owner is owner of a majority of lots on the plan of subdivision.

Some have argued that an initial owner may be able to be sued by the owners corporation or its members if the building contract it makes with the builder excludes the builder from a range of liabilities for defective works.

The making of a building contract by the initial developer is not the exercise by it of a right under the Act. Section 68 will be of no assistance to the owners corporation or its members in that case.

As for domestic building works, see below.

In any case after the initial owner ceases to be owner of the majority of lots the owners corporation and its members are unable to use Section 68 in any way to recover compensation from the developer or its builder for defects.

Domestic Building Contracts Act

Under the Domestic Building Contracts Act a builder is held to have given certain warranties regarding its works including warranties that:

  • building works will be carried out in a proper and workmanlike manner in accordance with the plans and specifications referred to in the contract;
  • the materials used will be good and suitable for the purpose for which they are used and unless otherwise stated in the contract will be new;
  • the works will comply with all laws and legal requirements; and
  • the works will be carried out with reasonable skill.

That Act also states that any person who becomes the owner of land on which domestic building works have been undertaken may take action against the builder for breach of those warranties even though that person was not a party to the building contract made with the builder.

The warranties referred to do not, however, apply to work that is not domestic building work.

Accordingly, the Domestic Building Contract Act alone or in appropriate cases together with the Owners Corporations Act may give an owners corporation or its members rights against the builder for defective common property if the defects:

  • are in domestic building works; and
  • arose because of breach by the builder of one or more of the warranties referred to above.

In substance, an owners corporation and its members may have some rights under legislation in limited cases to recover compensation from the builder in respect of defects in common property

Rights under contracts

Theoretically a developer can give to buyers of lots in a subdivision affected by an owners corporation and or the owners corporation,  warranties regarding works carried out.

The developer could even agree that the buyer can transfer the benefit of those warranties to subsequent owners.

In practice it is extremely rare for developers to give those warranties. On the contrary they usually provide in their contracts of sale that warranties of those types are not given.

Even in the very rare case where a developer gives some warranties of those types in a contract of sale of a lot  they are  usually limited to the relevant lot sold and do not include warranties in respect of works carried out to common property.

In practice it is therefore very rare for an owners corporation or its members to have any rights in contract against a developer for defects in common property. 

Apart from warranties implied into contracts for domestic building works under the Domestic Building Contracts Act, building contracts sometimes specifically exclude the builder from a range of liabilities and obligations or severely limit their liability for breach of those obligations.

Those contracts also sometimes prohibit the developer from  transferring or passing on any benefits of those warranties.

It is very rare for developers to transfer to buyers and the owners corporations warranties received under a building contract, (if any), except in respect of the specific sub contract items, (for example manufacturers and installers warranties in relation to mechanical plant and equipment), most of which will not form part of common property.

The rights of an owners corporation and its members to recover compensation for defects in common property under contract law are limited.

Common law rights — builder’s negligence

One avenue under common law that has been explored by the courts in recent times is the right to recover compensation for defects in property under the law of negligence.

In other words,  is compensation for defects in common property payable by a builder to an owners corporation or its members because the builder was negligent in carrying out its works?

For a builder to be so liable the courts have to find that the builder owed a duty of care to the developer and subsequent owners or the owners corporation.

There have been a number of cases in this regard in recent times

In one case, it was held that the builder of a dwelling owed a duty of care to a subsequent purchaser of the dwelling when the subsequent purchaser is vulnerable to or reliant on the actions of the builder and that accordingly the builder, because its negligence gave rise to defects, was liable to the subsequent purchaser.

In another case the court ruled, however, that an engineering company that had designed inadequate foundations for a commercial building which resulted in subsequent structural damage did not owe a duty of care for loss suffered by a subsequent purchaser. 

The cases generally provide that for the builder to be liable in negligence to a subsequent purchaser the following tests must be satisfied:

  • First does the builder owe a duty of care to the developer? and
  • If so then does the builder also owe a duty of care to the subsequent purchaser

In the latest case the High Court held that a builder does not owe a subsequent purchaser a duty of care when the relevant building contract expressly provided for the quality of work by the builder.

The Court held in that case that the contract demonstrated that the relevant parties had the ability to protect themselves against any lack of care by the builder in performing its obligations under the contract.

In other words the builder did not owe a duty of care to the developer because the parties to the building contract were savvy and used contract arrangements to allocate risk and therefore the builder did not owe a duty of care to the subsequent purchaser.

The implication of this decision is significant for owners corporations and their members because they have no control over the negotiation the terms of building contracts made by developers. They have no control over the first test to be satisfied when a subsequent purchaser seeks compensation from the builder for defects arising through the builder’s negligence.

The latest decision is, however, not the final word in relation to negligence claims by subsequent buyers against builders regarding defects given that the judges in that case were not unanimous in their decision.

The Chief Justice and another judge hearing that case commented that there may be other circumstances where a builder may owe a duty of care to a subsequent purchaser even though the builder does not owe that duty of care to the developer. They did not however make any decision in that regard in the latest case and did not describe in detail what those circumstances may be.

As a result of the latest decisions in relation to claims in negligence against builders by subsequent purchasers if the relevant building contract contains appropriate provisions in respect of the quality of the builder’s works and or allocation of risk between the builder and the developer, a subsequent purchaser (owners corporation and its members) is unlikely to be able to recover from a builder any compensation for defects due to the builder’s negligence.

Presumably most builders will build into their building contracts appropriate provisions in that regard if they do not already contain those provisions.

Similarly claims in negligence by owners corporations against builders are only likely to proceed if the developer and builder are relatively unsophisticated in building contract negotiations and that is likely to occur only in rare cases.

More information

To discuss an owners corporation’s rights and entitlements under the provisions of the Domestic Building Contracts Act or the Owners Corporations Act, please contact Anton Block, Principal Lawyer and Head of Owners Corporation, on (03) 8600 8833 or ablock@kcllaw.com.au.

Note: This update is a guide only and is not intended to constitute legal advice.