REAL ESTATE FINANCE and INVESTMENT ALERT
NSW Building Reforms – Developers access to finance to be affected
On the 3rd and 4th of June, the NSW Parliament passed two pieces of legislation as part of the reforms initiated in 2019 to deal with issues relating to the quality of construction and other problems evident in the building industry, especially in respect of residential apartments.
The legislation passed was the Design and Building Practitioners Act 2019 (NSW) and the Residential Apartment Buildings (Compliance and Enforcement Powers) Act 2020 (NSW).
Some of these reforms take effect immediately while others will become effective on 1 September 2020 and 1 July 2021.
In addition to the passing of the above legislation, the NSW Building Commissioner has put out to tender the online registration and information systems to be put in place to enable:
- All information relating to developers, builders and others involved in the construction industry (including information regarding previous projects in which they have been involved) to be stored on one database; and
- A rating system to be developed in respect of participants in the construction industry.
As mentioned in a number of our previous Alerts, (see most recently our February 2020 and November 2019 editions), the proposed reforms will have a major effect on the property development industry. Not all of these will be positive.
In this Alert we discuss:
- The new statutory duty of care which is now in force; and
- Consequences to developers in respect of their current and future financing arrangements.
If you would like to read more please click HERE or see below.
NEW STATUTORY DUTY OF CARE
As recently reported in the Australian Financial Review, the Design and Building Practitioners Act 2019 (NSW) (DBPA) contains a new statutory duty of care in favour of “owners”. This duty of care is now in force.
What is the new duty of care?
Under the DBPA:
“A person who carries out construction work has a duty to exercise reasonable care to avoid economic loss caused by defects:
- in or related to a building for which the work is done, and
- arising from the construction work.
The duty of care is owed to each owner of the land in relation to which the construction work is carried out and to each subsequent owner of the land.”
This duty of care entitles the persons to whom the duty is owed to damages for breach of the duty.
The duty of care is owed to an owner “whether or not the construction work was carried out:
- under a contract or other arrangement entered into with the owner or another person, or
- otherwise than under a contract or arrangement.”
Importantly, the duty:
- applies irrespective of when the relevant contract or arrangement was entered into,
- cannot be contracted out of,
- applies not only to construction work undertaken after the commencement of the DBPA but can apply to buildings up to 10 years old as at the commencement of the DBPA (in other words it has retrospective operation), and
- is in addition to any other duties or remedies in favour of or available to owners.
What buildings does the new duty of care apply to?
Although the DBPA expressly includes residential building work (as defined in the Home Building Act 1989 (NSW)) as being the subject of the duty, the types of buildings to which the duty applies can be extended by regulations, which have not yet been issued. This creates uncertainty as to the types of projects to which the duty relates.
Who is the duty owed to?
As mentioned above, the duty is owed to “owners” and subsequent owners. The term “owner” is defined to include:
- every person who is jointly or severally or at law or in equity entitled to the freehold estate in the land,
- “every person who jointly or severally or at law or in equity is entitled to receive, or receives, or if the land were let to a tenant would receive, the rents and profits of the land, whether as beneficial owner, trustee, mortgagee in possession or otherwise”, and
- “other persons prescribed by the regulations for the purposes of this definition”.
This could extend the parties able to take action for breach of the duty to unitholders in a unit trust which owns the building, joint venture parties and lenders (even though they may not have enforced their security).
The extremely wide definition of owner substantially increases:
- the range of persons to whom damages could be payable beyond the immediate contractual party for whom the building work is done, and
- the possible amount of damages payable due to the different economic consequences which could arise in respect of each “owner”.
By whom is the duty owed?
The duty is owed by each person who “carries out construction work” in relation to a building.
The term “construction work” means:
- building work, which extends to construction of a building, making alterations or additions to a building and repair, renovation or protective treatment of a building,preparation of designs for the building work,“manufacture or supply of building products for the building work”, and
- “supervising, co-ordinating, project managing or otherwise having substantive control over the carrying out of any of the other elements of construction work”.
As a result, nearly all contractors, sub-contractors, consultants and suppliers involved in a development are now subject to the new statutory duty.
This additional risk for such parties is likely to increase insurance costs and project costs for new projects.
CONSEQUENCES TO DEVELOPERS IN RESPECT OF THEIR CURRENT AND FUTURE FINANCING ARRANGEMENTS
As mentioned in our earlier Alerts, a large number of significant matters which developers, designers, builders and others involved in property development will need to know in order to understand the scope of the new laws and comply with their requirements will be set out in regulations. The regulations will cover such fundamental matters as the types of buildings to which the new regime applies.
Until drafts of such regulations are issued, it will be difficult for participants in the development industry to fully understand how the new regime will impact their business and how to prepare for it.
Rating System and Database: Increased scrutiny
The NSW Building Commissioner has put out to tender the online registration and information systems to be put in place to enable all information relating to developers, builders and others involved in the construction industry (including information regarding previous projects in which they have been involved) to be stored on one database.
Details of the database are not yet fully known.
The availability of such a database will enable both purchasers and financiers to undertake more detailed due diligence on developers and others involved in a project prior to committing to be involved in the project.
We assume this information will form the basis on which ratings will be awarded to participants in the industry.
Adverse impact on sales
To the extent developers, designers and building practitioners do not meet the new standards to be imposed by the new regime, or will not receive the required quality rating, their business is likely to suffer. They will experience increased difficulty in winning projects and, in the case of developers, in achieving pre-sales.
Adverse impact on financing
- In the case of future projects or current projects which have lots which remain unsold, the above possible adverse impact on sales may negatively affect the value of projects and decrease their future marketability. This may lead to greater losses for the developer and financier involved.
- Developers (with which financiers have existing facilities) may be subject to damages claims under the new statutory duty of care in respect of previous projects (potentially up to 10 years old). This may trigger:
- events of default under loan documents for current facilities resulting in default interest costs and potential enforcement by the financier,
- or review rights of financiers under such facilities.
- Due to the expanded information which will be available on the above-mentioned database, financiers may not wish to deal with developers that do not achieve the required quality rating or where the information on the database relating to the developer or any of the key contractors and consultants involved in a project discloses potential problems.
- Loan documents may be amended to include additional conditions precedent, information and other undertakings, events of default and/or review rights, making them more onerous for developers.
- Loan to value ratios and loan to development cost ratios may be reduced, resulting in developers having to find more equity for projects.
- A greater number of financiers (both bank and non-bank lenders) are likely to limit the developers and design and building practitioners they wish to deal with to those with a good track records, who are fully compliant with the new regime and are attributed a good quality rating under the new regime.
Although the reforms are important, the financial costs associated with compliance and the potential liability to which developers, builders and others involved will be exposed in respect of projects (up to 10 years old) may, given their already fragile financial position, result in some parties leaving the industry.
Please feel free to contact us about any loan facilities, current or future, in respect of which we may assist you in navigating the increasingly complex provisions found in such documents and help you in negotiating better commercial outcomes in your finance arrangements.
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The comments made in this Alert do not constitute the provision of any legal, tax or accounting advice by Peter Faludi Consulting or any Director or employee thereof and therefore you should not rely on this Alert in making any decisions relating to present or future transactions in which you are involved. We strongly recommend that you seek legal, tax and/or accounting advice (as relevant) in relation to the same.
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