On 1 January 2018, a new strata defects bond and defect inspection scheme came into effect in New South Wales. The new scheme is set out in Part 11 of the Strata Schemes Management Act 2015 (NSW) (Act).

In short, the new scheme applies to residential (or partly residential) strata developments that do not require home warranty insurance (ie developments of more than three storeys) and:

  1. requires developers, before an occupation certificate is issued, to lodge with the Department of Finance, Services and Innovation (Department) a bond equal to 2% of the contract price for the works (Defects Bond); and
  2. creates an independent defect inspection and reporting regime that is linked to the release of the Defects Bond.

The new scheme has been introduced in response to numerous cases of defective building works in high rise residential developments that often leave owners corporations out of pocket. The need for the scheme is supported by the high volume of cases commenced by owners corporations against developers and builders for the rectification of defects.

The scheme does not apply to building work under construction contracts before 1 January 2018.

Defects Bond

Before an occupation certificate is issued for any part of the development, a developer of a residential (or partly residential) strata development that is more than three storeys high must lodge the Defects Bond with the Department.

The amount of the Defects Bond is 2% of the contract price, ie the total price paid under all applicable contracts for the relevant building work as at the date of issue of the occupation certificate.

The Defects Bond may be in the form of a bank guarantee or a bond.

Together with the Defects Bond, the developer must lodge with NSW Fair Trading various documents including: a copy of the building contract(s); relevant specifications; relevant warranties; ‘for construction’ and ‘as-built’ drawings; design certificates; and subcontractor certificates.

Owners corporation claiming on the Defects Bond

An owners corporation may claim all or part of the Defects Bond to meet the costs of rectifying any defective building work identified in the Final Report (discussed below) or with the consent of the developer.

A claim on the Defects Bond must be made within the later of 2 years after the relevant building work is completed or 60 days after the Final Report (discussed below).

The moneys realised from the Defects Bond must be used to rectify defective building work or for costs related to rectification. Any excess amounts must be repaid to the developer.

Defect inspection regime

An independent building inspector (Inspector) must be appointed by the developer and approved by the owners corporation at a general meeting. The Inspector must impartially carry out inspections of the building works at two different stages after completion and produce reports of the inspections – the Interim Report and the Final Report.

All costs incurred in respect of inspections and the production of the Interim Report and the Final Report are to be borne by the developer.

Interim Report

The Inspector must prepare the Interim Report and provide a copy to the developer, NSW Fair Trading, the owners corporation and the responsible builder not earlier than 15 months but not later than 18 months after completion of the building work.

The Interim Report will identify any defective work and, if practicable, the cause of that defective work.

Final Report

If the Interim Report does not identify any defective building work, the developer may apply to the Department to determine that a Final Report is not required and that the Interim Report is to be taken to be the Final Report of the purposes of the Act.

If the Interim Report identifies defects, the developer must arrange for the same Inspector that prepared the Interim Report to prepare a Final Report.

The Final Report must be carried out by the Inspector not earlier than 21 months and not later than 2 years after completion of the building works. The Final Report must identify any defective building work which was identified in the Interim Report that has not been rectified, any defective work arising from rectification works associated with the Interim Report and how the defective work identified in the Final Report should be rectified. However, the Final Report must not contain any matters which relate to defective work not previously identified in the Interim Report, unless those defects are a result of rectification of those previously identified defects.

Contractual considerations

To take into account the new scheme, it is recommended that industry participants consider the following issues when preparing and entering into construction contracts.

  1. Given that the Inspector must prepare the Interim Report and the Final Report more than 12 months after the completion of the building work, extended defects liability periods should be included in construction contracts so that a developer can require the builder to rectify the defects identified by the Inspector. Defects liability periods of at least two years or that are referable to the Inspector’s Interim Report and Final Report will be common.
  2. Construction contracts should require builders to supply all documents necessary to be lodged with the Defects Bond to ensure that the developer can comply with the new scheme.
  3. Construction contracts should clearly provide whether the developer or the contractor is responsible for lodging the Defects Bond with the Department. A developer cannot contract out of the new scheme but can require the contractor to supply the Defects Bond or require the contractor to provide additional security equivalent to or greater than the amount of the Defects Bond with corresponding rights of recourse to that security as the owners corporation has under the new scheme.