The new NSW Strata Building Bond and Inspection Scheme ("the Bond Scheme") finally commenced on 1 January 2018 and applies to construction contracts entered into, on or (where there is no written contract from) after that date.

While it may not have shaken the residential building industry, it is certainly likely to cause a stir.

What is the Bond Scheme?

The Bond Scheme was introduced under part 11 of the Strata Schemes Management Act 2015 (NSW) ("the Act") and is regulated under part 8 of the Strata Schemes Management Regulation 2016 (NSW) ("the Regulations").

The Bond Scheme specifically applies to all building work involving the construction of residential or partially residential strata properties of four storeys or more. Buildings of three storeys or under remain covered under the Home Building Compensation Fund.

In essence, the purpose of the Bond Scheme is to provide the strata owners a fighting fund to rectify defects in a building that might not have ordinarily been discovered until after the expiry of the usual 12 months defects liability period.

How does it work?

Developers who have entered into an applicable construction contract are required to lodge a bond [by way of bank guarantee, unconditional undertaking, security bond or another form of security as prescribed by the regulations] of 2% of the contract price with the Commissioner for Fair Trading, Department of Finance Services and Innovation (Building Bond Secretary). The developer also needs to provide a lodgement form and supporting documents and information.

Under the Regulations, the contract price is calculated on the basis of the total price paid under all applicable contracts for building works as at the date of the occupation certificate. If there is no written contract or the parties are related entities or persons, the contract price is to be determined by a costs report prepared by an independent quantity surveyor. As the developer is the one paying those costs, there is certainly an incentive for developers to ensure that there is a written contract adequately setting out the contract sum to avoid uncertainty.

When is the bond payable?

According to Fair Trading, once a builder and developer enter into a contract, the developer should prepare to lodge the bond. However there is no specific timing provided for in the Act or the Regulations.

Based on how the contract price will be calculated i.e. as at the date of the occupation certificate, we would expect that developers will not lodge the bond until construction is almost complete to avoid the potential impact of contract variations. Otherwise, any bond lodged early may not reflect the actual contract price as at the date of issuance of the occupation certificate.

While the timing of the lodgement of the bond may be a matter for the developer, it pays not to delay too long as no occupation certificate will be issued until the bond is lodged.

Appointment of an independent building inspector

Developers are also required to appoint and pay at their own cost, for an independent building inspector to conduct two inspections i.e. an initial inspection between 15 and 18 months and a final inspection between 21 and 24 months after completion of the building works. Defects reports will be issued in relation to each inspection and provided to all relevant parties.

Notably, the Act or Regulations do not require any specific qualifications beyond being part of a strata inspection panel. The developer is not supposed to have any connection with the inspector in the two years prior to their engagement. Penalties may be imposed on the developer and building inspector where there is a connection between the building inspector and developer. However that does not stop a developer using former staff or business partners as inspectors.

The developer has to notify the strata owners and Building Bond Secretary of the proposed independent building inspector. If the strata owners reject the appointment, the Building Bond Secretary can appoint its own inspector. Whether the strata owners will be in a position to reject to appointments, having only been newly formed remains to be seen.

Building inspection reports

If there are no defects identified in the initial report, the bond can be released to the developer, two years after the date of completion. If, which is more likely, defects are identified in the initial inspection, the builder is given an opportunity to undertake the rectification work. Notably, while defects are listed, the initial report does not have to provide a scope of repair work.

The final inspection report will determine whether the recognised defects in the initial inspection report have been rectified and what remains outstanding. However, if defects are discovered during the final inspection that were not identified in the initial report, they cannot be included in the final report. That means the strata owners will not be able to claim any bond in relation to those defects.

The bond will be released in full to the developer if no further defects are identified. The bond money can however be claimed in full or in part by the strata owners if defects remain. The costs of rectification of the outstanding defects must be agreed between the parties’, otherwise the Building Bond Secretary will appoint a quantity surveyor to determine them.

Scope for appeal?

The Building Bond Secretary must not pay the whole or any portion of the bond unless it has given at least 14 days written notice to the strata owners, developer and builder of the proposed payment. Within those 14 days, each party can apply for review of the decision of the Building Bond Secretary with the NSW Civil and Administrative Tribunal (NCAT). NCAT will be able to affirm, set aside, or vary the Building Bond Secretary’s decision.

Significantly, while the review is being undertaken, the bond cannot be released.

The Bond Scheme or review process does not affect any action or right that any party may have against the other. However, the fact that any bond has been paid or rectification work has been undertaken can be taken into account.

Implications for you

It will naturally take some time (several years in fact) to see how the Bond Scheme plays out and whether it reduces litigation between strata owners, developers and builders.

While the scheme is certainly a welcome development, practical issues remain. How independent building inspectors will be remains to be seen. The fact that strata owners may not be able to recover any part of the bond if defects are identified after the initial inspection is a real concern – noting issues of water ingress would take time to manifest itself.

Where there are major defects (of a structural nature or otherwise), the relevant bond, being 2% of the contract price, would likely be exhausted pretty quickly rectifying the defects, leaving the strata owners to pursue litigation by traditional means in any event.

Developers will at least, need to ensure that they have their house in order before lodging the bond, including having all relevant supporting documents and information to avoid protracted delay in obtaining the occupation certificate.