Home » Strata Management Update: Understanding the NSW 2% Defect Bond Scheme – How & when does it apply?

Strata Management Update: Understanding the NSW 2% Defect Bond Scheme – How & when does it apply?

Posted by Ben Robertson | 04 March 2021 | Construction & Infrastructure

Defects in multi-storey buildings can cause enduring problems for owners and builders alike. The Scheme aims to resolve building defect issues swiftly and increase consumer protection for owners in strata buildings by securing 2% of the contract price for the cost of rectifying any defective building works identified.

 

The NSW Strata Building Bond and Inspections Scheme (‘Scheme’) applies to Construction Industry participants, especially builders and developers, entering contracts after 1 January 2018 for building works to construct residential or mixed-use strata properties over four or more storeys and where such building works are exempt from requiring insurance under the Home Building Compensation Fund safety net system (‘HBCF’).

The Scheme was developed to address the risk of owners corporations which do not have the benefit of the Home Building Compensation Fund insurance being left with the cost of defective building work if a builder and developer becomes insolvent, leaving a swath of building defects in their wake.

The Scheme comprises a building bond equal to 2% of the contract price for residential and mixed-use strata properties over four or more storeys and mandatory defect inspection reports.

The developer must lodge the building bond with the NSW Fair Trading and, in the event of defective building work being identified in the final inspection report, the bond may be used to pay the costs of rectifying any of the defective building work identified.

What is the Strata Building Bond and Inspections Scheme and how does it apply?

The NSW Strata Building Bond and Inspections Scheme (‘Scheme’) commenced on 1 January 2018. The Scheme is a consumer protection mechanism that comprises two components:

  1. Requiring a building bond equal to 2% of the contract price (being the total price paid or payable under all applicable contracts for the building work); and
  2. Mandatory defect inspection reports.

The Scheme applies to residential and mixed use strata building projects which are exempt from insurance under the HBCF in the following circumstances:

  1. For building contracts on or from 1 January 2018; or
  2. Where there is no building contract for the residential or mixed use project (such as where the builder and the developer are related entities), then the Scheme applies to works which are exempt from HBCF which is commenced on or from 1 January 2018

The developer must lodge the building bond with the NSW Fair Trading before an application is made for an Occupation Certificate.

The scheme mandates two rounds of inspections following practical completion and should any identified defects not be rectified by the developer, the bond may be utilised to pay for rectification costs.

A question mark remains as to whether the 2% of the contract price secured by the bond system is adequate to address schemes which are left with building defect costs after a developer and builder dies, disappears or becomes insolvent. It remains to be seen whether the bond amount will be adequate, but in the words of the great baseballer Yogi Berra: “You can observe a lot by just watching”.

How does the Strata Building Bond and Inspections Scheme work?

Developers, builders, owners’ corporations, strata and building inspectors are required to meet the conditions of the Scheme process, the stages of which are as follows:

 Lodgement and Payment of Bond

For projects to which the Scheme applies after 1 January 2018, and before an Occupation Certificate is issued, the developer (not the builder) must lodge the building bond with the NSW Fair Trading Secretary (‘the Secretary’).

When a developer is delivering a building bond to the Secretary, they must also provide the Secretary additional documents and information the Secretary considers necessary to substantiate the contract price and pay a $1,500 administration fee[1]. Documents and information include:

  1. Documents relevant to the determination of the contract price, including any quantity surveyor’s cost report
  2. Contract(s) between the developer and builder
  3. Specifications and variations (including “issued for construction” and “as-built” drawings and specifications and approved alternative solutions under the Building Code of Australia)
  4. Written warranties
  5. Schedule of samples
  6. Development consents, approvals or certificates
  7. For alternative solutions in respect of fire safety requirements under the Building Code of Australia, any report prepared in relation to the alternative solution by an accredited practitioner
  8. Certificates relating to the design of the building work
  9. Report(s) obtained by the developer or building relating to an inspection of the building work

The building bond can be a bank guarantee or ‘bond’ but must also contain the project number issued by the Scheme ePortal or the reference number issued by the NSW Planning Portal.

Appointment of Inspector

The developer must appoint an independent building inspector (‘inspector’) through the Strata Inspector Panel.

The appointed building inspector must not be connected with the developer, i.e.:

  1. Not involved in the design or any aspect of the construction or certification of the building
  2. Not be connected with any person so involved; or
  3. Not have a pecuniary interest in any aspect of the building work

The developer must notify the Secretary and the owners corporation of the proposed appointment and the owners corporation must approve the inspector prior to his/her appointment.

Should the developer fail to appoint an inspector, or if the developer’s proposed appointment is rejected by the builder or owners corporation, then the Secretary may arrange the appointment of inspector upon application by the developer.

The cost of the inspector is paid for by the developer.

Interim Inspection and report

The inspector performs the first inspection (the ‘interim inspection’), attending in person at the site and prepares an Interim Report between 15 and 18 months after the issue of the occupation certificate.

A copy of the Interim Report must be given to the Secretary, owners corporation, developer and builder responsible for defective building work within 14 days after completing the report and before 18 months after the occupation certificate was issued.

Where no defective building work is identified in the Interim Report, the developer can apply to Fair Trading to dismiss the requirement for a Final Report to be obtained. The bond may be released to the developer after two years from the date of completion.

Where defects are found in the Interim Report then a Final Report is to be conducted between 20 to 24 months after completion. The developer and builder have an opportunity to rectify the defects identified in the Interim Report and have a right to access the scheme to attend to same upon giving 14 days’ written notice.

If any defects are still present in the Final Report, the 2% Building Bond Scheme can be accessed to fund the rectification of those building defects.

It is important for developers and builders to be aware of their obligations to comply with the requirements of the Scheme and that fines may be imposed if the requirements of the Scheme are not complied with.

The risk of prosecution, in addition to any financial penalty applied, can negatively affect the reputation of a developer or builders’ business and may divert resources away from the profit-making arms of their business.

Rectification and release of the bond

Where agreement cannot be reached between the parties as to the cost to rectify any defects still present in a scheme when the Final Report is prepared, Fair Trading will appoint an appropriately qualified person, generally a quantity surveyor, to determine the cost. The cost of the qualified person will be shared equally between the developer and owners corporation.

4-Step Strategy for Developers for Compliance

To ensure a developer is compliant with Scheme, we recommend the consideration of the following 4-Step Strategy:

  1. Developers should ensure that they have in place the proper processes to obtain bonds for 2% of the cost of building works. Builders should also ensure that they have the proper facilities in place should developers request provision of sufficient security until such a 2% building bond matures.
  2. To accommodate expenditures, developers may want to consider passing on the cost of the 2% Building Bond on to purchasers of completed strata buildings.
  3. Ensure that any contractual defect liability period covers the period of the 2% Building Bond.
  4. The time frames in the legislation for a building inspector to perform interim and final building inspections must be kept front of mind and managed appropriately. Developers should also be mindful of the timeframe requirements for making notifications to be made to the Secretary.

Key Takeaways

The Scheme is a useful mechanism to provide greater consumer protection for developers and builders. Importantly, the Scheme only applies to the construction of new strata buildings that are exempt from requiring HBCF insurance i.e., residential and mixed-use buildings that are over four or more storeys tall.

Developers should plan for the cost of the 2% Building Bond, inspectors and the inspections in their timelines, project costs, investment information and finance arrangements.

The statutory right access a property for rectification of building work after completion is an important aspect in the rights of contractors of residential building work.

 It is important to note that the 2% Building Defect Bond Scheme does not supplant the owners corporation’s existing rights to statutory warranties under the Home Building Act 1989 (NSW) or the statutory duty of care owed by a builder to the owners under the Design and Building Practitioners Act 2020 (NSW). 

[1] As required by Schedule 4 of the Strata Schemes Management Regulation 2016

 

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Resources 

If you require assistance in relation to your strata management requirements, contact us on construction@nexuslayers.com.au

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 This publication is © Nexus Law Group and is for general guidance only.
Legal advice should be sought before taking action in relation to any specific issues. 

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