Builder Insolvencies and Holes in the Ground
By Kim Lovegrove RML, FAIB of Lovegrove & Cotton – Construction and Planning Lawyers; Chairman Centre for Best Practice Building Control; past president of the Australian Institute of Building (Victoria); immediate past president of the NZIOB; and past consultant to World Bank on building regulatory reform.
The Australian high-rise apartment boom is winding down and there are signs that some contractors are winding up.
The margins are tight, finance is harder to obtain and work in progress is diminishing. Some seasoned property developers have recently warned of an impending downturn.
In the emerging paradigm, there will be more insolvencies. When builders go into liquidation, the financiers and the property owners are left to ‘carry the can’ with the ‘can’ often taking the shape of a whopping great hole in the ground or a partially completed high-rise. When the property owner is confronted with this debacle, the developer and the developer’s backers have to be very, very careful. If they do not act quickly and prudently, they will take an absolute bath and their own solvency may be tested.
Having witnessed the construction industry carnage that was the early 1990s and having been involved from a construction law perspective in assisting administrators and developers manage the project rehabilitation phase, I have penned a few pointers on lessons that were learned in more testing times. The paradigm that will be canvassed in this piece is contractor insolvency culminating in a hole in the ground in circumstances where a developer or administrator assumes control of a defunct project.
- A new project manager will have to be appointed as soon as possible to put together an initial damage control team. Often a quantity-surveying firm will have an experienced project manager who can quickly get a financial snapshot of the status of the project – the project stage, the amount spent, the scope of works to complete and the costing scenarios.
- The relevant building surveyor (RBS) must be notified immediately. The RBS will need to be called upon to carry out an urgent site inspection to determine whether the site is safe. In the event that it is not safe, building notices or orders dictating what must be done to render a safe site must be carried out. The RBS will need to consult with the project manager to get agreement upon appropriate immediate remedial measures that are required to facilitate construction integrity on the site. This may well involve cordoning off the site and the erection of temporary fences and relevant signage.
- The project manager should ensure that photos are taken of the state of the site and the phase of construction immediately upon appointment. This information can become vital evidence in any ensuing litigation or insurance claim.
- All insurers that have provided various forms of insurance cover for the project should be notified and the project manager should conduct a review of the currency and scope of indemnity of all insurances that pertain to the project.
- Establishment of a project resuscitation team should occur. The project manager will need to identify those who will assist with the initial stabilisation of the project and the rendering of the project safe. This may require the deployment of demolition contractors or site stabilisation contractors, be they engineers, builders, or designers. The project manager will need to liaise with the construction lawyer, who by this time should have been appointed, to determine the nature and types of contracts for what is likely to be short term deployments. In some circumstances, the contractors will be required to enter into major domestic building work contracts that are designed to comply with acts of parliament such as the New South Wales Home Building Act or the Victorian Domestic Building Contracts Act. Furthermore, there will also need to be dialogue with the relevant building surveyor as to which work requires building permits to ensure that work is not carried out illegally, thus rendering the property owner and contractors liable for prosecution.
- The project manager will need to crystallise a cost to complete the project. The cost needs to be realistic to ensure that there is a margin in the completion costs to deal with post-insolvency imponderables.
- The project manager will then prepare a tender package which will comprise the drawings, special conditions and the building contract along with any special conditions for the tenderers to consider. It is a given that the Construction Manager would have sought counsel from the construction lawyer to ensure that the building contract ‘risk-proofs’ the developer. The contract also needs to marry with the tripartite agreement in any circumstance where the financier insists upon the execution of a tripartite agreement by the developer, builder and principal. It is critical to ensure that the tripartite agreement is fashioned to ‘dance with’ the head contract that the principal executes with the successful tenderer. Too often, tripartite agreements do not ‘dance with’ the head contract, rather the contracts jar with one another and are fundamentally incompatible in material respects. This can impact upon, amongst other things, the timely stage approval and finance pipeline. Again, a construction lawyer should vet both instruments to ensure that there is a seamless interaction between these paramount contractual instruments
- Choice of head contract should be prioritised. This can be a challenge when confronted with the opportunity to tender upon a partially completed multi-unit high-rise development, the builder might angle for a cost-plus contract. A cost-plus contract is contract where the contractor is paid the cost of the building plus a margin or a percentage over and above cost. Great for the builder, but lousy for the developer and the developers backers.
The smart play is to ensure that the successful tenderer executes a fixed-price contract and furthermore it is best if the fixed-price contract is a standard industry contract albeit with special conditions that are designed to fortify the developer’s position.
There are nevertheless a number of fixed-price permutations:
Design and construct contracts (D&C)
It is sometimes the preference of the parties for the contractor to execute a D&C contract where the contractor assumes the risk for the design and construction of the project. One queries the wisdom of this contracting model in circumstances where there has been a principal contractor insolvency as one would have thought that the design aspect of the project had been fully evolved and augmented. Nevertheless, if there were to be evidence of design documentation negligence, then there would possibly be mileage in the contractor operating under a D&C model.
Standard fixed price contract
Under this contractual iteration, the tenderers will submit tenders on the basis that they have been provided with a lump sum building contract along with fully evolved, augmented and approved plans, and the builder will submit a quote for a lump sum deal. However, there can be further contractual permutations and one that is recommended is either an architect-administered contract or project director-administered contract.
Under a project director-administered contract, the project director on behalf of the principal will assess quality control, time compliance and, all things going well, will certify the stages and payment approval, in the case of the latter, sometimes with the approval of the financier pursuant to the tripartite agreement.
Regardless of the type of contract, whether it be D&C or project-director administered, for fear of belabouring the point, it is critical that a construction lawyer settles and/or negotiates amendments to the contracts. Regard must also be given to the fact that in the case of multi-unit residential developments, the contracts must comply with the relevant domestic building regulations.
The contractual negotiations phase
No party should ever be too hard-nosed in negotiations. Everybody needs to make money – the developer, the builder and the ‘subbies’ – hence the machismo satisfaction of screwing the hell out of an opponent in negotiations is not commended. Cheapest quote does not mean cheapest project delivery cost – all it means is cheapest quote. A reputable builder will expect sound remuneration and be very wary of ‘the low quoter’ who does anything to get the job as this might be the very type of character that proves to lack the wherewithal to complete the project. The last thing you want is ‘serial insolvency’.
So the take-out is this: always try to get the best deal, but make sure there’s enough money in the job to enable the contractor to complete the job without either cutting corners, hitting the developer with a tsunami of variations, or worst case scenario, going belly up.
Choice of contractor and choice of rehabilitation team
As a rule of thumb, stick with the tried and true. Avoid the ‘new kids on the block.’ Just like your choice of lawyer, who should be well-known, well-regarded, in possession of a pedigree of experience and high-level dexterity, apply the same criteria to your project team regardless of whether it be the builder, the building surveyor or the project director.