How Cladding Exclusions May Change the Way Building Cases are Run
By Justin Cotton, Director, Lovegrove & Cotton – Construction and Planning Lawyers
On Thursday the 11th of July 2019, Victoria, along with a number of Australian jurisdictions, gazetted new insurance regulations enabling building surveyors and building inspectors to avail themselves of insurance policies that do not indemnify them for cladding related claims.
Section 4.3 of the 11 July 2019 Victorian Ministerial Gazette provides that building inspectors and building surveyors will be permitted to obtain insurance cover that excludes ‘liability for loss or damage arising from…. building work where the claim relates to…. –
- External wall cladding product that does not comply with the BCA, an Australian Standard or any other law of the Commonwealth, Victoria or any other State or Territory to the extent that it applies to cladding; or
- An external wall cladding product that is installed, used or applied to a building in a manner that does not comply with [the above mentioned laws and standards]; or
- A high risk wall cladding product that is installed, used or applied to a building in a manner that does not comply with any declaration under section 192 B of the Building Act 1993
The Order took effect from the 12th of August 2019.
The Reason for the Paradigm shift
The reason that the governments are amending their statutory insurance instruments is because insurers are not continuing to underwrite policies for cladding-related claims because of the very large underwriting exposure. It has been said that insurers are adopting a hard-line approach here, but insurers have for some years ventilated their concerns about the unsustainable regulatory risk landscape that exists in the building industry.
As the earlier ministerial gazette did not permit cladding exclusions, building surveyors would have been prevented from continuing to practice for fear of breaking the law. Were this to have occurred, the building industry would have been paralysed as the building approval system would have been stymied.
In addition, many insurers, as a condition of insurance renewal throughout the land, are imposing very high excesses. Excesses have been said in some cases to be in the vicinity of quarter of a million dollars or more. This means that those affected increasingly have to “self-insure”, for the amount that is not indemnified by the insurers.
On both counts these are game changing developments and the impact of these two new paradigms will be examined in this piece both in terms of the impact upon the insured i.e. the building professional and the flow-on effect for the consumer.
The Cladding Exclusions and ‘Running Bare’
Going forward, building surveyors will not be indemnified by insurers if they are sued for cladding-related defects. Absent the indemnity, the respondent will have no insurance protection for this type of claim – in other words will be ‘running bare’.
Sole traders unable to firewall themselves with the corporate veil of the company structure may face bankruptcy if large awards are visited upon them in circumstances where their policies do not respond. This may well precipitate a wave of asset protection activity as companies migrate assets to either trust structures or spouses. The spectre of the ‘man of straw’ building practitioner defendant may resume currency.
The Impact of the “Man of Straw” Defendant Upon the Consumer
Insurance is not a perfect panacea but it is a far better option than the alternative. Such is the high risk profile of building surveying, it is most unlikely that building surveyors will practice without incorporated structures. Consumers intent on availing themselves of redress through litigation and judicial awards may be confronted with a large litigation bill and therefore no compensation.
Absent the availability of compensation by way of a claim against the respondent building practitioner’s insurance, lawyers will be compelled to advise claimants that a victory in a Tribunal or Court of law may well be Pyrrhic. In the case of large claims, respondents will wind their companies up and that will be that.
The Impact Upon the Culture of Respondent Litigation
For more than two decades, insurers have run the majority of respondent litigation. When a building practitioner was sued, the insurer was notified and the insurer appointed a panel law firm to run the case. But under the new insurance exclusions, insofar as a cladding claim is concerned, building practitioner respondents may no longer have this professional indemnity safety ‘parachute’. The respondent may need to give serious consideration to appointing a law firm of their choosing in lieu of the insurer’s nominee law firm by virtue of the fact that the respondent will be largely ‘self-insuring’.
This may change the culture of respondent litigation – for it is not only the building surveyors that will be caught within the new landscape; the net will no doubt be expanded to envelop engineers and architects if the footprint of cladding exclusions ends up enveloping them. Home Warranty providers may also be looking closely at cladding exposure in policy wording going forward.
There will be interesting conundrums regarding legal representation for multi-causation litigation where there is a ‘hamburger with the lot” claim involving:-
- Cladding liability for which the insurer will not respond to; and
- Non-cladding related defects such as structural compromise, water ingress, concrete ‘cancer’ or the like for which the insurance policy will respond to.
There will, therefore, exist the real possibility for conflicts of interest if the same lawyer assumes conduct of both facets and separate subsets of the claim as the interests of the insurance provider will not necessarily align with those of the ‘insured’.
The situation will be pretty tricky – for in the past, the insurers’ lawyers could and did assume full conduct of all iterations and legal permutations of the respondent’s defence as the policies were broad in terms of insurance cover.
It will follow that respondents may even in some matters require two sets of law firms to represent them in so far as broad claims are concerned; for it is difficult to see how the traditional model of one lawyer assuming conduct of all ‘subsets’ of the defence will remain untrammelled.
Furthermore, decision makers will in all likelihood have to divvy up the judicial awards to allocate the quantum that applies to cladding and quarantine that from the quantum that applies to the balance of the broader claim. The insurer and the respondent will then apportion their respective payouts.
Needless to say, insurance policies will need to be reworded to work out how to best manage claims handling to avoid potential conflicts and novel scenarios.
But whichever way you cut it, there is going to be a paradigm shift with regards to the way by which respondent litigation is conducted and great care will need to be deployed by lawyers in ensuring that they do not find themselves in conflicted circumstances.
A New Paradigm of Higher Insurance Excesses
Some of the excesses have been ratcheted up at renewal time by a factor of 500 per cent and are in the vicinity of 250,000 dollars.
Simply put – that means if there is an award for less than the excess, the respondent will have to pay that amount by their own means. Further, typically the respondent will also be funding the legal costs for responding to the claim. The insurance indemnity will only crystallise if the claim exceeds the excess in other words. Were the excess to be $300,000 and the award were to be $400,000 the insurer would pay $100,000 and the respondent the larger portion.
So in a great deal of litigation, the respondent will, to reiterate, pretty much be self-insuring and again this will in all likelihood change the culture of practitioner respondent litigation. Whereas, in the past, the respondent would find comfort in a normal excess environment, in the emerging landscape there will be little comfort and whether there will emerge a further paradigm shift whereby respondents endeavour to appoint their own law firms to assume conduct of their defences will remain to be seen. It is difficult to see how that status quo that has existed for the past 20 years will continue because in a high excess environment, the respondent has far greater personal exposure. One or two pay outs could culminate in insolvency so there will be a much higher level of respondent anxiety with regards to the defence of their cases.
Municipal authorities will no doubt be rebooting their hiring departments. It will be a matter of time before consumers and even commercial enterprises choose to opt for the deployment of council building surveyors instead of private building surveyors. However this motivation may, in the case of the commercial sector, not be driven by altruism, rather it will be driven by recognition that local government will have the ability to indemnify building approval negligence, courtesy of the largess of the rate payer that pretty much guarantees local government solvency. Whether local government wants to expand its building approval hinterland will be interesting to see but it’s a matter of time before there is a deluge of new enquiry from those who are intent on obtaining building permits in circumstances where there is a capacity to account for compromised construction approval outcomes.
It is also likely that only the larger private certification firms will survive in the new paradigm as critical mass will be crucial, and it is difficult to see how sole traders and smaller concerns will survive in the new paradigm. We have already heard of a few smaller building surveying companies that have chosen to voluntarily wind their small business up; one of whom in 20 years of practice had never been sued. This is a great shame as the industry may lose some exemplars that have served the consumer and the industry well for a long time.
On a More Positive Note: a State Remediation Fund
On the 16th of July 2019, the Victorian Government announced a $600 million remediation fund to make 500 high risk buildings compromised by non-compliant cladding safe. This is a commendable initiative, particularly in circumstances where the issues that currently confront the building industry are incredibly challenging and the narrative going forward needs to be about solutions.
Lovegrove & Cotton Lawyers to the building industry
For thirty years, Lovegrove & Cotton have represented builders, building surveyors and building practitioners in Melbourne, Canberra, Sydney and Queensland. Justin Cotton is a leading Australian construction lawyer and widely respected in the building fraternity as evidenced by his appointment as Chairperson of the HIA Industrial Relations and Legal Services Committee, and member of the Regional Executive Committee, for HIA Victorian Chapter. Likewise, Doyles Guide ranks Kim Lovegrove as one of the leading construction lawyers in Australia. Lovegrove & Cotton can help practitioners resolve any type of building dispute and are preeminent in the area of building practitioner advocacy. If you wish to engage the firm, feel free to contact us via our website or by emailing email@example.com.