Standard building industry terms – definitions and explanations (Part 1)
By Kim Lovegrove RML, FAIB, Senior Lawyer, Lovegrove & Cotton
Date of Practical Completion
The date of practical completion is the date when the building is to be completed. The term generally means the date when the building reaches the stage of being fit for the purpose intended, or complete, except for minor omissions or defects.
Under most standard form contracts, the builder lodges a practical completion certificate when the builder considers the building complete. The owner then has a given number of days to determine whether the building is in fact fit for the purpose intended.
If the owner considers the building has reached that stage, the owner signs the practical completion certificate. If the owner does not consider the building has reached that stage, contracts generally have a provision under which the owner can issue the builder a “Notice of Matters and Things Required to Bring the Works to the Stage of Practical Completion”. Provided the owner’s requests are legitimate, the builder should then fix the items in the notice.
This procedure varies from contract to contract. It is important to read the clauses governing practical completion to understand the operative provisions and time frames.
Never confuse a Certificate of Occupancy (CFO) with practical completion. All a CFO establishes is that the building has reached the stage at which it complies with Council or authority standards.
In the case of domestic building work, the term practical completion may not be necessarily in usage, depending upon the state or territory. Have regards to the definition of “completion” in the domestic building contract to ensure that it complies with the relevant domestic building legislation.
Defects liability period
Contracts normally have a defects liability period which commences on the date of practical completion. It lasts from anywhere between three months and a year. During this time, the builder has to rectify any defects notified in writing.
Building contracts generally contain retention fund provisions. The fund gives the client some security for the rectification of defective workmanship.
A typical retention clause will have a provision for 10% of any progress payment to be deducted and placed into a retention account. The deductions continue until the fund equals 5% of the contract sum. When the work is complete, the client must release 50% of the fund. The remaining 50% must be released at the end of the defects liability period or upon issue of the final certificate.
There are two types of retention facility:
- One is where a retention fund is established in a bank account. The deductions are place into the fund which should be an interest bearing account.
Some contracts do not state who gets the benefit of the interest in the account. As money may be held in a retention account for 12 to 18 months, this is an important consideration. Ensure it is clear that the builder is paid the interest on the account when the fund is released.
- The other is a bank guarantee. Instead of the money being deducted from a progress payment, the builder provides the client with bank guarantees to the value of the deductions.
- One of the advantages of a bank guarantee is that the builder is not denied the use of the circulating capital. Whereas with the retention fund, the builder is deprived of its use for many months.
If a bank guarantee is provided, ensure that it is not an unconditional bank guarantee. An unconditional bank guarantee will enable a client to cash the guarantee at any stage. One can have a situation where the builder has not committed any default, the client wrongfully cashes the guarantee and he builder has to rely upon legal remedies to get the money back. Often the costs involved with resorting to those remedies makes this course of action prohibitive.
Ideally, a builder should try to negotiate any sort of retention facility out of a building contract.
Liquidated damages are an amount of money to be paid by the builder to the owner to cover damages for delays. The amount is negotiated by the parties before the contract is signed. The amount must be a genuine estimate of the costs that the client will sustain if the builder fails to complete by the date of practical completion (when the builder is not entitled to an extension of time).
The negotiated amount must be realistic. For example, if a builder is engaged to construct a building and the building is to be sold on the date of practical completion, the amount should be based upon the loss that say, for example, a developer would incur if the builder does not complete by that date.
The loss may include factors such as:
- Interest payable on the owner’s loan, or penalties that the future purchaser will enforce if the developer fails to settle on the date of practical completion.
- If the building is constructed for rental purposes, liquidated damages can reflect a market rent rate for the area.
Look out for next week’s Lovegrove & Cotton Bulletin for Part 2 of this piece.
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