The building industry is under siege with surging insolvencies and plummeting building approvals culminating in a hostile and oppressive building environment for contractors. Yet with the surge in migration there will be strong demands for new builds.

Back to the Future – Time to Consider a Return to Cost Adjustment Provisions in Building Contracts and Risk Sharing 

I discussed this piece with my colleague, Professor Kim Lovegrove who shared some history. He said when he started working as a construction lawyer in 1987 as the Legal and Contracts Officer at the Master Builder Association of Victoria (“MBA”), building contracting was very different.

Rise and Fall clauses were the norm

Until the mid-nineties standard industry building contracts had rise and fall clauses. They were designed to ensure that builders could claim for increases in labour and material (“L and M”) costs during the building project.

The entitlement recognised a contracting reality, i.e. during the life cycle of the project L & M would increase and the price that the builder quoted would change on account of external factors beyond their control.

This all changed with the Domestic Building Contracts Act 1995 (Vic) (“DBCA”) which heralded a paradigm shift. Rise and fall provisions of building contracts became illegal, as did arbitration clauses and charging clauses (that gave builders the ability to lodge a caveat on an owner’s property to secure any debt exposure by way of unpaid progress claims). Incidentally this writer is not recommending a reinstatement of either arbitration or charging clauses.

Then came the perfect storm

COVID-19 impacts, broken supply chains, Ukraine and shortages of labour have in the last 3 years bludgeoned the building industry, causing a mushrooming of insolvencies. Fixed price contracts have become instruments of incarnation, as builders are captured by the obligation to build in accordance with prices that were forecasted in a normal economic environment. The context has changed profoundly.

For example, if builders that have operated on a profit of let’s say, 10 percent, have had to contend with L and M cost escalations of well over 20 percent. Do the maths, it doesn’t work. On this formula the profits wiped out and the builder is haemorrhaging.

Some naysayers contend that some of the larger companies went under because of bad building practices. Wrong, some household name builders became victims of their own success. Victims of their ability to build well, on time and on budget; which led to larger market share and consequently greater vulnerability to abnormal market conditions.

The problem is that the bigger they became, the more they were going to be exposed to the tempest. Imagine building 500 homes with a 10 percent profit margin, and the job costs 20 percent more to build. Again, do your maths, not sustainable. Net effect insolvency and good builders going to the wall.

In these most unusual of times, it is not the fault of the builder, it is not the fault of the owner

It is the fault of external factors, factors that are tantamount to contract frustration events, i.e., macro-economic headwinds that conspire against the ability of the builder to discharge its contractual obligations. Unfortunately well thought through and policy responsive changes to adjust macro settings are still proving elusive. Rather a startled and paralysed ‘rabbit in the spot light’ policy inertia seems to have taken hold, so the insolvency spike continues to accelerate.

So, what could governments consider?

• Legislation like the Home Building Act 1989 (NSW) and the DBCA should be revisited.

Resurrect rise and fall clauses

• It is time to bring them back, at least for a sunset period i.e., there could be a reinstatement of the ability to claim rise and fall for new contracts pending a time where there is a return to normal conditions.

Legislate fairer and less one sided contracting regulations

• The DBCA exclusively visits statutory penalty offences upon builders. The legislation is very one sided, what about the situation where an owner refuses to pay a lawful entitlement?

• Said colleague tells of a time when he was working at the MBA and he could hear his boss remonstrate “not again, another case of the ten percent factor”. Code for the builder was having to fight to get the final 10 percent. Reason being, once the contract was close to completion, the builder had lost it’s contractual leverage and the final payment was withheld.

• It is self-evident that contractual dealings and the legislation that underpins same needs to be fair as at the moment the legislation is too one sided. Builders need to better protected from contractual default.

Promulgate the ability to have a risk sharing schedule mechanism

• The legislation does not allow for any equitable risk sharing. Once again, I am informed that a couple of decades ago, there were standard industry contracts that went by the name of JCC contracts. These contracts allowed for the contracting parties to fill out risk sharing clauses that allowed the parties to divvy up by way of percentages the amounts to be shared in the event of unforeseen circumstances.

Legislate to allow standard industry building contracts to include a mandatory mediation mechanism

Legislate to allow for front end mediation before legal proceedings are issued. There is precedence for contractually empowered mandatory mediation.  Said colleague informed me that the Law Institute of Victoria (“LIV”) and the Victorian Law Reform Commission (“VLRC”) in the early nineties published a ‘plain English building contract’ that contained a mandatory mediation clause. He was very familiar with the contract as the Victorian Law Reform Commission and the Law Institute of Victoria jointly engaged him as the principal draftsperson.

• The provision dictated that in the event of any dispute, the parties had to go to compulsory mediation.

• They could not ‘up the ante’ and issue legal proceedings, unless the mediation failed.

• It contractually behoved the parties to agree upon and nominate a mediator before they signed the contract. Whenever there was any flair up, the mediator could be ‘summonsed’ as it were, to mediate with the view to effecting a settlement.

• Granted the parties under the contract had to share the cost of the mediation on a 50/50 percent basis, but a small price to pay to front end a resolution and keep a project on track.

• Further such an innovation would have the effect of taking the pressure off the Domestic Building Dispute Resolution Victoria (“DBDRV”), in fact could even replace it and the conciliators could be redeployed as mediators, which would minimise the budgetary pressures that currently are being visited upon Treasury.

• As is the case with the DBDRV if the parties prove unable to settle through this mediation avenue, then the mediator would sign a declaration to that effect to enable the parties to issue proceedings in the dispute resolution theatre (“DRT”).

‘Somethings got to give’

The insolvency spike, drastic drop in new starts and surging migration are creating unprecedented oppressive market conditions for this sector.

So some strong and interventionist government policy resets would be well received

Fixed price lump sum building contracts were designed for normal times and normal market conditions, these conditions are no longer in play and won`t be for some time.

The inability of contractors to complete contracts on time on price is no good for builders and no good for owners. No good for government and insurers either as it will bring tremendous stress on the viability of the home warranty cover scheme.

Without governmental intervention it is reasonable to contend that the acceleration of a dire situation will gain momentum.

And maybe the Banks can afford some largess and come to the party

If negotiated increases in contract pricing are the difference between project survival and collapse, could not some allowance be made by the banks to entertain a lower interest rate for increased borrowings? A hole in the ground is no good to a bank, nor is a forced mortgagee sale induced by the domino effects of builder insolvency.

This is a Lovegrove and Cotton publication, authored by Tsigereda Lovegrove.

Disclaimer

This article is not legal advice and discusses it’s topic in only general terms. Should you be in need of legal advice, please contact a construction law firm. The experienced team at Lovegrove & Cotton can help property owners and building practitioners resolve any type of building dispute.