Ways to mitigate claims inflation in domestic building disputes commenced by Owners Corporations

Building defects claims brought by Owners Corporations against contractors and construction professionals is becoming an all too common occurrence in the Victorian domestic building jurisdiction. These claims are often slow to progress and can be difficult to resolve.

Commonly, Owners Corporations obtain a building defects report in the lead up to the expiration of the 10 year^[1] limitation period and issue a proceeding in haste, before the limitation date expires. It can take applicant Owners Corporations many months (on occasions years) to settle on a pleading (after multiple pleading amendments) and to obtain the expert reports they need to prosecute their claim. Where individual lot owners are also applicants in the proceeding, seeking compensation for non-common defects, the situation becomes even more complex. In practice we see months and on occasions years passing before respondents are ordered to file points of defence and other interlocutory steps can be undertaken. In a stable economic environment, delays whilst still frustrating, may not be such a cause for concern to respondent parties and their insurers. However, in the current inflationary environment these proceedings are becoming increasingly costly to respondents and their insurers. In this article we look at:

• ways we can try and reduce the length of these proceedings;
   
• the impact of claims inflation on proceedings commenced by Owners Corporations;
   
• mitigating the effects of claims inflation. 

Matters to consider when defending these claims

From the outset, respondent parties (and their lawyers) should be alive to the nature of the defects which are the subject of the claim being made by the Owners Corporation and whether your respondent client (or insured) has caused or contributed to those defects. We often see building defects claims brought against building surveyors, where the defects the subject of the claim do not fall within the scope of the building surveyor’s responsibilities and the cause of which cannot be attributed to the relevant building surveyor. Where this type of situation exists, respond promptly and set out clearly for the benefit of the Owners Corporation, why the claim will not succeed. It may be that the Owners Corporation and their solicitors are convinced that the claim is not worth pursuing against that respondent.

Consider whether the proceeding has been commenced in accordance with the requirements of the Owners Corporation Act 2006 (Vic) (the OC Act). This OC Act imposes requirements with which Owners Corporations must comply, to commence a proceeding. The OC Act requires an Owners Corporation to pass a special resolution to commence a proceeding, unless the matter is within the civil jurisdictional limit of the Magistrates’ Court (currently $100,000) in which case an ordinary resolution (majority vote) will suffice to commence a proceeding in VCAT.^[2]  A special resolution if passed by ballot or poll requires 75% of the total lot entitlements and in any other case, 75% of the total votes.^[3] Where a building dispute has been commenced by an Owners Corporation in close proximity to the 10 year limitation period, it is prudent to ensure that the Owners Corporation has met the requirements of the OC Act, before they commenced the proceeding. If not, the Tribunal can order a stay of the proceeding until such time as the Owners Corporations complies with the requirements of the OC Act.^[4]

Cases in the Building and Property List in VCAT have been suffering from significant delays since the pandemic. The retirement of some key Senior Members and the disruption caused by the lockdown has resulted in a significant backlog of hearings and currently, any party seeking a listing for hearing must wait until 2025 at the earliest. Further disruption has affected the List following the Court of Appeal’s decision in Thurin v Krongold [2022] VSCA 226. In this decision the Court of Appeal held VCAT does not have jurisdiction to hear cases involving a law made by the Commonwealth Parliament. In the subsequent case of Vaughan Constructions Pty Ltd v Melbourne Water Corporation (Building and Property)^[5] His Honour Justice Delany held that VCAT lacks jurisdiction to determine claims for contribution under Part IV of the Wrongs Act 1958. It is not uncommon for proceedings brought by Owners Corporations to involve a Federal matter and or claims for contribution (between respondents) pursuant to Part IV of the Wrongs Act.

Where such a proceeding involves either of these issues, respondents should promptly and carefully consider making an application to strike the matter from VCAT pursuant to section 77 of the Victorian Civil and Administrative Act 1998 (VCAT Act) and to seek the transfer of the proceeding to a Court. In a Court there is likely to be more pressure on the parties to comply with Court orders and to progress matters to hearing. The rules of evidence also apply and the Court requires pleadings. Parties to Court proceedings (County or Supreme) must also comply with their overarching obligations under the Civil Procedure Act 2010 (Vic) including the obligation to use ‘reasonable endeavours in connection with the civil proceeding to act promptly and minimise delay’.^[6]

Finally, look at the quantum of the claim against the respondent. If the quantum is modest, consider making an offer of settlement to the Owners Corporation at the earliest opportunity. If it is a multi-respondent proceeding, as these cases often are, the Owners Corporation may be reluctant to resolve its claim against one respondent, as this leaves it exposed to a shortfall if the apportionment of liability against that respondent is ultimately greater than the amount of the settlement. If this is the case, can you work with the other respondents to make a joint offer? Of course this is easier to achieve if the quantum is modest and much more difficult in a $1 million plus dispute and where the liability of [the respondent/insured] is in dispute.

Claims inflation

Covid 19 and the associated lockdowns combined with the Ukraine war, stimulated supply chain issues and labour shortages which saw the cost of building supplies and labour increase. Whilst lockdowns around the world largely ceased in 2021, since then we have faced the cost of living crisis and rising inflation (leading to a sharp increase in the cost of debt). This has meant that that the overall cost to insurers of resolving claims has increased, which has had a significant impact on certain lines of insurance including construction PI.

The claims inflation cost is significant. A recent VCAT decision demonstrates in dollar figures, just how significant. Owners Corporation PS623721 v Shangri La Construction [2022] VCAT 1499 involved a claim for damages for building defects brought by the Owners Corporation and 22 lot owners of a 23 apartment building in Brighton, Victoria against the builder of the complex, Shangri La Construction. In turn the contractor joined the building surveyor, fire engineer and others to the proceeding.

The applicants were successful in proving the defects. Their quantity surveying expert Mr Pavey first estimated the raw cost of rectification^[7] in November 2018 at approximately $6 million. The raw cost included the cost of labour and supplies. Pavey gave evidence that due to the effect of covid 19, the inflation or uplift from November 2018 to the end of the trial in July 2022 (31 months) should be 12.1%. Shangri La’s Quantity Surveying expert submitted that a 5.2% uplift was appropriate. The main explanation for the difference in uplift was Pavey’s evidence that COVID 19 had driven up building supply costs. VCAT preferred the evidence of Pavey and his uplift of 12.1% was applied.^[8]

The Tribunal applied add ons (including preliminaries, builder’s margin, consultant’s fees, contingency, GST and uplift) on a compounding basis such that the adjustment applied to the raw cost of each defect was 75%. A claim of $6 million in November 2018 ended with an award of damages in the applicants favour some 2.5 years later of $10.5million (plus costs).

What can Insurers do to try and mitigate claims inflation in these cases?

In these cases, Claims Inflation should be central to decisions being made by Insurers and their insured respondents. Typically, the longer a building dispute take to resolve, the more costly it becomes to resolve. It is also usually the case that where an Owners Corporation has evidence to prove building defects, it will succeed in its claim. The real dispute in these cases often lies between respondents who are each trying to minimise their contribution to any settlement and quantum. Ways in which Insurers of respondents in building disputes brought by Owners Corporations can try and mitigate claims inflation include: 

1. Working with and supporting Insureds at the earliest opportunity to carry out rectification work themselves. It is going to be more cost effective for an insured contractor to carry out rectification works than a contractor unfamiliar with the works;
    
2. Working with other respondents to try and resolve these claims at the earliest opportunity (as each respondent will be negatively impacted by claims inflation unless found not liable);
    
3. If despite attempts to resolve a proceeding, it is headed towards a hearing, respondents should ensure they have their own quantum evidence to challenge the evidence of the Owners Corporation’s quantum expert;
    
4. If an Owners Corporation cannot be convinced of the merits of settling the claim or for whatever reason settlement has not been achieved, try and ensure that the insured respondent(s) are protected on costs by making sensible offers of settlement at the earliest opportunity. 

[1] Section 134 of the Building Act 1993
[2] Section 18 of the Owners Corporation Act 2006
[3] Section 96 of the Owners Corporations Act 2006
[4] Burbank Australia Pty Ltd v Owners Corporation [2015] VSC 160
[5] [2023] VCAT 233 
[6] Section 25 of the Civil Procedure Act 2010 (Vic)
[7] Raw costs included the cost of labour and supplies
[8] Owners Corporation PS623721 v Shangri La Construction [2022] VCAT 1499 at [357] and [362]