Protecting your construction project amid rising contractor insolvencies
Construction insolvencies are at their highest level in seven years, and likely to break a decade long record according to ASIC. In the nine months to March 2023 construction insolvencies totalled 1601 across Australia. When a contractor becomes insolvent, there are considerations for those that have engaged them to undertake building works. Where the builder undertakes to procure cover for a project and becomes insolvent it is common that cover for the project will terminate. This leaves the owner exposed. Here we explore these exposures and set out coverage options for owners to consider. We also navigate coverage which may be procured to circumvent the risk of builder insolvency for owners.
Homeowners’ warranty insurance (HWI)
HWI indemnifies against immediate financial loss, where moneys have been paid for works that are incomplete. Most states operate statutory HWI schemes intending to cover consumers for such losses. Cover also extends to incomplete works (along with defects in completed works undertaken by the contractor). The coverage in New South Wales will only enliven upon the “death, disappearance or insolvency” of the contractor or business and pay a maximum of $340,000. It is important to note that most schemes do not cover high rise developments nor the interests of developers, so there is a potential for owners to lose their deposits in such circumstances.
For residential home construction, owners who have engaged a builder to renovate an existing property or build a new home on their land, there is additional risk and exposure when an insolvency event occurs. Whilst HWI may assist with monies paid and incomplete works, there is usually a significant delay from when the insolvency occurs to when payment is made, and until a new contractor can be engaged. This can take months.
Damage to property and materials
The significant risk during this time is the construction site itself. Depending on the stage of construction there is likely a semi complete site. The buildings on site may be compromised by vandals, thieves, and disgruntled unpaid subcontractors of the original builder. There are scenarios where such sites are of value and should be insured against loss or damage until such time as construction can recommence.
- arising from unauthorised access of the site (for personal injury). Whilst many attempt to prevent access to the property by keeping it fenced or even engaging security contractors, it is a common occurrence for a member of the public to access the site, and if injured in doing so, there is risk to the owner being liable for loss due to their injury.
- caused by the structure itself damaging an adjoining building (property damage) – for example, an unsupported wall falling over and damaging the adjoining neighbours’ properties.
Where injury or damage is a result of conduct whilst the builder is solvent (and by extension insured), but the injury/damage fails to manifest post insolvency, legislation enables a claimant / liquidator to bring proceedings to recover damages directly against the insurer of the now insolvent builder.
Depending on the form of the contract the builder is engaged under, there may be design obligations it has assumed. Where this is the case, and there are defects manifest from design during construction, it is ordinarily the builder’s responsibility to remedy those defects. The builder will ordinarily be required to insure for such exposure under the terms of a professional indemnity policy. Those policies are claims made. So, in circumstances where the defect manifests on or around the time of insolvency it is imperative to notify, with specificity and as soon as practicable, the builder’s professional indemnity insurer.
- have the builder’s insurance policies assigned to the owner. Insurance information will need to be obtained (it should be obtained prior to construction commencing in any case) and contact made with the insurers to seek transfer of interests and maintain cover in place. Insurers will charge a premium to complete this assignment/ transfer of interests.
- arrange separate cover. This is incredibly difficult and expensive to arrange particularly where there is no immediate plan for construction to recommence (which is usually the case).
- remain uninsured. Protect the structure and site to the fullest extent possible, and leave it uninsured. This involves securing fencing around the site, security patrols, and supporting/ protecting any parts of the structure which could incur damage as a result of works being incomplete. It may be the case that this option will breach obligations to any security holders/ financiers.
There is a lack of appetite from the insurance market to cover incomplete buildings. They see such properties as a much higher risk of loss or damage whilst unoccupied, they also are not willing to cover any defects arising from actions of the insolvent contractor.
Steps to mitigate against project insurance implications as a result of insolvency
- carry out comprehensive due diligence on the builder
- ensure you collect certificates of currency (COCs) representing evidence of cover for each class of insurance held by the builder
- consider owner’s protective or principal arranged insurance – this may be cost prohibitive for some projects. The benefit of such cover is that if the builder becomes insolvent cover remains on foot and does not terminate
- should your project be affected by insolvency, it is important that consideration be given not only to the potential financial losses incurred, but also actions to protect the asset immediately once possession of the site is regained.
If you have any questions regarding project insurance, please don’t hesitate to contact our Team of specialist construction risk advisors.