Financiers urged to consider new building compliance requirements before lending

Following a number of high profile cases in relation to the quality of developments, Construct NSW is implementing a new regulatory framework to help restore confidence in the NSW building and construction sector. With the new framework in place, financiers will need to be aware of what the new regulations mean for lending arrangements with developer clients and ensure compliance throughout the project.

Background

With the Residential Apartment Buildings (Compliance and Enforcement Powers) Act 2020 (NSW) (RAB Act) commencing in September 2020 and the Design and Building Practitioners Act 2020 (NSW) (DBP Act) commencing on 1 July 2021, there are an increasing number of Occupation Certificate Audits (OC audits) being carried out. These audits have led to the issue of various other prohibition orders in relation to defective and non-compliant buildings.               

Financiers (whether banks, other APRA regulated lending bodies, or non-APRA lenders) have a significant role to play in supporting the objectives of NSW Building Commissioner David Chandler OAM through governance and compliance monitoring in their lending arrangements with developer clients. While non-bank lenders are prepared to take more on risk than banks, the need to ensure compliance with the new regulatory framework applies regardless of the financier model.

Construct NSW has moved from an ‘education and inform’ phase to an ‘accountability, consequences and trustworthiness’ phase. This has seen the Building Commissioner increasingly using his statutory powers to conduct OC audits and issue stop work, building work rectification and prohibition orders as part of the compliance framework. This is designed to restore the public’s confidence in the building and construction industry.  

It is particularly important that financiers are aware of the broader liquidity issues in the building and construction sector so that they can consider how this new regulatory framework may affect companies at a practical level. In 2020, 925 companies in the construction industry entered external administration, 18.7% of all companies that entered external administration. This represents the second highest number of entries into external administration, with only businesses in the personal and business services sector recording a higher level of companies entering external administration.

Developers who fail to comply with the regulatory framework could see delays in having occupation certificates granted. This will lead to a delay in sales contracts settling and could potentially lead to defaults under the lending arrangements between financiers and developers. As noted below the scope for the Building Commissioner’s intervention will flow not just from audits in the lead up to completion but also at an earlier stage of auditing declared designs.

Increased audits for both Occupation Certificates and compliance declarations

Under the RAB Act, developers must give six months prior notice before an intention to apply for an Occupation Certificate (OC). This notification then allows the Building Commissioner to conduct an audit of the building work before an OC is granted. OC audits are designed to ensure that building work is performed in accordance with the Building Code of Australia (BCA) and approved designs, using products that meet the requirements of Australian Standards.

This is designed to raise the standard of construction for Class 2 buildings to give consumers more confidence in their purchase as they move from depositor to owner.

Nearly 500 developers have given their notice of an intention to apply for an OC since the RAB Act came into effect on 1 September 2020. The Building Commissioner has completed over 40 OC audits, and is expected to complete 100 by the end of 2021 and 200 by the end of 2022. The main issues identified relate to waterproofing, structural integrity, essential services, external cladding and fire safety.

OC audits are currently restricted to Class 2 multi-unit residential buildings. However, it is expected that the remit of the OC audit process will increase over the next year to include an audit of compliance declarations covering declared and “as-built” designs, issued under the DBP Act. Compliance declarations will need to be issued by principal design, design and building practitioners under the compliance process required by the DBP Act before an OC can be granted by a Principal Certifier.

As time progresses, the Building Commissioner has stated an intention to determine a distinction between ‘trusted’ and ‘non trusted’ players in the sector, with non trusted players being subject to the OC audit process. Trusted players will benefit from being exempt from the OC audit process. This incentivises developers to ensure that building work they are involved in is deemed as trusted during the earlier phases of the OC process to avoid a more burdensome regulatory process in the future.

The change will require developers to ensure that all parts of the building process (including designs) are compliant with the required standards. This is all part of a drive by the Building Commissioner to evaluate the ’sum of all parts’ of a building project, rather than individual parts of a project in isolation. The plan is designed to ensure the quality and durability of developments in the long term.

Next steps for financiers 

It is important for financiers to ensure that their processes reflect the expectations of the legislation with regard to their governance and oversight in lending practices to developers. It will also enable financiers to have strong oversight over building work which they have financed. This will facilitate the delivery of compliant buildings and minimise impairments to loans.

These steps may include the following:

1. Governance of developers: developers on most projects are generally in the form of Special Purpose Vehicles (SPVs). It is important that there are good governance practices for these companies in relation to the delivery strategy for each component of a project, including the form of the building contract. Some of the developers which are the subject of increased OC audits or prohibition orders have low levels of governance structures in place, for example single director companies with no independent oversight, or where the developer and the builder have the same director and management control. Financiers should be mindful that the RAB Act enables the calling in of any document associated with the procurement, organisation, inspection, certification and function of Class 2 buildings in NSW up to 10 years old which could include the construction contract used or applicable lending conditions.

2. Appropriate monitoring of compliance (or non-compliance) by developers: enhanced monitoring to ensure buildings are constructed in accordance with appropriate standards. This may require lending covenants to include obligations on those borrowers to:

a) notify financiers when they receive a request or direction for an OC Audit and the audit report outcomes;

b) provide copies of all required compliance declaration in relation to a project as a condition precedent and ongoing reporting obligation, and represent that they have complied with the requirements of the RAB Act and DBP Act;

c) provide financiers a copy of any documents they are required to provide Construct NSW for review;

d) provide notice of, and the option to attend, any OC audits conducted by Construct NSW and any other material notices issued by the RAB Act and DBP Act. These may include any expected completion  or expected completion amendment notices (each as defined in Building Law), or a stop work,  building work rectification or prohibition orders;

e) demonstrate use of appropriate contracts and the builders, certifiers and designers engaged are appropriately licensed under the relevant legislation;

f) comply and procure compliance by building and design practitioners, with the RAB Act and DBP Act.

We also recommend that appropriate defaults and review events are included in relation to the issuance of a stop work order, a building work rectification order or prohibition order, as well as disciplinary findings being made in relation to the borrower, builder, certifier or any other member of the professional team.

3. Monitoring of progress payments made to builders: oversight of how payments are certified by developers to ensure that any progress payments are for work carried out in accordance with the relevant legislation and standards, and payments are not made for non-project-related allowances. This will require transparency regarding the make-up of the payments.

4. Distinction between ‘trusted’ and ‘non trusted’ players: once Construct NSW begins to make a distinction between ‘trusted’ and ‘non trusted’ players, impose stricter lending limits and detailed conditions on non-trusted players.