This article aims to provide Principals with practical contract administration guidance should a defect arise during the defects liability period (DLP) of a construction contract.
Directing the Contractor to rectify the defective work
Nearly all construction contracts contain a procedure to be followed if the Superintendent or Principal believes that construction work is defective.
Most construction contracts require the Superintendent to give to the Contractor before the expiry of the DLP (‘final completion’) written notice that:
- identifies the work the Principal considers is defective;
- directs the Contractor to rectify the defective work; and
- states a timeframe for completing the rectification work, consistent with the contract requirements.
If the Contractor fails to rectify the defects within the specified timeframe, the Principal may have the work rectified by other contractors and recover the cost of those works from the Contractor. Failure to allow the Contractor the ability to rectify defects under the regime specified within the contract could reduce the damages that a Principal can recover from the Contractor. This proposition was confirmed by the Supreme Court of South Australia Court of Appeal in Bedrock Construction and Development Pty Ltd v Crea [2021] SASCA 66.
The rationale behind giving the Contractor a chance to rectify the work first is that it’s more cost-effective for all parties because, among other reasons, a Contractor can direct its subcontractors to rectify the defective work, often without charge. Conversely, engaging another contractor is likely to attract a heavy loading for contingency risk and could also affect the warranties for the works.
Principals may also face challenges in recovering rectification costs from the Contractor without legal action particularly when the Contractor has been paid the full contract sum, the Principal has returned the Contractor’s security, or the security does not cover the cost of the rectification works.
In disputes over defective work, the Contractor will often attack the validity of the Superintendent’s notice directing rectification of the defective work. We commonly see arguments that the Contractor was not afforded a fair and proper opportunity to properly consider or rectify the defective work. This is generally a question of fact and degree, and its answer can include a court inquiring whether the Contractor was afforded sufficient access and a reasonable time to rectify the defects.
A direction to rectify defective work will generally be effective under most construction contracts if it clearly:
- states the contractual requirements for the work, with reference to the Building Code of Australia, specifications, and drawings;
- explains why the works do not meet the requirements of the contract (i.e. the resultant defect);
- explains the conduct of the Contractor, whether, by act or omission, that is alleged to have caused or contributed to the defects;
- identifies the consequence of those defects;
- explains how (by reference to scope) the Superintendent considers that the Contractor must rectify the defects to bring the works into conformance with the contract;
- outlines the Superintendent’s expectation of when the rectification work must be commenced and completed (i.e. the timeline including details of when access will be afforded to the Contractor if the premises is occupied);
- invites the Contractor to propose a methodology for rectification of the defect, and allows the Contractor a reasonable time period for rectification, consistent with the contract requirements; and
- proposes to extend the DLP to accommodate the rectification work.
If a further defect is identified during the extended DLP, the above process should be repeated until all defects have been rectified to conform with the contract.
What if we are past expiry of the DLP, and we failed to issue an extension notice?
We are asked this question a lot. In practice, it is often the case that the Principal and the Contractor will deal with a defect informally and work together to achieve a resolution without formal dispute. In cases where the defect persists and financial resources required for the rectification grow, the relationship between the parties can become fractured and disputes often arise.
In this situation, the final security is critical leverage a Principal can use to ensure that a Contractor commits to rectifying defective construction work. A call on security, or a delay in the return of it, may affect a Contractor’s cash flow, reputation and ability to obtain security in the future.
The typical function of a “final certificate”
Construction contracts typically include “conclusivity” clauses providing the mechanism for the final adjustment of the contract sum at the end of a project.
For example, under an unamended AS4902-2000 design and construct contract, a final certificate:
- is issued by the Superintendent following the expiry of the DLP;
- is evidence the works are complete, and discharges all of the Contractor’s obligations under the Contract except for fraud, latent defects, computational error, or unresolved issues the subject of a notice of dispute served within 7 days after the final certificate;
- identifies the final amount due and payable between the parties;
- triggers the obligation for the Principal to release any remaining security (assuming there is no money owed to the Principal); and
- ends the Superintendent’s involvement with the project.
How do I keep final security alive after the final certificate is issued?
We often see situations where:
- the time for issuing a final certificate under the contract has passed;
- there is an outstanding defect that is yet to be resolved; and
- the DLP has not been extended; however, the Principal (absent of an entitlement) retains the final security.
In this scenario, subject to the terms of the contract, a Contractor has reasonable prospects of obtaining an injunction preventing the Principal from calling on a bank guarantee because the Principal, after issuing of the final certificate, is not contractually entitled to retain the bank guarantee.
Another example where a Principal’s right to final security can be compromised is if:
- the final certificate is subject to a notice of dispute issued within 7 days of the final certificate being issued; and
- the right to recourse is limited to “an amount unpaid after the time for payment” (unamended wording of AS 4902-2000).
In Tomkins Commercial & Industrial Builders Pty Ltd v Majella Towers One Pty Ltd & Anor [2017] QSC 202 the Supreme Court of Queensland stated that a final certificate that certifies an amount due by the Contractor, that is also the subject of a notice of dispute, cannot be relied on by the Principal as an “amount due” by the Contractor. In other words, the amount referenced in that notice of dispute could not be set-off by the Principal against the Contractor’s security.
Practical matters
To avoid these situations, Principals should consider making these amendments to their contracts:
- Clause 5.2: expressly allow recourse to security for any “bona fide” claim immediately following the provision of notice.
- Clause 5.4: stating that if, as at the date of the final certificate, there remain unresolved issues between the parties which are subject of a notice of dispute, the Principal’s entitlement to hold the final security shall cease 14 days after the resolution of the issues the subject of the notice of dispute.
- Clause 37.4: stating that any failure to issue a final certificate within the time prescribed will not invalidate the later issue of a final certificate.
Where a dispute arises and a call on security could eventuate, Principals should seek early legal advice on:
- the contractual entitlement of a call on security;
- the contractual requirements and other formalities of making a call; and
- any legislative requirements that may govern a Principal’s right to call on security.
For example, in Queensland, a Principal is required to give notice of its intention to use a security or retention amount within 28 days after it becomes aware, or ought reasonably to have become aware, of its right to obtain the amount owed (see s 67J, Queensland Building and Construction Commission Act 1991 (Qld)).
Takeaway
This update is intended to provide a brief overview of issues that can arise when the contract is not followed during the DLP and at final completion.
The two key takeaways from the article for Principals are the importance of ensuring:
- compliance with the procedures prescribed under the contract in notifying defects once they have been identified, and subsequently allowing the Contractor to rectify the defects; and
- that the contract contains terms sufficient to preserve a Principal’s entitlement to retain performance security to mitigate its losses if a dispute cannot be resolved out of court.
If you have any queries about structuring your construction contract to prevent claims or minimise losses, please get in touch with us.
This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader’s specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances, please contact one of the named individuals listed.
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