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Builder not liable to subsequent purchaser for “latent defects” - 17 October 2014

The High Court has overturned the decision of the NSW Court of Appeal, which held that the builder of strata-titled serviced apartments owed a duty of care to the Owners Corporation to take reasonable care to subsequent purchasers of the apartments from suffering pure economic loss resulting from latent defects in the building.

The High Court has held that Brookfield, the builder of the apartments, did not owe a duty of care to the Owners Corporation to avoid latent defects in the common property.

In this alert, Partner Kevin Dundo and Associate Andrew Vinciullo discusses the implications of this case for developers and builders.

BACKGROUND

The Dispute

In 1997, Brookfield (Builder) was engaged by Chelsea Apartments Pty Ltd (Developer) pursuant to a design and construct contract (D&C Contract) to construct a building in Chatswood, with nine levels of serviced apartments and 12 levels of residential apartments (Building). The serviced apartments were to operate collectively under the “Holiday Inn” hotel brand.

The serviced apartments were registered under a strata plan and The Owners - Strata Plan No 61288 (Owners Corporation) was created as manager of the strata scheme, with the common property vested in the Owners Corporation. The Owners Corporation acted as agent of the owners of the apartments.

Once the Owners Corporation was established, the Developer sold the serviced apartment to purchasers investing in the Holiday Inn commercial venture (Investors). The conditions of sale were outlined in the sales contracts between the Developer and the Investors (Sales Contract).

In 2004, the Owners Corporation discovered defects in the common property and in 2008 they commenced proceedings against the Builder for defective works, resulting in the diminution of the value of the common property.

Liabilities and Warranties of the Parties

Under the D&C Contract, the Builder provided a number of warranties to the Developer as to the quality of services, exercise of skill and care and completion of work such that the Building would be fit for purpose. The Developer also had rights under the D&C Contract to require of the Builder (through the developer’s Superintendent) to reconstruct, replace or correct any defective material or work that was later discovered but not readily apparent at the time of completion.

Under the Sales Contract, the Developer provided similar warranties to the Investors, warranting that the apartments and common property be completed in a proper and workmanlike manner. In relation to the common property, the Developer was obliged to repair any defects upon the Owners Corporation providing written notice to the Developer within seven months after the date of registration of the strata plan.

The Investors otherwise warranted that they had obtained independent advice and were satisfied with the purchase’s obligations and rights under the Sales Contract.

Decisions of the Lower Courts

At first instance, McDougall J dismissed the Owners Corporation’s claim, finding that “[w]here the parties have negotiated in full their rights and obligations, there is no reason for the law to intervene by imposing a general law duty of care.”  On appeal, Basten, Macfarlan and Leeming JJA held unanimously (in separate judgments) in favour of the Owners Corporation, overturning the trial judge’s decision. The Court of Appeal’s decision was seen as a major departure from the law at the time of judgment.

HIGH COURT FINDS IN FAVOUR OF BUILDER

The Full High Court unanimously found in favour of the builder, albeit in four separate judgments. French CJ and Gageler J each gave individual judgments, while Hayne and Kiefel JJ provided one joint judgment and Crennan, Bell and Keane JJ provided another.

There were a number of common themes and reasoning within the judgments based on no liability for pure economic loss and the vulnerability of the Plaintiff.

Nature of the Loss Claimed

Although the Investors were seeking damages in relation to “latent defects” in the property, they were not seeking damages for “property damage” but rather for ‘pure economic loss’ being damages for the “diminished value to the Building and the loss of rents and income during the period of and due to the rectifying of the defects”.

This has special implications in determining liability for the loss.

General Rule – No Liability for Pure Economic Loss

Crennan, Bell and Keane JJ restated the finding of the High Court in Woolcock Street Investments Pty Ltd v CDG Pty Ltd (2004) 216 CLR 515 that the general rule was that there was no liability in negligence to avoid against the risk of another’s pure economic loss. While not expressed in the other judgments, support for this position can be implied through the findings of the remaining judges.

Vulnerability of the Plaintiff is an important (if not determinative) factor

All of the judgments (save for Gageler J’s) discussed the role of vulnerability in determining liability for pure economic loss. Each of the judges drew distinction between two key relevant cases on pure economic loss in the building context, being Woolcock and the earlier case of Bryan v Maloney (1995) 182 CLR 609.

In Bryan, the Court held that the builder of a dwelling house owed a duty to a subsequent purchaser of the house to take reasonable care to avoid pure economic loss due to careless construction giving rise to latent defects in the house.

However, in Woolcock, the Court held that an engineering company which designed the foundations of an office building did not owe a duty to subsequent purchasers of the building to take reasonable care to avoid pure economic loss.

The judges unanimously held that Bryan and Woolcock were not inconsistent judgments. Rather, Bryan was a “special case” based on the vulnerability of the plaintiff’s, which the plaintiffs in Woolcock were held not to have.

Investors not sufficiently vulnerable

The Investors had contractual rights against the Developer which could have protected them against the latent defects, which they were now claiming were the responsibility of the Builder. The fact that their right to claim against the Developer might have extinguished due to contractual limitations did not demonstrate that the Investors were vulnerable in a tortious sense. The Investors were free to invest or not invest as they pleased and it was not the place of the court to remedy the Investors bad bargain by imposing a duty of care in this case.

That is, the Investors had an ability and a freedom to negotiate and contract in such a way that they could not be considered to be in a vulnerable position in purchasing the apartments in the Building.

As such, the plurality of the High Court held that the Builder did not owe the Investors a duty of care as alleged.

Builders Are Now Protected From Ongoing Liability?

The High Court has confirmed its cautious approach to exposing builders to liability for claims in negligence for pure economic loss.

In practice, it seems likely that Gageler J’s distinction between persons buying a dwelling for use as their own home and buildings purchased for commercial and investment purposes will be a useful guide in determining whether a builder is exposed to a negligence claim for latent defects. This is because persons buying residential homes are more likely to be deemed vulnerable due to their reliance on builders to exercise due care and their inexperience or perceived unequal bargaining power in entering contracts.

Builders and developers should otherwise be encouraged to draft and/or negotiate clear and detailed contracts for sale, which outline the parties’ rights, obligations, duties and warranties. It seems from Brookfield that the more exhaustive a building contract is in relation to these matters, the less likely a court will find that a purchaser was vulnerable or that a builder / developer owed a duty of care to avoid pure economic loss.

Finally, it should be noted that the Brookfield case only relates to liability of builders in negligence for pure economic loss. Builders are still potentially liable to subsequent purchasers for property damage claims pursuant to statutory warranties under the relevant state-based home building legislation.

For more information on both Litigation and Dispute Resolution, and Building and Construction matters, please contact HopgoodGanim's Litigation and Dispute Resolution and Building and Construction teams.

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