Australia: Combustible Cladding In Australia: An Insurer's Guide

High-rise apartment fires and the risks posed by the use of combustible external cladding are in sharp focus in Australia following a significant fire that occurred at the Lacrosse Docklands apartments in Melbourne on 24 November 2014. This update summarises the risks for property, public liability, and professional indemnity insurers who operate in the Australian market.

The Lacrosse fire

Lacrosse is a 23-storey mixed residential and commercial building constructed in 2011/12 as part of a redevelopment of Melbourne's inner-city former docklands precinct. The apartments were designed by a team of well-regarded consultants and constructed by one of Australia's leading residential building companies.

On 24 November 2014 a cigarette butt discarded on an 8th floor balcony late at night ignited a fire. Aluminium/polyethylene composite cladding (ACP) installed on the external balcony walls caught fire, causing the fire to spread rapidly up the exterior of the building to the roof. Over 500 people were evacuated from the building. Due to the incorporation of enhanced sprinkler and fire safety systems into the Lacrosse design, the fire was contained to the exterior of the building (in accordance with the design intent) and there were no fatalities or injuries.

Developments after the Lacrosse fire

The property insurer of the strata/owners' corporation incurred losses of around $6 million repairing the fire damage to the common property. The occupants were barred from returning to the building until the building was made safe. Civil proceedings are in progress to recover the property damage losses of the owners' corporation and private lot owners.

The municipal building surveyor (MBS) (called a municipal "certifier" in some jurisdictions) determined that the Lacrosse building had been clad with ACP in a manner that did not comply with the building code. In October 2015 the MBS issued building orders to 470 Lacrosse apartment owners requiring them to remediate the allegedly non-compliant cladding. The builder, on behalf of the owners, challenged the building orders in an appeal lodged with the Victorian building regulator. The builder conceded during the appeal that the cladding did not comply with the building code. The builder proposed to leave the cladding in its current configuration and install wall wetting and balcony sprinklers. It was anticipated that the regulator would allow the builder's remediation proposal, which was viewed by most design professionals as a safe and cost-effective solution. However, in January 2017 the regulator rejected the builder's proposal and required the cladding to be replaced in its entirety. The owners subsequently increased their civil property damage claim by around $8 million to include the anticipated cladding replacement costs.

The Victorian building regulator audited approximately 260 high rise residential and public buildings in the Melbourne city centre and surrounding areas to determine whether the external cladding is compliant with the building code. The audit focused on buildings constructed between 1 January 2005 and 30 April 2015. The regulator issued notices to 20,000 Victorian building practitioners requiring them to produce information and documents. The audit initially identified that for around half the buildings audited, the building permit files did not contain sufficient proof that the cladding was building code compliant. Where non-compliance has been established, the regulator has required the buildings to be remediated and has taken disciplinary action against building practitioners alleged to be responsible. The audit has concluded that no single category of practitioner involved in the design, approval or construction of those building projects audited is consistently responsible for the non-compliant use of cladding. As at 1 November 2017 there are 23 buildings that are still being remediated.

On 23 June 2015 the Australian federal parliament commenced an inquiry into non-conforming building products. The inquiry delivered its interim report concerning the use of ACP on 6 September 2017. The inquiry's report expressed concern that there was evidence of widespread use of ACP in a manner that did not comply with the building code. The inquiry considered that there was no legitimate use for ACPs on any building type and recommended that the government legislate to ban the importation, sale and use of ACP. As discussed below, before the inquiry's report was issued the Australian Building Codes Board gave notice of its intention to revise the building code to enhance fire safety protections.

In July 2017, following the Grenfell fire in London, the Victorian and New South Wales governments established "cladding taskforces" to assess fire safety in buildings across both of those states. The Victorian Taskforce believes that there may be approximately 5,000 buildings in Victoria with non-compliant ACP. The NSW Taskforce estimates there may be around 2,500 in that state. NSW is expediting reforms to state building control legislation to increase fire safety.

Summary of the Australian building control regime and the cladding issue

In Australia building control is regulated at a State level. Each State has its own building control statutes and regulations that prescribe the processes for practitioner registration and for the approval and regulation of building work in that State. Most States also have consumer protection statutes that apply to residential building.

The law of each Australian State requires building work to comply with the National Construction Code (NCC). The NCC is a performance based code that sets out uniform technical requirements for the design and construction of buildings in Australia. The NCC is monitored and revised by the Australian Building Codes Board (ABCB), which is a national standards writing body formed by an inter-governmental agreement. The building industry regulators of each State sit on the ABCB.

The NCC currently states that, for high rise residential towers and similar buildings with elevated fire risk, the external walls must be non-combustible. However, the NCC allows combustible materials that have certain properties to be used as an "attachment" to the outer element of a building in some circumstances. The NCC also states that "bonded laminated materials" are to be regarded in certain circumstances as being non-combustible. There has been an historical view among building practitioners and regulators that the NCC allows combustible ACP to be used as an "attachment" to an appropriately fire rated external wall. There have also been commonly held views that certain types of ACP are "bonded laminated materials" and therefore regarded by the NCC as non-combustible. Since the Lacrosse fire the regulators have been adopting revised interpretations of the NCC.

In August 2017 the ABCB circulated proposed amendments to the NCC to help improve fire safety in high rise buildings. It is proposed, among other things, to introduce a new verification method for testing of external wall assemblies for fire spread. It is also proposed to require external sprinklers where ACP is used. Public comment has been sought on the draft amendments to the NCC. It is anticipated the amendments will be subject to some refinement and will be implemented in March 2018.

In all Australian States, accredited "certifiers" or "building surveyors" are given statutory authority to assess building plans and to inspect building work to ensure that building is carried out in accordance with town planning approvals, building control statutes and the NCC. Most States have both private and municipal building surveyors. Most States require building practitioners (including certifiers, designers and builders) to be registered and to hold professional indemnity and public liability insurance.

Current issues for property and public liability insurers

Property and public liability insurance for high rise towers is ordinarily provided in a package of "strata insurance" covers issued to the strata/owners' corporations in respect of the common property.

Property damage policies do not typically provide cover for remediation of design or construction defects in a building. Owners of apartments in buildings with non-compliant ACP must pay for remediation out of their own pocket or claim compensation from the builders, designers and/or certifiers involved in the construction the building.

The presence of combustible cladding is likely to increase the amount of first party property loss and third party damage or injury in the event of a fire. Many owners of multi-unit buildings and their property and public liability insurers are currently conducting audits to establish whether there is non-compliant ACP or other external cladding on their buildings. The major strata insurers have been increasing premiums substantially where buildings are clad in ACP or other combustible materials. There are reports of insurance premium increases that render it uneconomical for the owners to obtain strata insurance. Lenders have expressed concern that a failure by apartment owners to maintain insurance will place them in breach of mortgage covenants.

Public liability insurers are concerned about the risks posed to occupants and their property in the event of a fire involving non-compliant cladding, particularly where the building owners may be aware of the non-compliance. As far as we are aware, there have not yet been any cases in Australia where a building owner or strata/owners' corporation has been sued by occupants for loss, damage or injury arising from non-compliant use of ACP or a failure to remediate known non-compliance. However, there is clearly a risk of those claims arising in the foreseeable future. Building owners and public liability insurers should bear in mind that the use of ACP does not in itself mean that the building is non-compliant with the NCC or unsafe. Expert assessment is required to determine whether the cladding is building code compliant and/or whether it poses a risk to safety.

Current issues for professional indemnity insurers

There has been a significant increase in claims against building practitioners, designers and certifiers alleging that buildings have been constructed from ACP or other combustible cladding in breach of the NCC and therefore in breach of building control statutes. Compensation claims made by owners against design consultants and certifiers for remediating non-compliant ACP allege breach of professional duty and therefore trigger professional indemnity insurance policies. Many design consultants and certifiers have made notifications to their professional indemnity insurers where regulatory investigations or audits have revealed allegedly non-compliant cladding. There has also been an increase in disciplinary action taken by regulators against building practitioners.

In its submissions to the non-conforming building products inquiry, IAG Australia, one of Australia's largest general insurers, expressed concern about a perceived failure of the building control regime to ensure compliant building, with reports that up to 96% of building approvals given in Australia have deficiencies in the design and certification documents.

Since the fire at the Lacrosse apartments, most designers have been cautious when specifying the use of ACP and most certifiers have been reluctant to approve such plans. Most of the current professional indemnity claims relate to designs prepared before the Lacrosse fire occurred in November 2014. When the limitation periods on civil claims are also taken into account, the biggest risk to professional indemnity insurers is posed by buildings that were completed in Australia in the period between 2007 and 2015.

Claims by owners against design professionals for the cost of replacing cladding are usually brought in negligence for pure economic loss. The decision to use ACP, which parts of the building to use it on, and how to install it, are matters of professional judgment for designers. The certifier's decision to approve building plans providing for the use of ACP is also a matter of professional judgment. In both cases, the proposed use of ACP must comply with the NCC and the practitioner must act in accordance with good industry practice, or else the practitioner is exposed to civil liability.

The common law of Australia recognises that builders, designers and certifiers can owe a duty of care to protect homeowners against economic loss resulting from the acquisition of a home with latent defects. However in recent times the Australian courts have been paring back the duty of care, casting more responsibility on purchasers to investigate the presence of defects before purchase or to protect themselves through appropriate clauses in the contracts of sale. This trend is reducing the liability risk faced by builders, designers and certifiers for building defect claims, including those involving ACP.

The High Court's decision in Brookfield Multiplex Ltd v Owners Corporation Strata Plan 61288 [2014] HCA 36 states that, where the claim is for pure economic loss, a building practitioner only owes a duty of care to a subsequent owner where the owner was reliant on the building practitioner or unable to protect themselves from suffering the loss. In Brookfield Multiplex a claim by an owners' corporation against the design and construction contractor for the cost of defects remediation was dismissed. The High Court decided that no duty of care was owed, because the contractual protections provided to the owners' corporation meant it was not vulnerable to the actions of the design and construction contractor.

In the recent decision of the NSW Court of Appeal in Ku-ring-gai Council v Chan [2017] NSWCA 226 a purchaser claimed against a municipal certifier in negligence for pure economic loss, alleging that he relied on the Occupancy Permit as establishing that the building was free from structural defects. The NSW Court of Appeal dismissed the purchaser's claim against the certifier, on the basis the purchaser could have protected himself by negotiating the inclusion of appropriate terms in the contract of sale, and that a general belief by the purchaser about the Occupancy Permit's correctness was not sufficient reliance.

Claims by owners against builders are usually brought under the state consumer protection statutes, which impose warranties on builders that their work complies with the NCC. The warranties are directly enforceable by subsequent owners against the builders. Builders do not typically have insurance cover for claims arising from construction defects arising from the use of ACP in contravention of the NCC.

Replacement of cladding on buildings is expensive. Given the regulator's rejection of a relatively low cost remediation proposal for the Lacrosse Apartments, building owners have been emboldened to pursue total removal and replacement instead of cheaper alternative remediation solutions. Fortunately for professional indemnity insurers, most claims by owners against designers and certifiers for cladding replacement are apportionable, meaning the liability of each defendant is limited to its proportionate share of the loss. In some States claims by owners against builders for breach of the consumer protection warranties are not apportionable and in such cases the designers and certifiers can face a risk of joint and several liability.

Since the Lacrosse fire, some professional indemnity insurers of building practitioners have started to include exclusion clauses in policies for claims arising out of the use of ACP. As far as we are aware, the effectiveness of such exclusions has not yet been tested by an Australian Court. We offer three suggestions to insurers who are considering ACP exclusions:

  1. Insurers will need to ensure that their exclusions do not result in the insured building practitioner contravening the minimum insurance requirements imposed by State legislation.
  2. Some push-back from design consultants and certifiers can be expected because the incorporation of the exclusion into new policies will cause them to lose insurance cover in respect of liabilities arising from past design work. Further, it is common for a builder to select ACP or to substitute the cladding product during construction.In those situations, an ACP exclusion may cause the design consultant or certifier to lose insurance cover for services supplied on a past project, even though they were unaware ACP was used by the builder.
  3. In claims where the builder selects ACP or substitutes the cladding product during construction, it will be alleged that the designer's plans lacked detail about the external cladding product to be used or that the designer should have monitored the builder's product selection.An ACP exclusion may not be effective where a claim is framed in those terms.

Finally, building valuers are also placed at increased risk of claims for failing to account for the effect of ACP on building values. Professional indemnity insurers of valuers have been encouraging the valuers to include disclaimers and qualifications in their valuation reports relating to the effects of ACP on building valuations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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