Lessons from Queensland - legal issues arising from recent natural disasters

Contributions to this article also by Elisa Kidston

Key Points:

The floods hold important lessons for negotiating, drafting or managing real property contracts, leases and body corporate or strata management.

In late 2010 and early 2011 Queensland was subjected to several devastating natural disasters, including widespread flooding and Tropical Cyclone Yasi. As Queenslanders move into recovery mode, the recent natural disasters have highlighted the need for the property industry (including developers, purchasers of real property, landlords, tenants, body corporate managers, lawyers and agents) to review their current and future arrangements (including contracts for the sale or purchase of real property, leases for commercial, industrial or office buildings and insurance arrangements) to ensure that they are aware of their rights, roles and responsibilities and are prepared in the event of any natural disasters.

This article examines some of the legal implications arising from Queensland's recent devastation for parties involved in the negotiation, drafting or management of real property contracts, leases and body corporate or strata management and sets out some important lessons for all of the parties involved in such transactions which can and should be applied in future dealings.

Contracts for Sale of Property

The position of a vendor and purchaser of a property which is destroyed or damaged as a result of a natural disaster will vary having regard to the terms of the contract and any relevant statutory provisions applicable.

Who bears the risk?

Under general law, from the date a contract is formed, the property is at the risk of the purchaser, who bears any loss to or destruction or damage of the property which occurs subsequent to the date of the contract (Fletcher v Manton (1940) 64 CLR 37). The vendor in possession is merely obliged to use the property with reasonable care until completion (Clark v Ramuz (1981) QB 456).

In the event of loss, subject to any statutory provisions or contractual terms to the contrary, and assuming the contract is otherwise valid and enforceable against the purchaser, the purchaser will be bound to complete, notwithstanding the damage or destruction to the property. The purchaser is not entitled to be discharged from the contract, or to a reduction of the purchase price (Ziel Nominees Pty Ltd v VACC Insurance Co Ltd (1976) 50 ALJR 106).

Further, there is no obligation on a vendor, either at law or statute, to appropriately insure their property (in Queensland, many property owners were not insured against damage by riverine flood) and, subject to some statutory amendment to the contrary (for example section 35 of the Sale of Land Act 1962 (Vic)), generally there is no right for a purchaser to seek contribution from the vendor's insurer.

Common contractual provisions

In Queensland, the common law principle relating to risk is incorporated as a standard term in the Real Estate Institute of Queensland standard conditions to land contracts ¹ with the only difference being that risk will pass to the purchaser on the first business day after the contract date (to allow a purchaser time to effect adequate insurance of the property).

In New South Wales, the general common law principle is reversed by section 66K of the Conveyancing Act 1919, which provides that risk does not pass until the earlier of completion of the contract or the date the parties agree risk passes, being not earlier than the time the purchaser takes possession. The standard contract terms for the sale of land – 2005 edition then provide that the risk as to damage to the property passes to the purchaser immediately after the purchaser enters into possession (standard clause 18.4).

By comparison, the Law Institute of Victoria standard contract also modifies the general law principle and prescribes that the vendor carries the risk of loss or damage to the property until settlement (section 21.4, Contract of sale of Real Estate – Standard Form as prescribed by the Estate Agents (Contracts) Regulation 2008). The vendor is required to deliver the property at settlement in the same condition it was in on the day of sale (fair wear and tear excepted) (standard clause 24.2).

Statutory rights

As the general law principle has not been reversed by legislation in Queensland and Victoria, there is legislation in place in those jurisdictions which changes the traditional rules relating to risk by providing purchasers of dwellings with rights in the event of damage or destruction prior to completion of a contract or entry into possession. That legislation is however limited in its operation.

In Victoria, section 34 of the Sale of Land Act 1962 provides a purchaser with the right to rescind a contract for the purchase of a dwelling before the purchaser is entitled to possession or to the receipts of rents or profits from the dwelling where the dwelling is destroyed or damaged to the extent it is unfit for occupation as a dwelling.

This provision is expressly subject to the right of a vendor to reinstate the property prior to the purchaser becoming entitled to possession or the receipt of rents and profits (section 36) which may operate as an injunction to any rescission notice pursuant to section 34. Because of this qualification, a purchaser may be compelled to complete a contract (once the property is so rectified or reinstated) where it was once capable of rescission.

Similarly in Queensland, where a contract is for a residential dwelling, section 64 of the Property Law Act 1974 allows a purchaser to rescind the contract prior to completion or possession where the dwelling is destroyed or damaged so that it is unfit for occupation as a dwelling.

In each case, consideration must be given to the degree of damage that would be necessary for a dwelling to be capable of being classified as "unfit for occupation as a dwelling" thereby invoking the statutory right of rescission. The decision of the High Court in Georgeson v Palmos 1962) 106 CLR 578 considered an analogous provision in a lease and required a distinction be drawn between temporary consequences which could easily be restored and more significant or permanent damage which prevented the resumption of that business within a reasonable time. From this, it is suggested that some degree of actual physical damage requiring more than minor cosmetic repair or cleaning would be required to safely rely upon these provisions.

Interestingly, the Queensland Supreme Court recently heard a case, Dunworth v Mirvac Qld Pty Ltd (No 3) [2011] QSC 27, concerning a purchaser's right to terminate a contract as a result of the damage caused by the Queensland floods in January 2011, where the purchaser sought a declaration that the contract was duly rescinded in reliance on section 64 of the Property Law Act 1974, notwithstanding the vendor's offer to rectify the damage and extend settlement until the property had been so rectified.

The Supreme Court noted that there were legal and factual questions about the application of section 64 which should go to trial and could not be determined summarily. As a result it ordered an extension of the settlement date which would not prejudice the purchaser's right to maintain the contract had been validly rescinded.

This case, once determined at trial, should provide clarification as to whether the application of section 64 in Queensland will be similar to its Victorian counterpart in that a purchaser's right to rescind is restricted where the seller indicates that it will reinstate the property prior to completion of the contract.

Practical implications

Irrespective of the applicable jurisdiction, purchasers should take care to ensure that they are satisfied that the contractual position in relation to the passage of risk is appropriate having regard to the nature of the property being acquired and the parties' commercial agreement. In particular, in jurisdictions where risk passes to the purchaser on the signing of a contract:

• purchasers must ensure that appropriate insurance cover is taken out promptly upon execution of a contract of sale; or
• if the passage of risk upon entry into the contract is not acceptable to the prospective purchaser then prior to entry into the contract appropriate amendments to the standard conditions of contract should be made (where practicable).

Care should be taken in amending contracts of sale in relation to risk. It is submitted that the inclusion of a provision in a contract which merely provides that risk remains with the vendor until the earlier of completion or possession by the purchaser may not adequately address the practical impacts of loss or damage to the property. A purchaser wishing to complete the contract in circumstances of damage or destruction to the improvements to a property will, subject to the operation of statute in the relevant jurisdiction, have no right of indemnity from the vendor's insurance (to the extent it exists and/or responds) or to compensation or reduction in the purchase price.

Consideration should be given to the insertion of a condition into the contract allowing the purchaser a right to elect to rescind the contract where there is material damage or destruction to improvements to a property (eg. rendering them unusable or uninhabitable) prior to possession or completion or alternatively to proceed to settle on the basis of a reduction in the purchase price equivalent to the reduction in value of the improvements to the property caused by the damage or destruction.

Leases of commercial property

In South East Queensland, many commercial premises were impacted by the recent flooding, including CBD office buildings, general commercial and industrial buildings and retail premises. Retail premises are subject to the application of the relevant retail shop leasing legislation application in each jurisdiction and will not be considered in this article.

Commercial leases are generally deal specific and can vary greatly in their terms from building to building. Accordingly, any assessment of the parties' contractual position will depend upon the terms of the particular lease in question. Consideration should be given to the all of the issues referred to below prior to negotiating commercial lease terms or executing leases in order to ameliorate the potential for adverse consequences to a particular party in the event of a natural disaster.

Repair

As a tenant, it is essential to ensure that the obligation to repair is appropriate having regard to the nature of the premises and the parties' commercial agreement. In stand-alone buildings, the tenant may be required to insure for and repair any damage caused to the building. In multi-tenanted buildings, the tenant's obligation is usually limited to repairing any damage caused to the leased premises (excluding structural repairs and repairs of a capital nature) and quite often the lease is silent upon whether or not the landlord is responsible for repairing the building and making all necessary structural repairs.

Tenants of multi-tenanted buildings should endeavour to include the following conditions in their lease:

• the lease should specifically exclude any obligation on the tenant to repair or reinstate premises (or services) arising as a result of an appropriate "insurable risk" or "Act of God" provision. Given widely reported issues in relation to insurance contracts and the extent of insurance cover available, care should be taken to ensure that the tenant's obligation of repair includes an appropriately drafted exclusion from liability in cases of flood or water damage (including riverine flood damage), cyclone and any other anticipated or potential Act of God event;
• an express obligation should be imposed on the landlord to repair the building and all attendant services to the premises. This obligation will not be implied into the lease where the lease is silent (Carbure Pty Ltd v Brile Pty Ltd [2002] ANZ ConvR 548). Further, it is unlikely that a failure to repair by the landlord will give rise to circumstances allowing the tenant to terminate the lease for a breach of the covenant of quiet enjoyment.

The absence of these provisions at worst could require the tenant to undertake significant capital repairs or alternatively result in lengthy delays of the repair or reinstatement of the building, while the landlord and tenant attempt to resolve responsibility for such repair.

Abatement

In Queensland, the Property Law Act 1974 incorporates an abatement of the obligation to pay rent for premises in circumstances where the premises are destroyed or damaged by fire, flood, lightning or other natural causes so as to render them unfit for occupation and use of the tenant. New South Wales is the only other jurisdiction that has a similar provision.

Such provisions are capable of, and are generally excluded from the operation of standard commercial leases, and accordingly these implied conditions should not be relied upon to regulate the parties' contractual position.

Appropriate abatement provisions should be included in each lease dealing with potential events of damage/destruction. Tenants should ensure that such abatement rights are drawn broadly enough to cover all of the tenant's obligations which the tenant is prevented from complying with as a result of the event. This would include the covenant to keep the premises in repair, the covenant to pay rent, outgoings and other moneys payable under the lease, any covenant to trade, etc. If an incentive is payable in monthly instalments, consideration should also be given as to the agreed treatment if there is no rent or other outgoings payable for the applicable period.

Further, the abatement provision should be drawn broadly enough so as to apply in circumstances not only of destruction or substantial destruction or damage caused to the premises, but also to extend to instances where the premises are otherwise rendered inaccessible or unusable as a result of the event or where services are not available. During the flooding in South East Queensland, many Brisbane CBD office buildings were evacuated and closed up to two days before flooding in the CBD. In some cases, premises were not affected by flooding, but were inaccessible as a result of the shutdown of services to the premises for safety reasons. Accordingly, any abatement provision which was drawn wholly having regard to damage or destruction of the premises themselves did not respond appropriately.

Abatement clauses therefore need to be drafted to ensure that they cover the main issues, being:

• the events in which an abatement will apply (ie. damage or destruction, lack of services, inaccessibility of premises);
• the obligations which are abated (repair covenant, obligations to pay rent, outgoings and other moneys, etc);
• the extent of the abatement (ie. whole or partial abatement having regard to the extent of the destruction, damage or impact from the event);
• a mechanism for determining the degree and period of abatement; and
• any disentitling circumstances (ie. where the tenant caused the damage).

Obligation to reinstate

Care should be taken to ensure that suitable and commercially acceptable clauses are incorporated into the lease to ensure that a landlord is obliged either to proceed to repair the building within a reasonable timeframe or, alternatively, to give notice to the tenant that it will not repair and that the lease is terminated (commonly known as damage and destruction clauses or break clauses). The timeframes for giving this notice are important in order to provide commercial certainty for the parties to the lease.

Often such provisions impose obligations on the landlord to provide notice of its intention (to repair or to terminate) within a relatively short period of time (eg. one month). In circumstances of widespread damage/destruction, the mere act of obtaining an insurance assessment can take a significant period of time, as has been the case in the recent Queensland natural disasters where some two to three months later Queenslanders are still awaiting assessment and approval to commence rebuilding. Accordingly, care should be taken when acting for landlords to make certain that any such provision provides the landlord with sufficient time to obtain an insurance assessment prior to having to give its election to repair or terminate.

Tenants in a specialised locations where alternative premises are difficult to obtain should consider negotiating an obligation upon the landlord to apply the insurance proceeds to reinstate the building within a reasonable time and any right on the landlord to terminate the lease because of damage or destruction should be deleted.

Insurance

In multi-tenanted buildings, generally the tenant will have an obligation to insure for public liability risks, plate glass damage and replacement of tenants' property, but not for reinstatement of the premises/building. Tenants should seek a covenant from the landlord to obtain and maintain appropriate reinstatement cover for the entire building.

As a practical matter, landlords would generally not agree to note any interest of the tenant on the insurance policy or for the insurance to be in joint names. In such cases, an obligation should be imposed upon the landlord to apply the proceeds of any insurance moneys in reinstatement of the premises in accordance with the agreed reinstatement procedure discussed above. The liability for shortfall on insurance proceeds should, where the commercial circumstances dictate, be borne by the landlord.

In stand-alone commercial premises, the tenant may be obliged to take out insurance for the reinstatement of the entire building, noting the interests of the landlord. Additionally, the tenant may be obliged to ensure that all proceeds of the insurance monies are applied to reinstate the building. Tenants in this situation should ensure that they take out adequate insurance which will respond in all situations. If the tenant in a stand-alone building is not required to insure items of a capital or structural nature, the tenant should ensure that the landlord has this obligation and that it is required to apply the insurance proceeds to the reinstatement of the building.

Both landlords and tenants should, as a practical matter, review their insurance policies and the provisions of leases to which they are a party, to ensure that insurance cover is appropriate having regard to their legal and commercial requirements. Queensland businesses have learned that "flood" insurance can have a different meaning to different insurers and, accordingly, both landlord and tenants should ensure that their insurance policies respond to all instances of flooding (including riverine, storm, water damage etc). Insurance for business interruption (as opposed to merely loss of profits) should be put in place by tenants who are relying upon their premises to undertake trade.

Emergencies

Landlords should ensure that they reserve themselves a right to require the tenant to vacate the premises where the landlord reasonably considers an emergency exists or is imminent or the landlord reasonably considers it is necessary for the protection of people, property and/or the building.

In the case of the Brisbane floods, all CBD landlords were advised by emergency services and the Brisbane City Council to evacuate CBD buildings up to two days prior to the commencement of significant flooding in the CBD area. Landlords should not allow themselves to be in a position where the tenant is not contractually obliged to vacate the premises in the event of an emergency (actual, imminent or threatened).

Other practical considerations

Both landlords and tenants should ensure that they have plans and procedures in place for dealing with emergency situations. The existence, knowledge and implementation of such procedures and plans in an emergency situation may be critical to an assessment of a party's liability for compliance with workplace health and safety regulations and other liabilities arising at law.

Further, from an operational perspective, consideration should be given to the implementation of emergency plans for business continuity, including the implementation of server mirrors, the installation of generators (in stand alone buildings) and the establishment of protocols and procedures for communication with key staff during periods where business is disrupted (eg. via SMS broadcasts and remote email communications).

Strata Schemes/Bodies Corporate

In South East Queensland, anecdotal evidence arising after the floods indicate that the majority of body corporate schemes (for both industrial and residential lots) were not insured against damage to buildings and body corporate common property arising from riverine flooding.

Statutory requirements

In Queensland, the relevant body corporate legislation imposes statutory duties for insurance on the body corporate. For example, the Standard Module regulation requires the Body Corporate to insure for full replacement value all common property, body corporate assets and buildings for damage and costs incidental to the reinstatement or replacement of insured buildings (including the cost of taking away debris and the fees of architects and other professional advisers) for reinstatement of the property to its condition when new (sections 178 and 179 of the Body Corporate and Community Management (Standard Module) Regulations 2008).

"Damage" is defined to mean:

(a) earthquake, explosion, fire, lightning, storm, tempest and water damage;

(b) glass breakage; and

(c) damage from impact, malicious act, and riot.

While water damage is not specifically defined, it is when given its natural meaning, arguably broad enough to include damage arising by flood water, including riverine flood water.

In circumstances where a Body Corporate's insurance cover did not extend to include the mandated insured risks under the Regulation, it may have breached its obligation under the Regulations. A lot owner who suffered damage as a consequence may have a claim against the Body Corporate for breach of statutory duty and/or negligence.

As strata scheme legislation varies from jurisdiction to jurisdiction, standards imposed by the relevant legislation will also vary. For example, in New South Wales, there is only an obligation on the owner's corporation to insure the building against destruction and damage caused by fire, lightning, explosion or any other occurrence specified in the policy (section 82 of the Strata Schemes Management Act 1996).

Similarly in Western Australia, if the strata company is required to take out insurance (the obligation is determined by the type of strata scheme and in the case of a single tier scheme, the resolution of the strata company – see sections 53B, 53C, 53D and 54 of the Strata Titles Act 1985), damage is limited to fire, storm, tempest, lightning, explosion and earthquake and it specifically excludes damage caused by the sea, flood or erosion (sections 53D and 54).

By contrast, in Victoria, an owners corporation must take out reinstatement and replacement insurance for all buildings on the common property against "damage" (sections 59(1) & (2) of the Owners Corporations Act 2006).

Impacts of non-compliance

Conceivably, body corporate or strata managers charged with administration of body corporate or strata title schemes which are not appropriately insured may, depending on the scope and extent of their appointment, be in breach of statutory duty, express or implied contractual duties (for example, to administer the Body Corporate appropriately and in accordance with laws) and/or duties of care, and may be subject to suit accordingly. It may not be sufficient defence for a manager to argue that they relied upon the expertise of their insurance broker to provide appropriate insurance cover in respect of the scheme.

Further, in some jurisdictions, developers may, depending on the timing of development of the scheme, also be obligated to ensure appropriate insurance cover is in place and liable if it is not².

It is recommended that all parties establishing or managing strata title developments take care to ensure appropriate insurance cover is taken out and maintained. As purchasers may not have an insurable interest in common property assets or buildings³, purchasers of lots in such schemes (and practitioners acting for them) should investigate the extent and appropriateness of existing insurance cover as part of their due diligence and consider the availability of insurance cover in respect of their interest.

You might also be interested in ...

• Insurance tips for flooded businesses
• Floods and insurance - Q&A with Fred Hawke, head of Insurance at Clayton Utz

1. Standard clause 8.1 in the Houses and Land Contract and the Community Titles Scheme Contract and clause 17 of the Commercial Contract.

2. In Queensland, the original owner is obliged by section 191 of the Body Corporate and Community Management Act 1997 to ensure that when the scheme is established policies of insurance that are required for the scheme by the relevant regulation module are immediately in force for the first 12 months of the scheme.

3. This will depend on the legislation in place in the relevant jurisdiction – see for example section 90 of the Strata Schemes Management Act 1996 in NSW and section 55 of the Owners Corporations Act 2006 in Victoria.

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.