Residential apartment building prohibition orders could make insolvency a realistic prospect - Construction & Planning

A prohibition order in place on a development in Hassall Street, Parramatta, NSW, serves as a useful reminder for developers, builders and financiers of the importance of complying with the requirements of the Design and Building Practitioners Act 2020 (NSW) (DBP Act) and the Residential Apartment Buildings (Compliance and Enforcement Powers) Act 2020 (NSW) (RAB Act) (together, the Acts) (and the consequences of non-compliance).

As a previous Insight explored, the NSW Building Commissioner is actively using the wide audit rights and enforcement powers under to address developments which are unsafe, defective or non-compliant.

As the Parramatta Prohibition Order demonstrates, the consequences of non-compliance with the Acts is becoming increasingly apparent, as builders and developers (and their financiers) come to terms with managing the financial implications of prohibition orders, stop work orders and building work rectification orders.

The Parramatta Prohibition Order

The NSW Building Commissioner issued a Prohibition Order in respect of the development at 9 Hassall Street, Parramatta (Parramatta Project) on 22 July 2021 which prohibited the issue of an occupation certificate until the order was revoked (Parramatta Prohibition Order).

The Parramatta Prohibition Order was issued on the basis that rectification work had not adequately addressed the serious defects identified in inspections carried out by authorised officers of the NSW Department of Customer Service in 2020. The Parramatta Prohibition Order has remained in force for over 10 months and has caused significant issues for the project and the developer.

As reported by the Australian Financial Review, receivers and managers have since been appointed to the Parramatta Project by the senior financier Wingate, as a result of the significant delays to the development. The receivers and managers will now be required to consider how to complete the work required by the NSW Building Commissioner to enable the occupation certificate to be issued, and to achieve settlement of any presale contracts.

Legislative power to issue Prohibition Orders

Under clause 9(1) of the RAB Act, the Secretary may issue a Prohibition Order if any of the following apply:

the expected completion notice required to be given to the Secretary was not given or was given less than six months before the application for the occupation certificate was made;
an expected completion amendment notice of a new expected date required to be given to the Secretary was not given or was given less than six months before the application for the occupation certificate was made;
the Secretary is satisfied that a serious defect in the building exists;
a rectification bond required under the terms of an undertaking given by the developer relating to the residential apartment building has not been provided to the Secretary;
any building bond required under section 207 of the Strata Schemes Management Act 2015 has not been given to the Secretary; or
a developer, in relation to building work of the residential apartment building, fails to comply with a direction of an authorised officer under section 17 or 18 of the RAB Act.

Consequences of Prohibition Orders

Prohibition Orders can have significant financial implications for builders, developers and their financiers.

In particular, Prohibition Orders may:

cause developers to breach the covenants under their finance documents and be liable for additional financing costs and interests. Financiers may enforce their security and take control of the development if the developers are unable to rectify the breach of those covenants caused by the significant delays to project completion arising from a Prohibition Order;
trigger liability of builders for liquidated damages under the relevant building contract. Orders are generally imposed where there have been significant non-compliance with and/or a breach of the legislation. Such non-compliance and/or a breach will take considerable time to rectify and will therefore result in significant liquidated damages. This may also force developers to terminate and replace builders who are unable to complete the late projects, which only amplifies the significant delays already encountered;
in some instances, allow purchasers of off-the-plan apartments the opportunity to rescind their sale contracts if the occupation certificate hasn't been issued by the sunset date under those contracts;
raise concerns in relation to the reputation of the developer and the project which is the subject of the Prohibition Order and discourage interest from prospective purchasers, impacting on the financial viability of the project and other projects the developers or builders are associated with; and
be registered on the General Register of Deeds with the NSW Land Registry Services

Executive liability for directors and management

Directors and individuals who are involved in the management of the corporation and who is in a position to influence the conduct of the corporation of developers and builders will also be liable for the breaches of the relevant legislation (including the DBP Act, Home Building Act 1989 (NSW) and the Building Product Safety Act 2017 (NSW)) (see our previous Insight for further details). This executive liability will continue to apply to those directors and individuals notwithstanding the relevant developer or builder may have become insolvent. The penalties under the relevant legislation can be up to $330,000 for corporations and $110,000 for individuals for each breach.

Implications for financiers and investors

The Parramatta Project should serve as a warning to financiers and investors (whether at senior, subordinate or mezzanine debt level) of the consequences that can arise as a result of a developer's failure to comply with the requirements of the relevant legislation.

The substantial delay to a project arising from a Prohibition Order will have a significant impact on the developer's ability to meet the completion timing under the sales contracts (failing which, purchasers may seek to rescind those contracts) which in turn, will impact the viability of the project, including the developers' ability to repay their loans.

Alternatively, developers or, in the case where the developers become insolvent, the receivers and administrators, may need to enter into enforceable undertakings to rectify the non-compliances to the satisfaction of the Secretary in exchange for the orders to be lifted. Financiers will then need to consider whether to increase their exposure to those projects.

Financiers and investors in such situations may not be able to recover the loans and equity provided to those developers. Better governance and oversight by financiers and investors are required to avoid the consequences of non-compliant projects and the impact of any orders imposed on the development.

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.