Legacy combustible cladding risks drive recent cases in Victoria

An area of evolving uncertainty for building participants arises from legislative amendments which empower the state of Victoria to recover the costs for cladding rectification work funded by Cladding Safety Victoria (CSV) from companies and their directors or other officers responsible for the installation or use of non-compliant cladding.

CSV is responsible for delivering the state’s A$600 million (approx. US$370m) cladding rectification program and has so far funded rectification work for more than 400 privately owned apartment buildings.

Two recent decisions by the Victorian courts have shaped the way forward for the state’s rights to recover the costs of CSV funded cladding rectification work from companies.

The legal landscape

When CSV has granted funding for cladding rectification work, the state automatically steps into the shoes of the owner-payee of the building in relation to the work, so that it may enforce the owner’s rights and remedies against any third parties involved in the original installation or use of the cladding.

A building company director’s recent failed appeal against an order to pay the state over A$1.2m in damages for the company’s use of non-compliant external wall cladding has made clear that company officers may be personally liable to the state for costs to remove combustible cladding from buildings.

A director of a builder company involved in the installation or use of non-compliant or non-conforming external cladding may be at risk of personal liability where the director knew that the cladding product had been used or installed.  The fact that the officer did not know that the cladding was non-compliant will not necessarily give rise to a defence.

A question mark remains over the state’s ability to pursue companies and company officers involved in the installation or use of defective cladding to recover the costs of cladding rectification work funded by CSV where that funding has been provided to the owner's corporation as distinct from the individual lot owners. 

The right of the state to bring claims to recoup funding provided by CSV to enable cladding rectification work from companies and company officers comes from the introduction of section 137F to the Building Act 1993 (Vic) (Building Act) in 2020 (633-page / 1.93MB PDF).

Under section 137F(2) of the Building Act, the state, upon CSV paying financial assistance to an owner of a building in relation to cladding rectification work, assumes all the owner-payee’s rights and remedies against any person in relation to the installation or use of any non-compliant or non-conforming external wall cladding product, or other building work, that required the cladding rectification work to be undertaken.

The concept of the transferral of rights and remedies in these circumstances is called ‘subrogation’.  The rights or remedies to which the state is subrogated include all that the owner of the building has in contract, equity or under legislation.

Claims arising from alleged non-compliant external cladding are commonly based on breaches of the Domestic Building Contracts Act 1995 (Vic), negligence or breach of contract, and often involve all persons or entities associated with the approval, installation or use of the cladding including the builder, building surveyor, architect and fire engineer.

When can the state pursue officers of body corporates?

Officers of an entity at the time the entity’s act or omission relating to the installation or use of non-compliant cladding occurred may be personally pursued by the state to recover the costs of cladding rectification work funded by CSV.

Under section 137F(3) of the Building Act, the assumed rights and remedies of the state are extended to ‘officers’ of an entity at the time the relevant act or omission occurred.  The Building Act applies the broad definition of ‘officer’ in section 9 of the Corporations Act 2001 (Cth), which includes a director or secretary of the entity, or a person ‘who makes, or participates in making, decisions that affect the whole, or a substantial part, of the business of the entity’.

No knowledge or consent defence

Under section 137F(4) of the Building Act, if the officer can prove that the entity’s act or omission occurred without the officer’s ‘knowledge or consent’, then the officer will have a defence to a claim bought by the state.

In Naqebullah v State of Victoria [2024] VSCA 307, the Victorian Court of Appeal clarified the application of the state’s ability to pursue companies and company officers in reliance on section 137F and considered the application of the defence in section 137F(4). 

Background and decision

The appeal involved a low-rise apartment building in Caulfield constructed by Shangri-La Construction Pty Ltd between December 2014 and August 2015, on which expanded polystyrene (EPS) cladding was installed.  EPS is a type of cladding that is combustible.

Litigation was commenced in the Victorian Civil and Administrative Tribunal by the owner’s corporation of the building in 2019, in relation to breaches of various statutory warranties under the Domestic Building Contracts Act 1995 (Vic) arising from the use of EPS cladding.  In March 2023, the builder company entered into liquidation prior to the trial.

The state was subrogated to the rights of the owners of the building under section 137F(2) of the Building Act because CSV had paid financial assistance to them in relation to cladding rectification work on the building.

The trial judge found that the director was liable to pay compensation to the state for breaches of statutory warranties arising from the installation of EPS cladding. 

The director sought leave to appeal from the decision of the trial judge on numerous grounds, including whether the defence in section 137F(4) of the Building Act applies where the officer of an entity can establish that he or she were unaware of the non-compliant or non-confirming nature of the external wall cladding product.

The Court of Appeal found, to rely on the defence in section 137F(4), the officer of the entity must show that they did not have knowledge of or consent to the act or omission that gave rise to the relevant right of the owner of the building, and therefore the state, to recover payment.

The identification of the specific act or omission which applies when a director or other company officer brings a defence under section 137F(4) will depend on the nature of the right or remedy that is exercisable against the company, according to the Court of Appeal’s determination.

The court, in applying these principles to the specific facts in issue, determined that the builder company was liable for breach of the warranties under sections 8(b), (c) and (d) of the Domestic Building Contracts Act 1995 (Vic) because it supplied and installed cladding that was not fit for purpose.

Therefore, the ‘act or omission’ was the installation or use of EPS cladding.  The builder company’s liability did not depend on having subjective knowledge that the cladding was dangerous, non-conforming or on the builder having been negligent in relation to its installation or use, and the defence provided by section 137F(4) was accordingly not avaliable to the director as it had been established on the facts that he had knowledge of the installation of the EPS cladding.

The director not necessarily having knowledge that the EPS cladding was non-compliant gave rise to no defence under section 137F(4).

Further guidance awaited

An important further decision of the Victorian Court of Appeal with potential ramifications on the application of the state’s subrogated rights under section 137F of the Building Act is awaited as at time of publication.

In State of Victoria v L U Simon Builders Pty Ltd & Ors [2024] VCC 1075, the County Court granted an application by the state that certain questions in that case be reserved and referred to the Court of Appeal for opinion.

The questions that have been directed to the Court of Appeal relate to whether the state in that proceeding is entitled to rely on the statutory subrogation provided under section 137F in relation to the installation of allegedly non-compliant combustible cladding on an apartment building.

The Court of Appeal will give an opinion on whether, because of the manner in which CSV provided funding for the cladding rectification work in issue, the statutory right of subrogation has in fact been enlivened, and whether CSV has made payment to the OC alone and in its own right.

Looking ahead

The legal landscape in Victoria continues to evolve in relation to the ability of the state to recover the costs of cladding rectification work from entities and company officers involved in the historical installation or use of non-compliant combustible external wall cladding.

In this environment, builders and building professionals involved in the historical approval, installation or use of combustible external wall cladding products should assess their potential exposure to claims by the state for recovery of costs for cladding rectification work funded by CSV, review document management policies and procedures to determine whether they are appropriate in view of the need to defend potential claims of the state, and continue to consider required insurance notifications and renewals of professional indemnity policies.