Is Switching to Cost-Plus Contracts the Solution the Building Industry in Australia is Looking For?

In the wake of the recent insolvencies of building companies in Australia, it is high time to reconsider the approach toward building contracts in the country.

Is Switching to Cost-Plus Contracts the Solution the Building Industry in Australia is Looking For?

April 22, 2023
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In the wake of the recent insolvencies of building companies in Australia, it is high time to reconsider the approach toward building contracts in the country. The collapse of companies such as Mahercorp, Porter Davis, and Lloyd Group in 2023 has had a major impact on the construction industry and stakeholders involved, leaving many wondering about the future of the industry.

Mahercorp, the parent company of Eight Homes and Urbanedge where I worked myself for a period between 2008-2010, recently went into voluntary administration but has managed to survive, with creditors voting to keep the doors open and saving 730 homes as 90% of customers voted to pay extra fees to fund their projects. This has left various suppliers, workers, and customers affected, with skyrocketing building and labour costs being blamed for the collapse. The administrators are hoping to restructure the business and complete the projects, but early professional advice is key for all stakeholders.

Similarly, Porter Davis went into liquidation in late March, leaving around 1,700 home-building projects in limbo. The majority of these projects were in Victoria, with about 200 in Queensland. The collapse has had a significant impact on employees, suppliers, and sub-contractors, with many collectively owed tens of millions of dollars.

However, the Victorian government has promised to reimburse the deposits paid by hundreds of families who were left without a home or insurance due to the collapse. Unfortunately, many other creditors are unlikely to recover any of their money, including those who paid a deposit that included an insurance premium, but the company had not lodged the insurance policies with the state's Victorian Managed Insurance Authority.

These recent insolvencies highlight the need for a change in approach towards building contracts in Australia. Many stakeholders in the construction industry have suffered a significant financial loss due to the collapse of these companies, and this could have been prevented if the right precautions were taken.  So, what can be done to address this issue and prevent it from happening in the future? One possible solution is to rethink the way building contracts are structured and managed in Australia.

One of the main issues with current building contracts is that they often heavily favor the builder, leaving homeowners with little recourse if something goes wrong. For example, contracts may require homeowners to make large payments upfront before any work has been completed, leaving them vulnerable if the builder later goes bankrupt or fails to complete the work to an acceptable standard.

Metricon who also faced fears of insolvency before being bailed by one of the four big banks last year is forcing their customers to sign new contracts with increases up to $100,000 or face the real possibility of losing their deposits and dream homes.  Strong arming vulnerable homeowners who do not necessarily have a strong understanding of the legal language used in contracts is not the solution.

A favourable outcome could be the introduction of more robust regulations for building contracts to protect both the builders and the clients. Clearer and more concise clauses could be added to contracts to ensure that all parties involved understand their obligations and responsibilities and that disputes can be resolved efficiently.  If the case goes to VCAT, which provides fair, efficient, and affordable justice for the Victorian community the outcome can take years to resolve with no real winner in end.

All stakeholders involved in the construction industry must seek professional advice and guidance early on to protect their interests and this is where a quantity surveying firm specialising in cost management could become an integral team member. As they can coordinate between suppliers, builders, sub-contractors, and clients. By being proactive, they can mitigate the risk of significant financial loss in the event of insolvency or other unforeseen circumstances.

Another solution is switching to a cost-plus contract instead of the traditional fixed price lump-sum contract.  Cost-plus contracts offer several advantages over traditional fixed price contracts, including greater transparency, increased collaboration, and flexibility.  For example, a cost-plus contract in Victoria is only applicable for works over $1,000,000 and is typically reserved for renovation, restoration, or refurbishment-type work.  If this figure could be reduced and include new home builds it would certainly offer a tantalising solution.

Cost plus contracts is an agreement where the builder is paid for the actual costs incurred, plus a fee. The fee is typically a percentage of the total costs (10-20%) and is negotiated between the builder and the client. This type of contract aims to build trust between the builder and the client leading to a smoother working relationship, encourages the builder to work closely with the client to identify cost savings while still meeting the project goals and make changes to the project scope or design without the fear of additional costs or delays.

Even with cost-plus contracts, there is the risk of disputes, and the potential for abuse if the builder overestimates costs or adds unnecessary expenses but these can be mitigated by conducting regular checks and audits of the project costs.

The recent insolvencies of Porter Davis, and Lloyd Group have emphasised the necessity for a shift in Australia's approach to building contracts. The construction sector must adopt a more adaptable and forward-thinking approach to managing contracts with all parties involved. Otherwise, the current insolvencies may only be the beginning of a more extensive problem.

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