Mandatory Warranties for Residential Housing: Taking the Mystery out of the "2-5-10"
The writer wishes to acknowledge the time and insight provided by Larry Munn and the assistance of Pratibha Sharma (Articled Student) in the preparation of this article.
Most folks in the construction business have heard about "mandatory warranties" for residential construction. They may know that the Homeowner Protection Office is involved in enforcing the requirements. They may even know that the Homeowners Protection Act contains the specific requirements for residential builders in B.C.
In my experience, however, many are surprised when they are advised of the specifics of the warranty program, and the responsibilities of the involved parties. The purpose of this article is to shed some light on what this warranty regime is all about.
The Inception And Purpose Of The Warranty Regime
Statutory regulations governing mandatory residential builder licensing and home warranty insurance for new homes were passed in January 1999, and implemented July 1, 1999. Since that time, builders are generally required to register with a warranty provider before they can develop and construct residential housing. In turn, a warranty provider promises to warrant the housing built by the builder in accordance with the requirements of the applicable legislation.
Mandatory warranties are in place to protect the end user of residential housing – the homeowner. The warranty requirements are intended to guarantee a certain quality of construction, and to ensure that when defects covered by the warranty are discovered they are corrected at no expense to the homeowner.
Who Does The Warranty Requirements Apply To?
To understand the specifics of the warranty regime, we must look to the Homeowners Protection Act, S.B.C. 1998 c. 31 (the "Act") and the related regulations (the "Regulation").
Those entities that fall under the definition of a "Residential Builder" under the Act must comply with the warranty requirements under the Act. A "Residential Builder" is defined in the Act as "a person who engages in, arranges for or manages all or substantially all of the construction of a new home, and includes a developer and a general contractor". The reader should note that the definition of "general contractor" in the Regulation specifically includes a construction manager and project manager, and, depending on the size and type of contract, could include contractors who contract with the owner under a construction management project delivery system.
If a party falls within the definition of a "Residential Builder", then this entity must obtain a Residential Builder Licence from the Homeowner Protection Office ("HPO") before carrying on business as a "Residential Builder" and provide certain warranties to owners of new homes. Securing a license is not automatic upon application by a builder, however, and a builder must satisfy certain requirements and conditions before the HPO will grant a licence.
What Are The Requirements Of Obtaining A Licence?
The Regulation sets out the requirements which a "Residential Builder" must meet before a license will be issued by the HPO. Generally, these requirements include disclosure of certain information pertaining to a builder's corporate make-up, work product history, training and accreditation of the members of the builder, and criminal convictions or other offences by members of the builder. In addition, the builder is required to provide certain undertakings to ensure integrity of the warranty regime.
The required warranty protection for new homeowners is offered by a handful of insurance companies offering this product in the local market, and prequalification by these insurers of "Residential Builder" is another condition, perhaps considered the most important requirement, of both receiving and renewing the licence from the HPO.
Upon acceptance of the "Residential Builder", the home warranty provider issues a Warranty Certificate, which a developer or builder may provide to each new homeowner.
What Is Involved In Securing Warranty Coverage?
Before a warranty provider will agree to provide warranty coverage for a project, it will require a "builder" to fill out an application which will include information that allows the warranty provider to better understand the risk they are underwriting. This application is similar to, but is a separate process from, the Licence Application and Agreement required by the HPO.
The successful "builder" must then enter into an agreement with the warranty provider which sets out the obligations of the "builder" under the warranty. I intentionally put "builder" in quotations because while the definition of "Residential Builder" under the Act for the purposes of licensing requirements is broad, industry norm has developed such that the "builder" that enters into the agreement with the warranty provider has generally been the developer of the project.
In addition to signing an agreement with the warranty provider (the "Builder Agreement"), a "builder" must also provide indemnities to the warranty provider which will require the "builder" to compensate the warranty provider for any future expenditures under the warranty.
Finally, the "builder" will be required to pay certain fees to the warranty provider for writing the warranty coverage.
The Obligations Under The Builder Agreement and Indemnity
It is beyond the scope of this article to enunciate in detail the obligations of a "builder" (generally the developer) under a Builder Agreement. The reader should be aware that these obligations are extensive and typically remain in place for the duration of the warranty.
Typically, a "builder" has obligations under a Builder Agreement to repair covered defects, or reimburse the warranty provider for repairing covered defects, or otherwise respond to a claim by a homeowner, for the duration of the 10-year warranty program and potentially beyond.
Under an indemnity, the "builder" (usually the developer) allows the warranty provider to recover any amount paid out by the warranty provider to remedy a default by the "builder" under the warranty program, along with all reasonable expenses incurred. A warranty provider's ability to recover against the "builder" will typically endure for as long as the "builder" has obligations under the warranty program and the Builder Agreement.
So What Exactly Is Covered?
Many have heard of the "2-5-10". The "2-5-10" reference is derived from the specific warranty coverage which a homeowner is entitled to under the regime.
According to the Act and the Regulation, warranty insurance must include the following coverage:
- defects in materials and labour for a period of at least 2 years after the date on which the warranty begins;
- defects in the building envelope, including defects resulting in water penetration, for a period of at least 5 years after the date on which the warranty begins; and
- structural defects for a period of at least 10 years after the date on which the warranty begins.
As with most insurance policies, however, there are exceptions to the general rule.
The Regulation contains "Minimum Standards of Coverage" which further defines the specific minimum warranty coverage for each of the 2, 5, 10 warranty coverage. In other words, within the 2-5-10 coverage under a warranty, the legislation provides insurers with some flexibility on what may or may not be covered within each category. So, for example, the minimum two-year materials and labour coverage does not require coverage for all such defects for the full two years. Under the 10-year structural warranty coverage, "structural defects" is specifically defined and, unless the defect falls under that definition, it is not considered a "structural defect" and will not be covered under the warranty.
Most if not all of the warranty programs available today have taken advantage of the leeway provided under the Act and the Regulation, and a careful reading of each warranty document must be conducted to determine the specific coverage afforded by each warranty. What you thought was a straight forward 2-5-10, may in fact not exactly be, 2-5-10.
Finally, the reader should be aware that the Act and the Regulation have provisions relating to mandatory warranty conditions, "permitted warranties" and allowable exclusions have been adopted by the warranty providers.
Are There Any Exceptions To The Warranty Regime?
The answers is "yes". Here are some examples of when the warranty regime may not apply:
1. Owner Builders
If an individual wants to build a home to live in it, or to renovate the home he or she lives in, then generally, the warranty requirements of the Act and the Regulation will not apply. There are exceptions to this general rule, however, and consideration must be given to each case individually.
2. Certain Classes of Homes
Certain classes of new homes that are not strata titled may be exempt from the definition of "new home" and may, therefore, be exempt from the requirements of the warranty regime, such as hotels and motels, dormitories, care facilities or floating homes.
While the referenced exceptions are not defined terms under the Act or the Regulation, the reader should be aware that each building must be analyzed in accordance with all requirements of the Act and Regulation. If any of these exceptions can be interpreted as a "dwelling unit", then the warranty requirements will apply notwithstanding its classification as a motel, dormitory, care facility or floating home.
For example, a "dormitory" built by a learning institution will be exempt from the warranty regime as long as the concept is of students living in a number of rooms which do not have sanitary or cooking facilities in the rooms themselves, and the students are required to share sanitary facilities which are located outside of the dorm room. However, if the "dormitory" is more akin to apartment living (with cooking and sanitary facilities within each dorm or unit), then the building will likely be classified as a "dwelling unit" under the Regulation and the warranty regime will apply.
3. Rental Purpose
Finally, multi-unit buildings constructed for rental purposes (either owned under a single legal title or strata-titled units held under single ownership) are exempt from the requirements of the warranty regime. However, this exemption is only available if a restrictive covenant, restricting the sale or disposition of any dwelling unit in the multi-unit building for 10 years from the date of first occupancy of a dwelling in the building, is registered against the title of the building.
Practical Implications Of The Warranty Program – What Should A Builder Know?
One issue which I have had to consider on behalf of clients is what practical risk management implications the mandatory warranty program has on the construction industry and, in particular, on owner developers.
Parties who sign on as the "builder" with a warranty provider will typically be exposed to claims arising out of warranties provided under the Act and the Regulation for a period of up to 10 years depending on the type of defect being claimed. In fact, a builder's exposure can extend beyond 10 years since a "builder" must warrant repairs to covered defects. If a repair is done within the last year of the warranty, then a "builder" will be on risk after the 10-year period.
In light of the long term risk that a developer may assume by being the "builder" in a warranty program, it would be prudent for developers to consider that risk at the planning stages of a project. It may be possible to assign some of that risk to other parties in the project by adding supplementary conditions in all owner contracts. Developers should also ensure that the necessary insurance is in place and communicate with their insurance broker on the types of insurance products that may be available. Finally, developers should consider obtaining additional warranties that may be available through the subtrades and product manufacturers which can respond in the event of a defect.
Conclusions
It is clear that the warranty regime provides protection to the British Columbia homeowner. The result, most would say, is better quality residential construction, and that is a positive outcome of a well intended program. That protection, however, does have a price, and the price of protection is borne by many players in the construction industry. It does appear that developers, by signing on as the "builder" under the warranty, bear a significant portion of that burden. It is essential for residential developers falling under this regime to be aware of the requirements of the legislation, to understand the risk and to plan ahead.
Currently, the requirements under the applicable legislation are not considered overly onerous and, generally, as long as a builder is able to qualify with a warranty provider for warranty insurance, the HPO will issue a license to the builder. Amendments to the existing legislation are expected in the near future which will allow the HPO to administer more stringent licensing requirements under the Act and the Regulations. We expect these amendments to be in place before the end of this year.
Avoiding the Low Bidder: Reasonable Exercise of Business Judgement Upheld
Common sense dictates that the dollar figure on the face of a bid does not always reflect the true value of the bid. Various factors can lead an owner or contractor to conclude that the low bid may in fact end up costing more than the next lowest bid. Privilege clauses are crafted to deal with this reality. These privilege clauses range from "bare bones" clauses which simply state that the owner/contractor has the "right to reject the lowest bid", to clauses that set out in detail what the owner may consider when rejecting low bids.
Courts have accepted that privilege clauses allow owners/contractors to take a "nuanced view of 'cost'" and reject the lowest bid if there are "valid, objective reasons for concluding that better value may be obtained by accepting a higher bid" (Sound Contracting Ltd. v. Nanaimo (City), 2000 BCCA 312 (CanLII), at para. 17). In practice, however, there is tension between privilege clauses and the implied duty to treat all bidders fairly, equally and in good faith. The result is that courts, especially when considering the " bare bones" privilege clauses, have from time to time refused to enforce these clauses.
This tension was underscored by last year's British Columbia Supreme Court decision in Continental Steel Ltd. v. Mierau Contractors Ltd. et al, 2006 BCSC 637 (CanLII). Continental was the lowest bidder by about $6,000 on a $260,000 bid. Mierau and its senior estimator investigated Continental and decided that if it went with Continental, additional costs and/or delays would eliminate the $6,000 savings. Mierau exercised its rights under the privilege clause in its tender but at trial, Mierau was found to have had breached its duty to Continental.
This decision begged the question – if Mierau did not do enough to satisfy its duty, just how much does one have to do to avoid Mierau's fate? Fortunately, the B.C. Court of Appeal has overturned the trial court decision (Continental Steel Ltd. v. Mierau Contractors Ltd., 2007 BCCA 292 (CanLII)) and has brought some common sense back into the tendering process.
The Court of Appeal found that Mierau had acted in an honest business-like way in reviewing Continental's bid and that in light of all of the circumstances of the tender, it did have valid and objective reasons for refusing to contract with Continental. The following excerpt from the decision is informative:
… [27] In my opinion, the trial judge erred in failing to consider the information acquired by Mr. Margison and Mr. Mierau cumulatively as well as from the appellant's point of view. His analysis was incomplete. He erred in finding that some of the evidence was "scant" and "not relevant". Mr. Margison and Mr. Mierau based their decision on the bids under consideration on several things: (1) the small price differential between the two lowest bids; (2) the relatively short construction timetable (7 1/2 months); (3) past experiences with the respondent; (4) Mr. Mierau's calls to other contractors and the information he received from them; and (5) Mr. Bichel's litigious posture on two occasions. They concluded that the small differential between the two bids would likely be more than eaten up by additional cost and perhaps construction delay if the appellant awarded the sub-contract to the respondent. On the facts found by the trial judge, I think that decision was a reasonable exercise of business judgment. [Emphasis mine]
The Court also reiterated that judges should not substitute their own views on the strength of the evidence against a low bidder, for that of the owner/contractor (Sound Contracting, at para. 19). After all, the issue is not whether Mierau's negative view of Continental was correct, but whether Mierau's treatment of Continental was fair. The Court concluded:
[29] In reaching the above conclusion, I asked this question: what if the bids of the appellant and of PMC had been for exactly the same amount? In that situation (absent a clause in the tender documents designed to address such a situation) I see no reason why the appellant could not have chosen the bid of PMC over that of the appellant for the reasons it gave at trial. It follows that it was not unfair of the appellant to choose the bid of PMC on the basis of an honest business assessment that, given the small differential between the two bids and the short construction term, the bid of PMC was likely to result in a lower ultimate cost to the appellant.
This case indicates that, in British Columbia at least, courts should in the future be more deferential to an owner/contractor who demonstrates that they have exercised their rights under the privilege clause in a business-like way. In other words, the court is supporting the notion that so long as an owner/contractor is not improperly favouring one bidder over another and has a business case for avoiding a bid, the owner's judgement should be upheld.
While this is a positive development in the law, it is not wise to leave it to the courts to interpret loosely worded or "bare bones" privilege clauses. For this reason, we recommend anticipating these types of situations and drafting extensive privilege clauses that avoid uncertainty and reduce the threat of litigation by disgruntled bidders. For further discussion on this topic, please see Roy Nieuwenburg's article in the February 2007 Construction Law Bulletin, "It's Foggy Out There, So Dress For It".
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