What happens if a residential property is damaged between exchange and completion?

With the early onset of bushfires this summer you might be wondering what happens if a catastrophic event like a bushfire occurs and a dwelling is destroyed or damaged between exchange and completion of a contract for the sale of residential property.

Who is responsible for the property between exchange and completion?

In the sale of a residential property, risk as to the property does not pass to the buyer until completion of the property. This means the seller is responsible for the property and should retain insurance until the sale completes. The only time this position would be different would be if the buyer took early possession of the property. In this case, the buyer takes on the risk for the property from the day they take possession. This means the buyer needs insurance from that date. In practical terms, a seller should never give a buyer early possession without seeing evidence that the buyer has insurance in place.

If there is damage to the property after exchange but before completion the options available to the parties are governed by the provisions of Part 4 Division 7 of the Conveyancing Act and depend on whether the damage is categorised as substantial or not.

Substantial Damage

If the damage to the property is categorised as substantial the buyer may rescind the contract within 28 days of the buyer becoming aware of the damage. In this case, the buyer will receive their deposit back and is released from any obligations under the contract. An exception to this right is if the damage is caused by a wilful or negligent act or omission of the buyer. This provides some protection to the seller if early possession was granted to the buyer and after the buyer took possession and before completion the buyer caused substantial damage to the property. In that case, if the buyer caused the damage the buyer would have to complete and wear the cost of the damage.

However, if the damage is substantial and the buyer still wants to proceed with the purchase, the seller cannot be forced to perform the contract if it would be just or inequitable to require the seller to complete the sale. For example, if a house was destroyed by fire and a total rebuild were required it would be onerous on a seller to have to claim on insurance and re-build the dwelling. The best course of action would be for the buyer to rescind the contract so that the seller could manage their own insurance claim and any rebuild.

Substantial damage is defined as damage which renders the land materially different from that which the buyer contracted to buy. The definition of land includes buildings and other fixtures. In practical terms, if a residential dwelling was purchased for the purpose of a residential use and it was burnt down and uninhabitable before completion, a buyer would be able to rescind on the basis that the land was substantially damaged.

An example where damage was found not to be substantial so as to invoke the buyer’s right to rescind is Bakhos v Fenner and Anor [2007] NSWSC 641. In this case, there was a fire in a property in Lane Cove which resulted in smoke damage, the windows being shattered, carpets being burnt and two ceilings were sagging from water from the fire fighters. The court found that there had not been substantial damage and the buyer’s attempt to rescind the contract was taken to be a repudiation of the contract and the seller was entitled to retain the deposit.

The circumstances which resulted in this finding were the fact that the structure of the property had not been damaged and the condition of the property before the fire. The property was a 50 year old 2 bedroom brick and tile house which was showing signs of its age. In addition, the seller had fixed the damage within a few weeks and before the required date for completion. The court took the view that these circumstances combined with the buyer having lodged an application to redevelop the property and the buyer’s behaviour (which suggested he had no intention of completing the contract) indicated that it was ‘extremely improbable that the house and the condition of the house were material in the valuation of the property or in [the buyers] decision to buy the property.’ In short, the court took the view that the buyer had purchased the property to re-develop the site so the damage caused by the fire did not result in the land being materially different to that which the buyer had contracted to buy.

Damage which is not substantial

If there is damage to the property after exchange and before risk passes to the buyer the purchase price is to be reduced by a just and equitable amount and, if the purchase price is not reduced on completion, the buyer may recover the amount by which the purchase price should have reduced from the seller as a debt. If a buyer takes early possession they cannot claim an abatement of the purchase price after they take early possession even if the property is damaged.

Tips for buyers and sellers

Buyers

If there is substantial damage after exchange and before completion buyers have options to address the damage either by getting out of the contract or negotiating a price reduction. If the damage is not substantial, buyers are still entitled to negotiate a price reduction.

Ideally buyers should sort out any price reduction before completion as the risks, costs and difficulties associated with pursuing the price reduction after completion may make the recovery of those costs impractical. Although the price reduction applies where damage is not substantial these protections are only to be relied on in the case of significant damage to a property and not something minor. Regardless, these provisions highlight the importance of a thorough pre-settlement completion so that if there is significant damage it can be addressed with the seller before completion.

If you agree to take early possession make sure you do a thorough inspection before taking possession. The act of taking possession passes the risk to the buyer and ends the buyers right to claim for any damage to the property before completion.

Sellers

Keep your insurance in place! Where there is significant damage to a property you are selling (but it is not substantial or it is substantial but the buyer still wants to proceed) you may have to consider a price reduction or to agree to fix the damage before completion. However, sellers can’t be forced to complete the contract if the damage is substantial and it would be just and inequitable for the buyer to require the seller to complete.