CRA Entitled To Priority Over Subcontractors To Trust Funds In Owner’s Hands

The Manitoba Court of Queen’s Bench recently held that the Canadian Revenue Agency (CRA) has priority over subcontractors and the bonding company in respect of holdback funds held by the owner in trust for the contractor. The decision in Manitoba Housing and Renewal Corp. v. Able Eavestroughing Ltd., once again underlines the impact of federal legislation on the holdback and trust fund sections of construction and builders’ lien legislation.

This decision raises questions about the scope of the subrogation rights of a bonding company under a labour and materials payment bond, and public policy issues about lien statutes being used for the purpose of collecting taxes.

Background

The Manitoba Housing and Renewal Corporation (MHRC) was the owner on a project In Brandon, Manitoba and Falcon Creek was the general contractor. The bonding company issued performance and labour and materials payment bonds in respect of Falcon Creek’s obligations under the general contract and the subcontracts. MHRC held back 7.5% of the amounts payable to Falcon Creek as mandated by the Manitoba Builders’ Lien Act (BLA). Unpaid subcontractors, and the bonding company which had paid over $600,000 to other lien claimants/subcontractors under the payment bond, asserted that they were entitled to the holdback funds under the payment bond and the BLA.

The Canadian Revenue Agency (CRA) asserted that it was entitled to the funds under s. 224(1.2) of the Income Tax Act of Canada (ITA). That section effectively provides that, once the section is triggered by the CRA, monies owing to a person who is liable to pay an assessment under the ITA (in this case, Falcon Creek) become the property of the CRA in priority to any other interest.

The bonding company and subcontractors asserted that MHRC had the legal right or privilege to pay the trust funds to the subcontractors holding liens, rather than to Falcon Creek. The bonding company asserted that, pursuant to the payment bond and the subrogation principles of the law of guarantee, it entitled to be recompensed out of the holdback funds for the monies it had paid to subcontractors. They argued that MHRC was not obliged to pay Falcon Creek and was entitled to pay the holdback funds to the subcontractors. Accordingly, MHRC was not “liable” to the contractor, Falcon Creek, in respect of those funds and therefore section 224(1.2) of the ITA did not apply.

Decision of the Manitoba Court of Queen’s Bench

The judge of the Manitoba Court of Queen’s Bench held that nothing in the arrangements between the owner, general contractor and bonding company could or did displace the effect of section 224 of the ITA. The court held:

“I am satisfied that the conclusion that the contract and Bond do not create an obligation on the part of MHRC to pay subcontractors is applicable to the case before me. That is, the private arrangements between MHRC, Falcon Creek and Guarantee Company cannot affect the rights of the Crown under s. 224(1.2). The Crown acquired those rights by operation of law and the issuance of a Requirement to Pay; its rights too cannot be displaced by private arrangements….. There are important policy considerations involved in the collection of withholding tax and source deductions. The Income Tax Act entrusts employers with the duty of deducting income tax from the wages of employees and remitting it on their behalf. Employers’ withholding tax or source deductions is at the heart of the collection procedures for personal income taxation in Canada…. Private arrangements between MHRC, Falcon Creek and Guarantee Company cannot interfere with this. (underlining added)

So far as the submissions of the bonding company and subcontractors relating to subrogation and assignment, the Manitoba court held that, while MHRC may have had the right or privilege to pay subcontractors, MHRC had no obligation to do so, and therefore the bonding company or subcontractors did not obtain, by subrogation or assignment, any rights of MHRC to pay the subcontractors. Accordingly, the bonding company and the subcontractors could not interfere with MJRC’s entitlement to pay the monies in it hands to the CRA.   In this respect, the Manitoba court appears to have differentiated between a performance bond, in which a subrogation right might arise compelling the owner to pay the subcontractors and bonding company, and a payment bond, in which case the court says no such subrogation rights arise.

The Manitoba court also rejected the argument that the subcontractors had a right to sue on the general contract as third party beneficiaries of that contract. There was no evidence that MHRC intended to extend the ability to sue on the contract to unpaid subcontractors. In addition, the third-party beneficiary exception to privity of contract is only a shield and not a sword.

In arriving at these conclusion the Manitoba court relied upon the decision of the Alberta Court of Appeal in Iona Contractors Ltd. (Receiver of) v. Guarantee Co. of North America, 2015 ABCA 240, 19 Alta. L.R. (6th) 87 (Alta. C.A.), leave denied (2016), [2015] S.C.C.A. No. 404 (S.C.C.)). In that case, the contest was between a bonding company and the contractor’s trustee in bankruptcy pursuant to the Bankruptcy and Insolvency Act.

Discussion

At one level, this decision raises an important issue about subrogation. The court has held that while the bonding company may be subrogated to the position of the owner under a payment bond, it does not acquire any rights to compel payment of the holdback to the subcontractors rather than the contractor. In this respect, the court appears to differentiate between a performance bond – which might permit the bonding company to compel such payment – and a payment bond – which apparently does not. The court also appears to differentiate between the exercise of subrogation rights in relation to a contractual obligation – in this case payment to the contractor – and the exercise of subrogation rights in relation to a contractual or statutory right or privilege – in this case, the owner’s right to pay the subcontractors.

The right of the owner to pay a liening subcontractor directly is so important that it is enshrined in section 30 of the Manitoba Act, as it is in other provincial lien statutes. Courts have previously recognized that a right – such as the right to settle a claim, or to complete the building – falls within the ambit of subrogation. Indeed, the failure by the obligee to properly exercise its rights and privileges may discharge the bonding company from its obligations under the bond. Yet, in this case, the court seems to say that the subrogation rights of the bonding company under a payment bond do not include the right to be subrogated to the right or privilege of the owner to pay the subcontractors.

It is to be hoped that this issue is addressed by an appellate court. There seems to be no dispute in the decision that, generally speaking, a bonding company is subrogated to the obligee’s right’s (that is, the owner MHRC’s rights) under the building contract (with Falcon Creek in this case). That seems to be black letter law. The Manitoba court did not provide a good rationale as to why those subrogation rights would not include all the rights of the owner, including the right to pay the subcontractors directly, and why subrogation should not apply to that right under a payment bond as well as a performance bond. If the efficacy of the holdback system under the builders’ and construction lien statutes is to be maintained, if the statutory right of the owner to pay subcontractors is to be fully recognized, and if bonding companies are to be encouraged to issue bonds on the basis that they are fully subrogated to the rights of the obligee, then there seem to be good arguments in favour of a bonding company being allowed to exercise the owner’s right to pay the subcontractors, or the bonding company itself if it has paid subcontractors.

At a second level, this decision raises issues of fairness about the purposes of the respective statutes, and in particular the purpose behind builders’ and construction lien statutes.

The purpose behind the holdback and trust fund provisions of those statues is to require the owner (and others down the pyramid scheme) to withhold monies for the purpose of having them paid to the subcontractors and suppliers who are not paid by the contractor. Without those holdback and trust fund provisions of the lien statutes, the owner (and others down the payment chain) would go ahead and pay the contractor. In effect, this case means that the whole scheme of the builders’ and construction lien statues can be used as a tax collection scheme. The tax authorities can wait until the end of the project and scoop up the holdback, a holdback which would not have been there except for the builders’ and construction lien regime.

While the Manitoba judge emphasized the public purpose behind tax statutes, it is arguable that the purpose behind the builders’ and construction lien statutes deserves at least as high a recognition. The taking of the holdback moneys for tax purposes removes those moneys from the payment chain that produced them in the first place through the construction of the building, and takes them from the payment chain that caused them to be preserved. It is only because the builders’ and construction lien statute mandates the holdback that those monies are there in the first place. The taking of those monies for tax purposes impairs the very structure of the lien statutes. Compared to the tax department, contractors and suppliers have few, if any, means to protect themselves from the failure of contractors to pay their taxes. Should the subcontractors suffer when a contractor doesn’t pay its taxes? And will bonding companies provide bonds to the construction industry at the same cost if those bonds can be undermined by the tax authorities? Some might argue that this example of the government preferring itself over the ”little guy” shows why there is angst among some citizens across the western world, who see governments as more the problem than the solution for small businesses.

This decision did not consider the succession-of trust-funds and “no leak” principles in the BLA. The Manitoba Act, like the lien statues in Saskatchewan, Ontario and Nova Scotia starts the trust fund obligation at the owner’s level, and the beneficiary of the trust fund at that level is the contractor which has contracted with the owner. In other provinces, the trust fund starts at the contractor level. In all these provinces, the trust fund provisions apply at the contractor level and below. So in Manitoba, the owner holds the funds payable to the contractor in trust for the contractor, and once the contractor receives the funds, the contractor then holds those monies in trust for the unpaid subcontractors. What is the purpose of the trust fund at the owner’s level? Surely, to ensure that those funds are passed down to the trust fund at the next lower lever, the contractor level. There is no other reason for the trust fund provision at the owner level. It is not to allow the contractor or another person or authority to come in and scoop the funds. The holdback and trust fund provisions do not envision any leakage in the payment scheme.

In the present case and those which it followed, the courts do not apply the second part of the “no-leak” principle, namely, that the monies paid by the owner to the contractor are held in trust by the contractor for the subcontractors.

In this circumstance, the wording in section 224. (1.2) of the ITA may require some re-visiting. That section applies if the recipient of the CRA’s notice is “liable to make a payment …(a) to another person…” In the present case, the Manitoba judge held that MHRC was liable to make a payment to Falcon Creek, so the section applied. But if “another person”, like Falcon Creek, is obliged to hold those funds in trust for others, the subcontractors, can the ITA interfere with the application of trust principles, and has it done so clearly? The Manitoba court has effectively answered Yes to this question, but it deserves consideration at the appellate level.

The drafters of the provincial lien statutes may wish to consider amendments that will address this situation. One way may be to provide that the subcontractors and other person improving the lands are beneficiaries of the trust at the owner level, and similarly at the contractor level, that sub-subcontractors and other persons improving the lands are beneficiaries of the trust at that level. This is what the New Brunswick statute states at the contractor level and below. However, most provinces have amended their lien statues to limit the trust fund obligation to the next lowest level (that is, to the contractor in the case of trust funds held by the owner) and may be unwilling to re-open the scope of the trust fund obligation.

Lastly, while the Manitoba court did appear to hold that the ITA applies no matter what the bonding contract says, the judge did go on to consider the contractual environment, as did the Alberta courts in the Iona case. That being so, it may be that creative drafters of guarantee bonds will go back to the drafting table. If the contracts can change this result, there appear to be several elements to be addressed.

First, the bonding company may have to ensure that the owner is party to the bond, which will normally be the case for a payment or performance bond at the contractor level.

Second, the bond may have to expressly state that the bonding company is subrogated to the owner’s rights and privileges, including the right to pay subcontractors and suppliers (or the bonding company after it pays the subcontractors or suppliers) , and that those rights of the bonding company become effective at some point before the CRA delivers its notice to the owner, perhaps at the time that the first lien arises although not exercisable until, and to the extent that, the bonding company pays the subcontractors or suppliers.

Third, the bond may have to ensure that the holdback monies are beneficially owned by the bonding company once, and to the extent that, it pays subcontractors and suppliers.

Whether provisions such as these could properly be included in a bond and would be effective against the ITA or in light of the builder’s or construction lien statutes, time, future case law and creative drafting may tell.

See Heintzman and Goldsmith on Canadian Building Contracts, 5th ed., chapter 16, part 6(i).

Manitoba Housing and Renewal Corp. v. Able Eavestroughing Ltd., 2017 CarswellMan 56, 2017 MBQB 27

Builders’ and construction liens – holdback – trust fund – bonds- income tax

Thomas G. Heintzman O.C., Q.C., LLD (Hon.), FCIArb                 February 19, 2017

www.heintzmanadr.com

www.constructionlawcanada.caom

This article contains Mr. Heintzman’s personal views and does not constitute legal advice. For legal advice, legal counsel should be consulted.

 

 

Are “Services” Lienable If They Relate To Something That Is Not An “Improvement”?

Whether something put on land is an “improvement” for the purposes of construction and builders’ liens can be a difficult question of fact and law. Usually the dispute revolves around the degree of attachment of the “thing” to the land and the permanence of the attachment.

Then, add to that dispute the fact that “services” are provided to design the thing, bring it to the land or place it on or attach it to the land. Are the services lienable?

In Grey Owl Engineering Ltd. v. Propak Systems Ltd., the Saskatchewan Court of Appeal appears to have recently held that the services may be lienable even if the “thing” is not an improvement, as long as the services are in relation to a larger project that falls within the lien statute. I say “appears” because the court also seems to have held that the matter was not finally decided. So, while this decision is very important so far as it goes, it may not be the last word on this issue.

In making its decision, the Saskatchewan Court of Appeal over-turned the trial judge’s decision to the contrary: Propak Systems Ltd. v. Grey Owl Engineering Ltd. 2015 CarswellSask 91, 2015 SKQB 43. That lower court decision was reviewed by me in my article of April 28, 2015.

Background

A lessee of land contracted with Propak for engineering, procurement, and fabrication services for an oil extraction system to be provided by Propak for use on the leased land. Propak entered into a subcontract with Advanced Metal for the construction of three storage tanks to be used on the land as part of the extraction facility. In turn, Advanced Metal entered into a sub-subcontract with Grey Owl to provide engineering design services relating to those storage tanks.

The storage tanks were each to be 24 to 38 feet tall and weigh between 34,000 and 43,500 pounds. Each tank was to sit on an engineered gravel pad. Piles would run through the gravel pad and extend about 20 feet into the ground. An anchor chair was to be welded to the base of the tank and then bolted to the piles. The three tanks would then be connected to the entire oil extraction facility through steel and fiberglass piping that would be bolted to the tanks.

Grey Owl materially completed its design services, but Advanced Metal abandoned the project before any of the tanks were built and failed to pay Grey Owl for any of its engineering services. Grey Owl then registered a lien against the leased land pursuant to the Saskatchewan Builders’ Lien Act (the Act).

Propak applied to the Court of Queen’s Bench to vacate Grey Owl’s lien. Propak paid into court the full amount claimed plus an extra 25% as security for costs, and an order was granted vacating the lien.

Propak then applied to the Court of Queen’s Bench for an order releasing the amount held in Court on the ground that Grey Owl was not entitled to register a lien under the Act on the ground that Grey Owl was not entitled to a lien as its engineering services were not provided in relation to an “improvement” as defined in s. 2(1)(h) of the Act.

As noted in my article of April 28, 2015, the judge of first instance decided that Grey Owl did not have a valid lien. The judge held that the storage tanks were capable of being moved, being part of a modular system that could be relocated to another oil field. They were not designed to be moved around the site, but they were capable of being moved beyond that site once the project was finished. Since the tanks were capable of being moved, the judge held that they were not an improvement, and since they were not an improvement, Grey Owl’s claim of lien was not valid. The judge ordered that the money paid by Propak into court be released to Propak.

Decision of the Saskatchewan Court of Appeal

The Court of Appeal allowed the appeal and re-instated Grey Owl’s lien. In doing so, it first engaged in an interpretation of the Act. It noted the definition of “services” and “subcontractor” in the Act:

“(q) “services” means any labour done or service performed on or in respect of an improvement and includes the rental of equipment and the wages of any operator provided with the equipment …

(t) “subcontractor” means a person, not contracting with or employed directly by an owner or his agent, but who provides services or materials to an improvement under an agreement with the contractor or under him with another subcontractor, but does not include a labourer …(Emphasis added)”

The court then stated:

“In short, it is a mistake to begin and end the inquiry with whether the storage tanks are the improvement. The issue is whether Grey Owl provided “services” “on or in respect of an improvement for an owner, contractor or subcontractor” within the meaning of s. 22 and, as part of this analysis, identify the improvement in question.”

The court applied the approach taken in its prior decision in Hansen v. Canadian National Railway (1983), 22 Sask. R. 126 and other Saskatchewan cases which followed Hansen or applied the same logic. The court described this approach as follows:

“This approach, which focuses on the main contract or contracts rather than its individual subcontracts and the work being done under them, has been consistently followed and applied in this jurisdiction…..Courts appear to have taken it as self-evident that the improvement was the work the owner was performing on the land and not the work performed by the various subcontractors and others contracting with them.”

In enunciating the policy reasons behind this broad approach, the court adopted words of the court in Hansen: “the principal object of this Act is to better ensure that those who contribute work and material to the improvement of real estate are paid for doing so”. The court expanded on this approach as follows:

“Two factors dictate the Saskatchewan Legislature’s approach to its builders’ lien legislation. The first factor is that, unlike any other commercial endeavour, the work, services and materials supplied to an improvement are provided on credit in a pyramidal structure, where payment often depends on whether the parties in the pyramid above the lien claimant are paid. The second factor is that the ordinary law of contract does not provide sufficient remedies to ensure that the contract funds flow from the top of the construction pyramid to those entitled to receive them. The statute supplements the law of contract and fosters the provision of credit in a complex piece of legislation designed to assist and facilitate construction….A restrictive reading of s. 22 does not serve the interests of those who provide services and materials on credit. To do so would not be in line with the protective purpose of the Act. Arguably, a restrictive reading of s. 22 does not serve the commercial interests of the owner and financier of an improvement either in that uncertainty as to who is or who is not entitled to a lien can only increase costs, either in the fixing of the contract price or in the litigation that will inevitably arise.”

The court then considered three questions: did Grey Owl provide “services”; were the services provided to a “subcontractor”; and were the services in relation to “an improvement”?

On the first issue, the court had no doubt: “First, it is clear that Grey Owl provided “services.” The definition of “services” includes “any labour done or service performed,” including equipment rental. The definition of “improvement” in s. 2(1)(h)(iii) also demonstrates the clear legislative intent to extend rights to those who provide design services.”

On the second issue, the court also had no doubt: “Second, it is also incontestable that Grey Owl contracted with a “subcontractor,” i.e., Advanced Metal.”

The only issue was whether the services to the subcontractor were in relation to an “improvement.”   On this issue, the court said the following:

“As can be seen from the Stauth affidavit, Grey Owl was retained to provide engineering drawings with respect to storage tanks that were to be used by the contractor or principal subcontractor “as part of their oil extraction system.” In such circumstances, it is an error to ask whether the claimant claims a lien in the storage tanks as an “improvement.” Applying Hansen, the “improvement” with respect to which the legislation is concerned is the project that will lead to the extraction of oil.”

Having arrived at this conclusion, the court did not finally order that Grey Owl’s lien was valid. Rather, it said the following

“When this principle is understood, it is clear that Propak’s application could not be allowed. It is not sufficiently plain and obvious that Grey Owl’s lien is invalid on the basis put forward by Propak: that Grey Owl did not provide services “on or in respect of an improvement for an owner, contractor or subcontractor” in accordance with s. 22…..Having found error in the decision of the Chambers judge, it is necessary to determine the next step. As I have indicated, Grey Owl did not ask this Court to go on to make any other order, if we were to allow the appeal. Grey Owl maintains the position it took in the Court of Queen’s Bench that Propak’s application should be dismissed leaving the parties to pursue the usual remedies under the Act….In the end, the appeal must be allowed. The Chambers judge erred by not dismissing Propak’s application under s. 56(4). The effect of allowing the appeal is that the parties resume the same positions they occupied before the application was made. Grey Owl’s lien continues to be a charge on the funds in court according to s. 56 until further steps are taken by the parties dealing with the funds and until further order of the Court of Queen’s Bench.

Discussion

If this decision finally concluded the issue as to whether the services provided by Grey Owl were lienable services, as it appears to have, then it has stated, or re-stated, an important principle, at least in Saskatchewan. That principle is that, in determining whether the services provided by a sub subcontractor to a subcontractor in relation to something placed on the land by the subcontractor, one looks to the whole work on the site, not (just) the work or material of the subcontractor.

However, the Court of Appeal declined to make an order to that effect, and instead found that it was not plain and obvious that Grey Owl had no lien. Yet, there does not seem to be any further evidence that would be needed to arrive at the final conclusion. It appears that the only reason that the court did not make that finding is that Grey Owl did not ask for it, or that there might be other reasons that Grey Owl’s lien could be challenged so the court was not precluding any such debate.

The principle that the Court of Appeal has apparently adopted seems to leave sub-subcontractors who are instrumental in providing improvements in different positions. If the sub-subcontractor provides the physical improvement itself – in the present case, the tanks – then if those tanks are not attached to the land and are moveable, then the Court of Appeal seems to have assumed that they are not improvements and no lien could be registered by that sub-subcontractor. But if the sub-subcontractor provides services to the subcontractor in relation to the provision of the tanks, then according to the Saskatchewan Court of Appeal, those services are lienable because one looks to the overall project. In that context, the total project amounts to an improvement to the land and so the services to design or install the tanks are lienable because they are part of the overall improvement.

Why should the services in relation to something brought onto the land be lienable when that something itself is not lienable? Certainly the policy behind the statute is well expressed by the Court of Appeal, but why should that policy apply to the services in relation to that thing if the policy does not apply to the thing that is brought onto the land (and the person who brought it there)?

The Saskatchewan legislature has said that the Act (and its policy) do not apply to the thing itself if it is not an “improvement”. Section 2 of the Act includes within the definition of improvement the following words: “except a thing that is not affixed to the land or intended to become part of the land.” That is where the Act has drawn the line. If that is so, can the policy behind the Act draw the line at a different place for the services?

See Heintzman and Goldsmith on Canadian Building Contracts, (5th ed.), chapter 16, parts 4(a)(i))II and 4(a)(ii).

Grey Owl Engineering Ltd. v. Propak Systems Ltd., 2015 SKCA 108, 2015 CarswellSask 612

Construction and Builders’ liens – improvement – services – subcontractors

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                       October 30, 2015

www.heintzmanadr.com

www.constructionlawcanada.com

 

Can A CCAA Order Affect The Priority Of Lienholders?

In Mission Creek Mortgage Ltd. v. New Recreations Ltd., the British Columbia Court of Appeal recently held that a lienholder whose liens had been discharged by an order made under the Companies’ Creditors Arrangement Act (CCAA) upon payment of security for their claims did not have any priority over or entitlement to that security.  This decision depended upon the wording of the Order by which the liens were discharged. Accordingly, this decision may alert owners, lienholders and mortgagees to the importance of the wording of orders discharging their liens and the submissions that are made when those orders are made, and may give rise to disputes over those orders in the future.

Background  

New Recreations was the owner and developer of property and obtained mortgage financing from Mission Creek Mortgage.   New Recreation contracted with construction companies for the construction of the project and the construction company registered liens when they were unpaid.  The project was delayed due to municipal bylaw issues. New Recreations ran into financial difficulties and brought an application for creditor protection under the CCAA.

During the CCAA proceedings, Mission Creek Mortgage advanced Debtor-in-Possession (“DIP”) funds to New Recreations. The funds were to be used, in part to satisfy the claims of lienholders which at that time amounted to about $750,000. The liens were discharged pursuant to a court order which provided that a security fund in the amount of $722,162.37 was to be held in trust pending the determination of the validity of the lien claims.

The order stated that:

4. The cancellation of the Liens against the Property pursuant to the provisions of the Builders Lien Act shall not deprive New Recreations, the respondents, or any other interested party, including secured or unsecured lenders, of the benefits of the provisions of the Builders Lien Act applicable to the Liens, the Security being in substitution for the Property;

5. The Order shall not affect the right of any person to claim that the Liens are improper or defective, or that the filing of the Liens has been improper or defective, nor shall the Order affect any right of any person under the Builders Lien Act;

6. Payment of the Security and the discharge of the Liens shall in no way change the relative priority of all creditors of New Recreations to the Security or the Property, the Security being substitution for the Property. For greater certainty, the secured creditors ….shall maintain any and all rights of priority that may exist to the Security, the Security merely standing in substitution for the Property.”

At the time of the making of this order, counsel for Mission Creek Mortgage said to the motion judge:

“[I]nclusion of paragraph 6 in the notice of application which maintains the priorities in the same manner as they are against the land such that if at the end of the day recovery was not sufficient from the land to pay out my client in full, my client would be in first priority on these funds. Hopefully that won’t be the case, but that’s what I understand paragraph 6 to be doing and on that basis we don’t have an issue with the application.”

Counsel for the lienholders on the motion advised the court they had no position to take on the application and the funds being held in a solicitor’s trust account.

The subsequent development was unsuccessful due to the bylaw problem. Mission Creek Mortgage caused the property to be sold.  The amount due under the mortgage financing was about $19 million and the amount advanced under the DIP financing was about $3.1 million. The amount realized on the sale was about $17.9 million or about $4 million less than the amount owing under the mortgage and DIP financing. The DIP financing was paid back out of the proceeds of sale. The lienholders asserted that their claims to the moneys being held in the security fund took priority over the mortgage and DIP financing.

The motion judge held that the mortgage and DIP financing had priority over the liens.  The motion judge said, in part:

“To interpret the Security Order as now suggested by the Lien Claimants would wholly re-order existing priorities when the clear intention of New Recreations Ltd. and the petitioner as made known by their counsel to the court was directly opposite the position now advanced by the Lien Claimants….I am not prepared to conclude in the face of the Lien Claimants’ silence at the time the Security Order was made, that Sigurdson J. intended the ordering of priorities they now assert.”

The British Columbia Court of Appeal upheld that decision.

The Decision

The lienholders relied upon a number of appellate decisions in Canada to the effect that, when liens are discharged by the provision of security, then the lienholders have an inviolate entitlement to first priority over that security, and that the mortgagee’s priority with respect to interests in the land did not apply to the security fund put in place when the liens were discharged.  The lienholders submitted that “the funds ordered to be held in a solicitor’s trust account are impressed with a first charge in favour of the lienholder appellants in priority to any claim that can be asserted by the mortgagee respondent.”

The Court of Appeal disagreed with the lienholders on this fundamental point. The court held that the order discharging the liens did give the lienholders a priority which they did not have at that time and that the mortgagee had an existing priority which applied to the security.  This conclusion appears to have rested on two points.

First, at the time the order discharging the liens was made, the mortgagee had priority to the liens, the land was worth less than the amount due under the mortgages and therefore there was no value in the land for the lienholders. In that circumstance, the order could not be interpreted to put the lienholders into a priority they did not then have. The court said:

“It must be remembered what the situation was at the time that the initial order of October 28, 2010 was made in the CCAA proceedings. An appraisal of the property expressed an opinion that a sale of the lands would realize less than the amount of the Mission Creek mortgages, but if the development could continue successfully, the property value should suffice to cover all outstanding indebtedness including the liens and another outstanding mortgage. Therefore, at that point in time and also at the point in time when the order of December 6, 2010 vacating the liens upon payment of security was made, there was no prospect of lienholders realizing anything on a present sale of the land…. In order to continue with marketing of the lands, it was necessary that the liens be vacated, hence the proceeding of December 6, 2010 to achieve this. It was the wish of all concerned, the landowner, the mortgagee and the lienholders that the development proceed to fruition so that all outstanding debts could be paid. ….. All parties who were before Sigurdson J. on December 6, 2010 were of a mind to have the development project continue in the hope and expectation that the successful completion of the project would accrue to the financial benefit of all concerned. If, for instance, the mortgagee respondent or any of the lienholders had sought a realization of security at that point in time, financial loss was a near certainty. In these circumstances, the inclusion of the crucial paragraph 6 of the order set forth in para. 9, supra, is entirely explicable.”

Second, the Court of Appeal expressed the view that the order discharging the liens was based upon the particular circumstances and understandings that could be gleaned from the events at that time – including the statements and silence of counsel – and importantly, that the order discharging the liens had been made in the CCAA proceeding. The court said the following:

“If this were a normal builders’ lien situation, the submissions made on behalf of the lienholders would have great force. However, this was far from the normal situation. The order of December 6, 2010 was made in course of the CCAA proceedings and purported to be made under the provisions of that Act and the Builders Lien Act.  Sigurdson J. was the judge dealing with the CCAA proceedings…. I think it is abundantly clear from paragraph 6 of the order made by Sigurdson J., which provided for the removal of the liens and the substitution of a fund as security for the lienholders, that the then extant priorities between the respondent mortgagee and the appellant lienholders would be unaffected by the posting of security to vacate the liens from title to the property. That term of the order is entirely in accord with the expressed wishes of all counsel before the judge. Those counsel included counsel for the lienholders.”

The Court of Appeal was also of the view that upholding the submissions of the lienholders could lead to “mischief and uncertainty in future CCAA proceedings” as the court would be “hobbled in the exercise of discretion to make necessary orders fostering the continuance of the enterprise.”

Accordingly, the Court of Appeal upheld the mortgagee’s priority to the security fund.

Discussion

The impact of this decision depends upon what is the true basis for it.

One view of this decision is that it is a one-off example of how the submissions of counsel at the time of the granting of the original order influenced the proper interpretation of the order. If that is the case, then counsel for lienholders may want to insist at the time of the making of the order that the order DOES entitle the lienholders to priority over the monies placed in trust when their liens are removed.  Normally, this should not be necessary and the effect of the order should be based entirely upon what it says, not the submissions (or silence) of counsel.

Another view would be that this decision is an example of the “super-priority” that can be given to DIP financing during a CCAA proceeding. However, if DIP financing could be given priority over pre-existing lien rights that had actual value at the time of the CCAA order removing the liens, that would cause a severe confrontation between the CCAA and the lien regimes and directly contradict the priority scheme set forth in the builders’ and construction lien legislation.

The third and better view appears to be that this decision is based upon the liens having no economic value due to the priority of the mortgages. Both the motion judge and the Court of Appeal proceeded on the basis that the advances under the mortgages having full priority over the liens.  In effect, the mortgage and DIP financing was given priority equivalent to the prior advances under the mortgage financing, even though the DIP financing was advanced after the work was done and the liens were registered and the liens would normally take priority over that financing under section 32(2) of the British Columbia Builders Lien Act.  The priority accorded to the DIP financing was due to two factors –

-the existence of the CCAA legislation empowering the court to keep the company alive while further business is conducted (in this case, the construction and sale of the project and land) with protection given to the lender who funds that business;

-and the liens having no economic value unless that further construction and sale occurred.

The result in the present case may be entirely due to the existing mortgages having priority over the liens, quite apart from the DIP financing. If, however, the decision is based upon the DIP financing gaining priority over the liens in respect of the security funds, then  the CCAA order was effectively held to be akin to an order under sub-sections 32(5) and (6) of the B.C. Builders Lien Act.  Under those subsections, the court may order that further advances made under a mortgage take priority over lien rights if the court is satisfied that the advances will be applied to complete the improvements and will increase the value of the lands.  However, sub-sections 32(5) and (6) require the court to be so satisfied before the order is granted and the order will expressly state that the further advances are accorded priority over the existing liens. Those requirements were not apparently met in the case of the CCAA order granted in the present case, and the order seems to have said to the contrary namely, that it did not affect the priorities between lienholders and the advances under the mortgages.

The result in this case may not be the same in other circumstances and other provinces. What if the lien rights did have value at the time of the CCAA order vacating the liens? Could that order still give the DIP financing priority over those liens, especially in the absence of the judge considering the factors and stating the priority of the DIP financing in accordance with subsections 32(5) and (6) of the B.C. Builders Lien Act before making the order?   And would the result be the same in Saskatchewan, New Brunswick and Prince Edward Island where the lien legislation states that when a lienholder’s lien is discharged by payment into court, the lienholder has a first charge upon those monies?  This issue was considered in my article dated March 13, 2012.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., chapter 11, part 4(l) and (m)

Mission Creek Mortgage Ltd. v. New Recreations Ltd. 2014 CarswellBC 760

Construction and builders liens   –  priority -liens and mortgages-order discharging liens  – Companies’ Creditors Arrangement Act

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                June 10, 2014

www.heintzmanadr.com

www.constructionlawcanada.com

Does A Construction Lien Bond Satisfy A Trust Fund Claim?

There are several different remedies provided in construction and builders lien legislation that do not necessarily fit together well. Two remedies available to a subcontractor are the lien claim against the land and the trust fund claim against funds received or receivable by a contractor.

In the case of a lien claim, the payment of money into court or the provision of a bond discharges the lien against the land. But does it discharge the trust fund claim?  If it doesn’t, does that mean that a subcontractor can pursue a trust fund claim, so that it gets paid through that remedy while at the same time the monies remain in court or the lien bond remains in place? And if the subcontractor can do that, how does that affect the contractor’s counterclaim and set off for delay? Through its trust fund claim can the subcontractor force the owner to pay the full amount of the subcontractor’s claim before the trial of the contractor’s delay claim?

These were the issues addressed in the recent decision of the Manitoba Court of Queen’s Bench in Stuart Olson Dominion Construction Ltd. v. Structal Heavy Steel.

The Background

In December 2010 Stuart Olson entered into a contract with the owner BB Stadium Inc. for the construction of a new stadium in Winnipeg.  In April 2011, Stuart Olson entered into a subcontract with Structal for the structural steel and other facilities.  The deadlines in the subcontract were not met and the opening of the stadium was delayed for a year.

Claims and counterclaims were asserted between Stuart Olson and Structal.  Structal claimed over $8 million due to work scope changes and other factors. Stuart Olson asserted a delay claim against Structal in an amount over $9 million.

In September 2012, Structal demanded payment from Stuart Olson for its outstanding invoices in the amount of about $4.2 million.  Structal also asserted that the monies due to Stuart Olson from the owner were impressed with a trust fund claim in Stuructal’s favour and that Stuart Olson must use those monies to pay subcontractors and not itself.  Structal also filed a  lien against the land in the amount of about $15 million.

In October, 2012, Stuart Olson obtained a lien bond, approved by Structal, for the full amount of the lien on payment of a premium of $159,003.07 per year, and Structal discharged its lien against the land.

Structal continued to demand that Stuart Olson pay its outstanding invoices and claimed that the monies receivable by Stuart Olson from the owner were impressed with a trust in Structal’s favour.  Stuart Olson continued to maintain that it had a set-off against any claim asserted by Structal and maintained that Structal’s claim, whether in a trust fund form or otherwise, was fully secured by the lien bond that had been filed.

Structal then asked the owner to withhold funds from Stuart Olson failing which it would sue the owner under the trust provisions of the Manitoba Builders’ Liens Act. (the “Act”).   In response, Stuart Olson commenced an application to determine the legal position.

In the meantime, Stuart Olson commenced an action against Structal asserting its delay claim.

A certificate of substantial completion had been issued relating to the subcontract with Structal.  There were no lien or trust fund claimants other than Structal. There are no deficiencies in the work done by Structal and the owner was ready to make the remaining payment to Stuart Olson which had not paid because of Structal’s threat.  The real and remaining issue was the delay claim by Stuart Olson against Structal which would be dealt with in the separate action.

The Decision

The application judge held that the posting of the lien bond exhausted the contractor’s trust fund obligations in the particular circumstances of this case.

First, the judge held that prior judicial authority in Manitoba supported the principle that the filing of a lien bond discharges any trust fund obligations of the contractor.

Second, he held that prior judicial authority also supported the proposition that a set-off could apply to, and reduce, a trust fund claim.

Third, he held that it would be unfair to determine, at this stage, whether Stuart Olsson had or didn’t have a right of set-off. So the present issue could not be decided on the basis that Stuart Olson had no rights of set-off. It would not be fair to order payment of the trust funds to Sturctal in the presence of the delay claim by Stuart Olson.

In all the circumstances, the judge held that the filing of the lien bond by Stuart Olson satisfied its trust fund obligations and that upon receipt of the progress payments from the owner, Stuart Olson could disburse those funds without being in breach of the trust fund obligations under the Act.

Discussion

Assuming that the contractor, Stuart Olson, was financially capable of paying the future lien bond premiums, this decision makes eminent business sense. But it does raise some practical concerns. What if Stuart Olson could not or did not pay the future premiums? Would the bond have remained in place? What protection for the subcontractor would there have been in this eventuality?

What if other subcontractors had liens or trust fund claims? In some provinces, a lienholder must share with other lienholders the amount of a lien bond posted to satisfy its lien.  In these circumstances, a lien bond may be an uncertain source of funds for a trust fund claim.  And why shouldn’t the remaining payments by the owner be paid into court, with the amount of the lien bond being reduced accordingly? Wouldn’t that be a better way of resolving the conflict between the purpose of a lien and the purpose of a trust fund claim?  Since the contractor had no other subcontractors or suppliers to pay, the real question was: whose litigation claim should be financed through the lien bond: the contractor’s delay claim or the subcontractor’s claim to payment under the subcontract? An argument could be made that the purpose of the Act is to give priority to the subcontractor’s claim for payment. If that is so, then that result could be achieved by paying the remaining monies due by the owner into court and reducing the amount of the lien bond.

The present decision highlights the different wording in the different provincial lien statutes. In Manitoba, sub-section 5(3) allows the owner to retain trust funds if “provision for the payment of other affected beneficiaries of the trust fund has been made.” The words “provision for payment” also appears in sub-sections 4(3) and 4(4) with respect to the trust fund obligations of contractors and subcontractors.  These words seem to contemplate a lien bond and may envisage that if a lien bond is in place then the owner, contractor or subcontractor can make payments from trust funds. In contrast, sub-sections 7(4), 8(2) and 9(2) of the Ontario Act state that the trust is in place until the contractors or subcontractors “are paid.”  In the Ontario Act, specific provision is made in section 12 for set-off by a trustee such as an owner, but not in respect of the amount of holdback.   No specific provision for setoff is made in the trust fund sections of the Manitoba Act. The judge did not comment on the presence or absence of these provisions in the Manitoba Act. It certainly seems odd that the trust fund sections of the provincial Acts do not specifically deal with the impact of lien bonds and other forms of security for the lien upon trust fund claims.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., chapter 11, parts 2(g) and 3.

 Stuart Olson Dominion Construction Ltd. v. Structal Heavy Steel, 2013 MBQB 48

Construction and builders liens   –   trust funds   –   discharging liens   –   lien bonds

Thomas G. Heintzman O.C., Q.C., FCIArb                                              August 26, 2013

www.heintzmanadr.com

www.constructionlawcanada.com