When Is An Officer, Director Or Controlling Person Liable For A Construction Lien Trust Fund Claim?

What are the limits of the trust fund liabilities under the Construction Lien Act? Those liabilities do not just apply to a contractor or subcontractor engaged in a building project.  Those liabilities may also apply to an officer or director or a person controlling the company.

But can an officer, director or controlling person be liable even if it is not proven that the contractor or subcontractor actually breached the trust fund obligations while that person was in office? And who has the burden of proving those facts? Those were the issues which the Ontario Court of Appeal dealt with in Belmont Concrete Finishing Co. Limited v. Marshall.

Section 8 and 13 of the Construction Lien Act

 In Ontario, section 8 of the Construction Lien Act creates the basic trust fund obligation of contractors and subcontractors engaged in building projects. Under that section, monies owing to or received by a contractor or subcontractor on account of the contract or subcontract price constitute trust funds for the benefit of its subcontractors and suppliers of services and materials to the improvement. The contractor or subcontractor is not entitled to appropriate any of those funds for its own use until its subcontractors and suppliers are paid.

 The trust fund obligations of contractors in section 8 are re-enforced by section 13 of the Act. That section imposes a liability on “every director or officer of a corporation” and “any person, including an employee or agent of the corporation, who has effective control of a corporation or its relevant activities.”  Liability arises under section 13 if that person “assents to, or acquiesces in, conduct that he or she knows or reasonably ought to know amounts to breach of trust by the corporation of the obligations under section 8 of the Act.

The underlined words are the important ones.  The statutory liability of the director, officer or controlling person depends upon a breach of trust by the corporation, and upon the person assenting to or acquiescing in that breach.

Factual Background

 Between 2001 to 2003, the general contractor received funds for several projects.  Those funds were trust funds under the Act.  The general contractor dispersed them in breach of trust. As a result, the supplier Belmont Concrete Finishing was not paid.

At the end of May 2002, the respondent Marshall took control of the general contractor sufficiently for s. 13 purposes. Only after May 2002 was he in a position with the general contractor so that he could have known or reasonably should have known about, and could have assented to or acquiesced in, any breach of trust by the general contractor that took place after that date.

The trial judge made no finding as to when the general contractor’s breaches of trust took place, and whether they occurred before or after May 2002. The Court of Appeal held that there was no evidence to support the allegation that any breaches of trust occurred “on the respondent’s watch.”

Decision of the Court of Appeal

 The Court of Appeal set out the three part test that applies to the potential liability of a person under section 13.  The court said that, for that liability to be imposed upon a person, it must be shown that:

“(1)       there is conduct by the corporation that amounts to a breach of trust;

(2)         the person is a director or officer of the corporation, or in effective control of it; and

(3)         the person knows or ought reasonably to know that the conduct amounts to a breach of trust and assents to or acquiesces in that conduct.”

The court then held that the supplier Belmont Concrete Finishing, which asserted that there had been a breach of the trust fund obligation by the contractor, had the burden of proving that breach. It was not Mr. Marshall, the court held, that had that burden of proof. The court explained its decision as follows:

“The appellants argue that the onus is on the respondent to fill this evidentiary void. I do not agree. Unlike s. 8 of the Act, s. 13 is not about liability as a trustee. It is about an individual’s liability for breach of trust by the corporation. The onus for the elements required by s. 13(1) is on the party seeking to attach liability to the individual…Since there was no evidence that any of the breaches of trust by the general contractor encompassed by the summary judgments took place after the end of May 2002, there was no basis to find that the respondent could be held liable for them under s. 13 of the Act.”

The Court of Appeal then considered whether Mr. Marshall could be held responsible for the payments that were made by the general contractor to him.  The court concluded that, unless it were proven that the funds used to make those payments were trust funds – and there was no proof that they were -the mere fact that payments were made by the general contractor to Mr. Marshal could not support a claim under section 13. The court said:

“There is simply no evidence that the funds used for these payments by the general contractor were funds impressed with a trust in favour of the appellants. Without such evidence, the payments to the respondent cannot serve as the basis for his liability to the appellants for breach of trust under s. 13.”

Accordingly, the Court of Appeal dismissed the claim of the supplier against Mr. Marshall.

Discussion

This decision shows the difficulties in proving a trust fund claim against an individual under section 13.  Two hurdles have to be overcome.

First, the claimant must show that there were trust funds which were received or receivable by the contractor or subcontractor, and were diverted.

Second, the claimant must show that, at the time the trust funds were diverted, the defendant officer, director or control person was in a position to know that the funds were trust funds and were being diverted, so that he or she could be said to have assented to or acquiesced in the diversion of those funds.

Section 13 does not state any burden of proof.  So the burden of proof is entirely a matter for the courts to decide.  In the present case, the Court of Appeal declined to put the burden of proof of these elements on the defendant officer, director or control person because that person is not being sued for breach of trust.  Rather, that person is being sued for assenting to or acquiescing in a breach of trust.  So, while a trustee may have a burden of explanation, a person assenting to or acquiescing a breach of trust does not.

Some may question whether this allocation of the burden of proof is fair.  It is true that, apart from claims against trustees, normally the burden of proof is on the claimant.  But courts often place the burden of explanation on the defendant when the defendant has special knowledge of the circumstances.  In the case of a claim against an officer, director or control person of a company, the claimant supplier has no knowledge of the facts relating to the receipt and disbursement of the trust funds by the contractor or subcontract, which are the key elements of the claim.  One might say that the officer, director or control person should have the burden of proof at least during that person’s “watch.”

At the very least this decision shows that extra care must be taken during a building project or during an action to enforce rights under section 13, in order to find and preserve the evidence necessary to establish those rights.  During the project, a supplier may be able to obtain information about the payments to the contractor or subcontractor.  If payments fall behind, then the supplier or subcontractor should be pro-active in taking steps to preserve evidence of any improper diversion of trust funds, by making inquiries of and notifying the owner or superior contractor of the supplier’s claim.

If a trust fund claim is brought, then it may be brought under section 8 against the defaulting contractor or subcontractor, and under section 13 against the director, officer and controlling person.  The claimant will have to conduct careful examinations for discovery and carefully demand production of documents.  By doing so, it may be able to establish that trust funds were diverted and that the defendant director, officer or control person assented to or acquiesced in that diversion.

The bottom line is that the effective scope of section 13 is only as good as the evidence.  That’s not a novel proposition but in the context of section 13 it’s a challenging one.

Belmont Concrete Finishing Co. Limited v. Marshall, 2012 ONCA 585. 

Building Contracts – Construction Liens – Trust Funds – Officers, Directors and Controlling Persons

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                                            December 1, 2012

www.heintzmanadr.com

www.constructionlawcanada.com

Is The Person Who Ultimately Pays A Guarantor Entitled To The Securities Held By The Guarantor?

Bonds and other forms of guarantees and indemnities are commonly used on construction projects. If a contractor applies for a performance bond, the bonding company will require the contractor to indemnify the bonding company. The bonding company may also require the principal shareholder of the contractor to guarantee the contractor’s obligation and to directly indemnify the bonding company. The bonding company may also take security over the contractor’s assets as a further condition of providing the bond. If the principal shareholder of the contractor is required to indemnify the bonding company, is that shareholder entitled to the security obtained by the bonding company over the contractor’s assets?

Normally speaking, one would think so. By indemnifying the bonding company, the indemnifying party should be subrogated to all the rights of the bonding company, including the security held by the bonding company.

But the English Court of Appeal held to the contrary recently in Ibrahim v. Barclays Bank Plc. There were two significant features of the indemnity and guarantee documents in that case, and they resulted in Mr. Ibrahim not being entitled to exercise rights under the securities which were originally available to the guarantor.

Those features of the Ibrahim decision must be carefully scrutinized by any persons about to give or to guarantee a bond. A bonding company, or a person holding competing security to the bonding company, may want to duplicate the features found in the documents in the Ibrahim case in order to avoid those securities passing to the third party which agreed to indemnify the bonding company. On the other hand, a third party who is indemnifying the bonding company may want to avoid those features in order to obtain the securities held by the bonding company.

Factual Background

LDV was an English van manufacturer. In 2008, it was in severe financial condition. Weststar was interested in purchasing the shares of LDV, but it needed a due diligence period to examine LDV’s affairs. Barclays was LDV’s banker. It was agreeable to advance further moneys to LDV during the due diligence period provided that the repayment of its further loan to LDV was guaranteed by a department of the British government, BERR. As a condition of providing its guarantee of LDV’s obligation, BERR demanded a letter of credit from a bank, UBS. UBS in turn demanded a guarantee from the principal shareholder of Weststar, Mr. Ibrahim. These arrangements were put in place.

The agreement between Barclays and BERR provided that “unless and until the Guarantor Liabilities have been paid and discharged in full and [BERR] has no further actual or contingent liability under or in respect of the Guarantee”, Barclays and BERR were to share in the recovery from the assets of LDV under the security which Barclays held over LDV’s assets. USB and Mr Ibrahim were not parties to those arrangements.

As a result of the due diligence conducted by Weststar, it decided not to proceed with the purchase of the shares of LDV and LDV went into insolvency. Barclays called on BERR ‘s guarantee of LDV’s obligation to repay the monies it had advanced to LDV. BERR in turn called upon UBS to pay under its letter of credit, and UBS demanded the Mr. Ibrahim pay under his guarantee. Having paid UBS, Mr Ibrahim asserted the right to exercise the rights accorded to BERR under its agreement with Barclays and to share in the recovery which Barclays had made under the security it held over LDV’s assets.

At trial, Mr. Ibrahim asserted his claim by way of subrogation to BERR’s rights. By the time the appeal was heard, Mr. Ibrahim had obtained an assignment of BERR’s rights under its arrangement with Barclays and asserted that BERR had a right, and that he had the same right by way of assignment, to share in the recovery from LDV’s assets.

The Decision

The English trial division and Court of Appeal held that Mr. Ibrahim had no right to share in the recovery made by Barclays from the assets of LDV, for two reasons.

First, they held the effect of the payment by UBS to BERR was that BERR was paid in full in respect of the obligation of LDV. Under the wording of the Barclays-BERR agreement, that payment discharged the obligation of LDV even though the proceeds came from UBS, and not LDV. Therefore, under the Barclays-BERR agreement, BERR’s rights to share in LDV’s assets had come to an end.

Second, the Court of Appeal held that the letter of credit given by UBS to BERR was an “autonomous instrument” which stated that the obligation to pay accrued when the Secretary of State certified that amounts were due in respect of the LDV debt and that it would discharge the LDV debt. Therefore, the payment by UBS to BERR under that letter of credit did discharge the LDV debt to BERR, and under the Barclays-BERR arrangement BERR had no further right to share in Barclays’ recovery from LDV’s assets.

Mr. Ibrahim argued that the payment by UBS did not discharge LDV’s obligation to BERR. He argued that a payment by a third party of a debtor’s obligation to the creditor does not discharge the debt, that the debt remains alive and that the third party can assert the creditor’s rights against the debtor by way of subrogation or assignment.

A considerable amount of old English legal authority was reviewed by the court. The point of the review was to determine the circumstance in which a debt is considered to be discharged by a payment made by a third party. Having reviewed those cases, the Court of Appeal concluded that when the third party has an obligation to pay the debtor’s obligation by reason of some outstanding obligation to do so, then the debtor’s obligation to the creditor is discharged but the third party has a direct right to recover from the debtor.

In the second situation, when the third party has no such obligation and makes the payment voluntarily, the debt is not discharged unless the payment is made as agent for the debtor, and the third party can bring a subrogated claim against the debtor based on the continued existence of the debt.

Since UBS’s payment was made under an obligation to do so contained in the letter of credit, and in any event UBS’s payment was not made as an agent for LDV, the English Court of Appeal held LDV’s obligation to BERR had been satisfied. Therefore, under the particular wording of the Barclays-BERR agreement, BERR had no further right to share in Barclays’ recovery from LDV’s assets.

Discussion

This decision has a number of lessons for those using bonds, guarantees and indemnities.

First, a third party who is providing a guarantee to the bonding company should examine the securities which the bonding company is taking. If those securities provide that upon payment to the bonding company the loan is effectively discharged, then that is not a good provision so far as the third party is concerned. Or if upon payment by the third party to the bonding company, the bonding company loses its security or its security is in any way impaired, the guaranteeing party will want to change that wording to ensure that its payment does not discharge the debt or impair the security which the bonding company is holding. Indeed, the third party may want to require the bonding company not to impair any securities obtained by it and to ensure that any securities held by it shall remain in effect and be transferred to the third party guarantor.

The time to do so is, of course, at the time of the initial guarantee. Mr Ibrahim may have been in a position at the outset to insist that Barclays agree that he would share in the LDV asset recovery if, through UBS, he effectively paid LDV’s obligation to BERR. If Barclays was willing to make that arrangement with BERR, it may have made that arrangement with Mr. Ibrahim who was the principal in Weststar and was providing the guarantee which supported the loan arrangement.

Similarly, when a shareholder of a contractor is asked to give a guarantee for the contractor’s performance bond, and the bonding company also asks for security over the contractor’s assets, the time when the application for the bond is made is the time for the shareholder to examine that security The guaranteeing shareholder will want to ensure that, if the guarantee is called upon and paid by the shareholder and not the contractor, the contractor’s debt will not be considered to have been paid or the security impaired, and that the security will be available to the shareholder who pays the bonding company. On the other hand, the contracting company itself, or those with a financial interest in that company including its other secured creditors, may have an opposite interest and may wish the security to terminate if the bond is paid by the guaranteeing shareholder.

Second, the Ibrahim decision may suggest that a letter or credit or negotiable instrument has an independent role which can nullify or impair the rights of the ultimate third party guarantor.

This suggestion could be supported from the absolute nature of these instruments. A guarantor such as BERR may wish to have the certainty of an unconditional promise to pay without any requirement to account for securities to which it is entitled. BERR may not have wanted any obligation on its part to bargain with Barclays to retain rights to a continued share in LDV’s asset after it was paid. If this is so, then bonding companies may wish to use these sorts of instruments and third party guarantors will want to avoid them.

However, others may argue that this suggestion is based on an incorrect reading of the Ibrahim decision. It can be argued that the wording of the particular letter of credit, when combined with the particular wording of the Barclays-BERR agreement, simply led to the conclusion that, once BERR was paid by UBS, BERR had no further rights under that agreement and therefore neither did Mr. Ibrahim either by way of subrogation or assignment. If so, then a third party guarantor will want to avoid the particular wording of the documents in the Ibrahim case, while a bonding company may want to use that wording as a useful precedent.

Whichever way one reads the Ibrahim decision, it serves as a warning to all those involved in bonds and other sorts of indemnities and guarantees. If the bonding company holds securities for the bonded obligation, then the parties should clearly understand the rights of a third party in that security if the third party has the ultimate obligation to indemnify the bonding company.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., chapter 9

Ibrahim v. Barclays Bank Plc., [2012} EWCA Civ 640

Building Contracts – Bonds – Remedies

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                                         November 11, 2012

www.heintzmanadr.com
www.constructionlawcanada.com

If You Want Specific Performance, Do You Still Have To Mitigate Your Damages?

Is a party to a contract obligated to mitigate its damages at the same time that it is asking the court to order specific performance? Since the party wants the contract performed, not damages for non-performance, the obligation to mitigate seems to be totally inapplicable.

Yet, in Southcott Estates Inc. v. Toronto Catholic District School Board the Supreme Court of Canada has just held that a plaintiff seeking specific performance may have an obligation to mitigate.  If it doesn’t do so, and the court holds that specific performance should not be granted, then the plaintiff may be awarded very little if any damages.

Building contracts do not often give rise to claims for specific performance. That is because a court cannot readily supervise the conduct of a construction project.  But specific performance is a remedy which is often sought by developers who assemble land for the purpose of construction projects.  So the decision in Southcott has direct implications for companies involved in the assembly of land for building projects.

Factual Background

Southcott was a single purpose company which was part of the Ballantry Group of Companies.  The Toronto Catholic District School Board agreed to sell to Southcott a property which was surplus to its needs. Southcott intended to develop the property for residential purposes.  It was a condition of the agreement that the School Board obtain a severance from the Committee of Adjustment on or before the closing date. The School Board failed to have a development plan prepared and failed to obtain the severance. When the closing date arrived, the School Board refused Southcott’s request to extend the closing date.  The School Board declared the transaction to be at an end, and returned Southcott’s deposit.

Southcott commenced an action for specific performance or, in the alternative, for damages. Southcott succeeded on the merits of the action, and the real question was whether it was entitled to specific performance or damages.

Southcott admitted that it didn’t intend and never tried to mitigate its damages.  It said that it was incorporated solely for the purposes of this project and had no assets other than the money provided by Ballantry. Southcott said that it neither intended to nor tried to purchase other land, especially having regard to its involvement in this action. At trial, the School Board led evidence that 81 parcels of vacant development land in the Greater Toronto Area (GTA) were sold between the date of breach and the date of trial. That land was suitable for residential development. In fact during that period other companies in the Ballantry Group purchased lands which were similar to the subject property.

The Decision

The Supreme Court noted that, in Asamera Oil Corp. v. Seal Oil& General Corp, [1979] 1 S.C.R. 633, it had dealt with the obligation to mitigate in relation to a claim for specific performance.  The Asamera case dealt with an investment contract, not real estate.  In Asamera, the court had said that the plaintiff needed to show “some fair, real, and substantial justification” before a claim for specific performance could be insulated from the obligation to mitigate. If the plaintiff could show some “substantial and legitimate interest” in seeking specific performance as opposed to damages, then the plaintiff might justify its inaction in failing to mitigate.

The Supreme Court also noted that, since its decision in Semelhago v. Paramadevan, [1996] 2 S.C.R. 415, a plaintiff could not assert that every piece of land was “unique” and insist on specific performance of a contract to purchase that piece of land.

The Court then proceeded to deal with three issues:

First, the fact that Southcott was a single purpose company did not exempt it from the general principles applicable to specific performance and mitigation of damages. If it were otherwise, everyone would establish single purpose companies to exempt themselves from these general principles.

Second, Southcott did not have a sufficient justification for its failure to mitigate its damages. The Court said:

“The trial judge made clear findings that the land was nothing more unique to Southcott than a singularly good investment and that this was not a case in which damages were too speculative or uncertain to be an adequate remedy. The unique qualities related solely to the profitability of the development for which damages were an adequate remedy … A plaintiff deprived of an investment property does not have a “fair, real, and substantial justification” or a “substantial and legitimate” interest in specific performance… unless he can show that money is not a complete remedy because the land has “a peculiar and special value” to him…. Southcott could not make such a claim. It was engaged in a commercial transaction for the purpose of making a profit. The property’s particular qualities were only of value due to their ability to further profitability. Southcott cannot therefore justify its inaction.”

Third, the Supreme Court held that there was evidence to support the Court of Appeal’s conclusion that Southcott had suffered no damages.  It agreed with Southcott that the mere fact that Southcott had admitted it did not mitigate its damages did not throw the burden of proof on the damages issue onto Southcott.  Since mitigation of damages was at issue, the normal burden of proof remained on the defendant, the School Board.  However, taken as a whole and in the light of purchases by other Ballantry companies of similar land during the same period, there was evidence to demonstrate that Southcott had suffered no damages.

Discussion

The Southcott decision shows that the plaintiff – and the defendant – rolls the dice on the same “uniqueness of the property” issue, both for the specific performance claim and the damage claim. If the property isn’t really unique, then the plaintiff won’t be awarded specific performance.  If the property isn’t really unique, then the plaintiff will be denied damages if it doesn’t mitigate. So the parties had better get that issue right, or someone is either going to win or lose both issues. In effect, the plaintiff is either going to obtain specific performance, or (if the damages could have been mitigated) little or no damages.

The second lesson to learn from Southcott is that the uniqueness cannot be solely based on value.  Value can be as much translated into a damage award as into an award for specific performance.  If the property is really valuable, or more convenient, or more developable, in relation to other available properties, then those advantages can be awarded by way of damages.  They may not be an excuse for the plaintiff not searching for reasonable alternative properties.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed.

Chapters 5 and 6, part 1.

Southcott Estates Inc. v. Toronto Catholic District School Board, 2012 SCC 51

building contracts – remedies – claims – specific performance – damages

Thomas G. Heintzman O.C., Q.C., FCIArb                                                       October 28, 2012

www.heintzmanadr.com

www.constructionlawcanada.com

Andrews v ANZ: What Are The Consequences For Building Contracts?

The recent decision of the Australia High Court in Andrews v. Australia and New Zealand Banking Group Ltd. is important for the building industry.  While it dealt with a banking contract, the principles it applied are directly relevant to building contracts.

The central decision in Andrews v. ANZ is that the doctrine prohibiting contractual penalties applies both to conduct which is a breach of contract and conduct which is permitted under the contract.  But in its review of the whole history of the law of penalties, the court draws conclusions which are of much wider consequence.  The court explains that non-monetary consequences of a contract are included in the doctrine against penalties.  That conclusion could have a dramatic impact on building contracts.  The court also clarifies the difference between a “condition” in a contract and a “condition” in a bond, and decides that these words do not have the same meaning in both settings.  Since bonds are an essential element in building projects, this decision should be well understood by those engaged in those projects.

Factual Background

The decision in Andrews v. ANZ arose from a motion to strike out certain claims in a class action relating to banking contracts.  The contracts permitted, but did not require, the bank to impose certain fees if the customer undertook, or asked the bank to undertake, various transactions. The transactions included:

  • requesting the bank to consider a withdrawal or payment which would result in an overdraft in the account; or
  • requesting the bank to honour a transaction that resulted in an overdraft.

The transactions were not contrary to the banking contract.  The fees might be payable by the customer if the bank considered the requested transaction, even if the request was denied.

In its motion to strike, the bank argued that the rule against penalties did not apply to these amounts on the ground that the rule against penalties did not apply when, as in this case, the triggering conduct was not a breach of contracts.  The Court of Appeal agreed.  The High Court reversed that decision, holding that the fact that these fees “were not charged by the respondent upon breach of contract by its customers and that the customers had no responsibility or obligation to avoid the occurrence of events upon which these fees were charged, do not render the fees incapable of characterisation as penalties.”

The High Court also held that the doctrine against penalties applies to non-monetary conduct.  The contract may state that a party will do something (the primary event) and then stipulate a further event if the primary event does not occur (the secondary obligation).  Neither event need be a monetary one for the doctrine against penalties to apply. Thus if the primary event is the transfer property, the doctrine can apply.  If the secondary event is the transfer of property, likewise the doctrine can apply.  In either situation, if the secondary event is totally disproportionate to the real consequences of the failure to perform the primary event, the secondary event can be examined to determine if it is really a penalty.  If it is, then it is unlawful.

The Consequences of Andrews v. ANZ  for Building Contracts

There are four important consequences of the decision in Andrews v. ANZ.

1.      Doctrine Against Penalties applies to more than Breaches of Contract

The central conclusion in Andrews v. ANZ is, of itself, extremely important for the law relating to building contracts.  All the clauses in a building contract which provide for monetary payments should be closely examined to see if they impose unlawful penalties. Even those clauses which do not give rise to a breach of contract should be examined.  If those payments are out of line with the actual detriment arising from the relevant conduct, potentially they are penalties and unlawful, whether or not they are in relation to a breach of contract.

2.      Doctrine Against Penalties applies to Non-Monetary Conduct

According to Andrews v. ANZ, this principle applies to any provision in a contract, not just those which involve monetary payments.  In the context of building contracts, this approach could have a wide and uncertain application. What sort of non-monetary consequences fall within it?  If a bidder submits an erroneous bid (the primary event), could a court hold that disqualifying the bidder (the secondary event) is unlawful as a penalty if it is shown that the error in the bid caused little harm to the owner and the disqualification of the bidder is a disproportionate “penalty”?  If an owner gives a “cure notice” and then terminates the contract, could the termination amount to a penalty if it was disproportionate to the damage suffered by the owner?  It may seem ridiculous to include those examples within the doctrine against penalties, but it is difficult to draw a clear line between what non-monetary consequences fall within that doctrine in the construction setting.

3.      Doctrine Against Penalties may not apply to Additional Obligations

The High Court expressly recognized that there may be an exception to the penalty doctrine arising from what it called a consensual “additional obligation.”  The High Court said that if the amount which the party must pay (or other secondary event) as a consequence of the conduct in question is really the result of a new contract, then the penalty doctrine may not be engaged.

Thus, the fee for the overdraft to the banking customer might be seen as really arising from a new contract and a new and additional privilege purchased by the customer.  Similarly, a distributor of films to a theatre owner might stipulate that the theatre owner would pay four times the original single-screening fee for extra showings of the film. The High Court said that those extra fees might amount to the purchase of additional privileges which fall outside the doctrine against penalties. It did not decide whether the banking fees in question fell within this exception and left that issue to the trial judge.

How would this exception apply to building contracts? If the building contract said that for every day of delay by a contractor, the contractor shall pay the owner $500,000, is that provision a penalty or an “additional obligation.”  If instead, the contract stated that if the contractor wished to extend the period of completion, then he may apply to the owner for permission to extend, and the parties agree that a new contract containing any such permission shall be made at a cost of $500,000 per day, would that be a penalty or an additional obligation?

4.      “Conditions” in Contracts and Bonds are Different

There is a further aspect of the decision in Andrews v. ANZ which is of interest to the building industry, and that is its discussion of “conditions” in contracts and bonds. The High Court pointed out that the word has an entirely different meaning in a contract than in a bond.

As the court said, in a contract the word “condition” refers to a term of the contract which is “vital, important or material.”  By using this word, the parties have agreed that the breach of this term amounts to a repudiation and permits the other party to accept the repudiation and terminate the contract.  In other words, in a contract conduct which does not comply with a “condition” is necessarily a breach of contract, and indeed a serious one.

In a bond, however, the word “condition” performs another function.  Like a contract, the bond seeks to “secure performance of the condition, but instead of attempting to secure this result by exacting a promise from the obligor to perform the condition, there is an acknowledgment of indebtedness –in effect a promise.” In Roman and early English law, a bond might be payable in full, no matter what damages the obligee might really suffer. That result was later modified by equity, through decisions which evolved into the doctrine against penalties, to ensure that the payment under a bond could be no more than the real loss of the obligee.

In addition, the High Court noted that the “condition in the bond may be any occurrence or event which need not be some act or omission of the obligor, analogous to a contractual promise by the obligor.” Moreover, the condition in the bond need not be the payment of money, and could relate to the transfer or vesting of interests in land. Indeed, “the cases do not establish any general proposition as to the contractual character of the condition in a bond.”

This discussion of bonds supported the High Court’s conclusion that the doctrine against penalties relates to conduct which does not necessarily amount to a breach of contract and to consequences that do not necessarily involve monetary payments.

In the result, the decision in Andrews v. ANZ provides a good review of the law of bonds and the use of the word “condition” in bonds.  That word designates a circumstance which is the basis for the obligation in the bond. That circumstance need not be a breach of a contract.  It can be whatever conduct the bond is intended to secure.

Conclusion:

Andrew V. ANZ results in a sweeping application of the equitable doctrine against penalties. The decision holds that the doctrine applies to all contractual conduct, including both breaches and permitted conduct and both monetary and non-monetary consequences. Whether this approach will be followed in Canada is uncertain. As a matter of logic and principle, it makes sense.  But the decision raises challenges when applied to building contracts.  And it raises difficult questions about where the boundary line is between conduct which falls within the doctrine against penalties and conduct which does not.

See Heintzman and Goldsmith on Canadian Building Contracts (4th ed.) at Chapter 6, para 2(b)(i)(B) and Chapter 9

Andrews v. Australia and New Zealand Banking Group Ltd., [2012] HCA 30

Building Contracts  –  Bonds  –  Penalties  –  Damages  –  Remedies for Breach of Contract

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                  October 20, 2012

www.heintzmanadr.com

www.constructionlawcanada.com

 

Can A Service Contract Create A Duty To Defend?

A clause obliging the insurer to defend an insured, or pay for the insured’s defence, is a well know feature of liability insurance policies. Recently, some Canadian courts have held that the duty of one party to defend or pay for defence of another party to the contract may arise in contracts outside the field of insurance, for instance in building contracts.  This obligation has been found to arise from an indemnity clause or insurance clause in the contract. Such a duty has been held to exist in a service or building contract even though that contract contained no express duty to defend or pay for a defence.

However, a duty to defend or pay for a defence before a finding of liability seems to be an obligation of a different kind than a duty to indemnify or to obtain insurance.  Recently, the Ontario Court of Appeal has clarified this issue in Papapetrou v. 1054422 Ontario Limited. The court held that an insurance clause may create an obligation to pay damages equal to defence costs, but it does not create a duty to defend.

Background

Ms Papapetrou brought a slip and fall claim after she fell on ice on the stairs of The Galleria.  That building was owned by the numbered company and managed by the Cora Group. The Cora Group hired Collingwood to provide winter maintenance and snow removal.

The service contract between Collingwood and the Cora Group contained the following indemnity clause:

The Contractor assumes sole responsibility for all persons engaged or employed in respect of the Work and shall take all reasonable and necessary precautions to protect persons and property from injury or damage. The Owner shall not be responsible in any way … resulting from any act or omission of the Contractor…The Contractor shall indemnify and save harmless the Owner …against all claims, losses, liabilities, demands, suits and expenses from whatever source, nature and kind in any manner based upon, incidental to or arising out of the performance or non-performance of the contract by the Contractor….[Emphasis added.]

The contract also contained an insurance clause. Collingwood agreed to obtain CGL insurance covering the liability of Collingwood and its employees and agents for bodily injury up to a minimum of $2,000,000 and to include the Owners as additional insureds on the policy. Instead, Collingwood obtained an insurance policy covering a maximum of $1,000,000 and the policy did not name The Cora Group as an additional insured.

The Cora Group brought a motion to compel Collingwood to indemnify, and assume the defence of the action on behalf of, The Cora Group. The motion judge granted the motion, finding that “the true nature of [Ms. Papapetrou’s] claim is that [Collingwood and The Cora Group] were negligent in failing to maintain an ice free pedestrian stairway” and that based on the service contract, a duty to defend and indemnify therefore arose. The motion judge stated that Collingwood “should not escape responsibility to defend/indemnify merely because [it] failed to meet [its] contractual responsibility” to name The Cora Group as an additional insured in its CGL policy.  She ordered that Collingwood indemnify The Cora Group and undertake the defence of the action against The Cora Group.

The Court of Appeal’s decision

In the Court of Appeal, The Cora Group acknowledged that an order that Collingwood indemnify it was premature.  No evidence about liability or damages had been led on the motion. The service contract did not require that Collingwood assume sole responsibility for damage to persons and property. Rather, it required Collingwood to assume “sole responsibility for all persons engaged or employed in respect of the Work” and “take all reasonable and necessary precautions to protect persons and property from injury and damage.”  Moreover, Collingwood’s contractual obligation to indemnify The Cora Group was limited to claims “based upon, incidental to or arising out of [Collingwood’s] performance or non-performance of the [service] contract”.

In these circumstances and at this juncture, the Court of Appeal held that there could be no finding that Collingwood’s duty to indemnify had been triggered. Accordingly, the motion judge’s order to indemnify was set aside.

The Court of Appeal also held that the order requiring Collingwood to assume the defence of The Cora Group must be set aside, for two reasons:

First, the service contract contained no duty to defend.

Second, any duty to defend could be no wider than claims arising from Collingwood’s performance or non-performance of its contract.

The Cora Group argued that Collingwood’s obligation to defend arose, not out of the indemnity clause, but rather out of the insurance clause.  It argued that Collingwood’s failure to name The Cora Group as an additional insured in its CGL policy was a breach of contract and that the appropriate remedy was an order requiring Collingwood to defend it. However, the court held that “Collingwood’s breach of this contractual obligation does not create a duty to defend; rather, it gives rise to a remedy in damages.” The court also held that the failure of The Cora Group to object to the form of the insurance was irrelevant.

The court held that the amount of damages suffered by The Cora Group was the amount the CGL insurer would have paid on behalf of The Cora Group.  That amount had to be determined from the service contract, not the CGL insurance policy that Collingwood obtained, since that policy did not contain the additional insured coverage for The Cora Group that it was supposed to contain. The scope of Collingwood’s contractual obligation to indemnify was limited to “claims … based upon, incidental to or arising out of the performance or non-performance of the contract by the Contractor”. Accordingly, the amount of damages was “the amount The Cora Group must pay to defend claims for bodily injury arising out of the manner in which Collingwood performed or failed to perform the service contract.”

The court held that “these costs will include all costs of The Cora Group’s defence of the Papapetrou action, save for any costs incurred exclusively to defend claims that do not arise from Collingwood’s performance or non-performance of the service contract.” The court arrived at this conclusion by analogy to the payment of defence costs under an insurance policy.

First, it applied the principle that an insurer’s obligation to defend is limited to claims that, if proven, would fall within the policy.

Second, it applied the apportionment principle applicable to defence costs under an insurance policy that “where an action includes both covered and uncovered claims, an insurer may nonetheless be obliged by the terms of the policy to pay all costs of defending the action save for those costs incurred exclusively to defend uncovered claims.”

In view of the allegations of Ms. Papapetrou, there was a conflict of interest between Collingwood and The Cora Group, and The Cora Group was entitled to retain separate counsel.

The Court of Appeal set aside the motion judge’s order and substituted an order requiring that Collingwood pay for The Cora Group’s defence of the action, save for any costs incurred exclusively to defend claims that did not arise from Collingwood’s performance or non-performance of the service contract.

Discussion

There are a number of interesting aspects of this decision from the aspect of construction law and insurance law.

First, this decision has to some extent clarified the law with respect to whether a duty to defend can arise from an indemnity or insurance clause in a non-insurance contract, such as a building contract.  The Court of Appeal has certainly held that such a duty does not arise from the breach of an insurance clause, and that the proper remedy is damages. If this is so, it seems hard to imagine that another court could conclude that an indemnity clause gives rise to a duty to defend and not damages. As well, it appears that a number of recent lower court decisions, holding that a duty to defend may arise from an indemnity clause in a non-insurance contract, are no longer good law.

Second, if a future action arises from the breach of an indemnity clause, we cannot be certain what principles the court will apply to the calculation of damages.  In the present case, since the breach was of the insurance clause, the court had a convenient proxy or reference point in the cases dealing with the determination and apportionment of defence costs under a liability insurance policy.  No policy reasons come to mind for applying different principles to breach of an indemnity clause, but we will have to await such a case for a clear answer.

Third, it may be a little surprising that, on an interlocutory motion, the court made what appears to be a final order determining the principles upon which damages were to be paid. There may be an argument on a duty to defend motion under an insurance policy as to whether, and to what degree, the court should finally determine the principles upon which the defence costs are to be paid, and the degree to which the trial judge should be left with some discretion on that matter.  In the present case, the Court of Appeal appears to have finally decided the matter.

Fourth, the court appears to have finessed the issue of whether the claim by Ms. Papapetrou was entirely covered under Collingwood’s CGL policy.  There is no mention in the decision of any coverage dispute under that policy, so perhaps coverage was not an issue. In addition, the Court of Appeal may be saying that, because Collingwood did not obtain the coverage for The Cora Group, it could not argue anything about the scope of coverage under the policy. But in another case, if coverage is an issue under the “policy that wasn’t obtained” then this may be raised as an issue by the defaulting party.  That party may argue that there should be an additional exception to its liability, namely, “to the extent that coverage was not available under the policy not obtained.”

Fifth, this decision shows how a breach of an insurance clause can be expensive. By failing to obtain the right insurance, Collingwood turned what would have been a claim for payment of costs against the insurer under the CGL policy into a claim for costs against it personally.

Finally, the insurance law junkies will take note that the Court of Appeal has once again applied the apportionment principle that requires the insurer (and by analogy in this case, the party in breach of contract) to pay defence costs except to the extent that those costs are due exclusively to uncovered claims.  This rule is favourable to the insured and is generally applied by Anglo-Canadian courts to apportionment disputes, but other rules less favourable to the insured may be applied in other jurisdictions and are advocated for by many insurers.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed. Chapter 5, part 3

Papapetrou v. 1054422 Ontario Limited, 2012 ONCA 506

Building Contracts –  Insurance –  Indemnity and Insurance Clauses  –  Duty to Defend    –   Damages

 Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                  September 23, 2012

www.heintzmanadr.com
www.constructionlawcanada.com

 

Is Certainty An Essential Element Of A Building Contract?

Overview

Courts are often unwilling to hold that an agreement is unenforceable for uncertainty when, by all appearances, the parties intended to make a contract.  But in a very spirited and colourful judgment, the Court of Appeal for Alberta has recently weighed in very heavily on the need for certainty in any contract, and particularly a building contract. In Seong Yun Ko v. Hillview Homes Ltd., that court provided a virtual law library on the Anglo-Canadian law, plus a dictionary of aphorisms and Latin phrases, on the subject of certainty in contracts.  Put this case in your hip pocket for the next time you need to address the issue because it will take you to all the important principles and cases.

The Alberta Court of Appeal also pointed out that the principles of contract law are a seamless web in which each principle is connected to another, while each principle remains an essential thread in a valid contract.  Thus, the intention to make a contract is one thread, but does not replace the need for certainty, and the mere existence of an intention to make a contract does not create certainty. And certainty of contract is connected not just to the initial validity of the contract, but to the objective terms of the contract and to a mistake about the terms of the contract, all of which may render the contract non-existent from the beginning, influence the contents of the contract or render it terminable by rescission.

Background

The plaintiff was a licensed realtor and the defendant was a home builder.  The defendant sold the plaintiff a lot and agreed to build a home on the lot for the total price of about $1.2 million.  The contract contained an Entire Agreements clause precluding any reference to representations, warranties and previous statements. The contract stated that a particular model of the house was to be built on the lot.  It also contained short form language that the parties agreed meant that the house was to contain 1,666 more square feet, costed at $80 per square feet.  Those 1,666 square feet were not a minor part of the proposed building, and amounted to about 60 per cent of the size of the building if the size of the model house referred to in the agreement was used as a reference. However, the parties did not agree on what those 1666 square feet were to be added on to (and thus, what the total square feet were to be), or where the 1666 square feet were to be located in the house, or what they would contain, or anything else about those square feet.

The Decisions

The trial judge held that there was a valid contract.  The trial judgment granted specific performance for the lot itself, but not as to the house.  The trial judge held that the plaintiff was entitled to damages for the increased cost of construction of the house.

The Court of Appeal for Alberta held that there was no contract because of the uncertainty as to what the defendant was to build.  The fact that the parties may have thought that they made a contract, and had the requisite contractual intent, did not overcome the necessity that the terms of the contract be reasonably certain.  And here, because the parties had not agreed upon what the 1,666 square feet were to contain or where they were to be located, the terms of the contract were uncertain and there was no contract.

The Reasons of the Alberta Court of Appeal

The reasons of the Court of Appeal canvas virtually the entire scope of the Anglo-Canadian law on the subject of certainty as an essential element of an enforceable contract. Since the issues that the court addressed are so numerous, it might be helpful to list them one after another.

Here are the Top 10 David Lederman-style lessons from Ko :

  1. A contract for the sale of land with a finished building for a specific price as adjusted by a square feet formula is not a design-build contract.  So the uncertainty of the agreement could not be repaired or justified on the basis that it was a contract to provide professional or trade services at a reasonable rate. Moreover, even for a design-build contract to contain terms which meet the test of reasonable certainty, there must be a “warranty of suitability by the designer, restrictions on any variation by the owner and permission for variations by the builder” with the result that there is “control of the design by the designer, and a limitation on interference in it by the owner.”  None of that was present in this case
  2. While “house-building companies commonly agree with a customer to modify one of their standing plans when building his or her specific house”, there must be “more care… and a moderate degree of detail” for the contract to be enforceable.
  3.   The Entire Agreement clause precluded the parties from relying upon the negotiations and discussions to create certainty of terms. In any event, the plaintiff acknowledged that there was no agreement on where the 1,666 square feet would go, nor did the evidence disclose what the 1,666 square feet represented. Moreover, the parties’ subsequent conduct could not, and did not, clarify their prior agreement.
  4.  Certainty is an essential element of the validity of a contract, and that element is tied into all the other elements of contractual validity. The court said that “certainty of terms is not a separate self-contained defence….Quite to the contrary, certainty is an integral part of the very heart of the contract… The rule is far from a technicality.”  Thus, it is part of the law of offer and acceptance.  It is part of the reasonable bystander test as to whether there is an enforceable contract: “if the bystander could not make any sense of it, or finds it contradictory, there is no contract. It is void ab initio for mistake.” It is part of the law of contractual mistake.  It is part of the law of contractual remedies: the court will not grant a remedy for an uncertain agreement because in awarding damages or granting specific performance, the court “compares what the vendor contracted to provide with what it did provide. So one must know what it contracted to give.”
  5.  Whether an alleged agreement is sufficiently certain to be a contract cannot be determined in the abstract.  It depends on the subject matter of the contract.  Thus, “what is enough specificity to make a valid contract to buy an existing power mower may not be enough for a contract to build a new house.”
  6.  Uncertainty as to any essential term of the alleged contract renders that contract void from the beginning.  Uncertainty is not just limited to parties, price and terms: “any term which the parties thought they needed and included in the agreement, but which is too vague, renders the contract void.”  The court said that: “Disagreement on even a small term bars a contract”, usually on the basis that the offer and acceptance did not match to create a contract.
  7.  Complete silence on price may enable the court to set a reasonable price.  But the court cannot do that for the subject matter and the parties: the court cannot “set the parties or the property”.  And so far as the price, if the parties specify a price formula which is uncertain, the court cannot supply the price for them.
  8.  There is a substantive difference between an agreement in which the parties agreed that the terms were to be “fixed by their later agreement” and an agreement in which “the parties called for a future formal contract, but all its terms were fixed at once.” The former is not a contract but the latter is.
  9.  There are solutions available to parties who wish uncertainty in their agreement but want to have an enforceable contract.  The court listed four solutions:

 (a)  A  specific means to decide the matter, such as a published standard, price list or other reference;

(b)   An arbitrator, valuator or referee to fix the matter;

(c)  A custom of the trade;

(d)  An implied term if the term or matter is obvious.

None of those solutions applied in the present case.

10.  The alleged duty to negotiate could not overcome the absence of certainty, for two reasons.

First, “designing and negotiating are not the same thing” and the court could not impose a duty to design the house which was enforceable on the parties.

Second, “a mass of binding and persuasive authority” made it impossible to overcome the absence of certainty with an obligation to negotiate.

The Aphorisms and Latin phrases of the Court of Appeal

The Court of Appeal was obviously steamed up about the state of contract law in Canada if the trial judgment was correct.  In addressing this state of affairs, the court employed colourful language, aphorisms and Latin phrases which certainly keep the reader interested.

Here are just a few which you can put in your kit bag for further use:

“Commerce needs predictability. So do ordinary Canadians about to commit their future earnings and life savings, especially to acquire a house.”

“If that truly is Canadian contracts law, it needs fixing.  It is another reason why litigation today is often priced out of reach. If it is not correct law, the present judgment should be changed and the correct law affirmed and clarified.”

 “’De gustibus non est disputandum’, says a Latin proverb millennia old. One cannot debate tastes.”

“Ex nihilo nihil fit is a maxim meaning ‘From nothing, comes nothing.’

Conclusions

In its reasons, the Court of Appeal cites over 45 Canadian cases, and also several of the leading English cases, tracing the law relating to contractual certainty back to the 1800s. So it is a virtual treasure trove of case law on the subject.

Some might argue with the strictness of the court’s approach to the subject matter.  Case law could be cited that is more generous to the use of conduct after the alleged contract to shed light on its meaning and certainty. The suggestion that lack of agreement on non-essential terms dooms the alleged contract also seems harsh.  But the facts of the case did not render those points essential: here, the conduct of the parties after the contract did not clarify the terms of the alleged contract, and the 1,666 square feet of undefined and undefinable square footage was an important part of the building.  So the comments of the Court of Appeal on these points may not be binding in future cases.

What is important about the decision is the re-affirmation of the need for contracts, and particularly building contracts, to be reasonably certain.  And helpfully, the court stated many reasons that support that principle and identified several techniques to deal with uncertainty if the parties cannot agree on the specifics.  The bottom line message is: when negotiating a contract, don’t throw the ball up in the air and expect the courts to catch it.

See Heintzman & Goldsmith on Canadian Building Contracts, 4th Edition Chapter 1, Part 1C

Seong Yun Ko v. Hillview Homes Ltd. 2012 ABCA 245

Building Contracts  –  Enforceability  –  Certainty of Terms

Thomas G. Heintzman O.C., Q.C., FCIArb                                                             September 15, 2012

www.heintzmanadr.com

www.constructionlawcanada.com

Does An Insurer’s Duty To Defend Apply If The Insured Complies With An Environmental Investigation?

The scope of an insurer’s duty to defend is a crucial issue in relating to any liability insurance policy, particularly those applying to building projects.   One of the questions which may arise is:  what is the nature of a “claim” for the purpose of the duty to defend?  That question will almost always be determined by the particular wording in the policy.  In General Electric Canada Company v. Aviva Canada, Inc., the Ontario Court of Appeal has just held that the wording of the policy did not apply when the insured complied with a request by the Ontario Ministry of Environment for an environmental investigation.

The Background

GE owned the subject property from 1903 to 1980, during which time it manufactured a variety of products on the site. During some period of that time, it used trichloroethylene (“TCE”) as a degreasing agent. In February 2004, the Ontario Ministry of the Environment (MOE) wrote to GE and other former owners of the property advising that it was reviewing potential TCE contamination and requested the assistance and co-operation of GE and the other recipients of the letter, asking them to provide any environmental assessments that they had in their possession.

In April, 2004, the MOE sent a second letter to GE, requesting further information concerning about potential TCE contamination.  The letter said that:

 “the data appears to support a TCE plume migrating from/ through the former GE property…As discussed you will be required to take action in delineating the source area on your former property. The delineation investigations are to determine the current levels and the full vertical and horizontal extent of all contamination within the soil and groundwater which are on site location. The delineation report shall include at minimum the following….At this time the ministry is willing to enter into an agreement with GE to pursue the required action items voluntarily. If at any time the ministry determines there is unsatisfactory progress a Director’s Order will be issued to resolve the matter.”

GE agreed to cooperate with the MOE request. It asserted that, in responding to that MOE request, it had incurred out-of-pocket expenses of $2.1 million for investigation costs, $1.86 million for remedial costs and $750,000 for legal costs. GE made a clam against its CGL insurers for payment of those costs.

The Policies

The two CGL policies contained language which required the insurer:

“to pay on behalf of the Insured all sums which the Insured shall become obligated to pay [by] reason of the liability imposed upon the Insured by law… for damages because of damage to or destruction of property caused by an occurrence within the Policy Period…

To serve the Insured by the investigation of claims on account of such damage to or destruction of property and occurrence alleged as the cause thereof,

To defend in the name and on behalf of the Insured any suit against the Insured alleging such damage to or destruction of property and seeking damages on account thereof, even if such suit is groundless, false or fraudulent.”

The Decision

The trial judge held that GE’s claim did not fall within the policy because GE had complied with the MOE’s request, and had not defended against it.  He said:

“What GE calls “defence costs” were not costs of defending against the MOE’s claim but, in fact, the costs of complying with the MOE’s claim. GE complied with the MOE’s request and performed the work on the basis that it was thought to be in GE’s best interests to do so.

In coming to this conclusion, I make no finding on whether the matters alleged and requested in the MOE’s letter fall within the coverage language of the Aviva and Dominion policies from an indemnity perspective. I base my conclusion rejecting GE’s request for a declaration that Aviva and Dominion have a duty to investigate and to defend the MOE’s request solely on the fact that there was no investigation or defence of the MOE’s claim at all. What GE is seeking, in my view, is indemnification for its costs of complying with the MOE’s claim. This is not the time to make findings on the merits of GE’s indemnity claim in this regard. As the Ontario Court of Appeal said in Halifax Insurance, supra, the time to determine the insurer’s duty to indemnify is at the conclusion of the underlying litigation, not during the abbreviated application for defence costs. My conclusion, therefore, is without prejudice to the parties’ positions on whether the MOE letter is a “claim” or to GE’s right to seek these costs by way of an indemnity claim against Aviva, Dominion, or both, as well as the right of those insurers to argue against the existence of that obligation.” (emphasis added)

The Court of Appeal agreed with this conclusion.  It said:

[T]the only evidence of a “claim” by the MOE in the April letter is the request, or requirement if you will, that GE take action in delineating the source of the TCE contamination. GE did not oppose, defend or investigate that request. GE, as it was invited to do in the letter, voluntarily complied with the request of the MOE. It cannot be said that it has suffered any defence or investigation costs recoverable under its insurance policies. As the application judge concluded, the costs incurred were compliance costs – not defence costs. The fact that GE provided a list of costs, which it has characterized as potential defence costs does not, in my view, change the analysis of whether the April letter triggers a duty to defend.

In the result, these decisions undertook no analysis of the indemnity coverage under the policy.  The courts did not consider whether there was indemnity coverage for the damage to the land, or whether there was an environmental exclusion.  Nor did they consider whether the MOE’s request was a “suit” against GE.  All that the courts decided was that GE’s cost of cooperation did not amount to defence costs.  The Court of Appeal declined to consider American case law on the issue.

This is an interesting decision from a number of aspects:

First, while the court’s reading of the word “defend” as excluding cooperation may be based on sound grammar and literal meaning, there could be a debate about whether it is based upon sound policy. If cooperation is the best defence, should the costs of that cooperation be excluded from coverage for defence costs?  Is fighting better or different than cooperating so far as a defence is concerned?

Second, if the cost of “cooperating” doesn’t amount to defence, does the cost of settling an action or regulatory proceeding amount to defence? Normally, the costs of settling an action, and obtaining the best evidence and expert reports to do so advantageously, would be included within defence costs under a liability policy.

Third, if the cost of cooperating is not defence costs, then that cost may fall within the indemnity coverage arising from damage to the property.  The trial judge’s decision appears to allow GE to argue that it does.  If so, then this proceeding was much to do about nothing.  Except that, by cooperating, GE may have materially reduced the insurer’s potential exposure.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed. Chapter 5, Part 3

General Electric Canada Company v. Aviva Canada, Inc., 2012 ONCA 525

Building Contracts   –   Insurance   –   Duty to Defend

Thomas G. Heintzman O.C., Q.C., FCIArb                                         August 14, 2012

www.heintzmanadr.com

www.constructionlawcanada.com

What Is The Effect of Piercing The Corporate Veil?

When the court pierces the corporate veil of a corporation, can another party be found to be the real party to the contract? Or is that other party only subject to consequential relief and not contractual relief? That is the issue which the English Court of Appeal recently faced in VTB Capital Plc v. Nutritek International Corp. That Court recently held that even in the face of fraud and other serious wrongdoing, the other party cannot be held to be a party to the contract unless the corporation which was shown as a party to the contract was a façade or sham.

The identity of the parties to a contract is fundamental to the contract’s legal existence and its commercial viability. In the context of building contracts, that identity is even more important since the parties undertake inter-related performance obligations and are relying upon the creditworthiness of the other parties to make sure that the project is completed. So the decision in VTB Capital should be carefully analyzed by those concerned with building contracts.

The Factual Background

 

The claim arose from a loan by VTB Capital, a company incorporated in England which carried on business as a bank in London. VTB Capital was controlled by a Russian state bank. The loan was to a company (RAP) incorporated in Russia, and was for the purpose of RAP buying six dairy companies in Russia. Other related agreements were also made, including a share warrant deed and participation agreement. The loan was not repaid and VTB Capital commenced an action in the English courts and sought to serve the claim on the defendants outside England. VTB Capital originally alleged that it was induced to enter into the loan by two other Russian companies and a Russian individual (the “Russian third parties”). It then sought to amend its claim to “pierce the corporate veil” of RAP, and assert that RAP was really only a puppet of the Russian third parties and that they were the real parties to the contract. VTB then asked permission to serve its claim outside England, with that contractual allegation included in the claim.

The English Court of Appeal held that when a corporation is a party to a contract and the corporate veil of the corporation is sought to be pierced so as to make others liable, then apart from the case where the corporation is a façade or sham, those others are not liable as parties to the contract. The other parties are only liable for consequential relief or based upon separate tortious or other wrongdoing. Accordingly, the Court of Appeal held that the new contract claim against the three Russian companies was not a valid legal claim and refused to permit the claim with this contractual allegation to be served outside England.

Piercing The Corporate Veil

The Court of Appeal undertook a lengthy review of English case law concerning “piercing the corporate veil.” It agreed that the corporate veil of a corporation can be pierced if there are “special circumstances….indicating that [the corporation] is a mere façade concealing the true facts.” Yet, it held that a proper reading of English cases disclosed that the “fraudulent or dishonest use of a company by its corporators or controllers so as to conceal the latters’ true identities” cannot in law possibly make those third party corporators or controllers the real and original parties to the contract. Rather, the corporation remained the party to the contract. If the corporators and controllers were to be held liable, that could occur through consequential remedies which would hold them accountable for monies or benefits received or for other equitable remedies, or they might be liable based upon separate tortious claims.

The Court of Appeal refused to apply the agency doctrine of undisclosed principals to this situation. The court said that the law on that subject was “anomalous”. On the facts of the case, the court said that the doctrine could not apply because “the puppeteers [had not] authorized the puppets to enter into the contracts on their behalf”, and because “VTB [did not intend] to contract with anyone other than the counterparties” named in the contracts.

The Court of Appeal accordingly found that the judicial authorities

“do not, however, go to the length of treating the puppet company as other than a legal person that is formally distinct and separate from the puppeteer; and were they to do otherwise, they would be ignoring the principles of Salomon. Consistently with that, they do not provide any basis for the proposition that the puppeteer should be regarded as having always been a party to a contract to which it or he plainly was not a party.”

This decision will have to be read very carefully. A bald conclusion – that the fraudulent or dishonest use of a company whereby the real actors’ identity is not disclosed cannot give rise to contractual liability for those actors -appears to raise serious legal questions, at least in Canada.

Moreover, this decision was given in the context of an application to serve the claim outside the jurisdiction and not upon the ultimate merits of the case. So the ambit or application of the decision may be somewhat in doubt. The following are some of the apparent limitations of the decision.

First, the Court of Appeal did not doubt that, if the corporation was a “façade or sham”, then the corporate veil could be pierced. So, the VTB Capital decision involves a party to a contract which was a real party with a real corporate existence. What amounts to a “façade” or “sham” in any particular case may be a factual issue, but the present decision does not exclude the contractual liability of a third party if the corporate party fits within those words. However, if the “puppet” is a real and existing entity, then the puppet and not the puppeteer is liable.

Second, the Court of Appeal did not hold that, if the facts of a case fit the doctrine of undisclosed liability, then that doctrine cannot and should not be applied. All it held was that the present facts could not be “shoe-horned” (as it said) into that doctrine.

In essence, the Court of Appeal accepted the “façade or sham” basis for piercing the corporate veil but rejected the two other submissions for doing so.

First, it rejected the proposition that the court has a general power to pierce the corporate veil and that the court could hold the third party contractually liable “in the interests of justice.”

Second, it rejected the proposition that the corporate veil could be pierced if “the company was involved in some impropriety”. If the latter conduct existed, then the “relevant wrongdoing must be in the nature of an independent wrong that involves the fraudulent or dishonest misuse of the corporate personality of the company for the purpose of concealing the true facts”, and not the contractual liability of the wrongdoer.

There is little doubt that, the next time a plaintiff in the Anglo-Canadian context attempts to pierce the corporate veil, the decision in VTB Capital will be pulled off the shelf, or downloaded from bailii. It is a densely written decision which cited many English decisions. But it cited no cases from Canada where the “corporate veil” issue has been frequently addressed.

On policy grounds, the decision adheres strictly to traditional contract law limiting the effect and enforcement of a contract to the parties named in it. The English Court of Appeal made a policy decision not to allow fraudulent corporate activity to give rise to a contract remedy against third parties. It did so at a time when courts, at least in Canada, are giving broader effect to contracts and allowing them to be enforced by third parties, and when Canadian courts seem inclined to provide wide remedies against corporate fraud. The future impact of the VTB Capital will depend, at least in Canada, on whether the same policy choice is made in Canada as was made in England.

Building Contracts – Parties – Corporations – Piercing the Corporate Veil

See Heintzman and Goldsmith on Canadian Building Contracts (4th ed.) at Chapter 1, Part 1(a)(i)(E)

VTB Capital Plc v. Nutritek International Corp., [2012] EWCA 808

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                          August 7, 2012

www.heintzmanadr.com

www.constructionlawcanada.com

Incorporation By Reference In Building Contracts

Incorporation by reference in building contracts

By Thomas G. Heintzman and Julie Parla1

A common clause in a building contract is one which incorporates the terms of another contract or document into the building contract in issue. The effect of such a clause is referred to as “Incorporation by Reference”. These clauses are common in building contracts because the various contracts necessary for a building project are often cross-referenced and their performance are inter-related.

Thus, the main contract between the owner and the general contractor is inter-related with the subcontract between the contractor and the sub-contractor. The tender or other pre-contractual documents are inter-related to the contracts later entered into. The payment or performance bonds are related to the contracts for which they provide financial guarantees. The contracts between the consultants are related to the building contracts themselves. To a great extent, all of these contracts are part of the same package. Whether the object is to save drafting time or to ensure absolute consistency, or laziness, one of these contracts may state that the terms of another document or contract are incorporated into it.

While an Incorporation by Reference clause may provide a useful correlation of one contract to a second contract, they also open up dangers when the clauses are arguably unsuitable for inclusion in the second contract. This paper will examine the circumstances in which Incorporation by Reference clauses have been used and the potential problems they raise.

Uses of Incorporation by Reference Clauses

Incorporation by Reference clauses have been used in a wide variety of circumstances in building contracts. Here are some of the circumstances in which they have been used and applied:

  • (a)  Specifications:  A specification list prepared by the owner was incorporated by reference into the contract ultimately entered into with the contractor, rather than attaching a specification list physically to the actual contract.2
  •  
  • (b)  Specific work and Best Practices:  A term in the main contract specifying the work to be carried out and stating the obligation to use “best trace practices” was incorporated by reference into the subcontract.3 In another case, the measurement and price to be paid for concrete work in the main contract was incorporated into the subcontract.4
  •  
  • (c)  Force Majeure and Claim period:  A force majeure clause and a clause stating the period in which a claim must be made, contained in the main contract, was incorporated by reference into the sub-contract.5
  •  
  • (d)  Profit Sharing:  A contractor’s obligation in the main contract to pay the owner 75% of savings from the contract price was enforceable against the bonding company. While there was no Incorporation by Reference clause in the bond, the Ontario Court of Appeal applied principles that related both to Incorporation by Reference and to contractual interpretation.6
  •  
  • (e)  Tender Conditions – GST:  The term of a tender, requiring the tender price to include GST, was incorporated into the contract ultimately entered into.7
  •  
  • (f)  Performance Bond:  A provision in the main contract requiring the contractor to post a performance and materials bond for 50% of the contract price was incorporated into the subcontract and precluded the contractor from requiring the subcontractor to post a 100% bond.8
  •  
  • (g)  Letter of Intent:  A letter of intent was incorporated by reference into the subsequent contract, thereby creating contractual representations.9

On the other hand, Incorporation by Reference clauses have not been applied in many cases to incorporate the provisions of another contract or document. Thus,

  • (a)  Liquidated Damages: A liquidated damages clause in the main contract was not incorporated by reference into the sub-contract.10 A bond which contained a clause incorporating the building contract between the owner and the contractor was held not to impose on the surety the obligation to pay the liquidated damages referred to in the building contract between the owner and the contractor.11
  •  
  • (b)  Lien Security:  The obligation to post security for lien claims contained in the main contract was held not to be incorporated into the subcontract.12
  •  
  • (c)  Guarantee Period:  A two-year guarantee given by the contractor to the owner in the main contract was not incorporated by reference into the subcontract.13
  •  
  • (d)  Insurance:  An obligation to obtain insurance was not incorporated into the subcontract because, although there was an Incorporation by Reference clause in that subcontract, there had been no main contract in fact entered into.14
  •  
  • (e)  Inconsistency:  A Term in a building contract was not incorporated into a bond because it was inconsistent with the limited liability of the surety stated in the Bond.15
  •  
  • (f)  Additional Terms:  The subcontractor understood that the main contract between the owner and contractor was the standard CCDC 2 contract. In fact the owner and contractor negotiated additional terms which were unknown to the subcontractor. It was held that those additional terms were not incorporated by reference into the subcontract.16
  •  
  • (g)  Dispute Resolution:  In Canada, courts have generally held that an arbitration clause in the main contract is not incorporated by reference into the subcontract without specific incorporation.17

The courts in other common law jurisdictions have also considered the incorporation of arbitration clauses from one contract to another. Their decisions illustrate the nuances of this practice, especially when those clauses affect rights and obligations outside of the project work per se. The incorporation by reference of arbitration clauses from one contract to another has been the subject of a number of cases in the United Kingdom and Australia.18 The general trend is that an arbitration clause in one contract is only incorporated into the other contract if the arbitration clause in the first contract is specifically referred to in the second agreement. This rule is sometimes referred to as the “rule in Aughton” after the decision in Aughton Ltd. v. M.F. Kent Services Ltd.19 The rule was effectively applied 100 years ago by the House of Lords in TW Thomas & Co. Ltd v. Portsea Steamship Co Ltd (The Portsmouth).20 While the rule is more or less settled in the UK, there are cases in which the rule was not applied on the particular facts.21

Two commentators have recently reviewed the law in the UK and Australia. Their view is that, in Australia, the pendulum is swinging from requiring express reference to an arbitration clause in order to validly uphold an incorporation by reference, to more flexibility allowing arbitration clauses to be incorporated by general reference to a contract which contains an arbitration clause, provided doing so can be supported on a proper construction of the contract. This shift is generally credited to a more pro-arbitration policy of the courts, and may provide insight as to the direction other common law jurisdictions will ultimately take.22

Incorporation by reference of arbitration clauses may also be subject to the governing arbitration statute. Thus, the UNCITRAL Model Law, which is incorporated into the various provincial and federal statutes applicable to international commercial arbitrations23, states as follows:

“The reference in a contract to any document containing an arbitration clause constitutes an arbitration agreement in writing, provided that the reference is such as to make that clause part of the contract.” (underlining added)

It is arguable that the proviso to this provision was intended to require specific reference to the arbitration clause in the other contract before incorporation of it into the second contract occurs. But the opinions of commentators and the decided cases do not necessarily demonstrate this point of view.24

In light of these apparently inconsistent decisions, one might wonder why any subcontractor would agree to an Incorporation by Reference clause in the subcontract. Since the provisions of the main contract are drafted to suit the circumstances of the owner and the contractor, there is every reason for the subcontractor not to agree, holus bolus, to the terms of the main contract being incorporated into the subcontract. This is especially so where the main contract may contain provisions such as liquidated damages, an arbitration clause and other specific provisions with respect to security, insurance and removal of liens which may be wholly suitable to the owner and contractor, but totally unsuitable to the subcontractor.

Some examples from the cases referred to above make this point clear. For example, in Q.Q.R. Mechanical Contracting Ltd. v. Panther Controls Ltd., the contractor had given the owner a specific two-year guarantee. There does not seem to be much reason why the subcontractor should be bound by that guarantee. In Litchfield Bulldozing Ltd. v. PCL Construction Ltd., the owner was a municipality. While a municipality may need a specific force majeure clause, it is not evident that the same force majeure clause is suitable to the subcontract.

Similarly, in Niagara Structural Steel v. LaFlamme, the liquidated damages clause stated a specific per diem amount which was based upon the owner’s particular circumstances and was set to cover the owner’s supervisory cost. Those costs would have no bearing upon the costs incurred by the contractor or subcontractor. In the result, that liquidated damages clause had no relationship to the subcontract. Similarly, in Lac La Ronge Indian Band v. Dallas Contracting Ltd., a bond was interpreted as not including on obligation upon the surety to pay the liquidated damages due by the contractor under its contract with the owner, because that obligation was contrary to the specific terms of the bond.

There may be a total disconnect between the necessity and rationale for terms in the main contract as opposed to the necessity or rationale for the same terms in the subcontract.

Nevertheless, standard form contracts in the Canadian building industry continue to contain Incorporation by Reference clauses. General condition 3.7.1 of the CCDC 2 Stipulated Price Contract between the owner and the contractor requires the contractor to “incorporate the terms and conditions of the Contract Documents into all contracts or written agreements with subcontractors and suppliers.” The wisdom of this requirement is questionable particularly when, as noted above, courts have found that the Incorporation by Reference will not necessarily occur even in the presence of such a clause.25

In these circumstances, it seems more advisable for the Incorporation by Reference clause to state that “the following provisions of the Contract Documents are to be incorporated into the subcontracts”, and then list them specifically, rather than incorporating each and every portion of the Contract Documents into the subcontract. This is particularly so in circumstances where the owner and the contractor have negotiated provisions which are peculiar to their relationship and which may have no place in the subcontract document.

Application of Contract Interpretation Principles

It should be kept in mind that the determination by the Courts of when a term will be found to have been incorporated by reference, will be subject to the general principles of contract interpretation as applicable to any contract.

First and foremost the court will look to the words of the contract, understood with reference to the “factual matrix”, that is, the circumstances and context surrounding contract formation.26 The factual matrix will include the purpose of the second contract to the overall project, in informing how to interpret the agreement.

Second, determining the intention of the parties is an objective exercise; the court does not look to the subjective intent of the parties, but rather presumes that the parties intended the legal consequences of their words.27

Third, the contract must be interpreted as a whole, such that meaning is given to all of the terms agreed to between the parties, without conflict.28

Finally, the contract is to be interpreted consistent with “sound commercial principles and good business sense” and in a way that is commercially reasonable.29

These principles guide how a court may treat terms incorporated into a contract by reference. So, for example, the court will look first to the words that the parties have used, and the subjective intent of one party to incorporate all terms of the incorporated contract (or to not do so) will not be determinative in interpreting what was intended to be incorporated. As discussed below, if a term makes little sense in governing the relationship between the parties who incorporate another contract, it may be inapplicable for failing to result in being commercially reasonable – for example an onerous liquidated damages term as applied to a relatively discrete subcontract, the value of which is far less than the purported liability, may be found to be inapplicable. Where the express terms of the contract appear to be in conflict with the terms of the contract purported to be incorporated, the incorporated terms may also fail to apply.

An Attempt to Draw General Principles

So long as Incorporation by Reference clauses are included in building contracts, can we derive any principles from the case law? To the extent that it is possible to do so, the following are general principles which, in our view, should be applied by the courts, based upon the decided cases, and the principles of contract interpretation:

1.   Incorporation by Reference will only occur if the objective intention of the parties was to incorporate one document into another. While this principle is sometimes stated to be based on the subjective intention of the parties, that approach is contrary to the fundamental principle of contract law that intention is to be objectively determined.30 The mere existence of Incorporation by Reference clause in a subcontract will not demonstrate such an objective intention in relation to matters which do not concern the coordination and undertaking of the physical work.

2.   Some of objective circumstances which may arguably demonstrate an objective intention not to include terms of one contract into another were discussed in the Dynatec Mining deicison, being: lengthy negotiation of the latter contract during which the terms proposed to be incorporated were never discussed; an entire agreement clause in the latter contract; and a comprehensive scheme (such as a dispute resolution procedure) in the latter contract which does not mention or is inconsistent with the term in the other contract (such as an agreement to arbitrate).

3.   Conflict between the provisions in the latter contract and the term sought to be imported from the other contract will in all likelihood preclude incorporation. In fact, the latter contract may directly address this conflict issue. Thus, the subcontract may well state, and should state, that if there is any conflict between the subcontract and the main contract, then the provisions of the subcontract apply.

4.   A conflict does not require an absolute conflict in wording. Indeed, the failure to provide for the matter in, say, the subcontract may itself preclude the importation of a term from the main contract, because to do so would be in conflict with the subcontract.

5.   If the parties are in a direct relationship with each other, then Incorporation by Reference will be more sustainable. Hence, if it is a question of incorporating a letter of intent or the terms of a tender into the contract which is ultimately made by the same parties who exchanged the letter of intent or participated in the tender, or incorporating the terms of a contract into a performance or payment bond relating to that contract, then a court will be much more likely to hold that the Incorporation by Reference clause is effective to bring all of the material portion of the other document into the contract.31

6.  The obligation in the main contract in respect of the actual physical work to be undertaken will likely be incorporated into the subcontract by virtue of the Incorporation by Reference clause.32 The courts view the purpose of an Incorporation by Reference clause in a subcontract to be for co-ordinating the prosecution of the actual physical project, and not for the purposes of subjecting the subcontractor to the same insurance, dispute resolution and similar regimes adopted by the owner and the contractor, absent the clear intention by the contractor and subcontractor to import into their contract the terms of the main contract.

For this reason, terms relating to liquidated damages, the obligation to obtain insurance, the provision for security for lien in the main contract will not likely be incorporated into the subcontract in the absence of a specifically articulated intention to do so.

7.   Similarly, arbitration clauses and other clauses relating to dispute resolution will not usually be imported from the main contract into the subcontract by virtue of a general Incorporation by Reference clause in the latter contract. However, the general principles of interpretation and the facts of the particular case may result in a general incorporation clause having that effect. Consideration must also be given to the specific arbitral statute governing the contract because it may favour or contradict such incorporation. In addition, the trend toward a more arbitration-friendly approach by courts may increase the likelihood of such general incorporation in the future.

Conclusion

Even though standard form building contracts contain Incorporation by Reference clauses, courts may not find that such incorporation has actually occurred. Incorporation by Reference will more likely be found to occur if the parties are in a direct relationship with each other or engaged in the preparation of, or exchanged, both documents, or if the document sought to be incorporated relates to the physical construction of the project. Otherwise, terms such as arbitration clauses, lien security, insurance and liquidated damages clauses will not likely be imported from one contractual regime into another. The interpretation of the contract as a whole, being the contract and the terms Incorporated by Reference, will be subject to the established principles of contract interpretation.

In these circumstances, the drafters of standard building contract might well revisit the Incorporation by Reference clauses contained in those contracts, and particularly in main contracts and subcontracts, and encourage the parties to direct their minds to which specific provisions of one contract they wish to be incorporated into the other contract.

[This article first appeared in Skylines – Newsletter of the CBA National Construction Law Section – July 2012]

  • 1 Thomas G. Heintzman OC, QC, FCIArb is counsel and Julie Parla is a partner in the Toronto office of McCarthy Tétrault LLP.
  • 2 Pozzebon v. Lamantea, 1988 Carswell Ont. 759 at para. 4
  • 3 Kor-Ban Inc. v. Pigott Construction Ltd. (1993), 11 C.L.R. (2d) 160 at para 529(Ont. S.C.J.)
  • 4 Online Constructors Ltd. v. Speers Construction Inc. 2011 CarswellAlta 104 at paras 17-20.
  • 5 Litchfield Bulldozing Ltd. v. PCL Construction Ltd. (1985) 14 C.L.R. 287(B.C. Co. Ct.)
  • 6 Whitby Landmark Developments Inc. v. Mollenhauer Construction Ltd., (2003) 26 C.L.R. (3d) 161 at para. 9-16 (Ont. C.A.)
  • 7 Ecozone Engineering Ltd. v. Grand Falls – Windsor (Town) (1995), 30 C.L.R. (2d) 277, (2000) 5 C.L.R. (3d) 55 (N.L.C.A.)
  • 8 Schaible Electric Ltd. v. Melloul – Blaney Construction Inc. (2005) 45 C.L.R. (3d) 41 (Ont. C.A.)
  • 9 Foundation Co. of Canada Ltd. v. United Green Growers Ltd. (1997), 33 C.L.R. (2d) 159 at para. 27 (B.C.C.A.)
  • 10 Niagara Structural Steel v. LaFlamme (1985), 14 C.L.R. 70 at para 28-32; aff’d (1987) 58 O.R. (2d) 773 (C.A.)
  • 11 Lac La Ronge Indian Band v. Dallas Contracting Ltd. (2004), 35 C.L.R. (3d) 236 at para 70, 82-95 (Sask. C.A.)
  • 12 1510610 Ontario Inc. v. Man-Shield (NOW) Construction Inc., 2010 Carswell Ont. 1395
  • 13 Q.Q.R. Mechanical Contracting Ltd. v. Panther Controls Ltd. (2005), 40 C.L.R. (3d) 154 at para 16-31 (Alta. Q.B.)
  • 14 529198 Alberta Ltd. v. Thibeault Masonry Ltd. (2001), 19 C.L.R. (3d) 63 (Alta. Q.B.)
  • 15 Lac La Rouge Indian Band v. Dallas Construction Ltd., (2004) 35 C.L.R. (3d) 236 (Sask. C.A.)
  • 16 Daiwood Construction Co. v. Wright Schuchart Construction Ltd. (1992), 3 C.L.R. (2d) 144.
  • 17 Dynatec Mining Ltd. v. PCL Civil Constructors (Canada) Inc. (1995), 25 C.L.R. (2d) 259 (Ont. Gen. Div.); Sunny Corner Enterprises Inc. v. Dustex Corp., (2011), 1 C.L.R. (4th) 281 (N.S.C.A.)
  • 18 Rebecca James and Michael Schoenberg, “Incorporating an Arbitration Clause “By Reference”: Reconciling Model Law Article VII and Australian Common Law in Light of Recent Developments”, (2011) 77 Arbitration, Issue I, 84. (“James and Schoenberg”)
  • 19 (1991), 57 B.L.R. 1; 31 Con. L.R. 60 CA.
  • 20 [1912] A.C. 1 HL.
  • 21 Modern Buildings (Waltes) Ltd. v. Limmer & Trinidad Co. Ltd. [ 1975], 1 W.L.R. 1281; [1975] 2 All E.R. 549 CA; Owners of the Annefield v. Owners of Cargo Lately Laden on Board the Annefieldl, [1971] P. 168; [1971] 2W.L.R. 320 CA
  • 22 James and Schoenberg, above.
  • 23 See, for instance, the Ontario International Commercial Arbitration Act, R.S.O. 1990, c. I.9, Article 7(2) of the Model Law attached to that Act The domestic Ontario Act, the Arbitration Act, 1991 ,S.O. 1991, c. 17 does not contain a provision that directly deals with incorporation by reference of an arbitration clause from one contract or document into a second contract. Section 5(1) does say that an arbitration agreement “may be an independent agreement or part of another agreement”.
  • 24 See James and Schoenberg, above, at footnotes 15 and 16.
  • 25 Dynatec Mining Ltd. v. PCL Civil Constructors (Canada) Inc., (1996), 25 C.L.R. (2d) 259; Daiwood Construction Co. v. Wright Schuchart Construction Ltd. (1992), 3 C.L.R. (2d) 144.
  • 26 SimEx Inc. v. IMAX Corp., [2005] O.J. No. 5389 (Ont. C.A.) at para. 23
  • 27 Eli Lilly & Co. v. Novopharm Ltd., [1998] 2 S.C.R. 129 at para. 56; SimEx, supra at para. 23; Drumbrell v. Regional Group of Cos. 2007 CarswellOn 407 (Ont. C.A.) at paras. 48-51.
  • 28 Ventas, Inc. v. Sunrise Senior Living Real Estate Investment Trust (2007), 85 O.R. (3d) 254 at para. 24; 3869130 Canada Inc. v. I.C.B. Distribution Inc. (2008) ONCA 396 (Canlii) at para. 31.
  • 29 Ibid.
  • 30 Heintzman and Goldsmith on Canadian Building Contracts, Chapter 1, Part 1(b)
  • 31 Foundation Co. of Canada v. United Green Growers Ltd. (1997), 33 C.L.R. (2d) 159 (B.C.C.A.); Pozzebon v. Lamantea, 1988 Carswell Ont. 759 at para. 4; Whitby Landmark Developments Inc. v. Mollenhauer Construction Ltd., (2003) 26 C.L.R. (3d) 161 (Ont. C.A.)
  • 32 Dynatec Mining Ltd. v. PCL Civil Constructors (Canada) Inc., (1996), 25 C.L.R. (2d) 259; Kor-ban Inc v. Pigott Construction Ltd, 1993 Carswell Ont. 825 at para 529.

www.constructionlawcanada.com                                                                                                                               July 25, 2012

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Does An Interim Lender To A Construction Project Owe A Duty of Care?

Construction projects don’t often proceed without a lender. And often there is an interim lender which provides financing pending the advancement of funds by the final lender. In this circumstance, two questions arise:

First:  Does the interim lender owe a duty of care to the owner or purchaser of the project?

Second:  If the interim lender makes representations to the owner or purchaser, does that lender owe a duty to make those representations carefully?

In Condominium Corporation No. 0321365 v MCAP Financial Corporation, the Alberta Court of Appeal recently answered Yes to the first question, but Maybe to the second question.

The MCAP decision is important because different answers were given to these two questions. The different answers highlight the difference between the duties of a lender, acting strictly as a lender, and the duties which a lender may assume if it makes representations to the owner or purchasers.

The answers to these questions become even more problematic when the interim lender receives vital information about the safety of the construction, or if the interim lender or its agents are arguably performing statutory duties. Can the lender ignore the impending safety risks? Can it ignore the potential application of statutory duties? If the lender receives vital information about the safety of the structures and makes representations to third parties about those matters, does it assume a duty of care which it would not otherwise have?

Background Facts

MCAP was the interim lender to a condominium construction project in Fort McMurray, Alberta. MCAP provided interim construction financing to the developer of the project.

The commitment letter between MCAP and the developer of the project stated that a soils test report by a professional engineer would be provided, demonstrating that the proposed construction and site improvements of the project were feasible under existing soil conditions. The commitment letter also required the lender’s cost consultant to verify the costs of the condominium project.

The commitment letter stated that, prior to the initial advance a project and budget review report would confirm that project has been designed in accordance with a geotechnical engineer’s report, and that all requests by the developer for advances would include an inspection certificate from the lender’s cost consultant confirming that the work to date was in accordance with the plans and specifications. The commitment letter also stated that if actual costs exceeded the budgeted and approved costs, then the developer would contribute the excess before receiving any further advances.

MCAP retained a cost consultant and parts of the commitment letter were attached to the contract between MCAP and the cost consultant. Effectively, the key provisions of the contract between MCAP and the developer were mirrored in the contract between MCAP and the cost consultant. The purchaser alleged that MCAP’s cost consultant was the “cost consultant” of the developer under section 14 of the Alberta Condominium Property Act (the Act). The purchasers accordingly argued that MCAP and its consultant had statutory duties with respect to certifying the cost to complete the project before funds were released to the developer.

In 2002, conversations occurred between a consultant acting for the purchasers of the condominium units and MCAP. According to the purchasers, in those conversations MCAP represented to the purchasers’ consultant that the terms and conditions of the commitment letter would be enforced for the benefit of the purchasers of units in the condominium project and that MCAP’s cost consultant would be the “cost consultant” under the Act.

In September 2001, the purchaser’s consultant wrote letters to MCAP’s cost consultants, copying MCAP, and set out various alleged serious deficiencies in the design and construction of the condominium project, including suspected Alberta Building Code, development permit and contractual deficiencies. It was the purchasers’ position that these letters signalled grave concerns that the units and related common property in the project were not in fact substantially completed as contemplated by the Act. The purchasers said that the suspected construction and design deficiencies required that statutory holdbacks be maintained to cover these deficiencies.

In late September 2003, a number of the purchases of the condominium units were completed and the developer received payment of the purchase prices. That money was used by the developer to reduce the loan from MCAP. In the closings, the developer’s lawyers gave undertakings about maintaining holdbacks pursuant to section 14 of the Act. In those undertakings, the developer’s lawyers referred to MCAP’s cost consultant as the developer’s costs consultant.

The purchasers and the condominium corporation then sued the developer and MCAP for damages. They alleged that the condominium was a disaster and was sinking into the ground due to numerous construction faults including the failure of the footings, improper compaction of fill and excessive moisture. The purchasers alleged that MCAP owed them a duty of care and had breached it by its failure and that of its cost consultant to take any steps to address the safety concerns of which they were well aware. The purchasers also alleged that MCAP had made negligent misrepresentations by effectively telling the purchasers that MCAP would enforce the commitment letter and that MCAP’s cost consultant would perform the duties of the “cost consultant” under the Act, and then failing to do either.

MCAP brought a motion to dismiss the action against it, asserting that it owed no duty of care to the purchasers, and that it owed no duty with respect to the statements which it or its cost consultant had allegedly made to the purchasers. The motion judge agreed with MCAP and dismissed the action against it. The purchasers then appealed.

The Decision

The Court of Appeal agreed that, apart from any duty arising from representations made by it, MCAP owed no general duty of care to the purchasers. The Court held that the purchasers’ assertion of such a duty failed on virtually every account.

First, the lender was entitled to waive defaults and give extensions in its own interest, and the existence of a duty to the purchasers would contradict that entitlement.

Second, the class of persons to whom the alleged duty was owed was indefinite as the circumstances relating to each purchaser could be different and the units could be “flipped”, making unfeasible for MCAP to consult with the class to which it allegedly owed a duty.

Third, the business interests of MCAP and the purchasers might well be different.

Fourth, the commitment letter was between MCAP and the developer and, as third parties to that letter, the purchasers had no legal rights in that letter.

Finally, policy reasons dictated that no such duty was owed. As the Court said: “The deleterious effects that recognizing this novel duty of care would have on commerce and the financial industry and in turn economic development are obvious.”

However, the Court of Appeal held that the purchasers had a potential claim against MCAP arising from negligent misrepresentation. The Court reversed the motion judge’s decision on this issue and directed that the action proceed to trial.

The Court held that the purchasers had a viable claim that MCAP had impliedly represented that it would enforce the commitment letter and that it had retained a cost consultant which would perform the duties of a “cost consultant” under the Act, and that MCAP had done neither. The Court of Appeal held that, on a disputed evidentiary record, the motion judge was not entitled to make factual findings as to the existence and scope of any alleged representations made by MCAP, the existence of any special relationship between MCAP and the purchasers and whether the purchasers reasonably relied on any statements of MCAP. Those were factual matters that must go to trial.

The Court of Appeal distinguished the two torts as follows:

“I agree that an interim lender owes no duty of care to purchasers of units in a project it is financing to ensure that the project it is financing is completed in accordance with the lending agreement. I have explained why that is so earlier. However, the court cannot use the absence of a duty of care based on a lender-purchaser relationship to determine whether the specific facts and circumstances of a particular case created or gave rise to a special relationship between the lender and purchasers and a corresponding duty of care sufficient to ground an action in negligent misrepresentation.”

The Court noted that the British Columbia Court of Appeal had held that, in the particular circumstances of that case, a lender did owe a duty to a third party not to make negligent misrepresentations and was liable to that third party.

The Court of Appeal also held that the other claims against MCAP should also proceed to trial. Those claims were based on knowing assistance in a breach of trust by the developer and unjust enrichment. MCAP had accepted the monies paid from the developer. Those monies were paid to the developer by the purchasers and were trust funds under the Act. MCAP received payment at the very time that the costs consultants under the Act should, arguably, have ensured that those monies were set aside to properly complete the project and correct the deficiencies. In these circumstances, the Court held that there were arguable claims of knowing assistance in breach of trust and unjust enrichment.

Conclusion

Even though the decision in MCAP arose on a summary judgment motion, it demonstrates the pitfalls which may face a lender to a building project. These pitfalls are magnified if the lender learns of facts which raise real concerns about the safety of the project or building, and if there are statutory duties relating to the project. Since building projects are subject to a number of statutory regimes, including construction lien and building code legislation, the role of the lender may not be a happy one.

This decision should alert lenders to a variety of potential claims that can be made against them. Indeed, the claims asserted in the MCAP action are a good shopping list to consider, both for project lenders and purchasers and owners of allegedly defective buildings.

Two precautions for lenders arise from the decision:

First, be very circumspect in any dealings with third parties to a lending agreement and avoid any conduct which could be construed as a representation to the third parties or the assumption of statutory duties.

Second, be aware of the trust fund legislation applicable to monies held by a borrower, and be very careful in accepting monies which may be trust fund monies.

Condominium Corporation No. 0321365 v MCAP Financial Corporation, 2012 ABCA 26

Building Contracts – Consultants – Negligence and Negligent Misrepresentations – Knowing Assistance – Unjust Enrichment

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                                         June 20, 2012

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