Does A “Pay When Paid” Clause Prevail Over The Construction Lien Act?

A pay when paid clause is one of the more contentious contractual provisions in the construction industry. That clause typically says that the subcontractor is not entitled to be paid until the contractor receives payment from the owner. Because of its perceived unfairness, the clause has been outlawed, or its effect has been substantially limited, in the United Kingdom and in many states of the United States.

In Canada, there is conflicting appellate authority about the effect of a “pay when paid” clause.  Aside from that controversy, another important issue is: What effect does a “pay when paid” clause have on construction or builders liens? Can the clause eliminate the subcontractor’s entitlement to a construction or builders lien on the ground that, since the owner owes nothing to the contractor, then the contractor owes nothing to the subcontractor and so the subcontractor has no lien?  That was the issue in the recent decision of the Ontario Superior Court in Bradhill Masonry Inc. v. Simcoe County District School Board.

Background

B.W.K was the general contractor on a project to renovate the Bradford District High School and Bradhill was the brick work subcontractor.  A claim for lien was registered by Bradhill and was vacated on the provision of security by B.W.K. The subcontract between B.W.K. and Bradhill appears to have been largely prepared or approved by the owner with little or no input from Bradhill. In the payment portion of the subcontract, that contract stated as follows:

“and the balance of the amount of said requisition, as approved by BWK and the Architects and Engineers, shall be due to the subcontractor  on or about the thirtieth day of the following month, and upon receipt by BWK of monthly payment by the owners.” (emphasis in the original)

The owner asserted that, based on this clause and the decision of the Ontario Court of Appeal in Timbro Developments Ltd. v. Grimsby Diesel Motors Inc. [1988] O.J. No. 448, there were no monies due to the subcontractor when the subcontractor’s lien was registered because the owner had not paid B.W.K. for any work which was the subject of the lien. For this reason B.W.K. asked for the lien claim to be dismissed.

The Decision

The court rejected B.W.K.’s argument in rather forceful language, calling it “antithetical to the law in the Construction Lien Act” and “a clever shell game.” The court noted that, while the owner had not paid B.W.K. when the subcontractor’s lien was filed, the owner later made full payment to B.W.K. when, as the court said, “BWK finally decided to put in its final invoice which it delayed.”

The court noted that, if accepted, B.W.K.’s argument would be devastating for lien claimants:

“The defendant’s argument would mean that if the general contractor’s lawyer is sharp enough in drafting the contract, the Act’s remedy for subcontractors who have not been paid for the fair value of their work would be rendered worthless as the owner and/or general contractor would become entitled to the costs of the lien action and could cut off all future payments to the plaintiff to reimburse itself when a lien claim was made. And if a sub-trade filed a claim for lien at the wrong time, its lien is worthless because money was not due and payable at that particular time even though the tradesperson has not been fully paid for their work and materials supplied to the job.”

The court held that the subcontract could not eliminate the subcontractor’s lien because section 5 of the Construction Lien Act states that the Act is incorporated into every contract in a project covered by the Act and every such contract is deemed to be amended to be in conformity with the Act.

Moreover, the court noted that section 14(1) of the Act provides that a person who supplies services or materials to an improvement for an owner, contractor or subcontractor, has a lien upon the interest of the owner in the premises improved for the price of those services or materials, and that under section 15(1) a lien arises when the person first supplies those services or materials.

The court concluded on this issue as follows:

“…as to the argument of the defendant that there was no lienable amount owing unless and until an amount became due and payable under the contract’s accounting terms in the contract, I reject it. Contrary to the defendant’s submission, this contract, like all building contracts, is subject to The Construction Lien Act.  It is not the reverse, . . . . . . , that the Act be subject to the contract between the general contractor and the masonry sub-contractor Bradhill. When a sub-trade is owed money due to work that has improved the site, its claim is for the “price of those services or materials”, the value of the work and material supplied, not what is due and payable at any given time according to the contract. And money owed the contractor or received by BWK was trust money held for the sub-trades until they are paid. It is not for BWK to fail to pay money due the sub-trade just because that sub-trade filed a lien claim. This is a reading of the contract and the Act which would make the contract the superior instrument whereas, as I have shown, it is the law in Ontario that the contract is to conform to the Act. I reject the argument on behalf of BWK that would hold otherwise.

Discussion

The controversy about “pay when paid” clauses is heightened in Canada not just by the public policy debate about whether these clauses should be allowed. As mentioned above, in other countries these clauses have been eliminated by statute or severely restricted in their application. In Canada, there is further controversy about these clauses because there are contrary appellate decisions concerning the effect of a “pay when paid” clause.

On one approach, the clause bars any claim, even at the end of the job, if the contractor has not been paid by the owner. That was the conclusion of the majority of the Ontario Court of Appeal in the Timbro decision.

The other approach says that the clause is a timing mechanism only, that the clause provides for payment by the contractor to the subcontractor when the contractor is paid by the owner, but does not operate as a complete bar to the subcontractor’s claim at the end of the job. That was the approach taken by the Nova Scotia Court of Appeal in Arnoldin Construction & forms Ltd. v. Alta Surety Co. (1995), 19 C.L.R. (2d) 1. In that case, a bonding company relied upon the “pay when paid” clause to argue that it owed no monies on the bond since the contractor did not owe monies to the subcontractor due to that clause. The Nova Scotia Court of Appeal held that the clause, properly interpreted, only related to the timing of payment during the project and did not entirely bar the claim. The Court may have thought that it made no sense for the “pay when paid” clause to be interpreted as a bar to payment to the subcontractor when there was a bond in place, presumably to be called upon in the very circumstance of the owner not paying the contractor.

Smack in the middle of the heightened controversy about these clauses is the issue about whether they over-rule the construction and builders lien legislation. If they do, then the controversy would move to an even higher level. Those familiar with the “pay when paid” debate have been waiting for a decision to address this issue, and here it is in the Bradhill decision.

In Bradhill, the court held that the “pay when paid” clause did not over-rule the Construction Lien Act, for two reasons.

The first reason was that, by virtue of the Ontario Act, that Act was incorporated into the subcontract contract and the parties could not contract out of the Act.  That reasoning will not apply in all provinces. In some provinces, the construction or builders lien legislation effectively says that third parties and workers are not affected by any contract purporting to eliminate rights under the lien legislation, but does not prohibit other parties from entering into such contracts.  So if the decision in Bradhill depends on the wording of the Ontario Act, then in other provinces the “pay when paid” clause could still potentially over-rule the construction and builders lien regime.

The other reason given by the court in the Bradhill decision is based on the fundamental nature of a construction or builders lien.  The lien is not based upon the contract between the contractor and the subcontractor, or the contract between owner and the contractor. Rather, the lien is based on two ingredients: the price of the materials or services, and the supply of those services or materials to the improvement of the land.  The price or supply may be influenced by the contracts, but it is the price and supply which create the lien. The court in Bradhill effectively concluded that, based on those elements of a lien claim, the status of the accounts between the owner and the contractor are irrelevant, or could not impair the validity of the subcontractor’s lien.

This second line of reasoning should be applicable in all provinces. If adopted by other courts, this reasoning will ensure that, whatever may be the other impacts of “pay when paid” clauses, they will not over-ride the protections contained in construction and builders lien legislation.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., at Chapter 4 , part 2

Bradhill Masonry Inc. v. Simcoe County District School Board, 2013 ONSC 4708.

Construction Liens  –   Pay when Paid Clauses

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                           August 15, 2013

www.heintzmanadr.com

www.constructionlawcanada.com

What Is The Priority Between Building Mortgages And Construction Liens In Respect Of Holdback Amounts Greater Than The Statutory Holdback?

The priorities between lienholders and mortgagees under the Construction Lien Act are not easy to understand.  They are even more difficult to understand and apply when the owner holds back more than the statutory minimum, and when the liens are discharged by security provided by the owner or mortgagee.

Under sub-section 44(1) of the Act, the court shall discharge the lien upon the payment into court or the provision of security of the full amount claimed as owing in the claim for lien, and the lesser of $50,000 or 25 per cent of the amount of the claim as security for costs. Under sub-section 44(2), the court may vacate the lien upon the payment into court or provision of security in a reasonable amount.

If the liens are vacated upon payment of the full amount of the liens, who is entitled to the difference between that amount and the 10 percent statutory minimum holdback?  Recently, in Basic Drywall Inc. v. 1539304 Ontario Inc. (Receiver of), the Ontario Divisional Court held that the mortgagee had priority to that disputed amount. The decision raises three important questions relating to the Ontario Construction Lien Act:

  • the priorities established in Section 78
  • the lien notice provisions in Sections 24 and 78
  • and the vacation of lien provisions in Section 44

Background

Basic was a subcontractor on the project and had not been paid. It registered a lien for $312, 859. The amount and timeliness of the lien was not disputed.  Other subcontractors also registered liens. When Basic’s lien was registered, the owner owed the general contractor about $276,000 and this amount was never paid. The work was certified as complete.

ICICI Bank Canada provided the mortgage financing for the project. Its mortgage was what is commonly called a “building mortgage”, and is dealt with under sub-section 78(2) of the Act.   The bank posted letters of credit to vacate the liens of Basic and other lienholders.  The Bank agreed that the amount of work certified as complete was about $506,000.  The Bank asserted that the 10 percent holdback that the owner should have maintained was, therefore, about $50,600. The owner had in fact not paid the contractor a much larger amount.

The issue in the case was this:  what amount was available for distribution to the lienholders out of the security provided by the Bank to discharge the liens?  Were the lienholders correct in asserting that $276,000 should be distributed to the lienholders, being the total amount owing by the owner to the general contractor? Or was the Bank correct in asserting that the lienholders were only entitled to $50,600, being the statutory holdback arrived at by applying 10 percent to the amount or work certified as complete? If it was the latter amount, then the Bank was entitled to the disputed amount, being the difference between the two figures, out of the security it had provided to discharge the liens.

The Decision

The Ontario Divisional Court agreed with the Bank.  It held that the lienholders were only entitled to the amount of the statutory holdback. It arrived at that conclusion for three reasons.

First, it held that no notice of any additional lien claim, over the statutory amount, had been given by the lienholders to the owner under section 24 of the Act.  So that section could not enlarge the lienholders’ rights. In any event, section 24 only applied to a “payer” and the Bank was not a payer, and therefore it was not governed by section 24.

Second, the posting of security by the Bank could neither increase nor diminish the rights of the parties, except to the extent that the Act specifically said so.  But section 44(6) of the Act, the court found, specifically said that that upon payment into court or the provision of security, the owner “shall be in the same position as if the lien had not been preserved or written notice of the lien had not been given.”  The court held that the effect of those words was that the “posting security removes ‘notice holdbacks’ as security for lien claimants by the specific language of s. 44(6).”  The court concluded by saying that “the specific language of s. 44(6) restricts an owner’s ‘notice holdback’ obligation from being extended to the posted security.”

Third, the issue between the parties was “a priority dispute.”  The court heldd that “under section 78(2) of the Act, ICICI, as mortgagee, has priority over all but the 10 per cent holdback of $50, 596.98.”

Discussion

This decision deals with a number of important principles in the Act, most particularly the operation of the priority code established in section 78 of the Act, the role of notice of lien to the owner or mortgagee and the effect of vacating a lien upon the provision of security.

Section 78(2)

The first question relates to the proper interpretation and effect of sub-section 78(2) of the Act. That sub-section states as follows:

“Where a mortgagee takes a mortgage with the intention to secure the financing of an improvement, the liens arising from the improvement have priority over that mortgage …to the extent of any deficiency in the holdbacks required to be retained by the owner under Part IV… “

On its face, that sub-section does not create rights for the mortgagee. It creates a specific right for lienholders. That right is to priority over building mortgages (that is, mortgages taken out to “secure the financing” of the improvement). That right is presumably given to lienholders as against building mortgagees because building mortgagees are akin in interest to the owner and are providing financing for the improvement, knowing that lienholders’ rights will be created by that improvement. In other words, building mortgagees are not like other mortgagees who are loaning based on the value of the land and the strength of the mortgagor’s covenant, and may be totally unconcerned as to whether a building is being built and lien rights are being created. Building mortgagees are loaning with the very expectation that lien rights will be created with the monies they are advancing and the Act contemplates that they should ensure that owners maintain the statutory holdback when the mortgage advances are being made. So their rights, unlike other mortgagees’ rights, are always subject to the statutory holdback provision.

Sub-section 78(1) of the Act provides further context for sub-section 78(2). Sub-section (1) states as follows:

“Except as provided in this section, the liens arising from an improvement have priority over all conveyances, mortgages or other agreements affecting the owner’s interest in the premises.”

So sub-section 78(1) states the premise for the whole priority code set out in section 78.  That premise is that lienholders have priority unless section 78 states otherwise.  Mortgagees must find their priority in section 78.  Sub-sections 78(3) to (8) do create specific priorities for mortgagees. But otherwise, sub-section (1) says that lienholders have priority.

The Bank’s argument was that the word “only” should be read into section 78(2), so that it would read that the lienholders’ priority over the mortgage would be “…only to the extent of any deficiency in the holdback required to be maintained.”  In effect, the court agreed with that submission because it held that “under s. 78(2) of the Act, ICICI, as mortgagee, has priority over all but the 10 percent holdback…”  The present question is whether that is the proper interpretation of that sub-section.

Sub-section 78(2) does not explicitly establish any rights in the building mortgagee.  It creates rights for lienholders that do not exist against other mortgagees. Interpreting the sub-section as the Divisional Court’s has done creates better rights for building mortgagees than other mortgagees, limiting their maximum exposure to the statutory holdback  when, at least on its face, the subsection sets a minimum exposure to the statutory holdback (presumably so that building mortgagees will ensure that owners maintain that holdback).  Is the inference of rights in favour of the mortgagee reasonable in those circumstances?

The Notice Provisions in the Act:  Sections 24 and 78

The second question relates to the proper interpretation of the notice provisions in the Act.

As the Divisional Court indicated, section 24 permits a lienholder to give notice of its lien to the owner.  If that notice is given, then the owner may no longer pay out 90 percent of the amounts due to the contractor. The Divisional Court said that if lienholders give such notice then “the lien claimant has security against the owner’s interest in the land to the full extent of the amount the owner, as payer, owes to the general contractor.”  The Divisional Court reasoned that the lienholders had not given notice to the owner of their claim but that “there is no time limit in the Act for giving written notice of a lien to an owner, so any notice before actual payment would suffice to create security against the full unpaid amount vis-a vis the owner.”  However, the court said that the Bank was not a “payer” so section 24 did not apply.

The present question is whether the provisions in section 24 of the Act relating to notice to the owner have any application to the priority issues between mortgagees and lienholders arising under section 78 of the Act. Sub-section 78(1) says that, if the mortgagee is to find any priority, it must find it in section 78. There is specific reference in section 78 to a mortgagee’s priority relating to notice given by leinholders and it is set out in sub-sections 78(4) and (6).   Those sub-sections refer to written notice of a lien to “the person making the advance.”  Absent such a notice to the Bank – and there does not appear to have been any – the Bank might well have been entitled to priority. But determining whether the Bank did have priority would require the application of sub-sections 78(4)-(8), not sub-section 78(2) and not section 24 relating to notice to the owner.    Whether the Bank had priority under sub-sections 78(4) and (6) would have depended upon a number of additional facts besides whether notice of the liens was given to the Bank.  Those facts would have included whether the mortgage was registered before the first lien arose or whether the mortgage advances were made before the time that the first lien arose or was registered. None of those facts were considered by the Divisional Court.

In effect, the priority section, section 78, has its own notice provisions.  Those provisions require the lien claimant to notify the mortgagee making the advance, not the owner.  Unless those provisions afford the mortgagee priority, the lienholders have priority. The notice provisions in section 24 apply to the owner and payments by the owner, not to the mortgagee and the payment of advances made by the mortgagee.  The present question is whether  the Divisional Court was correct in inferring into section 78 the notice provisions is section 24, and then using the absence of notice to the owner to find a priority for the mortgagee through sub-section 78(2).

Vacation of Lien under Section 44

The third issue relates to the effect of the vacation of liens upon the granting of security under section 44 of the Act. The Divisional Court appears to have found that, upon such a vacation of lien occurring, sub-section 44(6) has the effect of putting the lienholders in a position as if they had never filed a lien and never given notice of a lien.  That interpretation raises questions about the efficacy of section 44.

The Divisional Court focused on the words in sub-section 44(6) stating that the owner “shall be in the same position as if the lien had not been preserved or written notice of the lien had not been given.” From these words, the court concluded that “posting security removed the ‘notice holdback’ as security for lien claimants.”  If posting security had that effect, then it is hard to see why it would not have the same effect on the lien itself since sub-section 44(6) refers to both.

The words in sub-section 44(6) should be carefully examined to determine whether the Divisional Court’s interpretation is the intended one.  That sub-section states that upon security being given and the lien being discharged:

“…..the lien ceases to attach to the premises and ceases to attach to the holdbacks and other amounts subject to a charge under section 21, and becomes instead a charge upon the amount paid into court or security posted, and the owner or payer shall, in respect of the operation of sections 21, 23 and 24, be in the same position as if the lien had not been preserved or written notice of the lien had not been given.” (emphasis added)

This sub-section has repeatedly been interpreted to mean that the posting of security does not enlarge the rights of lienholders or give them rights of recovery that they did not have against the land itself. All the sub-section does is replace the land with the security or monies in court.

If this is so, the present question is whether the sub-section should be read to diminish the rights of lienholders in the security or monies in court. What could be the reasons for such a conclusion? Section 46 is an aid to the owner or mortgagee, to allow liens to be vacated by paying into court or providing security, so the job can be completed.  Why would lienholders agree to an order vacating their liens upon the provision of security, and why would the court so order, if that order diminishes the lienholders’ priority as against the mortgagee?

Sub-section 44(6) only refers to the rights of the “owner or payer”.  It does not refer to the lienholders. It does not say that the lienholders rights are diminished at all, and does not state that the lienholders’ rights are to be determined as if the lien had not been preserved or notice of the lien had been given.  Nor does sub-section 44(6) refer to mortgagees or to section 78. It does not say that the priority rights established in section 78 do not apply after a lien has been vacated and security has been provided.  Should sub-section 44(6) be interpreted to affect the rights of lienholders and mortgagees when those rights are not mentioned in the sub-section?

Also, sub-section 44(6) says that the owner or payer shall in respect of the operation of section 21, 23 and 24 be in the same position as if the lien had not been preserved or notice of lien not given. Those underlined word appears to mean that, so far as the obligations of the  owner or payer are concerned and since the liens claims are now secured by the monies in court or other security, the lien is no longer a charge against the holdback  (section 21), the owner is not personally liable for those secured amounts (section 23), and the owner  need not retain monies (under section 24) and can resume payment of the contractor.  Can those words be inferred to affect other rights, and in particular the priority rights in section 78?

These sections of the Act relating to priority, notice of lien claims and vacating of liens are some of the most important sections in the Act. It is to be hoped that the three questions raised in the Basic Drywall decision will be given further consideration by the courts in the near future.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., Chapter 13, parts 2(g) and (h)

Basic Drywall Inc. v. 1539304 Ontario Inc. (Receiver of) (2013), 114 O.R. (3d) 219 (Div.Ct.)

Building Contracts  –  Construction and Builder Liens  –  Hold-back  –  Priorities  – Notice of Lien – Mortgages -Vacating Liens

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                                                           July 3, 2013

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www.constructionlawcanada.com

 

Decision Holding That Demolition Is Not An Improvement Is Reversed

In my article dated December 11, 2011, I reported on a decision of the British Columbia Supreme Court holding that demolition is not an “improvement” for the purposes of the B.C. Builders Lien Act (the Act).  That decision has since been reversed by the B.C. Court of Appeal.  It was not reversed on the merits, but only on the basis that the B.C. Supreme Court did not have jurisdiction to make the order:  West Fraser Mills. Ltd v. BKB Construction Ltd. 

The Facts of the Case

As my earlier article reported, BKB and its subcontractor had filed builders’ liens against West Fraser’s property when they were not paid in full for their work in removing machinery from the property.  West Fraser had shut down its paper mill in Kitimat, B.C. and sold the paper machinery separately from the land.   Under the agreement by which West Fraser sold the machinery, the buyer was obliged to remove the equipment.  The buyer hired BKB to remove the machinery and BKB hired a subcontractor to assist in the removal.  BKB and its subcontractor were not paid in full by the buyer and so filed their builder’s liens.

The B.C. Supreme Court held that the removal of the machinery was not an improvement of the land.   Demolition work may be an improvement, it said, if undertaken as part of a project to create an altered structure, but work to preserve the value of removed or salvaged material which does not benefit the landowner qua landowner is not an improvement within the Act.

The B.C. Court of Appeal reversed this decision on the basis that the court had no jurisdiction to strike out the lien under sections 24 and 25 of the Act.  The Court of Appeal held that those sections were not intended to permit the court to rule on the merits of the liens or to grant summary judgment on the merits.  West Fraser did not contend that the lien was filed out of time or against the wrong property or had been satisfied by payment or litigated to conclusion.  Indeed, a lien action had not even been commenced.

The only provision in those sections under which the lien could be struck out was section 25(2) (b) on a showing that the lien claim was scandalous, frivolous or vexatious.  The Court of Appeal held that this test could not be met because it was at least arguable that the liens were valid, and not plain and obvious that they were invalid.  These sections could not be used to determine whether the liens had been proven, which is what the Supreme Court judge had done.

In the Court of Appeal, BKB argued that West Fraser had refused to produce the documents which might show the reason why West Fraser sold the equipment separately from the land, and had the equipment removed.  Those documents might show, BKB argued, that the removal work was an improvement to the land, having regard to West Fraser’s future  intended use of the building and the land.  The Court of Appeal said that this argument had “some merit.”

As a result, the issue of whether demolition can be an “improvement” under the Act has not yet been determined.  The B.C. Court of Appeal’s decision appears to support the conclusion that, at least in some circumstances, it can.  As in all things, the first chapter was not the end of the story, and we will have to wait for the next episode.

 Construction Law   –  Construction Liens  –   Removal of Equipment  –   Power of the Court to Strike Lien

West Fraser Mills. Ltd v. BKB Construction Ltd., 2012 BCCA 89

 Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                                             April 4, 2012

www.heintzmanadr.com

www.constructionlawcanada.com
 

What Mortgage Payments Are “Advances” That Have Priority Over Lien Claims?

A recurring issue for construction and builders liens is whether the liens have priority over mortgage advances.  One question which does not often arise is:  what sort of payments by a mortgagee do constitute “advances” under a mortgage?  In other words, what sort of payments by a mortgagee can even qualify for priority over lien holders?

A mortgagee may make payments for many reasons, but a lien holder may question whether the payment qualifies as an “advance” under the mortgage.  For example, when a mortgagee appoints a receiver and loans moneys to the receiver under new arrangements with the receiver, are those loans “advances” under the original mortgage?  Are those loans entitled to priority over existing registered lien holders?  The British Columbia Court of Appeal recently answered “No” to these two questions in Bank of Montreal v Peri Formwork Systems Inc.

 The background:

 The Bank was a mortgagee to the owners and developers of the project.  On June 21, 2009, it demanded payment of $29 million on the mortgage.  On July 21, 2009, the owners obtained an order under the Companies’ Creditors Arrangement Act (CCAA).  The order permitted the owner to borrow $2 million in Debtor-in Possession (DIP) financing from the Bank.  The order stated that the loan had priority over all other security interests including builders’ liens.

On July 28, 2009, Peri Formwork filed a builders’ lien.

In December 2009, the CCAA proceedings came to an end.  The monitor under the CCAA proceedings was then appointed as receiver of the borrowers.  Under the terms of the receivership order, the receiver was permitted to borrow up to $21 million from the Bank.  The terms of that loan had different terms than the original mortgage.

The receivership order stated that the receiver’s borrowings were to have priority over all other security interests or liens except builders liens filed prior to the date of the order which totaled about $2 million.  As to those liens, the order stated that the priority between the receiver’s borrowings and the prior liens would be determined in a separate hearing.

The Bank commenced foreclosure proceedings in December 2009.  Before the December 2009 receiving order, the monitor’s assessment was that, if the property was sold on an “as is” condition, there would be a substantial shortfall for the mortgagee, and that by continuing the construction, a substantially reduced shortfall would likely result.

In April 2010, a judge of the BC Supreme Court held that loans which the Bank proposed to advance to the receiver took priority over the prior liens.  This decision was reversed by the BC Court of Appeal.  That decision was based on three grounds:

First, the Court of Appeal held that the priority of the loans to the receiver could not be based on the CCAA proceedings and orders.  By the time of the mortgage and receivership proceedings, the CCAA proceedings had been “effectively terminated” and there was “no life remaining” in those proceedings.

Second, the Court of Appeal held that there was no inherent jurisdiction of the court to accord priority to the Bank’s loans to the receiver that would over-rule the statutory scheme in the Builders Lien Act (the Act).

Third, the Court of Appeal held that the loans to the receiver could not qualify as “further advances under the mortgage” within the meaning of Section 32(5) of the Act.  The Court noted that Section 21 of the Act expressly gives priority to liens over “receiving orders”.  The Court held that Section 32(5) provides an exception to the priority in favour of lien holders over mortgage advances in Section 32(2).    The words in Section 32(5) had to be given a restrictive meaning, and an interpretation which gives effect to the purpose of the Act, which is to “to ensure that contractors and suppliers are paid for materials provided and for services rendered”.  Accordingly, those words only apply to an advance under the original mortgage.  The loans to the receiver were to be under different terms and were distinct loans, and accordingly were not “advances” made under the original mortgage.

Section 32(5) and (6) of the Act states that the mortgagee may apply to the court and obtain an order that its further advances are to be given priority over the registered liens, and that the court must make such an order if it finds that the advances will be applied to complete the improvement and will result in an increased value of the land at least equal to the amount of the proposed advances.  The Court of Appeal held that, in light of its decision that the loans to the receiver were not “advances”, it did not have to consider whether Section 32(6) applied.

While this decision was made in the context of loans to a receiver, it raises the much broader question about when monies paid by a mortgagee will be given priority over lien holders.  Generally speaking, the construction and builders lien Acts across Canada use the words “advance” and “in respect of” or “on account of” the mortgage.  For instance, section 78(4) of the Ontario Construction Lien Act refers to “any advance made in respect of that conveyance, mortgage or other agreement.”  Section 31 of the Manitoba Builders’ Lien Act refers to “payment or advances made on account of any conveyance or mortgage”  Section 23(2) of the Nova Scotia Builders’ Lien Act refers to “funds advanced in good faith”, without stating that the advance must be in respect of the mortgage, although that requirement may be assumed.

What may not be obvious in each case is whether the payment made by the mortgage is an “advance” and whether it is “in respect of” or under the mortgage.  If it is not, then according to the Peri Formwork decision, the payment will not obtain priority over competing lien claims.

Construction Liens   –   Priority   –    Mortgage advances  –  Receiver

Tags:    priority – foreclosure proceedings – receiver – lien – builders

Bank of Montreal v Peri Formwork Systems Inc., 2012 BCCA 4

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                       March 22, 2012

www.heintzmanadr.com 
www.constructionlawcanada.com
 

The Equitable Doctrine of Marshalling Applies To Construction Liens

Construction Law  –  Construction liens  –  Marshalling

The Construction Lien Act seems to be a world unto itself, unaffected by the general principles of law.  But the recent decision of the Alberta Queen’s Bench in Gerrow v. Dorais reminds us that a construction lien is one form of secured interest.  The lien is therefore subject to the general principles of the law of mortgages and secured interests.  The court held that a construction lien is subject to the age-old equitable principle of marshalling.  This principle can be of great help to lien holders seeking to recover value from a highly mortgaged property.

The principle of marshalling applies if a creditor has security over two or more properties and there are creditors that have subsequent security over fewer properties.  The prior secured creditor is required to recover its debt in a fashion which is least injurious to the subsequent encumbrancers.  So, if the first mortgagee has security over two properties, and a subsequent mortgagee has security over only one of those properties, the first mortgagee is required to recover the debt, to the extent possible, from the property which does not have a second mortgage, leaving the other property, to the extent possible, available to satisfy the second mortgage.

In Gerrow v. Dorais, the Alberta Court of Queen’s Bench held that the principle of marshalling, developed long ago in relation to mortgages, applies to all secured indebtedness, not just mortgages.  Accordingly, the Court held that the principle applied to construction liens.  Lien holders are entitled to insist that a prior mortgagee must first satisfy the mortgage debt out of properties in which the lien holders hold no security.  Only to the extent that the mortgage debt cannot be paid out of other secured property can the mortgagee look to the property upon which the lien holders have registered liens.  In this fashion, value can be freed up for the lien holders even though the property is apparently highly mortgaged.

However, the Court held that the principle of apportionment must also be applied, in order to ensure fairness.  Under this principle, the marshalling of the prior mortgages must be effected according to the value of the properties, especially when there are several layers of mortgages and a competition between second mortgages and lien holders.  In this case, the lien holders objected to the application of the principle of apportionment as it meant that some of the recovery by the first mortgagee was apportioned to the land upon which they had registered liens.  However, the Court held that the principle of apportionment –and marshalling – applied, thereby apparently eliminating or diminishing the lien holders’ rights.

These equitable principles may appear arcane and confusing, but they are extremely important in sorting out the rights of lien holders in relation to other secured claims.  The construction and building lien statutes do contain rules relating to priorities between liens and mortgages.  But those rules are not a closed universe.  There are other long-standing principles that may substantially affect priorities of lien holders.  Marshalling and apportionment are just two of those principles.

See Goldsmith and Heintzman, Canadian Building Contracts (4th ed.), Chapter 11, Part 2(h)

Construction Law – Construction liens-  Marshalling:    Gerrow v. Dorais, 2010 ABQB 560

Thomas G. Heintzman, O.C., Q.C.                                                                               August 1, 2011

www.constructionlawcanada.com
www.heintzmanadr.com

What Is The Role Of Owners and Contractors In The Application Of Trust Funds?

Construction Law – Construction Liens – Trust Fund Provisions

The Ontario Court of Appeal has recently considered some interesting issues relating to the trust fund provisions of the Construction Lien Act of Ontario.  In Colautti Construction Ltd. v. Ashcroft Development Inc, the Court provided some useful guidance about the roles of owners and contractors in the application of trust funds. The Court also held that those provisions cannot be enforced by the owner, but only by the subcontractors or suppliers for whose benefit the provisions were enacted.

Ashcroft was the developer of residential and commercial real estate.  Colautti contracted with Ashcroft to provide services in relation to the construction of basements, municipal services and roads under seven different contracts.  Colautti also provided services for Ashcroft in relation to the projects under certain older contracts.  During the early stages of the projects, each time Ashcroft paid Colautti, it told Colautti which invoices of Colautti it was paying.  But later in the projects, Ashcroft refused to advise which invoices it was paying and for which contacts or projects, even though Colautti made repeated inquiries.  Colautti applied some of the monies it received against the oldest contracts.  Ashcroft later objected to the application of the funds by Colautti, alleging that Colautti had been paid on the seven contracts that it was suing under, if the payments were applied as Ashcroft maintained they should be.

The court held that Colauttii had acted properly in the application of the payments, particularly in the absence of any contemporary advice from Ashcroft about which invoices it was paying. The court applied two principles.

First, a contractor has an obligation to make reasonable inquiries of the debtor, to determine which invoices are being paid by the debtor. The court held that Colautti had fulfilled this obligation.

Second, absent an allocation of a payment by the debtor, the creditor can make the allocation. The court applied the words of the House of Lords in Cory Brothers & Co. v. Owners of the Turkish Steamship “Mecca”, [1897] A.C. 286, at p. 293:

“When a debtor is making a payment to his creditor he may appropriate the money as he pleases, and the creditor must apply it accordingly. If the debtor does not make any appropriation at the time when he makes the payment the right of application devolves on the creditor.”

Accordingly, the court held that Colautti acted reasonably in making the application of the funds it received from Ashcroft, in the absence of advice to the contrary from Ashcroft. The court confirmed that the trust fund obligations of the Act did require Colautti to apply the payments it received to the related projects. But having made reasonable inquiries and receiving no advice from the owner about the matter, Colautti was entitled to make the allocation of the payments to the various contracts relating to the projects, including the older contracts.

The court then dealt with Ashcroft’s claim that Colautti had breached the trust fund provisions of the Act. Ashcroft said that, at each time that Colautti received payments, Colautti had obligations to subcontractors under the seven contracts, and it was obliged to pay those subcontractors at that time. Ashcroft claimed a right to have its payments to Colautti re-allocated to those subcontractors, and particularly the subcontractors on the seven projects in question and not the older projects.

The court held that Ashcroft had no standing to enforce the trust fund provisions in this fashion. The court said that only subcontractors and other parties for whose benefit the trust fund provisions had been enacted could enforce those provisions:

“Simply put, standing to complain of a s. 8 breach of trust is limited to those
“who stand in direct privity with the contractor and who are owed amounts by the contractor”….. The protected class of creditors are those “down the chain” from the trustee of the s. 8(1) trust fund. The Developers, as owners of the Projects, do not come within that class.”

This decision is a welcome clarification of the trust fund provisions.  Those provisions are some of the most important parts of the Construction Lien Act.  They provide very substantial protection for contractors, subcontractors and suppliers. Clearly the Ontario Court of Appeal was concerned that an owner could effectively undermine those provisions or use them for a purpose for which they were not intended. The court was not prepared to allow an owner to refuse to allocate funds paid by it and then complain later about the contractor’s allocation of them. Nor was it prepared to allow the owner to use the trust fund provisions for its benefit in that re-allocation effort.

Construction Law – Construction Liens – Trust Fund Provisions:

Colautti Construction Ltd. v. Ashcroft Development Inc., 2011 ONCA 359 (CanLII)

Thomas G. Heintzman, O.C., Q.C.                                                                                               June 19, 2011
www.constructionlawcanada.com