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

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

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


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

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

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

Decision of the Manitoba Court of Queen’s Bench

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

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

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

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

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


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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



Two Construction Lien Issues: Architect’s Pro-Forma Certificate Is Invalid; GST Must Be Added To Holdback

The Ontario Superior Court recently decided two important issues relating to construction liens. In Wellington Plumbing & Heating Ltd. v. Villa Nicolini Incorporated, the court held that a late-issued pro forma architect’s certificate was invalid, and that GST must be added to a holdback.

Factual Background

Villa Nicolini constructed a retirement home in Vaughan. The project started in 2007 and was to be completed by the fall of 2008. In the spring of 2010, construction was 75% complete and numerous trades were unpaid and had registered liens.

The mortgagees exercised their rights to sell the project lands. To convey title to the purchaser, the mortgagees vacated the registered liens by posting a letter of credit to stand as security for the lien claims in place of the project lands.  The amount of the required holdback was in dispute between the lienholders and the mortgagees.

The lien claimants said that the required holdback was $497,236 while the mortgagees said it was $285,140. The difference between the two figures was due to the parties’ answers to two questions.

First, were the architect’s certificates of completion validity issued?  If not, as the lien claimants submitted, then the releases of holdback based on those certificates did not count toward the holdback and the mortgagees would have to add them to the holdback which had been made by the owner.

Second, was GST required to be maintained as part of the holdback?  If so, as the lien claimants submitted, the amount of GST would have to be added by the mortgagees to the holdback.

The mortgagees argued that the amount of the required holdback was reduced by about $212,000 paid by the owner to subcontractors in accordance with certificates issued by the architect during the project. Those certificates were issued under section 25 of the Construction Lien Act. That section allows the owner to pay subcontractors whose work has been certified by the “payment certifier” as being complete.  The payment certifier is normally the architect or engineer hired for the project.  Section 25 says that, on the basis of such a certificate of completion, the owner may pay the subcontractor “without jeopardy” and the payments reduce the holdback required to be maintained under the Act.

Section 33(2) of the Act says that “where a sub-contract is certified to be completed, the sub-contract shall be deemed to have been completed on the date of certification.”  Section 33(4) says that “within seven days of the date the sub-contract is certified to be completed, the payment certifier or the owner and the contractor, as the case may be, shall give a copy of the certificate” to the sub-contractor, the owner and the contractor.

The lien claimants argued that the architect’s Certificates of Completion did not comply with Act for three reasons:

(i) The certificates of completion were not in the prescribed form (Form 7 under the Act);

(ii) The certificates were not delivered in accordance with Section 33(4);

(iii)  The certificates were prepared after the holdback funds had already been released.

Issue 1:              Were the Certificates of Completion Valid?

The court held that, on the facts, each of these deficiencies actually existed. The court then considered whether those facts rendered the certificates invalid.

The court held that the form of the certificates did not make the certificates invalid. While the Act should be strictly construed so far as the existence of liens is concerned, the Act should otherwise be given a purposive interpretation. The difference in form was a minor irregularity and there was no evidence of any actual prejudice. As a result, the failure to strictly comply with the forms required by the Act did not invalidate the certificates.

As to the second ground, the court declined to decide whether the certificates were invalid, due to its finding on the third ground.  However, the court was troubled by the lien claimants asserting this ground of invalidity since, as the court said:

“the lien claimants now before the Court were never entitled to receive notice of the Certificates of Completion. It makes little sense that they should be able to complain about the non-delivery of a certificate that they were never entitled to receive, when the parties actually entitled to receive them are not complaining.”

On the third ground, the court held that the certificates were invalid.  The court explained its decision as follows:

“I have found that the Certificates of Completion in this case were issued by the architect as an after-the-fact attempt to cure payments improperly made to sub-contractors before the certificates were issued. At the time the payments were made, they were made in violation of section of the Act. There is no mechanism in the Act to cure a violation of s. 25 by a subsequently issued Certificate of Completion. Accordingly, even if [the mortgagee] was able to invoke s. 25 of the Act, I find as a fact that Villa violated the section by releasing funds before the Certificates of Completion were issued. Section 25 requires strict compliance with s. 33(1). The release of holdback funds without compliance with s. 33(1) is fatal.”

The court was concerned that the result might appear to be unfair to the mortgagees.  It concluded, however, that the mortgagees knew that they would inherit the owner’s holdback obligation whatever it might be, that “there is nothing unfair in requiring an owner to comply with the provisions of the Act” and that the subcontractors were not obtaining a windfall because there would in any event be a significant shortfall in the amounts owing to them.

Issue 2:              Was GST a required part of the Holdback?

The lien claimants asserted that GST must be added to the basic holdback obligation of the owner, and therefore, the mortgagees. They said that the contract included GST of 6%, that they were obliged to remit GST to the Canada Revenue Agency as a percentage of their gross sales and that the amounts they receive by way of holdback funds would be reduced by the GST.

No case authority was cited to the court which was directly on point, although the Master’s office regularly calculates holdbacks inclusive of GST.  The court acknowledged that “the Act does not mention GST as a component of the basic holdback.” However, GST funds are trust funds and they must be remitted to the CRA.  If the holdback does not include GST then the parties receiving the holdback will not, on a net basis, receive the 10 percent holdback prescribed by statute.  In the course of the project the owner would normally hold back from the progress payments to the contractor the statutory 10 percent plus GST, and pay that holdback amount, including the GST, at the end of the project.  Accordingly, it is appropriate that the mortgagee should pay the GST into court, and the court so ordered.


These two issues are of practical importance to the building industry and to lenders. Certificates of completion allow a building project to proceed smoothly by permitting the owner to pay subcontractors during the job without fear of having to repay those monies again later.  But the court will not permit that permission to be abused.  If the certification process is a mockery, and if certificates are later issued to paper over payments made without adherence to the statutory procedures, they will be ineffective.

There may be border line situations.  What if the architect actually scrutinizes the subcontractor’s work and decides it is complete and so advises the owner before the payment is made, but writes up the certificate of completion sometime later?  What if the architect writes up the certificate and gives it to the owner before inspecting the work and being satisfied that the work is complete, and then inspects the work later and is so satisfied?  Do these situations offend the Act?  This decision has opened these issues to judicial scrutiny.  The limits of validity of certificates of completion will depend on the extent to which the certificate satisfies or abuses the real purposes of the Act.

The requirement that the holdback include GST, or now HST, seems appropriate, especially when the contract itself refers to HST. This requirement will likely impose an obligation on mortgagees to pay the HST into court to discharge liens since it is doing nothing more than the defaulting contractor would have done if it had paid the holdback to the contractor, that is, pay the holdback and the HST.

Wellington Plumbing & Heating Ltd. v. Villa Nicolini Incorporated, 2012 ONSC 5444

Building Contracts  –  Subcontractor  –  Certificates of Completion  –  Holdback

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