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The Ontario Construction Act: What Does It Mean, Especially Regarding Paid When Paid Clauses?

The Ontario Construction Lien Act, 2017 was given Royal Assent on December 12, 2017 as S.O. 2017 C.24. This statue changes the name of the Ontario Construction Lien Act to the Construction Act (which I will refer to as the new Act) and fundamentally changes the law relating to construction projects in Ontario.

Before further comment, it should be noted that different parts of the new Act will come into effect at different times. As the Explanatory Note to the new Act states: “The commencement section of the Bill (section 86) provides that, for the most part, the housekeeping and non-substantive amendments come into force on the day the Bill receives Royal Assent, and the substantive amendments come into force on proclamation of the Lieutenant Governor.”

The Prompt Payment provisions contained in section 6.1 to 6.9 of the new Act, which are referred to in this article, are enacted by section 7 of the Ontario Construction Lien Act, 2017. Under subsection 86(2) of that Act, section 7 (and therefore the Prompt Payment provisions of the new Act) and most of the substantive provisions of the new Act will come into effect on a day to be named by proclamation of the Lieutenant Governor.

The expected dates of proclamation are as follows: July 1, 2018 for the amendments to modernize the Act and the holdback rules; and October 1, 2019 for the amendments related to prompt payment, adjudication and liens against municipalities. With an Ontario election looming, there may be further adjustments to these proclamation dates, and for the necessary organization of the prescribed forms and the adjudication regime that will enable the Prompt Payment regime to function.

In three articles, I have reviewed the Report leading up to the new Act, and the draft legislation. Those articles were posted on this site on May 3, September 10 and 27, 2017. So my thoughts about the various provisions of the new Act are set out in those articles in some detail.

There is one aspect of the new Act that remains a puzzle to me. What will the new Act do, and in particular, what will the Prompt Payment regime in the new Act do, to Pay When Paid clauses?

As I discussed in those articles, it remains a puzzle to me because the Ontario law with respect to Pay When Paid clauses is itself a puzzle.

On the one hand, the majority of a divided Ontario Court of Appeal held, in Timbro Developments Ltd. v. Grimsby Diesel Motors Inc. 1988 CarswellOnt 773, that a Pay When Paid clause can be relied upon to preclude both interim and final payments to the subcontractor if the contractor has not been paid by the owner. On the other hand, in Arnoldin Construction & Forms Ltd. v. Alta Surety Co. 1995 CarswellNS 31 the Nova Scotia Court of Appeal held (basically following the logic of the dissenting Justice Finlayson in the Timbro case) that a Pay When Paid clause should be interpreted as only being a payment timing mechanism during the project, and does not entitle the contractor to refuse payment to the subcontractor at the end of the job unless that interpretation is very clear to that effect. The Nova Scotia Court of Appeal held that it was not clear in that case. Leave to appeal from both decisions was refused by the Supreme Court of Canada.

More recent cases in Ontario have applied the logic in the Arnoldin decision, not so much by expressly refusing to follow the Timbro decision as by applying a tough standard of interpretation before the clause will be held to negate the subcontractor’s ultimate right to be paid.

The Report leading to the new Act, and the legislature in the new Act, did not expressly address this puzzle. This is puzzling in itself since, under the U.K. legislation on which the Ontario legislation is based (the Housing Grants, Construction and Regeneration Act 1996 (U.K.)), Pay When Paid clauses were rendered ineffective unless the third party payor (such as the owner who has not paid the contractor) is insolvent. Many U.S. states have also banned Pay When Paid clauses. So it remains for practitioners to work on the puzzle.

On the one hand, practitioners may rely upon the effect of the legislative choice not to expressly deal with Pay When Paid clauses in the new Act. Those in favour of Pay When Paid clauses may say that by not doing anything expressly, the legislature intended to leave the law in Timbro alone and not import into Ontario law the prohibition against Pay When Paid clauses which was staring the legislature so clearly in the face by way of the U.K. legislation. On the other hand, those opposed to Pay When Paid clauses may say that by not doing anything expressly, the Ontario legislature intended to leave the case law in Ontario alone, thereby leaving a very high degree of contractual clarity before a Pay When Paid will entitle a contractor to withhold final payment to the subcontractor because it has not been paid by the owner.

Let’s then consider the ingredients of the new Act and see if they help us determine whether Pay When Paid clauses will be more enforceable after the Prompt Payment provisions of the new Act are brought into force than they were before. At first blush, it seems that the new Act will strengthen the arguments of those in favour of the enforceability of Pay When Paid clauses, but a further analysis seems to sway the argument the other way.

The argument that the new Act enhances the enforceability of Pay When Paid clauses may be supported by the whole structure of the new Prompt Payment regime. That regime will mandate a payment system based upon the contractor giving the owner a “proper invoice”. Once that proper invoice is given, then the owner will have to pay the invoice unless the owner gives the contractor a “notice of non-payment”.

Under subsections 6.5(5) and (6) of the new Act, the contractor will be then able to give the subcontractor a notice of non-payment in a form to be prescribed in the Regulations, for two reasons:

  1. Because the contractor has not been paid by the owner, in which case the notice of non-payment to the subcontractor must be made within 7 days of the notice of non-payment by the owner, or if no notice of non-payment has been given by the owner then within the 35 days that the contractor must otherwise pay the subcontractor. In these circumstances, the contractor must undertake to have the “matter” adjudicated; or
  1. Because it disputes the subcontractor’s claim in which case the notice of non-payment to the subcontractor must specify the amount not being paid and detail “all of the reasons for non-payment”, and must be given with the said 35 day period.

Those arguing in favour of Pay When Paid clauses will point to the first reason for non-payment, namely non-payment by the owner, and ask: why did the legislature insert that ground for non-payment to the subcontractor, and provide a prescribed form for it, unless that notice to the subcontractor was to have effect and entitle the contractor not to pay the subcontractor? The legislature did not stipulate that this provision would only operate if there was a Pay When Paid clause in the contract; the provision apparently applies even if there isn’t such a clause in the building contract.

Indeed, it may be argued that the legislation has inserted a statutory Pay When Paid clause into Ontario building contracts, even if there is no such clause in those contracts, and this may well be the practical effect of the new Act for payments made during the project for all building contracts and not just those with Pay When Paid clauses. But if the contract does contain a Pay When Paid clause, then it may be argued that the legislature has now stipulated that the Pay When Paid clause is a good and valid reason for the contractor not to pay the subcontractor.

On reflection, in my view that argument is not as strong as the opposing argument, for a number of reasons.

  1. The Prompt Payment regime creates a right to prompt payment, but it does not create a substantive right to Pay When Paid at the end of the project. On its face, it is a procedural regime applicable to payments during the ongoing project and does not create a substantive rights to withhold payment.

Thus, with respect to the second ground for giving a Notice of Non-Payment – disputing the subcontractor’s claim – the regime does not give the contractor substantive rights not to pay the subcontractor by reason of giving a notice of non-payment. The contractor may dispute the subcontractor’s claim to payment for all sorts of reasons – the work was badly done, the work was delivered late, the amount charged is wrong etc., etc. But these substantive rights or defences are not determined or affected by the contractor’s right to give a notice of non-payment. These rights or defences will be determined in adjudication, arbitration or litigation. The legislature obviously hopes that their resolution will be more expeditiously determined through the adjudication regime contained in the new Act. But whether the dispute arises out of the first or second type of notice of non-payment, it does not appear that the legislature intended that the contractor’s entitlement to give a notice of non-payment to a subcontractor affected the subcontractor’s final entitlement to payment, whatever that entitlement may be.

On balance, the fact that the legislature didn’t say that a notice of non-payment entitles the contractor not to pay the subcontractor at the end of the project (if not paid by the owner or if the contractor disputes the subcontractor’s right to payment) seems to weigh more heavily in favour of the view that the notice of non-payment has no substantive effect, and leaves the legal rights of the parties enforceable as they now are (or are not), governed by the new procedural rights in place which will hopefully assist the parties to resolve the dispute more quickly.

  1. The argument then may be that the Prompt Payment regime creates an enforceable Pay When Paid regime if the contract contains a Pay When Paid clause, but not otherwise. That argument seems to be a bridge too far.

The new Act does not expressly create such a statutory regime, and it seems unlikely that the legislature intended to create such a regime applicable to some building contracts (those with Pay When Paid clauses) and not to others (those without), especially when so many other legislatures have expressly abolished Pay When Paid clauses.

While the Prompt Payment regime may not formally legalize the non-payment by contractors of subcontractors due to non-payment by owners, it may condone that practice in the short run, and cause or permit contractors to “throw out the anchor” by serving a notice of non-payment when they might otherwise not do so. In an apparent effort to inhibit that practice, the legislature has required a contractor serving such a notice due to non-payment from the owner to undertake to refer the matter to adjudication, which will presumably speed up the resolution of the non-payment. Such an undertaking by the contractor is not required if the notice of non-payment is given by the contractor by reason of a dispute with the subcontractor. The requirement of such an undertaking may be good evidence that the regime wasn’t intended to legalize non-payment of subcontractors due to non-payment by owners. As a further inducement to prompt payment, interest on outstanding amounts will now be payable at the greater of the contract rate or the Courts of Justice Act rate.

In the result, when the Prompt Payment regime of the new Act is proclaimed into force, it may stir up the debate about the effect of Pay When Paid clauses upon the ultimate right of the subcontractor to be paid by the contractor if the contractor is not paid by the owner. And the new Act may result in quicker adjudication of the disputes about those clauses. But it seems unlikely that the new Act will change the trend in the existing case law. That trend may only change if the Supreme Court grants leave to appeal to resolve the debate.

See Heintzman and Goldsmith on Canadian Building Contracts (5th ed.), chapter 6, part 2(d)(i), chapter 15, part 10(e), and chapter 16, part 3.

Ontario Construction Lien Act, 2017 , S.O. 2017 C.24

Pay When Paid Clauses – Construction Lien Amendment Act, 2017 and Construction Act

Thomas G. Heintzman O.C., Q.C., LL.D. (Hon.), FCIArb               March 11, 2018


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