Legal Blog

Conflict

Several remedies come into play in determining the outcome of construction disputes. Normally these remedies play nicely with each other, but sometimes they conflict. One such conflict, between the adjudication remedies under the Construction Act and remedies under a bond indemnification agreement, was dealt with in Westport Insurance v. BDA, a 2024 Ontario Superior Court of Justice decision. The losing party in the decision moved for leave to appeal to the Divisional Court, which was refused in 2025.

Bond Stream

A general contractor retained a subcontractor to provide electrical supply and installation for a project. As part of the subcontract, the sub was obliged to, and did, deliver a performance bond and a labour and material payment bond. Under the bonds, the general was the obligee and the sub was the principal.

Of course, because a bond is not the equivalent of insurance, the sub had to enter into an indemnification agreement with the surety so that, if the surety actually had to pay any money under the bond, the sub would be liable to the surety for the amount the surety paid. And because a sub is often in a precarious financial position when a bond is called, the principal of the sub is typically joined under the indemnification agreement. It is our experience that these indemnification agreements are drawn very widely in favour of the surety and often go almost as far as the principal having to put up his or her firstborn as security.

A dispute arose between the general and the sub; it was sufficiently serious that the general terminated the subcontract and refused to pay the sub’s final invoices. The general then claimed under the bond against the surety. The surety entered into a mitigation agreement with the general under which the surety advanced to the general approximately $340,000 on a without prejudice basis so that the general could complete the project.

The mitigation agreement provided that:

• the surety had not completed its investigation and the mitigation payment was subject to the surety’s reservation of its rights; and
• if the surety ultimately denied liability, the general would not be entitled to any further advances and would have to reimburse and indemnify the surety for any amounts the surety had previously paid the general.

Adjudication Stream

During all of this, the sub moved for adjudication under the Construction Act. The adjudicator rejected the general’s claim for setoff for delay – because the general did not provide the adjudicator with a schedule that bound the sub. The adjudicator specifically noted he had not made any determination as to whether the general had properly terminated the subcontract or whether there were grounds for this termination.

The adjudicator, however, did order the general to pay the sub’s two unpaid invoices for an aggregate of $316,960.

The Fight

Once the surety learned of the adjudication decision, it took the following positions:

• the sub was not in default under the subcontract, and that, therefore, the general was not entitled to make a claim under the bonds;
• it would be making no further payments under the mitigation agreement;
• the general was to reimburse it for all payments it had made to the general; and
• the general ought not release to the sub the funds awarded in the adjudication.

Not surprisingly, the sub demanded that the general pay the adjudication award to it.

The general was therefore caught between two competing claimants, the sub under the adjudication provisions and the surety under the mitigation agreement. The general paid the full amount to its lawyers in trust for the surety and the sub. The surety and sub agreed to release $161,000 of the disputed funds to the sub’s subsubs, leaving approximately $156,000 over which to fight. The surety then brought a motion for an order to pay the disputed funds to it.

Default Event

The sub argued that there had been no event of default and therefore the surety had no right to pay anything to the general. A determination of whether there was an event of default necessitated an interpretation of the indemnification agreement, which, if you will recall, is drafted very widely. The sub’s argument had no chance of success.

An event of default included any breach or alleged breach of the covenants and agreements with the general, any failure to pay bills or indebtedness, and any other occurrence that might expose the surety to damages. Once the general alleged that the sub had not completed its work and failed to meet its obligations to provide required documentation and provided notice of breach, there was an “alleged breach”. Further, the surety had also received claims from the union representing the sub’s electrical employees that the sub had defaulted on its employee wage and remittance payments. That also was an event of default.

Trust Funds

The indemnification agreement provided that:

• the sub assigned to the surety as collateral all of the sub’s interest in every contract, regardless whether an event of default had occurred, all holdbacks, progress payments, deferred payments, and all other funds that might be due under the subcontract or that might become due or awarded in connection with the subcontract; and
• all funds due to the sub constituted trust funds for the surety’s benefit.

The judge noted that this indemnification agreement was entered into after the adjudication provisions of the Construction Act came into force and did not carve out any exception for interim awards.

The judge also summed up the purpose of bonds and indemnities in a construction contract as follows:

“Additionally, it would not be a commercially reasonable interpretation to exclude from the security interest (an adjudication) interim award. (The sub) was only able to obtain the Subcontract on the condition that it obtain the Bonds. (The surety) would not provide the Bonds absent the Indemnity Agreement giving (the surety) security over all of (the sub’s) entitlements. Bonding is an important commercial agreement that permits subcontractors like (the sub) to obtain high value work and income. It would be an absurd result if interim awards were excluded without the parties specifically agreeing to this.”

Priority

The judge held that the policy of prompt payment and adjudication, to ensure that funds flowed down the construction ladder, was not defeated by upholding a surety’s security interest as set out in a freely-negotiated indemnification agreement. Indeed, all of the funds owed to subsubs had already been paid. The only remaining issue was the competing claim between the surety and the sub for the difference.

The judge noted that there was nothing in the Construction Act that purported to apply to sureties; nothing in the legislation gave a sub priority over a surety’s security interest after a determination in the sub’s favour.

The judge therefore awarded priority to the disputed money to the surety.

Setoff

The judge, however, held that the surety was not entitled to immediate payment of the disputed money due to ongoing litigation between the general, the surety, and the sub that could affect the surety’s ultimate entitlement. In that litigation, the sub had alleged a breach of the surety’s contractual duty of good faith when it paid the money to the general. The court ordered the disputed funds to be paid into court pending the outcome of those proceedings.

 

Image courtesy of Alexas_Fotos.

Written by Jonathan Speigel, the founding partner of Speigel Nichols Fox LLP, leads the litigation and construction practices.