Legal Blog

Construction Act – Part 2 – Irregularities, Set-Off, Trust Money, and Leasehold

This is our 2^nd instalment on the changes to the Construction Lien Act (“CLA“), which, on July 1, 2018, becomes the Construction Act (the “Act“).

Irregular

No, we are not discussing one’s bowel issues. We are referring to section 6 of the CLA as amended by the Act.

Section 6 of the CLA stated that if a claim for lien or a certificate of substantial performance “does not strictly comply” with the sections governing them, then the claim or certificate is still valid unless a person is prejudiced by the error. The jurisprudence held that this section allowed a court to refuse to invalidate some liens, but not others.

The new section 6(1) of the Act repeats the old one in essence, but adds a new subsection, listing the examples of errors to which section 6(1) applies:

1. A minor irregularity in:

a) names of owner, payment certifier, or person with whom the lien claimant contracted,

b) legal description of premises (if, however, you get the description completely wrong by, say, liening the wrong land, you may still be out of luck), or

c) address for service.

2. Inserting the owner’s name in the wrong portion of the claim for lien. (It seems that, previously, some lien claimants could not read).

Set-Off

We have written a number of times about this concept (see March 2013, September 2016, and March 2017 newsletters). Sections 12 and 17(3) of the CLA specifically allow setoff as between a payer and payee, for outstanding debts and claims regardless whether the claims were related to the same improvement. Accordingly, if, say, a general complied with its trust fund duties by ensuring that all disputed monies were held in a separate trust account, or other security such as a GIC, the general could set off the claims on project #1 against the amount that it would otherwise owe the sub on project #2.

Even if the general could not rely on sections 12 and 17(3) of the CLA, the general could still rely on equitable setoff if it could fit within the rules of equity, something that was possible, but unlikely.

The Act amends both sections, stating that the claims being set off have to be related to the same improvement unless the payee is insolvent. We interpret this to mean that, even if equitable setoff could otherwise be established, it will no longer be allowed. The fight under the Act will now invariably focus on whether the payee is insolvent. And that is as it should be. In practice, a general would rarely hold back payment on project #1 because of claims under project #2 if it knew that the sub was financially strong. Generals start to set off inter-project funds when they have reason to believe (e.g. receiving notice that subsubs are not being paid) that a sub is in trouble.

Trust Money

One short section, with major consequences, has been added to the trust fund provisions. Section 8.1 of the Act provides that every trustee (e.g. general for subs, subs for subsubs, etc.) is subject to the following rules:

1. All trust funds are to be deposited into a bank account.

2. The trustee must keep written records detailing the amounts received and paid from the funds and any transfers made from the account.

3. If the trustee is a trustee of more than one trust, the trustee may deposit the funds in one mixed account as long as the trustee keeps appropriate records separately for each trust.

In the good old days, the courts noted that trustees had to keep trust funds separate, to be used only for purposes of the trust (i.e. pay the beneficiaries of the trust). Trust funds could not be used to pay general overhead expenses. In practice, however, trustees, generals and subs never had a mixed trust account. All money would go into one account that dealt with everything, including payment of overhead and trust obligations. Everything went swimmingly until a contractor ran into trouble. It would use funds from a later project to pay its overhead and its remaining obligations on an earlier project and then find that it ran out of money on the later project. The trust provisions would be breached, the beneficiaries would not be paid their money, and the acquiescing officers and directors would be liable for breach of trust.

We would have ensured that section 8.1 mandate that all trustees (e.g. generals and subs) have a separate mixed trust account, just as all lawyers have a separate mixed trust account.

Unfortunately, the Reynolds & Vogel report did not recommend this and the legislation does not specifically reference it -although, if there is only one account, why would the legislation reference transfers from the account? Regardless, we suspect, that the courts will demand, and we strongly advise, that a contractor use a mixed trust account.

Under this scenario, a general will, as before, deliver an invoice to an owner breaking down the project contract price into its constituent elements. When that invoice is paid, the general will deposit the funds into the mixed trust account and, from those funds, pay each sub whose invoice is included in the general’s invoice. Anything else can then be transferred to the general’s regular account, what lawyers would call their general account. The general will use this regular account to pay its business expenses, just as it did previously, only now trust funds will not be intermingled with general funds.

Under the new regime (with or without a mixed trust account), the trustees will need software to keep the records that the Act mandates so that a trustee will know, at a glance, the money it has received on a project and how that money has been disbursed. We suspect that this will not assist contractors with the rigour required to ensure that trust funds are not misused and that they will continue to get themselves into trouble.

Leasehold

Under the CLA, a general had a right to register a claim for lien against the tenant’s leasehold interest in the land. Unfortunately, this right was, in most cases, useless. If the tenant had financial problems, the likelihood of the general being able to sell the leasehold interest was remote, particularly if, as was quite likely, the landlord would not cooperate. Section 19 of the CLA gave the general the right to claim against the landlord and the freehold interest in the land if the general had given written notice to the landlord before commencing the project work and the landlord did not, within 15 days, notify the general that it would not be responsible for the improvements.

In practice, generals never gave the appropriate notice before commencing their work. They tried, after-the-fact, to pin the landlord with responsibility by noting that the lease contemplated the improvement, but the courts held that this was not enough to comply with the section. It was not a good situation.

Section 19(1) has now been amended. The never-used notice provision is replaced with a provision requiring a landlord to hold back 10% of all tenant’s allowance payments made for leasehold improvements contemplated in the lease. The landlord is not, however, personally liable for the payments to be made on contract – unless the landlord can be characterised as an “owner” under a different guise.

Preservation

We will discuss holdback and preservation and perfection of liens in detail in our next newsletter. In summary, however, a lien must be preserved within 60 days (rather than 45 days) of the lien start date and a certificate of the action commenced to perfect the lien must be registered within 90 days (rather than 45 days) of the lien preservation expiry date.

 

 

Image courtesy of DodgertonSkillhause.

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