Legal Blog

Personal Liability

On occasion, an unscrupulous principal sweet talks an unsuspecting owner into signing a construction contract with the principal’s corporation and either the principal has no intention to complete the project properly or has no ability to do so. Can the owner recover damages against the corporation and its principal and, if so, what damages? These issues were discussed in Li v. Zhu, a 2023 decision of an associate judge of the Ontario Superior Court of Justice.

Procedural

Initially a law firm had represented the contractor corporation and its principal, but, presumably at the firm’s request, was removed from the record. At that point, the corporation and its principal could have appointed a new law firm to represent them or the principal could have filed a notice of intention to act in person and the corporation could have brought a motion to have the principal represent it in the legal proceedings. The principal and the corporation did nothing and the owners obtained an order striking their pleadings.

The owner then brought a motion for default judgment. Because the corporation and principal were noted in default, under the Rules of Civil Procedure all factual allegations of the owner in her pleadings were deemed to be true. The owner also provided affidavit evidence to support her claim for damages.

Contract

The principal falsely represented that the corporation and he were competent and experienced builders, representations on which the owner had relied. Based on the representations, the owner and the corporation entered into a cost plus contract with a guaranteed maximum price, by which the corporation was to demolish an existing house on the owner’s land and build a new, luxury house according to specified drawings.

To assist the corporation and to ensure an immediate flow of funds, the owner gave the corporation cash and cheques signed in blank so that the corporation could pay the subcontractors and itself for its fee. This was a mistake.

Eleven months later, the owner realised that the project was $150,000 over budget, the corporation had significantly deviated from the drawings, the new build had many deficiencies and, surprise, some of the money that the owner had provided the corporation for the project went to people other than the subcontractors who were supposed to have been paid.

The owner attempted to have the corporation rectify the deficiencies, but was met with silence. Accordingly, the owner terminated the contract one month later.

Breach

The existence of deficiencies does not necessarily entitle an owner to terminate a contract. The deficiencies must be so bad that they amount in substance to a failure to carry out the work. The owner did not just rely on her own observations; she hired an architect to review the construction. He delivered a report that “showed a shocking number of defects,” identifying 97 exterior deficiencies and 225 internal deficiencies. He identified incomplete work, improper installation, and materials substitutions. Many deficiencies resulted in code violations, safety hazards, and ongoing issues with water penetration.

All of this was sufficient for the associate judge to hold that the corporation’s performance was so poor as to amount to a repudiation of the contract and a justification for the owner to terminate the contract without prior notice.

The judge further held that it mattered not that the full extent of the deficiencies became known only after the termination. They were still deficiencies at the time of the termination.

Damages for Breach

The owner provided evidence that the costs to fix all deficiencies would be $740,000. However, the owner decided to complete only some, but not all, of the deficiency work. She paid $410,000 to have this work completed. The owner claimed the full $740,000 as damages for the breach of contract (i.e., the amount she spent plus the amount she would have spent to correct the remaining deficiencies). However, before completing the remaining deficiencies, the owner sold the house for $3.16 mil.

The judge noted that damages can be calculated in two ways: (i) the cost of curing the defective performance (which was what the owner claimed) or (ii) the difference in the value of the as-built project and its value had there been no defects. The judge preferred the second method in this case because he found that the owner was more interested in selling the property than in living in it. He did not want to give the owner a windfall.

The owner provided evidence that the sale price would have been $100,000 more were it not for the remaining deficiencies. Accordingly, the judge awarded that $100,000 plus the $410,000 incurred to correct deficiencies for a total of $510,000.

Other Remedies

The judge also awarded the owner $74,628 to compensate the owner for the money that she had provided the corporation to pay subs and suppliers, money that the corporation either converted to its own use or used to pay subs on other projects.

Punitive

The owner requested the judge to award punitive damages of $50,000 – based on the corporation’s reprehensible conduct. The judge noted that $50,000 was about 6% of the amount the owner had claimed and, without really saying why, awarded only $25,000. It is difficult to know exactly what a punitive damages award ought to be. It depends on the severity of the behaviour and a judge’s gut feel for the proper quantum.

Personal Liability

It is not easy to burden a principal with personal liability. A principal will be personally liable for a corporation’s actions if the principal dominated the corporation and used it as a shield for fraudulent or improper conduct.

The judge imposed personal liability on the principal in this case for the following reasons:

• The principal was the sole officer and shareholder of the corporation.
• He established the corporation as a single-purpose entity on the eve of the signing of the contract with the owner.
• He made numerous representations about his ability as a contractor, all of which were false.
• He made his girlfriend the director only to meet the residency requirement for a corporation operating in Canada.
• He himself was a non-resident.
• He conducted all the corporation’s business himself.
• He used the corporation in an attempt to insulate himself from liability for his improper conduct.
• He allowed the corporation to convert money that it was to hold in trust.
• It would be unjust to allow the corporation to shield the principal from liability.

Costs

The owner claimed $160,158 in substantial indemnity costs. The owner claimed $54,200 in disbursements, but it is difficult to determine from the reasons for decision whether the claim for disbursements was in addition to, or included in, the costs claim. The judge awarded $140,000 in total because the actions had not progressed into the discovery stage and because the judge had awarded only 70% of the damages the owner had claimed. The latter reason makes little sense to us.

 

Image courtesy of tswedensky.

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