FINANCING CONSTRUCTION PROJECTS; EXPANSION OF BUILDERS' LIENS TRUSTS BENEFITS

Posted: March 05, 2019 | Last Updated: March 05, 2019
Written by: Edward D. Brown

Edward D. (Ned) Brown
Pitblado LLP
February, 2019

If I, as the owner of land, engage a single person to make improvements to my land, the respective rights and obligations of the two parties will usually be set out clearly in the contract we enter into for this purpose. If the other contracting party does not engage any others to assist in effecting the improvements, then what can - and usually would - happen where the improvements are properly effected but I, for some reason, fail to make payment therefor, is that the other contracting party can sue me for breach of contract, get a money judgment and then use that judgment to realize against (i.e., liquidate) so much of my assets as is necessary to recoup the judgement debt. If the other party's monetary entitlement is very high - a rather unlikely situation in the case of a one-person contractor - the other party can - if I'm agreeable - extract a mortgage against my property to better assure the payment of what I owe.

However, in the "real world", with respect to the vast majority of construction/development projects, no such simple two-party/one contract arrangement is possible. The owner of real estate engages what is commonly known as a general contractor to effect substantial - and often costly - improvements to the owner's property. The general contractor performs its tasks by engaging and coordinating the activities of multiple other parties, usually called "subcontractors". One or more - or all - of each of those subcontractors may in turn engage sub-subcontractors and so on "down the line to the bottom". The "bottom" refers to the notional construct of the grouping of the parties involved and takes the shape of a pyramid, with the owner at the top, the general contractor immediately below the owner, and subs and sub-subs, etc. spreading out below the general contractor to the bottom level of subcontractors. At each level, starting with the general contractor, each of the parties inputting the improvements will typically engage a number of employees and purchase supplies from other parties. Unlike the "two party/one contract" arrangement described above, there will not be contracts between the various parties situated at different "separated" levels of the "pyramid".  Parties situated at lower levels of the "pyramid" will be separated by one or more other levels of parties within the "pyramid". Thus the owner, while it will have a contract with the general contractor, won't have any contracts with any of the subcontractors or with the sub-subcontractors. The general contractor will have contracts with the level of subcontractors immediately beneath its level in the "pyramid" but it will not have contracts with any of the lower level participants. This means that where the owner makes a payment of part of what it owes to the general contractor, but the general contractor fails to pay one of its direct subcontractors, absent "remedial legislation", the unpaid subcontractor has no source of recoupment of what is owed to it, other than by making a claim against the general contractor. Again, absent "remedial legislation", if the general contractor has become insolvent (or bankrupt), the unpaid subcontractor would have no claim against the owner and no security in the project which it has assisted in improving.

However, as we all know, there is "remedial legislation", namely the Builders' Liens Act (the "BL Act"). The BL Act provides more than one "mechanism" to assist parties improving or assisting in improving real estate that do not have a direct contractual relationship with the owner (the ultimate beneficiary of the improved real estate) or any effective security for the payment of what is owed to them. The builders' lien is one such mechanism.

This paper deals with another mechanism, namely the BL Act's creation of a trust or trusts imposed by the BL Act on the various levels of participants in the construction "pyramid" with respect to funds received by each of them for the benefit of those situated below their level in the "pyramid". Generally speaking when funds are acquired by an owner, a general contractor, a subcontractor, or a sub-subcontractor, etc., those funds are received by the recipient subject to a trust obligation to ensure that they are used firstly to pay those immediately below them in the construction pyramid before any of the funds are used for any other purpose including any "personal" usage thereof by the funds recipient (eg, including repayment of debts owed by the funds recipient to its creditors).

The application and operation of the trust provisions of the Manitoba BL Act and of other similar legislation in other jurisdictions is often cumbersome and somewhat ineffective. The expectations of the various parties in a construction pyramid - starting with the owner - are often unrealistic and construction disputes are a common feature of much real estate related litigation. With that problem in mind, private business interests have for many years worked out an alternate mechanism to provide some assurance to at least some of the participants in construction pyramids, in particular, those at the lower levels of the pyramid.  This mechanism involves the issuance of "bonds" by specialized underwriters.  There are two general categories of Bonds:

  1. a Performance Bond - a contract entered into by a general contractor and a surety corporation in which the general contractor and the surety corporation guarantee the project owner that the general contractor will perform its obligations under the general contractor's general construction contract with the owner. Where the general contractor fails to perform, the owner may claim against the surety corporation under the bond for the costs of completing the project and certain related costs, up to the maximum amount specified in the bond; and
  2. a Labour and Material Payment Bond - a contract entered into by a general contractor and a surety corporation which guarantees that the general contractor will pay its subcontractors, suppliers and labourers on a specific project. If the general contractor fails to honor its payment obligations, then the subcontractors, suppliers and labourers may claim against the surety corporation for payment under the bond up to the maximum amount specified in the bond. In a large construction project, such bonds may be issued by a surety corporation and a subcontractor to provide assurance to the general contractor that the subcontractor will pay its sub-subcontractors, suppliers, and labourers on the project.

 

A bond of the second of the above-described types (a Labour and Material Payment Bond) was the subject matter of a dispute which was recently decided by the Supreme Court of Canada in the Valard Construction Ltd. v. Bird Construction Co. case (judgment issued February 15, 2018 hereinafter, "Valard Case"). In the Valard Case:

  1. Suncorp was the owner of an oil sands project in northern Alberta and wished to expand/improve its existing project;
  2. Suncorp entered into a (general) construction contract with Bird Construction to effect the improvements;
  3. Bird Construction entered into a contract with Langford (a subcontractor) to perform/assist in performing the general contractor's project improvement obligations owed to Suncorp;
  4. Langford entered into a contract with Valard (as a sub-subcontractor) pursuant to which Valard was required to provide certain inputs to assist/facilitate Langford in the performance of its obligations owed to Bird Construction. Valard did what it was supposed to do under its sub-subcontract with Langford, but Langford failed to pay what was due to Valard and then Lanford became insolvent and completely unable to pay what it owed to Valard. Subsequently - and this related to the core issue before the Court - Valard discovered that to protect itself, Bird Construction had obligated Langford to produce a surety corporation backed Labour and Materials Bond to Bird Construction. Valard then made a claim against the surety corporation for what was owed to it, but was legitimately turned down by the surety corporation on the basis that the bond specifically required that claims be made within 120 days and that that deadline hadn't been met.

 

At the lower Court level, Valard argued that it couldn't make a claim within the 120 day limit because it had no knowledge of the existence of the Labour and Materials Bond. The Court of Appeal held that, in this situation, that was simply Valard's "tough luck". Although there was some dissent, the Supreme Court disagreed and confirmed Valard's claim.

The Supreme Court held that because the parties who could make claims under the Labour and Materials Payment Bond were, in effect, beneficiaries of or under the bond, the holder thereof (here, Bird Construction) owed trustee duties to the beneficiaries.  This included an obligation to exercise at least reasonable efforts to notify the beneficiaries of the existence of the bond. That should have included Valard.  Bird did not exercise such efforts, which might have included, at the least, posting a notice at the construction site of particulars of the bond. Consequently, Bird was liable to Valard for its loss.

The Court's judgements acknowledged that industry practice, at least in the context of the Alberta oil sands developments, was for the holders of Labour and Material Payment Bonds to not have to communicate such bonds' existences to the bond beneficiaries.

Accordingly:

  1. as a result of the Valard Case, it wouldn't be too surprising if bonding/surety companies increased their premiums/charges for bonds, in particular, Labour and Material Payment Bonds.  If the Valard Case results in bond holders making efforts - or greater efforts - to communicate the bonds' existences, it stands to reason that there will be more claims made.  If more claims are made, it is likely that the "price" of construction bonds will rise.
  2. in its recent report and review of the BL Act, The Manitoba Law Reform Commission recommended that bonding become mandatory for construction projects/contracts in excess of $500,000.00 where public works are involved.  As the Commission has stated, there are certain advantages to the use of construction bonds to ensure payment to those involved in real estate improvement which are not available when relying on the remedies available under the BL Act.