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Important recent rulings In Construction Law

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There are three recent and very important decisions of which owners and contractors alike should take note. One decision concerns an owner’s ability to exclude liability in tendering contracts. The second deals with competing rights between lien claimants and the Canada Revenue Agency to holdback funds. The final decision addresses when suppliers can avail themselves of the breach of trust provisions of the Construction Lien Act.

EXCLUSION OF LIABILITY CLAUSES IN THE TENDER PROCESS – TERCON CONTRACTORS LTD. V. BRITISH COLUMBIA 

The construction industry has been eagerly awaiting this Supreme Court of Canada decision, which was released in February 2010. The story of Tercon began with a Request for Proposal (RFP) issued by the Ministry of Transportation and Highways of British Columbia. The owner awarded the contract to a joint venture which included an unqualified bidder. An unsuccessful bidder alleged that the Ministry had breached the tendering contract. The owner attempted to refute the unsuccessful bidder’s claim by relying upon the exclusion of liability clause in the tender contract. The facts and the particular wording of the exclusion clause are important to the eventual outcome.

The RFP was limited to six eligible proponents. The RFP contained the following exclusion:

Except as expressly and specifically permitted in these Instructions to Proponents, no Proponent shall have any claim for compensation of any kind whatsoever, as a result of participating in this RFP, and by submitting a Proposal each Proponent shall be deemed to have agreed that it has no claim.

Brentwood, one of the eligible proponents, was unable to submit a competitive bid on its own and entered into a joint venture with another company which was not pre-qualified. Together they submitted a bid in Brentwood’s name. The Ministry knew Brentwood’s bid was actually that of a joint venture with an unqualified proponent; of significance is the fact that the Ministry took steps to hide the identity of the bidder. The Ministry accepted the Brentwood bid. Tercon, an unsuccessful bidder, claimed the province had breached the implied obligation of good faith in the tendering contract by entertaining a bid from and awarding the contract to an ineligible bidder. The trial judge agreed and awarded Tercon damages of $3.3 million. At the original trial, Justice Dillon found the province could not rely on the exclusion clause because it had “fundamentally breached” the contract.

By a majority of just five to four, the Justices of the Supreme Court of Canada upheld the trial decision, but in so doing eliminated the doctrine of ‘fundamental breach’. The doctrine of fundamental breach prevents a party from relying upon an exclusion of liability clause in the contract where that party’s actions have deprived the other contracting party of substantially the whole benefit of the contract. All members of the court agreed that when a plaintiff seeks to escape the effect of an exclusion clause, the following new three-part test applies:

  1. Does the exclusion clause as a matter of interpretation apply to the circumstances? The court will assess the intent of the parties as expressed in the contract.
  2. If so, was the exclusion clause unconscionable at the time the contract was made? For example, was this a situation of unequal bargaining power?
  3. If the clause is valid and applicable, should the court nevertheless refuse to enforce the clause because of the existence of overriding public policy grounds that outweigh the strong public interest in the freedom of contract?

Where the majority and minority parted company was the application of this test to the particular facts of the case and the unique wording of the exclusion clause at issue. The majority concluded that the clause did not apply to Tercon’s claim. In coming to this conclusion, the majority considered the special commercial context of tendering, which depends upon the integrity and business efficacy of the process. This factor becomes of particular concern, where, as in this case, the tender was in the context of public procurement. In this particular case, the foundation of the RFP process was a closed list of pre-qualified bidders. Tercon’s claim was not barred by the exclusion clause because “participating in this RFP” could not include an improper bidding process involving unqualified bidders. It is fair to say that the majority was not impressed with the Ministry’s conduct, describing it as “an affront to the integrity and business efficacy of the tendering process.”

In contrast, the minority focused less on the integrity and transparency of the bidding process and more on freedom of contract. In the minority’s opinion, “participating in this RFP” began with submitting a proposal, which Tercon did. To conclude that it ceased to be an RFP process because the Ministry had conducted the process unfairly was a trained and artificial interpretation of the plain words of the contract. Since, in the minority’s opinion, the clause applied to the facts, Tercon had therefore agreed to the exclusion of its claim for damages. Applying the second part of the three-part test, the minority found there was no imbalance in the bargaining power of the parties nor was there any overriding public policy that justified a refusal to enforce the clause. Although acknowledging a public interest in a fair and transparent tendering process and that Tercon had legitimate grounds to complain about the Ministry’s conduct, the minority concluded the misconduct had not risen to the level where public policy would justify depriving the Ministry of the protection of an exclusion clause freely agreed to by Tercon.

What does this decision mean to participants in the tendering process? It is clear that all members of the Court recognize and acknowledge the importance of a fair and transparent tendering process, especially in the public procurement arena. The majority is not saying that owners are unable to exclude damages for accepting a non-compliant bid. If that is the intent, the message from the Supreme Court of Canada is to draft very tight exclusion clauses using clear and unambiguous language to avoid disappointed bidders’ claims. In the wake of the Tercon decision, courts will undoubtedly continue to enforce well-drafted exclusion clauses which they consider to be bargains freely made by sophisticated parties, unless there is egregious conduct or a compelling public policy reason not to. However, since the Supreme Court of Canada could not agree upon the enforceability of the exclusion of liability clause in Tercon, contracting parties continue to have little in the way of certainty when attempting to enforce such a clause or trying to escape its effect.

CRA SUPERPRIORITY – PCL CONSTRUCTORS WESTCOAST INC. V. NOREX CIVIL CONTRACTORS INC.

There has long been a struggle between lien claimants and the Canada Revenue Agency (“CRA”) with respect to priority over holdback funds. In February 2009, the British Columbia Supreme Court released its decision in a trio of cases in each of which the Court was asked to determine whether lien claimants or CRA had priority over holdback funds. The relevant provisions of the British Columbia Builders’ Lien Act (the “BLA”) at issue in PCL Constructors Westcoast Inc. v. Norex Civil Contractors Inc. are very similar to the provisions in Ontario’s Construction Lien Act.

The facts in all three cases followed a similar pattern. The general contractor hired a subcontractor to provide services and materials in respect of a project. The subcontractor hired sub-subcontractors to undertake part of the work. The subcontractor defaulted and the general contractor completed the scope of work and remedied the subcontractor’s deficiencies. The general contractor maintained that, after setting off the completion and remedial costs, no amount whatsoever was owed to the subcontractor. The unpaid sub-subcontractors registered liens and claimed entitlement to the holdback being retained by the general contractor. The subcontractor also owed CRA under the Income Tax Act and the Excise Tax Act for unremitted employee withholdings and GST. CRA claimed entitlement to the holdback on two grounds. Firstly, the Deemed Trust Provisions of the Income Tax Act provide that employee deductions are a deemed trust in the property of the employer in favour of CRA in priority to secured creditors. Secondly, a Requirement to Pay (RTP), sometimes referred to as an ‘enhanced garnishment’, issued by CRA to the general contractor, requires the payer to pay CRA in priority to the interest of secured creditors, including lien holders.

Under the BLA, or the Construction Lien Act of Ontario, the amount owing by the general contractor is a trust fund for the benefit of the subcontractor. However, the subcontractor's entitlement to the fund is conditional in that it cannot lay claim to it until lien rights have expired and money is actually owed to the subcontractor. Accordingly, the Court found that until the subcontractor proves entitlement to the money, its interest in the fund is a conditional right, and no more than that. Therefore, CRA’s interest in the fund cannot be any different. The Court also concluded that the RTP cannot give the CRA a greater claim to the holdback funds. CRA’s interest under the RTP only arises the moment the general contractor becomes "liable to make a payment" to the subcontractor.

In the absence of a CRA claim, where the subcontractor defaults on the contract and liens arise, the usual chain of priority is as follows:

  • a contractor is required to maintain a 10% holdback fund;
  • sub-subcontractors have priority to this fund through the CLA lien scheme;
  • once their lien claims are satisfied, the balance of the holdback, if any, is payable to the subcontractor, subject to any set-off claims of the contractor.

However, in circumstances where a ‘super priority’ claim is asserted by CRA under the deemed trust provisions or under a RTP, CRA’s priority over the lien claimants is limited to the amount to which the subcontractor is entitled after taking into consideration the contractor’s valid set-off. If the subcontractor is owed “NIL” after set-offs, then CRA is entitled to “NIL” and the lien claimants are paid out of the holdback by the general contractor. Accordingly, on the facts of the three cases, because the contractor’s set-off claims exceeded the value of the holdback, the subcontractors could not establish a right to the holdback. That being the case, CRA also had no right to the holdback.

The Court noted the arbitrary result that may result from the application of its decision. Whether or not a lien claimant can access the holdback fund depends entirely on the validity and extent of the payer’s set-off claim. Where the set-off claim of the payer exceeds the holdback, the lien claims receive the holdback in priority to CRA’s claim. However, where the set-off claim is smaller than the holdback, that portion of the holdback (after deduction of the set-off claim) that would otherwise have been payable can be seized by CRA. In that case, the lien claimants are restricted to the remainder (the amount of the payer’s set-off claim). This arbitrariness, the Court said, is the “inevitable result of the collision of two legislative schemes designed by two levels of government, neither mindful of the other.”

The lesson for lien claimants and payers is this: Any payer holding holdback funds that receives a Notice of Assessment or a RTP from CRA, should pay the holdback into Court and consider adding CRA as a party to the lien proceedings so the competing claims of the lien claimants and CRA can be properly considered. The payer should also assess the extent of its right to set-off. The validity and extent of the payer’s set-off claim affects the amount of the holdback that can be claimed by the lien claimants and CRA.

BREACH OF TRUST – MUST THE SUPPLIER INTEND THE MATERIALS BE SUPPLIED TO AN IDENTIFIED IMPROVEMENT? SUNVIEW DOORS LTD. v. ACADEMY DOORS & WINDOWS LTD.

The trust provisions of the CLA are available to persons who supply services or materials to an improvement. It had been generally accepted that, as a result of the 2001 decision in Central Supply Co. 1972 Ltd. v. Modern Tile Supply Co., a supplier must intend that the material sold be used for the purpose of a known and identified improvement before a trust claim arises. In that case, Central Supply Company (1972) Limited (“Central Supply”) supplied floor and wall coverings to Modern Tile Supply Company Limited (“Modern Tile”), a small retailer of floor and wall coverings, for almost forty years. Deliveries from Central Supply to Modern Tile were made to the store, not to any of Modern Tile's customers. The invoices from Central Supply to Modern Tile never referred to the premises where the product was ultimately to be used. Central Supply was unsuccessful in its statutory trust claim because it could not establish that it intended that the material sold be used for the purpose of a known and identified improvement.

In Sunview Doors Limited v. Academy Doors & Windows Ltd., the plaintiff supplier questioned whether Central Supply had been correctly decided. The Court of Appeal, in a decision released on March 16, 2010, held that the trust provisions of the CLA generally require that a link be made between the materials supplied and the improvement, but there is nothing in the wording of the section that requires that the supplier actually intend that the material be incorporated into a known and specific improvement at the time of sale or supply.

Academy Doors and Windows Ltd. (“Academy”), a manufacturer, supplier and installer of windows, doors and curtain walls, placed numerous orders with Sunview Doors Ltd. (“Sunview”) for custom made doors. None of the purchase orders issued by Academy, or the corresponding invoices rendered by Sunview, identified the project or location where the doors were intended to be installed. Academy picked up the doors from Sunview. Academy failed to pay Sunview for patio doors and Sunview commenced a breach of trust action against the principals of the Academy. The trial judge, applying the Central Supply case, held that Sunview was not entitled to the benefit of the statutory trust because Sunview could not establish that at the time it supplied doors to Academy, it intended that they be used for known and identified improvements.

On appeal, the Divisional Court distinguished the facts of the case from those in Central Supply and granted the appeal. Notably, the Divisional Court pointed out that the Sunview doors were not "stock" items. The doors were intended to be incorporated into specific and identifiable improvements. While Sunview could not prove the location of the "known and identified improvements" at the time the materials were supplied, Academy clearly had that information and the destination was known. The Court went on to disagree with the principle from Central Supply that a supplier must intend that its materials be incorporated into a specific and identifiable improvement in order to attract a trust remedy.

The Court of Appeal upheld the Divisional Court’s decision and clarified that a supplier does not need to prove its intent that the material be incorporated into a known and specific improvement at the time of supply to succeed in a breach of trust action. Where the contractor or subcontractor does not allocate the supplier’s material to a particular piece of land or improvement within a project, but it is clear that the contractor or subcontractor has received money on account of the contract price for the project and that the contractor or subcontractor owes money to the supplier, the necessary link to the contractor’s or subcontractor’s contract for the project will be sufficient to establish a statutory trust. In this particular case, the Court was persuaded that the link was established because of Academy’s conduct in deliberately frustrating Sunview’s attempts to obtain the disclosure that would have enabled it to link its products to the improvements into which they had been incorporated.

Although we now know that intent is not part of the breach of trust equation, the decision of the Court of Appeal has not injected much certainty and predictability for suppliers. The necessary “link” between the materials supplied and the improvement will rest on the individual facts of every case.


 Anna Esposito is a Certified Specialist – Construction Law and is the head of the Construction Practice.

Pallett Valo LLP Construction Practice

Litigation risk management in the construction industry requires the advice and guidance of experienced construction lawyers. The Pallett Valo LLP Construction Practice has particular expertise in the resolution of all types of construction disputes. Their practical and timely advice assists our construction clients in meeting their day to day challenges.

Anna Esposito aesposito@pallettvalo.com
Direct Dial: 905.273.3022 Ext. 260
Scott Price sprice@pallettvalo.com
Direct Dial: 905.273.3022 Ext. 221
Maria Ruberto mruberto@pallettvalo.com
Direct Dial: 905.273.3022 Ext. 206
 

This article provides information of a general nature only and should not be relied upon as professional advice in any particular context. For more information about Construction Law contact a member of our Construction Practice at 905.273.3300.

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