Treatment of Surplus Construction Contract Funds in the Bankruptcy of a General Contractor

Authors: Dana Nowak, Eleanor Olszewski, Q.C.

This post was written prior to our January 2017 merger, under our previous firm name, MacPherson Leslie & Tyerman LLP.

The Alberta Court of Appeal confirmed in Greenview v. Bank of Nova Scotia, 2013 ABCA 302, that in the bankruptcy of a general contractor an owner cannot circumvent a secured lender by paying surplus contract funds directly to subcontractors. However, a lender’s security interest only vests in surplus contract funds if the bankrupt was entitled to payment of those funds.

Greenview entered into a contract with Horizon Earthworks Ltd. regarding work on Harper Creek Road. The contract price was estimated at $1,497,824.00. Horizon was paid approximately $723,560.00 when it ceased work on the project and left approximately $900,000.00 unpaid to its creditors.

The contract was bonded through Western Surety Company. The project was completed by a completion contractor by virtue of Western Surety’s performance bond. Surplus funds under the Horizon contract remained after the completion contractor finished the project. Greenview sought to pay the surplus funds to the unpaid unsecured subcontractors of Horizon.

The Court determined that the bank had a perfected first in time security interest in the assets of Horizon. The Court further found that the contractual agreements between Greenview and Horizon did not allow Greenview to pay third party creditors any monies that were owing to Horizon at the date of its bankruptcy.

However, the Court further determined that the matter raised “interesting questions” surrounding the various agreements and whether Greenview in fact owed a debt to Horizon as a result of these agreements. The Court declined to grant the bank entitlement to the surplus funds, stating that a debt owing by Greenview to Horizon must first be established. This issue could not be determined by the Court on a summary basis, therefore a trial of an issue was ordered to determine whether a debt was in fact owing.

Secured lenders must demonstrate that the bankrupt was owed a debt in order to claim entitlement to it. Contractual language limiting a bankrupt’s entitlement to payment may preclude a lender from realizing on that payment. Lenders should exercise caution and due diligence in reviewing clients’ construction contract agreements in order to identify whether there may be issues with entitlement to payments in the event that the client becomes insolvent.