What rights do subcontractors, bonding companies and owners have to project funds when a general contractor is insolvent?
A recent 2017 decision from the Manitoba Court of Queen’s Bench (Manitoba Housing and Renewal Corporation v. Able Eavestroughing Ltd., 2017 MBQB 27) considered an application by Manitoba Housing and Renewal Corporation (MHRC) to pay disputed project monies into Court. In this case, MHRC as owner retained a general contractor to perform repairs and improvements to a residential housing complex (the “Project”). The general contractor arranged for The Guarantee Company of North America to issue a performance bond and a labour and materials bond.
During the Project MHRC maintained the holdback as required by The Builders’ Liens Act (the “Act”). Near the end of the Project a number of builders’ liens were filed by subcontractors. In addition to the statutory holdback, MHRC held back payment to the general contractor, as allowed by the contract, for amounts owing by the general contractor to unpaid subcontractors. On the default of the general contractor, the bonding company paid lien claimants pursuant to the labour and materials bond, and obtained assignments of their rights. In addition, other subcontractors remained unpaid. No claim was apparently made by MHRC under the performance bond because the Project was completed.
A Requirement to Pay was delivered by Canada Revenue Agency (CRA) to MHRC pursuant to The Income Tax Act (the “ITA”) directing MHRC to remit amounts it had retained from the general contractor to CRA in satisfaction of the unpaid tax and source deductions that the general contractor owed to CRA . As the judge referenced, there is case law that has interpreted the provisions of the ITA to take priority over both lien and trust claims arising under provincial legislation.
CRA and the bonding company each made demand on MHRC for the monies that were held. As a result of the competing claims, MHRC sought to pay the monies into Court. At the same time, the Court considered the competing claims by the bonding company and subcontractors and by CRA.
On the application the bonding company argued that MHRC was legally required to pay it the funds on the basis of the law of guarantee and the obligation of MHRC to mitigate those amounts paid by the bonding company. It also argued that MHRC had a legal obligation to pay the trust funds to the subcontractors – and therefore to the bonding company – as it had paid some of those subcontractors under the labour and materials bond.
On the other hand, CRA argued that MHRC had no obligation to pay the funds directly to the bonding company or to unpaid subcontractors and that the funds remained payable to the general contractor. As long as the general contractor remained entitled to the funds held by MHRC, the Requirement to Pay was triggered and CRA’s Requirement to Pay took priority over the claims of the bonding company and the other unpaid subcontractors.
The judge agreed with CRA that the funds were payable by MHRC to the insolvent general contractor such that the Requirement to Pay was triggered. The judge also found that, despite the funds being “subject to lien and trust claims in favour of the unpaid subcontractors” under the Act, the Requirement to Pay took priority.
The judge disagreed with the bonding company that the wording of the contract and the right of subrogation held by the bonding company allowed the rights of the bonding company and subcontractors to defeat CRA’s claim to priority.
From the perspective of the bonding company, the decision raises issues as to the security, or lack thereof, it may have when providing a labour and materials bond or performance bond for a general contractor – particularly when subcontractors are paid out and a holdback remains available.
Because of the permissive wording of the contract between the general contractor and owner as to whether there is any obligation for an owner to pay subcontractors directly, it also raises issues of whether a differently worded contract, or a differently worded Act, would make any difference to the outcome.
From the perspective of subcontractors and suppliers “below” the general contractor in the construction pyramid, this decision is a recent confirmation by the Manitoba Court of Queen’s Bench that, despite the otherwise strict legal requirements in the Act designed to protect those parties, in these situations CRA has priority to both the contractual and statutory holdback on construction projects.
The decision has been appealed to the Manitoba Court of Appeal. What decision the Court of Appeal may render on these issues remains to be seen.
It is worth noting that in Ontario, as part of the Construction Lien Review Act, considerations are being made as to potential legislative amendments to clarify the priority of those involved in the construction industry to project funds subject to a trust over other creditors that may not be directly related in the industry, in an attempt to strengthen these protections and avoid the result of cases such as this one.
Here in Manitoba, the Law Reform Commission of Manitoba is currently performing a broad review of legislation applicable to the construction industry.
The Law Reform Commission will no doubt consider any decision of the Manitoba Court of Appeal on this issue, and whether legislative changes can and should be made in an attempt to strengthen the rights of those directly involved in the industry.
Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.
This article first appeared in the winter 2017 issue of Upword Magazine (now Build Manitoba), a publication of the Winnipeg Construction Association.
John Martens is a partner in the construction law practice at MLT Aikins LLP, Western Canada’s Law Firm. Reach him at (204) 957-4856 or firstname.lastname@example.org.