Summer 2009 - (Real Estate Brief Summer 2009)
When a construction project faces financial difficulties there are usually a number of parties fighting for limited funds. These parties usually include the owner, the contractor and subcontractors, the lender(s) and government agencies. In these situations contractors and subcontractors have the added benefit of the Builders Lien Act (British Columbia) (the "Lien Act"), and similar legislation in the other common law provinces. The Lien Act gives contractors and subcontractors the right to lien (charge) the property where work was performed if they are not paid.
The recent case of PCL Constructors Westcoast Inc. v. Norex Civil Contractors Inc. , decided by the British Columbia Supreme Court, shows how the involvement of multiple parties and the operation of the Lien Act creates a number of priority rules and schemes. This case involved three separate actions that all dealt with competing claims for holdback funds under the Lien Act. In one of the actions, the competing claims were between the general contractor, who held back funds as required by the Lien Act, the defaulting subcontractor who provided the services, the sub-subcontactors who had lien claims due to the failure of the subcontractor to make payment to them, and Canada Revenue Agency ("CRA") which claimed priority under the Income Tax Act against the subcontractor for failure to remit employee deductions.
PCL Constructors Westcoast Inc. ("PCL") was a general contractor who had subcontracted various works to Norex Civil Contractors Inc. ("Norex"). During the course of construction of the project Norex defaulted on its obligations to PCL and its contract was terminated. Prior to the termination of the contract PCL had paid Norex slightly over $1,100,000 on its contract, with 10% being held back pursuant to the provisions of the Lien Act (the "Holdback"). PCL claimed that the amount that it had paid Norex under the contract exceeded the works performed by Norex, resulting in Norex owing back to PCL more then the sum of the Holdback. Various sub-subcontractors of Norex filed builders liens seeking payment of the Holdback. Lastly, CRA made claim to the Holdback pursuant to a Requirement to Pay with respect to monies owed by Norex for employee deductions that were not paid to CRA.
For the purposes of this article, I will refer to PCL (the general contractor) as the Owner, Norex (the subcontractor) as the Contractor and the sub-subcontractors as the Sub-contractor, as this is the more common scenario and the findings of this case would equally apply to that setup. The Holdback
The person who is primarily liable on a contract under which a lien may arise under the Lien Act must retain a holdback that is equal to 10% of the greater of the value of the work provided under the contract and the amount actually paid under the contract.
The Holdback acts as security for every person engaged by the person from whom the Holdback is retained. The Contractor is entitled to receive the Holdback upon completion of the project or expiration of the Holdback period specified under the Lien Act. If a lien is filed, the Owner is entitled to discharge the filed liens by paying the Holdback into court (and the funds in court then replace the lien as the security). The purpose of these provisions of the Lien Act is to limit the liability of the Owner against any claims that may exceed the amount of the Holdback.
In the PCL case, the position of the Owner was that the Holdback was not due and owing to the Contractor by virtue of its right of setoff claims it has for overpayment to the Contractor under the contract (the "Setoff"). The Owner's position was that since no money is, or ever was, owed by it to the Contractor due to the Setoff, CRA is unable to claim any interest in the Holdback. The Subcontractors, who filed builders liens in relation to their work, also took the position that CRA was unable to claim priority over their lien claims to the Holdback. The Setoff
A setoff right arises when there are mutual obligations between two parties which arise out of the same contract. Courts have held that it is not appropriate for one party to require payment owed to it without taking into account what may be owing the other way.
The Court here went on to state that a setoff arises as work is performed on a contract such that an amount due under that contract is subject to the right of setoff at any given time. Holdback vs Setoff
Applying the principles of setoff, the Court stated that it would be unfair if the Contractor who completes work on a project but causes damage in the process is to be paid the entire amount of the contract before the Owner can sue for damages. The Court concluded that the Setoff, as claimed by the Owner, has the result of making the amount due under the contract unclear and the amount due must be determined first before the Contractor becomes entitled to the Holdback.
As discussed above, the Lien Act precludes the Owner from utilizing the Setoff against the Holdback until the possibilities of any liens arising under the Contractor by the Subcontractor are exhausted. The chain of priority and rights can then be summarized as follows:
The Deemed Trust
- An Owner is required to maintain the Holdback
- Subcontractors have priority to the Holdback
- Once the Subcontractors' claims are satisfied, the Holdback is payable to the Contractor, subject to any claims to Setoff from the Owner
CRA's position was that the Holdback is subject to a deemed trust in favour of CRA (the "Deemed Trust"). CRA, like certain other government agencies, has a super priority that gives it priority over other creditors and, in this case, submitted that pursuant to the Income Tax Act a Deemed Trust in the property of an employer is created in favour of CRA for any payroll deductions withheld by an employer at the time a deduction is made.
CRA submitted that the amount of the Deemed Trust created by the Contractor's failure to submit its payroll deductions exceeded the Holdback and, as such, the entire Holdback should belong to CRA.
In response, the Owner submitted that a Deemed Trust can only attach to property that belongs to the Contractor at the time the Deemed Trust arose. It submitted that as it had a Setoff against the Contractor for an amount that exceeded the Holdback, at no time did the Contractor have a claim to the Holdback, and as such, at no time could the Deemed Trust attach to the Holdback.
The Subcontractors, as builders lien claimants, joined with the Owner in asserting that CRA can make no claim to the Holdback. They argued that the provisions of the Lien Act entitle them to be paid their lien claims out of the Holdback and that CRA had no legal basis for interference. Deemed Trust vs. Setoff
The Deemed Trust creates a strong claim to the property of a tax debtor regardless of when the property was acquired or what security interests it may have subsequently been charged with.
The Court, however, determined that the Holdback, while said to be held in trust, does not create an ordinary trust. An ordinary trust occurs when the beneficiary has an unrestricted beneficial interest. The Holdback was held not to be such an unrestricted interest. Instead, the Holdback is a fund that the Contractor may become entitled to.
The Court held that the Deemed Trust could not result in CRA obtaining a greater beneficial ownership than that of the Contractor. In other words, the Deemed Trust will only give CRA a beneficial right to the property of the Contractor that the Contractor actually holds. The Holdback is a conditional right, and when the Contractor's right is appropriated by CRA through the Deemed Trust, CRA's interest is exactly the same as that held by the Contractor.
In the event of an Owner having a Claim of Setoff against the Contractor that exceeds the Holdback, the Contractor has no rights to any portion of the Holdback. As the Contractor has no claim to the Holdback, neither can CRA. Deemed Trust vs. Lien Claims
The Court, in assessing the applicable provisions of the Income Tax Act ,held that the Subcontractors, as lien claimants, are akin to secured creditors. As CRA takes priority to an employer's property, regardless of any secured interests in such property, CRA would take priority to the Holdback over the Subcontractors. Conclusion
The above priorities create a situation where an Owner's Setoff trumps CRA's Deemed Trust, a Subcontractor's lien claim trumps the Owner's Setoff and CRA's Deemed Trust trumps the Subcontractor's lien claims.
The Court held that in order to effectively work through this scenario the starting point must be whether the Owner has a claim of Setoff.
If there is a provable Owner claim of Setoff then:
if the Setoff exceeds the Holdback:
if the Setoff is less then the Holdback:
- CRA has no claim to the Holdback
- & the Subcontractors are entitled to their lien claims from the Holdback
- the Owner is entitled to whatever remains of the Holdback
- CRA is entitled to the amount by which the Holdback exceeds the Setoff
- the Subcontractors are entitled to their lien claims from the remaining Holdback
- the balance remaining, if any, goes to the Owner
If there is not a provable Owner claim of Setoff then:
- CRA would first get paid from the Holdback
- the Subcontractors are entitled to their lien claims from the remaining Holdback, if any
- the Contractor would be entitled to whatever remains of the Holdback
These priority rules can result in a situation where CRA may be required to litigate on behalf of the Subcontractor to get the Holdback. This situation will arise when the Owner has no claim of Setoff and, thus, no interest in the Holdback, and where CRA's claim is greater than the Holdback leaving no funds for the Subcontractor. Neither the Owner, the Contractor nor the Subcontractor will have any interest in the Holdback, leaving CRA to claim the funds as Holdback moneys.
This article appeared in Lang Michener's Real Estate Brief Summer 2009.