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The Feds Must Protect the Rights of Subcontractors In Bankruptcy Proceedings

The construction industry is littered with the bodies of the dead:  Comstock and Kappeler Masonry are but two of the construction companies that have ended up in bankruptcy protection.  Bankruptcy law affects the construction industry more than most.  That is why the construction industry needs to know about subtle changes in bankruptcy law that have put the industry at a disadvantage relative to other creditors, most notably banks. 

 

Bankruptcy in a Nutshell

 

When a company is assigned or petitioned into bankruptcy, the trustee in bankruptcy liquidates the bankrupt company's assets and collects its debts, insofar as it is economically feasible to do so.  The resulting pot of money, called the "estate" of the bankrupt, is divided up among the company's creditors according to the priority rules of the federal Bankruptcy and Insolvency Act.  Secured creditors of the bankrupt company (i.e. banks) typically get paid first.  If there is anything left over for the unsecured creditors they get paid the same number of cents on the dollar. 

 

Importantly, money held by the bankrupt company in trust for someone else does not form part of the estate of the bankrupt company.  That is where Ontario's Construction Act comes into play.  

 

Section 8 of Ontario’s Construction Act

 

Section 8 of Ontario’s Construction Act (formerly known as the Construction Lien Act) imposes a statutory trust upon any money paid to a general contractor for labour and materials.  The beneficiaries of the statutory trust are the subcontractors and suppliers who supplied labour and materials to the project.

 

In the good old days, the statutory trust created by the Construction Act gave subcontractors and suppliers a limited priority over other creditors of a bankrupt general contractor.  Any money paid by an owner to the trustee in bankruptcy were kept separate from the estate of the bankrupt general contractor because they were trust funds.  The trustee in bankruptcy would pay the trust funds to the subcontractors and suppliers on the project instead of paying the money to secured and unsecured creditors.  

 

Atlas Block Changed the Law

 

In the 2014 decision of the Ontario Superior Court of Justice in Royal Bank of Canada v. Atlas Block the Court ruled that only funds subject to a common law trust were to be kept separate from the estate of the bankrupt.  I won't bore you with the distinction between statutory and common law trusts.  The point is that funds impressed with a statutory trust of the type created by the Construction Act now form part of the estate of the bankrupt in spite of the trust.  In other words, as a result of Atlas Block, subcontractors and suppliers lost their limited priority over trust funds. 

 

A Local Example of Atlas Block In Action

 

The Kappeler Masonry bankruptcy illustrates how the Atlas Block case puts subcontractors and suppliers at a disadvantage relative to banks.  The trustee in bankruptcy collected $147,119 from the owner of a project Kappeler had worked on.  The trustee in bankruptcy asked the Court to approve payment of the $147,119 to Kappeler's bank, BMO.  Hargest Concrete Ltd. of Cambridge was a supplier of Kappeler Masonry on the project that had generated the $147,119 payment.  Hargest Concrete Ltd. objected to the proposed payment to BMO.  In the good old days, the $147,119 would have been paid to Hargest Concrete Ltd.  As a result of the Atlas Block precedent, the Court ordered the trustee in bankruptcy to pay the $147,119 to BMO. 

 

We Need a Legislative Amendment

 

The Federal government should reverse the effect of the Atlas Block decision.  It should amend the Bankruptcy and Insolvency Act to exclude funds impressed with a statutory trust pursuant to the Construction Act from the estate of a bankrupt general contractor. 

 

Giving banks priority over subcontractors and suppliers is bad public policy.  First, subcontractors and suppliers should have priority over funds arising from their labour and materials.  Second, Atlas Block gives banks an incentive to push general contractors into bankruptcy so they can jump to the front of the line.  Third, the law is now being applied differently in different provinces because judges in Alberta wisely declined to follow the Atlas Block precedent.  A legislative amendment is needed to bring uniformity to the application of federal law.  

 

In order to convince the Feds to amend the Bankruptcy and Insolvency Act we need as many voices as possible calling for change.  I encourage you to raise the issue with your national trade associations and your local MP. 

 

 

Ted Dreyer is a construction and insurance lawyer at Madorin, Snyder LLP in Kitchener.  It was previously published in the Grand Valley Construction Association Journal and is republished with permission.  This article should not be relied on as legal advice.  

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Introduction to Bill 142 - The Construction Lien Amendment Act

 

Watch a video by Ted Dreyer about Bill 142 and the new Construction Act.

 

 

Ted Dreyer is a construction and insurance lawyer at Madorin, Snyder LLP. Madorin, Snyder LLP is a full service law firm serving Kitchener, Waterloo, Cambridge, Guelph and the surrounding area.  

 

The information contained in this video is provided for general information purposes only and does not constitute legal or other professional advice. Viewers are advised to seek specific legal advice in relation to any decision or course of action contemplated.

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A Simple Example of How the Basic Holdback Works

One of the foibles of Ontario's Construction Lien Act (“Act") is that it does not take project scale into account:  The same rules apply to a bathroom renovation as they do to a multi-million dollar infrastructure project.  In particular, the obligation to retain a holdback applies to all construction contracts regardless of their size or complexity.  While not exactly rocket science, most homeowners and small contractors do not administer the basic holdback properly.  Here is a simple example of how the basic holdback works. 

 

Our example involves an addition to an existing home.  The contract price is $200,000 plus HST.   The contract requires the Owner to pay 30% of the contract price upon the completion of the foundation, 30% when the addition is closed-in, and pay the balance upon completion.  The contract further provides that all invoices are due and payable within 30 days.  

 

Section 22 of the Act requires each "payor" on a construction contract to hold back 10% of the price of the services or materials as they are actually supplied under the contract until all liens that may be claimed against the holdback have expired.  The obligation to maintain the basic holdback applies despite any wording in the contract to the contrary. 

 

When the foundation is complete, the value of the services and materials supplied by the Contractor is 30% of the contract price, or $60,000.  The Contractor should deduct 10% for the basic holdback (i.e. $6,000), apply HST to the balance of $54,000 (i.e. $7,020), and invoice the Owner for a total of $61,020.  The Owner should pay the invoice within 30 days. 

 

When the addition is closed in, the value of the services and materials supplied by the Contractor since its last invoice is $60,000.  Again, the Contractor should deduct the 10% basic holdback (i.e. $6,000), apply HST to the balance of $54,000, and invoice the Owner for a further $61,020.  The Owner should pay the invoice within 30 days. 

When the addition is complete, the value of the services and materials supplied by the Contractor since its last invoice is $80,000.  The Contractor should again deduct the basic holdback of 10% (i.e. $8,000), apply HST to the balance of $72,000 ($9,360), and invoice the Owner for $81,360.  The Owner should pay the invoice within 30 days. 

 

Finally, the Contractor should issue a separate invoice to the Owner for the holdback.  The amount of the holdback is 10% of the contract price, or $20,000.  The Contractor should apply HST to the value of the holdback (i.e. $2,600), and invoice the Owner for $22,600. 

 

Unlike the other invoices, and despite the contract language that invoices are due and payable 30 days after they are rendered, the holdback invoice is payable by the Owner after any construction lien that may be claimed against the project has expired.  All construction liens will have expired 45 days after the contract is complete unless a claim for lien is preserved by registering a claim against title.  Therefore, the Owner should have their lawyer review title to the property on the 46th day after the contract is complete.  If no claims for lien have been registered against title on or before the 46th day after the contract is complete, then the Owner should pay the basic holdback to the Contractor.  If a claim for lien is made before the 46th day, then the Owner should not pay anything further to the Contractor and seek further advice from their lawyer.  

 

Ted Dreyer is a construction lawyer at Madorin, Snyder LLP. Madorin, Snyder LLP is a full service law firm serving Kitchener, Waterloo, Cambridge, Guelph and the surrounding area.  Please visit our construction law page.

 

The information contained in this article is provided for general information purposes only and does not constitute legal or other professional advice. Readers are advised to seek specific legal advice in relation to any decision or course of action contemplated.

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