Canada: Mortgages And Construction Liens

The Construction Lien Act (Ontario) (the Act) is a complex statute designed to provide financial protection to persons supplying services or materials to a construction project in Ontario. Its provisions interact considerably – and in many cases surprisingly – with the financial protection afforded to lenders under mortgage security.

Overview of Construction Lien Act

The Act affords several levels of protection to persons supplying services or materials to a construction project, two of which are relevant for lenders.

The first is a construction lien, or charge, on the premises that have been improved. This lien arises when a lien claimant, who may be a contractor or subcontractor or materials supplier, first supplies services or materials to an improvement. The lien is for the amount owing to the particular lien claimant, including its subcontractors, but is limited to the value of such work performed to the date of the registration of the claim for lien.

Generally speaking, the lien must be preserved by registering a claim for lien against title to the project before the end of the 45-day period following the substantial performance of the general construction contract, failing which, the lien expires. Again, generally speaking, the lien must be perfected by initiating an action to enforce the lien and registering a certificate of action against title to the project before the end of the 45-day period following the last day on which the lien could have been preserved, failing which, the lien expires. There are many further details applicable to the foregoing, but this is the general scheme.

Secondly, the Act requires that a cascading series of holdbacks be retained for the protection of subcontractors that do not have privity of contract with the party making the payment. The holdback is 10% of the price of services or materials supplied and must be maintained by each payor in the construction pyramid at the time that any payment is made. In addition to a charge on the premises that have been improved, lien claimants also have a charge on these holdbacks. The holdbacks are of two types: a basic holdback for the benefit of persons supplying services or materials before the substantial performance of the general construction contract, and a separate finishing holdback – also 10% – for the benefit of persons supplying services or materials after substantial performance but before total completion. Generally speaking, the holdbacks may be released 45 days after the substantial performance of the general construction contract or, in the case of finishing holdbacks, 45 days after the date the general construction contract is fully completed.

Impact upon Mortgage Lenders

The lien and holdback provisions of the Act have a significant impact upon lending practices and procedures and can dramatically affect the priority of a lender's mortgage.

Overall Priority Scheme

The overall priority scheme as between construction liens and mortgages is set out in section 78 of the Act. Under section 78(1), the liens arising from an improvement are stated to have priority over all mortgages affecting the owner's interest in the premises except as provided in section 78. Thus, in the first instance, a construction lien will have priority over a mortgage unless an exception is specifically set out in section 78. Fortunately for lenders, there are a number of exceptions. Each has its own nuances and special features, however, so close attention must be paid.

Building Mortgages

The first thing to consider is whether a mortgage constitutes a "building mortgage" for the purposes of the Act. Special priority rules apply under section 78(2) of the Actif the mortgage is a building mortgage, which is a mortgage taken by the lender with the intention to secure the financing of an improvement – essentially, a mortgage securing a construction loan. Whose intention is relevant? It is the intention of the lender, not the borrower, that is determinative. The lender's intention regarding the use of the mortgage proceeds is usually set out in the commitment letter or loan agreement.

If the mortgage is a building mortgage – and therefore directly tied to the construction project – the Act imposes a special priority regime. A building mortgage, together with any mortgage taken out to repay a building mortgage, is subordinate to the liens arising from an improvement to the extent of any deficiency in the holdbacks required to be retained by the owner under the Act, regardless of when the mortgage is registered. As a result, the lender under a building mortgage, and any mortgage taken out to repay a building mortgage, has to be concerned with the activities of the owner/borrower in effecting and maintaining holdbacks.

This is one of the reasons why construction lenders are particularly vigilant regarding the borrower's construction activities. Construction lenders need to be concerned not just with whether a lien has arisen or been registered, but with whether the proper holdbacks have been retained by the owner under the Act. As a result, the lender is usually directly involved in the holdback process itself, either deducting 10% of each advance at source and holding it in an unadvanced "notional holdback" pool, or requiring the borrower to pay 10% of each advance into a separate escrow account as security to fund holdback obligations. On large construction projects, the lender may also appoint a monitor to ensure that holdback obligations are being observed.

Because the building mortgage priority scheme also applies to mortgages taken out to repay a building mortgage, lenders under takeout financing that will replace a construction loan must also be concerned about deficiencies in the owner's holdback obligations. Usually, construction is complete or at least substantially complete by the time takeout financing is advanced. Thus, the takeout lender's usual due diligence is to ensure that a certificate of substantial performance has been published in accordance with the requirements of the Act and that the time for filing liens has expired, or that sufficient collateral security is taken.

If there are no deficiencies in the owner's holdback obligations, however, then building mortgage lenders and takeout lenders will not be subject to any loss of priority as a result of the building mortgage special priority rules.

Prior Mortgages, Prior Advances

Other than the special rules relating to building mortgages, the rest of the priority scheme set out in section 78 of the Act depends upon priority of registration and timing of advances. These rules also apply to building mortgages. Section 78(3) deals with prior mortgages and prior advances – specifically, mortgages that were registered and advanced "prior to the time when the first lien arose in respect of an improvement". It is important to understand this timing, as the first liens in respect of an improvement arise at the time that the first work commences or the first materials are provided. In particular, it is not necessary for the first lien to have arisen that a claim for lien be registered.

Accordingly, to qualify as the holder of a prior mortgage under section 78(3) of the Act, lenders need to establish whether any work has commenced at, or materials have been supplied to, the property to be charged. On conventional mortgage loans, this is the reason for the delivery of borrowers' certificates or statutory declarations concerning the absence of any construction activity at the property.

If the lender's mortgage qualifies as a prior mortgage under section 78(3) of the Act, then the mortgage has priority over all of the liens arising from the improvement to the extent of all advances made under that mortgage prior to the time when the first lien arose. There is an important exception to this, however. If the actual value of the property at the time when the first lien arose is less than the amount of the mortgage advances, then the lender's priority is limited to the value of the property at the time when the first lien arose. In theory, this preserves for the benefit of lien claimants any enhancement to the property's value effected by the lien claimants. In practice, it means that lenders, particularly construction lenders, must be careful in determining the actual value – which the courts have interpreted to mean the market value – of the property at the time that advances are first made and not to over-advance on a multiple-advance loan.

A graphic example of the trouble that the "actual value" cap can cause for lenders is illustrated by a 1998 Ontario case called Park Contractors Inc. v. Royal Bank of Canada. In that case, a lender advanced money on the security of an environmentally contaminated property. A contractor who conducted environmental remediation work after the registration and advance of funds under the mortgage was able to claim full priority over the mortgage. Although the mortgage was a prior mortgage under section 78(3) of the Act as it had been registered and funds advanced under it prior to the time when the first lien arose, the court determined that the property had no actual value at the time when the first lien arose.

Subsequent Mortgages

If the lender's mortgage is not registered prior to the time when the first lien arose in respect of an improvement, then section 78(5) of the Act applies and the mortgage is treated exactly like a building mortgage: it will be subordinate to the liens arising from an improvement to the extent of any deficiency in the holdbacks required to be retained by the owner under the Act. Accordingly, lenders under subsequent mortgages, like the lenders under building mortgages, need to be concerned with the activities of the owner/borrower in effecting and maintaining holdbacks, as discussed above.

Subsequent Advances

In addition to the special priority rule that arises with respect to subsequent mortgages under section 78(5) in connection with any deficiencies in the owner's holdbacks, the priority of advances under subsequent mortgages is governed by section 78(6) of the Act. The same rules apply to subsequent advances (after the time when the first lien arose) under prior mortgages pursuant to section 78(4) of the Act.

Both sections 78(4) and 78(6) of the Act provide that a subsequent advance made after the time that the first lien arose will have priority over any liens arising from the improvement unless, at the time when the advance was made, there was a preserved or perfected lien against the property or the lender had received written notice of a lien. This is where the existence of registered claims for lien becomes important and this is why it is necessary for lenders to conduct a subsearch at the time of any subsequent advance.

If there is no registered claim for lien disclosed by the subsearch (and the lender has not received written notice of a lien), then the subsequent advance can proceed with full priority over all lien claims (subject to the priority rules relating to deficiencies in the owner's holdbacks discussed above). Conversely, however – and this is one of the most startling provisions of the Act for lenders – if a subsequent advance proceeds in the face of a registered claim for lien, the subsequent advance loses priority not just over the registered claim for lien, but also over all subsequently registered liens on that improvement (see the 1995 decision in Boehmers v. 794561 Ontario Inc.).

Dealing with Registered Liens

As a result of the rule that advancing in the face of a lien could lead to the lender losing priority to all subsequently registered liens, it is not sufficient for lenders to hold back the amount of the lien from the mortgage advance or to rely on an undertaking of the borrower to remove it. If the lender advances $2-million, for example, while a relatively insignificant lien of $1,000 remains registered against title to the mortgaged property, the lender will lose priority not only to the $1,000 lien but also to a $1-million lien registered after the advance is made. Any registered lien must be removed from title or the lender runs a significant and unnecessary risk. How can a registered lien be removed from title? Can such removal be effected quickly so as not to hold up a significant mortgage advance?

Fortunately, the Act provides for an expeditious procedure whereby registered construction liens can be removed from title by posting security with the court. The procedure is outlined in section 44 of the Act and requires that security equal to the face value of the lien, together with the lesser of 25% of the lien claim and $50,000 for costs, be paid into court. The security can be in the form of a lien bond, letter of credit or certified cheque. An attendance in court is required, often by an articling student or young lawyer, but the motion can be brought without formal notice to the lien claimant and can be completed in a single day.

Alternatively, it is possible for a registered lien claimant to postpone its lien to the holder of a mortgage in order to permit a mortgage advance to proceed. This procedure is contemplated by section 43 of the Act and, if a registered lien is postponed to a mortgage, the mortgage holder will enjoy priority not just over the postponed lien but over any unpreserved lien in respect of which no written notice has been received by the mortgage lender. In other words, provided no written notice of another lien has been received by the lender, the ability of subsequent-ranking lien claimants to establish priority over mortgage advances effected in the face of a lien will not apply. A postponement, however, has no effect on the priority that liens may enjoy as a result of any deficiencies in the owner's holdbacks.

Lenders sometimes also encounter claims for lien that were registered long ago, but never perfected by the subsequent registration of a certificate of action. These registrations can usually be deleted without having to obtain a court order or to post security. Depending on the circumstances, it is usually possible to have such registrations removed by registering an application to amend the register under section 75 of the Land Titles Act (Ontario) citing the fact that the lien has expired.


In summary, a lender needs to be concerned with a number of different issues in ensuring that its mortgage will have priority over construction liens. Is the mortgage a "building mortgage" taken with the intention to secure the financing of an improvement? Or is it a subsequent mortgage, registered after the time when the first work commenced or materials were supplied to the property? If so, the lender needs to ensure that the borrower adheres to its holdback obligations under the Act. If the mortgage is registered and advanced prior to the time when the first work commenced or materials were supplied to the property, the lender has to ensure that the aggregate amount of its loan advances does not exceed the market value of the property at the time when the first lien arose. Finally, for all mortgage advances effected after the time when the first lien arose, the lender must ensure that there are no registered construction liens and that the lender has not received written notice of a lien.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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