With the growing complexity and duration of infrastructure projects, construction lawyers increasingly receive questions about facilitating "early holdback release". Due to its previous infrequent use, early holdback release is a concept that is not always well understood. This Davis LLP Construction Law Blog entry considers the availability of this payment mechanism in the context of Ontario's Construction Lien Act (the "Act").
Holdback – The Basics
The essential characteristics of the basic holdback fund prescribed by the Act are well known. As work progresses, each payer under a contract or subcontract is required to retain ten percent of the price of the services or materials supplied as a statutory holdback fund, which provides a form of security for eligible contractors, subcontractors and suppliers. This holdback fund must then be maintained until after the expiry of all applicable construction lien deadlines.
In the case of a private project where a valid construction lien is registered, the lien claimant will assert a charge against the owner's interest in the property upon which the project is located, the value of which will be limited to the lesser of: (i) the amount owing directly to that lien claimant; (ii) the amount owing by a payer to the contractor or any subcontractor whose contract or subcontract was performed using the lien claimant's services or materials; and (iii) the statutory holdback fund. Where the project property is owned by the Provincial Crown and in the case of certain municipal projects, the construction lien is "delivered" rather than registered and the lien claimant's charge will be against the holdback fund only. The lien claimant will not have a charge against the property.
Timing of Holdback Release
The lien deadlines prescribed by the Act are different
for a contractor, who has a direct contract with the project owner,
than they are for a subcontractor or supplier, who is retained by
the contractor. The contractor's deadline to preserve a
construction lien through registration or delivery (as applicable)
is the 45th day following the earliest of: (i) the date of
publication of a Certificate of Substantial Performance of the
contract; (ii) the date the contractor's work is completed; and
(iii) the date the contractor's work is abandoned.
The subcontractor's deadline, however, is the 45th day following the earliest of: (i) the date of publication of the Certificate of Substantial Performance of the prime contract above it; (ii) the date the subcontractor last supplies services or materials to the project; and (iii) the date that the subcontract is certified as complete, as contemplated by section 33 of the Act.
One consequence of this holdback structure is that contractors, subcontractors and suppliers will only be paid for 90 percent of their work until after the applicable lien deadlines have passed. Since a project owner will not want to take on the exposure of releasing holdback to its contractor prior to the expiry of the lien deadline following substantial performance, certain subcontractors and suppliers may wait a long time to receive their holdback funds. On modern infrastructure projects, this waiting period can sometimes be counted in years.
The Act has always contained a built-in potential solution for this problem, an understanding of which is critical for any project owner who is asked to consider an early holdback release and any subcontractor or supplier who wants to request one.
Early Holdback Release Under the Act – the Certificate of Completion
As noted above, one of the potential trigger points for a
subcontractor's lien deadline is the issuance of a Certificate
of Completion of the subcontract, in the form required by the
Act. Such certificates are specifically contemplated
by section 33. The prescribed process is that the contractor
requests the certificate and the payment certifier then issues one
if it is satisfied that the subcontract work has been completed.
Alternatively, the owner and contractor may jointly issue the
certificate on their own.
However, while Certificates of Completion get the clock started on the subcontractor's lien period, they do not, on their own, provide the subcontractor with early access to the holdback fund retained by the owner from the contractor. This issue is addressed by section 25 of the Act, which specifically provides that, where a subcontract has been certified complete under section 33, a payer on a contract or subcontract "...may, without jeopardy, make payment reducing the holdbacks required by this Part to the extent of the amount of holdback the payer has retained in respect of the completed subcontract, where all liens in respect of the completed subcontract have expired...." (emphasis added). In other words, the owner is permitted to reduce its statutory holdback fund through early holdback release payments, if certain conditions are met.
Notwithstanding its availability, there are significant stumbling blocks to the regular use of section 25. First, from the subcontractor's perspective, it is optional for the owner. There is no language under the Act that can be used to compel an owner to release holdback early. Second, from the owner's perspective, there is risk associated with early holdback release. In particular, our courts have held in the past that section 33 (the section which sets out the requirements for a Certificate of Completion) will be strictly construed. Accordingly, an owner's failure to comply strictly with section 33 can lead to significant exposure.
For example, one of the very few decisions in which section 25 of the Act has been reviewed is Plumbing & Heating Ltd. v. Villa Nicolini Incorporated (2012 ONSC 5444). That 2012 case involved a group of mortgagees who exercised their right to sell certain project lands when the project owner defaulted on its financing terms. In so doing, the mortgagees also assumed the owner's holdback obligations.
A dispute arose over the proper amount of the mortgagees' holdback obligations when various lien claimants challenged the validity of early holdback releases that had been advanced by the project owner. Although certain deficiencies in complying with section 33 were seen as minor, curable issues, one of the key complaints asserted was that the payment certifier had issued its Certificates of Completion after the early holdback release payments had been made. The court viewed the issuance of these certificates as an "after-the fact attempt to cure payments improperly made" (para. 72) and found in favour of the lien claimants.
The court acknowledged that this type of decision could result in an owner paying twice, but nonetheless found that: (i) in this case, the mortgagees knew the holdback risk they were taking on in selling the property; (ii) there is nothing unfair in requiring an owner to comply with the Act; and (iii) there was no "windfall" for the unpaid subcontractors (para. 73).
Conclusion – When Should Early Holdback Release Be Considered?
It is increasingly common for construction contracts on large infrastructure projects to include detailed protocols for early holdback release. Since the Act specifically prohibits parties from contracting out of its application, it is essential that such contract provisions are compliant with the Act. Provided that hurdle is met, there can be significant advantages for all parties in addressing the possibility of early holdback release at the contract formation stage. For contractors and subcontractors, such mechanisms bring greater certainty to the timing of holdback release and all of the associated financial consequences. For owners, the advantage is the ability to negotiate a clear and specific process, which ought to reduce the likelihood of taking on additional liability. At the same time, all parties should consider in any given scenario whether early holdback release makes sense commercially and whether they have properly considered the risks associated with it.
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.