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.