Canada: PE Court Of Appeal Says "Knowledge" Not "Notice" Of Lien Sufficient For Priority Over Subsequent Mortgage

On July 9, 2014, the Prince Edward Island Court of Appeal released its much awaited decision in BMO v. 100875 P.E.I. Inc. The decision will have a significant impact on PE's construction industry and its financiers going forward.  The Court of Appeal was asked to determine whether, based on the specific facts, the lienholder or the Bank had priority over the funds being held "in trust" following the property owner's bankruptcy.  Ultimately, relying on unique language in PE's Mechanics' Lien Act, the Court of Appeal decided the lienholder was not required to give "notice" of its existing lien to the subsequent mortgagee for the lien to take priority; it was sufficient that the Bank had "knowledge" of the lien. Accordingly, the lien had priority.   

• Unique Wording of PE's Mechanics' Lien Act. The unique wording of the PE Mechanics' Lien Act section dealing with subsequent mortgages registered after a lien arises, but before the claim of lien is registered, requires only that the subsequent mortgagee have "knowledge of the lien" for the lien to have priority. 
• "Knowledge" and "Notice" Are Not Equivalent. "Knowledge" for this purpose cannot be taken to mean "notice".
• Bank Had "Knowledge". In this case, the Bank had "actual knowledge" a lien had arisen – and this is sufficient "knowledge of the lien" for the purposes of the relevant section of the Act.
• Strong Dissent in Bank's Favour Based on "Of a Lien". One judge disagreed; in his opinion, the Bank must have knowledge or notice that a lien is or is about to be filed – not that one has arisen – for the lien to take priority and in this case, the Bank should maintain its priority.

It's open to the Bank to ask the Supreme Court of Canada to hear an appeal of the PE Court of Appeal's decision. In the meantime, PE contractors and construction lenders must re-evaluate their current practices to ensure their priorities are maintained in light of it.

"NOTICE" v. "KNOWLEDGE: YOUR PRIORITY DEPENDS ON IT

In May 2008, the now defunct Owner hired the Defendant contractor to begin development work on a residential subdivision project.  The Contractor commenced development work shortly thereafter.  Starting in June 2008, the Bank made advances to the Owner to pay the Contractor and in August 2008, the Bank registered its mortgage. Both the Owner and the Contractor held accounts with the financing Bank and dealt with it for the purposes of the financing in respect of the project.  In December 2008, the Contractor filed a claim of lien. The Owner subsequently declared bankruptcy and a Trustee in Bankruptcy was appointed.  The Trustee in Bankruptcy eventually sold the property, but the proceeds were insufficient to satisfy the claims of both the Contractor and the Bank. The Bank claimed it had priority over the proceeds of sale because its mortgage had been registered before the claim of lien was registered; the Contractor claimed its lien had priority because its lien had arisen before the subsequent mortgage and the mortgagee had "knowledge" of its lien.

A majority of the PE Court of Appeal agreed with the Contractor, deciding that the lien had priority over the subsequently registered mortgage given the Bank had "knowledge" of the lien as a result of its involvement with both the Contractor and the Owner in respect of the project.

Unique Wording of PE's Mechanics' Lien Act. Other Canadian jurisdictions require "notice" or "registration" of a lien to effect priority of a subsequently registered mortgage. However, subsection 9(3) of the PE Act dealing with subsequent mortgages registered after a lien arises, but before the claim of lien is registered, requires that the subsequent mortgagee have "knowledge of the lien" for the lien to have priority. Based on this unique wording, the Court of Appeal decided that "knowledge" is sufficient for the purposes of section 9(3) of PE's Act.  

"Knowledge" and "Notice" Are Not Equivalent.  The Court of Appeal made it quite clear that "knowledge" (for the purposes of 9(3)) cannot be taken to mean "notice" (the wording used in subsection 9(4) of the PE Mechanics' Lien Act).  The Court relied a decision of the Supreme Court of Canada of Appeal (Celegene Corp. v. Canada (Attorney General), 2011 SCC 1) for the proposition that "words, if clear, will dominate." In deciding that this "incongruity" doesn't allow it to interpret "knowledge of the lien" to mean "notice in writing of the lien from the lienholder", the Court accepted that:

• subsection 9(3) of the PE Act is an anomaly amongst legislation across Canada; and
• as subsection 9(4) specifically contemplates "notice", "knowledge" in section 9(3) must be taken to mean something separate and apart from "notice" otherwise the word "notice" would have been used.

Bank Had "Knowledge". Both the Owner and the Contractor had accounts with the Bank and the Bank was involved with both of them for the purposes of financing the project.  For these reasons, the Court of Appeal decided that the Bank would have had "actual knowledge" that the Contractor was undertaking work on the project and, accordingly, would have had knowledge that a lien had arisen.  The Court of Appeal accepted that this degree of knowledge constitutes sufficient "knowledge of the lien" for the purposes of subsection 9(3) of the Act. The Court recognized that this interpretation creates challenges for lenders advancing funds to an owner based on a subsequent mortgage but suggested a mortgage lender could:

• ensure its mortgage is a prior mortgage so it falls under section 9(4) instead of 9(3) of the Act – thus requiring written notice rather than knowledge of the lien; or
• obtain a waiver of present and future liens to the extent of the advance under the building or construction mortgage.

Strong Dissent in Bank's Favour Based on "Of a Lien". One of the judges disagreed. This dissenting judge accepted the distinction between "knowledge" and "notice", but focussed on the meaning of the words "of a lien".  In his opinion, the Bank must have knowledge or notice that a lien is or is about to be filed – not that one has arisen – for the lien to take priority. As the Bank had none, it should maintain its priority.  Furthermore, in response to the precautionary steps the Majority of the Court noted, the dissenting judge questioned whether obtaining the contractor's waiver of present and future liens is effective given the contractor can't waive the priority of others, and further the lender's seeks security in the land – not the contractor's solvency.

Read the PE Court of Appeal's decision in BMO v. 100875 P.E.I. Inc., 2014 PECA 12 here.

NEXT STEPS

It's open to the Bank to ask the Supreme Court of Canada to hear an appeal of the PE Court of Appeal's decision, which it may choose to do in light of the:

• significance of the decision to PE's construction industry and its financing; and
• strong dissenting judgment in the Bank's favour.

In the meantime, the PE Court of Appeal's decision will stand and PE contractors and construction lenders must re-evaluate their current practices to ensure their priorities are maintained in light of it. It is notable, however, that section 9(3) of the Act covers liens for materials only and isn't applicable to all liens arising under the Act.

McInnes Cooper prepared this article for information; it is not legal advice. Consult McInnes Cooper before acting on it. McInnes Cooper excludes all liability for anything contained in or any use of this article. © McInnes Cooper, 2014. All rights reserved.