This article was originally published in LexisNexis Construction Law Letter, volume 31, number 1.
Holdback obligations under the Ontario Construction Lien Act [CLA] are stringent. Pursuant to s. 22 of the CLA,the owner is required to hold back 10 percent of the contract price from the contractor, plus the amount of any registered liens of which the owner has received notice, on behalf of subcontractors. In Ontario, this analysis also applies to contractor holdback, for the CLA requires contractors to retain holdback on behalf of sub-subcontractors, and so on. The owner can be personally liable in a lien action for these holdback obligations pursuant to s. 23. So when do these holdback obligations come to an end, and what happens when they do? This paper provides a general answer to these questions.
When do holdback obligations come to an end?
Since owners are required by statute to retain holdback, or risk personal liability for the amounts they failed to properly hold back (and risk paying twice, as the court ordered in Wellington Plumbing & Heating Ltd. v. Villa Nicolini Inc. as a result of the owner's improper payment of holdback to certain subcontractors), it is important to be clear about when holdback obligations end.
The general principle is that holdback obligations come to an end when subcontractors who have done work to improve a property can no longer make a lien claim against the property, and when any existing registered liens have been either satisfied or discharged with respect to the owner who has the holdback obligation.
It is important to recall that there are two kinds of holdback in Ontario, regular holdback (s. 22(1)) and "finishing" holdback (s. 22(2)). Regular holdback applies to subcontractors who performed work prior to substantial performance. Finishing holdback applies to subcontractors who performed work after substantial performance to total completion. According to s. 26 of the CLA:
26. Each payer upon the contract or a subcontract may, without jeopardy, make payment of the holdback the payer is required to retain by subsection 22 (1) (basic holdback), so as to discharge all claims in respect of that holdback, where all liens that may be claimed against that holdback have expired as provided in Part V, or have been satisfied, discharged or provided for under section 44.
In other words, regular holdback obligations come to an end when:
a) the period to register new liens has expired pursuant to s. 31 of the CLA, (i.e. 45 days have passed since the publication of the certificate of substantial performance), and
b) existing liens have been satisfied (paid, resolved in court, or finally settled), discharged with respect to the owner, which includes the common practice of the contractor paying security into court sufficient to cover the liens (bonding off) pursuant to s. 44 of the CLA, or vacated by the owner itself pursuant to s. 44.
Finishing holdback obligations come to an end pursuant to s. 27 of the CLA under the same conditions except that the expiry of the lien period (condition a) above) is 45 days after total completion of the project. If at any point, the project is abandoned, the expiry of the lien period is 45 days from the date that the project was abandoned.
Lastly, the holdback obligation can come to an end piecemeal by virtue of s. 25 of the CLA. If a subcontract is certified complete at the request of the contractor pursuant to s. 33, the owner is no longer obligated to retain holdback with respect to that subcontract if all liens with respect to that subcontract have expired (45 days have passed), or been satisfied, discharged or provided for pursuant to s. 44.
A Shift in Perspective
What happens next? Must the owner release the holdback funds to the contractor? What are the owner's continuing obligations with respect to these funds?
The first step to answering this question is a shift in the way we look at these funds. Holdback is a pure creation of statute, a mechanism designed by the provincial government to ensure that subcontractors and suppliers are paid for their work and materials. This means that once the owner no longer has holdback obligations under the statute, the funds are no longer "holdback," but simply funds owing to the contractor. More precisely, they are the notional profit component of the contract price that has been withheld from the contractor by statute and that now no longer needs to be withheld.
There are five important consequences of this transformation:
- The statutory liability of the owner to the subcontractor for lien claims under the CLA is eliminated.
- The owner has a contractual obligation to pay the contractor.
- The funds form part of the owner's trust for the benefit of the contractor (up to the amount certified as payable to the contractor).
- The owner has a right of set-off of any debts or claims it has against the contractor, whether related to the project or not.
- The owner has the ability to pay subcontractors directly.
We shall address each in turn.
1. No More Statutory Owner-Subcontractor Liability for Liens
Assuming that the security in court for any registered liens has been posted by someone other than the owner (typically, the contractor) which discharges the lien with respect to the owner, the owner no longer has the liability to subcontractors for liens that is imposed by the CLA.
There are several cases stating that in these circumstances, the owner is no longer a proper party to a subcontractor lien action. See, for example, Benny Haulage Ltd. v. Carosi Construction Ltd. and Dominion Bridge-Ontario v. Stephens Sura (Canada) Ltd., and Concord Carriers Ltd. v. Alnet Holdings Ltd.
There are, nevertheless, some important obligations to the subcontractor under the CLA that remain for the owner – in particular, the obligation to respond to requests for information pursuant to s. 39 of the CLA. Upon the subcontractor's written request, the owner must provide, within 21 days, the names of the parties to the contract, the contract price, the state of accounts between the owner and the contractor, a copy of the labour and material payment bond posted by the contractor, and a statement of whether the contract provides in writing that liens shall arise and expire on a lot-by-lot basis.
2. The Owner Is Bound to Pay the Contractor
The funds are owing under the contract, which binds the owner to pay them out to the contractor. The contract price for all contracts comes due when the contract is completely performed. In addition, most contracts will provide for progress payments, which come due at various intervals throughout the life of the project. When the holdback obligation is lifted, and the funds become funds owing to the contractor, there is no longer that restriction on paying the funds out under the CLA.
As explained in the recent case of Crina General Construction Ltd. v. Carrington Homes Ltd., failure to pay the contractor is not necessarily a breach of trust, but the owner is likely to incur liability if payment is not made within a reasonable time. In Salit Steel v. Mondiale Development Ltd., the owner was ordered to pay significant pre-judgment interest, in excess of $600,000, for failing to release the funds as of the 45 days after substantial completion.
Although presently off the table, Bill 69, Prompt Payment Act, 2014 that would have, if enacted, legislated a requirement for owners to pay these funds promptly (within one day after the owner is no longer required to retain the holdback under the CLA). Nevertheless, to date, there has been no legislation enacted requiring payment to be made within any particular time frame.
In the absence of a statutory requirement to pay the former holdback funds promptly, contractors may wish to give thought to including a clause in the construction contract dealing with timing issues with respect to this payment once the owner's holdback obligations come to an end.
3. The Funds Become Trust Funds
Once the holdback funds become funds owing to the contractor, they also become trust funds as required by s. 7 of the CLA (up to the amount certified as payable to the contractor). Subsection 7(2) of the CLA states:
7(2) Where amounts become payable under a contract to a contractor by the owner on a certificate of a payment certifier, an amount that is equal to an amount so certified that is in the owner's hands or received by the owner at any time thereafter constitutes a trust fund for the benefit of the contractor.
The CLA trust obligation requires the trustee and beneficiary to have privity of contract (i.e., they must have contracted with one another). The trust obligation of the owner is, therefore, to the contractor only, not the subcontractors. This principle was outlined in Tri-Tec Drywall Services Ltd. v. Wilson Memorial General Hospital, where s. 8 of the CLA was at issue (the contractor's analogous trust obligation to the subcontractor), and the court found that the contractor did not have a trust obligation to everyone down the construction supply chain. Thus, by analogy, the owner does not have a trust obligation to the subcontractor.
To avoid falling afoul of the trust requirements of the CLA, it is advisable for owners to retain these funds in trust if the owner is not paying them out to the contractor (discharging the trust), rather than using them for other purposes such as the rectification of deficiencies or the satisfaction of other claims against the owner. The owner may incur personal liability if the trust funds are misappropriated.
4. The Owner Can Set Off
As the Superior Court commented in Man-Shield (NOW) Construction Inc. v. Rainy River District School Board, while the funds remain holdback, the owner may not set off any outstanding debts, claims, or damages that the owner might have against the contractor because the holdback is being retained for the benefit of the subcontractor. Once the funds are no longer holdback, however, the owner may set off any outstanding debts, claims, or damages, whether or not related to the improvement, and deduct these amounts from the amount that it releases to the contractor. This right of set-off applies, according to s. 12 of the CLA,even though the funds are held in trust for the benefit of the contractor.
5. The Owner Can Pay Subcontractors Itself
Funds paid by the owner to the contractor, when the contractor owes money to the subcontractors for services or materials, automatically become trust funds for the benefit of the subcontractors pursuant to s. 8 of the CLA. Thus, there is typically no reason for the owner to pay the subcontractors directly.
However, there is provision within the CLA for the owner to pay these funds directly to subcontractors, bypassing the contractor. Pursuant to s. 28 of the CLA,if the owner gives written notice of this payment to the contractor, this payment to the subcontractors is deemed to be a payment to the contractor itself. Thus, the amount that the owner pays to the subcontractors is subtracted from the amount that the owner owes to the contractor. The payment also discharges the subcontractors' liens by the amount paid. This provision specifically states that such a payment cannot reduce the owner's holdback obligations, so it makes much more sense for the owner to take advantage of it, if it is necessary to bypass the contractor and pay the subcontractors directly, once the owner no longer has holdback obligations.
To sum up the takeaway points of this analysis:
Holdback is no longer holdback and becomes funds contractually owing to the contractor when
- the period for subcontractors to register new liens has expired, and
- existing liens have been satisfied or discharged with respect to the owner.
Once holdback is no longer holdback
- the statutory liability of the owner to the subcontractor for lien claims under the CLA is eliminated,
- the owner has a contractual obligation to pay the contractor,
- the funds form part of the owner's trust for the benefit of the contractor,
- the owner acquires a right of set-off of any debts or claims it has against the contractor, and
- the owner has the ability to pay subcontractors directly.
Simply put, it is useful to stop thinking of funds held back pursuant to section 22 of the Ontario Construction Lien Act as "holdback" once the statutory holdback obligations of the owner have come to an end. Instead, they become trust funds contractually owing to the contractor once again.
Benny Haulage Ltd. v. Carosi Construction Ltd., 1996 CarswellOnt 5328 (S.C.J. Master) (WL)
Concord Carriers Ltd. v. Alnet Holdings Ltd.,  O.J. No. 3748, 46 C.L.R. (3d) 313 (S.C.J.) (QL)
Crina General Construction Ltd. v. Carrington Homes Ltd., 2013 ONSC 4303,  O.J. No. 2944 (S.C.J.) (QL)
Dominion Bridge-Ontario v. Stephens Sura (Canada) Ltd.,  O.J. No. 3023, 35 C.L.R. (2d) 1 (Gen. Div.) (QL)
Man-Shield (NOW) Construction Inc. v. Rainy River District School Board, 2012 ONSC 323,  O.J. No. 556 (S.C.J.) (QL)
Salit Steel v. Mondiale Development Ltd.,  O.J. No. 958; 78 C.L.R. (3d) 54 (S.C.J. Master) (QL)
Tri-Tec Drywall Services Ltd. v. Wilson Memorial General Hospital,  O.J. No. 3405, 45 C.L.R. (3d) 314 (S.C.J.) (QL)
Wellington Plumbing & Heating Ltd. v. Villa Nicolini Inc., 2012 ONSC 5444,  O.J. No. 4745 (S.C.J.) (QL)
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.