Canada: Advances In The Face Of Liens: RSG Mechanical Inc.'S Guide To Owners And Lenders

This article originally appeared in The Construction Economist. The Construction Economist is a publication of the Canadian Institute of Quantity Surveyors (CIQS) and can be found at 

The Ontario Construction Lien Act ("CLA") attempts to strike a balance between the interests of those at the top of the construction ladder (i.e., owners) to have the necessary funds flow to complete a project and the interest of those at the bottom of the construction ladder (i.e., suppliers and small sub-trades), with limited bargaining power, that require the protection afforded by the ability to possibly halt a project by registering a construction lien against title to the project to ensure that they receive a portion of the pool of funds held back for their benefit.

In theory, the scheme is fairly simple. Pursuant to section 24 of the CLA, upon notice of a lien, anyone paying down the construction ladder has to withhold not only the statutorily required minimum of 10 percent of the value of the services and materials provided, but also the entire value of the claim for lien.

Similarly, under section 78 of the CLA, a mortgagee, whether a prior mortgagee making a subsequent advance or a mortgagee that registered its interest after work commenced, is discouraged from making an advance after a lien is registered against title and/or it receives notice of the lien by having the lien, as well as any subsequent liens that are registered against title, take priority over said advance.

In order to permit funds to continue to flow once a lien is registered against title, the parties either have to settle or the face value of the lien, plus the statutorily calculated security for costs, have to be paid into court pursuant to section 44 of the CLA, whereby the lien ceases to attach to the land and becomes a charge against the amount paid into court. By paying said funds into court and vacating the lien, the party posting said security is put in the same position as if the lien had not been preserved or written notice had not been given and payments may continue to be made.

Typically, the party on the rung above the lien claimant will vacate the lien.

Unfortunately, when someone on a rung of the construction ladder between the owner and the subtrades which registered liens becomes insolvent, the number of liens that are registered may be significant and the amount of money that needs to be posted may require the mortgagee to step in.

In such circumstances, financers and developers need to ensure that the subsequent flow of funds strictly complies with the provisions of the CLA, failing which, said parties may needlessly increase their exposure.

The Divisional Court's decision in R.S.G. Mechanical Inc. v. 1398796 Ontario Inc. ("R.S.G. Mechanical"), highlights, amongst other things, this particular issue and provides guidance as to how a mortgagee or owner can vacate liens without increasing their exposure beyond their statutory holdback obligations under the CLA.

In R.S.G. Mechanical, the developer, Bloorwood, purchased a parcel of land in 1999 with the intention to build sixty-one townhouses and potentially thereafter develop a high-rise condominium.

Not having the necessary funds to purchase the lands, post Tarion new home warranty security, and/or finance the construction itself, Bloorwood obtained funds from investors, financers, and its own shareholders, which secured their respective interests by way of registering mortgages against title to the land.

By May 2004, Bloorwood, which acted as its own general contractor and contracted directly with each trade, had constructed and sold forty-nine of the sixty-one planned townhomes and had ran out of money. As a result, fourteen (14) claims for lien by eleven (11) lien claimants, totaling $804,226.27, were registered against title to the lands.

By June 4, 2004, Bloorwood's registration with Tarion had expired and construction had effectively halted in the summer of 2004.

At that time, there were still 12 more townhomes to be finished and sold, as well as the proposed high-rise development, and the first/fourth mortgagee retained a general contractor, Maystar General Contractors Inc. ("Maystar"), as the mortgagees wanted to complete the remaining townhomes in order to mitigate their losses and maximize their recovery.

In order to have the sales close, the 14 liens needed to be vacated and, although the ten percent statutory holdback was found to be $424,537.00, a total of $978,588.74, being the full value of the liens plus security for costs, had to be posted to vacate the liens.

Accordingly, the first/fourth mortgagee provided $424,533.00 in funds to counsel for the third mortgagee to vacate the liens and on December 30, 2004, the liens were vacated.

After the liens were vacated, the mortgagees paid Maystar $309,465.00 for work that it had commenced on November 1, 2004, and Maystar completed 6 of the townhouses.

Thereafter, the mortgagees made a further payment to Maystar of $339,671.50 to complete the remaining 6 townhouses.

The lien actions were consolidated and referred to Master Polika, who found that by posting security and obtaining an order vacating the liens the mortgagees had made an advance under section 78 of the CLA and the lien claimants were entitled to not only the value of the deficiency in the holdback, being $424,537.00, but also had priority over the mortgagees with respect to the balance of the funds used to vacate the liens and should be paid in full from the security.

Master Polika also found that the lien claimants had priority over the mortgagees with respect to the amounts paid to Maystar to complete the 12 remaining townhomes.

On the motion to confirm Master Polika's Report, Justice Meyers found that the monies used to complete the 12 townhomes and funds used to post security were not advances under the CLA, the lien claimants were only entitled to deficiency in holdback, being $424,537.00, and Master Polika's report should be amended accordingly.

In affirming Justice Meyers' decision, the Divisional Court held that in order for funds delivered by a mortgagee to be deemed an 'advance', an owner or owner's delegate needs to acquire actual control of the money. Funds delivered in escrow to counsel for the sole purpose of vacating liens are not an advance that would increase a party's liability under the CLA. Furthermore, the fact that the funds held in escrow are not eventually posted and a bond was used to vacate the liens is immaterial, provided no funds were released from escrow until after the liens were vacated.

With respect to Master Polika's finding that the lien claimants would have priority over funds paid to Maystar, the Divisional Court held that, provided a trade does not receive payment when the liability was incurred (i.e., the work was done) on the understanding that it will not be paid prior to liens being vacated, subsequent payments to a trade for work done prior to the liens being vacated would not increase a party's liability under the CLA.

Although it would be preferable to vacate liens without relying on the mortgagee to do so, R.S.G. Mechanical sets out how to have a mortgagee provide funds to vacate liens and have replacement trades commence work prior to vacating liens, without increasing its liability to lien claimants.

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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