ARTICLE
4 July 2024

Caution: Letters Of Credit Challenged As Lien Security In Ontario - Stay Tuned

Letters of credit have been acknowledged as viable forms of lien security by courts for many years, but there is very little case law on this practice and none on the sufficiency of the commonly used standard form...
Canada Real Estate and Construction

Letters of credit have been acknowledged as viable forms of lien security by courts for many years, but there is very little case law on this practice and none on the sufficiency of the commonly used standard form that is found, for example, as an appendix in the precedents section of Conduct of Lien, Trust and Adjudication Proceedings. That is about to change, since this was precisely the matter under consideration in TruGrp Inc. v. Karmina Holdings Inc. 2024 ONSC 2165.

Associate Justice Robinson heard a motion to set aside an order vacating a lien upon posting of security in the form of a letter of credit. His Honour's reasons for decision released on April 15, 2024, put a spotlight on the current commonly used form of letter of credit and whether it is sufficient security for a lien.

Associate Justice Robinson outlined but did not finally resolve the issue of the sufficiency of the letter of credit. The Court will only issue its final decision upon notice and an opportunity for the Accountant of the Superior Court of Justice and the bank who provided the letter of credit to be heard.

It is worth keeping an eye on this matter. The final decision could potentially influence future legal interpretations and practices regarding the use of letters of credit in securing liens.

Vacating a lien

Section 44 of the Construction Act contemplates an ex parte motion to vacate the registration of a claim for lien and certificate of action upon posting "security" in the required amount.

"Security" is not defined in the Construction Act. However, for decades both lien bonds and letters of credit have been accepted as security by the court.

The form of lien bonds is prescribed by s. 2(20) of O Reg 303/18 under the Construction Act, i.e., Form 21. The actual form for letters of credit is not prescribed in the Act however, s. 44(5.1) was added in 2018 to clarify that letters of credit that contain references to an international commercial convention are acceptable for the purposes of s. 44.

As noted, the form of letter of credit at issue is not a mandated form under the Construction Act. It never has been.

A precedent form of letter of credit appears in the appendices to the current edition of Conduct of Lien, Trust and Adjudication Proceedings. The form is substantially unaltered from the precedent that appeared in the first edition of Conduct of a Lien Action in 2004, then authored by Duncan Glaholt. As Mr. Glaholt noted in the preface to the first edition, the Toronto masters presiding over construction lien court at the time provided invaluable assistance and input to that first edition, including in respect of this precedent form of letter of credit.

Associate Justice Robinson correctly notes that there is no case law addressing the sufficiency of the expiry and renewal provisions in the current standard letter of credit; in fact, courts have not addressed why they have accepted the commonly used form of letter of credit as sufficient security.

Background

Karmina Holdings Inc. ("Karmina") moved ex parte for an order vacating TruGrp Inc.'s ("TruGrp") two claims for lien and certificate of action supported by security in the form of a letter of credit issued by the Bank of Montreal ("BMO"). The court reviewed and rejected the initial wording of the letter of credit, for reasons which are immaterial to the issue still to be resolved. Karmina amended and resubmitted the letter of credit. The court approved the amended letter of credit and granted the Order.

Associate Justice Robinson correctly noted that the form of letter of credit at issue had been specifically reviewed, revised, and re-submitted before it was approved by the Court. This was more than just a "pro forma" approval. However, as is permitted by the Construction Act, the order vacating the lien was obtained ex parte and without notice to the lien claimant, TruGrp.

Subsequently, Karmina posted the letter of credit with the office of the Accountant of the Superior Court of Justice (the "Accountant") and registered an application to delete construction lien to vacate TruGrp's registrations from title to the premises.

After its claims for lien and certificate of action were already vacated from title, TruGrp moved to set aside Associate Justice Robinson's order vacating TruGrp's two claims for lien and certificate of action. Alternatively, TruGrp sought directions from the court to address its concerns.

TruGrp's letter of credit contains the same language found in the typical form of letter of credit. The current common form letter of credit provides for the automatic renewal for the letter of credit for the successive one-year periods unless the issuing bank elects not to extend the letter of credit. The bank may only exercise its option not to extend the letter of credit by providing at least thirty days' written notice to the Accountant and providing the Accountant with a bank draft for the balance of the security.

TruGrp initially brought the motion in Hamilton, where the lien actions were brought, however Justice Nightingale directed the motions to proceed before Associate Justice Robinson since the vacating order had been issued by the Associate Justice on an ex parte motion in Toronto. It is relatively commonplace for the Associate Justices in Toronto to hear vacating motions for liens outside of Toronto because they specialize in such motions and have ex parte court time set aside that may not be available outside of Toronto. It is therefore not unusual to seek to bring an ex parte motion in Toronto for a non-Toronto lien, particularly where there is some urgency to obtaining the order vacating the lien. The circumstances here were not unusual and the letter of credit was in standard form.

However, sometime after receiving Associate Justice Robinson's ex parte Order, TruGrp became concerned with the expiry and renewal language in the letter of credit issued by BMO. TruGrp submitted that the language was such that it could result in there being no security for its lien. As proof of this, TruGrp stated that it had received communications from the Accountant which confirmed that the Accountant would not accept a replacement bank draft sent by BMO without both a court order and compliance with subrule 72.03(2) of the Rules of Civil Procedure. Rule 72.03 (2) essentially states that in order to receive payment out of court in accordance with a court order, a person must file with the Accountant a written request for payment, as well as the court order or report ordering the payment, and an affidavit saying that, in the case of a report, the report has been confirmed and the manner of confirmation, or in the case of an order, the time prescribed for an appeal has expired and no appeal is pending or that the appeal period for the order has expired with no pending appeal.

The Legal Arguments

TruGrp put forward numerous arguments why the letter of credit was insufficient in the circumstances:

  1. The terms of the letter of credit providing for potential replacement with a bank draft at the bank's option gives rise to a contingency in the security that is at odds with the Construction Act.
  2. The letter of credit placed duties and obligations on the Accountant that are at odds with the Public Guardian and Trustee Act.
  3. There was a potential gap whereby the letter of credit is not renewed by BMO, but the Accountant will not accept the bank draft as contemplated by the letter of credit without a court order, resulting in there being no enforceable security held in court for TruGrp's lien between that time. Since Karmina is allegedly seeking to sell the liened premises, TruGrp is concerned that it could be left without any security for its lien, contrary to the intent of the Construction Act.
  4. Since nothing in the letter of credit requires notice to any party other than the Accountant, a lien claimant could also be entirely unaware of a potential deficiency with the security for its lien.
  5. The requirement in the letter of credit for the Accountant to accept a bank draft creates positive duties and obligations on the Accountant that are contrary to the scope of the Accountant's statutory role, which is limited to being a "custodian" of lien security. The role and duties of the Accountant are now governed by the Public Guardian and Trustee Act. TruGrp relied on the stated role of the Accountant as a "custodian", in s. 3(7) of the Regulation under that Act, which states that "[t]he Accountant is the custodian of mortgages, securities, other instruments and other personal property deposited with him or her, but has no other duties or obligations with respect to them."
  6. If the letter of credit is not renewed and the bank provides a bank draft instead, it would require the Accountant to interpret the letter of credit to determine if BMO's notice was compliant, then review the bank draft to confirm that it is also compliant, and then decide whether to accept or reject the bank draft, which may require the Accountant to actually investigate the matter. TruGrp argued that these duties are not properly part of the Accountant's role.

Karmina attempted to have the motion dismissed on procedural grounds, relying on five separate arguments for why the court should not entertain the motion. Ultimately, each of these arguments were rejected; Associate Justice Robinson held that now that the sufficiency of the letter of credit had been challenged, the challenge should be resolved on the merits.

With respect to the merits, Karmina maintained that the court's approval of BMO's letter of credit was not contrary to either the Construction Act or the Public Guardian and Trustee Act. It argued that courts have accepted this form of letter of credit for decades without any issues like the one advanced by TruGrp arising. Further, it argued that the approved letter of credit included a specific direction that BMO may provide replacement security to the Accountant by way of bank draft. That being the case, the Accountant, as the custodian of the letter of credit on the terms that have been approved by the court, has no basis for refusing to accept a bank draft from BMO, provided that the required notice of at least thirty days has been given.

The court reviewed but did not resolve the controversy on the merits without first affording the Accountant and BMO an opportunity to make submissions. The matter has been adjourned to allow those parties to be put on notice and to potentially respond.

Commentary

As one if its five procedural challenges, Karmina contended that the issue was moot because there was no evidence suggesting that BMO might not renew the letter of credit or opt for a bank draft instead. There is apparent merit in Karmina's argument regarding the mootness of the issue presented before the court. It is indeed notable that there was no evidence indicating BMO's intention to not renew the letter of credit or the likelihood of it opting for a bank draft instead. It is interesting that the court chose not to wait for a live controversy to address this matter.

In any event, the core matter for Associate Justice Robinson's consideration is whether the initial court order suffices in its entirety, or if a subsequent court order is necessary.

Should the court decide two orders are necessary under the current standard letter of credit form, it could pose complications for lien claimants whose liens are presently secured with the existing form for letters of credit. However, such an outcome appears unnecessary. The court's original Order sanctioned the letter of credit in its presented form, thereby endorsing the possibility of BMO substituting the letter of credit with a bank draft. This approval encompassed an express provision regarding the replacement condition in question. Thus, the court effectively sanctioned BMO's potential substitution of the letter of credit with a bank draft.

In other words, the original order inherently permits the substitution of the letter of credit with a bank draft, even if not explicitly stated. The Order provides that the letter of credit is only cancelled if the bank actually provides a replacement bank draft for the Accountant to accept. The Order, by its terms, at least implicitly requires the Accountant to not only accept the letter of credit but accept it subject to its terms, including tendering of the replacement draft.

Further, a bank draft, a familiar instrument to both banks and accountants, is essentially equivalent to cash. Unlike a normal "cheque" which merely directs one's banker to remit the face value of the instrument, provided that there is adequate credit held to the customer's account with the financial institution, a bank draft asserts to the holder that the issuing or certifying institution financially backs the instrument.

Therefore, in the authors' view the Accountant should not require further explicit court authorization to accept the bank draft as replacement security for the court-approved letter of credit.

The Construction Actspecifies the required forms or contents for letters of credit and bonds but is silent on the language for a bank draft. We believe this omission was intentional by the legislature, recognizing that while letters of credit and bonds may require legislative guidance, no such issues exist for bank drafts.

The historical context of the 1932 Mechanics Lien Act also supports this view. It allowed for the vacating of a lien using a bond or "other security" satisfactory to a judge or officer, without defining "other security." This flexibility has permitted the use of various forms of security, including bank drafts and letters of credit, for over 90 years without significant issues. This long-standing acceptance demonstrates that bank drafts are an effective and appropriate form of security.

Given their equivalence to cash and their established use in legal and financial contexts, bank drafts should be accepted without requiring additional court authorization. This interpretation aligns with legislative intent and practical considerations of efficiency and reliability in financial transactions. If the Accountant maintains that acceptance of the bank draft is contingent upon obtaining a further court order, then it seems logical that the letter of credit persists until such authorization is acquired. The bank cannot unilaterally revoke the letter of credit; it remains valid until all terms are met. This scenario does not appear to endanger or prejudice the lien claimant. Hence, the crux of Associate Justice Robinson's decision lies in determining the sufficiency of the original court order, rather than mandating a second one. Insisting on two orders might introduce uncertainty.

It will be interesting to see if and how the Accountant and/or BMO participate in the relevant motion, as well as the court's ruling on the suitable language for letters of credit utilized in lien security.

It is also worth keeping an eye on this from the perspective of the review of the Construction Act which the Ontario government has appointed Duncan Glaholt to conduct. The form of lien bond, for example, has been mandated by the Regulations to the Construction Act for many years. The form of letter of credit has not. It may be time to resolve any controversy and affirm this longstanding practice by stipulating the acceptable form of letter of credit to post as security through regulation.

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.

Mondaq uses cookies on this website. By using our website you agree to our use of cookies as set out in our Privacy Policy.

Learn More