There’s a passage in Ernest Hemingway’s novel The Sun also Rises in which a character named Mike is asked how he went bankrupt: “Two ways,” he answers. “Gradually, then suddenly.” We’ve all heard the story before… It starts with a delay in payment, then one is missed entirely – the next thing you know, you are knee deep in legal proceedings trying to recover some of the costs you expended on a project.
Many contractors and suppliers in Canada are willing to risk this gradual slope, believing that they will ultimately be able to rely on their statutory lien rights to provide some protection from the impending cliff. As any construction lawyer will tell you, however, liens are not always as simple as they sound. The fundamental question that needs to be asked, specifically in an insolvency context, is whether the contractor or supplier’s claim is “lienable”.
The lienability of a claim is determined pursuant to s.14(1) of the Construction Act, which provides: “A person who supplies services or materials to an improvement for an owner, contractor or subcontractor, has a lien upon the interest of the owner in the premises improved for the price of those services or materials”. In practice, the question of lienability often comes down to three things that need to be analyzed – “supplies services” or “materials” to an “improvement”.
The court in Toronto Dominion Bank v. 450477 Ontario Ltd., 2016 ONSC 4908 (S.C.J., Commercial List) reviewed the test for “lienability”, specifically looking at different variations where materials and services are on-site and non-construction related, or off-site and construction related. In this regard, Master C. Wiebe stated that: “The test should be a functional one, namely one that turns on the importance of the function to the project served by the work, not on the geographical location of the work or on the object of the work.” Therefore, a link must exist between the services or material and the improvement to the project, and determining whether this nexus exists, requires an in-depth factual analysis.
The important takeaway from this is that not every claim will be covered by the lien and a contractor or supplier would have to recover that amount through the normal dispute resolution channels. Lienability becomes even more crucial when the main contractor goes into bankruptcy and insolvency protection, as it can then mean the difference between having a priority claim against the funds available for distribution or hoping that some scraps are left to partially satisfy a general unsecured claim. Lienability is directly linked to priority, and consequently recoverability, and the onus of proving this falls on the creditor’s shoulders. It may therefore be useful to look at specific examples of what claims are and aren’t lienable:
In Stucor Construction Ltd. v. Brock University, 2001 CarswellOnt 3678, Taliano J. summarized the position in relation to delay damages: “It is clear from this section [s.14(1)] that a lien does not lie to recover damages suffered as a result of a tort or breach of contract since such a recovery would not form part of the "price" of the services and materials supplied to the improvement… Although the contract contains a provision for reimbursement to the plaintiff for costs incurred as a result of delay for which the defendant or its agents are responsible, it is one thing to have a right to recover damages for breach of contract and quite another to be entitled to a lien.”
A clear distinction should be made between the entitlement to claim damages and the lienability of such claim. The Court however went on to clarify that delay costs could, in certain circumstances, be lienable: “…damages which can be equated to compensation for the supply of services or materials to an improvement can support a claim for lien. Accordingly, even though the plaintiff itself has characterized its claim as being partly for damages, if its allegations regarding the owner's delay are valid, and its claim is subsequently determined to have added value to the improvement in the form of services and materials, then the lien is enforceable.”
Although the court did not specifically mention the test that applies, the reasoning provided appears similar to Toronto Dominion. One must also distinguish between the type of damage, which does support a lien and damages flowing from, for example, loss of profits on other jobs which it was unable to undertake because the respondent's delay unduly prolonged work on the present job. The latter claim would not be lienable.
Administrative overhead and onsite office overhead costs are generally not lienable. In Selectra Inc. v. Penetanguishene (Town), 2016 ONSC 2293, the court listed a number of non-lienable services, which included among other things: Setting up a sales office; Making building permit applications; Negotiating with various building trades; Dealing with local municipal officials; Communicating with and assisting the site supervisor with respect to decision making; Supplying construction management services including inter alia reviewing tenders, selection of trades, supervision of site superintendent and coordination of trades; Hiring; Reviewing tender documents and calculation of bids; Review of blueprints to assess material and labour requirements; Communications with suppliers to solicit quotes and coordination of the responses; Maintenance of binders at the office containing key project information; and preparation of progress billing statements.
These services often cannot be said to be supplied in respect of an improvement as those services are "not so directly related to the construction of the improvement" to fall within the contractual chain on construction projects that are given a financial preference and a security interest by the Act.
In Structform International Ltd. v Ashcroft Homes Construction Inc, 2013 ONSC 4544 (S.C.J.), the court noted that the extended duration costs claimed by the lien claimant such as crane and forming equipment as well as outside rentals such as concrete pumps being on site for the extended duration of the contract were legitimately lienable. However, other elements of the "delay costs" were simply a damage claim and not subject to lien rights. These included the "head office overhead" and meal allowance and fuel allowance charges which were never the responsibility of the owner under the contract. These amounts had to be backed out of the claim for extended duration for lien purposes.
A distinction should also be made between fixed price and cost-plus contracts. Fixed price or lump sum contracts already incorporate an element of overhead and profit in the contract price and therefore form part-and-parcel of the value of the improvement. Cost-plus contracts however, divorce overheads and profit, potentially excluding them from the value improvement.
There are a number of (often conflicting) judgments dealing with claims for overhead costs, however the golden thread that seems to run through these judgments is a question of whether the materials or services, “…contribute in a direct and essential way to the construction and improvement.”
The classic case on claims for additional labour is Marentette Bros. Ltd. v. City of Sudbury et al., 1972 CanLII 615 (ON SC); affirmed 1974 CanLII 444 (ON CA). The principle of that case is summarized as follows: “Where an owner fails, in breach of his obligation under a building contract, to facilitate the work for the contractor, and the contractor, in order to complete on time, is consequently compelled to make movements of men and machinery that would otherwise have been unnecessary, there is an implied contract that the owner, by requiring completion, will pay the reasonable value of the additional work caused to the contractor by the owner's default.”
In Structform the court recognized the possibility of additional labour hours forming the subject of a lien, where the labour hours reflect the labour actually used on the improvement and not already contained in change orders. The court however added an additional consideration when it comes to fixed price contracts, stating: “A contractor cannot simply charge extra labour charges to a fixed price contract because it had to use more labour than "usual". Some amount of risk of cost escalation is assumed by the contractor.”
Section 14(1) concludes with the following, “…improved for the price of those services or materials.” This adds an additional factor to consider, as a claimant will only be entitled to the actual “price”. As in Structform, the court in Selectra shared a similar view in relation to fixed price contracts:
“A lien is limited to the amount a contractor is owed. If there is a fixed price contract, in the absence of approved change orders, the contractor cannot include in its claim for lien extra labour or materials charges for work described in the fixed price contract simply because those costs were more than usual or anticipated when the fixed price contract (or change orders) were agreed to. Some amount of risk of a cost escalation is assumed by the contractor.”
In Franro Property Development Ltd. v. Heritage Glen North Ltd., 1993 CarswellOnt 2572 (Gen. Div.), the court cited Re Canario Development Corp. and Fitzsimmons, MacFarlane, 1987 CanLII 4183 (ON SC), a decision of the Ontario Supreme Court, for the proposition that "services" referred to in the Construction Lien Act of Ontario do not include legal services which are covered by the Solicitors Act of Ontario and which cannot be the subject of a claim for lien.”
The question of lienability is often a fine line, and there isn’t always a guarantee that a claim will receive protection under the Act. Parties should be cautious and open to potential signs that there is trouble up the construction pyramid. Parties should also remember to explore other potential avenues for recovery in addition to a lien, including trust claims or claims under any labour and material payment bonds.