The recent Court of Appeal decision in Urban Mechanical Contracting Ltd. v. Zurich Insurance Company Ltd., 2022 ONCA 589, has left open the possibility that a surety bond may be subject to rescission in case of fraud even where the rights of innocent third parties may be engaged. The decision was made after two applications were heard in writing on the discrete legal issue of whether rescission was available. The Superior Court judge ruled that rescission was available as a remedy but the determination could not be made in a vacuum.
On appeal, the Court of Appeal agreed with the lower court that rescission was available to the parties, at law, but the determination must be made with the benefit of a full record at trial.
In 2011, St. Michael’s Hospital entered into a contract to build a patient care facility. The construction contract was awarded to a wholly owned subsidiary of Bondfield Construction Company Limited (“Bondfield”). Bondfield was required to obtain a performance bond and a labour and material payment bond. The bonds were issued by Zurich in 2015.
By 2017, Bondfield was struggling to meet payment deadlines. A number of subcontractors made claims on the payment bond and Zurich paid the claims. Bondfield continued to experience financial difficulties. In November 2018, a receiver was appointed and the performance bond was called on. While Zurich was preparing to file materials in the receivership, it uncovered email communications between Bondfield and Hospital representatives disclosing alleged fraudulent misrepresentations which enabled Bondfield to win the contract.
Zurich took the position that had it known about the fraud, it would never have issued the bonds. Zurich commenced an action seeking declarations that the bonds be rescinded and sought to recover the money paid out under the bonds prior to rescission. Multiple subcontractors with unpaid claims under the payment bond brought applications seeking declarations that, as a matter of law, Zurich could not the rescind the bonds, as doing so would affect their rights as innocent third parties.
Rescission as an equitable remedy
The subcontractors argued that rescission is not available as a matter of law whenever the rights of innocent third parties are engaged. The court reviewed the jurisprudence and concluded that innocent third parties are not an absolute bar to rescission in the face of fraudulent misrepresentation. Such a determination must be made with a full record at trial where the trier-of-fact can take into account all the facts and circumstances of the particular case in order to dispense practical justice. A full factual record was particularly important given that Zurich had alleged that certain subcontractors with claims on the payment bond had participated in the fraud.
Equitable remedies and the Construction Lien Act
One question to be answered by the court was whether rescission of the bond can co-exist with the statutory remedies granted under s. 69 of the former Construction Lien Act (“CLA”). It is established law that a statutory scheme may oust equitable rights that would otherwise be available to the parties. However, to do so, the legislature must have expressed its intention to do so with “irresistible clearness” (Moore v. Sweet, 2018 SCC 52).
The relevant investigation in this case, then, was whether the CLA codifies, replaces or repeals, or leaves gaps that the common law must fill. At common law, trade contractors did not have a cause of action against the payment bond as they were third parties to the bond. While the industry had adopted a trust form of bond to remedy this problem, there remained some doubt as to its effectiveness. To address this problem, s. 69 was enacted to provide trade contractors with a direct right of action on the payment bond. In reviewing the legislative history of s. 69, the Court found no record that the statute contemplated the trades’ right of action on the payment bond when the bond was founded on fraud. On this basis, the court held it was not appropriate to foreclose this argument without hearing full submissions on this issue.
The Court of Appeal’s decision signals that should rescission be granted after a trial, that determination will be based on specific factual circumstances. For future litigants, such a determination is likely to be easily distinguished. For stakeholders in the industry, particularly underwriters and surety companies, this decision highlights the importance of a full and thorough prequalification and investigation of potential contractors.
 While section 69 of the CLA has been replaced with s. 85.2 of the new Construction Act, the operative language remains unchanged.