On May 31, 2017, the Ontario Government introduced Bill 142: the Construction Lien Amendment Act that will result in a very new Construction Act.
The new Construction Act, as it will be re-named, is based upon recommendations contained in the April 30, 2016 expert review report Striking the Balance: Expert Review of Ontario’s Construction Lien Act. Bill 142 has only received first reading. Second reading is expected this fall.
The new amendments will have a wide-ranging impact on every business that operates in Ontario’s construction industry. However, from a project finance point of view, the statutory requirements will not change significantly. Most of the changes are subtle.The important elements of the Act that a lender needs to observe in order to release purchase finance funds will not change, but the proposed amendments will affect certain details concerning the release and treatment of building improvement funds.
Definition of Owner
The few changes that are directed squarely at project finance are the revisions to the definition of “Owner” under section 1 of the present Construction Lien Act. The new definition of “owner” is the product of the increased use of “Public-Private Partnerships” or “P3s” as delivery models for public construction projects. The new Construction Act adds a definition of a “broader public sector organization” as well as an entirely new section 1.1 to codify which P3 entity is liable to unpaid contractors.
Pursuant to section 1.1, the “special purpose entity” created under the P3 model to undertake and finance the improvement is deemed to be the “owner” for the purposes of prompt payment (described in greater detail below), and other prescribed purposes under the Construction Act. The special purpose entity is also identified as the party that “contracts with the contractor” under this section. For lenders to construction projects that means that the special purpose entity (the entity to which it is lending) is specifically identified as the party responsible to unpaid contractors and subcontractors. This will address confusion over which of the P3 entities is “owner” for the purposes of preserving a construction lien.
Lien Rights and Holdback
Once the project is funded, lenders are familiar with the requirement to ensure that the lands are free from liens before advancing funds. Section 78 of the Construction Lien Act states that a lender can lose priority to a construction lien if it advances funds after receiving notice of a lien. This provision is not changing.
However, the timeline for contractors and subcontractors to preserve a claim for lien is to be extended from 45 days to 60 days. In addition, the release of holdback will now be mandatory on the 46th day after substantial performance of the contract, if there are no liens on the improvement. These two changes together are designed to allow lien claimant the ability to lien after holdback is released. Lenders should be aware that the result of this is that the release of the final holdback to the Owner will usually not be in jeopardy, as the contractors and subcontractors are much more likely to see if they are paid from the holdback before they register a lien.
Under the Construction Act, construction liens can no longer be registered on title to lands owned by a municipality and must be preserved by “delivery” of the claim for lien or notice of lien (in the same manner as liens are presently preserved on federal or provincial lands). As a result of this revision, lenders will not be able to determine the existence of construction liens by searching title to municipal lands.
In addition, if a lender is required to remove a construction lien from title, a Letter of Credit posted to vacate a lien will now be allowed to comply with international commercial conventions on Letters of Credit. Certain court decisions had effectively prohibited the use of Letters of Credit that referenced the international commercial conventions to vacate liens from title. This change overrides those decisions, and allows companies financed by international lenders to access this procedure under the Act
Bill 142 also includes other interesting changes to the holdback requirements:
a) The amount of the holdback an owner is required to retain (10%) will not change. However, the holdback amount is no longer required to be retained in cash. An owner can retain holdback in the form of a letter of credit or a “demand-worded holdback repayment bond” which will be prescribed by a regulation that will presumably be issued by the government after Bill 142 is passed; and
b) There will also be new provisions for the payment of holdbacks on a “phased basis” for subcontractors that complete their work early (excavation contractors, for example) under contracts that have phases; or on an annual basis for contracts that have a “completion schedule that longer than a year”.
Prompt Payment Obligations
Most significantly to lenders, the amendments include a new mandatory requirement for prompt payment. A general contractor will have 28 days to pay a contractor who issues a “proper invoice” (as defined by the Construction Act), and a contractor will have seven days to pay a sub-contractor after being paid. Payments are required unless the “payor” (a defined term) delivers a notice of non-payment within 14 days of receiving the invoice. Any undisputed amounts will have to be paid. Disputes over invoices are to proceed to a new adjudication regime.
The new prompt payment regime requires payments whether the payor has the money or not. However, whatever the requirement for the payor to pay, there is no equivalent requirement for a lender to fund the payment. The prompt payment requirements do not affect the loan agreement or mortgage provisions between a lender and a proponent of the project. However, since the owner will be required to pay within 28 days, from a practical perspective, payment review and approval processes ae likely to require a careful review and possible revision in order to permit the owner to comply.
Adjudication
The amendments also bring in another brand new, sweeping regime: adjudication of disputes. This is a fast, “rough justice” arbitration procedure adopted from a similar model in the United Kingdom. This will no affect lenders directly, but it is worthwhile understanding the process. Under adjudication, a party may dispute an invoice or non-payment and have the dispute resolved generally within one payment cycle of 28 days or so. Adjudicated disputes could be re-disputed at the end of the project, but, until then, the owner and the contractor (or contractor and subcontractor) will be bound the interim decision of the adjudicator and proceed accordingly. Whether or not the owner may draw on its project loan to make this payment, it will be obliged to make the payment. The UK experience is that they very rarely are re-fought at the end of the project. The aim is to free up cash flow, and not let single invoice disputes escalate into larger problems that put the project at risk.
Trust Provisions
Changes to the trust provisions of the Act (Part II) mean that the money advanced to fund an improvement must be placed in a trust account “in the trustee’s name” and written records must be maintained. Funds from different projects can be commingled, but only if these two requirements are followed. These changes will affect only contracts entered into after the legislation comes into force. As before, all funds received to fund an improvement are impressed with a trust in favour of the entity that provided labour or materials to the party receiving the funds. Lenders have often lamented these provisions as they prohibit lenders from accessing the accounts of over-extended contractors who are behind in their loan payments, because the accounts are subject to this statutory trust.
Financial Information
Finally, a minor change to the requirements to provide information affects mortgagees. Presently, if a contractor or subcontractor serves a “Section 39” notice asking for information about the status of the Owner’s contracts, that person will be entitled to know the amount of the mortgage advanced. The new Construction Act mandates that if the mortgage was partly to purchase land and partly for construction, the mortgagee must now identify the amount that was advanced for construction.
✳In summary, while the new Construction Act should not affect the risks that lenders face in financing projects, the devil is in the details. Lenders must be aware of the revisions and update processes so that they do not run afoul of the new legislation.