The Ontario Superior Court recently decided two important issues relating to construction liens. In Wellington Plumbing & Heating Ltd. v. Villa Nicolini Incorporated, the court held that a late-issued pro forma architect’s certificate was invalid, and that GST must be added to a holdback.

Factual Background

Villa Nicolini constructed a retirement home in Vaughan. The project started in 2007 and was to be completed by the fall of 2008. In the spring of 2010, construction was 75% complete and numerous trades were unpaid and had registered liens.

The mortgagees exercised their rights to sell the project lands. To convey title to the purchaser, the mortgagees vacated the registered liens by posting a letter of credit to stand as security for the lien claims in place of the project lands.  The amount of the required holdback was in dispute between the lienholders and the mortgagees.

The lien claimants said that the required holdback was $497,236 while the mortgagees said it was $285,140. The difference between the two figures was due to the parties’ answers to two questions.

First, were the architect’s certificates of completion validity issued?  If not, as the lien claimants submitted, then the releases of holdback based on those certificates did not count toward the holdback and the mortgagees would have to add them to the holdback which had been made by the owner.

Second, was GST required to be maintained as part of the holdback?  If so, as the lien claimants submitted, the amount of GST would have to be added by the mortgagees to the holdback.

The mortgagees argued that the amount of the required holdback was reduced by about $212,000 paid by the owner to subcontractors in accordance with certificates issued by the architect during the project. Those certificates were issued under section 25 of the Construction Lien Act. That section allows the owner to pay subcontractors whose work has been certified by the “payment certifier” as being complete.  The payment certifier is normally the architect or engineer hired for the project.  Section 25 says that, on the basis of such a certificate of completion, the owner may pay the subcontractor “without jeopardy” and the payments reduce the holdback required to be maintained under the Act.

Section 33(2) of the Act says that “where a sub-contract is certified to be completed, the sub-contract shall be deemed to have been completed on the date of certification.”  Section 33(4) says that “within seven days of the date the sub-contract is certified to be completed, the payment certifier or the owner and the contractor, as the case may be, shall give a copy of the certificate” to the sub-contractor, the owner and the contractor.

The lien claimants argued that the architect’s Certificates of Completion did not comply with Act for three reasons:

(i) The certificates of completion were not in the prescribed form (Form 7 under the Act);

(ii) The certificates were not delivered in accordance with Section 33(4);

(iii)  The certificates were prepared after the holdback funds had already been released.

Issue 1:              Were the Certificates of Completion Valid?

The court held that, on the facts, each of these deficiencies actually existed. The court then considered whether those facts rendered the certificates invalid.

The court held that the form of the certificates did not make the certificates invalid. While the Act should be strictly construed so far as the existence of liens is concerned, the Act should otherwise be given a purposive interpretation. The difference in form was a minor irregularity and there was no evidence of any actual prejudice. As a result, the failure to strictly comply with the forms required by the Act did not invalidate the certificates.

As to the second ground, the court declined to decide whether the certificates were invalid, due to its finding on the third ground.  However, the court was troubled by the lien claimants asserting this ground of invalidity since, as the court said:

“the lien claimants now before the Court were never entitled to receive notice of the Certificates of Completion. It makes little sense that they should be able to complain about the non-delivery of a certificate that they were never entitled to receive, when the parties actually entitled to receive them are not complaining.”

On the third ground, the court held that the certificates were invalid.  The court explained its decision as follows:

“I have found that the Certificates of Completion in this case were issued by the architect as an after-the-fact attempt to cure payments improperly made to sub-contractors before the certificates were issued. At the time the payments were made, they were made in violation of section of the Act. There is no mechanism in the Act to cure a violation of s. 25 by a subsequently issued Certificate of Completion. Accordingly, even if [the mortgagee] was able to invoke s. 25 of the Act, I find as a fact that Villa violated the section by releasing funds before the Certificates of Completion were issued. Section 25 requires strict compliance with s. 33(1). The release of holdback funds without compliance with s. 33(1) is fatal.”

The court was concerned that the result might appear to be unfair to the mortgagees.  It concluded, however, that the mortgagees knew that they would inherit the owner’s holdback obligation whatever it might be, that “there is nothing unfair in requiring an owner to comply with the provisions of the Act” and that the subcontractors were not obtaining a windfall because there would in any event be a significant shortfall in the amounts owing to them.

Issue 2:              Was GST a required part of the Holdback?

The lien claimants asserted that GST must be added to the basic holdback obligation of the owner, and therefore, the mortgagees. They said that the contract included GST of 6%, that they were obliged to remit GST to the Canada Revenue Agency as a percentage of their gross sales and that the amounts they receive by way of holdback funds would be reduced by the GST.

No case authority was cited to the court which was directly on point, although the Master’s office regularly calculates holdbacks inclusive of GST.  The court acknowledged that “the Act does not mention GST as a component of the basic holdback.” However, GST funds are trust funds and they must be remitted to the CRA.  If the holdback does not include GST then the parties receiving the holdback will not, on a net basis, receive the 10 percent holdback prescribed by statute.  In the course of the project the owner would normally hold back from the progress payments to the contractor the statutory 10 percent plus GST, and pay that holdback amount, including the GST, at the end of the project.  Accordingly, it is appropriate that the mortgagee should pay the GST into court, and the court so ordered.

Conclusion

These two issues are of practical importance to the building industry and to lenders. Certificates of completion allow a building project to proceed smoothly by permitting the owner to pay subcontractors during the job without fear of having to repay those monies again later.  But the court will not permit that permission to be abused.  If the certification process is a mockery, and if certificates are later issued to paper over payments made without adherence to the statutory procedures, they will be ineffective.

There may be border line situations.  What if the architect actually scrutinizes the subcontractor’s work and decides it is complete and so advises the owner before the payment is made, but writes up the certificate of completion sometime later?  What if the architect writes up the certificate and gives it to the owner before inspecting the work and being satisfied that the work is complete, and then inspects the work later and is so satisfied?  Do these situations offend the Act?  This decision has opened these issues to judicial scrutiny.  The limits of validity of certificates of completion will depend on the extent to which the certificate satisfies or abuses the real purposes of the Act.

The requirement that the holdback include GST, or now HST, seems appropriate, especially when the contract itself refers to HST. This requirement will likely impose an obligation on mortgagees to pay the HST into court to discharge liens since it is doing nothing more than the defaulting contractor would have done if it had paid the holdback to the contractor, that is, pay the holdback and the HST.

Wellington Plumbing & Heating Ltd. v. Villa Nicolini Incorporated, 2012 ONSC 5444

Building Contracts  -  Subcontractor  -  Certificates of Completion  -  Holdback

Thomas G. Heintzman O.C., Q.C., FCIArb                                                     December 28, 2012