The priorities between lienholders and mortgagees under the Construction Lien Act are not easy to understand.  They are even more difficult to understand and apply when the owner holds back more than the statutory minimum, and when the liens are discharged by security provided by the owner or mortgagee.

Under sub-section 44(1) of the Act, the court shall discharge the lien upon the payment into court or the provision of security of the full amount claimed as owing in the claim for lien, and the lesser of $50,000 or 25 per cent of the amount of the claim as security for costs. Under sub-section 44(2), the court may vacate the lien upon the payment into court or provision of security in a reasonable amount.

If the liens are vacated upon payment of the full amount of the liens, who is entitled to the difference between that amount and the 10 percent statutory minimum holdback?  Recently, in Basic Drywall Inc. v. 1539304 Ontario Inc. (Receiver of), the Ontario Divisional Court held that the mortgagee had priority to that disputed amount. The decision raises three important questions relating to the Ontario Construction Lien Act:

  • the priorities established in Section 78
  • the lien notice provisions in Sections 24 and 78
  • and the vacation of lien provisions in Section 44

Background

Basic was a subcontractor on the project and had not been paid. It registered a lien for $312, 859. The amount and timeliness of the lien was not disputed.  Other subcontractors also registered liens. When Basic’s lien was registered, the owner owed the general contractor about $276,000 and this amount was never paid. The work was certified as complete.

ICICI Bank Canada provided the mortgage financing for the project. Its mortgage was what is commonly called a “building mortgage”, and is dealt with under sub-section 78(2) of the Act.   The bank posted letters of credit to vacate the liens of Basic and other lienholders.  The Bank agreed that the amount of work certified as complete was about $506,000.  The Bank asserted that the 10 percent holdback that the owner should have maintained was, therefore, about $50,600. The owner had in fact not paid the contractor a much larger amount.

The issue in the case was this:  what amount was available for distribution to the lienholders out of the security provided by the Bank to discharge the liens?  Were the lienholders correct in asserting that $276,000 should be distributed to the lienholders, being the total amount owing by the owner to the general contractor? Or was the Bank correct in asserting that the lienholders were only entitled to $50,600, being the statutory holdback arrived at by applying 10 percent to the amount or work certified as complete? If it was the latter amount, then the Bank was entitled to the disputed amount, being the difference between the two figures, out of the security it had provided to discharge the liens.

The Decision

The Ontario Divisional Court agreed with the Bank.  It held that the lienholders were only entitled to the amount of the statutory holdback. It arrived at that conclusion for three reasons.

First, it held that no notice of any additional lien claim, over the statutory amount, had been given by the lienholders to the owner under section 24 of the Act.  So that section could not enlarge the lienholders’ rights. In any event, section 24 only applied to a “payer” and the Bank was not a payer, and therefore it was not governed by section 24.

Second, the posting of security by the Bank could neither increase nor diminish the rights of the parties, except to the extent that the Act specifically said so.  But section 44(6) of the Act, the court found, specifically said that that upon payment into court or the provision of security, the owner “shall be in the same position as if the lien had not been preserved or written notice of the lien had not been given.”  The court held that the effect of those words was that the “posting security removes ‘notice holdbacks’ as security for lien claimants by the specific language of s. 44(6).”  The court concluded by saying that “the specific language of s. 44(6) restricts an owner’s ‘notice holdback’ obligation from being extended to the posted security.”

Third, the issue between the parties was “a priority dispute.”  The court heldd that “under section 78(2) of the Act, ICICI, as mortgagee, has priority over all but the 10 per cent holdback of $50, 596.98.”

Discussion

This decision deals with a number of important principles in the Act, most particularly the operation of the priority code established in section 78 of the Act, the role of notice of lien to the owner or mortgagee and the effect of vacating a lien upon the provision of security.

Section 78(2)

The first question relates to the proper interpretation and effect of sub-section 78(2) of the Act. That sub-section states as follows:

“Where a mortgagee takes a mortgage with the intention to secure the financing of an improvement, the liens arising from the improvement have priority over that mortgage …to the extent of any deficiency in the holdbacks required to be retained by the owner under Part IV… “

On its face, that sub-section does not create rights for the mortgagee. It creates a specific right for lienholders. That right is to priority over building mortgages (that is, mortgages taken out to “secure the financing” of the improvement). That right is presumably given to lienholders as against building mortgagees because building mortgagees are akin in interest to the owner and are providing financing for the improvement, knowing that lienholders’ rights will be created by that improvement. In other words, building mortgagees are not like other mortgagees who are loaning based on the value of the land and the strength of the mortgagor’s covenant, and may be totally unconcerned as to whether a building is being built and lien rights are being created. Building mortgagees are loaning with the very expectation that lien rights will be created with the monies they are advancing and the Act contemplates that they should ensure that owners maintain the statutory holdback when the mortgage advances are being made. So their rights, unlike other mortgagees’ rights, are always subject to the statutory holdback provision.

Sub-section 78(1) of the Act provides further context for sub-section 78(2). Sub-section (1) states as follows:

“Except as provided in this section, the liens arising from an improvement have priority over all conveyances, mortgages or other agreements affecting the owner’s interest in the premises.”

So sub-section 78(1) states the premise for the whole priority code set out in section 78.  That premise is that lienholders have priority unless section 78 states otherwise.  Mortgagees must find their priority in section 78.  Sub-sections 78(3) to (8) do create specific priorities for mortgagees. But otherwise, sub-section (1) says that lienholders have priority.

The Bank’s argument was that the word “only” should be read into section 78(2), so that it would read that the lienholders’ priority over the mortgage would be “…only to the extent of any deficiency in the holdback required to be maintained.”  In effect, the court agreed with that submission because it held that “under s. 78(2) of the Act, ICICI, as mortgagee, has priority over all but the 10 percent holdback…”  The present question is whether that is the proper interpretation of that sub-section.

Sub-section 78(2) does not explicitly establish any rights in the building mortgagee.  It creates rights for lienholders that do not exist against other mortgagees. Interpreting the sub-section as the Divisional Court’s has done creates better rights for building mortgagees than other mortgagees, limiting their maximum exposure to the statutory holdback  when, at least on its face, the subsection sets a minimum exposure to the statutory holdback (presumably so that building mortgagees will ensure that owners maintain that holdback).  Is the inference of rights in favour of the mortgagee reasonable in those circumstances?

The Notice Provisions in the Act:  Sections 24 and 78

The second question relates to the proper interpretation of the notice provisions in the Act.

As the Divisional Court indicated, section 24 permits a lienholder to give notice of its lien to the owner.  If that notice is given, then the owner may no longer pay out 90 percent of the amounts due to the contractor. The Divisional Court said that if lienholders give such notice then “the lien claimant has security against the owner’s interest in the land to the full extent of the amount the owner, as payer, owes to the general contractor.”  The Divisional Court reasoned that the lienholders had not given notice to the owner of their claim but that “there is no time limit in the Act for giving written notice of a lien to an owner, so any notice before actual payment would suffice to create security against the full unpaid amount vis-a vis the owner.”  However, the court said that the Bank was not a “payer” so section 24 did not apply.

The present question is whether the provisions in section 24 of the Act relating to notice to the owner have any application to the priority issues between mortgagees and lienholders arising under section 78 of the Act. Sub-section 78(1) says that, if the mortgagee is to find any priority, it must find it in section 78. There is specific reference in section 78 to a mortgagee’s priority relating to notice given by leinholders and it is set out in sub-sections 78(4) and (6).   Those sub-sections refer to written notice of a lien to “the person making the advance.”  Absent such a notice to the Bank – and there does not appear to have been any – the Bank might well have been entitled to priority. But determining whether the Bank did have priority would require the application of sub-sections 78(4)-(8), not sub-section 78(2) and not section 24 relating to notice to the owner.    Whether the Bank had priority under sub-sections 78(4) and (6) would have depended upon a number of additional facts besides whether notice of the liens was given to the Bank.  Those facts would have included whether the mortgage was registered before the first lien arose or whether the mortgage advances were made before the time that the first lien arose or was registered. None of those facts were considered by the Divisional Court.

In effect, the priority section, section 78, has its own notice provisions.  Those provisions require the lien claimant to notify the mortgagee making the advance, not the owner.  Unless those provisions afford the mortgagee priority, the lienholders have priority. The notice provisions in section 24 apply to the owner and payments by the owner, not to the mortgagee and the payment of advances made by the mortgagee.  The present question is whether  the Divisional Court was correct in inferring into section 78 the notice provisions is section 24, and then using the absence of notice to the owner to find a priority for the mortgagee through sub-section 78(2).

Vacation of Lien under Section 44

The third issue relates to the effect of the vacation of liens upon the granting of security under section 44 of the Act. The Divisional Court appears to have found that, upon such a vacation of lien occurring, sub-section 44(6) has the effect of putting the lienholders in a position as if they had never filed a lien and never given notice of a lien.  That interpretation raises questions about the efficacy of section 44.

The Divisional Court focused on the words in sub-section 44(6) stating that the owner “shall be in the same position as if the lien had not been preserved or written notice of the lien had not been given.” From these words, the court concluded that “posting security removed the ‘notice holdback’ as security for lien claimants.”  If posting security had that effect, then it is hard to see why it would not have the same effect on the lien itself since sub-section 44(6) refers to both.

The words in sub-section 44(6) should be carefully examined to determine whether the Divisional Court’s interpretation is the intended one.  That sub-section states that upon security being given and the lien being discharged:

“…..the lien ceases to attach to the premises and ceases to attach to the holdbacks and other amounts subject to a charge under section 21, and becomes instead a charge upon the amount paid into court or security posted, and the owner or payer shall, in respect of the operation of sections 21, 23 and 24, be in the same position as if the lien had not been preserved or written notice of the lien had not been given.” (emphasis added)

This sub-section has repeatedly been interpreted to mean that the posting of security does not enlarge the rights of lienholders or give them rights of recovery that they did not have against the land itself. All the sub-section does is replace the land with the security or monies in court.

If this is so, the present question is whether the sub-section should be read to diminish the rights of lienholders in the security or monies in court. What could be the reasons for such a conclusion? Section 46 is an aid to the owner or mortgagee, to allow liens to be vacated by paying into court or providing security, so the job can be completed.  Why would lienholders agree to an order vacating their liens upon the provision of security, and why would the court so order, if that order diminishes the lienholders’ priority as against the mortgagee?

Sub-section 44(6) only refers to the rights of the “owner or payer”.  It does not refer to the lienholders. It does not say that the lienholders rights are diminished at all, and does not state that the lienholders’ rights are to be determined as if the lien had not been preserved or notice of the lien had been given.  Nor does sub-section 44(6) refer to mortgagees or to section 78. It does not say that the priority rights established in section 78 do not apply after a lien has been vacated and security has been provided.  Should sub-section 44(6) be interpreted to affect the rights of lienholders and mortgagees when those rights are not mentioned in the sub-section?

Also, sub-section 44(6) says that the owner or payer shall in respect of the operation of section 21, 23 and 24 be in the same position as if the lien had not been preserved or notice of lien not given. Those underlined word appears to mean that, so far as the obligations of the  owner or payer are concerned and since the liens claims are now secured by the monies in court or other security, the lien is no longer a charge against the holdback  (section 21), the owner is not personally liable for those secured amounts (section 23), and the owner  need not retain monies (under section 24) and can resume payment of the contractor.  Can those words be inferred to affect other rights, and in particular the priority rights in section 78?

These sections of the Act relating to priority, notice of lien claims and vacating of liens are some of the most important sections in the Act. It is to be hoped that the three questions raised in the Basic Drywall decision will be given further consideration by the courts in the near future.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., Chapter 13, parts 2(g) and (h)

Basic Drywall Inc. v. 1539304 Ontario Inc. (Receiver of) (2013), 114 O.R. (3d) 219 (Div.Ct.)

Building Contracts  –  Construction and Builder Liens  –  Hold-back  –  Priorities  – Notice of Lien – Mortgages -Vacating Liens

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                                                           July 3, 2013

www.heintzmanadr.com

www.constructionlawcanada.com