Can A CCAA Order Affect The Priority Of Lienholders?

In Mission Creek Mortgage Ltd. v. New Recreations Ltd., the British Columbia Court of Appeal recently held that a lienholder whose liens had been discharged by an order made under the Companies’ Creditors Arrangement Act (CCAA) upon payment of security for their claims did not have any priority over or entitlement to that security.  This decision depended upon the wording of the Order by which the liens were discharged. Accordingly, this decision may alert owners, lienholders and mortgagees to the importance of the wording of orders discharging their liens and the submissions that are made when those orders are made, and may give rise to disputes over those orders in the future.

Background  

New Recreations was the owner and developer of property and obtained mortgage financing from Mission Creek Mortgage.   New Recreation contracted with construction companies for the construction of the project and the construction company registered liens when they were unpaid.  The project was delayed due to municipal bylaw issues. New Recreations ran into financial difficulties and brought an application for creditor protection under the CCAA.

During the CCAA proceedings, Mission Creek Mortgage advanced Debtor-in-Possession (“DIP”) funds to New Recreations. The funds were to be used, in part to satisfy the claims of lienholders which at that time amounted to about $750,000. The liens were discharged pursuant to a court order which provided that a security fund in the amount of $722,162.37 was to be held in trust pending the determination of the validity of the lien claims.

The order stated that:

“4. The cancellation of the Liens against the Property pursuant to the provisions of the Builders Lien Act shall not deprive New Recreations, the respondents, or any other interested party, including secured or unsecured lenders, of the benefits of the provisions of the Builders Lien Act applicable to the Liens, the Security being in substitution for the Property;

5. The Order shall not affect the right of any person to claim that the Liens are improper or defective, or that the filing of the Liens has been improper or defective, nor shall the Order affect any right of any person under the Builders Lien Act;

6. Payment of the Security and the discharge of the Liens shall in no way change the relative priority of all creditors of New Recreations to the Security or the Property, the Security being substitution for the Property. For greater certainty, the secured creditors ….shall maintain any and all rights of priority that may exist to the Security, the Security merely standing in substitution for the Property.”

At the time of the making of this order, counsel for Mission Creek Mortgage said to the motion judge:

“[I]nclusion of paragraph 6 in the notice of application which maintains the priorities in the same manner as they are against the land such that if at the end of the day recovery was not sufficient from the land to pay out my client in full, my client would be in first priority on these funds. Hopefully that won’t be the case, but that’s what I understand paragraph 6 to be doing and on that basis we don’t have an issue with the application.”

Counsel for the lienholders on the motion advised the court they had no position to take on the application and the funds being held in a solicitor’s trust account.

The subsequent development was unsuccessful due to the bylaw problem. Mission Creek Mortgage caused the property to be sold.  The amount due under the mortgage financing was about $19 million and the amount advanced under the DIP financing was about $3.1 million. The amount realized on the sale was about $17.9 million or about $4 million less than the amount owing under the mortgage and DIP financing. The DIP financing was paid back out of the proceeds of sale. The lienholders asserted that their claims to the moneys being held in the security fund took priority over the mortgage and DIP financing.

The motion judge held that the mortgage and DIP financing had priority over the liens.  The motion judge said, in part:

“To interpret the Security Order as now suggested by the Lien Claimants would wholly re-order existing priorities when the clear intention of New Recreations Ltd. and the petitioner as made known by their counsel to the court was directly opposite the position now advanced by the Lien Claimants….I am not prepared to conclude in the face of the Lien Claimants’ silence at the time the Security Order was made, that Sigurdson J. intended the ordering of priorities they now assert.”

The British Columbia Court of Appeal upheld that decision.

The Decision

The lienholders relied upon a number of appellate decisions in Canada to the effect that, when liens are discharged by the provision of security, then the lienholders have an inviolate entitlement to first priority over that security, and that the mortgagee’s priority with respect to interests in the land did not apply to the security fund put in place when the liens were discharged.  The lienholders submitted that “the funds ordered to be held in a solicitor’s trust account are impressed with a first charge in favour of the lienholder appellants in priority to any claim that can be asserted by the mortgagee respondent.”

The Court of Appeal disagreed with the lienholders on this fundamental point. The court held that the order discharging the liens did give the lienholders a priority which they did not have at that time and that the mortgagee had an existing priority which applied to the security.  This conclusion appears to have rested on two points.

First, at the time the order discharging the liens was made, the mortgagee had priority to the liens, the land was worth less than the amount due under the mortgages and therefore there was no value in the land for the lienholders. In that circumstance, the order could not be interpreted to put the lienholders into a priority they did not then have. The court said:

“It must be remembered what the situation was at the time that the initial order of October 28, 2010 was made in the CCAA proceedings. An appraisal of the property expressed an opinion that a sale of the lands would realize less than the amount of the Mission Creek mortgages, but if the development could continue successfully, the property value should suffice to cover all outstanding indebtedness including the liens and another outstanding mortgage. Therefore, at that point in time and also at the point in time when the order of December 6, 2010 vacating the liens upon payment of security was made, there was no prospect of lienholders realizing anything on a present sale of the land…. In order to continue with marketing of the lands, it was necessary that the liens be vacated, hence the proceeding of December 6, 2010 to achieve this. It was the wish of all concerned, the landowner, the mortgagee and the lienholders that the development proceed to fruition so that all outstanding debts could be paid. ….. All parties who were before Sigurdson J. on December 6, 2010 were of a mind to have the development project continue in the hope and expectation that the successful completion of the project would accrue to the financial benefit of all concerned. If, for instance, the mortgagee respondent or any of the lienholders had sought a realization of security at that point in time, financial loss was a near certainty. In these circumstances, the inclusion of the crucial paragraph 6 of the order set forth in para. 9, supra, is entirely explicable.”

Second, the Court of Appeal expressed the view that the order discharging the liens was based upon the particular circumstances and understandings that could be gleaned from the events at that time – including the statements and silence of counsel – and importantly, that the order discharging the liens had been made in the CCAA proceeding. The court said the following:

“If this were a normal builders’ lien situation, the submissions made on behalf of the lienholders would have great force. However, this was far from the normal situation. The order of December 6, 2010 was made in course of the CCAA proceedings and purported to be made under the provisions of that Act and the Builders Lien Act.  Sigurdson J. was the judge dealing with the CCAA proceedings…. I think it is abundantly clear from paragraph 6 of the order made by Sigurdson J., which provided for the removal of the liens and the substitution of a fund as security for the lienholders, that the then extant priorities between the respondent mortgagee and the appellant lienholders would be unaffected by the posting of security to vacate the liens from title to the property. That term of the order is entirely in accord with the expressed wishes of all counsel before the judge. Those counsel included counsel for the lienholders.”

The Court of Appeal was also of the view that upholding the submissions of the lienholders could lead to “mischief and uncertainty in future CCAA proceedings” as the court would be “hobbled in the exercise of discretion to make necessary orders fostering the continuance of the enterprise.”

Accordingly, the Court of Appeal upheld the mortgagee’s priority to the security fund.

Discussion

The impact of this decision depends upon what is the true basis for it.

One view of this decision is that it is a one-off example of how the submissions of counsel at the time of the granting of the original order influenced the proper interpretation of the order. If that is the case, then counsel for lienholders may want to insist at the time of the making of the order that the order DOES entitle the lienholders to priority over the monies placed in trust when their liens are removed.  Normally, this should not be necessary and the effect of the order should be based entirely upon what it says, not the submissions (or silence) of counsel.

Another view would be that this decision is an example of the “super-priority” that can be given to DIP financing during a CCAA proceeding. However, if DIP financing could be given priority over pre-existing lien rights that had actual value at the time of the CCAA order removing the liens, that would cause a severe confrontation between the CCAA and the lien regimes and directly contradict the priority scheme set forth in the builders’ and construction lien legislation.

The third and better view appears to be that this decision is based upon the liens having no economic value due to the priority of the mortgages. Both the motion judge and the Court of Appeal proceeded on the basis that the advances under the mortgages having full priority over the liens.  In effect, the mortgage and DIP financing was given priority equivalent to the prior advances under the mortgage financing, even though the DIP financing was advanced after the work was done and the liens were registered and the liens would normally take priority over that financing under section 32(2) of the British Columbia Builders Lien Act.  The priority accorded to the DIP financing was due to two factors –

-the existence of the CCAA legislation empowering the court to keep the company alive while further business is conducted (in this case, the construction and sale of the project and land) with protection given to the lender who funds that business;

-and the liens having no economic value unless that further construction and sale occurred.

The result in the present case may be entirely due to the existing mortgages having priority over the liens, quite apart from the DIP financing. If, however, the decision is based upon the DIP financing gaining priority over the liens in respect of the security funds, then  the CCAA order was effectively held to be akin to an order under sub-sections 32(5) and (6) of the B.C. Builders Lien Act.  Under those subsections, the court may order that further advances made under a mortgage take priority over lien rights if the court is satisfied that the advances will be applied to complete the improvements and will increase the value of the lands.  However, sub-sections 32(5) and (6) require the court to be so satisfied before the order is granted and the order will expressly state that the further advances are accorded priority over the existing liens. Those requirements were not apparently met in the case of the CCAA order granted in the present case, and the order seems to have said to the contrary namely, that it did not affect the priorities between lienholders and the advances under the mortgages.

The result in this case may not be the same in other circumstances and other provinces. What if the lien rights did have value at the time of the CCAA order vacating the liens? Could that order still give the DIP financing priority over those liens, especially in the absence of the judge considering the factors and stating the priority of the DIP financing in accordance with subsections 32(5) and (6) of the B.C. Builders Lien Act before making the order?   And would the result be the same in Saskatchewan, New Brunswick and Prince Edward Island where the lien legislation states that when a lienholder’s lien is discharged by payment into court, the lienholder has a first charge upon those monies?  This issue was considered in my article dated March 13, 2012.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., chapter 11, part 4(l) and (m)

Mission Creek Mortgage Ltd. v. New Recreations Ltd. 2014 CarswellBC 760

Construction and builders liens   –  priority -liens and mortgages-order discharging liens  – Companies’ Creditors Arrangement Act

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                June 10, 2014

www.heintzmanadr.com

www.constructionlawcanada.com

Does A Construction Lien Bond Satisfy A Trust Fund Claim?

There are several different remedies provided in construction and builders lien legislation that do not necessarily fit together well. Two remedies available to a subcontractor are the lien claim against the land and the trust fund claim against funds received or receivable by a contractor.

In the case of a lien claim, the payment of money into court or the provision of a bond discharges the lien against the land. But does it discharge the trust fund claim?  If it doesn’t, does that mean that a subcontractor can pursue a trust fund claim, so that it gets paid through that remedy while at the same time the monies remain in court or the lien bond remains in place? And if the subcontractor can do that, how does that affect the contractor’s counterclaim and set off for delay? Through its trust fund claim can the subcontractor force the owner to pay the full amount of the subcontractor’s claim before the trial of the contractor’s delay claim?

These were the issues addressed in the recent decision of the Manitoba Court of Queen’s Bench in Stuart Olson Dominion Construction Ltd. v. Structal Heavy Steel.

The Background

In December 2010 Stuart Olson entered into a contract with the owner BB Stadium Inc. for the construction of a new stadium in Winnipeg.  In April 2011, Stuart Olson entered into a subcontract with Structal for the structural steel and other facilities.  The deadlines in the subcontract were not met and the opening of the stadium was delayed for a year.

Claims and counterclaims were asserted between Stuart Olson and Structal.  Structal claimed over $8 million due to work scope changes and other factors. Stuart Olson asserted a delay claim against Structal in an amount over $9 million.

In September 2012, Structal demanded payment from Stuart Olson for its outstanding invoices in the amount of about $4.2 million.  Structal also asserted that the monies due to Stuart Olson from the owner were impressed with a trust fund claim in Stuructal’s favour and that Stuart Olson must use those monies to pay subcontractors and not itself.  Structal also filed a  lien against the land in the amount of about $15 million.

In October, 2012, Stuart Olson obtained a lien bond, approved by Structal, for the full amount of the lien on payment of a premium of $159,003.07 per year, and Structal discharged its lien against the land.

Structal continued to demand that Stuart Olson pay its outstanding invoices and claimed that the monies receivable by Stuart Olson from the owner were impressed with a trust in Structal’s favour.  Stuart Olson continued to maintain that it had a set-off against any claim asserted by Structal and maintained that Structal’s claim, whether in a trust fund form or otherwise, was fully secured by the lien bond that had been filed.

Structal then asked the owner to withhold funds from Stuart Olson failing which it would sue the owner under the trust provisions of the Manitoba Builders’ Liens Act. (the “Act”).   In response, Stuart Olson commenced an application to determine the legal position.

In the meantime, Stuart Olson commenced an action against Structal asserting its delay claim.

A certificate of substantial completion had been issued relating to the subcontract with Structal.  There were no lien or trust fund claimants other than Structal. There are no deficiencies in the work done by Structal and the owner was ready to make the remaining payment to Stuart Olson which had not paid because of Structal’s threat.  The real and remaining issue was the delay claim by Stuart Olson against Structal which would be dealt with in the separate action.

The Decision

The application judge held that the posting of the lien bond exhausted the contractor’s trust fund obligations in the particular circumstances of this case.

First, the judge held that prior judicial authority in Manitoba supported the principle that the filing of a lien bond discharges any trust fund obligations of the contractor.

Second, he held that prior judicial authority also supported the proposition that a set-off could apply to, and reduce, a trust fund claim.

Third, he held that it would be unfair to determine, at this stage, whether Stuart Olsson had or didn’t have a right of set-off. So the present issue could not be decided on the basis that Stuart Olson had no rights of set-off. It would not be fair to order payment of the trust funds to Sturctal in the presence of the delay claim by Stuart Olson.

In all the circumstances, the judge held that the filing of the lien bond by Stuart Olson satisfied its trust fund obligations and that upon receipt of the progress payments from the owner, Stuart Olson could disburse those funds without being in breach of the trust fund obligations under the Act.

Discussion

Assuming that the contractor, Stuart Olson, was financially capable of paying the future lien bond premiums, this decision makes eminent business sense. But it does raise some practical concerns. What if Stuart Olson could not or did not pay the future premiums? Would the bond have remained in place? What protection for the subcontractor would there have been in this eventuality?

What if other subcontractors had liens or trust fund claims? In some provinces, a lienholder must share with other lienholders the amount of a lien bond posted to satisfy its lien.  In these circumstances, a lien bond may be an uncertain source of funds for a trust fund claim.  And why shouldn’t the remaining payments by the owner be paid into court, with the amount of the lien bond being reduced accordingly? Wouldn’t that be a better way of resolving the conflict between the purpose of a lien and the purpose of a trust fund claim?  Since the contractor had no other subcontractors or suppliers to pay, the real question was: whose litigation claim should be financed through the lien bond: the contractor’s delay claim or the subcontractor’s claim to payment under the subcontract? An argument could be made that the purpose of the Act is to give priority to the subcontractor’s claim for payment. If that is so, then that result could be achieved by paying the remaining monies due by the owner into court and reducing the amount of the lien bond.

The present decision highlights the different wording in the different provincial lien statutes. In Manitoba, sub-section 5(3) allows the owner to retain trust funds if “provision for the payment of other affected beneficiaries of the trust fund has been made.” The words “provision for payment” also appears in sub-sections 4(3) and 4(4) with respect to the trust fund obligations of contractors and subcontractors.  These words seem to contemplate a lien bond and may envisage that if a lien bond is in place then the owner, contractor or subcontractor can make payments from trust funds. In contrast, sub-sections 7(4), 8(2) and 9(2) of the Ontario Act state that the trust is in place until the contractors or subcontractors “are paid.”  In the Ontario Act, specific provision is made in section 12 for set-off by a trustee such as an owner, but not in respect of the amount of holdback.   No specific provision for setoff is made in the trust fund sections of the Manitoba Act. The judge did not comment on the presence or absence of these provisions in the Manitoba Act. It certainly seems odd that the trust fund sections of the provincial Acts do not specifically deal with the impact of lien bonds and other forms of security for the lien upon trust fund claims.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., chapter 11, parts 2(g) and 3.

 Stuart Olson Dominion Construction Ltd. v. Structal Heavy Steel, 2013 MBQB 48

Construction and builders liens   –   trust funds   –   discharging liens   –   lien bonds

Thomas G. Heintzman O.C., Q.C., FCIArb                                              August 26, 2013

www.heintzmanadr.com

www.constructionlawcanada.com