Prompt Payment Reform

Delinquent payment is a major problem in the construction industry, but legislative reforms may help

Delinquent payment in
the construction industry is a frequent and increasing problem for trade contractors, who say they are sometimes made to wait for periods of four months or longer to be compensated for work that has been certified as complete.

“A culture of slow payment has emerged,” says Geza Banfai, Counsel to McMillan LLP. “There has been the rise of powerful owners, in both the public and private sectors, who feel empowered to dictate commercial terms. From some owners, there is an explicit drive to extend what used to be 30 days to 60 or 90 days. That filters all the way down the pyramid to the guys supplying the nails and the lumber.”

Canadian provinces lag behind other jurisdictions, which have prompt payment legislation in place: 49 US states have it for public-sector projects, 31 US states for the private sector, the US federal government has had it since 1982. The European Union, Great Britain, Ireland, New Zealand and Australia all have prompt payment legislation.

 In Ontario, the Attorney General announced in March 2014 that the province would review the Construction Lien Act (CLA) in response to stakeholder concerns over prompt payment in the construction industry. The CLA provides a system of liens, hold-backs and trust provisions intended to give financial protection to those supplying services or materials to a project.

Bruce Reynolds, the province’s appointed construction lawyer, and a senior partner at Borden Ladner Gervais LLP, is to head an expert review panel. The move followed the Legislative Assembly’s failure to pass Bill 69, prompt payment legislation sponsored by a private member (see below). The expert review is expected to be finished by the end of 2015.

“It would make sense to make changes within the scope of the existing CLA,” says Howard Krupat, a partner at DLA Piper LLP. “It could become unwieldy to have a separate piece of legislation [on prompt payment].”

In addition to prompt payment provisions, the CLA is up for review in other respects. The statute was enacted before the advent of P3 infrastructure projects, so does not take account of the P3 structure. For example, projectco – the private-sector consortium that is positioned between the government owner and the general contractor – is not recognized in the CLA, which assumes a traditional structure of an owner hiring a general contractor.

The CLA treats the general contractor in a P3 project as a subcontractor. “There are different lien rights and different timelines for liening depending on whether you’re a general contractor or a subcontractor,” says Roger Gillott, a partner at Osler, Hoskin & Harcourt LLP. “One of the changes under consideration is to amend the definitions in the Act to better accord with the realities of P3 projects.”

Lien rights could be linked to carrying out work or providing materials or services to the project. “Another way you could do it,” says Gillott, “is to create a separate section of the Act dealing with P3 projects where there is a projectco entity. You would provide both projectco and the general contractor with the lien rights currently enjoyed by the general contractor and then make all entities below the general contractor have subcontractor lien rights.”

Also up for reconsideration are hold-backs. In any construction project, each payer is required by the CLA to hold back 10 per cent of each payment they make to the general contractor, subcontractor or supplier below them on the pyramid.

When liens are registered, the party has a right to claim against the hold-back fund.

The CLA now allows hold-backs to be released when lien rights expire, but doesn’t make that mandatory. Sometimes owners or general contractors retain the hold-back as leverage to ensure construction deficiencies are remedied. The subcontractors feel the lien hold-backs are retained far too long. The expert panel is likely to consider making release mandatory, as was proposed in the unsuccessful Bill 69.

A possible amendment to the CLA with particular implications for infrastructure projects is the phased release of hold-backs. Large infrastructure projects often proceed in phases, and the CLA currently provides that hold-backs be retained until the certified completion of the project. This means subcontractors involved in the early phases, e.g., excavation, may wait years for their hold-backs.

The CLA could be amended to allow contracts to proceed in phases, and allow certificates of completion to be issued for each phase. This would allow the hold-backs to be released in phases. Another amendment might allow for lien rights to be maintained for each subcontractor until the release of hold-backs related to their particular subcontract.

But all eyes in the industry will be on the prompt payment provisions that the expert panel recommends. Whereas presently, payment periods are determined by the contract between the parties, Bill 69 would have imposed mandatory statutory payment periods. Mandatory interest was to be payable on late payments. The release of hold-backs was to be mandatory one day after the expiry of the lien period. Also, the Bill would have prohibited hold-backs other than the 10 per cent lien hold-back, banning, for example, a hold-back for the warranty period.

“Perhaps we will see some legislative attempts to make payments flow more rapidly,” says Gillott, “but at the same time not completely shackle the ability of the parties to determine their own payment structure by contract. Maybe there would be statutory payment periods but giving the parties the opportunity to contract out of them if they wished.”

Banfai disagrees, saying that “if you have that, everyone will contract out.” But he acknowledges that statutory payment periods must take account of how projects are structured. “Prompt payment legislation could stipulate that payment must be made within 30 days of the achievement of a project milestone.”

Also under review is a need for separate accounts for trust funds. The CLA says that all money received by a contractor or subcontractor is a “trust fund” for the benefit of the people or companies hired for the project. Contractors or subcontractors must pay for work and materials supplied for the project before they can use the money for anything else. If they don’t, they may be in breach of trust and their directors and officers held personally liable. “There’s a debate over whether trust funds should be retained in a separate account,” says Krupat. “In an insolvency situation, what happens when the trust funds haven’t been properly segregated before the insolvency?”

In his 2014 decision in Royal Bank of Canada v. Atlas Block Co. Limited, Justice Penny of the Ontario Superior Court of Justice (Commercial List) held that trust claims under s. 8 of the CLA do not survive the bankruptcy of the would-be trustee debtor. The trust funds, if already commingled, “generally become part of the estate that is distributed to the creditors,” says Krupat. “The case law has said that the statutory trust fund required by the CLA does not meet the test of a common-law trust fund.”

If Ontario overhauls the CLA, it is likely to be a model for other provinces, says Banfai. “Initiatives like this are under active consideration in Manitoba, British Columbia, Quebec and Alberta.”

In British Columbia, the government in April 2014 asked the British Columbia Law Institute to launch a comprehensive overhaul of the Builders Lien Act. Senior lawyers who represent the various construction stakeholders serve on a committee formed to carry out this two-year project. “The process pre-existed all the publicity that surrounded prompt payment legislation,” says Karen Martin, a partner at Dentons Canada LLP (and a committee member) in Vancouver, “but that issue is front and centre in this initiative.”

The committee intends to propose draft legislation, says Martin. Like Ontario, BC’s experts haven’t decided whether to propose separate legislation on prompt payment or include provisions within the Builders Lien Act, “The purpose of prompt payment legislation is to facilitate cash flow from the owner down to the general contractor down to the subcontractors,” says Martin. “Some of the provisions in the Builders Lean Act facilitate that cash flow, but not in the direct way that proposed prompt payment legislation would.”

One idea being considered is the elimination of “set-off” rights. Under the current law, once a project has been certified as complete, the owner can still hold back funds (set-offs) to cover the cost of fixing work deficiencies. These could be eliminated. There might also be a prohibition on “pay when paid” clauses. In contracts, the general contractor stipulates to subcontractors that their bills won’t be paid until the general contractor has submitted them to the owner and received payment for them.

The real problem to be addressed, says Martin, is the lack of a quick, effective dispute resolution mechanism. In the UK and Australia, she says, prompt payment legislation provides for adjudication to settle payment disputes. In a tight timeframe, a third party (an “adjudicator”) determines whether money is owing or not, or whether an owner should be able to exercise set-off rights for a deficiency. “It is extremely rare that the unsuccessful party in an adjudication appeals and takes the dispute to a trial or arbitration later,” she says. “It’s a successful process.”