Three priorities for construction industry participants in 2019

Torys Quarterly: What to expect in 2019

Major amendments to the Ontario Construction Lien Act (now the Construction Act) have come into force on a rolling basis since late 2017. However the most significant will take effect on October 1, with the addition of two new parts to the statute that will have an unavoidable and material impact on all participants in the construction industry.1

The first new part of the statute will impose a mandatory regime of prompt payment, in which invoices must be paid, or notice of non-payment must be given, within very short time periods. A failure to give timely notice of non-payment—within 14 days of receipt of a proper invoice, in the case of owners—will create a statutory duty for the owner to pay by the 28th day after invoice submission, regardless of whether the invoice is disputed. Contractors and subcontractors will have an even tighter, seven day deadline by which to make payment downstream. A failure to make timely payments will entitle the unpaid party to force real time adjudication of the dispute, to be paid interest on unpaid amounts and to suspend work if payment is not forthcoming in a timely manner.

The second new part of the statute will impose the adjudication regime. Every direct participant in a construction project (notably, this excludes lenders) will be subject to mandatory expedited formal dispute resolution proceedings in connection with a broad array of issues—including not simply late payment but also defective work, delays and other substantive issues that can cause payment to be delayed or denied. The mandatory adjudication will take place in real time during the project, distracting operations personnel from their work and creating mini-crises, as both major and minor disputes are adjudicated with unprecedented rapidity—with evidence marshalled, positions formulated, hearings held and decisions rendered within a matter of weeks, not months or years. The adjudicator’s decision is binding on an interim basis, and can force a party to make a disputed payment even when there is ongoing arbitration or court litigation over the same issue, and even if the payer does not have the funds. For example, because a lender is not satisfied that the funds are properly owed, or an equity partner is not prepared to increase its project funding.

The introduction of the regimes is going to turn the Ontario construction industry upside down for a period of time.

The introduction of the prompt payment and mandatory adjudication regimes is going to turn the Ontario construction industry upside down for a period of time, while industry participants adjust to the new reality.

In the immediate term, between now and October 1, there are three very important priorities for construction industry participants.

  1. Changing the way parties contract.
  2. Implementing systems to address prompt payment.
  3. Preparing for the adjudication regime.

Changing the way parties contract

Many of the standard terms of construction contracts, project agreements, lending agreements, design agreements and other affected contracts will no longer work, and need to be substantially modified—both to accommodate the new mandatory requirements and also to mitigate the associated risks. A few examples are listed below.

  • Borrowers will want their lending agreements to ensure funds are available from the lender (or from equity) to make prompt payments on time, and to fund any disputed payments an adjudicator orders be paid, in order to avoid finding themselves with a stranded risk.
  • Owners will want to ensure their contracts specify all of the information and documentation that the owner requires from the contractor to support the submission of a “proper invoice,” whether in advance of, or at the time of, a payment application. It will be critical to avoid getting into disagreements during the course of a project over what constitutes a proper invoice, since it is the submission of a proper invoice that triggers the 14-day and 28-day deadlines for notice of non-payment and for payment under the Construction Act. A key goal here is to avoid getting into a situation where a prompt payment obligation is triggered without the owner being satisfied as to the appropriateness of payment.
  • Owner may wish to reduce the frequency of payment applications over the duration of the contract, to reduce the risk and frequency of being drawn into an adjudication, if less than full payment is made to the contractor.
  • Contractors and subcontractors will want (and be entitled) to eliminate “pay when paid” clauses. Subcontractors will be entitled to enforce the Construction Act’s requirement that a contractor must initiate adjudication proceedings if it does not pay the subcontractor on account of non-payment by the owner. Subcontractors and owners, who (unlike contractors) have the option but not the statutory obligation to trigger adjudication when they do not make downstream payments, will want to consider how to address the role of the adjudication regime in their contracts.

There is a host of other contractual terms that will, for the first time, be useful or required as a result of these fundamental Construction Act amendments.

Implementing systems to address prompt payment

In order for parties to comply with the prompt payment deadlines—which are both short and strict—it will be necessary to put in place new administrative and staffing systems within the organization. The consequences of non-compliance with the prompt payment requirements are sufficiently harsh that it will be important to have these systems in place before October 1. Key tasks will include:

  • tracking the deadlines to issue notices of non-payment;
  • tracking the deadlines to make prompt payment—including, in the case of contractors and subcontractors, tracking the receipt of upstream payments, to ensure timely (within seven days) corresponding downstream payments;
  • in the case of owners, reviewing payment submissions promptly after receipt to assess whether all the requirements of a “proper invoice” (as defined in the Construction Act, and as supplemented by the parties in their agreement) have been met and promptly notifying the contractor if they have not been met;
  • if an invoice is proper, reviewing the merits of the payment submission (including seeking input from relevant operations personnel, lenders and others) in order to assess whether a notice of non-payment should issue within the 14-day window for denying payment;
  • drafting notices of non-payment with sufficient detail to meet the Construction Act requirements, which include a requirement to disclose the reasons for non-payment;
  • in the case of contractors and subcontractors, reviewing notices of non-payment to assess which downstream subcontractors should receive corresponding notices and reductions in payment;
  • making downstream payments in appropriate pro rata shares, where a subcontractor is to receive less than full payment; and
  • in the case of contractors who are required to initiate adjudication because they are underpaying a subcontractor as a result of not receiving full payment from the owner, tracking the deadlines for adjudication.

Preparing for adjudication

Under the mandatory adjudication regime, disputes of all sizes—from $500 to $50 million and beyond—will be subject on a real time basis to a compressed and expedited alternative dispute resolution procedure similar to courtroom litigation in some respects, but conducted at high speed and without many of the procedural safeguards that are typically relied upon to generate a fair result.

Industry participants need to be ready to bring or respond to an adjudication. This will involve both administrative and strategic preparation.

When any dispute arises, an organization will need dedicated personnel who can gather the evidence needed to support the organization’s position (both documents and witnesses) within the very short time frame permitted by the adjudication regime. For example, when a contractor is compelled by the Construction Act to initiate an adjudication, it must start the adjudication within 14 days after giving notice of non-payment to its subcontractor, and must provide a notice of adjudication setting out its position, along with copies of any documents it will rely upon the adjudication, no later than five days after the adjudicator is appointed. The adjudicator’s appointment itself must occur within seven days after the adjudication is initiated unless the parties agree otherwise. This means that, from the date the contractor issues the notice of non-payment to the date it is required to deliver all of its documents to support its claim, 26 days or less will have elapsed. For a complicated case involving delay or defects, especially where expert evidence may be required, this is an extraordinarily short time frame.

It is worth taking the time to think through how these statutory reforms will affect an organization and how best to mitigate the risks and take advantage of the opportunities.

For disputes whose value is below the threshold that merits the expense of a lawyer, the organization will need to have designated dispute resolution personnel available internally. Given the time commitment required to prepare for and participate in an adjudication, and given the possibility of multiple adjudications per project, this may require the hiring or reallocation of personnel.

For disputes whose value or subject matter is potentially material, the organization will want to have a rapid response plan in place, involving both lawyers and appropriate expert consultants, to ensure that the organization’s interests are not prejudiced by the rapidity of the process and the relatively loose procedural regime associated with adjudication. In this regard, respondents to adjudications will often be the most pressed for time in preparing their position, collecting their documents and presenting their case. Under the Construction Act, an adjudicator is required to make a determination within 30 days after receiving documents from the initiating party, subject to extension only by agreement of the parties and the adjudicator. A late determination by the adjudicator is unenforceable. In some adjudications, the initiating party will have taken months to prepare its case prior to commencing an adjudication, while the responding party will be jammed by the statutory time limits, forced to submit a response within two or three weeks in order to allow the adjudicator to make the determination on time.

Conclusion

The new mandatory prompt payment and adjudication regimes will revolutionize the way construction projects unfold and the way construction disputes are resolved. It is worth taking the time and putting in the effort to think through, in advance, how these statutory reforms will affect an organization, and how best to mitigate the associated risks and take advantage of the associated opportunities.

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1 The two new parts of the statute will apply to contracts entered into on or after October 1, 2019, and subcontracts under those contracts, provided a procurement process with respect to the improvement that is the subject of the contract was not commenced by the owner prior to that date.

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