Holding back on holdbacks: ONCA confirms when construction lenders rank ahead of lien claimants in priority disputes

In KingSett Mortgage Corporation v. Mapleview Developments Ltd., the Ontario Court of Appeal explained the proper interpretation of the holdback provisions in the Construction Act in the context of a developer’s insolvency. The case involved a priority dispute between a construction lender and two contractors that had filed construction liens. The Court confirmed that, as long as there are no subcontractor lien claims, contractor lien claimants have a priority claim for unpaid holdbacks (calculated against the value of unpaid invoices), but do not have a priority claim for the total value of all holdbacks under the contract.

What you need to know

• In priority disputes, where there are no outstanding subcontractor lien claims, contractor lien claimants are entitled to receive holdbacks calculated against unpaid invoices only.
• Courts will prefer an interpretation of the Construction Act that balances the rights of payers, building mortgagees, contractors, and subcontractors.

Background

Mapleview Developments Ltd. (the developer), contracted directly with Alpa Stairs and Railings Inc. and Newmar Window Manufacturing Inc. (the contractors) to supply services and materials to a residential townhouse project.

The developer became insolvent after it defaulted on its repayment obligations to its senior secured construction lender, KingSett Mortgage Corporation. This led the Commercial List of the Ontario Superior Court to appoint a receiver, who then sold the townhouse project to Dunsire Homes Inc. (the purchaser).

During the receivership, a priority dispute arose over the disposition of the insolvent developer’s assets. As the contractors had perfected construction liens, they had priority over the secured construction lender with respect to “any deficiency” in the developer’s holdbacks, pursuant to section 78(2) of the Construction Act. As there were no subcontractor lien claimants, no parties had a claim to the holdbacks other than the contractors.

Though the contractors’ priority relating to the holdbacks was not disputed, the parties disagreed as to the quantum of the holdback in question. Specifically, the parties disagreed as to whether the language “deficiency in the holdbacks” in section 78(2) of the Construction Act meant the holdback should be calculated against the total value of all invoices or the total value of unpaid invoices only.

The contractors brought a motion to determine the quantum of holdbacks they were entitled to receive.

The motion judge’s decision

The Commercial List motion judge held that the quantum of holdbacks should be calculated against the value of unpaid invoices, rather than the total value of all invoices.

In coming to this conclusion, the motion judge reasoned that as a matter of “horizontal stare decisis” she was bound by the 1992 Ontario Court of Justice (General Division) decision in Dufferin Concrete Products v. Waterbrooke Development Ltd., which set out the principle that a contractor lien claimant is entitled to holdbacks only in respect of unpaid invoices, rather than all invoices, so as to avoid “double recovery”.

The contractors appealed the decision. They argued that Dufferin Concrete was wrongly decided and that the contractors’ holdback entitlement ought to be calculated as 10% of the total value of all invoices (including fully paid invoices), rather than only the unpaid invoices.

The Court of Appeal’s decision

The Ontario Court of Appeal upheld the motion judge’s decision. It held that, in a priority dispute where there are no subcontractor lien claims, a contractor lien claimant is entitled to a quantum of holdback calculated against the value of unpaid invoices, rather than the total value of all invoices. Accordingly, the contractors were entitled to 10% of the value of the unpaid invoices only.

The Court of Appeal came to this conclusion for two reasons.

First, the Court reasoned that the plain text of section 78(2) of the Construction Act, as well as its related provisions, reinforce this interpretation. Section 78(2) provides that lien claimants have priority over mortgagees “to the extent of any deficiency in the holdbacks required to be retained by the owner”. Section 22(1) stipulates that the payer of an invoice—such as the developer in this case—must retain a 10% holdback until all liens have been satisfied. Read together, the Court reasoned that these two provisions stipulate that where a payer has fully paid an invoice and there are no other potential claimants (such as subcontractors), no lien can arise: or if it could, it would have been satisfied by full payment of the invoice. Therefore, if an invoice has been fully paid, the contractor lien claimant is entitled to a quantum of holdbacks as calculated only against the unpaid invoices.

Second, the Court rejected the alternative interpretation—that the holdback entitlement should be calculated against the total value of all invoices—as it would be “commercially absurd”. Such an interpretation would lead to lien claimants receiving double payment: first, by receiving 100% of the invoice, including the statutory 10% holdback; and second, by receiving the 10% statutory holdback again in the event of a priority dispute. If double counting to the benefit of contractors was permitted, it would undermine the purpose of the Construction Act, which is to balance the rights of payers, building mortgagees, contractors, and subcontractors.

The Court of Appeal was careful to caution that “it is a critically important fact…that there were no subcontractor lien claims...” as “[t]he result might be very different if there were subcontractor lien claimants”. This is presumably because a subcontractor might be owed unpaid holdbacks even where the lead contractor has been paid in full.