This article is intended to provide an overview of the changes to the Construction Act in relation to the new bonding requirements and related Regulations.1
The modernization provisions of Ontario’s new Construction Act (the “Act”)2 took effect on July 1, 2018.3 Included in this extensive overhaul of the province’s existing construction lien legislation were amendments to definitions under the Act, amendments in relation to lien, holdback, trust rules and procedures. The modernization provisions also included new requirements in relation to mandatory surety bonds on public projects, which is the subject of this article.
Mandatory Surety Bonding under the Act
In Striking the Balance: Expert Review of Ontario’s Construction Lien Act4, the 2016 report prepared by the experts retained by the Ministry of the Attorney General, the authors made several recommendations in relation to surety bonds, including:
- The Act should be amended to require broad form surety bonds to be issued for all public sector projects, the form of such surety bonds should be developed in consultation with the Surety Association of Canada, and once finalized they should become Forms under the Act.
- The Act should be amended to require sureties to pay all undisputed amounts within a reasonable time from the receipt of a payment bond claim.
- A Regulation to the Act should be promulgated to embody a surety claims handling protocol, and that such surety claims handling protocol be developed in consultation with the Surety Association of Canada.5
As a result of these recommendations and the consultations conducted with the Surety Association of Canada (and other stakeholders), the new Act includes Part XI.1 (which requires mandatory bonding on public contracts in prescribed circumstances) and new Regulations which describe new bonding requirements.
Under Section 85.1(1), a public contract is defined as “a contract between an owner and a contractor respecting an improvement, if the owner is the Crown, a municipality or a broader public sector organization”.6 This section (i.e. s. 85.1) is not applicable in circumstances where the contract is between an owner and a contractor that is either an architect or engineer.7 Parenthetically, while the construction industry is familiar with the use of terms such as owner, contractor, improvement, Crown and municipality, the term “broader public sector organization” is relatively new. Broader public sector organizations, per the definition in the Act, include hospitals, school boards, universities, colleges, agencies designated as a children’s aids society, certain publicly funded organizations and organizations prescribed for the purpose of the definition.8 These organizations were included in the Act given the overarching goal of protecting subcontractors and suppliers.
Section 85.1(2) stipulates that the requirements of Part XI.1 apply to a public contract in circumstances where the contract price exceeds the amount prescribed for the applicable owner. As is further discussed below, the Regulations require that Section 85.1 applies to any public contract if the public contract is $500,000.00 or more.9
Section 85.1(4) and (5) describe the specific requirements for a contractor furnishing a bond to the owner of a project. Contractors are required to furnish labour and material payment bonds pursuant to Section 85.1(4) and performance bonds pursuant to Section 85.1(5) in the forms provided for under the Act. The bond must be from an “insurer licensed under the Insurance Act to write surety and fidelity insurance” and have a coverage limit of “at least 50 per cent of the contract price, or such other percentage of the contract price as may be prescribed”.10 In the case of labour and material payment bonds, the bond must also properly extend protection to subcontractors and persons supplying labour or materials to the improvement.11 As noted in Section 85.1(7), the Act is not intended to limit the ability of owners to require the contractor to provide other types of bond or security, these sections simply provide for a mandatory minimum bond coverage.12
Importantly, Section 85.1(6) requires that the bond form (set out in the Regulations) sets out a claims process applicable in respect of the bond.13 As noted in Striking the Balance, stakeholders in Ontario had expressed frustration with the payment bond claim process (issues with the performance bond claim process were also raised). Given these concerns, the Surety Association of Canada proposed the adoption of standard forms of bonds that included practical provisions for the claims process, with accelerated timelines of payment and expedited dispute resolution provisions.14 Following the recommendations in Striking the Balance and after extensive consultation with industry stakeholders and the Surety Association of Canada, bond forms were developed that embodied a robust surety claims handling protocol. This protocol was designed to provide a clear, understandable and streamlined process for bond claimants while also providing the Surety with fair timelines and the appropriate information necessary for it to conduct a proper investigation. The details of the bond form are discussed below.
Section 85.2 describes the right of action of claimants under labour and material payment bonds and performance bonds. Under the previous version of the Construction Lien Act, i.e. prior to the amendments, Section 69 provided a right of action for any person whose payment was guaranteed under a bond as against the surety on the bond (in accordance with the terms and conditions of that bond) up to the value of the bond. This provision, as well as a similar provision in respect of an owner’s right to claim in relation to a performance bond, were included as part of Section 85.2(1) through (3), respectively.
Finally, Sections 85.2(4) and (5) provide that: a) nothing in Section 85.2 is intended to make the surety liable as the principal15 under the bond, or make the surety a party to any contract; and b) on satisfaction of its obligations under the bond, the surety is subrogated to all the rights of the claimant.
Bonds as a Permissible Form of Holdback
Under Part IV – Holdbacks, in Section 22(4), several new permissible forms of holdback were provided for, including a letter of credit and a demand-worded holdback repayment bond in the prescribed form. Under this provision, each “payer upon a contract or subcontract under which a lien may arise” can retain the 10 per cent holdback in any of the forms permitted under Section 22(4). In other words, in lieu of maintaining cash in its bank account an owner required to retain the 10 per cent holdback may elect to do so by obtaining a letter of credit or a demand holdback repayment bond which is compliant with the Regulations. Given the drafting of this provision under the Act, it is unclear if an owner or contractor could require, at least contractually, a party to use one of these alternate forms of holdback.
Bonding on Alternative Financing and Procurement (AFP) Projects
Section 85.1 of the Act applies to AFP/P3 projects, with certain modifications. As is the case in respect of public contracts generally, the Act requires contractors on AFP or P3 projects to furnish a labour and material payment bond and performance bond. On these projects, however, rather than furnishing the bonds to the owner, the Act requires the bonds to be furnished on the special purpose entity (or “Project Co.”).16 In addition, the AFP owner may set a coverage limit that differs from the 50 per cent requirement of Sections 85.1(4) and (5), so long as that coverage limit meets or exceeds the prescribed coverage limit under the Regulations (described below)17, and when taken together with the overall package of project security, provides “an appropriate balance between the adequacy of the security required to ensure the payment of persons supplying services or materials under the public contract on the one hand and the cost of the security on the other”.18
The Regulations and the Bond Forms
In addition to the amendments to the Act noted above, the regulation under the former Construction Lien Act (i.e. R.R.O. 1990, Reg. 175) was revoked and three new regulations came into force:
- Reg. 302/18 does not directly address surety bonds, however, a surety may become involved in the lien process in certain circumstances (i.e. when a surety has become subrogated to the rights of a lien claimant).
As noted above, Section 12 of O. Reg. 304/18 sets out the lower threshold applicability of mandatory surety bonds on public contracts at a contract price of $500,000.00.22 In relation to AFP projects, Section 3 of O. Reg. 304/18 sets the minimum coverage limit as follows:
(a) 50 per cent of the contract price, if the contract price is $100,000,000 or less; or
(b) $50,000,000, if the contract price is more than $100,000,000.23
Arguably the most critical amendment to the surety bonding regime in Ontario came under Ontario Regulation 303/18 – Forms. Specifically, the amendments to the Act included the provision of several new bond forms which were posted in final cabinet approved form on April 25, 2018, and are as follows:
- Form 31 – A labour and material payment bond under section 85.1 of the Act; and
These new bond forms are significantly modified from the various forms of bond used by surety companies. The material differences and general provisions of these forms are discussed below.
Demand-worded Holdback Repayment Bond Form
Labour and material payment bonds and performance bonds are commonly required in the construction industry in Ontario, and the use of lien bonds is also fairly standard in lieu of posting funds into court to have a lien vacated24. That said, the demand-worded holdback repayment bond (“Holdback Repayment Bond”), while not completely novel, remains a rarely used instrument in Ontario, and the rest of the country. The Holdback Repayment Bond essentially takes the place of the holdback funds typically held by an Owner, allowing for the remaining 10 per cent of contract funds to flow. This bond operates as a result of Section 22 of the Act, as noted above. From a market perspective, we will have to wait and see if the Holdback Repayment Bond is accepted and encouraged in practice. However, some owners may be particularly interested in the use of this secured instrument in lieu of cash.
Form 32 – Performance Bond Form
Broadly speaking, anyone in the industry who uses bonds should spend a significant amount of time reviewing the new bond forms. We are often asked whether the new bond forms significantly differ from historically used CCDC forms and other commonly used forms. The answer is yes.
The new form of performance bond is significantly longer and has several new and distinct features. The bond now includes a pre-notice meeting option, requires very quick response times for the surety and the claimant, standardizes the process (claim and response forms are now attached to the bond and simply need to be filled out) to avoid confusion and technical delays, and allows for interim and/or mitigation work options where required by the owner. The performance bond also provides specific details of what the bond covers, clearly laid out under the Owner’s Direct Expenses paragraph 7.1-7.2. Conversely, it is clear what the bond does not cover:
Subject to any agreement to the contrary, between the Obligee, the Principal and the Surety25, the Surety shall not be liable under this Bond for:
- any liquidated damages under the Contract;
- if no liquidated damages are specified in the Contract, any damages caused by delayed performance or non-performance of the Contractor, except as provided in Section 7.1(d); or
- any indirect or consequential damages, including but not limited to costs of financing, extended financing, hedging arrangements, loss of or deferral of profit, productivity or opportunity, or head office overhead costs.
The performance bond also incorporates concepts such as Necessary Interim Work and Mitigation Work. The Necessary Interim Work provision (Section 4) allows the Owner to take certain actions. Actions that may be necessary to, for example, ensure public or worker safety, preserve/protect the contract work from deterioration or damage, or comply with the law. The Owner must act with due diligence and provide written notice to the Surety within three (3) business days of the commencement of that work. The notice of Necessary Interim Work is included as an option as part of Schedule A – Form of Notice. Importantly, the right to carry out Necessary Interim Work is subject to certain conditions, such as allowing the Surety reasonable access to the site for monitoring purposes. The provision includes a further caveat that it is not intended to limit the ability of an Owner to “take whatever steps are reasonably necessary in the public interest”. The Necessary Interim Work provision was the result of a significant dialogue between owner stakeholders and the surety industry.
Similarly, Section 5.2 provides the opportunity for Mitigation Work to be conducted by the Owner after the Necessary Interim Work and throughout the period of investigation by the Surety. As is the case with Necessary Interim Work, Mitigation Work is subject to certain conditions (e.g. providing reasonable evidence to the Surety that such work is necessary during the Surety’s investigation and that the anticipated costs are reasonable, the Owner paying the reasonable costs of that work, separate record keeping, reasonable access for the Surety to the site, etc.).
The Necessary Interim Work and Mitigation Work provisions are intended to provide owners with flexibility in relation to protecting project sites and preventing work stoppages during the Surety investigation process. We anticipate, however, that despite best efforts to provide clear language in the performance bond, the courts may need to weigh in regarding what properly constitutes Necessary Interim Work under Section 4 and Mitigation Work under Section 5 of Form 32.
Most importantly, as noted above, the new form of bond provides clarity in relation to the bond and the claims protocol it employs. The following are some salient details of the performance bond claim process, including the relevant timelines:
- The Owner may, at its sole discretion and acting reasonably, require a pre-Notice conference by notifying the Surety and the Contractor in writing that it is considering its option to declare the Contractor in default under the underlying contract (this notice of meeting does not constitute a notice of claim under the bond). The Surety is then required to have a meeting (either face-to-face or by telephone or electronic media) within seven business days unless a longer period is agreed. This meeting allows the owner to express concerns about the Contractor’s performance and potentially resolve the issues prior to engaging the bond itself;
- In circumstances of a claim, an Owner may make a written demand in accordance with the bond by giving notice to the Surety substantially in the form provided (i.e. the Notice);
- From the time of the notice of claim being delivered, the Surety has four (4) business days to respond (in substantially the form provided) as an acknowledgement and request for specific information;
- Following receipt of the acknowledgment, the Owner must promptly (and in accordance with the contract) provide the Surety with the requested information and access to the site;
- The Surety is required to promptly initiate an investigation of the Notice to determine if the Conditions Precedent of the Bond have been satisfied and to determine liability under the Bond, if any;
- Within 20 days of receipt of the Notice (subject to extension by agreement of all the parties), the Surety shall provide the Owner with its written response (again in the prescribed form) advising, generally: a) whether it accepts liability and proposes to satisfy the obligations under the Bond (i.e. selecting the Surety’s option), b) it rejects liability (with reasons); or c) the Surety is unable to determine whether or not the Conditions Precedent have been satisfied, and the Surety proposes a process for collaborating with the owner in the advancement of the work to attempt to mitigate the Owner’s cost to complete.
These timelines are aggressive and will initially result in a significant burden on the surety industry in Ontario to adjust. However, over time, the changes will lead to enhanced efficiencies and claims handling, and make the surety industry more responsive. That said, as noted by the Surety Association of Canada, this protocol was part of the bargain required to ensure mandatory bonding and related protection would be provided to the construction industry in the province.
Form 31 – Labour and Material Payment Bond Form
Similar to the performance bond changes, the payment bond now includes all of the required claim and response forms, sets out fast response times for the Surety and the Claimant, and standardizes the process (claim and response forms attached) to avoid technical conflicts. A more significant change to the labour and material payment bond is the expansion of the Claimant definition one level further down in the chain (the form covers subcontractors and sub-subcontractors with direct contracts), which makes it similar to the Federal form bonds currently in use.26
The following are some salient details of the labour and material payment bond claim process, including the relevant timelines:
- The Surety must respond to a Notice of Claim from a Subcontractor or from a Sub-subcontractor no later than three (3) business days following receipt of the notice (in substantially the form provided) as an acknowledgement and request for specific information required for the Surety to determine the claimant’s entitlement, if any, under the bond;27
- In relation to a Subcontractor claim, upon the earlier of: ten (10) business days following receipt of the requested information, twenty-five (25) business days after the receipt of the Notice of Claim or a time agreed upon between the Surety and the Subcontractor, the Surety is required to provide its position (substantially in the form required) in response to the Notice of Claim.28
- In the case of a Notice of Claim from a Sub-subcontractor, the above timeline is adjusted to fifteen (15) business days and thirty-five (35) business days.29
- No later than ten (10) business days after the Surety delivers its position to any Claimant, the Surety shall pay any undisputed amounts subject to an application to the court in relation to amounts that, in the aggregate of all claims under the bond, exceed the total amount of the bond.30
Prior to the implementation of further changes to the Act in 2019 (i.e. prompt payment and adjudication), bond claim disputes will have to be litigated where unresolved. However, after prompt payment and adjudication come into effect, payment timing will be more certain and remaining labour and material payment bond claims will be subject to adjudication, along with prompt payment disputes. We note however, that Section 9 of Form 31 (which is in relation to adjudication) refers to Section 13 of the Act, which is not yet in force. Therefore, this section of the labour and material payment bond, which acts to stay the Surety’s obligations, will not apply until the adjudication provisions of the Act come into force.
Form 21 – Lien Bonds
Also worth mentioning, is the fact that the “Financial Guarantee Bond under section 44 of the Construction Act” (commonly referred to as the lien bond), previously available as Form 15.1, has been slightly amended and is now available as Form 21. We note that there have been no significant amendments to this bond form, yet we anticipate that the lien bond will remain a commonly used tool for contractors in Ontario in relation to vacating liens under the Act.
Potential Concerns with the New Bond Forms and How to Address Them
Claims Processing and Potential Risks
Without seeing the new bond forms yet in application, it is difficult to predict issues that may arise in the claim process through usage of the new bond forms. We have, however, heard from members of the construction industry about several anticipated concerns discussed in brief below.
For example, the timelines under the new performance bond and labour and material payment bond forms are considered by some to be quite narrow. In circumstances where a Surety receives a Notice of Claim, but that Notice does not directly reach the claim department (i.e. if the Notice is directed to the wrong department or the CEO of the insurer, generally) the person or persons in charge of providing the Surety’s Acknowledgement may already be late by the time they receive the Notice. The issue here is one that may require Sureties to invest in further internal processes and/or increase claim processing staff. Many in the industry are already looking to solutions to ensure efficiency in their internal claims handling process.
Claimants, however, particularly in relation to claims on labour and material payment bonds and in respect of urgent issues under performance bonds, may experience frustration if the new timelines are not met. In the past, when a surety was incapable of providing a quick response (whether, for example, due to the extent of documents required for the investigation or the speed at which the claimant provided documents), the Surety would receive complaints or would often see claims evolve into litigation. In extreme circumstances, a claim could be commenced as an action against a Surety which includes allegations of breach of a duty of good faith as a result of the Surety’s investigation. These claims are certainly concerning, but are very difficult to establish. It would take another article to consider all of the implications of the Surety’s duty in relation to its investigation. But for this purpose, we note that the industry will have to endure a potential increase in such allegations while surety companies and claimants re-engineer their internal processes to address the new claim process under the bond forms.
Despite significant consideration by the Ministry of the Attorney General and the review, as well as lengthy consultation with the industry and the Surety Association of Canada, the new bond forms are not without their nuanced technical deficiencies. We view this simply as being the result of the commendable speed at which these documents were prepared and the difficulty in capturing every last requirement of the bonding process.
In that regard, the Ministry generally advised that the bond forms were being situated within the Regulations so that, over time, if issues arise, they can be addressed promptly in comparison to the significant political exertion required to amend the legislation itself.
At this time, it is our view that the bond forms may require some revision. By way of example, some minor technical/drafting issues include (not an exhaustive list):
- Duplicate signature blocks in the bonds;
- Duplicate asterisk explanation instructions in the payment bond;
- The payment bond is missing the signed and dated recital at the end;
- Paragraph 9 in the Holdback Repayment Bond should follow the Surety and Contractor addresses and information provision spaces, which are intended to be included at the bottom of paragraph 8;
- The Holdback Repayment Bond contains contradictory payment terms; paragraph 2 notes that payment will be made within ten (10) business days; however in Schedule A – Demand, the demand for payment provides for payment within twenty (20) business days.
Aside from these minor technical revisions, there are several other technical issues in relation to amendments to the bonds and riders. While the bond forms must be used and the minimum requirements are set out in the Regulations and bonds, the Act specifically contemplates alterations to the bonds to increase coverage (i.e. in relation to AFP projects). It is unclear, at this time, how the bond forms are to be modified. In our view, and as has been the case in the past, additional coverage could be amended into the body of the bond or added via a rider. This is not specifically addressed in either the Act or the Regulations.
For example, a simple change such as increasing the bond amount, from 50 per cent of the contract price to 100 per cent, conceivably will be a simple change on the face of the bond. In another example, in order to add liquidated damages coverage to a performance bond, a rider is likely required, specifically stating that paragraph 7.3 (a) of the performance bond does not apply.
Another more complex rider would be required for the addition of multiple or dual obligees, and possibly adapting the bond forms to the Integrated Project Delivery model31 or the AFP model. Up to this point, AFP bonds typically contain a performance component, and a separate liquidity component, and the obligees include the Project Co., the lenders, and the Owner. The use of multiple obligee riders begs the question of whether the obligee in the bond could potentially risk losing some of its mandated coverage under the bonds, and if so, whether this runs afoul of the legislation. As with other elements of the bonding process, we will have to wait and see how the industry and the courts react to the implementation of the new bond forms, including in relation to amendments and riders.