Understanding the Impact of Bill 142 – the Act to Amend the Construction Lien Act

Construction Update

With the summer months behind us, the fall season in the construction industry will include the next steps in passing Bill 142, also known as the Act to Amend the Construction Lien Act. If implemented, Bill 142 will represent the most significant legislative reform seen in the Ontario construction industry since 1983, when the existing Construction Lien Act came into force. The first reading of Bill 142 was carried on May 31, 2017 and it is widely anticipated that the second reading will occur early in the fall. Although consultation on the language of the draft continues, it is almost a certainty that Bill 142 will pass well before the provincial election in the spring of 2018.

While the themes giving rise to this legislation have been under discussion for many years, the industry should be prepared for dramatic change with respect to both contract administration and dispute resolution. The hot button terms representing this reform are without a doubt “prompt payment” and “adjudication”. Together with a slew of changes intended to modernize construction liens, and a new requirement for bonding on most public projects, these key concepts are going to impact virtually every player in the construction industry and every type of project – from the largest P3 infrastructure project to the renovation of your kitchen. Indeed, one of the commonly cited challenges with Ontario’s construction legislation has always been that projects sitting at opposite ends of the spectrum with respect to size and contract price are nonetheless governed by the same law.

There are many ways that the objectives of this construction law reform can be captured. The following three are salient:

  • creating a statutory mechanism to enforce timely payment for work performed;
  • reducing the prevalence, cost, complexity and duration of construction dispute resolution proceedings; and
  • simplifying the construction lien process.

Bill 142 has been modelled, in part, after other jurisdictions. However, the purpose of this article is to focus more on a forward-looking summary of what Bill 142 will mean for the industry, and less on the process that led to it. The scope of the overall changes can be seen even in the title of the legislation. Rather than the Construction Lien Act, Ontario will soon have the Construction Act.

Prompt payment

A lengthy debate within the construction industry over the need for prompt payment was the primary driver behind the provincial government commissioning a full review of the Construction Lien Act. It is therefore not a surprise that prompt payment features prominently in Bill 142. One of the principal criticisms of past efforts at prompt payment (many readers will recall Bill 69) was that with payment terms imposed by legislation, parties would not have the freedom to customize their contracts for the unique nature of each project. For example, while some contracts contemplate monthly billing and payment, it is quite common on larger projects for payments to be tied to the achievement of specific milestones.

The prompt payment structure contemplated by Bill 142 seeks to achieve that balance. The deadline for making a payment will be triggered by the submission of a “proper invoice”. The Bill sets out the minimum information that a proper invoice must include and then allows for “any other requirements that the contract specifies” and any other information that may be prescribed by regulation. In addition to basic information such as the contractor’s contact information and where to send payment, a proper invoice must include the authority (usually the contract) on which the work was supplied, a full description of the work, the amount owing and the payment terms.

Importantly, Bill 142 provides that proper invoices shall be submitted monthly unless the contract provides otherwise. Accordingly, it will be more critical than ever for parties to figure out the timing and basis for invoices (including milestone payments) at the time they draft their contract. The decision will otherwise be made for them by the legislation.

It is also essential to understand that the statute will prohibit any contract clause that makes the giving of a proper invoice contingent upon payment certification or the prior approval of the invoice by an owner. In other words, if the statutory and contractual requirements for the contents of a proper invoice are met, the deadline for paying it will start to run. This concept may be disappointing to some in the industry who would have preferred to see payment deadlines tied to certification. However, the counterargument to that reaction will be the freedom to negotiate the invoice delivery process at the front end of the job.

The key concept in the prompt payment section of Bill 142 is the imposition of statutory payment deadlines. The deadline for payment by an owner to a contractor will be 28 days from the delivery of the proper invoice, unless the owner delivers a prescribed form of notice of non-payment within 14 days of the proper invoice being received. Notably, such a notice must particularize the amount and basis for non-payment and can be tested, at the discretion of the contractor, in the binding adjudication process that is described below.

At the next rung down, a contractor will be required to pay its subcontractors within seven days of the contractor’s receipt of payment from the owner or, if the owner has not paid the contractor, a contractor will be required to pay its subcontractors within 35 days of the contractor’s delivery of the proper invoice. However, like the owner, the contractor also has the option to deliver a notice of non-payment within deadlines prescribed by the statute, depending upon the basis for non-payment. If the reason for non-payment is the owner’s refusal to pay the contractor, then the contractor is required to refer its dispute with the owner to adjudication, as a condition of delivering a notice of non-payment to the subcontractor.

Similar requirements continue down the construction pyramid, with adjustments in the applicable deadlines, for payments by subcontractors to theirsuppliers and trades.

The ultimate remedies in the event of non-payment are essentially as follows: (i) the payer will be required to pay a prescribed rate of interest; (ii) the dispute can be referred to adjudication (see below); and (iii) the outcome of the adjudication process will be binding.

Adjudication

Although prompt payment has always been the focal point for those within the construction industry lobbying for change, it is adjudication that will arguably be the most revolutionary aspect of this statute. If implemented as expected, adjudication may radically change the way that construction disputes are resolved. Construction industry players who have experience with litigation or arbitration, particularly for large and complex disputes, are familiar with the time and investment that is involved. The volume of documents exchanged by the parties can easily number into the millions. Key employees commit considerable time to supporting the legal team and providing evidence. Numerous subject matter experts are required. It typically takes at least a year after a project is completed to get to a hearing in an arbitration process. In a traditional litigation process, the time required to get to a trial can be several years.

There are many good reasons for all of this. First and foremost, it is obviously not easy on a complex project involving a design that was developed over many years to “prove” who is responsible for a particular issue or delay or to allocate a certain amount of cost to a single event. Each party must do a massive amount of work to canvass the available evidence needed to advance their argument. Further, this typically takes place after the project is built, which means extensive forensic work by people who now have to “re-live” the project. All of this is further complicated by a variety of unpredictable factors. For example, memories will have faded and key individuals will have moved on to new employment. The decision maker is then left with the equally complex task of sorting through the evidence to arrive at a just result.

The intention of adjudication is to streamline this entire process and to allow for determinations to be made as issues arise. Adjudication is essentially an interim dispute resolution process that is binding upon the parties. A determination is made by a qualified adjudicator. The parties must then abide by that decision, whatever it is, and carry on with the project. Should either party wish to “re-litigate” the issue down the road, they are entitled to do so. However, the objective behind this statute is for such a scenario to be rare.

Without delving too far into the intricacies of the adjudication process set out in Bill 142, the essentials include the following:

  • a party to a contract or subcontract may refer to adjudication a dispute with the other party to that contract or subcontract;
  • matters may only be adjudicated by a person who has been identified as a qualified adjudicator by an entity called the Authorized Nominating Authority, a body which will be designated by the provincial government;
  • adjudication is only available for disputes relating to matters that are prescribed by the statute or the regulations to be prepared for the statute. However, the prescribed list is sufficiently broad such that, at least in the writer’s view, most disputes that may arise on a construction project are captured;
  • an adjudication is restricted to a single matter, unless the parties and adjudicator agree otherwise;
  • the parties can set out an adjudication procedure in their contract, if it meets the minimum requirements of the statute. However, they are not permitted to name an adjudicator in their contract;
  • an adjudication will be commenced by the issuance of a notice of adjudication. The notice is required to contain prescribed information, including the name of a proposed adjudicator;
  • if an adjudicator does not consent to be appointed within four days of a notice of adjudication being served, then the party giving the notice shall request that the Authorized Nominating Authority appoint an adjudicator. The Authorized Nominating Authority shall then have seven days to do so, subject to the adjudicator’s consent;
  • within five days of the adjudicator being appointed, the party initiating the adjudication shall provide the adjudicator with the documents it intends to rely upon for the adjudication;
  • while the adjudicator then has a fair bit of latitude to design the adjudication procedure, the adjudicator shall render a decision within 30 days after receiving these documents. That decision is binding until a determination of the matter is made in a court process or arbitration (which is anticipated to be rare – see above);
  • the 30-day deadline can be extended, but only with the written consent of both parties and the adjudicator;
  • a party who is required by the adjudicator’s determination to make a payment shall do so within ten days of receiving the decision, failing which interest will be payable and a contractor or subcontractor who does not receive payment shall be entitled to suspend their work, with compensation for costs incurred in so doing; and
  • the determination of an adjudicator may be enforced in court.

In sum, all of this means that most disputes on a construction project will be referable to an adjudicator as soon as they arise, for a binding decision within a very short period of time. The common criticisms associated with this process are that it will result in “rough justice”, that parties will not have the full opportunity to prove their case and that the party receiving an adjudication notice will have very little time to respond to a party who may have been planning their claim for quite some time. The response to these criticisms by advocates for adjudication is that projects will no longer be paralyzed by the accumulation of multiple disputes, quick decisions will allow for money to flow, the dispute resolution process will be more streamlined and less costly and adjudicators will have the discretion they need to ensure a fair process.

It is also important to point out that Ontario will not be the first jurisdiction to try adjudication. Adjudication has been employed in the United Kingdom for many years now and has since spread to various other jurisdictions around the world.

What will be unique in Ontario is the continued existence of a robust construction lien regime working in parallel with adjudication. Other jurisdictions that rely upon an adjudication system generally do not also allow for significant construction lien rights. In conjunction with implementing prompt payment and adjudication, the Construction Act will therefore modernize our construction lien legislation as well.

An updated construction lien regime

The changes within Bill 142 to construction liens are too numerous to set out in detail in this commentary. However, it is worth highlighting some of the key components:

  • the deadline to preserve a construction lien will increase from 45 days to 60 days from the applicable trigger date;
  • the deadline to perfect a lien by commencing a lawsuit will be increased from 45 days after the last date the lien could have been preserved to 90 days after the last date the lien could have been preserved;
  • there will be a mandatory requirement for holdback release unless the payer first publishes, within the prescribed time, a notice specifying the amount the payer refuses to pay;
  • in response to concerns raised over the years about the difficulty in arranging for early holdback release, holdback will be permitted to be released either on an annual basis or on a phased basis, for appropriate projects;
  • it will formally be recognized that permissible forms of holdback include letters of credit or holdback release bonds, in a prescribed form;
  • termination of a contract will be formally recognized as one of the trigger dates for the determination of the construction lien deadline. Further, where a contract is terminated, a notice of termination will be required to be published in a prescribed form;
  • landlords who provide tenant inducements under a lease will have exposure to construction lien claims, to a maximum of ten percent of the value of the inducement;
  • the formulas for calculating both substantial performance and completion of a contract will be modified to account for inflation since the Construction Lien Act was implemented almost 35 years ago;
  • the maximum amount of costs required to be posted to vacate a construction lien will increase from $50,000 to $250,000, in addition the amount of the lien itself;
  • rigorous accounting requirements will be implemented for trust funds received by a contractor or subcontractor on a project to ensure that all such funds can be traced (although dedicated project accounts will not be necessary);
  • construction liens for municipal projects will be required to be served rather than registered, as is presently the case for projects owned by the Provincial Crown; and
  • as described in further detail below, Bill 142 will also have a significant impact upon the way construction liens operate in the context of what are commonly referred to as alternative financing and procurement or public-private-partnership (P3) projects.

A word about P3 projects

It is beyond the scope of this summary to assess the full impact of Bill 142 upon P3 projects, which will only be known once a P3 project has been organized and built under the new legislation. There has consistently been a general recognition, however, that the current Construction Lien Act was not designed for the P3 structure. For example, financing for these projects is generally arranged by a special purpose entity (usually known as Project Co) that typically has no real interest in the lands upon which the project is located. Further, the entity that does own the land, which is often the Provincial Crown or a Crown corporation, may not make any payments until after the project is constructed. As a result, there is always a great deal of confusion around issues such as whose interest is being liened and the extent of each party’s holdback obligations. P3 lawyers and other professional advisors have spent many years working to make their contracts function within the framework prescribed by the Construction Lien Act.

Bill 142 seeks to address some of this confusion through a provision that expressly designates Project Co as the “owner” for the purpose of certain sections of the new Construction Act, rather than the Crown, municipality or other “broader public sector organization” that may own the premises. As a result, the new prompt payment and adjudication regimes will not apply to that public entity. Further, holdback obligations will be determined on the basis of the agreement between Project Co and the contractor it retains and the determination of substantial performance will be based upon that agreement as well.

Although this approach will fix some of the existing confusion, there has also been concern raised within the P3 community that Project Co and its lender will be subject to the risks associated with holdback, adjudication and prompt payment, in circumstances where they will not have corresponding recourse against the public owner.

Another open question is whether this exception will apply to projects that do in fact receive payments from the public owner during the construction phase, notwithstanding that they are structured as a P3.

It remains to be seen whether these issues will be addressed further during the next phase of the drafting process and before the statute is passed.

Bonds

Last but not least is another dramatic change that has perhaps flown somewhat under the radar during all of the discussions that have arisen in conjunction with Bill 142. In short, all contracts on public projects that exceed a certain value, to be prescribed by regulation, will require both a performance bond and a labour and material payment bond.

The effect of this change is to ensure the added security of a performance bond for public owners who encounter defaulting contractors. Similarly, unpaid trades and suppliers on public projects will have the additional option of pursuing labour and material bond claims. As a result, the progress of work on public projects should be less likely to be impacted by insolvencies and distressed or non-performing contractors. However, the concerns raised with this requirement will inevitably include the additional cost for bond premiums on such projects and the more limited flexibility available to parties who wish to negotiate their own security arrangements. It is presumably intended that these concerns will be offset by the advantages described above.

Looking forward

As with any dramatic industry change, it is inevitable that the Construction Act will be accompanied by growing pains, significant learning curves and major adjustments for all impacted parties. However, it follows an exhaustive process that was intended to address longstanding concerns within the construction industry. Only time will tell how well Bill 142 will be able to meet those daunting objectives. A key to this statute’s success will be a careful and well-planned ramp-up and transition period, during which public and private sector entities are given the opportunity to educate their staff, adjust their accounting and other administrative systems and consider how they will be impacted. It will likely take several years after implementation before the impact of this legislation can be meaningfully assessed.