February 2013 Construction Law Section CONSTRUCTION AND INSOLVENCY LAW, PROCESS AND PRIORITIES THE INTERSECTION OF COMPLEX AND CONFUSING By Michael P. McGraw i Introduction Two of the more specialized areas of law are construction and insolvency law. Each area largely operates under its own rules, in its own forum with specialized counsel and clients. When the two disciplines intersect, disputes can become complex and contentious. Given the reality of insolvencies, these disputes are usually over a limited pool of funds insufficient to satisfy all claims. Counsel accustomed to operating in their own disciplines and clients who extended credit with the assumed comfort that their priorities would always prevail may escalate these disputes. While the interaction of construction and insolvency law can be confusing, an early review of procedural and priority issues can help lien claimants to determine the best course of action and minimize unnecessary time and costs. What follows is a brief, non-exhaustive discussion of some of key issues and considerations for Ontario lien claimants. Procedure Claims against an insolvent debtor subject to Court protection are governed by the Bankruptcy and Insolvency Act (Canada) ( BIA ), the Companies Creditors Arrangement Act (Canada) ( CCAA ), and the orders granted in insolvency proceedings. In Sun Indalex Finance LLC v. United Steelworkers, released on February 1, 2013, the Supreme Court of Canada confirmed that the doctrine of federal paramountcy is invoked where provincial law is inconsistent with federal bankruptcy and insolvency law. ii Therefore, subject to the doctrine of federal paramountcy, provincial law, such as the Construction Lien Act (Ontario) ( CLA ), applies to claims by a lien claimant against a Court-protected debtor. How a construction lien claimant advances its claim in the face of insolvency proceedings depends on numerous factors. The primary consideration is usually the type(s) and timing of the debtor s insolvency proceeding(s). Other factors include the number and identity of the defendants to the claim; the relationship of the parties in the construction chain; and the nature and amount of the claim against the insolvent debtor. There are four main types of insolvency proceedings which a lien claimant may encounter: CCAA proceedings; receiverships under the BIA (also often under the Courts of Justice Act (Ontario)); bankruptcy proceedings under the BIA; and proposal proceedings under the BIA. Sometimes two or more insolvency proceedings may be operating concurrently. Automatic Stay of Proceedings A stay of proceedings automatically arises upon the commencement of an insolvency proceeding. While the terms of a stay will differ depending on the proceeding, in all cases, the ability to preserve and/or
2 perfect a lien and advance a claim will be prohibited or impeded. When a stay arises, a lien claimant may not have completed, or even started, the necessary steps to preserve and perfect its lien. As a claimant s lien must still comply with the requirements of the CLA to be valid, it is important to take any necessary steps promptly. Some key considerations are as follows: In CCAA and receivership proceedings, the terms of the stay will be set out in the initial order commencing the proceedings. Some initial CCAA and receivership orders now provide that the stay does not prevent the registration of lien claims. iii However, such provisions only permit the preservation of a lien claim, and leave of the Court and/or the consent of the monitor or receiver is still required to commence an action and file a certificate of action on title to perfect a lien. iv If necessary, lien claimants should take advantage of come-back clauses in CCAA and receivership orders to bring issues before the Court, particularly if the order was obtained ex parte or on short notice. Unlike CCAA and receivership proceedings, the terms of the stay in bankruptcy and proposal proceedings are set out in the BIA and not in an order. v Under the BIA, lien claimants are secured creditors and technically unaffected by a stay in a bankruptcy proceeding. vi However, the common practice in a bankruptcy is for lien claimants to seek the Trustee s consent and leave of the Court in any event. vii The stay in a proposal proceeding, where the purpose is to facilitate the debtor s restructuring, not its liquidation as in a bankruptcy, is broader and prevents all creditors, including secured creditors, from enforcing their rights. Therefore, a lien claimant faced with a proposal proceeding must obtain leave of the Court to both preserve and perfect its lien. As most lien claimants will be seeking only to perfect and preserve their liens and not to proceed against a debtor, the monitor, receiver, Trustee in Bankruptcy or Proposal Trustee (as applicable) will typically be prepared to consent to the granting of leave by the Court to lift the stay for this limited purpose. As insolvency proceedings may continue for an extended period of time, lien claimants may have to seek leave in order to have their action as against the insolvent debtor set down for trial within two years of perfection, as required by the CLA. viii Insolvency Claims Procedures The procedure for advancing claims against an insolvent debtor varies with the type of proceeding. This will be more important to lien claimants if the insolvent debtor is the only defendant to its lien action or represents the only or best opportunity to maximize recoveries. The following are some key considerations: The claims procedure in a CCAA or receivership proceeding will be set out in a court order sometimes referred to as a claims bar or claims procedure order. A typical claims procedure order requires that all creditors file proofs of claim with respect to any and all claims against the insolvent debtor by a prescribed claims bar date pursuant to a detailed claims bar procedure approved by the Court. Such an order will typically empower the monitor/receiver or a court-appointed claims officer to initially review and either allow or dispute claims, with the claimant having a right of appeal to a claims officer or the supervising court. It is common for claims involving specialized areas of law, or law from other jurisdictions, to be adjudicated based on affidavits of law filed by practitioners from those specialties and jurisdictions.
3 In order to obtain a more specialized and familiar forum, lien claimants, particularly if there are multiple lien claims, may consider seeking a reference of any lien claims in an insolvency procedure to a Construction Lien Master on construction-specific issues. One example of where insolvency and construction lien counsel worked co-operatively to facilitate the adjudication of lien claims in a receivership was WestLB AG v. Rosseau Resort Developments Inc.. ix In that case, the parties developed a stand-alone construction lien claims procedure order whereby the receiver (which was also appointed as a trustee under the CLA) had the authority to accept or reject lien claims and negotiate settlements, with appeal rights to the supervising Court. At the same time, counsel agreed to refer certain complex holdback issues to a Construction Lien Master. Even if a lien claimant does not intend to actively pursue any claims against a debtor, it should comply with the terms of a claims procedure order. Given the real-time nature of most insolvency proceedings, the deadlines are often short, and missing any of them may result in a permanent bar and extinguishment of a claim. If a deadline is missed, the lien claimant should move as quickly as possible to remedy the situation and seek the appropriate consent of the applicable Court-appointed officer or leave of the Court. x Claims procedures in bankruptcy and proposal proceedings are set out in the BIA. xi Lien claimants should file claims, even if only to reserve any rights they may have against the debtor. If a lien claimant is asserting a trust claim against a debtor, a separate trust claim must be filed with the Trustee. xii It may be difficult to compel the participation of an insolvent debtor in an action outside of insolvency proceeding(s). Where participation, even as a witness, in an ongoing action would disrupt the restructuring of a debtor, the Courts have held that the stay operates to prevent such participation. xiii Priorities In an insolvency, lenders, including mortgagees, and lien claimants will usually be asserting priority over the same real property and its proceeds. This will engage the comprehensive priority scheme set out in the CLA and may engage the doctrine of federal paramountcy. xiv Undertaking an analysis of priority positions from the outset may assist in making timely decisions that may prevent unnecessary costs, particularly if it is clear that even if the lien claimant has a valid claim, it will not receive any distributions. The following are some considerations: For the purposes of the CLA priority scheme, a key determining factor is whether the funds advanced by a mortgagee are a building mortgage or a non-building mortgage. This determination is based on whether the intention of the mortgagee was to secure the financing of an improvement, the evidence for which will typically be set out in the relevant loan documentation. xv To maximize protection and priority with respect to mortgage advances, a lien claimant should preserve and perfect its lien or provide mortgagees with written notice as soon as possible. xvi To determine if there are any potential proceeds available to satisfy its claims against the real property, and if so, how much, a lien claimant should obtain, as soon as possible, usually from the court-appointed officer, the estimated value of the real property in question, including the estimated amount of any environmental remediation costs.
4 Priority disputes may also arise with respect to post-filing financing advanced to a debtor company in CCAA or proposal proceedings, (called debtor-in-possession financing or DIP financing) or to a receiver (called receiver s borrowings ). Where a courtappointed officer is also appointed as a construction lien trustee under the CLA, any advances to the construction lien trustee have priority over construction liens. xvii This is more common where post-filing financing is required to complete the improvement in question. In Sun Indalex Finance LLC, the Supreme Court held that a court-ordered DIP priority under the CCAA has the same effect as a statutory priority for the purposes of the doctrine of federal paramountcy. xviii In Bank of Montreal v. Peri Formwork Systems Inc., the British Columbia Court of Appeal held that under the Builders Lien Act (British Columbia), Receiver s borrowings advanced by the debtor s lender did not constitute further advances under an original mortgage; but rather advances under a new loan secured by a new charge to a new borrower. xix In a more recent British Columbia decision released prior to Sun Indalex Finance LLC, Peri Formwork was distinguished where it was held that DIP financing in a CCAA proceeding had priority over construction liens; in part on the basis that the DIP financing was consistent with the purpose of the CCAA proceedings and afforded the lien claimants the only opportunity to realize on their claims. xx The Ontario Court of Appeal held in Veltri Metal Products, Re that where real property is sold in a CCAA proceeding and the proceeds are held by the monitor, not the debtor, there is no statutory trust over the sale proceeds under sections 7(1), 7(2), 7(3) and 9(1) of the CLA. xxi Conclusion Determining a lien claimant s rights, relative priorities, and procedural options in the face of an insolvency proceeding may save significant time and costs, particularly where there may be limited or no possibility of recovery. An early analysis can help a lien claimant decide if, how, or how aggressive to advance its claim. i The author is a Partner at Blake, Cassels & Graydon LLP, practicing general commercial, insolvency and construction litigation. The author would like to thank students-at-law Beth Romano, Aryo Shalviri, and Leah Noble for their input and assistance. ii Sun Indalex Finance LLC v. United Steelworkers, 2013 SCC 6 at paras. 48-60, 241, 264-265. iii Companies Creditors Arrangement Act Initial Order Form and Receivership Order Form; (January 2010) Online: Ontario Superior Court of Justice, http://www.ontariocourts.ca/scj/en/commerciallist/. iv Ibid. v BIA, ss. 69, 69.1, 69.2, and 69.3. vi BIA, ss. 2, 69, 69.1, 69.2, and 69.3 vii L.W. Houlden Ed, The 2012-2013 Annotated Bankruptcy and Insolvency Act, (Toronto, Canada: Carswell, 2012) at 461. viii CLA, s. 37(1). ix WestLB AG v. Rosseau Resorts Development Inc. (24 July 2009), Toronto (Commercial List), CV-09-8201-00CL (Ontario S.C.J.) x For a complete discussion of claims bar procedures and dates, see M. McGraw, "The Claims Bar Date - Temporary Road Block or End of the Road?", (2011) National Creditor Debtor Review, Vol. 26, No. 3, p. 29, September 2011. xi BIA, ss. 50.1, and 124-135. xii BIA, s 67(1)(b). xiii Canwest Global Communications Corp., Re, 2009 Carswell Ont. 7882 (Ont. SCJ.) at paras 45-46.
5 xiv CLA, s. 78; Sun Indalex Finance LLC at paras. 48-60; for a complete overview of the operation of s.78, see C. Huband Mortgages and Construction Liens, Blakes Bulletin, (27 April 2012) Online: http://www.blakes.com/english/view_disc.asp?id=5458; see also H. Krupat, Where Construction Law and Insolvency Meet in Ontario (2009), 83 CONSTRLR-ART 12 and M. Alter, Construction Liens and The Companies Creditors Arrangement Act, (2004), 41 CONSTRLR ART 9. xv CLA, s. 78(2); Northway Developments Inc. v. 1200946 Ontario Inc. 1998 Carswell Ont. 3048 (Ont. Gen. Div.). xvi CLA, ss. 74(6)(a) and (b) and 78.4 (a) and (b). xvii CLA, s. 78(7). xviii Sun Indalex Finance LLC at paras. 52-60. xix Bank of Montreal v. Peri Formwork Systems Inc. 2012 Carswell BC 10 (C.A.) at para 69; leave to appeal to SCC refused, 34958 (January 24, 2013). xx Mission Creek Mortgage Ltd. v. New Recreations Ltd. [2012] B.C.J. No.2698 at paras. 100-116. xxi Veltri Metal Products, Re, 2005 Carswell Ont. (ONCA) at paras. 26-29 and 35.