Tuesday, 23 October 2018

Lien Holdbacks and Deficiency Holdbacks

By Corbin Devlin

A frequently-asked question is, can the Alberta builders’ lien holdback be used for the correction of deficiencies? The short answer is, the holdback can be used for correction of deficiencies, only after the statutory purpose of the holdback is expired.  The Builders’ Lien Act does not contemplate using the statutory holdback for anything other than security for payment to lien claimants. But the Builders’ Lien Act does not dictate what happens to the statutory holdback after the lien holdback period expires. Read on for further explanation…

Legitimate Setoff


The first thing to consider is whether there is a legitimate right to set off a claim or hold back funds otherwise payable – ignoring for the moment any issues arising under the Builders’ Lien Act. A construction deficiency does not automatically give rise to a right to deduct an estimated repair cost from amounts otherwise payable. One must consider the payment provisions and other related provisions of the contract. Some contracts expressly allow for rights of setoff, or the right to hold back an amount on account of construction deficiencies.  On the other hand, common law rights of setoff may allow for an owner to retain funds on account of deficiencies, even where the contract is silent.

A fulsome discussion of the principles of setoff is beyond the scope of this article. For our present purposes, we assume that there is a legitimate right to retain a deficiency holdback (i.e. claim a setoff), per contract or common law. The question is, how does this relate to builders’ lien holdback requirements?

As Between Owner and Contractor


There’s two statutory restrictions on payment of the builders’ lien holdback: 1) the owner is required to maintain the holdback until the lien period is expired (ss. 18 and 23 of the Act); and 2) the Act expressly states that the lien fund “shall not, as against a lienholder, be applied to the completion of the contract or for any purpose other than the satisfaction of liens.” One might read these requirements and conclude that the lien holdback is simply not available for the completion of deficiencies. However, this is only partly correct, and there is some flexibility inherent in the legislation.

The legislation specifies when the holdback must be retained, but it does not specify when the holdback must be released. If the statutory requirements to retain the holdback are expired, then the owner may pay out the holdback. Whether (and when) the owner must pay out the holdback is a question of contract interpretation. Standard form contracts typically specify when the holdback is to be paid to the contractor. But express or implied contract terms may also permit the owner to hold back funds or set off the costs of unfinished work or deficiencies against payment amounts otherwise due to the contractor.

In other words, once the lien period is expired, if no liens are registered, the owner is permitted, but not required, by statute to release the holdback.  At that point, the owner may use the holdback for the completion of the work or correction of deficiencies, if permitted by contract, because the owner is no longer required by statute to continue retaining those funds.

As Between Contractor and Subcontractors


The lien legislation in Alberta does not impose any obligation to retain a lien holdback on anyone other than the owner. However, as a matter of contract requirements and industry practice, a general contractor will often retain a holdback from a subcontractor (and so on down the line) to mirror the owner’s retention of funds from the contractor.

Therefore, whether a contractor can use holdback funds to correct deficiencies by a subcontractor is entirely a matter of contract interpretation.

Examples


If a contractor or subcontractor has performed deficient work, and the lien period has expired without the registration of any liens, the owner’s lien holdback may be applied (set off) against the cost of the deficiencies - if expressly or impliedly permitted by the contract.

If a contractor (or subcontractor) has performed deficient work, and liens are registered or may become registered (i.e. because the lien period is not yet expired), the owner (or contractor) should not use the lien holdback for the completion of the work or correction of deficiencies – even if the contract would permit it. The lien holdback may soon be required to be paid into court to discharge liens against the project (for example, if the subcontractor becomes insolvent, resulting in sub-subcontractor lien claims). The owner (or contractor) who has used the statutory lien holdback to account for the cost of repairing deficiencies, while liens are registered or may be registered, may end up short of funds for completion of the work or for the discharge of liens (i.e. risk of shortfall). If a deficiency holdback is permitted by the contract, it should therefore be a separate/additional holdback from the statutory lien holdback, so long as liens are registered or may become registered. Then, when the liens are discharged (or the lien period expires without lien registration), the statutory lien holdback can be released separately from the deficiency holdback.

Summary


In essence, if liens are claimed or may be claimed (i.e. before the lien period is expired), the lien holdback should be considered as reserved for a single purpose; security for payment to lien claimants. However, once that purpose runs out due the expiry of lien rights (assuming no liens are registered), the lien holdback is just another sum payable under the contract, and express or implied rights of setoff may be exercised and taken into account to determine the actual amount payable. In other words, the owner or contractor may employ the lien holdback to offset legitimate deficiency costs, only after the statute allows the lien holdback to be released.

Some contracts expressly contemplate a deficiency holdback that is separate and additional to the lien holdback. If the contract expressly addresses the issue, those agreed terms will prevail, unless they somehow conflict with the lien legislation. Much more frequently, there is no express right to a deficiency holdback set out in the contract. Such a right may nevertheless exist, based on the common law right of setoff.

The statutory trust provisions, if applicable, may also impact on these issues. The limited trust provisions under the Alberta Builders’ Lien Act are discussed in another recent article [insert link to August blog Article] on this blog.