Thursday, 18 January 2018

Progressive Holdback Tricks and Traps

There are a few tricks and traps associated with the progressive release of builders’ lien holdbacks.  As mentioned in a prior article, the Alberta Builders’ Lien Act includes provisions for releasing the statutory holdback early, or in stages ("progressively"), which can be very important to promote cash flow on larger construction projects. In the simplest terms, a Certificate of Substantial Performance may be used to authorize the release of part of the holdback – that is, the holdback in relation to the value of work referenced in the Certificate – even though the overall project is not yet entirely complete.

Basic Principles

As a starting point, the Builders’ Lien Act requires the owner to retain a 10% lien holdback throughout construction.  On large projects, this can result in a significant drag on cash flow to the contractor and subcontractors.  In particular, subcontracts often provide that payment of the subcontractor’s holdback is not due until the general contractor receives corresponding payment from the owner.   This can result in a subcontractor waiting an extended time to receive its holdback.  The progressive release of holdback mechanism exists to remedy this problem.

Importantly, either the general contractor or a subcontractor can post a Certificate of Substantial Performance in respect of the work of the subcontractor.  This gives the subcontractor a measure of control over the timing of release of holdback by the project owner.  It also provides a means by which the overall holdback on the project can be reduced in several stages, as various subcontracts are completed.  If a Certificate is properly posted, and no liens are registered, the project owner may safely release the portion of the statutory holdback associated with the Certificate 46 days after the Certificate is posted. 

Basic Example

Consider for example a construction project that is expected to extend over two full years.  A subcontractor who does all his work in year one does not want to wait another year to receive his portion of the owner’s builders lien holdback.  So, the Act permits the general contractor or the subcontractor to post a Certificate when the subcontractor’s work is substantially performed.   Assuming no liens are registered, the owner can safely release the portion of the holdback attributable to that subcontractor 46 days after the Certificate was posted. 

On a $10M general contract, the holdback at the end of the project would be $1M if not for progressive release of holdback provisions.  But the progressive release of holdback by the owner in relation to the early completion of a $500k subcontract would reduce the statutory holdback by $50k (i.e. 10% of the subcontract value), such that the owner’s statutory holdback is reduced to $950k at the end of the project.  The owner retains the holdback to comply with the Builders’ Lien Act, but also to protect itself against insolvency or default by any contractor on the project.  In our example, assuming the owner has complied with the legislation in progressively releasing $50k upon completion of the subcontract, the owner’s liability for the holdback is reduced from $1M to $950k.

Permissive vs. Mandatory

One thing to keep in mind is that the Builders’ Lien Act permits the progressive release of holdback; it does not require it.  General contractors and subcontractors who want to be able to insist on progressive release of holdback by the owner must ensure there are contract provisions that require the owner to progressively release the holdback.  For example:

When 45 days have expired from the date of issue of the certificate of substantial performance in respect of that Subcontractor’s subcontract, as verified by the Consultant, and no builders’ liens have been registered for the Work, the Owner shall promptly release that Subcontractor’s portion of the major lien fund to the Contractor.  If no builders’ liens have been registered for the Work, the Contractor shall promptly release that portion of the major lien fund to that Subcontractor. (Canadian Construction Association, CCDC 2 (2008) Supplementary General Conditions for use only in the Province of Alberta)

Subcontractors might want to ensure that progressive release of holdback provisions are included in both their subcontract and the general contract; an omission of such provisions from either contract could prevent the subcontractor from insisting on the progressive release of holdback.  (Sub-subcontractors should ensure that such provisions are included in the general contract and every subcontract in the chain.)

Other Tricks and Traps

As always, owners must minimize their risk of liability under the Builders’ Lien Act by ensuring that the subcontractor or general contractor has complied with statutory requirements, before making a progressive release of holdback.  Many contracts are structured to include administrative requirements that mirror the statutory requirements, thereby protecting the owner who follows his contract.  Other contracts do not get into such detail regarding conditions for payment.  Above all, and in any event, the owner should check title to the project lands, to ensure no lien claims have been registered (for claims arising under the general contract in question) before making any payment on the contract, for progressive release of holdback or otherwise.

Finally, it is important to note that the legislation only contemplates the progressive release of holdback upon the substantial completion of an entire contract or subcontract.   It is not consistent with the legislation, and may expose the owner to financial risk, to progressively release holdback month-to-month, or in association with the completion of a phase of work that does not comprise an entire contract or subcontract.  I have seen a number of circumstances where the concept of progressive release of holdback is misunderstood, sometimes even set out by contract in a way that does not comply with the statute, resulting in significant financial risk to the owner (i.e. potential shortfall in the statutory holdback).

Properly accounting for multiple progressive releases of holdback can be challenging under any contract.  Experienced contract administrators and project managers are familiar with these challenges.  But we know from experience that administration of progressive releases is not straightforward, and errors can happen through inadvertence or inexperience.