Indemnity Clause "Red Flags"

Author: Corbin Devlin

In most construction contracts, there is nothing more tricky than the indemnity clause. Indemnities don’t come into play on most projects (but when they do, it is because something has gone badly wrong.) As a result, indemnity clauses often get short shrift in negotiations.

A blog is no place for a discussion of such a complex subject. Or is it? Determining whether or not an indemnity clause is problematic is the starting point.

With the intent of giving a complex subject a simple treatment, this is my list of “red flag” issues that call for (re)negotiation of an indemnity clause:

• Indemnity for risks out of your control: This is a basic principle. The indemnitor (the party with the burden of the indemnity clause) should ask, am I taking on any risk under this indemnity clause that I cannot control? The purpose of indemnities is (or should be) to attach a particular risk to the party best able to control that risk.
• Indemnity for risks controlled by the other party: This is worse. Unless you are in the insurance business, you should not agree to indemnify the other contracting party for something in their control.
• Indemnity for losses resulting from the other party’s own negligence: This is the absolute worst. (Fortunately, this is also a very rare animal. And the Canadian courts say that they won’t imply an obligation to indemnify the other party for a loss caused by their negligence unless the contract says so in the most clear and obvious language. I have seen such express clauses, but not many.)
• Indemnity for an uninsured (or uninsurable) risk: This is another basic principle. The indemnitor should always be asking, do I have insurance that protects me against these risks covered by the indemnity clause?
• Indemnity without limit: Is there no cap on the indemnity obligation? Remember that insurance policies have monetary caps; an indemnity without a cap is a sure sign that the indemnitor are taking on an uninsured risk (i.e. in excess of policy limits).
• Indemnity disproportionate to the contract: Is the indemintor taking on risk under the indemnity clause that is far greater than the contract value? Would the indemnity clause put the company at risk of bankruptcy if the unexpected comes to pass?
• Indemnity for consequential damages or economic loss: Indemnity clauses broad enough to include consequential damages or economic loss require very careful consideration. By definition, such indemnity clauses expose the indemnitor to liability that is broader than ordinary principles of contract law or common law would allow. (Perhaps another day I will elaborate; this is a topic that warrants an article of its’ own.)
• Indemnity for negligence or breach of contract: Now we are getting into clauses that are common, but require caution. Indemnity clauses that cover negligence or breach of contract expose the indemnitor to potential liability for unforeseeable losses. But at least such obligations require the indemnitee to prove that the indemnitor was negligent, or breached the contract. If the indemnitor has to give such an indemnity, the other “red flags” mentioned in this list become even more important; e.g. If you must agree to indemnify the other party for any loss resulting from your breach of contract, can you negotiate a monetary cap, and/or an exclusion of consequential damages or economic loss?
• Indemnity for any loss “arising from or related to” the work: Such broad indemnity obligations do not depend on proof of negligence, or breach of contract – it may be sufficient to trigger indemnity obligations if the loss is (somehow) related to the work, even without negligence or breach of contract. Therefore, such indemnities require even more caution than indemnities for negligence or breach of contract. Once again, however, such indemnity clauses may be fine – if they are otherwise subject to some reasonable limitations in scope and amount.

There are infinite permutations of project risks, indemnity provisions, and insurance programs; an indemnity clause may be unreasonable in once case but justifiable, even necessary, in another case. Be sure to consider the indemnity clause in the context of possible real world risks on the project (bodily injury, damage to existing facilities, delay in completion, environmental risk…) and the project insurance program. Just don’t ignore the indemnity clause or treat it as boilerplate. A bad indemnity clause can be a very big problem, not only when that unexpected loss occurs but also in the event of any contract dispute.

Federal Exemption from Liens is No Simple Matter

Author: Corbin Devlin

With significant recent and ongoing expansion at the Calgary, Edmonton and Fort McMurray airports, a number of trades have been interested in the question whether airports are subject to builders’ liens. In the recent Alberta decision Park Avenue Flooring Inc. v. EllisDon Construction Services Inc., the judge states categorically that the Alberta Builders’ Lien Act has no application to the Calgary Airport because it is federal property. This is the first time a court has made such a clear pronouncement on this issue in Alberta.

The issue is canvassed more fully in the 2009 B.C. case Vancouver International Airport v. Lafarge Canada Inc.

Constitutional Questions
 
The issue is actually more complex than the decision in Park Avenue Flooring case might suggest. It is not every construction project relating to an airport that is exempt from provincial lien legislation. First, an interest in land owned by the federal government is clearly exempt. But... not all airport lands are owned by the federal government. Second, an operation or “undertaking” that is within the jurisdiction of the federal government may be exempt (whether or not the lands in question are owned by the federal government) based on constitutional principles. The federal government clearly has jurisdiction over aeronautics. But this doesn’t mean that airports are exempt from provincial legislation for all purposes and in all cases; various case-specific considerations might come into play, such as the degree of federal control over the operation or undertaking… and not all airports are subject to the same degree of federal control. Third, there may be multiple interests in land at an airport; i.e. the federal government, the airport authority, airlines, hotels, car rental agencies, concessions... Different considerations may come into play depending which interest in land is in issue; the cases referenced here do not resolve the question whether subsidiary interests (e.g. leases) in airport lands could sometimes be subject to liens at the same time other interests are exempt.

Airports
 
Although it would be easy to suggest that airports are categorically exempt from lien legislation based on the Park Avenue Flooring case, it would be a mistake to interpret the court’s comments in that case too broadly. It remains arguable that not all interest in airport lands are exempt from provincial lien legislation. But no doubt valid provincial lien rights at airports would very much be the exception.

Interpreting a "Withholding of Payments" Clause

Author: Corbin Devlin

A contract provision that permits an owner to withhold payment from a contractor is not a “penalty” clause.

Penalty Provisions
 
The courts do not like, and typically do not enforce, “penalty” clauses. For this reason, liquidated damages clauses in favour of the construction owner generally have to be based on a “genuine pre-estimate of damages” in order to avoid the court striking the liquidated damages clause down.

No Further Payment Provisions
 
In a recent Ontario case, Ottawa Community Housing Corp. V. Foustanellas, the contractor argued that a clause providing that (in certain instances of default) “the obligation of the Owner to make payments will cease” was a penalty clause, and therefore not legally enforceable. The contractor was overbilling the owner, and consequently the owner acted on a clause in the contract that permitted the owner to “take work out of the hands of the Contractor.” The owner then hired someone else to complete the work, but the Contractor sued to recover payment for the work it had performed before the owner took the work out of its hands.

Specifically, the contract permitted the owner, upon default by the contractor, to “take the whole operation, or any part of the operation out of the hands of the Contractor.” The owner relied upon that clause and a further clause stating:   “…where any or all of the work has been taken out of the hands of the Contractor, the Contractor will not be entitled to any further payment, including payments then due and payable but not yet paid. The obligation of the Owner to make payments will cease, and the Contractor will be liable upon demand to pay the Owner an amount equal to all of the losses and damages incurred by the Owner for the non-completion of the work.”

The court decided this last clause did not erase the debt due to the contractor (if any). It suspended payments due to the contractor (if any) until a final accounting could be done, after the owner had the work completed by others. Since the clause only suspended payments, and it did not erase the debt, it was not a penalty clause. It was enforceable.

Debts Owing vs. Payments Due
 
This is not a surprising outcome or new law. But it is useful case authority for the interpretation of a fairly common contract provision. It is also a reminder of the distinction between a debt owing and a payment due. This is a deceptively simple distinction that is essential to proper interpretation of construction contracts and lien legislation. I frequently see misinterpretations of contract and lien legislation due to misunderstandings on this point. In the Foustanellas case, it appears that the contractor went to trial on the misinterpretation that the default provisions in the contract erased the debt, whereas the proper interpretation was that the default provisions merely suspended the payment obligation.

The court called this “a ‘stop payment’ provision. It is designed to halt the owner’s contractual obligation to make any payments to the contractor pending determination of the owner’s losses and damages arising from the contractor’s breach of contract.” In Foustanellas, the debt was erased, but not because of a penalty clause. The debt to the contractor was erased because the owner’s increased cost to complete the work as a result of the contractor’s default exceeded the value earned by the contractor prior to the default.

Towards a More Relaxed Interpretation of the Builders' Lien Act

Author: Corbin Devlin

A few recent cases from Alberta Masters show a trend towards a less strict interpretation of lien deadlines and requirements. In particular, these cases suggest that equitable considerations may sometimes operate to avoid the strict interpretation of the statute.

Saving a Lien Through Estoppel
 
The most recent example is the decision of Master Prowse in Boulevard Real Estate Equities Ltd v 1851514 Alberta Ltd.

A lien claimant discharged its' lien when the owner promised payment. When the owner failed to come through with payment, the lien claimant re-registered a lien - even though it was out of time. The owner applied to court to ask for the lien to be discharged on the grounds that it was registered out-of-time. The Master held that the promise to pay, which the lien claimant relied on to miss the lien registration deadline, estopped the owner from obtaining a discharge of the lien. The owner's promise created a "promissory estoppel" that prevented the owner from relying on the strict operation of the legislation. In effect, equitable considerations overruled the strict interpretation of the legislation.

The Master made a point of observing that only the rights of the owner and the lien claimant were in issue. If a third party would be affected (prejudiced), then the Court would have to strictly follow the legislation.

Not a Unique Case
 
This case seems to indicate a trend, as a similar result was obtained in TRG Developments Corp. v. Kee Installations Ltd.

In that case, a lien was lost because the lien claimant did not register a lis pendens within 180 days of lien registration as required by the statute. But the court ordered the lien to be restored because, even though the requirements of the legislation were not strictly followed, the lien claimant had started a proceeding in which the validity and value of the liens could be determined, and nobody was prejudiced by the failure to register the lis pendens. This decision was upheld on appeal.

The Problem With The Trend
 
At first blush, it is hard to argue against introducing principles of equity and fairness into the interpretation of the Builders' Lien Act, particularly when all the affected parties are before the court. This trend certainly benefits the lien claimant. But there are competing considerations – such as protecting the rights of construction owners and lenders.

For one thing, a more relaxed interpretation of the legislation is less predictable, and so we might see a corresponding increase in lien litigation, at least until there are additional reported cases to clarify the issue. More significantly, this development may cause practical concerns for those who rely on the predictable operation of the lien legislation to make lending and payment decisions (owners, lenders and construction managers). There is some comfort in the Master's assurance that the doctrine of promissory estoppel will not operate if any third party would be prejudiced. On the other hand, liens affect contractual rights in addition to statutory rights. Lending and payment decisions are made every day based on lien deadlines elapsing, and based on the registration or non-registration of liens – in other words, based on an assumption that the lien legislation will be strictly enforced. The commercial consequences of allowing an expired lien to be restored may therefore extend beyond the obvious.

Arbitration Clauses and Lien Rights

Author: Corbin Devlin

Lien rights can’t be enforced through arbitration, but many construction contracts provide for mandatory arbitration. In a recent decision, West Coast Installations, Inc. v. Frazier Industrial Co., the Alberta Court explained how arbitration clauses and liens can co-exist. This is not new law, but it is useful clarification of an issue that comes up time and again.

Arbitration Clauses
 
Many construction contracts provide that the parties choose to resolve their disputes outside of court, usually by arbitration. The courts will give effect to these agreements – that is, a party who has agreed to resolve a dispute by arbitration may find his case thrown out if he tries to proceed instead by way of a lawsuit.

Lien Rights
 
Lien rights can only be enforced by the courts. Section 8 of the Builders’ Lien Act makes it clear that the parties cannot contract out of the remedies provided by the Act. As stated by the court, in the West Coast Intallations case: “That does not mean that the parties to a contract cannot agree to have the substance of any dispute referred to arbitration, but it means that the party who has done the work cannot be prevented from claiming a builder’s lien and similarly the landowner or the general contractor cannot be prevented from providing security to stand in place of the lien under section 48 of the Builders’ Lien Act. These are remedies available under the legislation.”

A Pause in the Legal Process 
 
In the West Coast Installations case, the lien claimant sued despite the existence of a mandatory arbitration clause. (In fact, the lien claimant probably had no choice but to sue, to preserve its’ lien rights in accordance with the Builders’ Lien Act.) On a court application by the counterparty, the court issued a stay of proceedings. That is, the court referred the dispute to be resolved by arbitration, and directed that the parties could return to court only after the arbitration concluded, or upon settlement of the dispute, for the court to give directions in respect of the claimant’s lien rights. In this way, the court process would be put on pause, the substantive dispute between the parties would be resolved by an arbitrator, and then a judge would (if necessary) give effect to the arbitrator’s decision by enforcing the claimant’s lien rights. 

Allowing for some minor variations in the process, there is no doubt that lien rights and arbitration clauses can co-exist. In many cases, co-existence would not be the subject of any real dispute; the court process would be paused (“stayed”) by agreement while the arbitration proceeds.

More Frequently Asked Lien Questions

Author: Corbin Devlin

I am frequently asked by owners, contractors or construction managers, which subcontracts or material supply contracts are subject to lien holdback requirements? There is an easy answer to this question, and a hard one.

The Legislation 

The easy answer is that the Alberta Builders’ Lien Act only requires a lien holdback by the owner. So, only those contracting directly with the project owner are required by statute to submit to a 10% holdback – and it is the owner, not the contractor, that has the statutory obligation to hold back this amount.

It does not matter if the owner is dealing with a general contractor, trade contractor, material supplier or other service provider; if they have lien rights, and they are contracting directly with the owner, then the owner should (indeed, must) take a 10% holdback from them.

The Subcontract
 
If the legislation does not require it, why is there usually a 10% holdback on subcontracts? The answer to this question is found in the subcontract itself. In Alberta there is no statutory requirement for holdback on subcontracts; but this requirement is found in most subcontracts (including standard forms), and arguably it is a standard industry practice in some sectors even if there is no subcontract in writing. In other words, subcontractors are not required by statute to allow for a 10% holdback – but they are often required by contract to allow for a 10% holdback.

There is good reason for the contractor (the party contracting directly with the project owner) to provide for a holdback in its’ subcontracts. It is a question of risk and cash flow. The contractor is at risk of liability to the owner if liens are registered by subcontractors or those further down the chain, so the holdback gives the contractor a measure of protection. If the contractor will not receive its’ holdback until substantial completion, then in accordance with the lien legislation, the contractor will want to protect its’ cash flow by taking a corresponding holdback from its’ subcontractors.

This is one of those issues that varies from province to province. For example, in Saskatchewan, a holdback on subcontracts is required by statute, unlike Alberta which leaves this issue to be dealt with by contract law.

Material Suppliers and Service Providers  

What about material suppliers, or those who supply only services? As far as the legislation goes, the same analysis applies. However, in some sectors it is uncommon for material suppliers, or those who supply only labour or services, to agree to a 10% holdback by contract. Certain material suppliers have the clout to refuse to allow holdbacks and for some reason lien holdbacks are simply unusual for some service providers (particularly design professionals). It is often overlooked that even these parties who would purportedly refuse to allow lien holdbacks can’t escape the legislation; if they have lien rights, and they are in a direct contract with the owner, the owner is not only permitted but required to withhold 10% from them.

In short, it is a question of contract law as to whether subcontractors, material suppliers and service providers – those who are not in a direct contractual relationship with the project owner – are subject to a holdback. In theory, the contractor has to negotiate for this right when it is negotiating payment terms with its’ subcontractors, material suppliers and service providers. In some sectors (i.e. the major trades), this is no issue. In other sectors such holdbacks are not the norm. When a party with lien rights refuses to agree to a holdback, the contractor can negotiate the issue, incur the risk, or find another party to contract with.

Mischievous Liens

Author: Corbin Devlin

From time-to-time we see lien legislation abused or distorted for mischievous purposes. Anyone who deals with liens on a regular basis has witnessed such abuse. Anyone involved in the lien process – owners, contractors, subcontractors, suppliers, and yes even lawyers – can be guilty of such abuse.

One of the more common abuses is the mischievous lien registered by a subcontractor. The registration of a lien can have fairly significant consequences. It will often disrupt project financing and suspend further payments by the construction owner. It can also be costly to get resolved. All experienced subcontractors know this, and use it to their protection or advantage when appropriate. Unscrupulous subcontractors will register liens even when they know they do not have the right to do so.

Cancelling the Lien
 
Last week I was pleased when a Master of the Court of Queen’s Bench, in an unreported decision, cancelled a subcontractor’s builders’ lien and ordered the lien claimant to pay legal costs to the contractor. Not only was the subcontractor’s lien registered out of time (the subcontractor had falsely claimed that work was ongoing, in an attempt to extend the lien period), the lien was also registered for an improper amount (there was strong evidence that the subcontractor had inflated the lien amount).

It is not an easy thing to get a lien removed on the grounds that it is improper or mischievous. The lien legislation is considered “remedial” in nature (which is often used to justify a broad interpretation in favour of the lien claimant). A court application to remove a lien is usually done based on affidavit evidence (i.e. without a full trial) such that the courts are reluctant to make decisions when there is any controversy on the facts. Also, the courts are sympathetic to smaller lien claimants – even though it is often a false assumption that smaller lien claimants are unsophisticated; many of them know their lien rights very well.

Lack of Merit

In this particular case, the contractor’s attempt to cancel the mischievous lien was not guaranteed to be successful as there was disputed evidence. The Master relied on a new line of authority, including a recent Supreme Court of Canada case, to order the cancellation of the lien. Based on this new line of cases, the Court should consider if there is any claim "of merit" and if there isn't, the matter should be dismissed summarily and without the time and expense associated with bringing the case to trial. Although the Supreme Court of Canada was not dealing with a lien case, this reasoning is applicable to the lien context, considering that the Builders’ Lien Act expressly provides “The procedure in adjudicating on the claims shall be of a summary character, so far as is possible, having regard to the amount and nature of the liens in question and the enforcement of them at the least expense” (s. 49(6)). So, the Master did not actually have to go so far as to conclude that the lien was mischievous or improper; he cancelled the lien upon determining that the lien did not have sufficient merit to justify further legal process.

Lien rights are an important protective mechanism for contractors, subcontractors, service providers and material suppliers. But the lien process is complex, and unfortunately this complexity means there are ways to manipulate the process. This case was a gratifying reminder that the Court can sometimes identify such mischief on a summary application, and deal with it appropriately.