Does A “Pay When Paid” Clause Prevail Over The Construction Lien Act?
By Thomas G. Heintzman, O.C., Q.C., FCIArb
Mr. Heintzman specializes in arbitration, mediation and civil litigation. He has been counsel in actions, arbitrations and appeals in Ontario, Newfoundland, Manitoba, British Columbia and New Brunswick and has made numerous appearances before the Supreme Court of Canada. He has been particularly active in commercial disputes relating to securities law and shareholders rights, government contracts, broadcasting and telecommunications, construction and environmental law.
A pay when paid clause is one of the more contentious contractual provisions in the construction industry. That clause typically says that the subcontractor is not entitled to be paid until the contractor receives payment from the owner. Because of its perceived unfairness, the clause has been outlawed, or its effect has been substantially limited, in the United Kingdom and in many states of the United States.
In Canada, there is conflicting appellate authority about the effect of a “pay when paid” clause. Aside from that controversy, another important issue is: What effect does a “pay when paid” clause have on construction or builders liens? Can the clause eliminate the subcontractor’s entitlement to a construction or builders lien on the ground that, since the owner owes nothing to the contractor, then the contractor owes nothing to the subcontractor and so the subcontractor has no lien? That was the issue in the recent decision of the Ontario Superior Court in Bradhill Masonry Inc. v. Simcoe County District School Board.
B.W.K was the general contractor on a project to renovate the Bradford District High School and Bradhill was the brick work subcontractor. A claim for lien was registered by Bradhill and was vacated on the provision of security by B.W.K. The subcontract between B.W.K. and Bradhill appears to have been largely prepared or approved by the owner with little or no input from Bradhill. In the payment portion of the subcontract, that contract stated as follows:
“and the balance of the amount of said requisition, asapproved by BWK and the Architects and Engineers, shall be due to the subcontractor on or about the thirtieth day of the following month, and upon receipt by BWK of monthly payment by the owners.” (emphasis in the original)
The owner asserted that, based on this clause and the decision of the Ontario Court of Appeal in Timbro Developments Ltd. v. Grimsby Diesel Motors Inc.  O.J. No. 448, there were no monies due to the subcontractor when the subcontractor’s lien was registered because the owner had not paid B.W.K. for any work which was the subject of the lien. For this reason B.W.K. asked for the lien claim to be dismissed.
The court rejected B.W.K.’s argument in rather forceful language, calling it “antithetical to the law in the Construction Lien Act” and “a clever shell game.” The court noted that, while the owner had not paid B.W.K. when the subcontractor’s lien was filed, the owner later made full payment to B.W.K. when, as the court said, “BWK finally decided to put in its final invoice which it delayed.”
The court noted that, if accepted, B.W.K.’s argument would be devastating for lien claimants:
“The defendant’s argument would mean that if the general contractor’s lawyer is sharp enough in drafting the contract, the Act’s remedy for subcontractors who have not been paid for the fair value of their work would be rendered worthless as the owner and/or general contractor would become entitled to the costs of the lien action and could cut off all future payments to the plaintiff to reimburse itself when a lien claim was made. And if a sub-trade filed a claim for lien at the wrong time, its lien is worthless because money was not due and payable at that particular time even though the tradesperson has not been fully paid for their work and materials supplied to the job.”
The court held that the subcontract could not eliminate the subcontractor’s lien because section 5 of the Construction Lien Act states that the Act is incorporated into every contract in a project covered by the Act and every such contract is deemed to be amended to be in conformity with the Act.
Moreover, the court noted that section 14(1) of the Act provides that a person who supplies services or materials to an improvement for an owner, contractor or subcontractor, has a lien upon the interest of the owner in the premises improved for the price of those services or materials, and that under section 15(1) a lien arises when the person first supplies those services or materials.
The court concluded on this issue as follows:
“…as to the argument of the defendant that there was no lienable amount owing unless and until an amount became due and payable under the contract’s accounting terms in the contract, I reject it. Contrary to the defendant’s submission, this contract, like all building contracts, is subject to The Construction Lien Act. It is not the reverse… that the Act be subject to the contract between the general contractor and the masonry sub-contractor Bradhill. When a sub-trade is owed money due to work that has improved the site, its claim is for the “price of those services or materials”, the value of the work and material supplied, not what is due and payable at any given time according to the contract. And money owed the contractor or received by BWK was trust money held for the sub-trades until they are paid. It is not for BWK to fail to pay money due the sub-trade just because that sub-trade filed a lien claim. This is a reading of the contract and the Act which would make the contract the superior instrument whereas, as I have shown, it is the law in Ontario that the contract is to conform to the Act. I reject the argument on behalf of BWK that would hold otherwise.
The controversy about “pay when paid” clauses is heightened in Canada not just by the public policy debate about whether these clauses should be allowed. As mentioned above, in other countries these clauses have been eliminated by statute or severely restricted in their application. In Canada, there is further controversy about these clauses because there are contrary appellate decisions concerning the effect of a “pay when paid” clause.
On one approach, the clause bars any claim, even at the end of the job, if the contractor has not been paid by the owner. That was the conclusion of the majority of the Ontario Court of Appeal in the Timbro decision.
The other approach says that the clause is a timing mechanism only, that the clause provides for payment by the contractor to the subcontractor when the contractor is paid by the owner, but does not operate as a complete bar to the subcontractor’s claim at the end of the job. That was the approach taken by the Nova Scotia Court of Appeal in Arnoldin Construction & forms Ltd. v. Alta Surety Co. (1995), 19 C.L.R. (2d) 1. In that case, a bonding company relied upon the “pay when paid” clause to argue that it owed no monies on the bond since the contractor did not owe monies to the subcontractor due to that clause. The Nova Scotia Court of Appeal held that the clause, properly interpreted, only related to the timing of payment during the project and did not entirely bar the claim. The Court may have thought that it made no sense for the “pay when paid” clause to be interpreted as a bar to payment to the subcontractor when there was a bond in place, presumably to be called upon in the very circumstance of the owner not paying the contractor.
Smack in the middle of the heightened controversy about these clauses is the issue about whether they over-rule the construction and builders lien legislation. If they do, then the controversy would move to an even higher level. Those familiar with the “pay when paid” debate have been waiting for a decision to address this issue, and here it is in the Bradhill decision.
In Bradhill, the court held that the “pay when paid” clause did not over-rule the Construction Lien Act, for two reasons.
The first reason was that, by virtue of the Ontario Act, the Act was incorporated into the subcontract contract and the parties could not contract out of the Act. That reasoning will not apply in all provinces. In some provinces, the construction or builders lien legislation effectively says that third parties and workers are not affected by any contract purporting to eliminate rights under the lien legislation, but does not prohibit other parties from entering into such contracts. So if the decision in Bradhill depends on the wording of the Ontario Act, then in other provinces the “pay when paid” clause could still potentially over-rule the construction and builders lien regime.
The other reason given by the court in the Bradhill decision is based on the fundamental nature of a construction or builders lien. The lien is not based upon the contract between the contractor and the subcontractor, or the contract between owner and the contractor. Rather, the lien is based on two ingredients: the price of the materials or services, and the supply of those services or materials to the improvement of the land. The price or supply may be influenced by the contracts, but it is the price and supply which create the lien. The court in Bradhill effectively concluded that, based on those elements of a lien claim, the status of the accounts between the owner and the contractor are irrelevant, or could not impair the validity of the subcontractor’s lien.
This second line of reasoning should be applicable in all provinces. If adopted by other courts, this reasoning will ensure that, whatever may be the other impacts of “pay when paid” clauses, they will not over-ride the protections contained in construction and builders lien legislation.