Despite the robust construction activity in Canada, insolvencies of owners and construction companies are at a pace that is significantly higher than the number of insolvencies ten years ago. Between 2009 and 2013, the construction sector as a value of the Canadian economy grew by 18%. However, over the same period, the number of insolvency proposals in the construction sector increased to 16.8%. These figures exclude cases where the court appointed a receiver or where a receiver was privately appointed. The data from the Office of the Superintendent of Bankruptcy suggests that as the construction sector grew, there was an increase in the number of insolvencies in the construction sector as compared to all insolvencies in Canada.
In Ontario, there was a move to pass prompt payment legislation. The legislation entitled contractors and trades to receive progress payments in a timely manner and to suspend work or terminate their contracts if the progress payments are not made on a timely basis. The prompt payment legislation in Ontario stalled in Committee. However, the experience in Australia, which has had prompt payment legislation for several decades, demonstrates that prompt payment legislation does not necessarily prevent the insolvencies of construction companies as insolvencies in New South Wales are at an all-time high.
Meanwhile secured creditors, contractors and their trades are chasing the same dollars. Canadian Courts in the recent decision of Royal Bank v. Atlas Block, (2014) ONSC 3062, (Ont Sup Ct) in Ontario affirmed that the trusts in builders' and construction lien legislation does not have all the elements of a common law trust and therefore the deemed trusts does not defeat a secured party's rights to funds in CCAA or BIA proceedings. Therefore, if the construction trust remedy is to be of any effect in insolvency proceedings, an amendment is required to the legislation, yet to date, the legislators have failed to act and the recent review of the Ontario Construction Lien Act only recommended a two year pilot project for the use of project bank accounts.
In Australia, the Collins Inquiry made two major recommendations. The first relates to the introduction of a construction trust similar to that in Ontario. The second major recommendation was the use of project bank accounts (PBA). Michael McCagh in his paper Adequately Protecting Construction Insolvencies: Disposition of Trust to Facilitate Security of Payment in Australia (Journal of Legal Affairs and Dispute Resolution in Engineering and Construction, February 2015, Volume 7, Issue 1) reviews construction trusts and PBAs recommended by the Collins Inquiry and concludes that the form of trust created by PBAs is to be preferred over the construction trust. The reasons cited by McCagh are transparency, efficiency and additional protection to contractors, trades and suppliers. It is apparent that construction trusts and prompt payment legislation, although laudable, are not the answer.
The Law Reform Commission of Western Australia in Project No. 82, Financial Protection in the Building and Construction Industry, March 1998 recommended the use of a statutory trust scheme with the trustee segregating the funds in a trust account, separate from its general bank account. The Collins Inquiry in 2012 also recommended the use of a segregated trust account. The New South Wales Government responded by introducing legislation that would require retention (holdback) funds to be placed in a segregated trust account. The Government was not prepared to introduce the concept of the trust but would try project specific bank accounts for certain government projects. The pilot project demonstrated that PBAs improved the certainty and timing of payment. As a result, in September 2016, the Government announced the use of PBAs on the majority of public projects with a construction value over $1.5 million.
In the United Kingdom, government agencies have undertaken a pilot project to introduce PBAs. In the Cabinet Office 2012 briefing document, Government Construction, Project Bank Accounts – Briefing Document, 10th February 2012, the Government set out that "Government Construction Board members have committed, over the next three years, to deliver £4bn worth of construction projects using PBAs." The UK Government Cabinet Office's guide to implementing PBAs states that a PBA "is linked to a Trust Deed, and provides insolvency protection for the supply chain." The Briefing Document also identifies the benefits of a PBA as follows:
Simple though the concept is, PBAs directly deliver against a range of the aims of the Government Construction Strategy. By addressing unfair payment practices, benefits will accrue to the whole supply team, by ensuring transparency of and certainty of payment. In particular, for the SMEs down the supply chain PBAs will protect their often very fine margins, obviate the need for unnecessary borrowing and can lead to a much more balanced trade environment, hence supporting growth. Cost savings accrue from supply chain members not having to chase payment or have to finance lengthy credit periods. PBAs eliminate payment disputes and the costs associated with them (which ultimately feed back into costs for the client). They also help the supply chain concentrate on the job in hand and reinforce or facilitate team working, increased trust leads to greater collaboration, which in turn incentivises innovation.
After delivering £3.7 billion in contracts using PBAs, Highways England concluded that PBAs have had a positive impact with the payment cycle such that the contractor and its trades are paid within a 21 day period (Lloyd Biddell, Implementation of Project Bank Accounts across Highways England).
PBAs have also been implemented in Northern Ireland. The guidance note on PBAs issued by Northern Ireland expressed the same benefits: "Insolvency of a Main Contractor often leads to a domino effect in the supply chain where, upon entering administration, its Subcontractors become exposed to the risk of insolvency."
Project Bank Accounts
A PBA is described as a "ring fenced" bank account into which the owner makes its payment and from which payments are made to the contractor and the trades. The significance of the PBA is that it has trust status and that its beneficiaries are the contractor and the subscribing trades and suppliers.
The trust status of a PBA is established by a series of agreements, or trust deeds. The Northern Ireland model requires the owner and the contractor jointly to open the PBA, execute a trust deed related to the account, and the owner, contractor and trades or suppliers execute a "Joining Deed".
Under the UK model, there are similar trust deeds executed by the parties. The UK model permits a dual authority account where the owner and the contractor are joint trustees or a single authority account where only the contractor is the trustee. Trades known at the time of contract would sign the trust deed and new trades would execute a Deed of Adherence or a Joining Deed depending on the model used. Where the Dual Authority account is used, the owner and contractor have to authorize the payment to the contractor and to the trades. Under the Single Authority model, after the progress payment is agreed upon, the contractor authorizes the bank to pay the contractor and the trades. In any event, whether a Dual Authority or Single Authority account is used, the intent is not to alter in any way the protection offered in terms of the security of the funds. To adapt PBAs for use in Canada, other rules may be adopted regarding the operation of the PBA. For example, the UK PBA model is coupled with fair payment practices so that payment is made by the owner in a timely manner and then payment to the contractor and trades occurs within days of receipt.
If owners started to require the use of PBAs in Canada, with the use of trust deeds, the insolvency of contractors may be nothing more than an inconvenience. As at the date of the insolvency, the owner could value the work, pay any additional amount owed for the work to the date of insolvency into the PBA and have the trades and suppliers paid the amounts owing to them from the PBA. This would avert the registration of liens by the trades and suppliers, or at the very least minimize this risk. The owner would be holding onto the balance of the contract funds and use these funds to complete the project with either a new contractor or the insolvent contractor. If the owner proceeded to complete the work with the insolvent contractor, the monitor or the trustee would be required to sign the trust deed for the PBA, and the project could continue. Simply put, issues of priority to the funds vanish as the funds will be held in a trust account that meets the elements of a common law trust.
The priority disputes in insolvency proceedings to funds can be relegated to a memory by the use of PBAs that satisfy the elements of a common law trust. The use of PBAs is becoming more common and should be adopted across Canada.