When Can Owner ‘Jump a Rung’ in Construction Pyramid to pay Subcontractors directly in Ontario: Divisional Court interprets s. 28 of Construction Act

On December 13, 2024, the Divisional Court of Ontario released its decision in Demikon Construction Ltd. v. Oakleigh Holdings Inc. et al, 2024 ONSC 6261, setting aside the Order of Justice McCarthy (2024 ONSC 2151) which had, on a motion brought under s.44(5) of the Construction Lien Act RSO 1990 c.C30 (the “Act”), reduced the security posted to vacate the claim for lien of the Appellant, Demikon. We acted for Demikon.? (We note that the sections of the Act discussed below remain under the current Construction Act and are altered by the further changes called for in Ontario’s Bill 126, which has not yet been proclaimed into force).

The Appeal is significant because it is the first Ontario case to consider how and when an owner (or other payer in the construction pyramid) can rely on s. 28 of the Act to make and be credited for payments made to subcontractors further down the ladder, with whom they have no privity of contact.?

Demikon was the construction manager, retained by the Respondent, Aurelia Limited Partnership (“Aurelia”), under a CCDC5B standard from of Contract for the construction of a mixed-use condominium project (the “Work”) owned by the co-Respondent, Oakleigh Holdings Inc. (“Oakleigh”). Under the Contract, Demikon was required to retain, and pay, subcontractors and suppliers (of which there were dozens). ?Aurelia terminated Demikon’s contract when it was near completion and Demikon preserved a claim for lien for over $5 million.?

Commencing shortly before the termination, and for more than a year, Aurelia made direct payments to Demikon’s subcontractors. Its representative acknowledged on cross-examination that it did not need the trades to complete the Work and that it had made the payments out of a “moral obligation”.? The payments totaled more than $4 million, including over $2 million in holdback which had been retained under the Act.? Aurelia made the payments based solely on the invoices Demikon had presented to it for payment (which identified the amounts owed to subcontractors as part of each invoice).

Aurelia had the lien vacated (or removed) from title by posting security with the court for the full amount of the lien plus $50,000.00 for costs in accordance with s.44(1) of the Act.? It then issued a counterclaim against Demikon in the lien action, claiming $6 million for deficiencies and delays in the Work.? Although the majority of the Work had been physically performed by Demikon’s subcontractors, and notwithstanding the substantial counterclaim, Aurelia did not ask Demikon to confirm whether or not Demikon agreed that the amounts were still owing.? In other words, it did not ask Demikon if Demikon agreed to the payments or whether it might have a set-off against the paid subcontractor for possible deficiencies or delays.

Aurelia moved before the Court under s.44(5) to have the security posted into Court to be reduced by over $3.5 million for the direct payments made.? This was before affidavits of documents, “scott schedules” or productions were exchanged, before discoveries were conducted and before Aurelia had provided particulars of its alleged deficiency and delay claims.

Section 44(5) allows for security paid into Court to vacate a claim for lien to be reduced “where it is appropriate to do so”.? In bringing the Motion, Aurelia relied heavily on section 28 of the Act.? The Section provides:

28.?? Where an owner, contractor or subcontractor makes a payment without obligation to do so to any person having a lien for or on account of any amount owing to that person for services or materials supplied to the improvement … the payment shall be deemed to be a payment by the owner, contractor or subcontractor to the proper payer of that person, but no such payment reduces the amount of the holdback required to be retained… (emphasis added).

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On the motion, Aurelia argued that s. 28 applies to payments made to any subcontractors, regardless of whether they were to persons “having a lien” and regardless of whether they were payments of holdback.? The Motion Judge agreed, finding at para. 20 that s. 28 “was meant to encompass the very types of payments made in the case at bar”.? His Honour more particularly found at para. 23 the s. 28 “wording to be expansive:?it would encompass persons who have an amount owing to them for services and materials.”?

In allowing our Appeal, Justice Lococo held (at para. 44) that:

“the use of the words ‘owing to that person’ in section 28 is inconsistent with the motion judge’s conclusion that the scope of section 28 extends beyond direct payments to a ‘person having a lien’. Otherwise, including the words ‘owing to that person’ in section 28 would serve no purpose.”

Justice Lococco further noted at para. 45-47 that such an interpretation is consistent with commentaries offered by Harvey J. Kirsh & Matthew R. Alter in?A Guide to Construction Liens in Ontario, 3rd ed. (Toronto: LexisNexis Canada, 2011) and by David Bristow, Duncan Glaholt & R. Bruce Reynolds in?Construction Builders’ and Mechanics’ Liens in Canada, loose-leaf, 7th ed. (Toronto: Carswell, 2005, rev. to 2018), as well as those contained in the?Report of?Attorney General's Advisory Committee on the Draft Construction Lien Act?(Toronto: April 1982).? His Honour held:

“Limiting the scope of the?s. 28?payments to persons having a lien makes sense when considered in the context of the statutory scheme and the purpose of the legislation. While a person has a lien, they have an interest in the owner’s premises and in the holdbacks:?Construction Act, ss. 14,?21. The owners have an interest in seeing liens resolved because their lands can be tied up and because they have holdback obligations. This interest, however, disappears once the liens expire or are resolved. Once the liens expire, there is no practical reason under the?Construction Act?to allow payors to ‘jump the rung’ to avoid privity of contract, which is what s. 28 permits. This analysis is consistent with the conclusion that?s. 28?“merely provides a method of preventing the registration of a lien or to facilitate the removal of a lien already registered” [referencing Bristow, Glaholt & Reynolds at p.4-27)].”

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In this circumstance, and with one very minor exception, there was no evidence on the record that the payments were made to persons having a lien.? (Indeed, it appears that many, if not most, of the payments were made well after the expiry of the relevant lien period). For that reason, the Divisional Court allowed the Appeal and set the Order reducing the security aside (Justices Sachs and Howard concurring).?

There were, perhaps not surprisingly, other issues on the Motion and Appeal.? These included whether the requirement that a s.28 payment be made “for or on account of any amount owing to that person” means that payments in excess of the amount actually owing cannot be credited for the purposes of the section.? In this case, we submitted that Aurelia’s unparticularized counterclaim called into significant question the extent to which the paid subtrades were actually owed any of the amounts paid.? We also noted that in each of the very limited circumstances in which s. 28 had been applied by our Ontario Courts the subcontractor’s proper payer had agreed that the payments were owed.

Where s. 28 might not apply, owners and others who wish to pay subcontractors directly can, of course, avail themselves of other remedies.? These include taking assignments of the debts owed and obtaining a direction from the proper payer (in this case Demikon) to make the payment.? (In this case, Aurelia was entitled to take an assignment of subcontractor debts, both at common law and under the Contract, but chose not do so).?

In the end, we recommend that payers in the construction pyramid in Ontario exercise caution when considering whether to ‘jump a rung’ and make payments to subcontractors directly. If they wish to rely on s. 28, we recommend that they be certain that the subcontractor is a “person having a lien” and that the funds to be paid are actually owed to that person.? Generally, the best practice would be to obtain an acknowledgement of the amount owing from the subcontractors’ proper payer.? If uncertainty exists as to whether or not s.28 can be utilized, other options, such as assignments and directions, can be utilized.? However, if a payer fails to show either that the requirements of s. 28 are met or that another legal justification for the payment exists (by way of assignment or direction) it may not receive credit for such payments.?

Robert J. Kennaley and Joseph E. O’Hearn