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Section 12 of the Construction Act, the forgotten but important amendment

By now participants in the construction industry have had an opportunity to familiarize themselves and experience the changes implemented in the not-so newly named Construction Act, R.S.O. 1990, c. C.30. Most are aware that the deadlines to preserve and perfect a lien have been extended from 45 days to 60 days and 90 days to 150 days, respectively. Many are aware of the new prompt payment provisions, which are an attempt by the Ontario legislature to encourage the flow of funds from the owner all the way down to suppliers. However, one change that is not often appreciated or considered is the amendment to the  set-off provision found at Section 12 of the Construction Act, which now reads as follows:

12 Subject to Part IV, a trustee may, without being in breach of trust, retain from trust funds an amount that, as between the trustee and the person the trustee is liable to pay under a contract or subcontract related to the improvement, is equal to the balance in the trustee’s favour of all outstanding debts, claims or damages related to the improvement or, if the contractor or subcontractor, as the case may be, becomes insolvent, all outstanding debts, claims or damages whether or not related to the improvement.

Under the previous legislation, Section 12 of the Construction Lien Act, R.S.O. 1990, c. C.30 provided that a trustee was entitled to retain from trust funds an amount equal to all outstanding debts, claims or damages it was owed by the other contracting party. The ability to retain funds applied whether or not such damages, debts or claims resulted from the same project for which money is owing. For example, a contractor could withhold from a subcontractor a claim for damages incurred on account of deficient work completed on an unrelated project.

Under the new provision, Section 12 only allows a trustee to retain such amount from the trust funds if (i) the debts, claims or damages are claimed with respect to the same improvement; or (ii) if the other party has become insolvent. For example, under the new provision, if a subcontractor is solvent, a contractor can only withhold funds on account of deficient work, if such deficient work was completed on the same project for which money is owing. The ability to claim set off on account of damages incurred on unrelated projects only arises if a subcontractor becomes insolvent, presumably by entering into bankruptcy, receivership or some other form of creditor protection.

This commonly unnoticed and unacknowledged change is in line with the legislation in that it promotes the flow of funds down the construction pyramid. Except for when one party has become insolvent, these amendments prevent having those higher up in the construction pyramid complicate situations by withholding funds on account of work completed or not completed on unrelated projects.

Although such parties may consider claims of equitable set off or set off pursuant to Section 111 of the Courts of Justice Act, R.S.O. 1990, c. C.43, such set-off rights have their own limitations and requirements. As a result, the somewhat recent amendment to Section 12 of the Construction Act can and will have a drastic impact on owners, contractors and subcontractors throughout Ontario, making it even more important for parties to review and consider the dispute resolution processes prescribed by the Construction Act and contractual agreements. Given the recent restriction placed upon an owner’s, contractor’s and subcontractor’s ability to withhold funds on account of a breach of an unrelated contract, having disputes resolved in a timely and efficient manner has and will become much more crucial for those higher up in the construction pyramid.