By and large, the Construction Act, formerly the Construction Lien Act (the “Act”) intends to protect members of the construction industry who otherwise did not have contractual relations with owners and financers and, therefore, had less control over receiving payment. One of these mechanisms includes the concept referred to as “holdback”.
Namely, pursuant to Section 22 of the Act, each payer upon a contract or subcontract under which a lien may arise is required to retain ten percent (10%) of the price of the services or materials as they are supplied. These monies must be retained until all liens have either expired, been discharged, or vacated. This protection ensures that, if any disputes arise between parties, there is a pool of money against which lower-level subcontractors may claim.
Holdback Issues Faced by Subcontractors
Despite its intention to benefit subcontractors, holdback has disadvantageous features to certain subcontractors in the context of larger-scale projects. Suppose there is a mass-development project, whose timeline is anticipated to last two-three years (plus anticipated and accounted for delays). In such a project, excavation and demolition trades may be the first subcontractors involved, whose work will be finished significantly before the project itself can be deemed complete. As such, these trades face the problem that they will now have to wait 2+ years until they are paid the remaining 10% of their subcontract price.
In an attempt to resolve this issue, the drafters of the Act included an exception in Section 25, which provides a discretionary ability for payers upon any contract and/or subcontract to release holdback for specific subcontractors whose work is certified as complete pursuant to Section 33 of the Act. Section 25, however, is not mandatory – the wording holds that “each payer upon the contract and any subcontract may, without jeopardy, make payment of the holdback.” Thus, through Section 25, subcontractors can receive payment in full without waiting for the entire completion of a project.
Practicalities of Early Holdback Release
Unfortunately, and given the discretionary nature of Section 25, holdback is rarely released before full completion of a project. Although Section 25 allows payment to be released “without jeopardy”, owners are still cautious about the potentially significant risks associated with early release. Holdback is shared for the benefit of all subcontractors. Early release effectively reduces the amount of holdback to be spread between the subcontractors through reliance on proper certification under Section 33 of the Act.
The risk lies in proper certification. Namely, where certification does not follow the procedural requirements laid out in the Act – such as the scenario where holdback is released before official certification – a payer may still be liable to other lien claimants for early released holdback.[1] As such, owners and contractors may feel that they are in a more secure position by waiting until full completion rather than releasing holdback early for specific trades.
Nevertheless, since early holdback release is not contrary to the Act, parties are able to make early release of holdback mandatory through contractual negotiation. For example, a general contractor who has an established crew of subcontractors may wish to negotiate with an owner on price in exchange for early holdback release requirements. This includes adapting contractual provisions that set out guidelines and processes by which trades working on initial stages of the project may be paid out early. As counsel, incorporating such a term may also be advantageous in safeguarding subcontractors from potential bankruptcies faced by owners and to limit the contractors’ liability in such events.
In short, while not mandatory, organized mechanisms allowing for early holdback would allow for better flow of cash on a project. Given the legislature’s adoption and incorporation of the Prompt Payment regime, it is entirely possible that Section 25 may be amended in the future to make early release mandatory upon proper certification.
The foregoing is for informational purposes only and should in no way be relied upon as legal advice. If you have any further questions, or would like to schedule an appointment for legal advice tailored to your circumstances and business, please contact me at dan@fridmar.com.
[1] Wellington Plumbing & Heating Ltd. v. Villa Nicolini Incorporated, 2012 ONSC 5444.
