The financial difficulty precipitated by COVID-19 has reached virtually every industry, and the construction sector is no exception. Debtors, lenders and trades dealing with insolvent construction projects will inevitably face priority disputes under Ontario’s Construction Act[1] (the “Act”) in instances where there is a limited fund available for stakeholders.
A recent decision from the Ontario Superior Court of Justice in Dal Bianco v Deem Management Services et al[2] is a good example of the problems that can arise in this situation. It is also an important reminder of the purpose and operation of the priority scheme set out in the Act, as well as the necessary procedural steps that must be followed in order for a mortgagee to successfully claim priority over a construction lien claimant. As of the date of posting, this decision is under appeal to the Ontario Court of Appeal.
Facts
On May 31, 2018, the court appointed a Receiver over real property (the “Property”) owned by Deem Management Services Limited (“Deem”). The owner and sole director of Deem, Mr. Dal Bianco, incorporated a company (“Uptown”) for the purpose of planning and redeveloping a portion of the Property into a retirement home (the “Project”). The Project became insolvent prior to completion and the general contractor was advised to cease construction.
Shortly thereafter, various service providers registered construction liens against title to the Property worth a total of $7,673,672.48. In addition to the construction lien claimants, various mortgages and loans were registered against title to the Property, in excess of $20 million.
As part of the receivership, and pursuant to various court-orders, the Receiver liquidated the Project. After distributions were made to the first and second-ranking mortgages, a dispute arose between the third-ranking mortgage and the registered construction lien claimants over priority to the remaining funds held in trust by the Receiver in the amount of $5,477,224.57.
The third-ranking mortgage was in the amount of approximately $8 million. A total of six construction liens were registered between March 7, 2018 and July 13, 2018. It was established that the first construction lien arose and took effect with respect to the Project prior to the third-ranking mortgage being registered on title. It was also established that advances were made by the holder of the third mortgage prior to registering the mortgage and those advances did benefit the Project.
Issue and Law
Justice Gilmore was asked to determine the priority dispute between the third mortgagee and lien claimants under section 78 of the Act. The general priority scheme set out in that section gives priority to construction lien claimants over mortgages unless one of the exceptions apply.
Justice Gilmore, quoting prior case law[3], emphasized that the onus is on the mortgagee to prove that its mortgage falls within one of the exceptions under section 78.
In this case, the third-ranked mortgagee raised two possible exceptions in support of its position that it had priority over the lien claimants:
- The third mortgage was a “subsequent mortgage” under section 78(6) of the Act, which gives the mortgage priority over the lien claimants for specific advances in certain circumstances; and
- The third mortgage was a “building mortgage” under section 78(2) of the Act, which gives the mortgage priority except in respect to any deficiencies in the holdbacks.
What is a “Subsequent Mortgage”?
Section 78(6) provides that where a mortgage is registered after construction has commenced on a project (and thus, after the lien rights have arisen), three conditions must be met with respect to the funds lent in order for a mortgagee to gain priority over the lien claimant[4]:
1) the funds must have been advanced “in respect of that mortgage,”[5]
2) there must not be any preserved or perfected liens at the time of the advance; and
3) at the time of the advance, the mortgagee must not have received written notice of a claim for lien.
What is a “Building Mortgage”?
Section 78(2) of the Act provides that where a mortgagee takes a mortgage with the intention to secure financing of an improvement, the liens arising from the improvement have priority over that mortgage to the extent of any deficiency in the holdback, irrespective of when that mortgage is registered.
Application
Justice Gilmore rejected both of the mortgagee’s arguments. She noted that section 78(6) was not triggered because the funds were not advanced “in respect of” the third mortgage. When amounts are advanced under a different financial arrangement and then subsequently secured by a mortgage, section 78(6) does not apply. Justice Gilmore reiterated that both the advances and the registration of the mortgage must have been made prior to the lien claims arising in order to trigger the exception. The Court relied on the prior decisions in XDG Ltd v 1099606 Ontario Ltd[6] and Jade-Kennedy[7], holding that a section 78(6) analysis does not require the Court to also consider whether the proceeds of an advance created a “benefit” to the borrower. The key to triggering the exception is whether there has been an advance. As the advances had already been made in this case, it did not apply.
Justice Gilmore further noted that the third mortgage does not qualify as a “building mortgage” under section 78(2) of the Act. While the Act does not define the term “building mortgage”, the Court held that it should be interpreted in a manner that is consistent with the overall intention of section 78 – which is to grant priority to lien claimants.[8] In that regard, section 78(2) infers that the mortgage is being taken by the mortgagee a with a future intention to secure financing. In this case, the mortgagee advanced the funds prior to registering the mortgage, and section 78(2) was not triggered.
The result of the decision was that the lien claimants were found to have priority over the third-ranking registered mortgage.
Takeaway
This case raises relevant considerations for both lenders and trades. For lenders engaged in construction financing, timing matters. Lenders should ensure that advances of funds are always made after the mortgage is registered on title to the subject property. Lenders in other contexts should also take caution from this decision if, subsequent to making advances under a credit facility, a mortgage is obtained over land as further security for past advances, as the priority scheme of the Act may not give a lender the priority security it may have expected.
For trades, this decision serves as comfort that the Court will enforce the general purpose of the Act – the protection of lien claimants – when interpreting its priority scheme. Either way, the analysis is definitely a complicated one and we will await the decision of the Court of Appeal in the next round with interest.
[1] Construction Act, R.S.O. 1990, c. C.30.
[2] Dal Bianco v Deem Management Services et al, 2020 ONSC 1500.
[3] Boehmers v. 794561 Ontario Inc. [1993 CarswellOnt 821 (Ont. Gen. Div.)], affirmed 1995 CanLII 660 [1995 CarswellOnt 244 (Ont. C.A.)]
[4] Dal Bianco v Deem Management Services et al, 2020 ONSC 1500 at para 31.
[5] Section 78(4)
[6] XDG Ltd. v. 1099606 Ontario Ltd. 2002 CarswellOnt 4535 (Ont. S.C.J.), [XDG].
[7] Jade-Kennedy Development Corp., Re., 2016 ONSC 7125 (Ont. S.C.J.), upheld on appeal Dircam Electric v Am-Stat-Corp., 2017 ONSC 3421 (Ont. Div. Ct.) [Jade Kennedy].
[8] Dal Bianco v Deem Management Services et al, 2020 ONSC 1500 at para 39.
