Introduction:
A labour and material surety bond (“L&M Bond”) is a type of surety bond that guarantees that the bonded contractor will pay all claimants for goods or services supplied for the bonded project. Claimants under L&M Bonds are typically suppliers or sub-contractors that contract with the bonded contractor (the Principal) to supply goods or provide services for the bonded job. However, under some L&M Bonds, “lower tier” suppliers or sub-sub-contractors are not protected.
L&M Bonds may be necessary when dealing with a commercial or public property owner that requires a general contractor to post such bonds. Although owners of property are not claimants under L&M Bonds, L&M Bonds provide assurance to owners in fulfilling any legal obligations they owe to the suppliers or sub-contractors, should the Principal default on payment.
Case Background:
In Metro Paving and Roadbuilding Ltd (Re), 2021 ABQB 719, the Court had appointed BDO Canada Limited (“BDO”) as receiver and manager of Metro Paving and Roadbuilding Ltd. (“Metro”) following the insolvency of Metro. BDO applied to the Court for direction regarding two construction projects involving Metro as a subcontractor.
PCL Construction Management Inc. (“PCL”) contracted with the Government of Canada to make improvements to a campground in Jasper, Alberta (the “Whistlers Contract”). Trevcon Enterprises Ltd. (“Trevcon”) entered into a contract with the Government of Alberta to replace a highway bridge near Morrin, Alberta (the “Morrin Contract”). Both PCL and Trevcon contracted with Metro as a sub-contractor. Metro itself engaged various sub-subcontractors to complete different parts of the work.
The Whistlers Contract and Morrin Contract required PCL and Trevcon, respectively, to post L&M Bonds. As a result, PCL and Trevcon were holding L&M Bonds on the respective projects when Metro went into bankruptcy. Once Metro became insolvent during the construction projects, its sub-subcontractors claimed payments totalling approximately $2.5 million under the L&M Bonds for their work. In addition, BDO claimed that PCL and Trevcon owed Metro roughly $1.8 million for work it had performed on the construction projects before filing for bankruptcy.
The Court’s decision
The Court had to consider two main issues. First, whether the sub-subcontractors were claimants under the Whistlers and Morrin Bonds. Second, whether their claim against the Bonds that Trevcon and PCL held would result in Trevcon and PCL paying the funds to BDO (Metro’s receiver) or whether those funds should be paid directly to the sub-subcontractors.
In answering whether the sub-subcontractors could be claimants under the Whistlers and Morrin Bonds, the Court applied the following contract interpretation principles applicable to bonds:
- The words in a bond’s terms must be given their ordinary and literal meaning,
- The intentions of the parties must be considered for the Court to give commercial efficacy to the agreement,
- Where the disputed contract is part of a series of contracts, surrounding contracts may be examined, and,
- The preferred meaning of an ambiguous term may be the one that works against the party that drafted the bond agreement.
After considering the above principles, the Court found that the sub-subcontractors were proper “claimants” under the Whistlers and Morrin Bonds. As such, Trevcon and PCL were obligated to pay the sub-subcontractors under the Bonds the amount of any proven claims.
Following this, the Court considered whether PCL and Trevcon were entitled to “set-off” amounts payable to the sub-subcontractors under the Bonds against amounts owing to Metro without violating federal bankruptcy legislation. “Set-off” can be viewed as a practical tool and an equitable remedy. Under certain circumstances, set-off can enable parties to discharge reciprocal obligations to the extent of the smaller obligation. For instance, if a bankrupt has a claim against a debtor for $100,000, who is also a creditor that has a claim of $20,000 against that bankrupt, the debtor can subtract that amount from the $100,000 that it owes to the bankrupt.
Importantly, the Court had to consider the federal Bankruptcy and Insolvency Act, under which a debtor of a bankrupt cannot alter the creditor priority, which typically prioritizes secured creditors. As PCL and Trevcon were contractually obligated to compensate the sub-subcontractors under the Bonds, which they entered into before Metro’s bankruptcy, PCL and Trevcon’s Bond obligations accorded with the Bankruptcy and Insolvency Act. The fact that the Court would grant PCL and Trevcon equitable set-off would not alter the creditor priority, as the terms of the Bonds require that the sub-subcontractors be compensated regardless.
Lastly, the Court found that it would be inequitable to demand PCL and Trevcon to pay both Metro’s estate and the sub-subcontractors, as that would effectively result in PCL and Trevcon providing double payment.
Conclusion
Where a sub-contractor on a bonded project defaults in its obligation to sub-subcontractors, those sub-subcontractors are claimants as against the bond obtained by the Principal. The bond responds directly to the claims made by the sub-subcontractors, and where the Principal pays money to sub-subcontractor claimants, it can set-off those payments against any debt that may be owing to the sub-contractor who defaulted.
Written by Jeremy Ellergodt with contribution from articling student Ali Sarhill.