Owners beware: Factoring invoices should not be factored into the major lien fund

In Factors Western Inc. v DCR Inc., 2021 ABCA 433 (« Factors Western« ), the main issue that the Alberta Court of Appeal was faced with was determining whether or not an invoice that was factored between a project owner, a general contractor (who had since been placed into receivership), and a third party purchaser formed part of the major lien fund under the Alberta Builders Lien Act, RSA 2000 c B-7 (the « BLA« ).

When dealing with cash flow restraints, it is not unusual for companies to « factor » their accounts receivable, a process where accounts are sold to a third party at a discount for immediate cash. This practice, colloquially referred to as « factoring, » is not unusual in the construction industry where quick access to funds is an important operating requirement when advancing a project.

As provided for by the Supreme Court of Canada it has been held that factoring agreements contain three elements:

1. purchasing a business’ book debts;
2. taking over and administration of a business’ credit control function relating to that debt; and
3. providing a business with immediate financing in the amount of a specified percentage of the debt.[1]

Factoring can be invaluable in the construction industry especially where companies are looking for a cash flow solution outside of traditional funding from a financial institution. With interest rates on the rise and access to capital at the forefront of the industries’ mind, factoring arrangements will likely be seen as an appealing alternative to traditional debt; however, pursuant to the Court of Appeal’s reasoning in Factors Western, an invoice that has been factored should not be included as an « amount payable under the contract » when calculating the major lien fund under the BLA.

Background

In Factors Western, three actions were commenced by parties wherein the outcome would be affected depending on the legal implications of an invoice that was factored.

1. The first action was commenced by the owner of certain lands, Point Design Homes Ltd. (« Point Design »), which lands had been subject to certain builders liens. Point Design pursued an order setting the major lien fund under the BLA;
2. The second action was commenced by a subcontractor on the project in question, Slimdor Contracting Ltd. (« Slimdor »), where Slimdor sought an order confirming the validity of its two builders’ liens;
3. The third action was commenced by Factors Western Inc. (« FactorCo »), which action sought judgment against Point Design with respect to an invoice that was factored to FactorCo by the general contractor, DCR Inc. (« DCR »).

Importantly, the invoice in question was received by Point Design on July 7, 2015 and was in the amount of $216,878.92 (the « Factored Account »). On July 9, 2015, and pursuant to a factoring agreement, FactorCo agreed to purchase this invoice from DCR for $205,989.97. As a result of the factoring agreement between FactorCo and DCR, FactorCo and DCR issued a « Notice of Sale and Assignment of Debt & Direction to Pay » (the « Notice of Assignment ») to Point Design in relation to the payment of the Factored Account. Point Design executed the Notice of Assignment. After the Notice of Assignment was executed, FactorCo paid DCR the amount of $205,989.97 on account of the Factored Account. The amount owing by Point Design to FactorCo with respect to the Factored Account was never paid.

In addition, as a general contractor DCR failed to pay a number of subcontractors resulting in certain builders’ liens being registered against the lands owned by Point Design. Point Design posted security with the court in order to have those builders liens discharged. The setting of the major lien fund and the implication of the Factored Account in calculating the major lien fund was in issue.

At summary trial, the trial judge held that the major lien fund should include the invoice that was factored by DCR to FactorCo, that the liens filed by Slimdor were valid with Slimdor being entitled to a pro rata distribution under the lien fund, and that Point Design was liable to FactorCo for the factored invoice. As a result, the owner, Point Design, became liable for amounts under the Factored Account twice; once on account of the major lien fund and secondly, by virtue of the payment owing to FactorCo.

Court of Appeal

Liability for Factored Account

On appeal, Point Design argued that it should not be liable for the entirety of the Factored Account as it had already paid amounts to discharge a number of liens registered against its lands, which amounts would have been deducted from any amounts owing to DCR under the contract. The court held that Point Design’s position ignored the effects of entering into a factoring agreement, and the court broke down the « factoring triangle » as follows:

48      The « factoring triangle » includes the debtor, the creditor and the factor. A « tripartite contract » or « three-cornered agreement » exists where all three parties agree that the debtor will pay the debt directly to the factor. In these cases, consideration flows from the factor to the debtor in reliance on the promise that the creditor will make payment directly to the factor: see Gauthier Estate v Capital City Savings & Credit Union Ltd, [1992] 2 Alta LR (3d) 277, 1992 CanLII 6121 (QB) at para 25.[2]

There was no question that the agreement between FactorCo and DCR was a valid factoring arrangement, and that Point Design signed the acknowledgment contained in the Notice of Assignment wherein it was acknowledged that Point Design would pay FactorCo directly without dispute or offset.

The court dismissed the ground of appeal relating to the assertion from Point Design that it was not required to pay FactorCo the entirety of the Factored Account.

Calculation of the major lien fund and the Factored Account

The Court then considered whether the Factored Account constituted an « amount payable under the contract » which would result in it being captured by section 18(2) of the BLA and form part of the major lien fund.

Through a review of the definition of « major lien fund » and section 18 of the BLA, it was held that the trial judge erred in concluding that the Factored Account was an amount « payable under the contract, » and that the « contract » referred to in section 18 of the BLA is rightfully interpreted as the contract between Point Design (owner) and DCR (contractor). As succinctly summarized by the court:

71      In our view, the contractual holdback that Point Design was to holdback pursuant to the « contract » under s. 18(2) of the BLA is calculated by reference to the Contract between Point Design and DCR, and in this case, includes DCR’s unpaid invoices only (the amount owing but unpaid). As Point Design’s liability under the Contract to DCR with respect to the Factored Account was replaced by its liability to Factors Western pursuant to the factoring agreement, the only unpaid invoice under the DCR Contract was $68,250. As this amount included the 10% statutory hold back of $47,497.98, the contractual holdback for « amount payable under the contract that has not been paid under the contract » is $20,752.02. (emphasis added).

The court further held that the trial judge incorrectly relied on the decision of Iona Contractors Ltd (Receiver of) v Guarantee Co of North America, 2015 ABCA 240 (« Iona« ) and the policy reasons contained therein to determine that Iona represented a shift in the law of builders’ liens, as opposed to the Court of Appeal’s assertion that Iona merely summarized existing principles of interpretation under the BLA. The court further found that the trial judge incorrectly relied on Saskatchewan caselaw relating to the Saskatchewan Builders’ Lien Act, and the Court of Appeal commented that the « final reason that the Saskatchewan authorities are not helpful is because the Saskatchewan Court of Appeal and the Alberta Court of Appeal have taken different interpretative approaches to builders’ lien acts, which limits the guidance that can be gleaned from the other jurisdiction… »[3]

Takeaway

The takeaway from this case will be surprising to those who frequently utilize builders’ liens and are impacted by the holdback provisions under the BLA.  Put simply, this case stands for the principal that a factored invoice should not be included in the calculation of the major lien fund where the factoring agreement contains a requirement/acknowledgment of an owner to pay a party who has factored an account of a contractor and that payment takes place. This conclusion is notwithstanding that the amounts invoiced and subject to the factoring agreement arise from an improvement to the property created by the lien claimants, and presumably was composed of amounts invoiced for and unpaid by DCR to the subcontractors.

Both levels of decision should emphasize the risk to the owner in signing factoring agreements. At the trial the owner was faced with paying twice, the appeal decision is an improvement in the sense only one payment is required, however, the implications of a separate agreement with the factoring company necessarily impacts an owner’s ability to set-off its damages against amounts owed to the contractor (now factoring company). The financial difficulties that go hand in hand with factoring, typically find themselves tied to incomplete and deficient work that the owner may find itself repairing at its own cost while simultaneously being bound to pay the factoring company for inadequate work. Bottom line: exercise caution before signing a factoring agreement.

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[1] Canada Trustco Mortgage Corp. v Port O’Call Hotel Inc., [1996] 1 SCR 963, 1996 CarswellAlta 366 at para 30; Factors Western Inc. v DCR Inc., 2021 ABCA 433 at para 47

[2] Factors Western at para 48

[3] Factors Western at para 62