Owners’ set-off rights against Part B of the lien fund are contractual, not equitable

Recently the Alberta Court of Queen’s Bench clarified that contractual set-off is available to an owner as against Part B of a lien fund even if the set-off amounts are unrelated to work performed by subcontractors that have registered liens, in Neptune Coring (Western) Ltd v Sprague-Rosser Contracting Co Ltd, 2020 ABQB 277 (Neptune). The court held that while it is true that the purpose of the Builders’ Lien Act (Alberta) (the “Act”) is to ensure owners pay workers for the benefit of work performed on the owners’ land, this principle does not override owners’ rights of contractual set-off as against Part B of the lien fund.

Neptune is an appeal from a decision of a Master in Neptune Coring (Western) Ltd v Sprague-Rosser Contracting Co Ltd, 2018 ABQB 883. In this appeal Justice Kendell considered whether an owner had a right of set-off against Part B of a lien fund. The lien fund is made up of two parts – Part A, the 10% holdback of the initial contract price, and Part B, all amounts owing but unpaid to a contractor or supplier at the time a lien is registered. Set-off is not permitted against Part A, but set-off is permitted against Part B, and these decisions consider how the Part B set-off may be calculated.

Facts

In the Neptune case, the City of Edmonton (the “City”) hired the defendant, Sprague-Rosser Contracting Co. Ltd. (“Sprague-Rosser”), as a general contractor to perform road and utility services for a new subdivision. The contract between the City and Sprague-Rosser (the “Contract”) was a unit-price agreement based on estimated quantities wherein the final amount to be paid would be reflective of the final quantities of work performed and materials supplied. The Contract price was $1,448,119.78. Four subcontractors, Neptune Coring Western Ltd., Wolseley Canada Inc., EMCO Corporation, and United Rentals of Canada Inc. (collectively, the “Subcontractors”) performed work on this project.

Sprague-Rosser went into receivership and then bankruptcy prior to the completion of the project. At that point the City had held back $144,811.98, representing the (Part A) 10% holdback of the Contract price, along with $165,244 for work completed or invoiced by Sprague-Rosser as of the date of its receivership but not yet paid (Part B). The Subcontractors each registered liens. The collective total of these liens was $815,856.22.

Part A of the lien fund is sacrosanct and not available to satisfy a set-off claim, so the City sought to set-off the total amount of $138,088.35 against Part B. $138,088.35 represented charges for time spent by an engineering company dealing with the Sprague-Rosser receivership/bankruptcy and supervising the completion contractor’s work, Epcor’s safety work, and the cost of completion of the road including sweeping, asphalt pre-fill, inspections, and reporting (Neptune at para 12).

The amounts permitted as set-off would be deducted from the amounts available to the Subcontractors in Part B of the lien fund with the effect of reducing the total amounts available on a pro-rata basis to each of the Subcontractors. As such, the issue at the heart of the case was whether the City could set-off deficiencies or additional costs caused by Sprague-Rosser’s default against Part B of the lien fund.

Master’s Decision

The Master acknowledged in his decision that an owner can generally set-off cost overruns/additional costs of completion, deficiency costs, and damages arising from a contractor or subcontractor defaulting against Part B (para 16). According to the Master, at common law there are three types of set-off:

1. legal set-off, wherein one liquidated claim may be set-off against an unrelated liquidated claim;
2. equitable set-off, which allows the set-off of an equitable liquidated claim against another liquidated equitable or legal claim; and
3. procedural set-off, wherein two unrelated claims are weighed against each other and a net judgment given.

The Master held that none of the amounts the City sought to set-off against Part B fell within the types of expenses that it was specifically permitted to set-off under the terms of the Contract so contractual set-off did not apply. Rather, equitable set-off applied to the facts of this case and the Master accordingly evaluated those facts and the applicable law through the lens of equity.

At paragraph 27 of his decision the Master addressed a concept that he termed “inequitable set-off,” wherein an owner is unfairly permitted to set-off expenses entirely unrelated to a subcontractor’s work against the lien fund with the effect of reducing the subcontractor’s ultimate compensation for work performed. The Master held at paragraph 28 that in the absence of a contractual right of set-off owners are only entitled to set-off claims against the lien fund when the claims relate to the work of the subcontractors on the project.

In light of the above, the Master held that it would be unjust and not in keeping with the purpose of the Act to allow the City to set-off unrelated expense claims against the funds available to the Subcontractors. Applying the concept of inequitable set-off to the case before him, the Master held at paragraph 37 that “… it would not be appropriate to use equitable set-off to reduce the second portion of the lien fund by any of these amounts because in doing so the purpose of the Act would be defeated by allowing the owner to retain the benefit of an improvement, or materials supplied, but not have to pay for it….” Accordingly, the City’s set-off claim was dismissed.

This decision upset the standard analysis relating to set-off in builders’ lien cases. The City appealed.

The Appeal

Justice Kendell overturned the Master’s decision on appeal. The Justice held that contractual set-off did in fact apply because the Contract explicitly allowed set-off. Her analysis is set out below.

Courts begin the evaluation of whether contractual set-off applies with an analysis of the terms of the contract to evaluate whether it authorizes set-off. Justice Kendell said that only set-off amounts explicitly permitted by a contract may be applied against Part B of a lien fund. The Contract in Neptune specifically permitted the City to set-off additional administrative costs which costs included “[a]ny additional costs or loss of revenue incurred by the City due to the delay” against amounts owing to Sprague-Rosser in the event those costs were caused by Sprague-Rosser’s delay. Since Sprague-Rosser had defaulted when it went into receivership, it was unassailable that it had caused delay.

The set-off clause an owner relies upon must apply to the type of additional amounts claimed as set-off. For example, in Neptune, the City sought to rely on a clause that permitted it to set-off business licensing, taxation, or assessment costs owing by the Contractor against the lien fund. The court held that although this clause contemplated set-off, none of the amounts sought were for business licensing, taxation, or assessment costs so it was not applicable.

Once a court has determined that a contract expressly permits set-off, the next step is to assess whether the expenses claimed are the type of additional expenses contemplated by the set-off clause. In Neptune, after analyzing the Contract to determine whether set-off was available, the court evaluated whether the evidence established that the additional expense claims fell within the appropriate set-off clauses in the Contract. Justice Kendell held that the City must have incurred the costs as a direct result of Sprague-Rosser’s default so that portion of the set-off clause was satisfied.

The balance of the dispute between the City and the Subcontractors was over whether the City’s claimed amounts were costs contemplated by the relevant clause relating to additional administration costs caused by Sprague-Rosser’s default. Although the City’s evidence did not specifically state that the extra costs were ones that fell within the contractual definition of administration costs arising from the delay of Sprague-Rosser in the applicable provision, the court accepted that the evidence established as much because it was uncontradicted.

The takeaway is that in order for an owner to successfully set-off additional amounts against Part B of the lien fund the following elements must be present:

1. the contract must specifically and explicitly permit set-off; and
2. the amounts claimed as set-off must be supported by evidence establishing their quantum and that they are the type of expenses contemplated by the set-off clause.

After engaging in the above analysis, Justice Kendell then addressed the concept of “inequitable” set-off as discussed by the Master. The Justice held that because she had already ruled that the City had a contractual right of set-off for most of the amounts it claimed against Part B she did not need to address the concept of “inequitable set-off.” However, she specifically stated that she not endorse the Master’s decision relating to inequitable set-off. The Justice elaborated on this point, noting that the Act seeks to protect the interests of both owners and contractors by balancing owners’ interests in avoiding liability against contractors’ interests in full payment. In this case the unfortunate reality was that neither party’s interest could be fully protected because of Sprague-Rosser’s default.

Takeaway

Neptune clarifies that owners are entitled to contractual set-off regardless of whether or not the set-off amounts are related to the work performed by subcontractors. Owners and general contractors should ensure that their contracts specifically and expressly permit them to set-off costs of completion and costs arising from the contractor’s (or subcontractor as the case may be) default against amounts owing. Owners or general contractors should also keep careful track of costs of completion and additional costs after the default of a general contractor or subcontractor.

If you have questions about or are dealing with a builders’ lien problem, Miller Thomson’s experienced construction lawyers are available to help you. Please give us a call!