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Financial insolvency can open up a Pandora’s Box of issues for contractors, subcontractors and suppliers.

All should be aware of situations where provincial Construction Act lien and trust processes can be overridden by federal insolvency laws. They need to act quickly to assert and perfect their lien and trust claims, write Bruce Reynolds, co-managing partner of Singleton Uruquart Reynolds Vogel LLP, and associates Nicholas Reynolds and Tanya Soni.

Subtrades and suppliers are, of course, entitled to various statutory rights and remedies under Ontario’s Construction Act, they write. However, “those rights and remedies can be imperilled in circumstances of an insolvency (or near-insolvency) giving rise to CCAA proceedings.”

The matter of Waygar Capital Inc. v Quality Rugs of Canada Limited is instructive.

Quality Rugs was part of the Quality Service Group (QSG), providing materials and installation services to residential and commercial construction services across Ontario, Alberta and British Columbia. However, QSG ran into financial trouble while owing $11 million to their suppliers and sought CCAA credit protection.

“QSG’s sole meaningful asset was its accounts receivable,” writes Miller Thomson associate Matthew Cressatti.

It was understood that under normal circumstances, the accounts receivable would be subject to a statutory trust in favour of QSG’s suppliers, Cressatti writes. However, these rights became entangled with the CCAA proceedings which went on for months. The court presentations were complex and were adjourned frequently prior to QSG being placed in receivership.

QSG continued operating under a $5 million Debtor-In-Possession (DIP) loan from Ironbridge Equity Partners, secured by a court-ordered priming lien (the DIP Charge) over the company, with QSG advising the court it would be financing its operations, in part, through its accounts receivable.

Meanwhile, Cressatti continues, QSG suppliers wanted payment, and argued their statutory trust took priority over the DIP Charge and that therefore under Ontario’s Construction Act, the accounts receivable were not QSG’s property. Neither QSG nor its creditors or the DIP lender had the right to force them to involuntarily fund QSG with funds that technically belonged to the suppliers.

Cressatti summarizes by saying the Ontario Superior Court rejected the arguments made by the supplier creditors and ruled the priming charges created by federal law took priority over a statutory trust created by provincial law. Thus, it ranked QSG’s accounts receivable, its only remaining asset, below the liens granted by the court to lenders in the insolvency process.

“The suppliers in this case rightly felt aggrieved,” write the Singleton Reynolds experts.

They were effectively, “deprived of their ability to pursue project owners to the extent of their holdback obligations and were instead left at the back of the line in relation to their claims against QSG. Ultimately, the suppliers’ misfortune may have been an unfortunate incident of timing (due to) the fact that the suppliers’ arguments were raised after the DIP financing and other court-ordered charges had been approved.”

What could the suppliers have done as an alternative?

The Singleton Reynolds authors suggest that being more actively involved and proactive in the insolvency process and registering or asserting liens trust claims more promptly would have strengthened their position, even when the CCAA process intervened later.

Cressatti writes, “Subcontractors and suppliers need to be prepared to demonstrate why such a charge would be detrimental to all of the insolvent contractor’s stakeholders. They also should be prepared to propose an alternative path towards project completion, which might involve contributing additional funds themselves.”

Both the Singleton Reynolds experts and Cressatti further suggest the suppliers could have provided their own DIP financing instead of Ironbridge. This would have secured their priority over other charges.

“In the event that a contractor commences CCAA or other insolvency proceedings, subcontractors and suppliers should consider working together to provide DIP financing within the insolvency proceeding, effectively becoming the DIP lender and gaining control over the priming charges,” writes Cressatti.

“Acting as the DIP lender allows suppliers to avoid being primed by another DIP lender.”

John Bleasby is a freelance writer. Send comments and Legal Notes column ideas to editor@dailycommercialnews.com.