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Lessons from Chandos Construction Ltd. v Deloitte Restructuring Inc.

By David A. de Groot, Partner, and Yang Guo, Associate, Durnet, Duckworth & Palmer LLP

 

In an October 2020 decision, the Supreme Court of Canada affirmed the common law anti-deprivation rule. This rule prevents parties from agreeing to contractual provisions that, upon insolvency, remove property that would otherwise vest in the trustee of a bankrupt’s estate.

The decision in Chandos Construction Ltd. v Deloitte Restructuring Inc. has implications for construction industry participants and acts as a reminder to contractors of the importance of ensuring contracts are properly structured.

These implications are particularly important for subcontractors with early scopes of work, but whose ongoing and future warranty and other long-term obligations could have significant financial impacts on a project. Accordingly, contractors in those industries should be aware of potential future contractual changes to address the practical issues arising in Chandos.

Background

Chandos Construction Ltd. (Chandos, referred to as Contractor), the general contractor, entered into a subcontract (the Subcontract) with Capital Steel Inc. (Capital, referred to as Subcontractor) valued at approximately $1.37 million, which contained the following clause (the Disputed Clause):

VII.Q In the event the Subcontractor commits any act of insolvency, bankruptcy, winding up or other distribution of assets, or permits a receiver of the Subcontractor’s business to be appointed, or ceases to carry on business or closes down its operations, then in any of such events:

...

(d) The Subcontractor shall forfeit 10 per cent of the within Subcontractor Agreement price to the Contractor as a fee for the inconvenience of completing the work using alternate means and/or for monitoring work during the warranty period.

While performing the Subcontract work, but near the end of the work, Capital filed an assignment in bankruptcy. At the time of the assignment, Chandos owed Capital $149,618.39, but incurred $22,800 in increased costs to complete the Subcontract work. There was no dispute that under the Bankruptcy and Insolvency Act (the BIA) and at common law, Chandos was entitled to set-off the $22,800 from the amount owing. However, Chandos also claimed a debt of approximately $137,000 arising from the Disputed Clause, which would mean Chandos did not owe Capital anything, after setting off this debt.

Issues before the Court

The Supreme Court of Canada heard five issues, but the Court’s decision focused on three.

First, the Court found that the anti-deprivation rule exists in common law and has not been eliminated by either jurisprudence or by Parliament. The Court affirmed that at common law the test had two parts: “first, the relevant clause must be triggered by an event of insolvency or bankruptcy; and second, the effect of the clause must be to remove value from the insolvent’s estate. This has been rightly called an effects-based test.”

Second, the Court rejected the submission that the anti-deprivation rule’s second prong should be amended to invalidate only clauses without a bona fide commercial purpose. According to the Court, substituting a “purpose based” approach would:

  • Undermine an express requirement in the BIA that all the bankrupt’s property be collected in the trustee,
  • Create commercial uncertainty because the Courts would be required to assess parties’ intentions long after the fact, and
  • Invite parties to create preferences under the guise of commercial purposes because the party who might become insolvent has no incentive to resist a clause that deprives its estate of value, and the creditors of that party are without a seat at the bargaining table.

 

Despite this, the Court held that contractual terms triggered by other events, or that create other mechanisms (such as insurance, guarantees, security) to protect against insolvency consequences might not offend the anti-deprivation rule. In a lengthy dissent, Justice Suzanne Côté would have adopted the bona fide commercial purpose alteration to the anti-deprivation rule.

Third, the Court acknowledged that the BIA incorporates common law set-off, but it only applies to enforceable debts or claims, whereas the anti-deprivation rule undermines the enforceability of the debt or claim.

Applying the above considerations, the majority of the Court held that the Disputed Clause offended the anti-deprivation rule.

Implications for parties in construction

On a plain reading of the Disputed Clause, it is clear that its intention was to award Chandos a pre-estimate of damages for the actual costs of performing contractual warranty obligations that Capital ought to have performed, but failed to in breach of the Subcontract.

In other words, it gave Chandos a monetary protection for a guarantee of a long-term Capital obligation, but without any immediate cash-flow or financial impact on Capital. Given the issues discussed in Chandos, it is unlikely that general contractors will not seek alternative financial protections for those same issues. Accordingly, subcontractors, including those with foundation, geotechnical and piling scopes of work, may find that there is increased pressure to agree to other forms of contractual guarantees, if sufficient guarantees are not already in place.

In conjunction with issues such as builders’ lien holdbacks, such changes are likely to further reduce the immediate cash flow available to those contractors. Contractors should review and negotiate their contracts carefully given the incentives created by the Chandos decision. 

 

 

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Piling Canada is the premier national voice for the Canadian deep foundation construction industry. Each issue is dedicated to providing readers with current and informative editorial, including project updates, company profiles, technological advancements, safety news, environmental information, HR advice, pertinent legal issues and more.