Defence + Indemnity: February 2018 - VI. SURETY AND BOND ISSUES

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VI. SURETY AND BOND ISSUES
A. Supreme Court of Canada finds obligee/trustee under a Labour and Material Payment Bond breached the fiduciary duty owed to a claimant by failing to disclose existence of the Bond.

Valard Construction Ltd. v. Bird Construction Co., 2018 SCC 8, per Brown J. (McLachlin C.J. and Abella, Moldaver and Rowe JJ. concurring, Côté J. concurring in result, and Karakatsanis J. dissenting) 

I. FACTS AND ISSUES
Bird Construction Co. (“Bird”), as general contractor, entered into a contract with Suncor Energy Inc. (“Suncor”) for construction work on one of Suncor’s oilsands projects (the “Project”). Bird subcontracted a portion of its work to Langford Electric Ltd. (“Langford”).

The subcontract between Bird and Langford obligated Langford to obtain and provide a Labour and Material Payment Bond (the “L&M Bond”). Langford obtained the required bond, which named Bird as obligee, Langford as principal, Vermillion as obligee, and The Guarantee Company of North America (“GCNA”) as surety.

Valard Construction Ltd. (“Valard”) entered into a subcontract with Langford, but was not paid in full for its work after Langford became insolvent. Valard was unaware of the existence of the L&M Bond and did not find out it existed until approximately a year after Langford last worked on the Project. Valard’s project manager gave uncontradicted evidence at trial that although he had experience with labour and material payment bonds on municipal projects, he had never encountered one on any of the oilsands projects in which Valard was engaged.

When the payment issues between Valard and Langford arose, Langford’s representative advised Bird’s representative that there was a problem as Valard was looking for further payments for extra work it had carried out. Valard also knew Bird was aware, but did not raise the issue with Suncor directly as it did not want to “rock the boat”.

Upon learning of the L&M Bond, Valard immediately made a claim to GCNA on the L&M Bond with respect to amounts it claimed were due and owing but unpaid. GCNA denied Valard's claim as it was outside of the express time requirements of the L&M Bond (Valard's claim was approximately seven months late).

Valard sued GCNA and Bird. The claim against GCNA was dropped by Valard after GCNA was able to demonstrate to Valard that it had been prejudiced by Valard's late claim (with such prejudice undermining Valard's ability to seek relief from forfeiture, which otherwise may have allowed the Court to find Valard's claim was valid notwithstanding it was late).

With respect to its claim against Bird, Valard had no knowledge of the L&M Bond until after the notice period had already long expired. Valard argued that Bird as obligee, and as trustee under the L&M Bond, had a fiduciary duty to inform Valard of the L&M Bond’s existence within the relevant time frame, and that Bird breached this duty by not disclosing the existence of the L&M Bond to Valard.

Bird denied it had any duty to advise potential claimants of the existence of the L&M Bond. Justice Verille of the Alberta Court of Queen's Bench agreed with Bird and dismissed Valard's claim: Valard Construction Ltd. v Bird Construction Co., 2015 ABQB 141. Valard appealed and the Alberta Court of Appeal upheld the Queen’s Bench decision: Valard Construction Ltd. v Bird Construction Co., 2016 ABCA 249. Valard then took its argument to the Supreme Court of Canada.

 
II. HELD: Bird, as trustee, owed a fiduciary duty under the L&M Bond to Valard. In these circumstances that duty required Bird to disclose the existence of the L&M Bond. As Bird took no steps to disclose the existence of the L&M Bond, it breached the fiduciary duty it owed to Valard.

Brown J. writing for the majority of the Supreme Court of Canada agreed with Valard that the text of the L&M Bond created an express trust which named Bird as trustee, the potential class of defined “claimants” being the beneficiaries of the trust, and the subject matter of the trust being the ability to claim from GCNA the sums owed by Langford.
 
Properly, the Supreme Court then identified the “hallmark” characteristic of the trust to be the fiduciary duty owed by a trustee to a beneficiary of the trust. That then led the Supreme Court to consider whether, on the facts before it, that general fiduciary duty included a duty on the trustee (i.e. Bird) to disclose the existence of the trust (i.e. L&M Bond) to a beneficiary (i.e. Valard).
 
The Supreme Court was clear that a trustee’s duty does not always necessarily include the obligation to disclose the existence of a trust. However, the Supreme Court did then explain when such an obligation does arise:

 
In general, wherever “it could be said to be to the unreasonable disadvantage of the beneficiary not to be informed” of the trust’s existence, the trustee’s fiduciary duty includes an obligation to disclose the existence of the trust. Whether a particular disadvantage is unreasonable must be considered in light of the nature and terms of the trust and the social or business environment in which it operates, and in light of the beneficiary’s entitlement thereunder [emphasis added].
 
The Supreme Court continued:

 
For example, where the enforcement of the trust requires that the beneficiary receive notice of the trust’s existence, and the beneficiary would not otherwise have such knowledge, a duty to disclose will arise. On the other hand, “where the interest of the beneficiary is remote in the sense that vesting is most unlikely, or the opportunity for the power or discretion to be exercised is equally unlikely”, it would be rare to find that the beneficiary could be said to suffer unreasonable disadvantage if uninformed of the trust’s existence.
 
Applying the facts before it to that law, the Supreme Court held that Valard was “unreasonably disadvantaged by Bird’s failure to inform it of the trust’s existence”. In assessing the social and business environment in which this trust existed, the Supreme Court held:

 
Questions of industry understanding, practice, and expectations are, however, matters of fact [emphasis in the original].
 
The Supreme Court noted that one fact was uncontradicted: that the use of labour material payment bonds was uncommon on private oilsands construction projects. That fact, combined with the finding “that Valard’s interest under the trust was not so “remote” that vesting was unlikely”, cemented the Supreme Court’s conclusion that, on these facts, the fiduciary duty owed by Bird to Valard included a duty to disclose the existence of the L&M bond.
 
While the Supreme Court acknowledged the labour and material payment bonds do protect obligees, such as Bird, from work stoppages and builders’ liens, it rejected Bird’s argument that then it was solely Bird who was to benefit from the L&M Bond. The Supreme Court noted that if potential trust beneficiaries cannot enforce their rights under a labour and material payment bond, the protection such a bond offers an obligee is lost.
 
Having found that Bird had a duty to disclose the existence of the L&M bond, the Supreme Court then considered what should have been required of Bird to discharge its duty. The Supreme Court held:

 
Like all duties imposed upon trustees, the standard to be met in respect of this particular duty is not perfection, but rather that of honesty, and reasonable skill and prudence.
 
Again depending on the facts, the extent of the effort required by an obligee/trustee changes and one must be careful to not use the perfect vision that comes with hindsight:

 
In considering what was required in a given case, therefore, a reviewing court should be careful not to ask, in hindsight, what could ideally have been done to inform potential beneficiaries of the trust. Rather, the proper inquiry is into what steps, in the particular circumstances of the case — including the trust terms, the identity of the trustee and of the beneficiaries, the size of the class of potential beneficiaries and pertinent industrial practices — an honest and reasonably skillful and prudent trustee would have taken in order to notify potential beneficiaries of the existence of the trust.
 
The Court noted that, depending on the specific facts, an obligee/trustee may not have to expend much effort to disclose the existence of a labour and material payment bond:

 
But, where a trustee can reasonably assume that the beneficiaries knew of the trust’s existence, or where practical exigencies would make notification entirely impractical, few, if any, steps may be required by a trustee [emphasis in the original].
 
Of course, Bird did nothing at all, except file the L&M Bond in an office drawer. That amount of effort was not going to discharge its duty on any analysis. The Supreme Court adopted the observation of Wakeling J.A. from the Alberta Court of Appeal, who in his dissent noted that Bird had an on-site trailer where project-related notices were commonly posted. In stressing the question was not what Bird could have done, but what Bird should reasonably have done, the Supreme Court held that with little effort and cost, Bird could have posted the L&M Bond at the on-site trailer. Given the context of a private oilsands construction projects where labour and material payment bonds were uncommon, Bird had to do more than nothing.
 
Côté J. and J. Karakatsanis J. each wrote separate reasons which differed in result. However, both agreed that an obligee/trustee did not have any proactive duty to take steps to inform potential claimants of the existence of a labour and material payment bond.
 
Côté J. held that on the specific facts, the discussions between Langford and Bird regarding the “serious problem” Langford had with Valard, did trigger Bird’s duty to respond accurately to enquiries by potential claimants. Valard was aware Langford had asked Bird how it should proceed. When Bird did not advise Valard of the L&M Bond when it knew of the issues with Valard, combined with the communications between, Valard, Bird, and Langford, it failed to respond accurately to Valard, notwithstanding Valard did not specifically enquire about a bond. For those reasons, she concurred with the result held by the majority.
 
Karakatsanis J., in his dissent, noted that for decades the practice and understanding in the construction industry has been that an obligee/trustee has no obligation to inform potential claimants of the existence of a labour and material payment bond. Rather the practice and understanding has been that claimants are expected to enquire if a bond exists.
 
Karakatsanis J. noted that the trustee language found in the L&M Bond serves a narrow purpose of ensuring a claimant would not be prevented from successfully suing on a labour and material payment bond due to the operation of the “third party beneficiary rule”, as any claimant lacks privity of contract with the parties expressly identified in the bond. He also noted that Ontario and British Columbia have ensured that no such bar exists by enacting legislation which ensures a claimant has a cause of action against a surety under a labour and material payment bond.
 
Karakatsanis J. also highlighted that a labour and material bond protects an obligee (whether an owner or general contractor) by ensuring they do not need to spend time and money dealing with liens or other claims resulting from a defaulting contractor’s subcontractors and suppliers. Karakatsanis J. concluded that it was absurd to interpret a labour and material bond, the purpose of which is to provide an obligee protection, as including obligations on the obligee. He also noted that using the fact that the project in question was “a privately owned oilsands project” to justify a determination that a fiduciary duty to disclose the bond’s existence was triggered would only lead to instability and uncertainty.

III. COMMENTARY

In my mind, many of the observations and conclusions made by Karakatsanis J. are accurate. It has been long accepted that bonds like the L&M Bond, a standard form CCDC 222-2002 bond, contained “trustee language” only to circumvent the operation of the third party beneficiary rule. However, with this decision, the “trustee wording” has been interpreted in accordance with the usual meaning of “trustee”. Where trustees travel, so along come fiduciary duties – which generally require a trustee to put a beneficiary’s interest ahead of its own.
 
This decision is clear confirmation that an obligee under a labour and material payment bond has obligations to potential claimants under such a bond. This is a dramatic shift. The group to which an obligee now owes obligations is a class with an unknown number of members. It is a group with which an obligee has no contractual relationship. It is a group to which it owed no obligations, aside from what is contained in provincial lien legislation. Where obligations are found, so is exposure to risk. Labour and material payment bonds are marketed and sold as offering obligees protection. While it is the “principal” under a labour and material payment bond who is billed the premium by the surety, it is the obligee who ultimately bears expense through a contract price. Why would an obligee now pay for a form of protection that only increases its exposure to a group of claimants?
 
Further, consider the amount of the potential exposure. Here there was only one claimant, Valard, but there could have been any number of unpaid subcontractors and suppliers of Langford in a similar position, and advancing similar claims against Bird. I also question if there are other unpaid subcontractors and suppliers of Langford who could now commence similar actions against Bird (although they might be barred by operation of the Limitations Act)?
 
Implicit in the majority’s reasons is an approval of idea that an obligee should at least take the step of posting a labour and material payment bond at the site trailer or office. While this makes sense with respect to subcontractors who attend at site, what about suppliers who never visit the site? Posting a bond at site does nothing to inform suppliers who do not attend at site of the bond’s existence or to discharge the fiduciary duty now owed by an obligee to those suppliers. What is the obligation on then on an obligee with respect to notifying suppliers? Will advertising in a local newspaper or publication suffice? What about suppliers from other provinces or from other countries? How does that help them? These are kinds of questions construction litigation lawyers would be happy to have the Court answer for their clients.
 
In the first instance, the consequence for the surety industry is obvious. The fact that issued labour and material bonds are going to be openly posted or otherwise advertised will certainly result in more claims being received. Personally, I cannot count the number of times I have seen a subcontractor or supplier, or their counsel, completely miss the fact there was a bond available which could have offered them another remedy.
 
But a potential deeper problem is that this decision may kill the viability and marketability of the labour and material bond product altogether, at least in its current form. What obligee wants to pay for protection that actually increases its exposure by the amount of the penal sum of the bond? Why would an obligee want a protection that heretofore came with no risk and now comes with significant risk? They certainly will not want to pay the same amount for that protection. While it cannot be known exactly how the market will respond to this decision, at the very least, sureties should be motivated to ensure that there is a clear process for any obligee to follow to publicize its labour and material payment bonds so to ensure that obligees minimize the risk now associated with this product.
 
It is certainly possible that this decision will lead to changes being made to the standard form of labour and material payment bonds. One option is to remove the “trustee language”, however, that then creates a problem with the third party beneficiary rule. Legislators in other provinces could also follow Ontario and British Columbia’s lead to create a legislated work-around to the hurdle caused by this rule.
 
The proper fix may be to limit the right to make a claim under such a bond to the obligee. The obligee can then decide in any given situation whether it wants to call on the bond on behalf of an unpaid subcontractor or supplier. The obligee will then receive the protections such bonds previously offered but without the additional risk and exposure which are now concomitant with them. This solution is not likely to be viewed well by subcontractors or suppliers who might have previously fallen in the definition of “claimant”, as they lose the power to initiate a claim.
 
No doubt the majority of the Supreme Court was motivated by a desire to see that subcontractors and suppliers are protected, which is a motivation for which they cannot be faulted. However, the consequences of this decision, which clearly expands an obligee’s exposure to liability, may only lead to an end of the limited protection offered by labour and material payment bonds.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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