January 2009

You own a parcel of land (the "Property") and have decided to sell it to someone (the "Purchaser") on the understanding that the Purchaser uses the Property for a specified purpose and develops the Property with particular/particular types of improvements.  A more or less common example of this situation is where the current owner (you) subdivides a Property into a number of building lots and then enters into purchase and sale contracts with a number of buyers who promise that they will use their lots solely for, say, recreational purposes, and additionally promise you that they will, within a specified period of time, build cottages on the lots, with the cottages having to be constructed to meet, to a greater or lesser degree, your specifications.  Such an arrangement may be encouraged or indeed required by the municipal/local government for the jurisdiction in which the Property is situated.

You know that you can enforce the Purchaser's promises by court action brought against the Purchaser, but you also know that positive - as opposed to negative - covenants (promises) are not considered interests in land which are capable of being enforced against a successor in title to the original contracting Purchaser, absent the original Purchaser's successor undertaking to you directly to be bound by the original Purchaser's promises to you.  Instead, you accept the suggestion of a lawyer, who has a little, but not sufficient knowledge of these matters, to include an option in your favour to buy back the Property from the Purchaser, if and when the Purchaser breaches its promises to you.  The lawyer tells you that such an option is an interest in land and thus, if properly recorded (caveated) against the title to the Property, will indeed bind all successive title holders of the Property.

The use of options to purchase in this situation is fairly common, and while it is true that a "pure"/"unadulterated" option to purchase does constitute an immediate interest in land, an option in the above-described situation - which is really a conditional option which will only arise in the future upon the occurrence of some event which may or may not happen (ie., the original Purchaser's breach of its promise(s) to you) - is not an interest in land.  The arrangement is binding between the immediate parties to it, but will not "follow" the title into the hands of subsequent owners, barring an undertaking by a subsequent owner to be bound by the arrangement (ie., the conditional option).  The case law makes it clear that this type of a (conditional) option is really akin to a first right of refusal (which is also not an interest in land, although some people think it is and even try to caveat it), because unless and until the Purchaser breaches its promises to the promisee, the promisee has no unequivocally existing right to compel (at its choice) reconveyance of the Property.

Can an original land owner enter into any sort of arrangement with its Purchaser which would enable the original owner to get the Property back where the Purchaser's promise(s) is/are breached by a successor in title, with the original owner being able to enforce the promise(s) against a successor in title?  The answer is "yes", although counsel for the original owner will have to be very careful how he or she drafts the contract.

Before dealing with the law pertaining to this matter, please keep in mind that there are two elements of the Purchaser's promise(s) referred to above, namely:

(i)            the promise to only use the Property for a specified purpose; and

(ii)           the promise to develop/construct specified improvements on the Property.

Common law recognizes two similar, but in fact, in terms of legal consequences, substantially different, types of fee simple estates in land, namely:

(i)            a determinable fee simple.  This is a grant of fee simple ownership by the original owner to the transferee to last and exist during a period of time in which, or only for so long as, the transferee uses the Property for a specified use or uses.  Upon the Property ceasing to be used for the specified purpose or purposes, the fee simple ownership of the Property automatically reverts to the original owner, that is, reversion occurs without any exercise of discretion, an option, etc. on the part of the original owner.  The determinable fee simple is an interest in land and as such is caveatable against the title to the subject Property and will bind successors in title.

(ii)           a fee simple which is terminable upon a condition subsequent.  Here, where the Purchaser breaches its promise(s) to the original owner, then the original owner has a right or choice to require forfeiture of the Property back to the original owner.  Such an arrangement is enforceable between the parties but is not an interest in land which would bind successors in title.

Case law and legal commentators have made it clear that "the law has been jealous in its scrutiny of conditions subsequent and will readily hold them void as offending pubic policy, as incapable of performance, or for uncertainty".  In such a case, when the Court holds the condition subsequent to be void, the result is that the fee simple estate becomes absolute in the hands of the (then current) owner.  On the other hand, in the case of a determinable fee simple where the Court holds that the requirement specified to end the estate is void, typically due to uncertainty, the transferred estate will be held to have terminated, with the result that ownership will automatically revert to the original owner (ie., the result would be the same as where the terminating requirement was held to be valid and enforceable and that such event had occurred).

So, going back to the original example, if you are contemplating the sale of your Property, and you wish to induce performance of the purchaser's use/development promise(s) to you with the threat of forcing the return of the Property to you, and you would in fact want the Property back in your hands if the Purchaser (or its successor in title) ceased to use it in accordance with the Purchaser's promise(s) to you, how should the contract be worded?

The key is to word the agreement/transfer of ownership so that the conveyance is to be "for so long as" or "during when" the conveyed lands are used for one or more specified purposes only, or possibly "for so long as" or "during when" the lands are used in accordance with certain specified (typically, development) requirements.  The writer uses the word "possibly" here because when you move from characterizing the transferred ownership as being required to be utilized for a specified use or uses, to specifying compliance with requirements other than "purely" usage obligations, you start to get into the area of what may be, in any particular instance, requirements which obligate the owner to take specific actions and/or expend monies in order to meet the requirements.  The Courts have traditionally frowned on promises binding successors in title whereby the owner is obliged to take certain actions and/or expend monies.  In other words, it is one thing to require that the land be used only for "recreational purposes", but perhaps quite another to require that the owner (and its successors in title) build a cottage (in accordance with certain specifications) by a certain deadline.  The latter requirement, which would obligate the owner (or its successor) to take certain actions and/or expend funds, are requirements which are substantially akin to the imposition of positive - as opposed to (passive) negative - covenants/promises on or against land, and as such, may not be enforceable against successors in title.

Nevertheless, the dividing line between a grant of ownership "for so long as"/"during when" the land is used only for specific purposes, and a grant of ownership "for so long as"/"during when" the land is used in accordance with specific (development type) requirements, is a fine one.  Thus, counsel would no doubt be better advised to at least attempt to arrange for a conveyance of ownership "for so long as"/"during when" the land is utilized in accordance with specific development type requirements, than attempt to establish an arrangement whereby the vendor has a conditional option to re-acquire the land where the Purchaser (or its successor) breaches the obligation to develop the Property in accordance with specified development type requirements.

Land owners contemplating the imposition of usage/specific development type requirements on one or more purchasers from them by way of the establishment of determinable fee simple arrangement(s), should take into account the likely reaction of a Purchaser's (or its succesors') mortgage financier(s).  No mortgage lender would want its security to suddenly disappear by virtue of reversion of ownership of the mortgaged land back to the mortgagee's mortgagor's vendor, free and clear of the lender's security.  At the very least, a mortgagee would want its mortgage security to "follow" ownership of the Property back to the vendor, with some assurance that the vendor would be bound - at least on a non-recourse basis - under the mortgagee's security.  Whether the original owner/vendor would be willing to be bound by a Purchaser's mortgage financing may be a difficult question to answer, but it is certain that no mortgagee in its right mind would advance money to a mortgagor where the mortgagor's ownership could suddenly disappear through no fault of the mortgagee.

Readers are referred to the writer's earlier memorandum entitled "NEW PROVINCIAL GOVERNMENT RULES FOR WASTEWATER MANAGEMENT SYSTEMS" ("Original Memorandum").  Since sending out the Original Memorandum, the writer has received a number of comments thereon which he believes are worth sharing with interested persons.  Words and expressions used in this memorandum which have been given defined meanings in the Original Memorandum shall have the same meanings herein as given to them in the Original Memorandum.

1. Might the Amended Wastewater Regulation apply to leased property?  Given the number of cottages/recreational properties utilizing (private) onsite wastewater management systems, this is much more than an academic question.  Sections 8.1 to 8.3 refer to a/the "land owner" and to a/the "transfer of (the) land".  The Amended Wastewater Regulation does not define "owner" nor does it define "transfer", so that arguably, the lessee under a (typically, although not necessarily, long-term) lease of land and any transfer, assignment, etc by the lessee to an assignee might well be caught up under the Regulation's requirements for onsite wastewater management systems.  The same analysis applies to Section 14.2 of the Amended Wastewater Regulation dealing specifically with sewage ejectors.  If lessees are caught, it is the writer's view that a lessee plus the lessee's lessor would be both obliged to comply with and would both be subject to sanction under the Amended Wastewater Regulation.
2. Should purchasers, mortgagees and their counsel require the inclusion of one or more appropriate statements in a seller's/mortgagor's typically taken (at closing) statutory declaration as to possession ("Closing Declaration")?  A statement or statements pertaining to the status of the property in relation to onsite wastewater management systems and/or the availability of a ("public") wastewater collection system contained in a Closing Declaration couldn't "hurt".  However:

(a)          a written statement/advice as to the availability of a ("public") wastewater collection system and/or the likelihood of one becoming available within the next five years issued by Manitoba Conservation would be preferable to a statement to that effect by the seller/mortgagor; and

(b)          because a Closing Declaration is not typically taken until just before or concurrently with a closing of a transaction - ie., long after when the  sale or mortgage contract is first entered into - the practical usefulness of relying solely on statements in a Closing Declaration is probably minimal.  The time when an intending purchaser or mortgagee would want to learn of the status of the property in relation to these matters would be at the time of, and in fact preferably before, when the contract is entered into.  That way the contract (sale agreement/mortgage commitment letter agreement) can be adjusted to specify the appropriate warranties and to properly specify who is to do what (and when) in relation to compliance, and in particular, non-compliance, with the applicable requirements of the Amended Wastewater Regulation.  Such matters would likely have a bearing on the purchase and sale price or the amount and the timing of advancement of a mortgage loan.

1. Septic tanks and fields will be banned for properties which are less than two acres or which have less than 60 meters (198 feet) frontage, and this is so even if there is no available ("public") wastewater collection system.  This is a new requirement under the Amended Wastewater Regulation which was not mentioned in the Original Memorandum.  While it is possible for a property owner to apply to the government for permission to install a septic tank or septic field type system, there certainly is no guarantee that an applicant would be successful.  This is of course of concern to any cottage/recreational property owners who frequently have less than two acres land or less than 60 meters (198 feet) frontage.  The Amended Wastewater Regulation does not specify what "frontage" means here - does it mean frontage on a public or road or a private road?
2. In the Original Memorandum, the writer suggested that persons who contracted for the sale of affected property before and without knowledge of the coming into force of the amending regulation #156/2009 consider "splitting the difference" of the costs of compliance.  It has been suggested to the writer that a seller might reasonably agree that a "50 - 50 split" doesn’t make sense for the simple reason that the purchaser will be getting a substantial benefit from the remedial action that the seller is forced to make prior to closing, and that consequently, the purchaser should pay for most if not all of such benefit.  Difficult negotiations may well be in store for sellers and purchasers in this position.

Generally speaking, in considering the matters raised in this memorandum and the Original Memorandum, the writer strongly believes that the following should be done:

(i)            As noted above, the time when a (potential) purchaser or mortgagee should be aware of the status of the seller's/mortgagor's property in relation to onsite wastewater management systems is before the underlying contract is entered into.  If the underlying contract fails to properly deal with the matter, then by the time that lawyers become involved, it will, in most if not all cases, be too late.  Thus the need for potential buyers and potential mortgagees - as well as potential sellers and mortgagors - to be properly educated on the Amended Wastewater Regulation.  Hopefully, one can assume that most businesses purchasing real estate or advancing value on the security of real property mortgages will so educate themselves either directly, or through their legal advisors.  For the vast majority of others involved, in particular, "ordinary" sellers and buyers of real properties outside of areas served by ("public") wastewater collection systems, that will mean that the usual "gatekeepers", namely REALTORS must be educated so that they can advise and assist their seller and buyer clients to properly complete purchase and sale agreements.  The writer is aware of certain efforts being made - and which have already been made - to so educate realtors, and this effort must be kept up and be ongoing.

(ii)           It is necessary for the government to clarify certain of the questions which have arisen and which will no doubt arise in the day-to-day application of the Amended Wastewater Regulation.  The original memorandum and this memorandum have raised some of those questions, and no doubt those "in the field" will, through experience, raise others.  Ideally, these questions should be clarified by further amendment to the Amended Wastewater Regulation, but even the publication of written statements of policy or intention by Manitoba Conservation would be helpful.  One significant question raised by one of the writer's correspondents has to do with such correspondent's understanding from Manitoba Environment regarding the disconnection and decommissioning of sewage ejectors.  It is this person's understanding that where an owner sells its property to a purchaser who specifically agrees to undertake to disconnect and decommission the ejector within two years from closing, the seller would not be prosecuted.  Unfortunately, the way that the Amended Wastewater Regulation currently reads, this doesn't appear to be the case, and in fact, even where a purchaser undertakes responsibility and then fulfills that responsibility to remove the ejector, the seller is still open to prosecution.  Clearly, the government should clarify this matter, perhaps by a policy statement.

The recent Manitoba Court of Appeal decision (Kadyschuk and Sawchuk, hereinafter the "Kadyschuk Case") confirmed what has been established law for quite some time relating to first rights of refusal.  That is, that such arrangements are purely contractual in nature and do not constitute interests in land, and thus cannot - apart from further contractual assignments and undertakings - bind a successor in title to the original land owner who grants a first right of refusal. The theory underlying this is that, unlike an option to purchase which gives the optionee the right and power to compel the optionor to sell its land to the optionee (upon the optionee properly exercising the option), under a first right of refusal, the grantee thereof does not have such right and power within its control, but must await the occurrence of one or more acts and/or decisions taken by the grantor of the first right of refusal, which acts/decisions are entirely within the control or discretion of the grantor, and in particular, are not within the control or discretion of the grantee.

At first instance in the Kadyschuk Case, the motions judge, in referring to the first right of refusal which the parties had agreed to, stated that "…that right needs to be placed not only in this agreement but on the title or registered somewhere such that an innocent party without notice is not caught in this legal argument that there is a first right of refusal. …I am not going as far as saying that (the grantee of the first right of refusal) has an interest in the land…but he certainly has a right that has to be registered and that right, in this court's opinion, can be registered on title in the Winnipeg Land Titles Office…".

As the Court of Appeal pointed out, the problem with the motion's judge's position was that registration of the grantee's rights of first refusal can not be made against the grantor's title (by way of caveat or otherwise), because under the Real Property Act (Manitoba), a caveat can only be used to register an interest in land and a first right of refusal is not an interest in land. However the motions judge did raise an interesting question as to whether or not a third party contemplating taking an interest in the grantor's land (after the grantor has provided a first right of refusal to a grantee thereof), namely someone who the motions judge would refer to as an "innocent party", who searches the title and finds no record of the first right of refusal, would be prejudiced by its existence where such "innocent party" contracted to purchase the land and then got caught up in an argument as to whether or not the first right of refusal took priority over the "innocent party's" purchase rights. One could argue that if the first right of refusal is not a registrable interest in land and the third party purchaser has no knowledge of it and is thus not bound by it, by being not bound by it and being able to close its purchase free and clear of the first right of refusal, the "innocent" third party purchaser is not prejudiced. Also, it is probably reasonable to assume that in most cases, in accepting a third party purchaser's offer to purchase, an owner would make it clear that its acceptance was subject to the first right of refusal, and that the sale transaction could only be completed if the holder of the first right of refusal failed to exercise its rights. The writer has often heard from other counsel and people in the land development business that clients/developers would not be amendable to spending the time required to consider the possible purchase of a land owner's property and to engaging counsel to draft an offer to purchase, if they knew at the outset that their time, trouble and expense could be all for naught and would merely establish a benchmark price and sale terms for a sale by the owner to the holder of the first right of refusal. In this situation, and assuming that a first right of refusal was legally capable of being registered against the owner's title, the potential third party purchaser would not be prejudiced because, seeing the first right of refusal caveated against the owner's title, he would simply "walk away" and not make an offer to purchase.  However, the owner would be prejudiced because the existence of notice of the first right of refusal on the title would no doubt "scare off" most potential purchasers. But wouldn't that prejudice to the owner/grantor of the first right of refusal "come with the territory" when the owner agrees to a first right of refusal and is thereafter open to receiving and/or soliciting offers to purchase from third parties?

The other party possibly prejudiced by the fact that a first right of refusal is not currently capable of being registered on the owner/grantor's title is the grantee of the first right. As stated above, it is the writer's assumption that most grantors of first rights of refusal will honour same and make it clear to any third party purchaser that acceptance of purchaser's offer is subject to the first right of refusal.  But what about the first right of refusal grantor who fails (carelessly or fraudulently) to advise a subsequent third party purchaser - or for that matter, anyone else contemplating acquiring a subsequent interest in the land, such a mortgagee - of the existence of the first right of refusal? Under current law, the subsequent third party purchaser, mortgagee or other person acquiring an interest in the land would no doubt acquire free and clear of the first right of refusal. This would leave the grantee of the first right of refusal with a claim for damages against the owner.  Such a claim may not be adequate redress for the aggrieved first right of refusal holder.

PerhapsManitobalegislation should be amended so that holders of first rights of refusal are able to register, record or otherwise place notice of their rights against the owner's title so as to bind persons subsequently acquiring any interest in the owner's land.  Such amendment could specify that:

             (i)                in order to so register, record or otherwise place notice on title, the agreement creating the first right of refusal must clearly specify that it is the intention of the owner and grantee that the rights given to the grantee are intended to bind successors in title to and other persons acquiring interests in the owner's land; and

            (ii)                the agreement must itself be a legally valid agreement or grant (this may go without saying, but - and as noted by the Court in the Kadyschuk Case - it was open to argument that the first right of refusal agreement in question was void for uncertainty in several respects).

-               When financing a borrower's acquisition of equipment, and taking security on that equipment, the following matters should be kept in mind:

(i)            to obtain the highest possible priority for your security (which means it will have retroactive priority over most previous security interests), you must file your financing statement in the Personal Property Registry no later than 15 days after the day upon which the borrower acquires possession of the equipment;

(ii)           If the equipment is "serial numbered goods" within the meaning of The Personal Property Security Act (Manitoba) (the "PPSA"), then in your financing statement, you have to include an accurate statement of the serial number (or numbers) together with statements pertaining to the make, model, manufacturing year and the "type" of equipment involved; and

(iii)          If the equipment is "mobile equipment", then you must perfect (typically, register a financing statement in) the jurisdiction in which the borrower is "located".  For an individual borrower, that would be the borrower's place of residence.  For a corporate borrower, that would be the jurisdiction in which the borrower has its office, and if it has more than one office, then in the jurisdiction in which the borrower's chief executive office is located.

-               For equipment that isn't "serial numbered goods", your financing statement should still include the serial number - if one is available - but it doesn't have to be included in the "serial numbered goods" portion of the financing statement.  As with any secured collateral, your financing statement should describe the collateral in a way that enables third parties to - relatively easily - identify it, and, to be able to distinguish it from other equipment (or other collateral) which the borrower holds but which is not subject to your security.

-               "Mobile collateral" is - obviously - motor vehicles. But it also includes less obvious "moveable" goods such as:

(i)            outboard motors on motor boats;

(ii)           aircraft;

(iii)          certain kinds of trailers;

(iv)         forklifts; and

(v)          heavy construction equipment that is "mobile", even if it doesn't move very fast and only (typically) moves short distances within an area within which it is being used.

-               Most farming equipment - even if it is "mobile" is not considered to be mobile equipment.  However, the two main exceptions to this are:

(i)            harvesting machines; and

(ii)           tractors.

-               Where the equipment you are financing is to be incorporated into real estate and as such, the equipment, when so incorporated, would be considered to be a "fixture" within the meaning of the PPSA, additional steps should "usually") be taken.  Generally, fixtures are any tangible goods which are built into, incorporated into or affixed into land and/buildings, excluding:

(i)            building materials; and

(ii)           elements or portions of a building or other improvement which, if removed, would adversely affect its structural integrity or the removal of which would expose the building to adverse effects of the elements.

-               Where what you are financing is or is to become a fixture, then in addition to filing a financing statement in the Personal Property Registry, you should also file a "Notice" against the title to the underlying land which states your interest in fixtures/goods which are described in your registered financing statement.  The priority you hold with respect to the affixed fixture depends on the alacrity with which you file your Notice against the title.  In this regard:

(i)            if your security interest attaches to the equipment before the equipment is affixed to the realty, then your security interest will hold priority over anyone with a competing interest in the land who has registered their claim or interest prior to the fixtures affixation date. However, a pre-existing registered mortgagee who makes an advance under its mortgage subsequent to when your financed equipment becomes a fixture may hold priority over your interest in the fixtures;

(ii)           where your security interest does not attach to the equipment until after the equipment has become affixed to the realty, you will be subordinate to:

(A)          all pre-existing real estate registered interests; and

(B)          any subsequent arising real estate interest who registers its interest before you register your Notice against title.

-               In my experience, where security is taken by a lender to finance a debtor's acquisition of equipment that becomes affixed to land, the required registrations - including registration of a Notice against the title to the underlying land - are not done until after the equipment has become affixed.  Thus in most cases, in addition to registering against the underlying land's title, you should do a search of the title before advancing value so as to ensure that there are no pre-existing competing mortgages or other interests.  Or if there are any of the same, you should not advance until you have  postponements or consents to advance from the prior registered land interest holders.

-               Where the debtor defaults and you wish to realize against your security, you are entitled to enter upon the land and remove the affixed equipment provided that you don't cause any damage in effecting the removal.  You do have to provide prior notice to all interested parties. Anyone who has an interest ranking in priority to your interest in the affixed equipment is entitled to require you to put up security to cover any damage to the property you cause by removal.

-               Where you are financing a debtor's acquisition of equipment which is not affixed - or to be affixed - to the realty, you should proceed in the ordinary course.  However, if the debtor doesn't own the underlying land but is merely a tenant holding from somebody else, you should get some sort of a subordination/consent from the landlord to permit you to remove the goods and liquidate them for your own account, in particular, with reference to the landlord's right to levy distress against goods on the premises for rent arrears.

-               If you are financing a tenant's "leasehold improvements" - which may or may not include fixtures - you should (again) obtain a postponement/consent from the landlord.  However additionally, you should review the lease between the parties so as to determine what your rights are should you find yourself in a position where you wish to realize on your security.  Matters of particular interest to consider in a lease in this context are:

(i)            What does the lease say about the ownership of leasehold improvements (fixtures and non-fixtures) in the contexts of termination of the agreed to lease term by virtue of the tenant's default or the landlord's default under the lease?

(ii)           Does the lease outright prohibit the taking of any security in the leasehold improvements?

(iii)          What are the rights and obligations of the involved parties consequent upon damage or destruction to the property?

-               If you are financing a tenant's leasehold improvements and the tenant has a "long-term" lease, it may be appropriate for you to take security against not only the leasehold improvements, but also - and perhaps in particular - against the tenant's leasehold interest.  In other words, you want a mortgage of the borrower's leasehold interest.  In that case you will definitely have to review the terms of the lease to see what - if anything - the lease says about granting of such security by the tenant.  You have to consider carefully, keeping what's in and what's not in the lease - about what you would want to have happen where:

(i)            the tenant defaults to the landlord and the landlord has the right to terminate the lease;

(ii)           the tenant as your borrower defaults in the performance of its obligations owed to you and you wish to realize your security.  This would no doubt mean your selling the balance of the term of the lease (and the right to hold and use the improvements you have financed) over the balance of the term, to a new lessee.

(iii)          the tenant becomes bankrupt?

February 2019

If I, as the owner of land, engage a single person to make improvements to my land, the respective rights and obligations of the two parties will usually be set out clearly in the contract we enter into for this purpose. If the other contracting party does not engage any others to assist in effecting the improvements, then what can - and usually would - happen where the improvements are properly effected but I, for some reason, fail to make payment therefor, is that the other contracting party can sue me for breach of contract, get a money judgment and then use that judgment to realize against (i.e., liquidate) so much of my assets as is necessary to recoup the judgement debt. If the other party's monetary entitlement is very high - a rather unlikely situation in the case of a one-person contractor - the other party can - if I'm agreeable - extract a mortgage against my property to better assure the payment of what I owe.

However, in the "real world", with respect to the vast majority of construction/development projects, no such simple two-party/one contract arrangement is possible. The owner of real estate engages what is commonly known as a general contractor to effect substantial - and often costly - improvements to the owner's property. The general contractor performs its tasks by engaging and coordinating the activities of multiple other parties, usually called "subcontractors". One or more - or all - of each of those subcontractors may in turn engage sub-subcontractors and so on "down the line to the bottom". The "bottom" refers to the notional construct of the grouping of the parties involved and takes the shape of a pyramid, with the owner at the top, the general contractor immediately below the owner, and subs and sub-subs, etc. spreading out below the general contractor to the bottom level of subcontractors. At each level, starting with the general contractor, each of the parties inputting the improvements will typically engage a number of employees and purchase supplies from other parties. Unlike the "two party/one contract" arrangement described above, there will not be contracts between the various parties situated at different "separated" levels of the "pyramid".  Parties situated at lower levels of the "pyramid" will be separated by one or more other levels of parties within the "pyramid". Thus the owner, while it will have a contract with the general contractor, won't have any contracts with any of the subcontractors or with the sub-subcontractors. The general contractor will have contracts with the level of subcontractors immediately beneath its level in the "pyramid" but it will not have contracts with any of the lower level participants. This means that where the owner makes a payment of part of what it owes to the general contractor, but the general contractor fails to pay one of its direct subcontractors, absent "remedial legislation", the unpaid subcontractor has no source of recoupment of what is owed to it, other than by making a claim against the general contractor. Again, absent "remedial legislation", if the general contractor has become insolvent (or bankrupt), the unpaid subcontractor would have no claim against the owner and no security in the project which it has assisted in improving.

However, as we all know, there is "remedial legislation", namely the Builders' Liens Act (the "BL Act"). The BL Act provides more than one "mechanism" to assist parties improving or assisting in improving real estate that do not have a direct contractual relationship with the owner (the ultimate beneficiary of the improved real estate) or any effective security for the payment of what is owed to them. The builders' lien is one such mechanism.

This paper deals with another mechanism, namely the BL Act's creation of a trust or trusts imposed by the BL Act on the various levels of participants in the construction "pyramid" with respect to funds received by each of them for the benefit of those situated below their level in the "pyramid". Generally speaking when funds are acquired by an owner, a general contractor, a subcontractor, or a sub-subcontractor, etc., those funds are received by the recipient subject to a trust obligation to ensure that they are used firstly to pay those immediately below them in the construction pyramid before any of the funds are used for any other purpose including any "personal" usage thereof by the funds recipient (eg, including repayment of debts owed by the funds recipient to its creditors).

The application and operation of the trust provisions of the Manitoba BL Act and of other similar legislation in other jurisdictions is often cumbersome and somewhat ineffective. The expectations of the various parties in a construction pyramid - starting with the owner - are often unrealistic and construction disputes are a common feature of much real estate related litigation. With that problem in mind, private business interests have for many years worked out an alternate mechanism to provide some assurance to at least some of the participants in construction pyramids, in particular, those at the lower levels of the pyramid.  This mechanism involves the issuance of "bonds" by specialized underwriters.  There are two general categories of Bonds:

(i)            a Performance Bond - a contract entered into by a general contractor and a surety corporation in which the general contractor and the surety corporation guarantee the project owner that the general contractor will perform its obligations under the general contractor's general construction contract with the owner. Where the general contractor fails to perform, the owner may claim against the surety corporation under the bond for the costs of completing the project and certain related costs, up to the maximum amount specified in the bond; and

(ii)           a Labour and Material Payment Bond - a contract entered into by a general contractor and a surety corporation which guarantees that the general contractor will pay its subcontractors, suppliers and labourers on a specific project. If the general contractor fails to honor its payment obligations, then the subcontractors, suppliers and labourers may claim against the surety corporation for payment under the bond up to the maximum amount specified in the bond. In a large construction project, such bonds may be issued by a surety corporation and a subcontractor to provide assurance to the general contractor that the subcontractor will pay its sub-subcontractors, suppliers, and labourers on the project.

A bond of the second of the above-described types (a Labour and Material Payment Bond) was the subject matter of a dispute which was recently decided by the Supreme Court of Canada in the Valard Construction Ltd. v. Bird Construction Co. case (judgment issued February 15, 2018 hereinafter, "Valard Case"). In the Valard Case:

(i)            Suncorp was the owner of an oil sands project in northern Alberta and wished to expand/improve its existing project;

(ii)           Suncorp entered into a (general) construction contract with Bird Construction to effect the improvements;

(iii)          Bird Construction entered into a contract with Langford (a subcontractor) to perform/assist in performing the general contractor's project improvement obligations owed to Suncorp;

(iv)         Langford entered into a contract with Valard (as a sub-subcontractor) pursuant to which Valard was required to provide certain inputs to assist/facilitate Langford in the performance of its obligations owed to Bird Construction. Valard did what it was supposed to do under its sub-subcontract with Langford, but Langford failed to pay what was due to Valard and then Lanford became insolvent and completely unable to pay what it owed to Valard. Subsequently - and this related to the core issue before the Court - Valard discovered that to protect itself, Bird Construction had obligated Langford to produce a surety corporation backed Labour and Materials Bond to Bird Construction. Valard then made a claim against the surety corporation for what was owed to it, but was legitimately turned down by the surety corporation on the basis that the bond specifically required that claims be made within 120 days and that that deadline hadn't been met.

At the lower Court level, Valard argued that it couldn't make a claim within the 120 day limit because it had no knowledge of the existence of the Labour and Materials Bond. The Court of Appeal held that, in this situation, that was simply Valard's "tough luck". Although there was some dissent, the Supreme Court disagreed and confirmed Valard's claim.

The Supreme Court held that because the parties who could make claims under the Labour and Materials Payment Bond were, in effect, beneficiaries of or under the bond, the holder thereof (here, Bird Construction) owed trustee duties to the beneficiaries.  This included an obligation to exercise at least reasonable efforts to notify the beneficiaries of the existence of the bond.  That should have included Valard.  Bird did not exercise such efforts, which might have included, at the least, posting a notice at the construction site of particulars of the bond.  Consequently, Bird was liable to Valard for its loss.

The Court's judgements acknowledged that industry practice, at least in the context of the Alberta oil sands developments, was for the holders of Labour and Material Payment Bonds to not have to communicate such bonds' existences to the bond beneficiaries.

Accordingly:

(i)            as a result of the Valard Case, it wouldn't be too surprising if bonding/surety companies increased their premiums/charges for bonds, in particular, Labour and Material Payment Bonds.  If the Valard Case results in bond holders making efforts - or greater efforts - to communicate the bonds' existences, it stands to reason that there will be more claims made.  If more claims are made, it is likely that the "price" of construction bonds will rise.

(ii)           in its recent report and review of the BL Act, The Manitoba Law Reform Commission recommended that bonding become mandatory for construction projects/contracts in excess of $500,000.00 where public works are involved.  As the Commission has stated, there are certain advantages to the use of construction bonds to ensure payment to those involved in real estate improvement which are not available when relying on the remedies available under the BL Act.

July 2017

Many businesses operate, in whole or in part, out of leased premises.  A business owner may lease fully developed and fully completed premises in an existing building with all services and amenities already in place.  At the other end of the spectrum, a business owner may lease - typically on a long term basis - vacant undeveloped land on the understanding that the business owner will improve the land with the facilities - including making arrangements with local government utility service providers - and for the services that the owner requires in order to operate its business.  In the latter situation, the business owner/tenant will usually need to have much work and materials done and brought and incorporated on to and into the site in order to be in a position to "open its doors" and commence to carry on its business.  But even the business owner who leases space in a fully developed building will usually require some renovations or design alterations to the existing premises in order to "customize" the space for the owner's particular needs and desires.  Businesses in both types of situations will also need to acquire equipment, business furnishings and the like, and ,office "supplies" will, in almost all cases, be needed.  For a business that is producing and/or selling goods (retail and/or wholesale), the owner will have to acquire, usually on an ongoing basis, inventories.

All of this costs money.  Frequently, in commercial leasing arrangements, the landlord will, as "part of the deal", pay for the cost of acquisition and/or installation of some - and sometimes virtually all - of the tenant's required improvements.  In many cases, the business owner will have to finance such acquisition and installation.  Thus banks, credit unions and other professional lenders will often be called upon to provide credit to a business tenant in order to enable it to improve the leased realty, and additionally, to financing the business's acquisition of equipment, office supplies and inventory.  It follows that the lender which provides value to the commercial tenant so as to enable it to acquire and install what it needs to carry on its business, will wish to take security in the subject matters of what it finances.  Thus, lenders will take security in the business's inventories (including the "proceeds" thereof, typically accounts receivable) and will take security interests in the business's equipment, furnishings etc.  A lender who is called upon to finance a tenant's improvements will wish to take security in:

(i)            what can perhaps be best described as the "bundle" of rights that the tenant obtains under or by virtue of the lease (or what is often called the tenant's "leasehold interest"); and

(ii)           the tenant's leasehold improvements themselves.

The efficacy of security held or acquired by a lender depends on the ease with which it can liquidate the security's subject matter so as to generate funds which can be applied on account of the secured debt.  Some leasehold improvements are more easily capable of being so liquidated than others.  Clearly, improvements that have become attached or affixed to or incorporated into the building (of which the leased premises form part), but which may be removed and taken away to be sold and used in another location, without undue cost and difficulty, are most valuable to the lender as security.  Unfortunately, it often happens that when a commercial tenant's business fails, and both the tenant's landlord and its lender wish to end their relationships with the tenant, disputes arise between the landlord and the tenant's lender as to just what, and to what degree, the lender should be entitled to remove the tenant's improvements and sell them to someone else, or, if convenient, sell those improvements to the landlord or to a new tenant that the landlord brings into the premises to replace the previous tenant.  Complicating such disputes are these two particular factors:

(a)           the fairly ancient common-law rule that when the owner of tangible property attaches, affixes, or incorporates such property into real property (land and/or buildings) belonging to someone else, the owner of the tangible personal property loses its ownership and such items become the property of the realty owner, but with the exception of what have been called "trade fixtures".  Trade fixtures are goods that a tenant brings onto and incorporates into the landlord's realty but which have a particular or a peculiar connection to the tenant or  the tenant's business operations, so that on termination of the lease, it is considered reasonable for the tenant to remove and retain the same as its own property; and

(b)           the often conflicting and confusing terms found in commercial leases dealing with what is to happen regarding tenant's improvements on termination of the lease (the provisions often varying within the same lease, depending on the cause or reason for the lease's termination).

The recent Ontario Superior Court of Justice case The Toronto-Dominion Bank and The Hockey Academy Inc. (and others), judgement given August 2, 2016, (hereinafter, the "Hockey Academy Case") illustrates the difficulties that can arise on lease termination where a tenant's landlord and its lender each claim entitlement to improvements made to the leased premises which have been financed by the lender for the tenant.

The facts in the Hockey Academy Case were that Hockey Academy entered into a lease of premises from its landlord (Champagne Centre Ltd., hereinafter the "Landlord"), and as contemplated by, and pursuant to, the terms of the lease (the "Lease"), Hockey Academy developed a commercial hockey rink facility.  The Lease was twice amended.  To finance its said facility, Hockey Academy borrowed a substantial sum from The Toronto-Dominion Bank (the "Bank"), and in consideration thereof, Hockey Academy entered into a general security agreement (the "GSA") with the Bank, pursuant to which it granted the Bank a security interest in all of Hockey Academy's present and after-acquired personal properties, including Hockey Academy's rink and related equipment facilities.  Subsequently, the Landlord terminated Hockey Academy's lease, and following default in payment of its obligations owed to the Bank, the Bank demanded repayment in full and proceeded to realize its security under the GSA.  The Bank and the Landlord then argued over which of them was entitled to the rink equipment or the realization proceeds thereof.  That dispute led to the Hockey Academy Case.

The Court neatly summarized the "essence" of the dispute as follows:

"At the heart of the main dispute is whether, on a lease termination, the debtor (Hockey Academy) retained ownership of the disputed items or whether these items became fixtures of the premises and therefore owned by the Landlord.  It is common ground that this dispute principally falls to be determined by an interpretation of the debtor's lease with the Landlord (as amended)."

In reviewing the matter, the Court took note of the following terms of the Lease;

(i)            The Lease provided that "nothing herein prevents or bars the tenant from pledging and borrowing against its leasehold improvements";

(ii)           The Lease further provided that "all alterations and additions to the premises made by or on behalf the tenant, other than the tenant's trade fixtures, shall immediately become the property of the landlord without compensation to the tenant. The Lease defined trade fixtures as items designated as such on a plan of the premises.

(iii)          The original iteration of the Lease allowed the tenant to make alterations and additions and to designate any of the same as "trade fixtures", with trade fixtures not to become the property of the Landlord. Additionally, it permitted the tenant to remove trade fixtures at the end of the Lease term, and required the tenant, upon any termination of the Lease, to remove all rink equipment and fixtures not permanently attached to the premises.  The subsequent amendments to the provided that on "expiration or (any other) early termination of the Lease", the tenant was not required to remove additions or improvements, except for "rinks, sand, boards, piping, refrigeration, and related rink equipment". It further provided that the tenant had the right to remove "other trade fixtures" and equipment not permanently attached to the premises.

(iv)         Thus under the Lease, as amended, the tenant was both required and permitted to remove its equipment. Lest anyone might wonder if the specification of a tenant's obligation to remove its equipment/trade fixtures did not also, at least by implication, give the tenant the right to remove same, the Court clearly enunciated that an obligation to remove encompasses a right to remove.

(v)          Clearly, the tenant would not be entitled to, in effect, remove the whole building, or the structural elements thereof, but as the Court observed, "…it is…entirely reasonable for the tenant to retain the ownership of the rink equipment because it was the tenant, not the Landlord, that was in the hockey rink facility business".

(vi)         Thus, since the tenant's equipment was held to be its property, and not that of the Landlord, the Bank's security interest in the same trumped the Landlord's interest therein. 

What then does the Hockey Academy Case suggest for those considering leasing realty and lenders considering advancing credit - often substantial credit - to such prospective tenants, on the security of the tenant's leasehold improvements and equipment?

The Court noted that "at the heart of the main dispute", the question was, upon lease termination, did certain tangible items remain with and form part of the realty, thus subsumed into the realty owned by the Landlord, or, did such items continue to be owned by the tenant, and thus subject to the Bank's prior ranking security interest?  The Court also stated that the dispute "principally falls to be determined by an interpretation of the debtor's lease…".

Applying the principle that when interpreting a contract, a court is to determine the intentions of the parties, in the first instance, by looking at the "plain meaning" of the words used by the parties in their contract, and, considering the above-noted contract terms, the items in dispute did not revert to the Landlord (as part of its real property ownership), but were in fact the property of the tenant removable by the tenant on lease termination.  None of the removable items were improvements which "entirely (had) to do with the building itself, such as: column and removal, structural framework, drains for washrooms, cinder block walls and provision for exterior access to the building's sprinkler system".  Rather, the removable items all had to do with the tenant's operation of the premises as a hockey rink facility business.  It should be emphasized that these conclusions were based essentially on the wording contained in the contract, but the Court also observed that it would have held the tenant's items to have been its property and not "fixtures" at common law (ie, not part of the Landlord's reversionary interest), even if the Court's decision based on the contract wording was later held to be incorrect.

Landlords, tenants and tenants' leasehold improvement financiers (and their respective counsel) should carefully review the terms of a proposed commercial lease before committing themselves to same.  It is this writer's experience that, depending upon the precedent used, most typically by a landlord or its counsel, the wording pertaining to rights and obligations relating to leasehold improvements - and in particular, those relating to the a tenant's right to remove or pledge same - will differ from lease to lease.  The particular wording proposed in each lease should be carefully reviewed and considered by each of the parties, and not merely "glossed over".