Distributing Proceeds to Lien Claimants
What policies do the distribution provisions of the Act advance?
| Commentary: funds may become available for distribution among lien claimants from two different sources. The first is money that is paid into court under section 23. The second is the proceeds of a sale of the improvement. The distribution of these funds to lien claimants is regulated by sections 36, 37 and 38 of the Act.
On their face, these provisions seem complex but they do have an underlying logic. Once that logic is appreciated and understood, their application becomes much simpler.
Pro rata Sharing
The most basic principle reflected in these provisions is to carry through the implications of the multiple holdback scheme into the distribution phase and, in particular, to make sure the limited recovery principle embodied in section 34 is fully realized.
Priority for enforcement costs and wages
A second principle reflected in these provisions is that for reasons of public policy, certain priorities should be reflected in the distribution scheme. In particular, priority is given to
Can you provide a brief overview of the distribution process?
Overview of distribution
| Commentary: mapping out a distribution under the Act requires three steps. The first step is to take the proceeds of a sale of the improvement (if any) remaining after paying secured creditors and divide those proceeds into two portions. The first portion is allocated to the claims of those claimants, such as subcontractors, who are not engaged directly by the owner (“subcontractor group”.) This allocation is made according to a formula set out in the Act. Any of the proceeds of the sale remaining after the appropriate amount has been allocated to the “subcontractor group” is allocated to the claims of persons who were directly engaged by the owner (“contractor group.”)
[See section 36]
Distribution to the contractor group
The amount of the proceeds of the sale (if any) allocated for distribution among the members of the “contractor group” are distributed in accordance with section 38. It provides, subject to the priority given with respect to costs and six weeks of workers’ wages, for a pro rata distribution among the members of the contractor group. Any funds remaining after distribution to the contractor group are payable to the owner.
Distribution to the subcontractor group
The amount of the proceeds of the sale of the improvement allocated to the subcontractor group are combined with any money previously paid into court under section 23 and these funds are distributed according to the terms of section 37. Again, costs and six weeks of workers’ wages have a first claim on those funds. The balance remaining is available for distribution toward the satisfaction of the other lien claims.
This distribution requires that the funds be pro ratedpro rated.
This is intended to be an overview only. The distribution provisions, with illustrations, are reviewed with greater rigour below.
Note that the expressions “contractor group” and “subcontractor group” are not used or defined in the Act. They are used here merely as a convenient way of referring to these two bodies of claimants.
How are the proceeds of a sale of the improvement allocated between the contractor group and the subcontractor group?
Allocation of sale of proceeds
|Commentary: the first step in this allocation is to calculate the value of what the Act refers to as the “owner’s discharge sum.” This is the amount which, if paid into court by the owner under section 23, would be sufficient to discharge the owner from liability with respect to all claims of lien filed by the subcontractor group. Depending on the state of accounts between the owner and the members of the contractor group and the value of the lien claims filed by the members of the subcontractor group, the owner’s discharge sum may be greater or less than the required holdback.
The next stage is to inquire whether any amount has previously been paid into court by or on behalf of the owner under section 23. The value of the owner’s discharge sum, less any amount paid into court, is then compared with the value of the proceeds from the sale of the improvement, less any amounts payable to secured creditors. The lesser of those two figures is the amount to be applied to the claims of the subcontractor group.
Where the proceeds of the sale, less any amounts payable to secured creditors, was the greater of the two values, then the funds remaining, after deducting the amount allocated to the subcontractor group, is allocated to the contractor group for distribution under section 38.
[See section 36]
How are funds distributed among the members of the contractor group?
Distribution to contractor group
|Commentary: the contractor group refers to all the persons engaged directly by the owner which may include contractors, architects, engineers, material suppliers and workers. Section 38(1) provides that the funds allocated to the contractor group be distributed according to the following priorities:
How is a distribution among the subcontractor group carried out?
Distribution to subcontractor group
|Commentary: distribution to the subcontractor group is governed by section 37. The money to be distributed is what the section refers to as the “available holdback fund.” This consists of the portion of the proceeds of sale allocated to the subcontractor group under section 36, money paid into court under section 23 on or behalf of the owner (which was used in calculating the amount allocated under section 36) and money paid into court under section 23 by persons other than the owner.
Not all these funding sources will come into play in every distribution. In some cases, all the lien claimants may have been engaged by one subcontractor, and their liens cleared by payment into court by the head contractor under section 23. In other cases, various liens may have been discharged through a payment into court by the owner with no sale of the improvement being necessary. Only rarely will all three sources be involved.
The basic distribution rule is set out in Section 37(2)
It will be observed that section 38 in creating three categories of claims and establishing priority among them. Top priority is given to claims in relation to costs and six weeks of worker wages. Within those two categories of claims, the rule is a simple pro rata distribution where there are insufficient funds to satisfy all claims. The basis of calculating the pro rata is the amount of the lien claims of the individual claimants.
The distribution of funds to the third category of claim, money owed to subcontractors and to workers (in excess of six weeks’ wages), requires special treatment.
Here, simply pro rating the claims will not operate fairly. The unfairness would arise when there are two different insolvencies within the pyramid and lien claims arising under both insolvencies must be satisfied.
[Figure 21 illustrates the unfair results of a simple pro rata distribution among the lien claimants]
The approach taken in section 38 is to pro rate the available holdback fund in two stages. The first stage involves pro rating the available holdback fund among classes of lien claimants.
“Class of lien claimants” is a defined term meaning all lien claimants engaged by the same person in connection with an improvement. It must not be confused with a “category of lien claimants” which refers to the grouping of lien claimants in each of paragraphs (a) to (c) of section 37 calls the “priority computation base” of the class. This is defined as follows:
Each class of lien claimant is entitled to a proportion of the available holdback fund equal to the ratio of the priority computation base of that class to the total of the priority computation bases of all classes.
[See section 37(4)]
Once particular portions of the available holdback funds are allocated to the various classes of lien claimant, they must then be distributed to the individual members of the class. This is the second stage at which the pro rating takes place. This time, it is with reference to the size of the individual lien claims.
[See section 37(5)]
Does the distribution mechanism just described fully define the rights and entitlements of all parties?
Residual operation of trust
|Commentary: not quite. Money distributed under section 37 and 38 remain subject to the trust provisions of the Act.
The residual operation of the trust provisions will mainly assist unpaid creditors within the pyramid who for one reason or another failed to file lien claims within the time set out. Where a payment is made under section 37 or 38 to the person who engaged that unpaid claimant, the payment is subject to the trust and cannot be used by the person to whom it has been paid for personal purposes unless the debt below has been satisfied. Where the person receiving the payment does not use it to satisfy the debt below, the creditor may take steps to enforce the trust.
What if the person entitled to enforce the trust chooses not to do so?
Application of section 10(3)
|Commentary: where a distribution under section 37 results in a trust as described in paragraph 14.6, the beneficiary of that trust will not necessarily choose to enforce it. The beneficiary may be indebted to a person one step down in the pyramid and the result of enforcing a trust would simply be that the payment would “flow through” to the person lower down. Where enforcing the trust would not result in any personal advantage to the beneficiary, the trust may go unenforced, to the detriment of creditors lower in the pyramid who have not been fully paid.
Section 10(3) gives the unpaid creditor a remedy in this situation. It provides that where the liens of a class of lien claimants are discharged by the payment of an amount that is less than the amount owing to the person who engaged the class, the members of the class are subrogated to trust rights of the person who engaged them. In other words, the unpaid creditors will stand in the shoes of the person who engaged them for the purposes of recovering trust money owing to that person.