Certificates of Payment

Are certificates of payment authorized by a consultant for a construction project binding on the owner? What prevents the owner from raising any set-off or other cross-claims — say for delay or deficiencies — and not immediately paying the contractor the amount certified? The question was settled in England in 1973 in the landmark decision of Modern Engineering (Bristol) Ltd. v. Gilbert-Ash (Northern) Ltd. There has been, however, very little litigation on the point here at home.

A recent British Columbia decision suggests that the courts will likely follow English authority and require explicit wording in the contract before any certification provision in a construction contract or sub-contract will prevent the owner from asserting a set-off or other cross-claim against sums certified for payment.

In Swagger Construction Ltd. v. The University of British Columbia, a case heard in the B.C. Supreme Court last year, the parties entered into a standard form of the Canadian Construction Documents Committee’s “stipulated price” contract known as CCDC-2 1994, modified with supplementary general conditions.

The project, the Forest Sciences Centre located at the university campus was a substantial one. Work commenced on February 20, 1996 with substantial completion certified by the “contract consultant” on September 8, 1998. The contractor, Swagger Construction Ltd., had been paid, by virtue of the first 32 certificates of progress payment, in excess of $40 million. At the conclusion of the job and after the assessment of a deficiency holdback of $406,000, the contract consultant certified that $675,000 was due.

The owner, however, claimed that it had incurred damages for delay and deficiency correction that exceeded $4 million. The owner refused to pay on the certificate.

When the contractor applied for summary judgment, the issue before the court was essentially this: if there are claims for delay and deficiencies from the owner, does payment on a certificate have to await determination of those claims? In other words, is an owner entitled to set off his cross-claims against the amount certified as due and owing by the contract consultant? The question is significant because an affirmative answer could allow an owner to postpone payment of certified sums to a contractor by claiming set-off for poor workmanship or delay, arguably at any stage of a construction project. Where the flow of funds is critical to the timely execution of the contract work, a set-off claim early on in the project could have significant adverse implications on the construction schedule.

At the summary trial, the contractor argued that the contract was a complete code governing the relationship of the parties to the contract. To that end, it noted that Article A-5 states that the owner “shall make payments when due in the amount certified.” The contractor encouraged the court to view the clause as a mandatory provision which could only be departed from where the contract made expressed allowances for set-off. It noted that the subject contract provided four specific instances where set-off was permitted, none of which included a right of set-off for delay and poor workmanship. Finally, the contractor argued that the right of set-off should be limited to the deficiency holdback as fixed by the contract consultant.

The contractor was encouraged by an earlier 1996 British Columbia court decision in Metro-Can Construction (HS) v. Noel Developments et al wherein the court concluded that the building contract amounted to an agreement to exclude set-off, and indeed that “the entire scheme of the contract militates against such a right.” On appeal, the court stated that “fairness is at the root of the right to deduct a cross-claim” and that determination of what is fair will come from an analysis of the reasonable expectations of the parties. The appeal court declined to interfere with the chambers judge’s conclusion, that is, that the mutual expectations of the parties were that the certified amount would be paid without dispute. The appeal court went so far as to say that “this conclusion makes sense in the construction arena generally, because the inability to dispute payment based on the certificate is fundamental to the scheme of the Construction Contract.”

The court in Swagger was not swayed by the contractor’s submissions nor did it feel bound by the Court of Appeal decision in Metro-Can. Rather, the court concluded that the owner was entitled to set off against the payment certificate the owner’s claim for damages for “breach of contract on the part of the contractor, which include delay, deficiency and completion work.”

In reaching its decision the court proceeded on the premise that the right of set-off has long been the law in Canada. It noted however, that there is nothing preventing the parties from extinguishing, curtailing or enlarging the ordinary rights of set-off, provided the parties do so expressly or by clear implication. The court found that the “requirement to pay” provision was not mandatory, and as there was no expressed language in the contract prohibiting set-off, the common law right of set-off remained available.

Regarding the contractor’s argument that the right of set-off was fixed or limited to the deficiency holdback, the court was not moved. It noted that there was nothing in the General or Supplementary Conditions expressly restricting the right of set-off, and therefore the owner’s substantive rights continued.

Open to abuse

The Swagger decision underscores the importance of having a reasoned and balanced contract using clear and unequivocal language. In the writer’s opinion, the decision opens the door for abuse by owners who need simply assert a claim for poor workmanship or delay to frustrate payment under the contract and thereby gain leverage in disputes with contractors. Owners will no doubt take a different view of the decision, noting that a contractor’s right of payment should not be absolute, especially where there are legitimate cross-claims.

Until standard form contracts are amended to address the concerns raised herein, consultants, when drafting contracts should consider the inclusion of a supplementary condition specifically addressing when and under what circumstances owners are permitted set-off against certificates of payment. For example, Article A-5 to CCDC 2 1994 could be amended by striking out the phrase “Subject to the Contract Documents…” in favour of the words “Unless exercising a right of set-off which is expressly permitted in the Contract Documents…”

Timothy A.M. Peters is a lawyer with the firm of Jenkins Marzban Logan of Vancouver. He is the chair of the B.C. Canadian Bar Association, Construction Section.