CONSTRUCTION AND INFRASTRUCTURE LAW NEWSLETTER

CONSTRUCTION AND INFRASTRUCTURE LAW NEWSLETTER December 2009 A publication of Miller Thomson LLP s Construction and Infrastructure Group Inside Demystifying Construction Risk Management and Insurance The Obligation to Provide Personal Protective Equipment What if No Appropriate PPE exists? British Columbia Court Rules on CRA Priority Over Statutory Holdback What s Happening Around Miller Thomson In This Edition You will find the first installment of a series of articles from Kathy Kendrick in our Calgary office dealing with construction risk management and insurance. This interesting series will continue with installments in the next editions of this newsletter. Bryan Buttigieg writes about a perplexing problem facing owners and their duty to provide personal protective equipment to their workers. It is not as simple as it sounds. Patrick Greco writes for our newsletter again, this time addressing a priority contest between the beneficiaries of a construction holdback pool and the court that directs traffic under court administered bankruptcy. DEMYSTIFYING CONSTRUCTION RISK MANAGEMENT AND INSURANCE Kathleen J. Kendrick CALGARY 403.298.2455 kkendrick@millerthomson.com This is Part 1 of a continuing series of Construction Communiqué articles that have been designed with our existing and prospective construction clients in mind. These articles will provide our readers with a basic understanding of risk allocation and insurance policy principles most relevant to the construction industry. The goal of this series is to provide a basic outline of risk management fundamentals to assist readers in better managing risk on their next project. Introduction Everyone in the industry recognizes the inherent risks in the construction business. It is an open-air manufacturing facility producing a one-off product, subject not only to the vagaries of the weather, but potential labour shortages, disputes, material shortages and accidents. When something goes seriously wrong on a construction project, the respective parties inevitably turn to the construction, design, consultant, subcontractor, supplier and vendor contracts - and the various insurance policies - searching for the answer to the question who is going to pay for this? Unfortunately, the ensuing claim and dispute resolution process often reveals insufficient attention to risk management and insurance. From inadequate limits, to gaps in coverage, to a failure to delineate responsibility for payment of deductibles, experience teaches that time of loss is a bad time to discover that the various parties did not understand their responsibility to control, mitigate, and finance risk, or that the insurance coverage provided does not respond the way everyone thought it would. Contrary to traditional wisdom, the reality is that parties who rely simply on contractual indemnification and insurance requirements are trusting that others will effectively manage and finance risk often with devastating results. The parties to design and construction contracts will typically endeavour to shift responsibility for managing risk to others, who will in turn seek to protect themselves by limiting their own liability to a fixed amount such as their fee or the amount of available insurance. Through indemnification

provisions, funded in part by required insurance, the owner will assign responsibility to their designer and contractor who in turn will assign responsibility to the subconsultants and subcontractors, and on down the contractual chain until final responsibility often rests with the party least capable of managing the risk. Because insurance provisions and coverage are often affected or even triggered by language contained in the design and construction contracts themselves, understanding the interplay between these documents is critical to implementing an effective insurance program. Take the case of a design-build contract. It is accepted that where supply of equipment or materials is concerned, the party responsible for selection (the design-build contractor) is to some extent covered through that selection by a manufacturer s warranty or by the insurance cover of that manufacturer. However, where equipment or materials are designed (as opposed to selected off the shelf ), the designer does not provide such warranty (being required to only exercise due skill and care in design) and the professional liability insurer of the designer does not extend coverage to fitness for purpose. Where equipment or materials have been designed, therefore, construction contractors are exposed to liability for which they have no indemnity from the designer or from the insurer of the designer. Awareness by the construction contractor of this unfunded risk is critical because designers frequently do not have assets enough to satisfy claims arising from work that fails to meet the due skill and care standard imposed on contractors. Generally and to the extent possible, risks in construction should be specifically allocated between the parties to the construction contract. Construction risks may also be shifted to a third party such as an insurer - but that choice should be specified in the contract and based on proper principles relevant to the transaction. Very occasionally, insuring a construction project is almost as simple as buying a builder s risk policy and adding the owner and the owner s consultant as additional insureds to the commercial general liability (CGL) policy of the contractor. However, even in an extremely straightforward project unburdened by complex contractual considerations, this simplistic approach exposes the contracting parties to unnecessary risk for unidentified and uninsured risks. The choice of which insurance coverage should be purchased and by whom ought to occur at the final stage of the risk analysis process. The first step should always be an analysis of the project risks. For example, What is being built? (industrial, commercial, residential)? Who is building it? (public or private sector)? Where is it being built? Why is it being built? Are there facility interconnection risks? Are there off-premises and transit exposures? Is there machinery breakdown risk? What are the consequences of delay in completion of the project? Are aircraft or watercraft to be used? Is there blasting exposure? Will there be any demolition of existing structures? Is there any environmental impairment risk? Is there any public relations risks? Will an accident expose the property of others or even passers-by to unusual risk? Risks should be allocated at the outset of the project as part of the contractual agreement between the parties involved when amicable relationships exist. It is too late to try and make that allocation after the event when the responsibility and liabilities become the focal point and disputes arise. Construction is a Risky Business Based on statistics gathered in the past three decades on topics such as disputes in the construction industry, arbitration, accidents at work and exposure to natural hazards around the world, it is clear that construction projects are sensitive to an extremely large matrix of hazards (and thus to risks). This sensitivity is due to inherent nature of construction projects where: (1) the time required to plan, investigate, design, construct and complete a construction project can span extended periods of time; (2) the number of people required to initiate, visualize, plan, finance, design, supply materials and plant, construct, administer, supervise, commission and repair any defects in a construction project is enormous; (3) the location of projects in isolated regions of difficult terrain, sometimes stretching over 2

extensive areas and exposed to naturals hazards or unpredictable intensity, frequency and return period can result in uncontrollable risks; (4) the materials selected for use in projects may include a number of new products of unproved performance or strength that may result in injury, defects and delay; (5) the technology required for projects may be technically complex and unpredictable and result in injury, defects and delay; and (6) the multitude of firms involved in construction, including those engaged as designers, contractors, subcontractors, suppliers and manufacturers, can result in any number of conflicting requirements, commitments and goals. It is therefore extremely relevant for the construction industry, and those involved in it, to understand the concept of risk and to know how to properly manage the risk matrix generated when a construction project is initiated. Unique Nature of Construction Process The unique risks faced by the construction industry are illustrated by comparing and contrasting the process of construction with other manufacturing industries. In contrast to other manufacturing industries that fabricate large numbers of units such as automobiles or television sets, the construction industry is generally focused on a single end product. The product of the construction industry is a facility that is usually unique in design and method of fabrication. It is a single one-off item that is stylized in terms of its function, appearance, and location. Manufacturers offer their products for sale either directly to individuals, to wholesalers or to retailers who sell directly to the public. The product is produced on speculation that a purchaser will be found for the item produced. In order to attract possible buyers, advertising is required and is an important cost centre. The manufacturer is at risk of failing to recover money invested to produce the items. The market may not respond to the product at the price offered. Units may remain unsold or sold below the cost of production, yielding no profit. In construction, projects are sold typically to the client in a different way. The process of purchase begins with a client who has need for a building or facility. The purchaser typically approaches a design professional to more specifically define the nature of the project. This leads to a conceptual definition of the scope of work required to build the desired building or facility. It is important to remember that prior to the age of mass production, purchasers typically presented plans of the end object (i.e. a piece of furniture) to a craftsman for manufacture. The craftsman then proceeded to produce the desired object. For example, if King Louis XIV desired a desk at which he could work, an artisan would design the object, and a craftsman would then be selected to complete the construction of the desk. In this situation, the purchaser (King Louis XIV) contracted with a specialist to construct the unique object. The end item was not available for inspection until it was fabricated. Due to the unique one of a kind nature of constructed facilities, this is still the method used for building construction projects. The purchaser approaches a set of potential designers and construction contractors (or design-build contractors). Once agreement is reached among the parties (i.e. owner, designers, etc.) as to the scope of work to be performed, the details of the project or end item are designed and constructed. The facility is purchased on the basis of graphic and verbal descriptions of the end item, rather than on the completed item itself. This is the opposite of the speculative process where design and mass manufacture are complete before a purchaser is identified. In construction, manufacture of the facility is not commenced until a purchaser is identified. The fundamental nature of project risk is greatly influenced by the process of purchasing ( sight unseen ) a complex, highly technical item that involves many stakeholders (i.e. owners, designers, constructors, suppliers, government authorities, etc.) to complete an exercise that inevitably results in any number of complex issues which can lead to failure to complete the project in a functional and timely manner. Risk Allocation Fundamentals Risk management is defined as the process by whereby decisions are made to accept a known or assessed risk and/or the implementation of actions to reduce the consequences or probability of occurrence (British Standard 4778, 1991). 3

If a decision is made to accept a risk, a further decision must be made on whether or not the risk should be shared between the contracting parties. Before such decisions can be made, it is necessary to go through a systematic process which involves analysis of the possible events to which the project may be exposed and the evaluation of their intensity, frequency and return period. Ultimately, the rules for allocating risks in construction may simply revolve around the ability of a contracting party to: (a) (b) (c) (d) control any arrangements which might be required to deal with the hazard or any triggering incident relating to it; control the risk or to influence any of its resultant effects; perform a task relating to the project, such as, obtaining and maintaining insurance cover; or benefit from the project. However, (a) through (d) do not represent the only model and in fact, the rules for allocating construction risk in a given situation may well revolve around an already established policy in a large organization or a governmental agency. See for example I.N. Duncan Wallace in his paper Price Under Common Law System: while an event may be foreseen owners may see advantages in a contract that requires the contractor to assume that risk, and to include for the cost of dealing with that situation in his tendered contract price. Where the risk is uncertain, this logically requires that a contingent element will have to be included in the original price. If the contingent risk does not materialize, the owner will have agreed to an unnecessarily high price but may regard that as preferable than a lower price that may be subject to a post-contract award upward adjustment at a late stage of the project should the risk materialize. Whether or not a particular risk should be included in the price is in essence a question of policy and not of fairness, morality, or justice. In the US, risk allocation is informed by a desire to preserve a large pool of competent contractors and obtain low contract bids. The old model of risk shifting where owners would endeavour to shift all project risk to the construction contractor has been replaced (in some cases, by statutory means) with a more reasoned risk sharing model where owners do absorb particular risks and seek to assure that contractors will be treated fairly. Next Issue: Risk Allocation Fundamentals (con t), Construction Risk Categories and Allocation of Unidentified Risks. THE OBLIGATION TO PROVIDE PERSONAL PROTECTIVE EQUIPMENT WHAT IF NO APPROPRIATE PPE EXISTS? Bryan J. Buttigieg TORONTO 416.595.8172 bbuttigieg@millerthomson.com A recent decision of the Ontario Court of Justice adds an interesting clarification to the duties of an employer to provide Personal Protective Equipment. In many cases, the legislation and the regulations do not specify precisely what PPE must be provided, instead the legislation will contain a general obligation that appropriate PPE be provided. In the event that a prosecution arises under such a section, evidence is typically presented to the court as to what appropriate PPE should have been under the circumstances. Often, factors such as the standard used by the relevant industry will be considered, at least as long as the industry standard itself is not found by the court to be deficient. But what if there is no evidence that appropriate PPE even exists? This was the basic question faced by the court following a serious burn injury suffered by a worker who was exposed to steam under 4

pressure while wearing a fireproof Nomex suit. The clothing, while protective against burn injuries caused by flames, was not able to prevent injury to the worker from exposure to steam. Evidence was led at trial by the defendant to the effect that steam plants across the province did not provide workers with PPE that could prevent workers from injury from steam. By the end of the trial, the court had no evidence that any such equipment even existed. Of course the fact that no one used such equipment, would not be an adequate excuse if the entire industry was acting in a negligent manner. But that point would require evidence that the industry was ignoring some viable alternative to its current practice. There was no such evidence in this case. The Crown even tried to argue that there was some obligation on the company to develop appropriate PPE where none existed. The Court, in its reasons stated the following: [The defendant] cannot be convicted under the second count of failing to provide personal protective equipment under the circumstances where there is no proof beyond a reasonable doubt that such equipment existed or that it was reasonable to provide it. Without such evidence, the Crown has not established that compliance with the offence as alleged is even possible. As set out in R. v. 605884 Saskatchewan Ltd.29: It would be repugnant to the rule of law to convict in a situation where the accused could not have complied with the law. It is of course not for [the defendant] to prove beyond a reasonable doubt that no such PPE exists. It is sufficient for [the defendant] to raise a reasonable doubt. In fact, more than a reasonable doubt has been established on the evidence as there has been a complete failure by the Crown to prove the existence of appropriate personal protective equipment or that it is reasonable for an employer to have such personal protective equipment available under the circumstance. This is not a case where there is an industry standard which is itself deficient. There is no doubt that if appropriate PPE exists and it is reasonable that it be worn, then the fact an industry does not use it will not be sufficient. I find that [the defendant] acted reasonably in providing the appropriate personal protective equipment that it did, so long as it ensured workers would not be exposed to the hazard. It would not be reasonable to expect that for [the defendant] to act reasonably, it had any obligation to develop additional PPE when there is no evidence that such PPE can even in theory be developed. I agree with the defence that the plain meaning of the word provide in the context used in the particulars to this offence does not include the concept of developing or inventing, and presupposes that such appropriate PPE in fact exists. The case is a useful reminder to employers that while it is important to always consider what appropriate PPE needs to be worn at the workplace, there may well be instances where no such PPE in fact exists. While as the above case illustrates, one can not be convicted for failing to provide something that does not exist, this will not absolve the employer from the general obligation to take every precaution reasonable to protect the worker still applies. The risk of an explosion for instance, not an uncommon risk at a construction site, could well be one such risk. In such cases, employers must be very cautious about exposing workers to the hazard of an injury. Great care will need to be taken to ensure that the risk of exposure is kept to a minimum. The standard of care required to demonstrate due diligence when no appropriate PPE is being provided will be very high. BRITISH COLUMBIA COURT RULES ON CRA PRIORITY OVER STATUTORY HOLDBACK Patrick Greco TORONTO 416.595.2982 pgreco@millerthomson.com In PCL Constructors Westcoast Inc. v. Norex Civil Contractors Inc., [2009] B.C.J. No. 142, the British 5

Columbia Supreme Court dealt with three separate applications made by subcontractors against general contractors for the payment of statutory holdback funds under the British Columbia Builders Lien Act ( BLA ). Background As part of the proceedings, the Canada Revenue Agency ( CRA ) (who were also owed money by the subcontractors for the failure to remit funds, including payroll deductions) claimed that they were they were entitled to a priority over the 10% statutory holdback funds on the grounds that the subcontractors were tax debtors. In particular, CRA claimed that they were entitled to any money owed to the subcontractors under section 224(1.2) of the Income Tax Act ( ITA ), which gives CRA a right to garnish any money owed to a tax debtor by serving a third party with a Requirement to Pay ( RTP ). CRA also claimed that section 317(3) of the Excise Tax Act ( ETA ) entitled CRA to a beneficial interest in the money owed to one of the subcontractor s due to the subcontractor s GST debt. Finally, CRA claimed that sections 227(4) and (4.1) of the ITA created a deemed trust in favour of CRA in certain instances. The contractors took the position that they did not owe money to the subcontractors by virtue of their rights of setoff pertaining to matters such as additional costs to complete a subcontractor s scope of work. The contractors position was that CRA could not claim an interest to the holdback funds since no holdback money was actually owed to the subcontractors after claimed setoffs were applied. According to the contractors, there could not be a deemed trust in favour of CRA for the holdback money, because the subcontractors never had a right to the holdback money, that is, it never became the subcontractors property against which CRA could realize. Basic Principles The Honourable Madam Justice Arnold-Bailey based her decision on the basic proposition that a subcontractor s entitlement to holdback funds does not arise unless money is actually owed under the contract. The holdback fund, held in trust for the benefit of subcontractors is not the property of a subcontractor, as it is not an ordinary trust in which the beneficiary has an unrestricted interest. Rather a holdback fund creates a trust in which the subcontractor may become entitled to money if it is not totally consumed by setoff. Therefore, while CRA has a priority over the property of a tax debtor, in this case a subcontractor, CRA s interest in the holdback fund cannot be greater than that of the subcontractor, who merely has a potential interest in the fund (subject to the application of setoff). In discussing setoff, the court found that it is not a mere defence, but rather that setoff arises as work is done under the contract such that, conceptually at least, the net amount due under the contract at any given moment is subject to setoff. The court found that these principles applied similarly in both the trust and garnishment (RTP) contexts. The Court held that the CRA has a priority over funds owed to subcontractors under the BLA and ETA. However, this priority is subject to the contractor s right of setoff. Therefore, if the setoff amount is higher than the statutory holdback, the CRA is not entitled to any money. Rights of Sub-subcontractors The three applications dealt with by the court also included certain lien claims by sub-subcontractors, who wished to assert their lien claims both directly against subcontractors, but also against the holdback fund retained by the general contractor. The court found that for a direct claim against a subcontractor, CRA held a statutory priority over a lien claimant with regard to any monies coming into the subcontractor s hands, as this was property to which the subcontractor was entitled. This priority would also apply vis-à-vis the general contractor s holdback payment obligations to the sub-subcontractor if the general did not assert a right of setoff. However, in finely-worded language, the court appeared to come to the conclusion that where a general contractor successfully asserts a setoff against the holdback monies, these monies are free of any CRA priority, as they were never owing to the subcontractor. However, as these monies are still technically holdback under the BLA, the general contractor would have to fulfill its payment obligations to sub-subcontractors before it could keep the balance. It is for this reason that the positions of the general contractors and sub-subcontractors in the applications were completely aligned. 6

Practical Considerations Ultimately the Court did not decide whether the general contractors had rights to setoff amounts higher than the holdbacks retained, as the final disposition of this question required an assessment as to the setoff amount to which the contractors were entitled. The Court held that in such cases where CRA wishes to access the holdback funds, it must actually bring a claim on behalf of the subcontractors in order to determine this issue. According to the court, These consequences are the inevitable result of the collision of two legislative schemes designed by two levels of government, neither mindful of the other. Upon being served with an RTP by CRA, an owner or general contractor, or anyone retaining a statutory holdback fund, should not make payment to CRA out of the fund until it has taken the opportunity to evaluate whether it may have grounds to assert a setoff against the holdback. Likewise, a party two payment levels below a statutory holdback fund should take a close look at whether its ability to collect on a lien claim can be exercised as against holdback monies retained by an owner or general contractor by operation of a successful setoff. It remains to be seen how this decision will be treated by the Ontario courts on similar questions in the context of the Ontario Construction Lien Act, as well as in other jurisdictions. WHAT S HAPPENING AROUND MILLER THOMSON Our firm is pleased to welcome our newest colleague to the national Construction and Infrastructure Group: Alisha Hurley, Associate, Edmonton Alisha maintains a broad litigation practice focussed mainly on commercial litigation. She has appeared before all levels of court in Alberta. In addition to her law degree, Alisha has a Masters degree in Business Administration. She is based in our Edmonton office. And Off the Presses The Fourth Edition of Bidding and Tendering: What Is The Law? was released by LexisNexis in August. This book was co-authored by Paul Sandori and Bill Pigott. Owen Pawson and So Yin Woo wrote an article for the Canadian Consulting Engineers Magazine on the Susan Heyes/Canada Line case. Charles Bois also wrote an article for the Canadian Consulting Engineers Magazine on the security for costs for removal of liens under the BC Lien Act. Recent Seminars and Speaking Engagements Drazen Bulat gave the following seminars/lectures: September 18, 2009 seminar/lecture on the law of contracts to the Association of Architectural Technologists of Ontario as part of their accreditation course. September 29, 2009 presented at the Canadian Institute s 2nd Annual Conference on Managing Risk on Minimizing Risks at the Pre-Tender Stage. October 7, 2009 seminar/lecture on the law of tendering to the Toronto Construction Association. October 14, 2009 seminar/lecture on bonds and insurance to the Toronto Construction Association. Bill Pigott spoke at a Canadian Institute Seminar on September 29th, 2009 with respect to the important distinction between a true RFP and a bid. And, when each is appropriate. On November 2, Bill Pigott delivered a lecture on project execution strategies at the University of Toronto, Faculty of Architecture Landscape and Design. 7

On August 20, 2009, the Calgary office gave a seminar on Arbitration under the Alberta New Home Warranty Program: How to Prepare for Success. Philip Carson and Kent Jesse were speakers. Scott Hammel presented at the Canadian Institute Construction Contract Conference and he also presented at the Construction Superconference (Calgary/Edmonton). Upcoming Events of Potential Interest In Ontario at least, controversy around public procurement has provided continuous background noise through the summer and fall. Public owners throughout Ontario and those who read Ontario newspapers outside the province are rightly concerned about the legal and reputational damage that can attach to a procurement gone wrong. In response to this uneasy situation, the Health Industry Practice of Miller Thomson LLP will convene four procurement workshops in mid January of 2010, one in each of Toronto, London, Sudbury and Ottawa. These sessions are geared for owners in the healthcare field. For those who might be interested in attending one of the workshops, complete details are available on the Miller Thomson website (http://www.millerthomson.com) or, e-mail a request for information to our seminar e-mail address at healthgroup@millerthomson.com. Anyone who watches procurement closely knows that the Tercon case is under reserve at the Supreme Court of Canada. While no one knows when a decision will be rendered, we are ready to bring you the outcome of this pivotal case on whether an owner can successfully negate its Contract A obligations by writing an exclusion of liability clause into its bid documents. For more information on these or other events taking place at Miller Thomson, please visit our website or contact one of the lawyers listed on the last page of this newsletter. Keeping You Informed Miller Thomson is dedicated to providing timely updates to our clients on a wide range of legal developments. We have more than 20 national industry and specialty groups in various areas of the law, and our lawyers provide advice to their clients in over 30 areas of practice. You can subscribe to one or more of our complimentary newsletters at the "Publications" section of our website at www.millerthomson.com (under Subscriptions). Once you complete the subscription form with your choice of newsletters, we will forward electronic legal updates on those topics to you on a regular basis. 8

MILLER THOMSON LLP CONSTRUCTION AND INFRASTRUCTURE GROUP Our Construction and Infrastructure Law Group is comprised of approximately 80 lawyers across the country. Our key contacts in Miller Thomson's offices are listed below. These individuals are able to assist you with any questions that you may have, or will refer you to the appropriate lawyers within our national group, depending upon the nature or scope of your inquiry. Toronto / Markham Drazen F. Bulat 416.595.8613 William M. Pigott 416.595.8179 Vancouver Charles W. Bois 604.643.1224 Owen D. Pawson 604.643.1254 Calgary Philip A. Carson, Ph.D. 403.298.2403 Kathleen J. Kendrick 403.298.2455 Edmonton Scott J. Hammel 780.429.9726 Darin J. Hannaford 780.429.9714 William J. Kenny, Q.C. 780.429.9784 London Aaron E. Atcheson 519.931.3526 Kitchener-Waterloo F. Stephen Finch, Q.C. 519.593.3210 Guelph Steven W. Pettipiere 519.780.4624 Montréal Normand D'Amour 514.871.5487 Louis-Michel Tremblay 514.871.5421 Note: Miller Thomson LLP s Construction and Infrastructure Law newsletter is provided as an information service to clients and is a summary of current legal issues of concern to business persons and their advisors. These articles are not meant as legal opinions and readers are cautioned not to act on the information provided without seeking specific legal advice with respect to their unique circumstances. Miller Thomson LLP uses your contact information to send you information on legal topics that may be of interest to you. It does not share your personal information outside the firm, except with subcontractors who have agreed to abide by its privacy policy and other rules. Miller Thomson LLP, 2009 All Rights Reserved. All Intellectual Property Rights including copyright in this publication are owned by Miller Thomson LLP. This publication may be reproduced and distributed in its entirety provided no alterations are made to the form or content. Any other form of reproduction or distribution requires the prior written consent of Miller Thomson LLP which may be requested from the editor at newsletters@millerthomson.com www.millerthomson.com