Builders Lien Issues for Oil and Gas. Collin Hirschfeld McKercher LLP

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1 Builders Lien Issues for Oil and Gas Collin Hirschfeld McKercher LLP Oil and Gas Update June 3, 2014 Regina Saskatoon June 5, 2014

2 Resource Bulletin BUILDERS LIEN ISSUES FOR OIL AND GAS Oil and Gas Update for Law Society of Saskatchewan Written by: Collin Hirschfeld June 3, 2014 Regina June 5, 2014 Saskatoon McKERCHER LLP BARRISTERS & SOLICITORS SASKATOON 374 Third Avenue South Saskatoon, SK S7K 1M5 (306) F (306) mckercher.ca REGINA Hamilton Street Regina, SK S4P 4B4 (306) F (306)

3 Table of Contents I. Where does the lien right come from 01 II. Where the lien arises 02 III. What does the lien attach to 02 A. All Estates and Interests 03 B. Attaching the oil and gas 03 C. Fixtures, machinery, tools and appliances 03 IV. Registration of liens on oil and gas 03 A. Search 04 B. Claim of Lien 04 C. Automatic Discharge 04 V. Other provisions of the act 04 A. The Trust Provisions 05 B. The Lien Provisions 06 C. The Holdback Provisions 06 VI. Practical Considerations 07 A. Direct Payment 07 B. Substantial Completion Payment Certified Contracts/Subcontracts Non-payment Certified Contracts/Subcontracts 08 C. Two Holdbacks? 09 D. Late Registered Liens 09 E. General Liens 09 F. Things to do/consider before release of funds 09 VII. Conclusion 10

4 BUILDERS LIEN ISSUES FOR OIL AND GAS Oil and Gas Update Written by: Collin Hirschfeld The Builders Lien Act, S.S , c. B-7.1 (the Act ) is one of those pieces of legislation that you see often enough but that in practice may not always be understood that well. This is not for a lack of trying on the part of practitioners, but rather, to some degree, has to do with the unique nature of the legislation and the various remedies and provisions under the Act. This is even more so with respect to oil and gas work. There is a relative dearth of Saskatchewan case law in the area. The writer is unsure as to the real reason for this, particularly given the significance of the oil and gas industry to the province. One word of caution about the Act that applies beyond the oil and gas context--one must pay careful attention to the specific definitions in the legislation as it can impact what rights your client may or may not have. For example contract and subcontract are specifically defined terms and various timelines and requirements under the Act turn on which of those two you are talking about. I. Where Does the Lien Right Come From? The Act does not speak to builders liens in a direct way with respect to oil and gas. Rather, oil and gas are only mentioned specifically in two subsections of the Act, namely subsection 22(2) (paragraphs (e) and (f)) and subsection 51(1). Subsection 22(2) extends lien protection to services and materials that are preparatory to, in connection with or for an abandonment operation in connection with the recovery of a mineral. Subsection 51(1) talks about where to register the lien if you are intending on attaching to petroleum or natural gas rights Mineral is not defined in the Act and most people s first thoughts would turn to typical minerals like potash or uranium--in other words something in a rock-like form. One has to look closely at paragraphs (e) and (f) of subsection 22(2) to find the references to an oil well and a gas well. Paragraph (e) gives an interest in the severed minerals and the proceeds thereof, and it is only with respect to the latter where mention is made of payments by an operator of a gas well or oil well. It is this reference which shows that mineral is broad enough to include oil and gas. 01

5 Similarly, paragraph (f) refers to giving the lien claimant an interest in the oil/gas well and related fixtures, machinery, tools, and appliances, again implying that oil and gas are included as minerals for the purposes of the Act. Subsection 51(1) only talks about where to register a lien if you intend to attach petroleum or natural gas. It does not give the lien rights directly in petroleum or natural gas, again leaving it to be implied from the circumstances. So while the Act uses some inconsistent terminology and does not go into a lot of detail regarding what is or is not a mineral, the references found in the Act demonstrate that the Legislature had in mind that minerals was intended to include oil and gas. Perhaps with the increased activity and significance of the oil and gas industry at some point the Legislature may turn its mind to trying to deal with liens in this area more directly. Alberta s legislation, for example, makes it clear oil and gas is included and even provides for a 90 day period within which one can register a lien for work in relation to an oil and gas well or an oil and gas well site. II. Where the lien arises As mentioned above, the lien right arises with respect to work that is preparatory to, in connection with or for an abandonment operation in connection with the recovery of a mineral. Basically, if you are dealing with the oil and gas at any stage, you may have a lien. However, it should be noted that none of these terms have received any judicial consideration in Saskatchewan. That being said, a reasonable interpretation of their meaning is: (a) preparatory - this would be services or materials that are consumed prior to any oil and gas coming from the ground. (b) in connection with - this would likely be services or materials that are consumed for an operational well that is being improved in some fashion or possibly even repaired. Arguably, it could apply to any work that is done to the well, possibly including regular maintenance work. (c) abandonment operation - presumably this would cover off services or materials provided in relation to closing out a well, either temporarily or permanently. One wonders, though, of the utility of such a lien in cases where the well is being completely abandoned. III. What Does the Lien Attach To? The lien attaches to three main things: the interests in the oil and gas, the actual oil and gas itself, and the oil and gas well and related items. With respect to the latter two points, the Act specifically recognizes that what is being attached is not an interest in land, but rather is personal property. Specific mention of this is made likely because of this unique nature of the lien given by the Act for minerals, as it differs from the general concept of an interest solely in real property. The Semenchuk Report done prior to the Act being passed felt extending the lien to the severed minerals and equipment was justified. The rationale was that there was little for the lien claimant to attach by way of an improvement so resort had to be had to personal property. However, the Committee felt that the decision in Canada Trust Company v. Cenex Limited, [1982] 2 W.W.R. 361 (Sask.C.A.) went too far when it said the predecessor of subsection 22(2) gave a lien claimant priority over a secured creditor. 02

6 In the subsequent decision in Cambrian Blasting Co. Ltd. v. Trican Well Services Ltd., 2003 SKQB 355, though, the Court agreed with the Cenex decision, holding the lien claimants had priority over secured creditors. But that priority only extended to the severed minerals in the hands of a receiver and not to a third party down the road who may extract the minerals. Cambrian Blasting was not an oil and gas case but would have application just the same. A. All Estates and Interests With respect to the interests attached, the lien affects all estates and interests in the minerals, regardless of whether that person requested the services or not. The intent behind this provision is fairly straightforward--if someone is providing services or materials that aid in the recovery of oil and gas, regardless of who may hold an estate or interest in that oil and gas, clearly the holder of those estates and interests should have to pay for the improvement to their property. This is, after all, one of the main purposes of the Act. The exception to this is the holder of the fee simple is not affected unless they expressly requested the services or materials. One may question why this would be the case. However, one has to recall who holds most of the mineral parcels in the Province--the Crown. As the Crown grants dispositions to others for the oil and gas, it is up to the recipients of those dispositions to develop the dispositions if they see fit. It is those recipients that are directly benefitting from the services or materials being provided and therefore the rationale would be that they should bear the costs of improvement. The same rationale applies to mineral parcels held by others, but the Act specifically allows for their interest to be attached if they expressly request the services or materials. What would be considered an express request in this context has not been judicially considered, but guidance might be found in the cases dealing with who is an owner and requests in non-mineral situations under the Act. B. Attaching the oil and gas The lien attaches to the mineral when it is severed and recovered and still in the hands of the owner. Given the fluid nature of oil and gas, it may not remain in the hands of the owner for very long. There will be situations where the oil and gas is being pooled until it is needed or can be moved elsewhere. But obviously at some point it will be moved and ultimately consumed or processed further. The Act recognizes this by giving the lien claimant an interest in the proceeds from the mineral. It also addresses the situation where the owner may not be the one operating the oil or gas well. In those instances, the Act specifically says that the lien attaches to whatever amounts the operator may be paying to the owner. C. Fixtures, machinery, tools, and appliances Again, the Act specifically provides for the lien attaching an interest in personal property. The interest provided for is in any fixtures, machinery, tools, appliances or other property in or on the oil or gas well. This provision has not been judicially determined. On its face, the wording used in quite broad and could apply to many different things. IV. Registration of Liens on Oil and Gas Most of the oil and gas rights in the Province are held by the Crown. There may be some that are not and in those instances you will likely want to register the lien on the related mineral parcel. But even in those instances, you will want to be 03

7 sure you search for any underlying dispositions as it depends on what mineral rights go with the mineral parcel. By way of background, the interest in oil and gas held by the Crown can be subject to dispositions to third parties. The nature of these dispositions is set out in other legislation, but the gist of them is the holder is entitled to a license allowing them to explore and ultimately extract oil and gas. The dispositions are limited in time and can affect different geological soil levels. A. Search The first step in registration would be to confirm the legal description for the surface land. This is needed to find out who holds the related mineral dispositions under this land. The search can be done by fax (which is the writer s practice) or resort can be had to the Geological Atlas of Saskatchewan. The latter is an online electronic tool that allows you to zoom in any piece of land in the Province and apply different filters to show the results you are looking for. For example, one filter identifies oil and gas dispositions. The writer s knowledge of this system is limited, but from the short time I have spent on it, I think it can be a powerful tool. The searches should be submitted to the Ministry of the Economy, Lands and Mineral Tenure. A charge applies to each search along with fax charges if you want the search results sooner. The searches will identify the mineral dispositions relating the legal land description you provide. B. Claim of Lien Once you have your search results back, you will have identified the dispositions your client has worked on and it is time to file your lien. On the claim of lien form, the owner will be the party that owns the disposition you want to lien. You are not required to indicate any related mineral parcel number on the claim of lien form as it is not required by the Lands and Minerals Tenure. You should include the legal land description, though, as further identification of the specific interest you want to attach to. One critical part is to include the disposition number as that is ultimately what you want to attach your lien to. The claim of lien should be filed the same place you did your search, i.e. the Lands and Mineral Tenure. C. Automatic Discharge A unique aspect of liens on oil and gas is the ability to have them automatically discharged without notice. Subsection 51(2) provides that if the disposition that is subject to the lien is surrendered, forfeited, terminated or cancelled, the related lien is vacated and removed. There is no requirement that notice be given to the lien claimant. However, if the vacated disposition is reinstated, the claim of lien is to be reinstated in the records with Lands and Mineral Tenure (subsection 51(3)). The claim of lien is of the same force and effect as if it had not been vacated. Although there is no case law on this point, the wording of the Act would seem to suggest that the effect of this is the reinstated lien would take priority over any intervening interests. This could include, for example, any advances made by secured parties in the period of time between the vacating and reinstatement. V. Other Provisions of the Act The holder of any estate or interest in fee simple in mines and minerals is not included in the 04

8 definition of landlord under section 31 of the Act. The general concepts under the Act still apply and should be kept in mind. A brief overview follows as a refresher of some key concepts. A. The Trust Provisions Part II of the Act sets out the various provisions dealing with three main types of statutory trusts, namely the owner s trust, the contractor s trust, and the subcontractor s trust. Regardless of type of trust involved, if you have non-monetary consideration for part of the agreement, the value of that consideration is deemed to form part of the value of the amount available for the respective trust. For example, if an owner contracted with a contractor to build a building for $1,000,000 with a discount for early payment of 5% (i.e. if the owner paid within a shorter time frame the contract price would be reduced), the owner s trust would be $1,000,000. Another important consideration is that set off is allowed between the trustee and whomever they have contracted with. In other words, the trustee is allowed to claim against (and therefore effectively reduce) the amount of the trust for amounts that its payee may owe or be liable to the trustee for. This is, however, subject to the obligation to maintain a holdback. Every payment a trustee makes to a party they are liable to pay reduces the trust obligations to all beneficiaries. For example, if a contractor has subcontracts with several subcontractors (or subtrades), the overall contract price would be a trust held for all the subcontractors. Every payment that contractor rightfully made to any one of those subcontractors would correspondingly reduce the trust obligations of the contractor. However, again, this is subject to the obligation to maintain a holdback. A significant factor that some overlook is who may be liable for breach of the trust provisions. This liability not only extends to directors and officers, but can also apply to any person who has effective control of the corporation or its relevant activities. This could extend to, for example, a parent company, as the Act specifically allows a Court to ignore the form of the transaction and any separate corporate existence. It should be noted that the Act provides for quasi-criminal liability as well. The trust provisions themselves are a remedy separate and apart from the lien remedy. This is made clear in that the Act specifically states that the trust provisions are not affected by the expiry of the time to register a lien. That being said, it is important to note that the trust remedy has a one year limitation period to commence an action for breach of trust from when the contract is abandoned or completed. At one time, there was essentially one trust under the Act for the benefit of all in the construction pyramid. However, the Act now provides for three separate trusts, namely the owner s trust, the contractor s trust, and the subcontractor s trust. Although the writer has seen several pleadings assert that in effect there is one trust, the Act itself seems to distinguish between the three types of trusts. The owner s trust is held for the benefit of the contractor or contractors (there can be more than one entity that has a direct contract with the owner). The trust attaches to all monies received by the owner for the financing of an improvement exclusive of the purchase price of the land. This trust also attaches to the owner s own capital or money in hand that can be used to pay amounts 05

9 owing to the contractor. If an owner sells the improvement, the sale price less any amounts required to payout encumbrances or sale expense is a trust for the contractor. The contractor s trust applies to amounts owing to the contractor whether they are due or payable or received by the contractor. The word payable suggests that even though payment may not yet be due under the strict terms of the contract, if the contractor has earned it, the value of what was earned is part of the trust. This trust is held for the benefit of the subcontractors, the suppliers who provided material to the contractor, and the labourers employed by the contractor who are working on the specific improvement. The subcontractor s trust is essentially the same in form as the contractor s trust, with the exceptions being that the subcontractor becomes the trustee and the beneficiaries are those in some form of contractual relationship with the subcontractor. In terms of priorities, the trust has not had success against the ever present Canada Revenue Agency for source deductions (TransGas Ltd. v. Mid Plains Contractors Ltd. (1993), 105 Sask.R. 211 (C.A.), aff d [1994] 3 S.C.R. 753). However, it has been held that the trust trumps s.67 of the Bankruptcy and Insolvency Act (D&K Horizontal Drilling (1998) Ltd. (Trustee of) v. Alliance Pipeline Ltd., 2002 SKQB). Lenders have to be cautious with this as well, since they can be held responsible for breach of trust if they know or ought to have known of the breach of trust or of facts to put it on notice. B. The Lien Provisions The lien provisions grant those providing services or materials to an improvement a claim on the improvement. The lien rights arise as soon as the work or materials are provided to the improvement. The lien is a charge on the estate or interest of the owner, as well as a charge on the materials provided, up to the value of what was provided but remains unpaid. In determining if someone is a lien claimant, a strict interpretation is applied, since liens are an abrogation of the common law. However, once a person establishes they should be a lien claimant, the determination of their rights under the Act are to be given a liberal interpretation. There are several cases that help in that determination of what is a lien claim and what is not. Unregistered liens may even enjoy some protection and can have priority over unsecured creditors, assuming there are registered liens in place. A joint owner is generally bound by a lien as well, even if they had no direct dealings with the lien claimant. The joint owner can, however, avoid that binding effect if, before the lien first arises (i.e. first services or materials are provided to the improvement), actual notice is given to the lien claimant that the joint owner assumes no responsibility for the improvements to be done. The lien is a charge on the holdback as well as on any additional amount owed by the payer to the payee against whom a lien is claimed. C. The Holdback Provisions Each payer in the construction pyramid is required to holdback 10%. The 10% is calculated to be the greater of the actual value of what has been provided and the amount of any payment already made by the payer. This obligation applies regardless of any payment terms under any contract or subcontract. A mortgagee can maintain the holdback on behalf of the owner and that satisfies the owner s obligation to maintain a 06

10 holdback. The holdback is inviolable meaning it cannot be used by the owner to complete the project or remedy a default if the contractor fails to complete or defaults on the contract. If a payer on a contract fails to release the holdback when required to do so, they can be liable to the payee for any damages they suffer as a result. An owner is personally liable to each lien claimant who has a valid lien claim in the proportion that the lien claimant is entitled to the holdback. For example, if you had a holdback of $30,000 and had valid three lien claimants each with liens of $30,000 (for a total of $90,000), the owner would be personally liable to each lien holder in the amount of $10,000. Although all payers are required to retain the holdback, the owner is the only one required to maintain a holdback trust account. The writer is of the view that in many instances this is not in fact done, even on large projects. In addition, there are some specific directions as to how that account should be dealt with, but, again, the writer suspects those are not always followed. The requirement to maintain a holdback trust account does not apply to the Crown or where the contract is in relation to a house, four-plex or condominium (all as defined under the Act) or a contract with an architect or engineer. Any interest that might accumulate on the holdback trust account is to be dealt with according to the terms of the contract, something that is not always dealt with expressly in contracts. In those cases, the default under the Act is that the interest goes to the owner. However, if there are unpaid lien claimants after the holdback has been paid out, any accrued interest would be distributed to those lien claimants first. Related to the holdback provisions is the concept of the written notice of lien. This is a separate concept from the claim of lien and there is a separate form for it. There is in theory an argument that can be made that serving a claim of lien is equivalent to serving a written notice of lien (section 100 of the Act talks about irregularities), however, rather than test that argument, the better practice is to serve both of claim of lien and a written notice of lien. While the claim of lien stakes the lien claimant s claim to the holdback, the written notice of lien has the effect of freezing all funds on the project unless the payer who is served retains an amount equal to the lien claim. There is a very important distinction between a claim of lien and written notice of lien that must be kept in mind when dealing with them and in potentially settling a dispute. Once a claim of lien is discharged, it cannot be revived. A written notice of lien, however, can be withdrawn and served again any number of times. VI. Practical Considerations With that background in mind, I now want to turn to how some of the above plays out in practice and some ways that you might want to consider in dealing with lien issues and complying with the Act. As a preliminary comment--and as mentioned before--many times an owner does not actually maintain a separate trust account for the holdback. While this may not apply in residential situations, it does apply elsewhere. A. Direct Payment One provision that can prove somewhat useful is section 47 of the Act. It allows a payer to pay a lien claimant directly. The payer has to give to the 07

11 proper payer of the lien claimant three days notice of its intention to do so. If the proper payer fails to object, the payer can make the payment without jeopardy and the proper payer cannot complain. To illustrate, if an owner gives a contractor three days notice that it is going to pay a lien claimant and the contractor fails to object, the owner is at liberty to pay the lien claimant and the contractor is then unable to challenge that payment. It is important to keep in mind, though, that any such payments do not reduce the amount of the holdback to be maintained. B. Substantial Completion This is an important concept under the Act as it generally triggers when a payer is entitled to release the holdback (the other triggers being abandonment or completion as defined under the Act). Substantial completion can be certified by a payment certifier (defined to be an architect, engineer or other person on whose certification payment is made) or, if none, the owner (if talking about the contract) or the owner and contractor jointly (if talking about a subcontract) certifying that the work is substantially complete as defined under the Act. Substantial completion is when the work is able to be or is being used as intended and the cost to complete or remedy a defect is less than or equal to 3% of the first $500,000 in contract value, 2% of the next $500,000 of contract value, and 1% of the remaining contract value. 1. Payment Certified Contracts/ Subcontracts For those contracts that have a payment certifier, they are required, when requested, to determine within a seven day period whether the contract is complete as defined in section 3 of the Act or not. If they determine to issue a certificate of substantial completion, they then have to deliver that certificate to the party making the request, as well as anyone else who requested in writing to get a copy of the certificate. But the obligations do not end there, as the payment certifier has to post the certificate on a prominent spot on the job site. This is an important step that has to be taken, but, in some instances is not. The effect of not following this mandatory provision (i.e. that the certificate be posted) is such that whoever fails to post the certificate is liable to those who suffer loss (for e.g. someone who missed out on filing a lien). So the prudent advice is to make sure the certificate is posted on the job site. The actual date of substantial completion is the date the certificate is signed or the decision is rendered, unless, of course, the certificate or decision specifically says it is another day. However, the date of substantial completion is perhaps not as critical as the time of delivery of the certificate or decision. It is this date that starts the clock running and which ultimately determines when you can release the holdback. It is important to note that, where you are delivering the certificate to several people, it is when the last person receives the notice that the clock starts to run. You may think that once you have the certificate, that is the final word. Alas it is not, as the Act allows for an arbitrator or the Court to come to a different conclusion. If a party takes the issue of substantial completion to arbitration or the Court, any decision rendered on the point has to be delivered in the same manner as the certificate of substantial completion. 2. Non-payment Certified Contracts/ Subcontracts For non-payment certified contracts, the trigger is when the contract is complete (defined under 08

12 section 4 to be 1% of the contract value) or abandoned. This is a determination that your client must make and has to be reasonably certain about. If there is any doubt, it could have a serious impact on your client down the road, particularly if they released the holdback too soon, as that could result in personal liability for them. On the issue of abandonment, Courts have consistently held this is a question of fact in each set of circumstances. Courts have held that the mere passage of time does not equate to abandonment. Further, cessation of work does not necessarily mean the contract has been abandoned. Rather one must look at the evidence to determine whether the work was abandoned or not. C. Two Holdbacks? Believe it or not, there can be two holdbacks on the same contract. This arises because, at substantial completion, obviously the job is not 100% complete. There is still additional work that needs to be done. What can be released 40 days after substantial completion is the holdback in relation to work done up to substantial completion. Because work is still ongoing on the contract after substantial completion, the requirement to maintain a holdback still applies. In some provinces, these holdbacks are referred to as the major lien fund (i.e. the holdback for work done up to substantial completion) and the minor lien fund (i.e. the holdback for work done after substantial completion). This latter fund is only releasable 40 days after the contract is complete or abandoned. D. Late Registered Liens Subsection 49(5) specifically allows for registration of liens beyond the typical 40 day period, something distinctly Saskatchewan, as the writer is unaware of a similar provision in any other Canadian jurisdiction. Although limited in what is attached, nonetheless subsection 49(5) still can create wrinkles for you and it is something you should be aware of in advising clients. Although not specifically dealt with under the Act, but related to this unique provision, is the concept of sheltering. Courts have allowed lien claimants who have not registered or who have registered late to, as they say, ride the coattails of those who did register and registered in the 40 day period. E. General Liens General liens allow a party to file a lien where they have supplied labour and material to several parcels of land but are unable to discern what the exact amounts for each parcel are. A general lien can be discharged with respect to one or more parcels and still be valid for the remaining parcels. Practically speaking, you may be able to negotiate a discharge of a general lien for payment of a pro rata amount, particularly since subsection 56(3) allows you to apply to the Court to obtain that relief. F. Things to do/consider before release of funds Before you advance any funds on a building project, regardless of what stage it is at, you should do a search of title. The Mortgages Procedures Practice Checklist advises to do a search prior to registration of your mortgage, post registration, and, perhaps most importantly in the context of builders liens, prior to disbursements. This latter point is especially important because any advances made prior to the registration of a lien are generally fine, subject of course to any possible arguments under the trust provisions of the Act. With the advent of registration time down to seconds, it may be important to record the time the actual disbursements are made, as well, as that could be critical in determining whether an 09

13 advance was made before or after registration of the lien. From the perspective of the lien claimant, this is where it can become important to not only register a claim of lien but to serve a written notice of lien as well. Registration of the lien is subject to the vagaries of the land titles registration system and the lien is only actually registered when it goes on title. Because of the possible delays in registration time, there could be advances made while your lien is sitting in the registration queue. A written notice of lien, however, has immediate effect once it is delivered to the payer or mortgagee and the Act specifically says any advances made in the face of a written notice of lien lose priority to the lien. Because of this, it is also likely prudent to check with the mortgagee as to whether they have received any written notices of lien prior to actually disbursing any advances. VII. Conclusion Although not intended to be a thorough review of builders liens and their interplay with oil and gas, it is hoped this paper has given you some things to consider in your practice. On a final note, several senior members of the bar have always been accommodating to my calls and questions, and, in keeping with that tradition, I am always happy to talk to someone about an issue they are facing, even if for no other reason than to be a sounding board. Collin K. Hirschfeld McKercher LLP 374 Third Avenue South Saskatoon, SK S7K 1M5 c.hirschfeld@mckercher.ca Phone: (306) With offices in Regina and Saskatoon, McKercher LLP has almost 60 practicing lawyers in all major areas of law. These lawyers are backed by an outstanding team of support staff with a wealth of resources. We are strategically positioned to take advantage of all that Saskatchewan has to offer. Tracing our roots back to 1926, we are proud of what we have accomplished and consistently work towards serving our clients with innovation and integrity. SASKATOON 374 Third Avenue South Saskatoon, SK S7K 1M5 (306) F (306) REGINA Hamilton Street Regina, SK S4P 4B4 (306) F (306) mckercher.ca This resource bulletin is for information purposes only and should not be taken as legal opinions on any specific facts or circumstances. Counsel should be consulted concerning your own situation and any specific legal questions you may have.