The Fine Print: Form and Sufficiency of Letters of Credit to Vacate Liens

Originally published on Building.ca 

One of the most efficient ways to have the lien removed from title is to “vacate” the lien. However, vacating the lien does not resolve the underlying dispute between the lien claimant and the contracting party

If a contractor is not paid within a certain amount of time, they may register a construction lien against the property as security for their purported entitlement to payment for improving the property. There are specific requirements under the Ontario Construction Act on when and how this can be done, which are not covered in this article. The property itself is then encumbered with that lien, and third parties will almost always refuse to take conveyances, mortgages, or other dealings with a property subject to a lien. Moreover, a lien on title will often constitute a default under loan agreements and development agreements if the lien is not removed within a certain time period.

This results in liens being a powerful tool, when used correctly, to drive a resolution between contractors and property owners, because owners are strongly incentivized to remove the lien from title. One of the most efficient ways to remove a lien from title is to “vacate” the lien.

Security to Vacate a Lien

Pursuant to Section 44 of the Construction Act, the party seeking to vacate the lien may post security with the Superior Court of Justice equal to the sum of: (i) the full amount of the lien, plus (ii) 25 percent of the lien amount (up to $250,000) as security for costs. This security can come in the form of cash, an irrevocable letter of credit, or a lien bond. Cash is most commonly used as security for costs when there is urgency to have the lien vacated. However, where there is less urgency, a bond or a letter of credit are both acceptable and often used as forms of security.

If the motion is successful, the Court will issue an Order to “vacate” the lien, provided that the approved security is delivered to the Accountant of the Superior Court of Justice. Upon the Court’s receipt of the approved security, the applicant can vacate the lien, which removes it from title to the property.

If the applicant wishes to substitute the security provided, a subsequent Court Order is required to do so. This would come into play where, for example, an applicant previously posted cash with the Accountant but wanted to change the security to a letter of credit.

As noted above, when there is urgency to have the lien removed from title, applicants will often propose cash as the form of security, at least initially. This is done for expediency but also to avoid the risk of the motion being denied or varied. Although banks and sureties are able to process these requests relatively quickly for creditworthy clients, even a few days’ delay may be material to the applicant. In addition, there is some risk that security other than cash will not be in a form sufficient to the Court, this risk is illustrated below.

Sufficiency of Form of Letter of Credit

In the case of TruGrp Inc. v. Karmina Holdings Inc., 2024 ONSC 2165, heard by the Ontario Superior Court of Justice earlier this year, the form of a letter of credit was brought into question. In this case, TruGrp had registered a lien against Karmina’s property, and Karmina brought a motion to vacate the lien and proposed a letter of credit from the Bank of Montreal as security for same.

Associate Justice Robinson heard the motion and rejected the initial form of letter of credit because it contained two problematic provisions: (1) an uncertain requirement for the Accountant to provide the original letter of credit if making any draw request, and (2) a reference to an international commercial convention without including or appending the text of that convention as required by the Rules of Civil Procedure.

Karmina obtained a revised form of letter of credit and resubmitted it to the Court. This time, an Order to vacate was granted, the letter of credit was delivered to the Accountant, and the lien was removed from title. But the story does not end there.

TruGrp then brought a motion to set aside the Vacating Order on the basis that the form of letter of credit was not sufficient to secure TruGrp’s rights under the Construction Act. Specifically, the form of letter of credit contains the following provision:

This letter of credit shall be deemed to be automatically extended without amendment for successive one-year periods from the present or any future expiration date, unless at least thirty (30) days prior to any such date we shall notify you in writing, by registered mail or courier, that we elect not to extend this letter of credit for any further period and at the same time forward to you, together with such written notice, a bank draft in the amount of [the security].

The crux of TruGrp’s concern was that if BMO refused to renew the letter of credit, the Accountant would not be able to accept the replacement bank draft without a further Court Order approving the substituted security. This concern was fair-minded, particularly given that TruGrp had discussions with the Accountant’s office, where the need for a further Court Order was purportedly confirmed.

It is notable that this language in the letter of credit is also contained in the authoritative text Conduct of Lien, Trust and Adjudication Proceedings, 2023 edition (Toronto: Thomson Reuters, 2023) (as well as prior editions of that text), and has been contained in countless letters of credit approved in Ontario as sufficient security to vacate a lien.

Decision

Justice Robinson did not make a determination on the issue of whether the form of the letter of credit was sufficient, because the motion was brought without notice to either the Accountant or BMO. Instead, the original motion was stayed to allow both the Accountant and BMO an opportunity to make submissions on the matter.

A lawyer for the Accountant advised that the clause noted above, permitting the issuing bank to decline renewal and replace the letter of credit with a bank draft in the amount of the security, “is sufficient authority for the Accountant to accept and deposit the bank draft provided that a Court Order has permitted the payment into Court of the letter of credit with these provisions” (para. 3),  and clarified that a Court Order would be required where parties other than the issuing bank seek to substitute security provided, which is not contemplated by the approved form of security.

Based on the Accountant’s submissions, TruGrp’s concerns were addressed, and the motion was effectively withdrawn. Although there is no stated decision on the issue, it can be safely assumed that a letter of credit containing the above-noted provision is sufficient security to vacate a lien and that the Accountant can accept replacement security without a further Court Order if already approved in the initial Order from the Court.

Takeaway

In this author’s opinion, common sense won in this case. Had the Accountant’s office determined that they could not accept a bank draft from the issuing bank of a letter of credit the bank did not wish to renew, this would have effectively eliminated the ability to use letters of credit as security to vacate a lien, as most banks would not issue a letter of credit without that flexibility. A decision determining that standard language was not sufficient from a Construction Act perspective would have also brought into question a large number of letters of credit currently with the Accountant as security for a vacated lien. Although the form of letters of credit being proposed as security to vacate a lien must still be reviewed to ensure sufficiency, lien claimants and property owners alike should take comfort that the previously accepted forms remain unchanged.