DATE: 2005-05-02

DOCKET: C42484

COURT OF APPEAL FOR ONTARIO

FELDMAN, SIMMONS and GILLESE JJ.A.

B E T W E E N :

ZURICH INDEMNITY COMPANY OF CANADA and ZURICH INSURANCE COMPANY

Hans P. Engell for the appellants Plaintiffs (Respondents)

• and -

DONALD J. MATTHEWS and ORVILLE PARKES

Richard H. Shaban and Cullen F. Price

for the respondents Defendants (Appellants)

Heard: February 1, 2005

On appeal from the order of Justice Peter G. Jarvis of the Superior Court of Justice dated July 7, 2004.

GILLESE J.A.:

[1] The appellants moved for an order permitting them to amend their statement of defence and to obtain a further and better affidavit of documents. By an order dated July 7, 2004, Jarvis J. dismissed the motion. The appellants appeal from that dismissal.

BACKGROUND

[2] The appellants, Donald Matthews and Orville Parkes, were officers and directors of Matthews Contracting Inc. (“MCI”).

[3] Between September 1992 and August 1993, MCI, as general contractor, entered into six contracts on various construction projects. The contracts were subject to the provisions of the Construction Lien Act, R.S.O. 1990, c. C.30.

[4] The respondents, Zurich Indemnity Company of Canada and Zurich Insurance Company (collectively “Zurich”), issued labour and material payment bonds, and performance bonds, for the projects.

[5] The labour and material payment bonds were issued to guarantee payment in respect of any default by MCI in paying its subcontractors. The performance bonds were issued to guarantee performance in respect of any default by MCI in completing the various projects.

[6] In December 1993, the Royal Bank of Canada placed MCI in receivership. Later, the bank petitioned MCI into bankruptcy. As a result, Zurich’s labour and material payment bonds and performance bonds were called upon. Zurich hired Lindsey Morden Claim Services Limited to adjust the claims under the bonds.

[7] Zurich paid out approximately $5.257 million to satisfy the subcontractors’ claims under the labour and material payment bonds and became subrogated to the subcontractors’ rights against MCI. Based on their subrogated rights, Zurich commenced an action against the appellants for breach of the trust provisions of the Construction Lien Act.

[8] The appellants sought disclosure of certain documents from Zurich but Zurich maintained, based on the pleadings, that the documents were not relevant. Consequently, the appellants moved to amend their statement of defence. A number of the proposed amendments were not opposed. However, Zurich did oppose the amendments contained in paras. 18, 19 and 20 of the draft amended statement of defence.

[9] In paras. 18 and 19, the appellants alleged that Zurich had acted improvidently in underwriting the MCI bonds (the “improvident underwriting claims”). Paragraphs 18 and 19 read as follows:

Further, the plaintiffs, had discretion to execute, provide or procure fresh bonds for and on behalf of MCI. By virtue of its position as underwriter the plaintiffs were fully aware of MCI’s financial position and, regardless continued to execute and provide such bonds.

Further, the plaintiffs offered to provide financing to MCI which would have allowed it to complete the construction projects, listed in the Statement of Claim. The defendants’ assert that, as the plaintiffs’ ultimate refusal to provide financing led to MCI’s bankruptcy the plaintiffs therefore caused, contributed, and failed to mitigate their own damages.

[10] In para. 20, the appellants allege that Zurich’s claim was barred either under s. 45(1)(h) of the Limitations Act or by the doctrine of laches. The proposed para. 20 was:

Further, and in the alternative, if the defendants’ alleged acts and omissions give rise to a cause of action, which is not admitted but specifically denied, the defendants plead and rely on section 45(1)(h) of the Limitations Act R.S.O. 1990, c. L.15, and submit that the plaintiffs are barred from recovery. In the alternative the defendants rely on the doctrine of laches.

[11] The appellants also moved for production of additional documents, including Zurich’s underwriting file, which file included:

(a) a report by Lindsey Morden that related to a review of Zurich’s potential exposure should MCI default on its obligations; and

(b) documents relating to meetings of Zurich, MCI and the bank in respect of potential refinancing of MCI.

[12] The motion judge dismissed the motion, holding that the proposed pleading of improvident underwriting was not a tenable defence and that s. 45(1)(h) of the Limitations Act did not apply to an action for breach of trust. Nothing was expressly stated about the doctrine of laches. The motion judge refused to order additional disclosure on the basis that the documents sought were irrelevant to the issues as pleaded.

[13] The appellants appeal, saying that the motion judge erred in refusing to permit the amendments and to compel further production of documents.

ISSUE 1: AMENDMENT OF THE PLEADINGS

[14] Rule 26 of the Rules of Civil Procedure provides that the court shall grant leave to amend a pleading at any stage of an action absent prejudice that is not compensable by costs or an adjournment. Case law makes it clear that the motion judge has the jurisdiction to refuse to allow amendments that are not tenable in law. See Keneber Inc. v. Midland (Town) (1994), 16 O.R. (3d) 753 (Gen. Div.).

[15] Zurich does not claim prejudice. Thus, this appeal turns upon whether the motion judge correctly found that none of the defences of improvident underwriting, s. 45(1)(h) of the Limitations Act or laches was tenable. Each of the proposed defences is considered below.

Improvident Underwriting

[16] Section 8(1) of the Construction Lien Act stipulates that all amounts owing to the subcontractors (on account of the contract or subcontract of an improvement) constitute a trust fund. Section 8(2) provides that the contractor is the trustee of the trust fund created by subsection (1).

8. (1) All amounts,

(a) owing to a contractor or subcontractor, whether or not due or payable; or

(b) received by a contractor or subcontractor,

on account of the contract or subcontract price of an improvement constitute a trust fund for the benefit of the subcontractors and other persons who have supplied services or materials to the improvement who are owed amounts by the contractor or subcontractor.

(2) The contractor or subcontractor is the trustee of the trust fund created by subsection (1) and the contractor or subcontractor shall not appropriate or convert any part of the fund to the contractor's or subcontractor's own use or to any use inconsistent with the trust until all subcontractors and other persons who supply services or materials to the improvement are paid all amounts related to the improvement owed to them by the contractor or subcontractor.

[17] In addition to those liable in an action for breach of trust, s. 13 of the Construction Lien Act makes directors and officers of a corporation liable for breach of trust if they assented to, or acquiesced in, conduct that they reasonably ought to have known amounted to a breach of trust by the corporation. Based on these provisions of the Construction Lien Act, the subcontractors had the right to take action against MCI and the appellants for breach of trust.

[18] Pursuant to s. 69(3) of the Construction Lien Act (and at common law including by virtue of the assignment of claims by the subcontractors), Zurich became subrogated to the rights of the subcontractors. Section 69(3) provides:

The surety, upon satisfaction of its obligation to any person whose payment is guaranteed by the bond, shall be subrogated to all the rights of that person.

[19] For the purposes of the subrogated action, Zurich stands in the shoes of the subcontractors. Zurich can sue the appellants because the subcontractors had the right to sue them. However, because Zurich stands in the subcontractors’ shoes, it is the conduct of the subcontractors that is relevant from a defence perspective, not that of Zurich. The improvident underwriting claim that the appellants seek to advance - whether characterized as such or as contributory negligence or negligent misrepresentation - relates to actions by Zurich, not the subcontractors. Tenable defences are those that can be made against the subcontractors. Thus, improvident underwriting is not a tenable defence at law to a subrogated action for breach of trust under the Construction Lien Act.

[20] As the motion judge correctly noted, relying upon Axa Pacific Insurance Co. v. R.J.B. Nicol Construction (1975) Ltd. (1998), 67 O.T.C. 271 (Gen. Div.), the actions of a surety - even if it knows of possible default and continues to provide bonds - does not make the surety responsible for the misconduct of the defendants relating to their trust obligations.

[21] Accordingly, as the proposed amendments in paras. 18 and 19 of the draft amended statement of defence are based on claims of improvident underwriting, the motion judge correctly refused to permit the amendments.

Section 45 (1)(h) of the Limitations Act

[22] The motion judge gave the following reasons for refusing to permit the appellants to amend their statement of defence to raise a limitation period defence based on s. 45(1)(h) of the Limitations Act:

The defendants seek to amend their statement of defence to plead s. 45(1)(h) of the Limitations Act and for laches. There is no limitation period in actions for breach of trust provided in the Construction Lien Act. It is significant that there was such a provision in its predecessor legislation. The Limitations Act, section 44(2) provides expressly that no claim of a beneficiary of a trust against the trustee for any property held on an express trust, or in respect of such trust, “shall be held to be barred by any statute of limitations”.

In addition the authorities are clear and state that section 45(1)(h) of the Limitations Act does not apply to an action for breach of trust. Rather, its application is solely to “penal actions”. See West End Construction Ltd. v. Ontario (Ministry of Labour) (1989), 70 O.R. (2d) 133 (C.A.) at pp. 144-45 and Abraham v. Canadian Admiral Corp. (Receiver of) (1998), 39 O.R. (3d) 176 (C.A.) at 182.

[23] On my reading of these reasons, the motion judge concluded that s. 45(1)(h) was not a tenable defence on two grounds. The first is that limitation periods do not apply in respect of trustees and he appears to have assumed that the appellants were trustees. The second is that s. 45(1)(h) of the Limitations Act applies only to penal actions.

[24] In my view, the trial judge was incorrect in assuming that the appellants were trustees.

[25] Section 13(1)(a) of the Construction Lien Act extends liability to directors and officers of a corporation if the directors or officers assented to, or acquiesced in, conduct by the corporation which the directors or officers reasonably ought to have known amounted to a breach of trust.

13. (1) In addition to the persons who are otherwise liable in an action for breach of trust under this Part,

(a) every director or officer of a corporation; and

(b) any person, including an employee or agent of the corporation, who has effective control of a corporation or its relevant activities,

who assents to, or acquiesces in, conduct that he or she knows or reasonably ought to know amounts to breach of trust by the corporation is liable for the breach of trust [emphasis added].

[26] Section 13 does not declare the directors and officers to be trustees nor does it deem them to be such. It does not make the directors and officers trustees. It imposes liability on directors and officers for breaches of trusts committed by the corporation and only if it is found that the directors and officers assented to, or acquiesced in, conduct by the corporation that they reasonably ought to have known amounted to breach of trust. In coming to this conclusion, I adopt the reasoning in Patrick Harrison & Co. v. Devran Petroleum Ltd. (1993), 22 C.P.C. (3d) 285 (Gen. Div.) and Baltimore Aircoil of Canada Inc. v. ESD Industries Inc. (2002), 60 O.R. (3d) 290 (Sup. Ct.).

[27] It remains to be determined whether s. 45(1)(h) of the Limitations Act can apply to an action taken pursuant to s. 13 of the Construction Lien Act. Section 45(1)(h) reads as follows:

45.(1) The following actions shall be commenced within and not after the times respectively hereinafter mentioned,

(h) an action for a penalty, damages, or a sum of money given by any statute to the Crown or the party aggrieved, within two years after the cause of action arose;

[28] At first blush, it appears that s. 45(1)(h) applies. Zurich, standing in the shoes of the subcontractors, has commenced an action for damages and the right to bring the action was given to the subcontractors, as aggrieved parties, by s. 13 of the Construction Lien Act. However, as explained below, the weight of the jurisprudence is to the effect that s. 45(1)(h) applies only to penal actions. And, as also explained below, in my view because s. 13 is remedial rather than penal in nature, s. 45(1)(h) does not apply.

Section 45(1)(h) Applies Only to Penal Actions

[29] The English Court of Appeal considered the antecedents of s. 45(1)(h) in Thomson v. Lord Clanmorris, [1900-03] All E.R. Rep. 804. Lindley M.R. stated that s. 3 of the Civil Procedure Act, 1833, 3 & 4 Geo. IV, c. 42, - the statutory equivalent and predecessor to s. 45(1)(h) of the Limitations Act – was intended to apply to penal actions. He held that an action brought under s. 3 of the Directors’ Liability Act, 1890, to recover damages from a director for loss sustained by reason of an untrue statement in a prospectus, was compensatory, not penal, and that consequently s. 3 of the Civil Procedure Act, 1833, did not apply. In coming to this conclusion, Lindley M.R. stated at pp. 806- 07:

The first thing that I will deal with is s. 3 of the Civil Procedure Act, 1833, which has been so much relied upon. In construing that enactment, as in construing any other enactment, you must look, not only at the words used, but at the history of the Act, and consider what were the reasons which led to its being passed. You must look at the mischief which had to be cured as well as the cure afforded. And when you have looked at the state of the law previous to the Civil Procedure Act, 1833, you see pretty well what it was that had to be dealt with. There were certain causes of action as to which there was no defined time of limitation. Some of them were alluded to in the earlier part of the section - actions for debt on specialties and other things which are there enumerated. They were not provided for by the existing statutes of limitations, and they are brought in. That was defect number one. There was another class of actions as to which there was no definite time for suing. Those were actions for penalties and damages and sums of money given by various Acts of Parliament by way of penalty or punishment and not by way of compensation. But as was pointed out by LORD ESHER, M.R., when commenting in Saunders v. Wiel, [1892] 2 Q.B. 321 upon Adams v. Batley 18 Q.B.D. 625, the punishment was there an object. And, whether you call it penalty, damages, or sum of money, it was not assessed with a view to compensate the plaintiff, although he might put some of it in his own pocket. That is the class of action. In other words, they were what are popularly called “penal actions.” You get at that from the history of the legislation, and from knowing what the state of the law was and what the defect was.

[30] In West End Construction Ltd. v. Ontario (Ministry of Labour) (1989), 70 O.R. (2d) 133 (C.A.), Finlayson J.A., on behalf of the court, quoted at length from the judgment of Lindley M.R. and noted that the decision in Clanmorris had been followed by the Federal Court of Canada and the Alberta Court of Appeal. He held that a complaint under the Human Rights Code was not an action and that therefore s. 45(1)(h) could not apply. Nonetheless, while he found it unnecessary to determine whether s. 45(1)(h) was limited to penal actions, he expressly approved the reasoning of Lindley M.R. in Clanmorris saying, at p. 144:

If I was obliged to consider the matter from this perspective, I do not think I could ignore the reasons of Lindley M.R. in Clanmorris. When a judge of his experience and reputation stated so baldly that the genesis of s. 45(1)(h) referred to “penal actions” and based that assertion on “the history of the Act, and from a knowledge of the then state of the law and the defect which was to be cured”, it hardly lies in my mouth to contradict him. Certainly no one else has. Despite Robinson v. Essex, I do not think that s. 45(1)(h) has any application to the remedies sought under the Code. Even if the complaint of Tabar can be construed as an “action”, it is not a penal action and s. 45(1)(h) does not apply.

[31] In Abraham v. Canadian Admiral Corp. (Receiver of) (1998), 39 O.R. (3d) 176 (C.A.), McKinlay J.A., writing for the majority, approved of the comments of Finlayson J.A. in West End Construction.

[32] The reasoning in Clanmorris has been followed in the Ontario superior court. See Superior Propane Inc. v. Tebby Energy Systems (1992), 9 O.R. (3d) 769 (Gen. Div.). It has been followed in the Federal Court of Canada, as well. See A.M. Smith & Co. Ltd. v. The Queen (1981), 120 D.L.R. (3d) 345 (C.A.) and Johnson Controls Inc. v. Varta Batteries Ltd. (1984), 80 C.P.R. (2d) 1 (C.A.). In addition, it has been followed by other Canadian courts with legislative provisions that are equivalent to s. 45(1)(h). See, for example, Bank of Nova Scotia v. Dunphy Leasing Enterprises Ltd. (1987), 1987 ABCA 78, 38 D.L.R. (4th) 575 (Alta. C.A.); Saskatchewan (Beef Stabilization Board) v. Thomas (1992), 13 C.P.C. (3d) 190 (Sask. Q.B.) and Herbin v. Halifax Atlantic Investments Ltd. (c.o.b. Wandlyn Inns) (2002), 36 C.P.C. (5th) 118 (N.S. S.C.).

[33] The 1969 Ontario Law Reform Commission Report on Limitation of Action at p. 52 notes that s. 45(1)(h) does not bring all actions brought on statutes within its scope, noting that in England the words of the provision have been construed so as to include only actions for recovering sums in the nature of penalties.

[34] I acknowledge that the decision of this court in Robinson v. Essex (1932), 41 O.W.N. 342 held that s. 45(1)(h) was not limited to penal actions. Only a very brief report of the judgment rendered in Robinson is available. In that report, the court held that a claim for damages arising from works constructed pursuant to the Municipal Drainage Act was barred by the then equivalent of s. 45(1)(h) as an “action for damages given by any statute must be brought within two years after the cause of action arose”. There is nothing in the report to suggest that the court considered Clanmorris. In West End Construction, Finlayson J.A. referred to Robinson and chose not to follow it.

[35] For these reasons, in my view, the weight of authority is to the effect that s. 45(1)(h) of the Limitations Act applies only to penal actions. A factor that further militates in favour of interpreting s. 45(1)(h) as applying only to penal actions is the passage of new limitations legislation. The comments of Feldman J.A. in Lax v. Lax (2004), 70 O.R. (3d) 520 at para. 35, although made in the context of enforcement of foreign judgments, are equally apt in the circumstances of the within appeal:

[T]he legislature has now passed a new Limitations Act that radically changes the approach to limitations generally, imposing a standard two-year limitation for most actions and eliminating any limitation on the enforcement of court orders. … [T]he existence of the new Act is another factor that militates in favour of leaving the original meaning of the sections of the former Act as they have been interpreted historically.

Section 13 of the Construction Lien Act is Remedial in Nature

[36] Section 13 of the Construction Lien Act imposes liability on the corporation’s directors or officers when they are found to have assented to, or acquiesced in, the corporation’s breach of trust. As the statute does not impose a fine or term of imprisonment, in my view, the intention is not to punish the directors and officers but to provide an additional remedy to the injured parties.

[37] A historical review of s. 13 reinforces that conclusion. Section 13 dates from the reform of the Mechanics’ Lien Act in 1983. Section 3(7) of the Mechanics’ Lien Act, R.S.O. 1980, c. 261, the antecedent to s. 13, provided for penal sanctions of a fine and/or imprisonment. Section 3(7) read as follows:

Every person upon whom a trust is imposed by this section who knowingly appropriates or converts any part of any trust moneys referred to in subsection (1), (3) or (4) to his own use or to any use not authorized by the trust is guilty of an offence and on conviction is liable to a fine of not more than $5,000 or to imprisonment for a term of not more than two years, or to both, and every director or officer of a corporation who knowingly assents to or acquiesces in any such offence by the corporation is guilty of such offence, in addition to the corporation, and on conviction is liable to a fine of not more than $5,000 or to imprisonment for a term of not more than two years, or to both.

[38] According to the 1982 Report of the Ontario Attorney General’s Advisory Committee on the Draft Construction Lien Act, s. 3(7) was “unnecessary in light of s. 296 of the Criminal Code which makes it an indictable offence, punishable by up to fourteen years imprisonment, to convert trust funds with an intent to defraud”. The Report went on to state, “Where there is no intent to defraud, the civil liability for breach of trust (i.e. s. 13) should be sufficient to rectify any such breach.” The word “rectify” accords with the notion of a remedy rather than punishment.

[39] The purpose and intent of the trust provisions in the Construction Lien Act have been held to be remedial in effect. See Baltimore Aircoil of Canada, supra, at para. 36 and Essroc Canada Inc. v. Towne Concrete Forming Ltd., [2004] O.J. No. 2460 at para. 25, where Paisley J. said, “The trust provisions of the Act do not create a penalty. They are undoubtedly in place to ensure that persons are properly credited for work and services provided and that trust is in respect of monies received for work performed.”

[40] Although provisions for personal liability of officers and directors may in one sense be penal, in that they impose liability on directors and officers, they are protective and remedial insofar as a creditor is concerned. See Huntington v. Attrill, [1893] A.C. 150 (P.C.) at 159. In Huntington, the Privy Council allowed the action of a creditor of a corporation to be heard on the basis that the action was remedial in nature and not penal, as had been found in both the Ontario High Court of Justice and Court of Appeal. The creditor brought an action against the director of the company for fraudulent misrepresentations in signing false certificates as to the amount of paid up stock in the company. The creditor had recovered judgment in the state of New York, pursuant to s. 21, ch. 611 of the New York Statute of 1875, and was taking action upon the judgment in Ontario. However, according to the rules of international law, if the matter was penal in nature, it could not be adjudicated upon in a foreign jurisdiction. In holding that the provisions were not penal in nature, the Privy Council stated:

In one aspect of them, the provisions of sect. 21 are penal in the wider sense in which the term is used. They impose heavy liabilities upon directors, in respect of failure to observe statutory regulations for the protection of persons who have become or may become creditors of the corporation. But, in so far as they concern creditors, these provisions are in their nature protective and remedial.

[41] Finally, s. 10 of the Interpretation Act, R.S.O. 1990, c. I.11, requires that all legislation shall be deemed to be remedial whether its immediate purport is to prevent or punish the doing of a thing:

Every Act shall be deemed to be remedial, whether its immediate purport is to direct the doing of any thing that the Legislature deems to be for the public good or to prevent or punish the doing of any things that it deems to be contrary to the public good, and shall accordingly receive such fair, large and liberal construction and interpretation as will best ensure the attainment of the object of the Act according to its true intent, meaning and spirit.

[42] For these reasons, I conclude that an action for breach of trust taken pursuant to s. 13 of the Construction Lien Act is remedial, not penal, in nature. Having previously concluded that s. 45(1)(h) of the Limitations Act applies only to penal actions, it follows that s. 45(1)(h) is not a tenable defence.

Laches

[43] A defence based on the doctrine of laches would require the appellants to show that inordinate delay, or acts or omissions on the part of Zurich (in their capacity as subrogated claimants under the Construction Lien Act), resulted in prejudice to them. See Perry, Farley & Onyschuk v. Outerbridge Management Ltd. (2001), 54 O.R. (3d) 131 (C.A.).

[44] Zurich says that the cause of action for breach of trust under the Construction Lien Act arose in the fall of 1993. The action was brought in October of 1997, some four years later. I accept Zurich’s submission that the proposed amended statement of defence does not plead delay or allege prejudice but that is not an answer to the matter in issue. The issue before this court is whether the appellants can amend their statement of defence to allege laches, not whether particulars should be ordered or whether part of the pleading should be struck for failing to disclose a minimum level of material fact. In my view, it cannot be said at this stage of proceedings, that laches is not a tenable defence. If Zurich is troubled by the amendments, once they are made, they can take the appropriate steps to address their concerns, but that is a matter for them to pursue before a different court and pursuant to a fresh motion.

[45] I would add a final comment in relation to the matter of laches. At the conclusion of oral argument in this appeal, the court asked counsel for additional written submissions on whether s. 45(1)(h) of the Limitations Act applies to an action brought pursuant to s. 13 of the Construction Lien Act. In their additional written submissions, for the first time, Zurich submitted that s. 45(1)(g) of the Limitations Act applied. In its original submission, Zurich took the position that there was no limitation period in respect of an action for breach of trust under the Construction Lien Act and cited authority for that proposition. Then, in two brief paragraphs at the end of their additional written submission, Zurich submitted, based on Fleury v. Fleury (2001), 9 C.P.C. (5th) 222 (Ont. C.A.), that laches was not a tenable defence because s. 45(1)(g) applied.

[46] In the circumstances, in my view, it is not appropriate for the court to consider the applicability of s. 45(1)(g) or Fleury. The motion below was argued on the basis that the relevant limitation period provision was s. 45(1)(h). The appellants have not been heard on the matter of s. 45(1)(g), the motion judge was not called upon to decide the matter and there is no proper record upon which to consider the issue.

ISSUE 2: PRODUCTION OF DOCUMENTS

[47] Assuming that this court has jurisdiction to entertain an appeal in the matter of production of documents, I would decline to decide it. There is no proper record on which to make such an order. Having said that, it will be apparent that as there is no tenable defence based on improvident underwriting there can be no right to require production related to such a claim.

[48] In any event, Zurich has undertaken to provide the appellants with a fresh affidavit of documents and, following release of this decision, disclose all documents made relevant by the decision.

DISPOSITION

[49] Accordingly, I would allow the appeal in part and set aside the order below. I would grant the appellants leave to amend their statement of defence so as to plead laches and award the appellants the costs of the motion and costs of this appeal fixed at $2,000, inclusive of disbursements and GST.

RELEASED: May 2, 2005 (“KNF”)

“E. E. Gillese J.A.”

“I agree K. Feldman J.A.”

“I agree Janet Simmons J.A.”