COURT FILE NO.: CV-20-00652065-00CL and CV-20-00651774-00CL
DATE: 20210408
ONTARIO
SUPERIOR COURT OF JUSTICE
Court File No. CV-20-00652065-00CL
BETWEEN:
Urban Mechanical Contracting Ltd., Ozz Electric Inc., Oakdale Drywall & Acoustics Ltd., NORR Limited, WSP Canada Group Limited, Noram Building Systems Inc. and Safway Services Canada Inc.
Applicants
– and –
Zurich Insurance Company Ltd.
Respondent
AND BETWEEN:
Bank of Montreal as Administrative Agent
Applicant
-and-
Emilio Bisceglia for Urban Mechanical Contracting Ltd. and Oakdale Drywall & Acoustics Ltd.
Michael Tamblyn and Stewart Thom for Ozz Electric Inc.
Sandra D. Astolfo and Philip Cho for NORR Limited.
Howard Borlack and Eric Turkienicz for WSP Canada Group Limited
Howard M. Wise and Jesse-Ross Cohen for Noram Building Systems Inc.
Adam Wainstock for Safway Services Inc.
Counsel for the Applicants
Matthew B. Lerner, Brian Kolenda, Jonathan McDaniel and Sarah Bittman
Mark Wiffen (in respect of NORR Limited only)
Counsel for the Respondent
Court File. No. CV-20-00651774-00CL
Harvey Chaiton, Stephen Schwartz and Darren Marr, Counsel for the Applicant
Zurich Insurance Company Ltd.
Respondent
Matthew B. Lerner, Brian Kolenda, Jonathan McDaniel and Sarah Bittman, Counsel for the Respondent
Non-Party Counsel:
Sarit Batner and Julie Parla for Unity Health
Lorne Honickman and Alyssa Jagt for Vasos Georgiou
Aryo Shalviri and Mariangela Asturi for Alvarez & Marsal Canada Inc. as Receiver of 2442931 Ontario Inc.
Stephen Brunswick, Harvin Pitch, Alan D. Gold and David T. Ullman for John Acquino
Julia Lefebvre for the Globe & Mail
HEARD: March 18 and 19, 2021
JUDGMENT ON APPLICATIONS
C. Gilmore, J.
OVERVIEW
[1] In the two Applications before the Court, the question that must be answered is whether rescission is available as a matter of law on a construction bond where there has been fraud and collusion in the procurement process.
[2] In the first Application, Urban Mechanical Contracting Ltd., Ozz Electric Inc., Oakdale Drywall and Acoustics Ltd., NORR Limited, WSP Canada Group Limited, Noram Building Systems Inc. and Safway Services Canada Inc. (“the Trades”) seek a declaration that the Labour and Material Bond (“the Payment Bond”) issued by the Respondent, Zurich Insurance Company (“Zurich”), cannot be rescinded.
[3] In separate actions, each of the Trades has asserted a claim against Zurich, as surety, for payment of amounts outstanding and owed to them by Bondfield Construction Company Limited (“BCCL”) for labour and services, material and/or supply which they provided to the subject Project.
[4] In its defence of the claim brought by NORR, Zurich has different counsel due to a conflict. However, Zurich’s counsel in relation to the NORR claims was aligned with Zurich on all issues.
[5] In the second Application, the Bank of Montreal (“BMO”), in its capacity as Administrative Agent for a syndicate of lenders, seeks a declaration that Zurich is not entitled to rescission of the Performance Bond.
[6] BMO also seeks an Order that Zurich pay to Alvarez & Marsal Canada Inc., the Receiver of 2442931 Ontario Inc. (“ProjectCo”), the amount due and owing pursuant to Zurich’s election to pay under the Performance Bond and an Order for directions with respect to the process for determining the disputed amount owing.
[7] Zurich defends both actions on the grounds that both the Trades and BMO are seeking to have the Court pre-emptively decide Zurich’s Rescission Action and that the legal propositions on which both Applicants rely are wrong. This is not a matter which can be decided in a summary fashion as suggested by the Applicants, it must be decided on a full record with related factual findings as an equitable remedy such as rescission cannot be decided in the abstract. Zurich also raises objections with respect to the procedure by which this issue has been brought before the Court.
[8] In a separate action “the Rescission Action”, Zurich seeks rescission of the Bonds as against ProjectCo, BCCL, John Acquino, Vasos Georgiou and Unity Health based on it being induced to issue the Bonds in reliance on the misrepresentations of the Defendants. While that action is not before this Court, it is clear that a finding on these Applications that rescission is not available to Zurich would effectively put an end to the Rescission Action.
[9] As will be set out below, the Applications will not be dismissed based on an alleged procedural defect as the Court has already endorsed this process. However, and despite the very able arguments of counsel for BMO and the Trades, it is this Court’s view that rescission remains a possible remedy for Zurich, cannot be precluded at this early stage as a matter of law, and the matter must proceed to trial on that basis.
THE GLOBE & MAIL MOTION
[10] At the commencement of the second day of this hearing, the Globe & Mail brought a motion for an Order to unseal certain documents which were subject to the sealing Order granted by Justice Hainey on February 26, 2021.
[11] By way of motion on February 26, 2021 Zurich sought and was granted an Order for relief from the deemed undertaking rule with respect to the evidence provided by Unity Health, Mr. Acquino and Mr. Georgiou in the Rescission Action such that that evidence could be used in its defence at the hearing of these Applications. The Hainey Sealing Order was an interim one made with the understanding that the judge hearing the Applications would determine whether the Sealing Order would continue.
[12] Submissions were received from counsel for the Globe & Mail, and counsel for Unity Health, Mr. Aquino, Mr. Georgiou and Zurich.
[13] By way of oral reasons given on March 19, 2021, I ordered that the documents subject to the Sealing Order be unsealed and made available in the public record and that the hearing of the Applications be made open to the public in all aspects. The unredacted versions of the court material were subsequently made part of the public record.
BACKGROUND FACTS AND OTHER LITIGATION
The Project is Formulated and Tendered
[14] In 2011, St. Michael’s Hospital (“SMH”) and Infrastructure Ontario (“IO”) (“the Sponsors”) jointly initiated the redevelopment of SMH (“the Project”). The redevelopment consists of the construction of a new 17-storey patient care tower at Queen Street and Victoria Street in downtown Toronto, the construction of a new Shuter Wing and the renovations of various other existing hospital wings. The Project was a public/private partnership or a “P3 Project” in which the Sponsors delineated the scope of the project and financing was to be provided by the private sector.
[15] The Project was to be awarded based on IO’s rules of procurement which were intended to ensure a transparent procurement process. This included rules that prohibited communication between members of the evaluation committees and bidders submitting in the Request for Qualifications (“RFQ”) and the Request for Proposals (“RFP”) process.
[16] Committees were formed from employees of the Sponsors to evaluate the RFQ and the RFP proposals. At both stages the Evaluation Committee was to have made a good-faith recommendation regarding selection of the Proponent and then the Preferred Proponent.
[17] BCCL went through the RFQ and RFP process and was the winning bidder of the Project. BCCL created a special purpose entity, ProjectCo, for the Project. ProjectCo is a wholly owned subsidiary of BCCL and controlled by its principal, John Aquino (“Mr. Aquino”). Under the Construction Contract between BCCL and ProjectCo, BCCL undertook to complete the Project work and ProjectCo made progress payments to BCCL.
The Bonds and the Financing
[18] Construction of the Project was financed by BMO through its syndicate of lenders by way of a credit facility in the amount of $230M (“the Construction Loan”) on the terms set out in the Credit Agreement. The Credit Agreement required that ProjectCo obtain and maintain a Performance Bond and a Labour and Materials Bond (“the Payment Bond”) (together “the Bonds”) as part of BMO’s security for payment of the Construction Loan.
[19] The Bonds were required to guarantee the Project in the event of BCCL’s failure to complete the Project. The Bonds were also intended to provide certainty to BMO’s lenders and to the Trades who would be providing work and materials to the Project. In Ontario, surety bonds are mandatory for public contracts valued over $500,000, such as the SMH Project. The Construction Act, R.S.O. 1990, c. C.30, requires a contractor to provide the owner with a performance and payment bond providing coverage of at least 50% of the contract price.
[20] In general, surety bonds are guarantees to protect against the risk of the general contractor’s insolvency. When the contractor makes full payment to the bond claimants, the bond becomes null and void. Until that point, the surety’s obligation remains in full force and effect. A surety bond, such as the one in this case, is a financial instrument which transfers project risk to a third party (Zurich), thereby providing assurance to purchasers, lenders, subcontractors and suppliers.
[21] It assumed that the surety will undertake a thorough review of all bonded contractors to ensure the contractor can fulfill the obligations under its contract. As such, and after completing that investigation, it issues a bond as a form of “promise” to pay out if the project fails.
[22] Zurich issued the Performance Bond on January 27, 2015 under which BCCL was the principal, Zurich was the surety and ProjectCo was the obligee. The amount of the Performance Bond was $156,325,362.60 representing 50% of the total contract price for the Project. The obligations under the Bond are set out below:
Bondfield Construction Company Limited as Principal, ("Principal"), and Zurich Insurance Company Ltd, a corporation created and existing under the laws of Switzerland having a place of business in Canada and duly authorized to transact the business of Suretyship in the Province of Ontario, Canada as Surety, ("Surety"), are bound unto 2442931 Ontario Inc. as Obligee, ("Obligee"), in the amount of $156,325,362.60 lawful money of Canada (the "Bond Amount", as further defined below), for the payment of which sum the Principal and the Surety jointly and severally bind themselves, their heirs, executors, administrators, successors and assigns. …
The Surety has agreed to enter into this Public Private Partnership Performance Bond ("Bond") to guarantee the performance of all of the obligations of the Principal under the Design and Construction Contract, subject to the Excluded Liabilities (as defined below) and all other terms and conditions herein (the "Bonded Obligations").
[23] On the same day as Zurich issued the Performance Bond, the Payment Bond was issued for $142,113,966. The Claimants are not parties to the Payment Bond, they are beneficiaries of an express trust created by that Bond. ProjectCo as the Trustee holds the right to claim on the Payment Bond in trust for the Claimants. The terms, set out below, were similar to those of the Performance Bond:
This Bond is issued simultaneously with a Performance Bond and Multiple Obligee Rider and is subject to the terms and conditions of the Labour and Material Payment Bond and Multiple Obligee Rider attached hereto.
Bond No. 6343517 Bond Amount: $142,113,966.00
BONDFIELD CONSTRUCTION COMPANY LIMITED as Principal (hereinafter called the "Principal"), and ZURICH INSURANCE COMPANY LTD a corporation created and existing under the laws of Canada and duly authorized to transact the business of Suretyship in Canada as Surety, (hereinafter called the "Surety") are subject to the conditions hereinafter contained, held and firmly bound unto 2442931 ONTARIO INC., as Trustee (hereinafter called the "Obligee"), for the use and benefit of the Claimants their heirs, executors, administrators, successors and assigns, in the amount of ONE HUNDRED AND FORTY TWO MILLION, ONE HUNDRED AND THIRTEEN THOUSAND, NINE HUNDRED AND SIXTY SIX DOLLARS ($142,113,966.00) of lawful money of Canada for the payment of which sum well and truly to be made, the Principal and the Surety bind themselves, their heirs, executors, administrators, successors and assigns, jointly and severally, firmly by these presents.
[24] As is usual with such Bonds, the Surety agreed with the Obligee that if the principal defaulted on the contract, the Surety would either remedy the default, complete the contract or arrange for bids to completion. In this case, a Multiple Obligee Rider (“the Rider”) was executed naming SMH as the owner of the Project and adding SMH and BMO as additional obligees under both Bonds. Zurich’s obligations under the Bonds could only be triggered after an Obligee declared that BCCL was in default of its obligations under the Construction Contract.
[25] The Multiple Obligee Rider for the Bonds provides that BMO and SMH are entitled to enforce the obligations of Zurich and BCCL under the Bond as if named as an Obligee under the Bond. These guarantees were inducements for the lenders in advancing the Construction Loan as the security provided by Zurich as Surety reduced BMO’s risk of not having the Construction Loan repaid if BCCL defaulted.
The Project Begins to Falter
[26] BCCL was to have achieved Tower Interim Completion by November 27, 2017, at which time the first partial payment of the Construction Loan in the amount of $173,274,150 was due. Due to delays and defaults caused by BCCL’s insolvency, Tower Interim Completion has not yet occurred, and no amount of the Construction Loan has been repaid to BMO’s syndicate of lenders.
[27] In August 2018, Zurich learned of difficulties with BCCL’s performance and began to make payments to contractors and suppliers to keep work on the Project continuing. Zurich retained Perini Management Services Inc. to manage the Project and Ellis Don to provide construction management services.
[28] Zurich also entered into Ratification Agreements with some Trades to ensure they would keep working on the Project. The Ratification Agreements set out that payment was being made with respect to that Trade’s claim under the Payment Bond. The Ratification Agreements were premised on the validity of the Payment Bond.
[29] SMH issued a Notice of Default under the Project Agreement on November 2, 2018. This created risk for BMO as the Default Notice triggered a 90-day period following which SMH would be entitled to terminate the Project and BMO would risk recovery on its Construction Loan. Therefore, on November 16, 2018, BMO sent a notice to Zurich declaring BCCL in default of its obligations and making a demand on the Performance Bond. On December 4, 2018, BMO made demand for payment of the Construction Loan.
[30] Zurich did not recognize BMO’s call on the Performance Bond as valid, claiming that BMO had failed to exercise its step-in rights as an assignee of the Construction Contract. When it was clear that matters between Zurich and BMO could not be resolved, BMO obtained an Order appointing a Receiver over ProjectCo to make a call on the Performance Bond. The Receivership Order, dated December 21, 2018, stipulated that it did not affect Zurich’s rights as a Surety and did not constitute a waiver of any of Zurich’s entitlements.
[31] On the day of the Receivership Order, the Receiver made a call on the Performance Bond on behalf of ProjectCo. Zurich continued to fund the Project on what it described as a “reservation of rights process.” Zurich funded over $68M in costs for the Project before the facts giving rise to Zurich’s claim for rescission were discovered.
[32] On December 20, 2019, a court Order was made, on notice to and unopposed by Zurich, declaring that demand on the Performance Bond by the Receiver was valid and that Zurich had elected and was bound by Option 2.4 of the Performance Bond. That option required Zurich to pay the lesser of a) the remaining balance of the Bond amount; or b) the Obligee’s reasonable estimate of the cost to complete the Bonded Obligations under the Construction Contract, less the balance of the contract price. Option b) would provide BMO with all or a substantial part of the contract price to repay the Construction Loan.
[33] In March 2020, BMO and SMH brought a motion requiring Zurich to pay the amount in accordance with the option elected under section 2.4 of the Performance Bond. Zurich requested and was granted an adjournment to April 23, 2020 to allow Zurich time to file material. However, Zurich had already commenced its Rescission Action on April 16, 2020 as detailed below.
Zurich Discovers Collusion in the Procurement Process
[34] On March 10, 2020, a consultant for Zurich discovered hard copies of two emails dated May 18, 2014 between Mr. Aquino and a then unknown person using the email address bccldevelopment@bondfield.com. It was later determined that this was a secret email address used by Mr. Vas Georgiou (“Mr. Georgiou”) who was, at the time of the emails, the Executive Vice-President and Chief Administrative Officer of SMH with primary responsibility for the Project within SMH. Mr. Georgiou and Mr. Aquino have admitted that they would email one another on a Blackberry device regarding questions related to the Project and the procurement process.
[35] Forensic searches were then undertaken to locate the email communication. The investigation discovered that over 5,000 emails containing the terms “BCCLDevelopment”, “Vas Georgiou”, “vas.georgiou” and “gp8.ca” had been intentionally wiped from the archive system. The timing of the destruction of the emails coincided with articles in the Globe & Mail relating to questions about the business relationship between Mr. Aquino and Mr. Georgiou.
[36] Zurich alleges that Mr. Georgiou received financial benefits in exchange for the information and assistance provided to Mr. Aquino and BCCL. These facts are contested in the Rescission Action.
Zurich Commences Litigation
[37] After the discovery of emails in March 2020 and the results of the forensic searches, Zurich commenced the Rescission Action against Mr. Aquino, Mr. Georgiou, SMH, BCCL and ProjectCo on April 16, 2020. Zurich sought a declaration that the Performance Bond and the Payment Bond were rescinded, that the Receiver’s call on the Bond on behalf of ProjectCo was invalid and sought damages in relation to all amounts expended by Zurich on the Project to date. BMO is not a party to the Rescission Action. It is undisputed that BMO was not involved in or aware of the alleged fraud or collusion.
[38] In the Rescission Action, Zurich alleges that Mr. Aquino and Mr. Georgiou colluded to give BCCL an advantage in the procurement process. Zurich alleges that evidence in that action also reveals that the fraud extended to other employees of BCCL, SMH and other subcontractors.
[39] Zurich further alleges that the fraud and conspiracy goes deeper. It alleges that Mr. Georgiou exploited his position at SMH to influence the evaluation process in favor of BCCL and by convincing the evaluation team to move BCCL from fourth to third place in the RFQ process. This was critical since only three proponents were invited to bid and BCCL had previously been in fourth place in the RFQ process. Mr. John Keen, SMH’s discovery representative conceded that he now believes that Mr. Aquino and Mr. Georgiou colluded to influence the SMH procurement process.
[40] There are also allegations that Mr. Georgiou and others at SMH leaked helpful information to BCCL employees and that Mr. Georgiou even assisted BCCL in drafting its submissions for the procurement process. While Mr. Georgiou denies this, Zurich alleges that his interventions were pivotal in BCCL making it past the RFQ stage.
[41] As a result of the alleged fraud and collusion, Zurich claims that it is entitled to rescind the Bonds. That is, the fraudulent misrepresentations made by BCCL, ProjectCo and SMH induced Zurich to assume the default risk on a project by a contractor who was awarded the contract as a result of collusion between BCCL, ProjectCo and SMH.
[42] The nature and the scope of the fraud in the Rescission Action has yet to be determined, despite 19 days of discovery and more discovery remaining. There are hundreds of discovery refusals to deal with and many factual disputes. Over 700,000 documents have been produced by the Defendants in the Rescission Action.
[43] BMO and all but one of the Trades have provided “Statements of Position” in the Rescission Action. The Trades have sought similar relief to this Application as well as other relief in at least nine other bond and lien actions. Some of the Trades have also made claims against SMH and BCCL.
[44] More specifically, Ozz Electric Inc. has asserted a claim against Zurich under the Payment Bond for $30M on unpaid invoices. Noram Building Services Inc., a glass and glazing service provider, has asserted a claim against Zurich under the Payment Bond for $1.882M on unpaid invoices. NORR Limited, the architect for the Project, has asserted claims against Zurich and BCCL for $3.396M. Safway Services Canada Inc., a scaffolding service provider, has asserted a claim against Zurich under the Payment Bond for $181,509. Oakdale Drywall and Acoustics Ltd. have asserted claims against Zurich under the Payment Bond for $5.950M. Urban Mechanical Contracting Ltd., a mechanical and fire protection contractor, has made a claim against Zurich under the Payment Bond for $34.832M for its mechanical subcontract and $252,542 for its fire protection subcontract. WSP Canada Group Limited provided engineering services for the Project and asserts a claim under the Payment Bond for $1.213M for unpaid invoices.
[45] Each of the abovementioned Trades contracted with BCCL to provide services, labour and materials to the Project, rendered invoices to Zurich for unpaid amounts owed to them for those services and is a beneficiary of and a Claimant pursuant to the terms of the Payment Bond.
THE LEGAL ISSUES
1. Procedure – Are the Applications an Abuse of Process?
[46] Zurich argues that the Applications should be dismissed because they are an abuse of the Application process. That is, a party cannot initiate a new proceeding (these Applications) to determine issues in the first proceeding (the Rescission Action).
[47] Further, these are not Applications in which there are no material facts in dispute. There is no need to interpret the Bonds. The issue is that Zurich would never have issued them if it had been aware of the fraud in the procurement process.
[48] Zurich submits that the procedure sought by the Applications is akin to the one in a Rule 21.01(a) motion but to proceed in that manner requires that the moving party demonstrate that in order to avoid a trial, the result must be “plain and obvious.” The parties cannot place themselves in a better position and avoid the onerous test on a Rule 21 motion by putting forward these Applications. The procedure sought is novel, unheard of and an abuse of process.
[49] BMO’s position is that Zurich should not be surprised by this procedure. When BMO and SMH brought their motion to compel Zurich to pay out based on its election under Option 2.4, much discussion took place between the parties and the Court as to the best procedure to move matters forward. As per the Endorsement of Justice Conway, dated November 4, 2020, BMO and the Trades were never made parties in the Rescission Action. As such, this was the process that was authorized by the Court to bring matters forward. Justice Conway specifically stated that:
I see no reason why the non-party lenders and subtrades should not be entitled to seek this court’s determination of whether, as a matter of law, rescission is or is not an available remedy where (as they claim) the rights of innocent third parties are at stake.
[50] BMO also argues that this is an acceptable process under Rule 14 of the Rules of Civil Procedure, 1990, Reg. 194, because Zurich’s liability is within the interpretation of a contract (the Performance Bond). There are no disputed facts as they relate to BMO as they are not implicated in the fraud. There is, therefore, no reason to go to trial on the issue of whether rescission is an available remedy. That issue can be decided in the context of BMO’s Application.
[51] The position of the Trades is aligned with that of BMO on this point. Zurich chose to commence its Rescission Action without notice to the Trades. It would be unrealistic for Zurich to think that it could have proceeded with its Action, have the Payment Bond rescinded and then let the Trades know about that later.
[52] The Trades also rely on Justice Conway’s Endorsement of November 4, 2020, which was arrived at after much discussion by all parties as to the best way forward. Zurich’s position on this process is not surprising since they took the position on November 4, 2020, that the matter required a trial.
[53] I do not find that the procedure in this matter is an abuse of process. This is complex and multi-faceted litigation. Justice Conway, as the Case Management judge, determined a way forward that she concluded was the most efficient at the time and in consideration of the interests of the various stakeholders. The issue of whether rescission was an available remedy to Zurich had to be decided and Justice Conway quite rightly directed a route to that determination.
[54] The Applications will not be dismissed based on a procedural objection. The main issue must be determined.
2. Is Rescission an Available Remedy to the Applicants?
[55] Zurich seeks rescission of the Bonds on the basis of alleged impropriety and collusion between certain individuals at SMH and Bondfield in the procurement process for the Project. In essence, Zurich claims that if it had known of the alleged fraud, it would not have issued the Bonds. Zurich seeks rescission of the Bonds ab initio thereby relieving it of all obligations and providing it with a complete defence to the claims of both BMO and the Trades.
[56] Zurich argues that the material misrepresentations go to the root of the contract (or in this case the surety bond) and gives it, as the innocent party, the right of rescission. The principal (BCCL) and the Obligees (SMH and ProjectCo) who were aware of the fraudulent procurement process had a duty to disclose it to the Surety. BMO and the Trades wish to preclude Zurich from pursuing this relief on the grounds that they are innocent parties whose interests are dispositive of the issue.
[57] Zurich reminds the Court that all of the various issues raised prior to this hearing, including the dispute about the deemed undertaking rule, the attempt by SMH to bring a partial summary judgment motion, the contest about the Sealing Order and these Applications, are attempts by BMO, the Trades and the Defendants to the Rescission Action to avoid adjudication on the merits of a serious issue involving taxpayers’ money for a public hospital.
[58] Zurich relies on several arguments as to why rescission is an available remedy:
a. BMO is not an innocent party but is relying on enforcement of a claim from an integral participant in the fraud, as ProjectCo is the only party who has made a claim on the Performance Bond. Fraudulent concealment of material facts generally entitles a surety to rescind a bond.
b. The Trades’ claims are derivative of those of ProjectCo. They are therefore not third parties and can be in no higher position than ProjectCo with respect to asserting claims under the Payment Bond.
c. Rescission is an equitable remedy which is not available without an adjudication on the facts.
d. A third party cannot acquire and enforce rights under the very contract procured by fraud.
BMO’s Claims that it is an Innocent Third Party
Zurich’s Position
[59] BMO did not pursue a call on the Performance Bond as an additional named Obligee. Had it done so, it would have exercised its step-in rights and assumed the role of ProjectCo under the Construction Contract. ProjectCo is wholly owned by BCCL and both are controlled by Mr. Aquino who is at the centre of the alleged fraud. In short, payment on a Bond cannot be granted where the call on the Bond is made by one of the alleged fraudsters.
[60] BMO cannot portray itself as an innocent Obligee where it requests that the Court deny relief to Zurich but seeks to have ProjectCo’s claim paid when ProjectCo is a party to the fraud. Additionally, if BMO was pursuing its own call on the Performance Bond, which it has not elected to do, it would do so as an assignee of the Construction Contract. As an assignee of that Contract, it can have no higher rights than the assignor, ProjectCo.
BMO’s Position
[61] BMO’s position is that it would never have underwritten the risk involved in this project without the material inducement of the Performance Bond. It will suffer a substantial loss on its $230M loan if Zurich were relieved of its payment obligations when Zurich has not named BMO in the Rescission Action and BMO and its lender syndicate are innocent parties to the fraud. Zurich’s claims are against those involved with the alleged fraud.
[62] BMO’s position is that the Performance Bond does not require that it exercise its step-in rights before it can enforce payment under the Bond. The Bond also does not say that the Obligee who exercise the call on the Bond is the party required to enforce it. BMO is, therefore, entitled to enforce as an innocent co-obligee.
[63] BMO refers to the Order of Justice Conway dated December 20, 2020 in which there is a declaration that the demand on the Performance Bond by the Receiver, dated December 21, 2018, is valid and that Zurich has elected and is bound by Option 2.4 of the Performance Bond. Zurich declined to make payments in accordance with its election and instead commenced the Rescission Action without notice to BMO.
[64] Further, the BMO’s step-in rights are set out in the Lender’s Agreement between SMH, BMO and ProjectCo. Zurich is not a party to that Agreement and the step-in rights are permissive not mandatory as set out below:
- STEP-IN RIGHTS
(a) Subject to Section 8(b) and without prejudice to rights of the Lenders’ Agent to enforce the Security, the Lenders’ Agent may give SMH a Step-In Notice at any time.
[65] With respect to BMO’s position that it is an innocent third party, BMO relies on Harris Steel Ltd. v. Alta Surety Ltd., 1993 NSCA 147, 119 N.S.R. (2d) 61. That case involved trade claims under a labour and material bond issued with respect to the construction of a hotel at the Halifax airport. A bond for 50% of the contract price was issued, guaranteeing the performance of the construction contract and payment of suppliers of labour and materials.
[66] Alta denied the validity of the bond because the obligee (KMI) declined to pay the principal, Gem. The trial judge determined that KMI’s conduct did not release Alta from its obligations to pay the subcontractors. BMO noted that in coming to its conclusion to dismiss the appeal of the surety, the Court in Harris Steel relied on American jurisprudence (see paras. 22-24) which confirmed that the right of trades to claim against a surety on a bond cannot be defeated by an act or omission of an obligee if that act or omission was not authorized or participated in by the trades. That is, the trade claimants had done nothing to interfere with the performance of the contract by Gem and, as such, their rights were not affected.
[67] BMO submits that in the Harris Steel case, the surety, as in this case, argued that the sub trades’ claims were derivative and depended on the liability of the surety to the obligee. The Appeal Court did not agree.
[68] BMO’s position is that if Zurich wants to exclude liability to all co-obligees on the basis of misconduct that must have been expressly provided for in the Bond. In that regard, BMO relies on Arrangement relating to Investissements Hexagone Inc., 2017 QCCA 970 (translated). In that case Hexagone was awarded major construction contracts by the City of Montreal and the City of Laval (“the Cities”) who claimed that they were victims of bid rigging for public contracts by Hexagone in amounts exceeding $74M.
[69] Hexagone’s unpaid trades (about 140 trades) were owed over $25M on the construction contracts and claimed from the bonds issued by Aviva and Zurich. The Cities claimed they owed nothing to Hexagone due to the bid rigging and made claims under what was then Bill 26 to allow for the recovery of sums unjustly paid because of fraud in the course of granting public contracts. The Lower Court judge determined that the Cities’ refusal to pay Hexagone did not relieve the sureties of their obligations under the bonds.
[70] Aviva and Zurich appealed arguing that the Cities could not trigger the liability of the sureties on the bonds based on their default. They also argued that the Bill 26 claims were risks that were unforeseen when the sureties entered into the bonds. Forcing them to assume this additional risk would extend their liability beyond the contracts.
[71] In dismissing the appeal, the Court of Appeal held, at paras. 25-26, that:
Indeed, under the terms of the GMS Suretyship Contracts they have entered into, Aviva and Zurich assume all risks of default by Hexagone to its subcontractors, regardless of the nature or causes of such risks…
If Aviva and Zurich wished to exclude from the bond the risk of default by the Cities – whether or not such default was the result of fraud or malfeasance by the contractor towards the Cities – they had to either stipulate this or refuse to enter into the relevant GMS guarantor Suretyship Contracts. They did not. Aviva and Zurich are now attempting to unilaterally and retroactively add such an exclusion to the contracts, which they cannot do either….to decide otherwise would be to deny the very basis of the GMS Suretyship Contracts which they freely entered into and for which they were paid.
[72] BMO also relies on the decision in New Amsterdam Cas. Co. v. Bettes, 407 S.W.2d 307 (Tex. Civ. App. 1966) with respect to innocent lender co-obligees. That case involved four bonds issued by New Amsterdam Casualty Company as surety to L.A. Peterson as principal (“the Contractor”) for the construction of various buildings. One of the projects was abandoned after which time it was discovered that false payment certificates had been issued and that the overpayment on the certificates had been diverted by the Contractor to pay bills on other projects. A co-obligee, Bettes, had made loans on the construction contracts and sought to recover on the bond as an innocent party.
[73] The surety argued on appeal that the breach of contract by the Contractor released the surety from its obligations on the bond in relation to that project. The Court, quoting from the Commission of Appeals in Williams v. Baldwin, Tex.Com.App., 228 S.W. 554, held the following:
‘The rule is that, where the bond names the materialmen and laborers as obligees and is conditioned for the payment of claims for labor performed and material furnished, the sureties are not discharged from liability to persons furnishing labor and material by reason of the owner having made payments in violation of the bond unless they knew of such violation at the time of furnishing the material and performing the labor.’ (Citing authorities.)
[74] As per New Amsterdam above, BMO did not know of any “violations” of fraud either during or after the procurement process. As such, Zurich cannot be relieved of its liability under the Performance Bond.
[75] In Rachman Bag Co. v. Liberty Mut. Ins. Co. (1995), 46 F.3d 230 (2d. Cir.), Rachman as obligee sought payment on a bond from Liberty Mutual. In that case, Textiles of America (“TOA”) obtained a bond from Liberty Mutual. Unbeknownst to Liberty, the bond did not secure the business transaction as presented, rather the bond secured an arrangement whereby TOA would be repaid for money stolen by its President. The Court held that the issue of whether communications between Rachman and Liberty and the wording of the Agreement between Rachman and TOA amounted to misrepresentations were issues for trial.
[76] BMO argues that the Rachman Bag case solidifies its arguments because the surety’s obligations to the obligee were not terminated unless the obligee had a positive obligation to disclose information to the surety. In the case at bar, BMO had no knowledge of the collusion.
[77] BMO reminds this Court that a contrary decision that would do anything other than require Zurich to pay out on its obligations would undermine the foundation of surety law and the purpose of surety bonds.
The Trades as Innocent Third Parties
[78] The Trades take the position that as they are not Obligees, they cannot be tainted by what the Obligee has done.
[79] In Truro(Town) v. Toronto General Insurance Co. (1973), 1973 CanLII 169 (SCC), [1974] SCR 1129, the surety insurance company refused to pay a claim made by an electrical contractor under the bond because the Town of Truro had assigned its rights under the prime contract to a school board. Toronto General Insurance argued this was a fundamental change in the contract whereby the surety ceased to be the surety.
[80] The Court held, at p. 1141, as follows:
In Doe et al. v. Canadian Surety Co., and in each of the other cases cited to this Court, the acts of the obligee relate to the contract, performance of which is guaranteed by the surety. The Court has not been referred to any case, and I can find none, in which a material change in contract A, to which the obligee is a party, discharged a guarantee in respect of contract B, to which the obligee is not a party.
I would take the matter one step further and say that even if the construction for which the surety contends is the proper construction to be placed upon the bond and a material change in the prime contract would discharge the surety, the surety must none the less remain liable.
[81] As such, Zurich may pursue damages as against the named defendants in the Rescission Action, or it may defend the claims made by the various Trades. Proceeding otherwise would be highly prejudicial to the Trades given the guarantee provided by the Bond. The statutory and common law rights of the Trades as beneficiaries to seek recovery must therefore prevail.
[82] Finally, permitting Zurich to pursue rescission would ignore and extinguish the rights of innocent third parties.
Analysis – Impact of Rescission on the Rights of Innocent Third Parties
[83] Rescission is an equitable and discretionary remedy which may be refused on certain grounds even where rescission has been established. One ground for refusal is where granting the remedy would adversely affect the rights of an innocent third party. Both BMO and the Trades submit that Zurich is not entitled to rescission on this ground.
[84] This is confirmed by Professor Gerald H.L. Fridman in The Law of Contract in Canada, 6th ed. (Toronto: Carswell, 2011), as follows:
Rescission is only possible where to grant such remedy would not operate to the prejudice of a third and innocent party, who was not implicated in the original contract and so ought not to be affected adversely by the subsequent, later avoidance of that transaction. If granting rescission would have such an effect, a court of equity will refuse that remedy, leaving the plaintiff to his common-law remedy, that is, damages if it is available in the circumstances ...
[85] Where the rights of innocent third parties are at stake, the Court has refused to award the remedy of rescission leaving the plaintiff to pursue damages. However, this must be balanced with what Professor Fridman describes as the “exceptional and unusual cases.” These are the cases in which the contract resulted from fraud, undue influence or some other unconscionable conduct.
[86] Further, Kenneth Scott & Bruce Reynolds, Scott and Reynolds on Surety Bonds (Toronto: Carswell, 1994), referring to the Harris Steel case, confirm that Canadian authorities continue to rely on the English common law fiction that a claimant’s rights are only derived through its trustee as follows:
The Nova Scotia Supreme Court agreed that the Canadian authorities dealing with bonding claims appear to continue the fiction established by the English common law that a claimant, not being a party to the bonding contract, derives its right to claim only through the obligee as its trustee. The court also agreed that they were valid reasons for maintaining this well-established fiction. ...
[87] In this case I find that BMO, in making its call on the Bond via the Receiver through ProjectCo, is not a third party but an assignee whose rights are derivative of ProjectCo as per Harris Steel.
[88] In Isobord Enterprises Inc. v. Stone & Webster Canada Ltd., 2003 CarswellOnt 5464 (S.C.), aff’d 2004 CarswellOnt 2125 (C.A.), the Lender Plaintiffs provided financing to the Defendant for the construction of a particle board facility in Manitoba. Subordinate Debenture Holders had security on the same assets as Isobord but agreed to postpone their security to the Senior Lenders.
[89] The Defendant was required to provide a performance bond which was issued by Chubb Insurance. Various lenders were named as dual obligees on the bond. $58M was advanced by the Lenders for the project which ultimately failed. The Plaintiffs sued the Defendant and Chubb claiming that the Defendant had defaulted on the contract and that Chubb had failed to remedy the default.
[90] CIBC as one of the Senior Lenders took the position that the rights of the Subordinate Debenture Holders were derivative of the rights of Isobord and that the surety’s obligation to the obligee was no greater than the obligation of the principal. In granting summary judgment to the bank on behalf of the Senior Lenders (upheld on appeal), the Court held that the Subordinate Debenture Holders had no greater or lesser rights against the surety independent of rights held by Isobord under the performance bond.
[91] I accept and find that in the case at Bar, the rights of the Trades and BMO (similar to the Subordinate Debenture Holders in Isobord) are derivative of the rights of ProjectCo.
[92] BMO argues that Isobord has no application because it related to rights under an intercreditor agreement. I disagree. Although priorities under the intercreditor agreement were an issue in that case, the Court did decide the issue of whether co-obligees (the Debenture Holders) had different rights than the principal as against the surety. The Court determined that their rights were derivative and therefore not independent. That is, if ProjectCo’s rights are voidable for fraud then so are those of the beneficiary Trades and BMO.
[93] Apart from its rejection of the argument that its rights are not derivative of ProjectCo, BMO insists that an innocent third party cannot be affected by the misrepresentation of a co-obligee. BMO relies on Standard Brands Ltd. et al. v. Fox et al., 1972 CarswellNS 194 (NSSC TD). In that case the Court considered the effect of a fraud on a guarantee. Citing an American text, Pingrey on Suretyship and Guaranty, 2nd ed. (1913), at 151-153, as follows:
A surety or guarantor cannot interpose the fraudulent or false representation of his principal as a defense to the payment of a note, without connecting the payee with such representations; the surety is not relieved if the false representations are made by a third person.
[94] However, the facts of this case do not simply relate to a surety and a principal but to the Trades as beneficiaries of the express trust created by the Bond. As such, ProjectCo and SMH owed fiduciary obligations to the Trades by disclosing their knowledge and role in the fraudulent scheme and the resultant possibility of the voidability of the Bond. The breach of those fiduciary duties was out of the control of Zurich and I agree with Zurich that it cannot be responsible for a risk it did not know of nor agree to bear.
[95] In terms of the case law relied upon by BMO and the Trades, I find that the Hexagone case relied upon by the Trades and BMO does not apply. That case was about default on a contract by the two Cities. Further, that case concluded that if Aviva and Zurich wished to exclude default as a result of fraud, they should have included that provision in their bond contract. Respectfully, it is not necessary as a matter of law to require an exclusion for fraud in every contract. Fraud always has its own remedies regardless of whether they are specifically stated in the contract.
[96] In the U.S. cases cited by BMO, the New Amsterdam case involves a contractor issuing false completion certificates. The fraud was perpetrated well after the bond was issued. In Rachman Bag the issue was whether an obligee had to disclose a material risk to the surety. The Court determined that the matter required a trial. I agree with Zurich that the Rachman Bag actually assists its position in that in Rachman, the Court found a positive obligation on the part of obligee to disclose facts of which it was aware to the surety. In general, I do not find that American cases cited to be of assistance in determining whether Zurich is entitled to its remedy or not.
[97] In terms of the innocent third-party rights, BMO insists that such rights will always defeat a claim where rescission is sought as a remedy. I do not agree. In Kingu and Kingu Holdings Inc. v. Walmar Ventures Ltd. (1986), 1986 CanLII 142 (BC CA), 10 B.C.L.R. (2d) 15, 1986 CarswellBC 2 (B.C. C.A.), at para. 18, the Court set out the test for granting rescission in a case of innocent misrepresentation. While the case at Bar deals with fraud, similar considerations apply. In Kingu, McLaughlin, J.A. (as she then was), determined that “no innocent third parties must have acquired rights for value with respect to the contract property.” If such a subsequent transaction was entered into, it is a bar to rescission. Neither BMO nor the Trades were induced to enter into any subsequent transactions as a result of the Bonds.
Can the Trades’ Statutory Rights of Action be Extinguished by Equity?
[98] The Trades argue that the s. 85(1) of the Construction Act provides a clear right of action for claims under a labour and material bond and that equitable doctrines, therefore, do not apply. However, once Zurich learned of the fraud it immediately commenced the Rescission Action. If successful and the Payment Bond is rescinded ab initio¸ the Payment Bond would not be “in effect” as required by the wording of the section.
…if a labour and material payment bond is in effect in respect of an improvement and the principal on the bond defaults in making a payment guaranteed by the bond, any person to whom the payment is guaranteed has a right of action to recover the amount of the person's claim, in accordance with the terms and conditions of the bond, against the surety and the principal. [emphasis added]
[99] I agree with Zurich that the Legislature cannot have intended that the liability of a surety be absolute. That is, common law and equitable remedies are still available; otherwise, the section would stipulate that the Surety’s liability arose upon execution rather than when the Bond is “in effect.”
[100] That section of the Construction Act also makes clear that the right of action by the claimant must be in accordance with the terms of the Bond. This means that the express trust created in the Payment Bond imposes limits on any statutory rights acquired by the Trades under the Construction Act. As such, the Trades’ rights as Claimants are subject to the provisions under the Payment Bond and through their Trustees ProjectCo and SMH. As ProjectCo and SMH are alleged to have engaged in fraudulent conduct, claims by the Trades are subject to Zurich’s equitable defences.
Do the Ratification Agreements Affect the Availability of Rescission to Zurich?
[101] The Trades argue that those Trades that entered into Ratification Agreements with Zurich are entitled to treat those Ratification Agreements as an independent obligation which confirms Zurich’s requirement to pay the Trades under the Payment Bond.
[102] I do not agree. The Ratification Agreements are wrapped up in actions taken by Zurich prior to March 2020 when it discovered the collusion in the procurement process. It appears that both Zurich and the Trades were mistaken about the risks undertaken in the bonding process and providing services for the Project. As such, the Ratification Agreements would be either void for mutual mistake or rescinded along with the Bonds.
Summary of Finding and Conclusions
[103] In dismissing the Applications, I rely on the following findings and conclusions based on all of the above:
a. The Trades’ rights, as beneficiaries under the express trust created by the Payment Bond, are derivative to and no greater than the rights of ProjectCo and SMH, the Trustees.
b. The Trades cannot rely on the Trustees’ actions in allegedly defrauding Zurich as a basis to make claims against Zurich.
c. The question of the Trades’ innocence cannot be answered for all Trades without full discovery and a trial. While that is unfortunate for those who may not be implicated in the fraud, all parties in these Applications are, to varying degrees, the victims of fraud.
d. BMO is not an innocent party based on the express trust established by the Bonds, whereby BMO is enforcing the rights of ProjectCo whom it knew was aware of the fraud.
e. Given the lack of authority on the effect on Bond calls of fraud in relation to the procurement process, it would be inequitable to deprive Zurich of any remedies at this stage where discoveries in the Rescission Action remain incomplete and the uncovering of fraudulent activity may continue.
f. The right of rescission relates back to the time of election. As such, if Zurich is successful in making out its claim for rescission, the Bonds would be of no effect and the Trades’ statutory rights to claim under the Payment Bond would be unavailable. The Trades would be free to pursue claims against SMH or any of the other Defendants to the Rescission Action.
g. Equitable remedies are not determined in a vacuum and must be decided on a factual record. Without a complete record, including all of the allegations related to the fraud implicating the various parties, the Court is unable to determine at this stage whether or not the remedy is available to Zurich. Certainly it has not been shown that rescission is unavailable as a matter of law.
Orders
[104] The Applications are hereby dismissed.
Going Forward
[105] I am agreeable to convening a case conference with all parties and non-parties for 1.5 hours to discuss the following:
a. How the remaining claims may be constituted and whether they should be joined, heard one after the other and whether new claims need to be commenced to ensure all parties are properly involved.
b. Whether the parties are agreeable to a judicial mediation.
c. A schedule for all matters.
COSTS
[106] If the parties cannot agree on costs, I will receive written submissions of no more than 6 pages (double spaced), exclusive of any Bill of Costs or Offer to Settle. Costs submissions are due on a 7-day turnaround starting with Zurich, 7 days from the date of release of this judgment. Costs submissions must be hyperlinked to any references to caselaw or Application materials. Costs submissions are to be sent directly to my assistant at therese.navrotski@ontario.ca. If no costs submissions are received within 35 days, there will be no order as to costs.
C. Gilmore, J.
Released: April 8, 2021
COURT FILE NO.: CV-20-00652065-00CL and CV-20-00651774-00CL
DATE: 20210408
ONTARIO
SUPERIOR COURT OF JUSTICE
BETWEEN:
Urban Mechanical Contracting Ltd., Ozz Electric Inc., Oakdale Drywall & Acoustics Ltd., NORR Limited, WSP Canada Group Limited, Noram Building Systems Inc. and Safway Services Canada Inc.
Applicants
- And –
Zurich Insurance Company Ltd.
Respondent
AND BETWEEN:
Bank of Montreal as Administrative Agent
Applicant
-and-
Zurich Insurance Company Ltd.
Respondent
JUDGMENT ON APPLICAITONS
C. Gilmore, J.
Released: April 8, 2021