The recent Ontario Superior Court of Justice decision in Walsh Construction v. Toronto Transit Commission¹ provides guidance on how subcontractor flow-through claims may be advanced by a general contractor against an owner.

In this case, Walsh, a general contractor, attempted to flow-through certain subcontractor delay claims to the Toronto Transit Commission (TTC), the owner of the project, after Walsh had settled the claims with the subcontractors pursuant to certain release and assignment agreements, which are commonly known in the US as liquidating agreements. The Court ultimately held that Walsh could not obtain recovery from the owner for the damages suffered by its subcontractors after Walsh had been released of any possible liability for the same losses. Walsh has appealed the decision to the Ontario Court of Appeal.

Background

The dispute pertains to a contract between TTC and Walsh for the construction of the Pioneer Village Station, one of six subway stations forming the Toronto-York Spadina Subway Extension. While the case covers many different issues, including contractual delay, design issues, liquidated damages, and scope changes, this insight focuses its analysis on the Court’s treatment of Walsh’s flow-through subcontractor claims.

Decision

1. Lack of privity of contract

Before addressing Walsh’s ability to flow-through subcontractor’s claims, the Court first confirmed there was no privity of contract between TTC and the subcontractors.

TTC never entered into an agreement with any subcontractors. It hired Walsh as its general contractor and Walsh then subcontracted for the various services and work required to complete the project. Justice Hood noted that it was clear between the parties that there was no privity of contract and therefore the subcontractors could not bring a claim for breach of contract damages against TTC:

The subcontractors clearly acknowledge this in their contracts with Walsh. As a result, the subcontractors have no direct cause of action against TTC, only against Walsh.

The Court found that flow-through claims are a procedural device used to get around this lack of privity of contract between the subcontractors and the owner. However, for a flow-through claim to be successful, the general contractor must at a minimum be potentially liable to its subcontractors for the damages being claimed.

In this instance, the Court found that Walsh had no liability for the subcontractor flow-through claims, potential or otherwise, as it received a full release pursuant to the liquidating agreements.

2. Release of Walsh’s liability fatal to claim

The Court found that Walsh had entered into two types of liquidating agreements: (i) assignment liquidating agreements; and (ii) non-assignment liquidating agreements. Under the assignment liquidating agreements, Walsh paid an amount representing all of the contract payments due and payable to the subcontractor and the subcontractor assigned its claim to Walsh. For the non-assignment liquidating agreement, Walsh paid an amount representing the contract payments due and payable to the subcontractor but if Walsh recovered anything from TTC, it would have to pay the subcontractor a portion of the amount recovered dependent on whether it was a global recovery or specific to the subcontractor’s damage claim. Critically, pursuant to both types of agreements, Walsh was released of all liability to the subcontractor for further claims under the subcontract.²

The Court held that under Canadian law a contractor is only entitled to recover damages from an owner that they have actually incurred or expect to incur as a result of the owner’s breach of contract.^[3] Since Walsh had been fully released of all liability to the subcontractors pursuant to the liquidating agreements, there was no basis on which to find TTC liable to Walsh for any of the subcontractor flow-through claims.

In dismissing the subcontractor flow-through claims, Justice Hood expressed concern regarding the fairness of contractors using liquidating agreements to circumvent the lack of privity between an owner and a subcontractor:

Caselaw in the United States seems to accept liquidating agreements as being a valid way to maintain liability and to flow through both the subcontractor claim and the contractor’s liability to the subcontractor to the owner. While perhaps useful in minimizing litigation, in my view the attempt to place liability upon the owner for the subcontractor’s damages, where the owner has not contracted with the subcontractor and where the contractor has effectively removed itself from the picture, is not right. This makes these claims untenable.⁴

Further to this point, the Court observed that the use of liquidating agreements “removes any motivation or requirement” for contractors to scrutinize or minimize subcontractor claims, despite being in the best position to do so. It did not take positively to this attempt pass on a claim which Walsh had not vetted and been released of liability. By way of illustration, it was noted that Walsh had failed to take advantage of potential contractual defences available in its subcontracts, such as express terms that disentitled its subcontractors to additional costs for delay, and a waiver by the subcontractors of any claims to compensation for which Walsh could not in good faith certify.⁵

The Court’s comments on Walsh’s failure to scrutinize the subcontractor claims before asserting them against the owner as flow-through claims suggests that general contractors may be expected to demonstrate a minimum level of due diligence in assessing or vetting subcontractor claims before seeking recovery for them against an owner.

Going forward

The finding of the Court in Walsh raises important questions regarding the implications of liquidating agreements that formally release the general contractor from any liability for their subcontractors’ flow-through claims, relative to the use of “pay if paid” clauses in subcontracts, which limit a contractor’s liability for a subcontractor’s delay damages to whatever amounts can be recovered against the owner.

Prior Ontario case law authority has suggested that “pay if paid clauses” could be interpreted as making the general contractor liable for their subcontractor’s delay damages, subject to the condition precedent that the contractor recover damages from the owner in respect of the delay.⁶ In Ledcor Construction Ltd. v. Carleton University,⁷ the Court found that if the subcontract gave rise to a positive obligation on the general contractor to advance the subcontractor’s delay claim against owner, the failure to do so would make the contractor liable to the subcontractor. The Court held that this potential liability against the contractor could be sufficient to provide a legal basis for the flow-through claim to be asserted against the owner. This approach was considered to be “more in keeping with the harmonious operation of the construction pyramid.”

However, the question of whether a subcontractor flow-through claim could be dismissed on the basis of a “pay if paid” clause was not definitively decided in Ledcor. The Court merely rejected the owner’s attempt to have the flow-through claim dismissed summarily on this basis. Importantly, there was also no indication in the Ledcor case that the parties had entered into a liquidating agreement, or any other kind of agreement that released the contractor of liability. As a result, it remains to be seen whether the Ontario Court of Appeal will use the appeal of the Walsh decision to endorse or reject the treatment of flow-through claims proposed but not decided in the Ledcor line of decisions, or whether the cases will be distinguished on the basis of Walsh’s liquidating agreements.

Presently, the one definitive takeaway from the Walsh decision is that, pending the outcome of the appeal, general contractors and subcontractors should exercise caution when considering entering into liquidating-type agreements in respect of subcontractor claims for damages for which recovery against the owner may be sought.

If you are interested in a more detailed discussion regarding the Walsh decision and its implications for the construction industry, we encourage you to attend Dentons Hard Hat Forum on October 30, 2024, as it will be one of the main topics of the forum.

We look forward to seeing you there! 

For more information, please reach out to the authors, Morgan Burris and Aljosa Zenicanin. The authors wish to thank articling student Ramy Sarouf for his contributions to this article.

[1] Walsh Construction v. Toronto Transit Commission et al., 2024 ONSC 2782.

[2] Walsh, paras. 331, 333 and 334.

[3] Walsh, para. 343.

[4] Walsh, para. 350.

[5] Walsh, para. 346.

[6] Ledcor Construction Ltd. v. Carleton University, 2009 CarswellOnt 1213 at para. 17; Ledcor Construction Ltd. v. Attorney-General of Canada, 2013 ONSC 2407 at para. 22.

[7] Ledcor Construction Ltd. v. Carleton University, 2009 CarswellOnt 1213.