Anti-deprivation rule applies to construction contracts

In Chandos Construction Ltd. v. Deloitte Restructuring Inc., the Supreme Court of Canada confirmed the application of the common law anti-deprivation rule in the context of a Bankruptcy and Insolvency Act (“BIA”) proceeding. The anti-deprivation rule renders void any contractual clause that provides for value to be removed from the reach of the creditors of an insolvent entity upon a bankruptcy or insolvency.

We have previously written an Update outlining the Supreme Court’s decision in Chandos, which can be accessed here. In this post, we examine the specific contract and clause that triggered the anti-deprivation rule.

Stipulated price subcontract

In this case, the contract at issue was a stipulated price subcontract between Chandos Construction Ltd., as general contractor, and Capital Steel Inc., as subcontractor. The contract related to the construction of a condominium project in St. Albert, Alberta.

The clause at issue dealt with the implication of a Capital Steel Inc. insolvency, and reads as follows:

VII Q Subcontractor Ceases Operation

In the event the Subcontractor commits any act of insolvency, bankruptcy, winding up or other distribution of assets, or permits a receiver of the Subcontractor’s business to be appointed, or ceases to carry on business or closes down its operations, then in any of such events:

  1. this Subcontract Agreement shall be suspended but may be reinstated and continued if the Contractor, the liquidator or Trustee of the Subcontractor and the surety, if any, so agree. If no agreement is reached, the Subcontractor shall be considered to be in default and the Contractor may give written notice of default to the Subcontractor and immediately proceed to complete the Work by other means as deemed appropriate by the Contractor, and
  2. any cost to the Contractor arising from the suspension of this Subcontract Agreement or the completion of the Work by the Contractor, plus a reasonable allowance for overhead and profit, will be payable by the Subcontractor and or his sureties, and
  3. the Contractor is entitled to withhold up to 20% of the within Subcontract Agreement price until such time as all warranty and or guarantee periods which are the responsibility of the Subcontractor have expired and,
  4. the Subcontractor shall forfeit 10% of the within Subcontract Agreement price to the Contractor as a fee for the inconvenience of completing the work using alternate means and/or for monitoring the work during the warranty period.

The majority of the Supreme Court found that VII Q (d) violated the anti-deprivation rule because it sought to remove value from the subcontractor’s estate upon an insolvency or bankruptcy.  However, the Supreme Court found that clauses (a)-(c) were valid since they did not remove value from the insolvent’s estate.

Key takeaways

The Supreme Court has confirmed that the anti-deprivation rule operates within construction contracts, meaning parties to such contracts need to be aware that any clauses seeking to remove value from an estate upon a triggering event of insolvency or bankruptcy will be read as void and unenforceable.

This does not mean, however, that parties are left without protection.  As noted by the majority of the Supreme Court, parties wishing to protect themselves against the insolvency or bankruptcy of their contracting counterparty may include clauses in an agreement that:

  • eliminate property from the estate, but do not eliminate value;
  • apply where the effect is triggered by an event other than insolvency or bankruptcy; or
  • take security, require insurance or require a third-party guarantee.

With respect to the final point, while the Supreme Court did not elaborate on what types of security could be contemplated, we would expect that such security could include a letter of credit or other financial instrument which could be drawn against in the event of default.