Holdback rules could cost you thousands of dollars more than you expected.
Construction holdbacks are one of the most confusing elements of a renovation contract. The basic holdback rule in Ontario is this: by law, the homeowner should wait 45 days after the work is finished before paying the last 10% of the contract price. Now here’s the major confusion: this delay and payment is not there for final adjustments or fixing problems. It is there to cover disputes between your contractor and his suppliers – disputes that you, the homeowner, might not even know about.
Before we go any further, let’s be clear that I am an engineer, not a lawyer, and I am not qualified to give legal advice. However, I’m still going to share my thoughts, since real legal advice is typically too expensive and too complicated to understand anyway. You can try reading the Construction Lien Act yourself, but judges aren’t necessarily bound by the written law, especially when it’s this messy. For example, in Forte Aluminium Ltd. v. Frank Plastina Investments Ltd. (1989), the judge ruled that although the act could be interpreted one way, it was so widely understood differently that it was better to go along with the majority view. So take anything you read with a grain of salt; I do not believe anyone can ever predict what might happen in court.
Why are holdbacks required by law?
Thomas Jefferson and James Madison modified the concept of maritime liens to apply to buildings
It’s hard to make any sense out of modern holdback rules without looking at the history of liens. The concept of a lien goes back to medieval times when it originally applied to ships, but we won’t need to go back quite that far. We can start when Thomas Jefferson and James Madison came up with the idea of applying liens to buildings. The idea was to encourage builders to take on projects without demanding full payment in advance.
Without the lien system, builders would have a greater risk than merchants. If you fail to make payments on your car or refrigerator, a merchant can eventually repossess it. But what can a builder do if the homeowner does not pay? If he came to rip the pipes out of your property, that would cause disproportionate harm to your home, and the recovered pipes would be worthless to him anyway. By placing a lien on a building, the builder records that part of the building’s value belongs to him, and he will get his money when the building is eventually sold.
The original 18th century American implementation was a simple system designed to minimize lawsuits. Then the lawyers got a hold of it and figured out how to abuse and counter-abuse the system, and answered their own abuses with ever more complicated laws. It’s now more complicated to preserve a lien than it is to sue directly for the money. Everybody loses, except for the lawyers. On top of that, Ontario’s current law seems to have been written with condo developments in mind, as have most articles online, and it becomes hard to figure out how the system is supposed to work for residential renovations.
The holdback concept was introduced to protect homeowners against liens, which were originally meant to protect builders against homeowners who did not pay. The end result is that all construction companies and material suppliers in Ontario are now forced, not just encouraged, to finance at least 10% of any project, secured by a lien on your house. This is supposed to represent the “notional profit” for all of the companies involved in the renovation. Then the banks caught on, so if you’re borrowing money to renovate, they may refuse to lend you the last 10% until the work is done.
Here’s the key point to understand: since this 10% holdback is essentially a loan from your builders, not a final payment, that means that you agreed to pay it when you made the progress payments. The question that takes 45 days to resolve is who should the loan be paid out to, nothing to do with the quality of the work.
If you really want to withhold some money until you are satisfied that a problem has been fixed, that’s called a “set-off,” and it needs to come out of an earlier progress payment, not the final holdback. For example, imagine a $100K contract structured like this:
- $40K phase 1
- $50K phase 2
- $10K as holdback 45 days after final completion
Suppose that the project runs into a problem, and the contractor agrees to take $10K off the total price to compensate you. Now that the total project price is $90K, and the legally required holdback is $9K. So 10% of the price reduction can come out of the holdback, but the other $9K has to come out of the phase payments. Here’s the revised payment schedule:
- $40K phase 1
- $41K phase 2
- $9K as holdback 45 days after final completion\
If you’ve already paid the two phase payments, then the contractor owes you a $9K refund right away, and you will owe him $9K back after the 45 days. Do you think you can trust your contractor to cancel out those two debts? Even if he’s professional and trustworthy, it’s not up to him. Any of his subcontractors, or their subs, or their material suppliers, could come out and claim that holdback during those 45 days. If that happens, you really want to know that your contractor will give you the $9K refund he owes you.
Exceptions to holdbacks
Just in case that was too simple, the holdback rule is not universal, and it is often incorrectly applied. If your renovation contract includes goods that can be repossessed, like a refrigerator, you cannot keep a holdback on that portion of the contract. If a contractor does a simple repair job himself, without hiring any subcontracts or buying any materials, then there is no other party who could surprise you with a lien, and I’m not sure what would be the point of waiting 45 days. On large projects, (usually condos,) portions of the holdback can be released in proportion to the finished work based on statutory declaration. Rules also vary by jurisdiction; for example British Columbia does not allow holdbacks from architects or engineers.
Weigh your options before deciding to sue.
You will find many editorials written by lawyers who advise you to take a hard line and demand your rights, but I find a conciliatory approach is usually more productive. Keep in mind that lawyers profit from adversity, but you don’t. Many contractors out there genuinely misunderstand the holdback laws and may respond well if you educate them. Or maybe your contractor can educate you about some subtleties of the law that you were not aware of. Even if you are sure you are right, and have a lawyer to back you up, the court’s eventual decision might surprise you.
Many homeowners are intimidated by contract negotiations, so it’s good for them to pump themselves up with that hard-line advice before picking up the phone. But if your contractor offers you reasonable assurances or compensation, sleep on it for a night before making a decision. In the end, you might still have to fire him, withhold payment, or even take him to court, but make sure you’ve tried talking it out first.
If you don’t think your contractor’s work is finished, then don’t sign off anything saying it is. If you do, then that last holdback payment will come due 45 days later, regardless of whether your contractor came back to do any more work. You are not allowed to keep it as a penalty for poor quality or incomplete work.
If you are happy that everything was done right, then you still need to wait those 45 days before sending the last cheque, no matter how much you trust your contractor. Otherwise you could wind up paying the holdback twice, so that your renovation costs you 10% more than you expected.
That’s what Holmes says, from the TV show Holmes on Homes.