Citadel Assurance v. Johns-Manville Canada, [1983] 1 SCR 513

Supreme Court of Canada

Citadel Assurance v. Johns-Manville Canada, [1983] 1 S.C.R. 513

Date: 1983-05-17

Citadel General Assurance Company (Defendant) Appellant;

and

Johns-Manville Canada Inc. (Plaintiff) Respondent;

and

Her Majesty the Queen in Right of the Province of Ontario as Represented by the Ministry of the Environment, Trustee (Plaintiff);

and

John Carlo Limited (Defendant).

File No.: 16687.

1982: November 16; 1983: May 17.

Present: Laskin C.J. and Ritchie, Estey, McIntyre and Lamer JJ.

ON APPEAL FROM THE COURT OF APPEAL FOR ONTARIO.

Insurance—Labour and material contract bond—Default in payment by contractor—Supplier not participant as lien claimant under The Mechanics’ Lien Act—Action commenced against surety under the bond for monies owing—Whether or not claim under bond defeated for want of strict compliance with bond’s notice provisions—Whether or not first necessary to exhaust all mechanic’s lien remedies and to set off amounts so awarded, before claiming under bond—The Mechanics’ Lien Act, R.S.O. 1970, c. 267, s. 11

A contractor, supplied with pipe for an Ontario government construction project, defaulted in the purchase price. The contractor had entered a labour and material bond with appellant’s predecessor as surety and the contractor as principal. The Ministry, as obligee, was trustee for all claimants and every claimant had the right to sue under the bond for payment of monies owed by the principal under its contract with the principal. The bond specified the notice to be given by the claimants. Respondent, which did not participate as a lien claimant in a mechanics’ lien action, commenced an action under the bond, and gave appellant notice in accordance with the bond requirements but did not comply strictly with the bond terms in giving notice to

[Page 514]

the ministry and contractor. At issue were whether or not strict compliance with the bond’s notice provisions were prerequisite to the action and whether or not respondent was obligated to exhaust all remedies under The Mechanics’ Lien Act and credit the amount received from the hold-back against the surety.

Held: The appeal should be dismissed.

The rules hitherto applicable to accommodation sureties were in many ways inapplicable, as unrealistic, to cases where professional sureties undertook surety contracts for profit in the ordinary course of their business. The compensated surety cannot escape the liability found in the bond merely because of a minor variation in the guaranteed contract or because of a trivial failure to meet the bond’s conditions. Here, the object of the notice provisions in the bond was fully achieved within the time limit imposed and appellant suffered no prejudice. The whole object of the bond would be defeated were appellant discharged. The relationships between the parties and the true basis of the bond contract were unaffected by the failures.

Respondent should not fail because it did not pursue any remedy under The Mechanics’ Lien Act. The imposition of an implied obligation on a claimant to exhaust all other remedies before claiming under the bond would be to defeat the very purpose underlying the bond. Appellant here was not prejudiced by respondent’s failure to pursue its claim,

Capel v. Butler (1825), 4 L.J. Ch. 69; Calvert v. London Dock Co. (1838), 7 L.J. Ch. 90; Pearl v. Deacon (1856), 26 L.J. Ch. 761; levins v. Latvian (Toronto) Credit Union Ltd. (1977), 19 O.R. (2d) 53; Re Wolmershausen; Wolmershausen v. Wolmershausen (1890), 62 L.T. 541; Bryans v. Peterson (1920), 47 O.L.R. 298; Royal Bank of Canada v. Girgulis, [1979] 3 W.W.R. 451; Bank of Montreal v. Robertson, [1976] 5 W.W.R. 680; Rose v. Aftenberger, [1970] 1 O.R. 547; Town of Truro v. Toronto General Insurance Co., [1974] S.C.R. 1129; Klockner-Moeller Ltd. v. Fidelity Insurance Company of Canada, 1977, unreported decision of

[Page 515]

Supreme Court of Prince Edward Island; Alberta Concrete Products Co. Ltd. v. Simcoe & Erie General Insurance Co. (1978), 15 A.R. 437; Fleisher Engineering & Construction Co. v. United States, 311 U.S. 15 (1940); Houston Fire and Casualty Insurance Co. v. United States, 217 F.2d 727 (1954); Liles Construction Co. v. United States, 415 F.2d 889 (1969); United States v. Cortelyou & Cole, Inc., 581 F.2d 239 (1978); Bauer v. Bank of Montreal, [1980] 2 S.C.R. 102; referred to; La Rivière Inc. v. Canadian Surety Co., [1973] C.A. 150, applied.

APPEAL from a judgment of the Ontario Court of Appeal (1981), 123 D.L.R. (3d) 763, 32 O.R. (2d) 697, dismissing the appeal of Citadel General Assurance Company from a judgment of R.E. Holland J. Appeal dismissed.

R.B. Moldaver and D.W. Glaholt, for the appellant.

E.M. Kelday for the respondent.

The judgment of the Court was delivered by

MCINTYRE J.—The respondent Johns-Manville Canada Inc. supplied pipe to John Carlo Limited, a contractor, for use in the execution of a contract with the Ontario Ministry of the Environment for the construction of certain works in the Town of Thessalon, Ontario. The last materials were shipped on October 28, 1977. The contractor defaulted in payment of the purchase price, leaving an unpaid balance due to the respondent in the amount of $80,068.16. As a term of the contract between the Minister of the Environment and the contractor, the contractor entered into a labour and material payment bond which named the CNA insurance company (the predecessor of the appellant) as surety and the contractor as principal. The conditions of the bond so far as they are relevant to the issues raised in this appeal are set out hereunder:

1. A Claimant for the purpose of this Bond is defined as one having a direct contract with the Principal for labour, material, or both, used or reasonably required for use in the performance of the Contract, labour and material being construed to include that part of water, gas, power, light, heat, oil, gasoline, telephone service or rental equipment, directly applicable to the Con-

[Page 516]

tract provided that a person, firm or corporation who rents equipment to the Principal to be used in the performance of the Contract under a contract which provides that all or any part of the rent is to be applied towards the purchase price thereof shall only be a Claimant to the extent of the prevailing industrial rental value of such equipment for the period during which the equipment was used in the performance of the Contract.

2. The Principal and the Surety hereby jointly and severally agree with the Obligee, as Trustee, that every Claimant who has not been paid as provided for under the terms of his contract with the Principal, before the expiration of a period of ninety (90) days after the date on which the last of such Claimant’s work or labour was done or performed or materials were furnished by such Claimant, may as a beneficiary of the trust herein provided for, sue on this Bond, prosecute the suit to final judgment for such sum or sums as may be justly due to such Claimant under the terms of his contract with the Principal and have execution thereon. Provided that the Obligee is not obliged to do or take any act, action or proceeding against the Surety on behalf of the Claimants, or any of them, to enforce the provisions of this Bond. If any act, action or proceeding is taken either in the name of the Obligee or by joining the Obligee as a party to such proceeding, then such act, action or proceeding, shall be taken on the understanding and basis that the Claimants, or any of them, who take such act, action or proceeding shall indemnify and save harmless the Obligee against all costs, charges and expenses or liabilities incurred thereon and any loss or damage resulting to the Obligee by reason thereof. Provided still further that, subject to the foregoing terms and conditions, the Claimants or any of them may use the name of the Obligee to sue on and enforce the provisions of this Bond.

3. No suit or action shall be commenced hereunder by any Claimant:

(a) unless such Claimant shall have given written notice within the time limits hereinafter set forth to each of the Principal, the Surety and the Obligee, stating with substantial accuracy the amount claimed. Such notice shall be served by mailing the same by registered mail, or served in any manner in which legal process may be served in the Province of Ontario, to the Principal and Surety at any place where an office is regularly

[Page 517]

maintained for the transaction of business by such persons, and to the Obligee addressed to the attention of the Manager, Claims and Contract Section, Project Co-ordination Branch, Ministry of the Environment, at 40 St. Clair Ave. W., Toronto. Such notice shall be given

…

(2) in respect of any claim other than for the holdback, or portion thereof, referred to above, within one hundred and twenty (120) days after the date upon which such Claimant did, or performed, the last of the work or labour or furnished the last of the materials for which such claim is made, under the Claimant’s contract with the Principal.

The first condition defines a claimant in terms which include the respondent. The second makes the obligee (the Minister of the Environment) a trustee for the claimant and gives the claimant, though not itself a party to the bond, the right to sue under the bond for the payment of monies owing to it by the principal in accordance with the claimant’s contract with the principal. The third condition prescribes the notice to be given when action is taken by the claimant.

The respondent commenced action against the principal and the surety on August 14, 1978, claiming the balance owing for the supply of material in the amount of $80,068.16 with interest at 12 per cent until payment. The action succeeded and judgment was obtained after trial before R.E. Holland J. in the Supreme Court of Ontario on July 8, 1980. The judgment was for $80,068.16, together with interest at 12 per cent per annum from February 1, 1978 to July 8, 1980 in the sum of $23,375.52, making a total of $103,443.68, and costs. An appeal was taken to the Ontario Court of Appeal (Houlden, Blair and Wilson JJ.) which was dismissed on May 15, 1981 with short reasons given by Houlden J.A. This appeal comes by leave granted October 20, 1981.

Before commencing the proceedings, the respondent gave notice to the appellant surety by

[Page 518]

registered mail within 120 days in accordance with the provisions of the third condition of the bond. Notice was also given to the Minister of the Environment within the 120-day time limit, but by ordinary mail. The principal received no written notice but was kept informed of the proceedings and, in the view of the trial judge, suffered no prejudice. The notice provisions were not therefore strictly complied with before action was commenced. It should be noted here as well that the Minister of the Environment held back $81,264.12 from the contractor, John Carlo Limited, pursuant to s. 11 of The Mechanics’ Lien Act, R.S.O. 1970, c. 267, being 15 per cent of the work certified as complete. This sum was paid into court and by judgment, dated February 26, 1979, it was distributed. The respondent received notice of these proceedings but did not pursue the matter, and did not participate in the distribution of the hold-back monies.

The trial judge noted that the respondent was not a party to the bond and ordinarily would not have a direct right of action against the surety. He observed, however, that the provisions of the bond created a trust relationship between the obligee and the claimants and conferred on the claimants a right to sue directly. He dealt with the argument that such a right to sue directly would depend upon a strict compliance with the provisions of the bond with these words:

It appears to me that in this case, unlike performance bonds, the plaintiff company does possess an independent cause of action, apart from the right to sue given by the contract. The trust has arisen by virtue of the contract but is governed by the terms of the trust and not by the terms of the contract and the plaintiff company is not required to comply with the conditions concerning notice imposed by the contract.

He went on to observe that the defence of absence of notice had not been raised by the appellant in its pleadings even though the respondent in its pleadings had asserted the giving of the required notice. He referred to Rule 148 of the Ontario Rules of Practice which is reproduced hereunder:

148. Any condition precedent, the performance or occurrence of which is intended to be contested, shall be

[Page 519]

distinctly specified in his pleading by the party relying thereon, and an averment of the performance or occurrence of all conditions precedent necessary for the case by the plaintiff or defendant shall be implied in his pleading.

After reviewing certain authorities, including Williston and Rolls, The Law of Civil Procedure (1970), he concluded:

…it is incumbent upon the defendant to raise the defence of lack of or improper notice by plea and if this defence is not pleaded then, in my opinion, the defence cannot succeed. I realize that this is a highly technical position but it is a technical defence.

He disposed of certain other defences which have not been pursued in this Court and then held that “the claimant is not required to seek recovery from all sources before claiming under the bond,” in disposing of the argument that the respondent was required to exhaust its remedies under The Mechanics’ Lien Act before suing on the bond.

The Court of Appeal expressed the view that the purpose of requiring notice to be served by registered mail was merely to avoid questions of proof as to the receipt of notice. It was then said:

The trial Judge has found that notice was given to all parties entitled to it. The fact that it was not given by the method specified in the bond should not, in our opinion, enable the Appellant to evade liability.

It then expressed agreement with the trial judge that the respondent was not required to seek recovery from all sources before claiming under the bond.

In this Court the appellant puts its argument upon two principal grounds. It contended, firstly, that the Courts below were in error in not holding that strict compliance with the notice provisions of the bond was a requirement before action could be brought and, secondly, that the respondent was obligated at law to exhaust remedies under The Mechanics’ Lien Act and give credit for any

[Page 520]

amounts received from the hold-back in any claim against the surety.

I will deal first with the notice argument. It has already been pointed out that the appellant received notice in accordance with the provisions of the bond. The obligee, the Minister of the Environment, and the principal, the defaulting contractor, were also notified of the claim, although not in strict compliance with the method specified in the bond. It was found in the courts below, and indeed it was evident from the argument advanced in this Court, that the appellant, the obligee, and the principal all had full knowledge of the commencement of the proceedings within the time limited by the bond. None of them suffered any prejudice whatsoever by the departure from the strict wording of the instrument. The purposes of the giving of notice were in each case fully served. The appellant, the only one who complains in this Court, was given notice in full compliance with the terms of the bond. The defence advanced on this heading of the case was technical in the extreme.

The appellant concedes that the respondent has the right under the bond to sue directly for its performance notwithstanding the fact that it is not a party to it. It argues, however, that as a surety it can be made liable to pay the debt of the principal only in strict compliance with all the provisions of the bond. The requirement of the giving of notice prior to the commencement of action was not strictly complied with and, therefore, the respondent’s action was not entitled to succeed. The appellant cited many cases illustrating this principle including Capel v. Butler (1825), 4 L.J. Ch. 69, where the failure by the creditor in his agreement to register mortgages on two ships which were to secure the payment of an annuity was held to discharge the surety; Calvert v. London Dock Co. (1838), 7 L.J. Ch. 90, where, pursuant to a performance bond, an owner was required to advance certain sums to the contractor, but advanced sums in excess of that amount. As a result, the surety was discharged; Pearl v. Deacon

[Page 521]

(1856), 26 L.J. Ch. 761, where the application of security by a creditor to a different debt than the one guaranteed discharged the surety pro tanto; levins v. Latvian (Toronto) Credit Union Ltd. (1977), 19 O.R. (2d) 53, where failure in an agreement by the creditor to obtain a mortgage as security discharged the surety pro tanto; Re Wolmershausen; Wolmershausen v. Wolmershausen (1890), 62 L.T. 541, where release by a creditor of security for the debt discharged the surety pro tanto; Bryans v. Peterson (1920), 47 O.L.R. 298 (C.A.), where the lapse of a mortgage held as security by the creditor discharged the surety; and further cases such as Royal Bank of Canada v. Girgulis, [1979] 3 W.W.R. 451 (Sask.C.A.); Bank of Montreal v. Robertson, [1976] 5 W.W.R. 680 (B.C.S.C.) and Rose v. Aftenberger, [1970] 1 O.R. 547 (C.A.).

It will be observed that all these cases involved sureties of the type which have been described as accommodation sureties. This expression is taken to mean sureties who have entered into their contract of surety in the expectation of little or no remuneration and for the purpose of accommodating others or of assisting others in the accomplishment of their plans. In respect of them, the law has been astute to protect them by strictly construing their obligations and limiting them to the precise terms of the contract of surety. Any material variation in the terms of the guaranteed indebtedness and any extension of time or postponement of the debtor’s obligation, or any discharge or relinquishment of any security for the debt without the consent of the surety will discharge him. In other words, courts have adopted the strictissimi juris construction of the surety contract.

In more recent times, particularly in the construction industry, the need for financial guarantees to ensure prompt payment for materials and labour supplied has seen the entry into this field of professional surety companies, often called bonding companies, which are frequently also engaged in the insurance business. Their business consists

[Page 522]

of guaranteeing performance and payment in return for a premium. They are known as compensated sureties. It was argued that they should not be treated by the courts with the same solicitude reserved heretofore for accommodation sureties. The question of whether there should be a different judicial approach to compensated sureties than to accommodation sureties was raised as a ground of appeal in this Court in Town of Truro v. Toronto General Insurance Co., [1974] S.C.R. 1129. Dickson J., who wrote the judgment of the Court, did not find it necessary to deal with the point since the appeal was decided upon other issues. The respondent contended, however, that the direction of jurisprudence in Canada dealing with labour and material payment bonds of the type in issue here has been toward a more liberal interpretation of such bonds in favour of the claimant. On this point the respondent cited no English authority and I have found none dealing directly with the point. Counsel did, however, cite Canadian and American authorities in support of his position.

The respondent’s position on this point, as I understand it, is that a mere technical breach of the terms of a bond by an obligee or a claimant in advancing a claim should not permit the compensated surety to escape liability under its covenant where the technical breach complained of has not prejudiced the surety. It was argued that in the present case, despite a failure to comply strictly with the notice provisions of the bond, the object of those provisions (that is, full notification to the appellant, the obligee and the principal) was achieved before the action was commenced.

The respondent referred to several Canadian authorities. In Town of Truro v. Toronto General Insurance Co., supra, a change in the ownership and control of the structure under construction without the surety’s consent was held not to discharge the surety from liability under the bond because, despite the change, the surety’s position

[Page 523]

was unaffected. In La Rivière Inc. v. Canadian Surety Co., [1973] C.A. 150, the failure by an unpaid material man to preserve privileges under the Civil Code of Quebec was held not to discharge the surety from its obligations under a labour and material payment bond. That case is the subject of a helpful article, Labour and Material Payment Bonds (1973), 19 McGill L.J. 433, by N.H. Salomon. In the case of Klockner-Moeller Ltd. v. Fidelity Insurance Company of Canada, a 1977 unreported decision of the Supreme Court of Prince Edward Island, alleged irregularities or insufficiencies in the formation of a contract for the provision of materials by a material man to a defaulting sub-contractor were held not to deprive the material man who had supplied the goods of the protection of a bond. Finally, in Alberta Concrete Products Co. Ltd. v. Simcoe & Erie General Insurance Co. (1978), 15 A.R. 437, funds due and owing by an owner to a contractor as progress payments, after the contractor had made default in the agreement permitting such payment, were paid by the owner into court. Although no notice was given to the surety, the payment into court was held not to release him. These cases, all involving professional or compensated sureties, support the view of the respondent that surety contracts should be more liberally construed in favour of claimants in the case of compensated sureties than in the case of accommodation sureties.

Turning to the American authorities, the respondent referred to the following cases: Fleisher Engineering & Construction Co. v. United States, 311 U.S. 15 (1940); Houston Fire and Casualty Insurance Co. v. United States, 217 F.2d 727 (1954); Liles Construction Co. v. United States, 415 F.2d 889 (1969); United States v. Cortelyou & Cole, Inc., 581 F.2d 239 (1978). These cases concerned the interpretation of the Miller Act, 40 U.S.C., s. 270b (1935), which enacts in statutory form provisions regarding notice of claims by subcontractors claiming against sureties similar to

[Page 524]

those contained in the bond executed in this case. In each of the above cases, actual notice of claim was given before action commenced but not in the form required by the Miller Act. In each case the surety was nevertheless held to be bound by his contract of surety. They support the view that where notice in fact is given and no prejudice is caused to the surety, a mere technical failure to give notice in compliance with the Act will not enable a surety to escape liability. See also Simpson, Handbook on the Law of Suretyship (1950), at pp. 101 et seq, where the author discusses the clear distinction in United States courts between accommodation and compensated sureties.

It is clear that, while Canadian authority to date has tended to favour a more liberal approach to the consideration of the rights of claimants under bonds of this nature, it has not gone as far as the American courts in distinguishing the compensated from the accommodation surety. It is my view, however, that the rules which have been applied to accommodation sureties are in many ways unrealistic and inapplicable to cases where professional sureties, in the course of their ordinary business, undertake surety contracts for profit and thereby approach very closely the role of the insurer. The basis of the surety’s liability must, of course, be found in the bond into which it has entered, but in the case of the compensated surety it cannot be every variation in the guaranteed contract, however minor, or every failure of a claimant to meet the conditions imposed by the bond, however trivial, which will enable the surety to escape liability. Where, as here, the object of the notice provisions in the bond has been fully achieved within the time limits imposed and where there has been no prejudice whatever to the appellant, the whole purpose for the obtaining of the bond would be defeated if the appellant were to be discharged. The failures complained of in this case in no way affect the relationship between the parties and in no way change the true basis of the bond contract. The appellant is simply faced with the duty of carrying

[Page 525]

out the bargain it made. I would not give effect to this ground of appeal.

On its second argument, the appellant argues that the claim of the respondent should fail because it did not pursue any remedy under The Mechanics’ Lien Act. The evidence on this aspect of the case is not clear as to what steps were actually taken by the respondent under The Mechanics’ Lien Act and no reason was given for its failure to proceed to judgment in the matter. Although it did not initiate the proceedings, it seems to have been a party to them but did not pursue them to a conclusion. A copy of the judgment in The Mechanics’ Lien Act proceedings appears in the record and discloses that the respondent was served with notice of trial. It also discloses that $81,264.12 was paid into court in full satisfaction of the obligation of the Minister of the Environment under s. 11 of The Mechanics’ Lien Act to hold back 15 per cent of the contract price. The claims of certain claimants, including the respondent, were dismissed and the trial judge ordered the distribution of the hold-back fund in payment of claims and costs in the amount of $71,711.75, leaving an undistributed balance of $9,552.37. He ordered that this last mentioned sum remain in court until further order and we are without information as to any further disposition which may have been made of those funds.

The respondent points out, correctly in my view, that there is no requirement in the bond itself that a claimant must have recourse to other remedies before claiming on the bond. The appellant must therefore rely on the well-established principle that a creditor who holds security for the payment of a debt must protect it and be in a position upon payment of the debt by the surety to assign and deliver such security to the surety: see Bauer v. Bank of Montreal, [1980] 2 S.C.R. 102. Any failure to preserve securities results in a discharge of the surety pro tanto (see, for example, Pearl v. Deacon, supra).

[Page 526]

Even if the respondent’s claim to the holdback fund can be characterized as a security, which is not free from doubt, there are other difficulties with the appellant’s position. I am not convinced that the appellant was prejudiced at all by the respondent’s failure to pursue its claim. If the respondent had recovered under the mechanics’ lien action, the award to other claimants would have been reduced accordingly and, presumably, these other claimants would have made a claim against the surety under the bond. In other words, the appellant would have been no further ahead. As to the undistributed balance of $9,552.37, there is nothing before this Court to indicate that this money is forever beyond the reach of the appellant. Another difficulty with the appellant’s position is that the cases relied upon by it concern accommodation sureties. It may be that the discussion earlier in this judgment regarding a distinction between compensated and accommodation sureties may be relevant to this defence raised by the appellant, but for the purpose of this case it is not necessary to decide the issue.

I prefer for the purposes of this appeal to adopt the approach taken by the Quebec Court of Appeal in La Rivière Inc. v. Canadian Surety Co., supra. In that case the surety under a bond similar to the one at bar raised the defence that the claimant had failed to exercise certain privileges against the land involved to which it was entitled under the Civil Code of Quebec before bringing action under the bond. It was asserted that since the benefit of the privileges had been lost by the claimant and the appellant could not therefore give subrogation to the surety, the surety was entitled to be discharged pro tanto. Rinfret, Casey and Hyde JJ.A. rejected this argument and Casey J.A. said, at p. 155:

With all respect I do not read this bond, and it is this document that evidences the agreement, as imposing on appellant the duty of subrogating respondent in the rights which it might have had under article 2013e C.C., and I consider as irrelevant the fact that it did not or

[Page 527]

could not do so. Since this bond was there to protect the contractor and the owner against privileges and the like it is unreasonable to suggest that respondent’s liability thereunder depends on its being enabled to exercise those same rights.

The same reasoning applied to the case at bar. To impose on a claimant an implied obligation to exhaust all other remedies before claiming under the bond would be to defeat the very purpose for which the bond was entered into. I would therefore refuse to give effect to this argument by the appellant. On this point I would refer again to Salomon’s article, Labour and Material Payment Bonds, supra.

I would add in conclusion that neither the defence relating to absence of due notice nor that relating to the failure to exercise mechanics’ lien claims were pleaded in the appellant’s statement of defence. The respondent relied on Rule 148 of the Ontario Rules of Practice to argue that the notice defence should fail on that ground. While it is not necessary for me to deal with this point since I have formed the opinion that neither defence can succeed on the merits, it is my view that the trial judge was right upon this point. Rule 148 should have its effect and defences of this nature should be pleaded if they are to receive consideration by the Court. I would dismiss the appeal with costs.

Appeal dismissed with costs.

Solicitors for the appellant: Bristow, Catalano, Moldaver & Gilgan, Toronto.

Solicitors for the respondent: Upshall, Mackenzie & Kelday, Brampton.