Ontario's signature legislation for the construction industry was overhauled in 2018 and 2019. The amendments, first introduced in 2017 by Bill 142, modernized the 35-year-old piece of legislation and changed its name from the Construction Lien Act to the Construction Act (the Act).
The Act is designed to ensure that workers who provide services or materials during construction projects are paid on a timely basis. To speed up payments in the construction industry, the Act includes mandatory prompt payment and a fast-track dispute resolution process. Most of the amendments came into force on July 1, 2018, except for the prompt payment and adjudication sections, which came into effect on October 1, 2019.
Changes to the Act impact all construction work and projects in Ontario, including P3/infrastructure, energy, mining, and real estate developments — no matter the size. Several other provinces have pursued their own amendments for prompt payment and adjudication amendments, as has the federal government for federal construction projects. As a group, these changes bring Ontario, and eventually the rest of Canada, in line with practices in Europe, Australia, and most U.S. states.
There are many legal implications, which should be discussed with your construction lawyer. However, what about the implications for your accounting systems? The Act affects construction projects, contractors and subcontractors up and down the construction pyramid. It's important to review your accounting systems and processes to ensure they support the Act.
Five areas of the Act will most impact your accounting back office:
Proper Invoices
A "proper invoice" has a specific definition in the Act, which outlines exactly what an invoice must contain in the construction industry. A proper invoice is "a written bill or other request for payment for services or materials in respect of an improvement under a contract". Proper invoices must contain the following information:
- The contractor's name and address
- The date and period during which the services or materials were supplied
- Information identifying the authority, whether in the contract or otherwise, under which the services or materials were supplied
- A description, including quantity where appropriate, of the services or materials that were supplied
- The amount payable for the services or materials that were supplied, and the payment terms
- The name, title, telephone number, and mailing address of the person to whom payment is to be sent
- Any other information that may be prescribed (no additional information is currently prescribed)
- Note that the parties are permitted to specify other requirements for the proper invoice, but these requirements must be expressly set out in the contract. The invoice will then need to meet these specified requirements.
Timing
The Act deems all projects to require monthly progress payments unless another payment structure, such as milestones or a payment schedule, is set out expressly in the contract. A proper invoice must therefore be provided to an owner on a monthly basis, unless the contract states otherwise.
Revisions
Contractors can revise a proper invoice after it's given to an owner, but only if the owner agrees in advance to the revision and the date of the proper invoice is not changed. The revised proper invoice must still meet all of the above criteria.
- Does your accounting system easily allow you to include all items on a proper invoice?
- Have you updated existing invoice templates in your accounting system to ensure all of the criteria for a proper invoice are met?
- Do your accounting processes ensure that proper invoices are provided on a monthly basis?
- Do your accounting processes ensure that contractually set timing obligations on proper invoices, if not monthly, are clearly defined and easy to meet?
- Does your accounting system allow invoices to be edited after the fact without date changes?
- Does your accounting system allow invoices to be paid in part or are they only able to process payments for the full amount of the invoice?
- Do you have controls in place to ensure invoices are not revised without the agreement of the owner?
- Does your bookkeeper and/or accounting department understand the proper invoice requirements, and how to ensure they are met?
Prompt Payment
Accounting systems must support the prompt payment regimes, whether you are:
- Creating proper invoices
- Collecting on outstanding invoices
- Paying for received invoices
- Evaluating whether to pay a "proper invoice" that you have received
- Evaluating whether to dispute an invoice or payment
The new bottom line: owners generally have 28 days to pay a contractor after delivering a "proper invoice", and contractors have seven days to pay a subcontractor (after getting paid by the owner).
The timelines in the prompt payment regime are triggered by "delivery of a proper invoice" by the contractor to the owner.
Prompt payment is mandatory for all contracts. Parties can set milestones, payment schedules, or other payment structures that are not based on monthly progress payments if set out clearly in their contract, but the 28-day clock starts once a proper invoice is submitted in accordance with that payment structure.
Owners may dispute a proper invoice, and contractors may dispute a subcontractor's invoice, but they now need to deliver a formal "notice of non-payment" on strict timelines. The notice of non-payment must be in the form prescribed in the Act and it must set out all of the reasons for not paying the full amount of the invoice. The undisputed portion of the invoice must be paid within the statutory timelines.
The timelines are very tight for prompt payment:
- Owners have to pay a contractor within 28 days of receiving a proper invoice.
- Contractors have seven days to pay a subcontractor (after getting paid by the owner).
- After receiving a proper invoice from the contractor, owners must deliver a notice of non-payment within 14 days if they are disputing all or part of an invoice.
- Contractors have to deliver a notice of non-payment to subcontractors within seven days (and subcontractors to sub-subcontractors) if they do not intend to pay the full amount of the invoice. If an owner pays all or a part of the contractor's invoice, the contractor must deliver the notice of non-payment to that subcontractor within seven days of receiving the payment from the owner.
- If the owner does not pay any part of the contractor's proper invoice, the contractor has 35 days after its proper invoice to either pay the subcontractors out of its own pocket (even though the owner did not pay) or deliver the notice of non-payment to its subcontractors and commence an adjudication against the owner.
- Is your bookkeeper and/or accounting group prepared to go through contracts and payments in a quick enough timeframe to meet the prompt payment obligations?
- Is your team integrated with your accounting processes so that amounts to be paid can be verified?
- Have you reviewed your payment authorization procedures?
- Will your accounting and information systems support the need to provide supporting documentation quickly and easily for the prompt payment regime?
- Have you reviewed your revenue recognition polices? Accounting and tax rules on revenue recognition often use the percentage of completion basis method. Simplified, if the job is 40% complete, you would recognize 40% of the revenues for accounting and tax purposes. You have less "flexibility" in estimating these percentages with more rapid invoicing, verification and payments. In other words, the person receiving money may want to defer revenue recognition, and vice versa for person paying money, to the following fiscal year.
Adjudication
Those in a construction contract can refer disputes to adjudication, such as claims for delays, materials, and services. While the adjudication sections of the Act are focused on your legal obligations, your accounting systems need to support, not hinder, the adjudication process.
Adjudication is a very fast dispute resolution mechanism for payment or change disputes. An owner, contractor or subcontractor can commence it. The timelines for responding to a notice of adjudication are extremely short: two days to respond to a notice of adjudication for the selection of an adjudicator, five days from the appointment of the adjudicator for the first submission of documents, and 30 days for a determination by the adjudicator. If a payment is required after adjudication, it must be paid within seven days.
- Is your bookkeeper and/or accounting group prepared to go through contracts and payments in a quick enough timeframe to meet the adjudication obligations?
- Is your team integrated with your accounting processes and lending draw requirements so that amounts to be paid on time?
- Do you have an accounting system and process that integrates into the new dispute resolution and adjudication processes?
- Will your accounting and information systems support the need to provide supporting documentation quickly and easily for the adjudication regime?
Construction Holdbacks
Holdbacks will remain at 10% of the value of the improvement, but security can be offered in lieu of cash holdbacks. Consider the tax implications though. More significant is the requirement to pay holdbacks on the day after the expiration of the lien period (is there enough time to process the payment, especially if funds are borrowed) and the requirement for a notice of non-payment of the full amount of the holdback on the 40th day after substantial performance. For more details on tax and accounting implications, see Understanding Construction Holdbacks and the Potential Tax Implications.
Trust Fund Rules
The Act imposes trust obligations on contractors and subcontractors anytime they receive payments that include funds owed to someone else on the project.
The Act does not require project-specific bank accounts, but does have new rules relating to the deposit, administration, recording and traceability of project trust funds. These rules apply on all new projects after July 1, 2018, and trust funds will need to be treated from a bookkeeping perspective as though they are held in a separate account.
While a single bank account per trust account is not required, you must keep books and records for those funds as though they were segregated. This is to ensure that all construction trust funds are traceable and not commingled with operating funds or other trust funds. These should include, at a minimum, details of amounts paid from or received in trust, and any transfers made. Future regulations may impose additional requirements regarding trust funds and accounting.
Additionally, the bank account in which the trust funds are held must be in the name of the actual trustee of the funds. If you are using affiliates or new companies for each project, they must be named on the account or added to the account.
However, this creates new bookkeeping challenges, especially for smaller businesses, because of the much more stringent trust account requirements. Detailed written records and reconciliations will be required.
- Determine best practices for managing trust funds. You can use a single bank account for all the trust funds, but your bookkeeping and accounting systems must be able to trace all the transactions back to each trust fund. This can get extremely messy very quickly if your processes are not well defined.
- The added complexity for trust fund accounting may mean you need to explore adding to your bookkeeping and accounting team, and/or hiring an external bookkeeper if you do not have one now.
- Discuss the trust accounting rules and traceability issues with your accountant to ensure your team understands the standards.
- Do bankers have their own requirements for your trust funds, such as rules for limiting your line of credit limits? What are the new best practices lenders will require on a project?
While many have focused on the legal implications of Construction Act changes, real estate and construction businesses across the industry must also ensure that their accounting systems and processes support these changes.