Sjostrom Sheet Metal v Kelson: Transparency and Effective Communication in Non-Fixed Price Construction Contracts

In Sjostrom Sheet Metal Ltd v Geo A Kelson Company Limited,[1] the Ontario Superior Court of Justice provided a timely reminder regarding the significance of careful pleading, clear and transparent change order processes, precise record-keeping, adherence to contractual obligations, and effective communication amongst contractual counter-parties in the context of a construction project with subcontractors and sub-subcontractors performing overlapping scopes of work. Below, we discuss some of the key takeaways.

Background

This matter arose as a result of issues in respect of the construction of the University Health Network (“UHN“) Centre for Cell & Vector Production (“CCVP“). UHN hired Canadian Turner Construction Company (“Turner“) as the general contractor for this project. In this case, UHN and Turner were not parties to the action, nor were they relevant to the Court’s analysis.

Turner subcontracted with Geo A Kelson Company Limited (“Kelson“) to perform the mechanical work on the Project. Kelson then sub-subcontracted with A Amar and Associates Ltd (“Amar“) for Amar to perform certain sheet metal work for a fixed price. After being retained by Kelson, Amar subsequently faced labour issues which resulted in it hiring labourers from Sjostrom Sheet Metal Ltd (“Sjostrom“) to assist with its scope of work. Kelson was not aware of the hiring of Sjostrom at the time.

Ultimately, Sjostrom abandoned the Project as a result of non-payment by Amar.[2] Per the Court, Kelson and Sjostrom then reached an arrangement whereby Sjostrom would return to site and continue working, with Kelson being responsible for direct payments to Sjostrom on a go-forward basis. Consequently, Kelson issued a change order which reduced the total amount of Amar’s subcontract due to the work performed (and to be performed) by Sjostrom (the “Change Order”).[3] Although not explicitly stated, this Change Order was presumably agreed to by Amar, given that the change was implemented via change order rather than change directive.

Amar subsequently brought a claim against Kelson for unpaid services and materials under its sub-subcontract. In addition, Amar argued that it was relieved of its remaining sheet metal responsibilities due to the Change Order issued by Kelson and thus no longer had any obligations to Sjostrom.

In parallel with Amar’s action against Kelson, Sjostrom brought a lien action against Kelson for unpaid amounts allegedly owing pursuant to the aforementioned arrangement between Kelson and Sjostrom, which Sjostrom alleged to be a contract between the two. In response, Kelson argued that it had no contract with Sjostrom, and that as result, it had no liability for Sjostrom’s claim and that Amar was in fact required to pay any amounts proven by Sjostrom’s claim. Kelson also counterclaimed against Amar for damages, contribution, and indemnity if Kelson were found liable to Sjostrom.[4]

The Superior Court’s Decision

Given the somewhat unusual (and more importantly, disputed) contractual arrangement amongst the parties, the Court’s analysis touched in relevant part on a number of issues that are broadly relevant to the construction industry.

In particular, the Court considered the following:

• The alleged agreement between Kelson and Sjostrom;
• The claimed amount of work performed by Sjostrom;
• The Change Order’s impact on Amar’s scope of work; and
• The alleged breach of Kelson and Amar’s subcontract.

Broadly speaking, Amar argued that its responsibility for sheet metal labour performed on the Project (whether by Sjostrom or otherwise) ceased after the issuance of the Change Order, and Sjostrom’s work was subsequently governed by a separate, direct sub-subcontract with Kelson. Sjostrom held the same position as Amar. Conversely, Kelson alleged that it had no direct contract with Sjostrom, alleging any responsibility for any owed amounts to Sjostrom rested with Amar.

The Agreement Between Kelson and Sjostrom

A key issue was of course whether a direct contract was established between Kelson and Sjostrom; in that regard, and despite the absence of a written agreement Sjostrom alleged that the parties entered into an oral agreement. In determining whether Kelson and Sjostrom entered into a contract, the Court considered first principles of contract formation including (1) offer, acceptance, consideration, certainty of terms and intention, (2) the factual matrix between the parties, (3) an examination based on an objective standard, and (4) the presence of a meeting of the minds.[5]

Ultimately, the Court found that it was unnecessary to rely on these contractual principles, given that Kelson’s pleadings were sufficient to establish the existence of an agreement.[6] In particular, the Court observed that subrule 25.07(3) of the Rules of Civil Procedure requires a party who intends to prove a version of facts that is different from the facts pleaded by the opposing party must plead the party’s own version of the facts in their defence.[7] However, Kelson’s statement of defence failed to dispute Sjostrom’s claim of the existence of a direct contract between Kelson and Sjostrom. Rather, the Court found that Kelson unintentionally acknowledged the existence of a direct contract with Sjostrom.

Further, in its pleadings, Kelson relied on s. 17(3) of the Construction Lien Act, which permits a party that is liable for payment to another to claim a set-off against such payment. This subsection contemplates that a payee’s outstanding debts, claims, or damages related to their payer can be set off against the amount of the payee’s lien. However, Kelson could only rely on s. 17(3) if it qualified as the “payer” of Sjostrom, which was defined under the CLA as “the owner, contractor, or subcontractor who is liable to pay for the services or materials supplied to an improvement under a contract or subcontract” (emphasis added). The Court found that Kelson’s reliance on this provision logically required privity of contract between Sjostrom and Kelson. Thus, relying on this section was effectively an admission of a direct contractual relationship by Kelson.[8]

Moreover, even in the event that Kelson’s statement of defence did not admit a direct contract, the Court would have found that the objective evidence supported the existence of a contract between Sjostrom and Kelson,[9] referring to communications between the parties, negotiations, as well as email correspondence suggesting an agreement on terms and pricing.[10] Indeed, the examination of whether a contract has been formed entails assessment based on an objective standard – in which the parties’ conduct is assessed based on how it would be construed by a reasonable, disinterested third party (i.e., a reasonable person) – rather than a subjective standard, based on the subjective understanding of each party. In applying this standard, the Court therefore found that a reasonable person would conclude that both parties intended to enter into a direct contractual relationship.

Claimed Amount of Work Performed by Sjostrom

The next issue considered by the Court was whether Sjostrom had proven the amount claimed in respect of the work it allegedly performed.

The agreement between Sjostrom and Kelson (now found to exist) was based on hours spent on sheet metal labour at a set rate, which the Court considered sufficiently similar to a cost-plus contract such that the case law on cost-plus contracts applied in this case. In that regard, the Court identified several distinct principles that applied to the assessment of a damages claim including the need for the parties to practice diligence in managing costs, prevention of wasteful or uneconomic use of labour and materials, reasonableness of estimates, examination of the context to an estimate, and the sophistication and knowledge of the parties.[11]

The Court found that Sjostrom failed to provide sufficient evidence that the time summaries it had provided were an accurate reflection of the hours worked by Sjostrom. Specifically, Sjostrom combined its overtime hours with its regular hours, leading to a distorted picture. Further, Sjostrom provided weekly summaries that were not signed by the labourers themselves, and which lacked details of the actual work undertaken.[12] Timesheets were not accurately kept, and often consisted of notes on scrap paper, pieces of drywall, cardboard and napkins.[13]

Moreover, the Court found that time summaries were not provided to Kelson on a weekly basis.[14] Rather, they were only provided with Sjostrom’s invoices, which made it such that there was “no evidence tendered at trial supporting that Kelson could reasonably have known how many hours Sjostrom was spending on site until receiving the invoices”.[15] The Court also found that there was a discrepancy between the actual hours worked and estimates, as evidence suggested that the sheet metal labour was substantially completed earlier than Sjostrom’s estimate.[16]

The Court emphasized the principle that “time spent by labourers must be strictly proven due to the difficulty in verifying them after the fact”.[17] The Court found that Sjostrom did not meet its evidentiary burden to demonstrate actual hours, how the hours were incurred, why they varied significantly from estimates, and why no notice was provided regarding the fact that actual labour hours were significantly exceeding the estimate. Thus, the Court dismissed Sjostrom’s claim for payments made exceeding the sum already remitted by Kelson due to insufficient evidence.[18]

The Change Order’s Impact on Amar’s Scope of Work

Kelson and Amar also disagreed with respect to the contractual impact of Kelson’s Change Order which reduced the amount of Amar’s sub-subcontract, but also arguably the scope – depending on the view of each party considering it. In this regard, Kelson asserted that the Change Order merely credited the cost of Sjostrom’s labour against the price of the sub-subcontract between Kelson and Amar, but did not remove sheet metal labour from Amar’s scope of work, while Amar argued that it fully removed sheet metal labour from Amar’s scope of work.[19]

In this case, the Court noted that the Change Order was ambiguous, only referring to a price reduction and a description of “work performed by others.” As a result, an analysis of the surrounding circumstances was required in order to assess the intentions of the parties.[20]

In examining the factual background, the Court observed that the labour rate as agreed upon between Kelson and Sjostrom was not discussed with Amar. The Court found this “curious” given Kelson’s assertion that, despite Sjostrom not being included in their discussions, Sjostrom continued to be Amar’s sub-subcontractor, and that Amar was liable to pay the labour rate agreed upon by Kelson and Sjostrom in their agreement.[21]

Moreover, Sjostrom sent an email to Amar stating, “going forward Sjostrom will have to follow instruction as directed by [Kelson], exclusively.  This includes but not limited to, time sheet [submittal] etc.”[22]The Court found that this email was consistent with the understanding that Kelson assumed responsibility for Sjostrom, especially given the fact that there was no response from Kelson or Amar to indicate otherwise.[23]

In another e-mail exchange in response to an e-mail from Sjostrom to which Kelson was copied regarding labour required for installation of control dampers, Amar responded ” [Kelson] has received and deducted costs from my contract for the entirety for ‘cost to complete'”[24]. While Kelson responded to the e-mail, it did not dispute Amar’s characterization that the “cost to complete” was deducted from Amar’s sub-subcontract. Thus, the Court found that the Change Order had the effect of removing sheet metal labour from Amar’s scope of work. [25]

Breach of Kelson and Amar’s Subcontract

The Court then considered who breached the subcontract between Kelson and Amar. Amar claimed that Kelson breached the subcontract through non-payment, while Kelson claimed that Amar breached the subcontract due to its failure to provide sheet metal labour. The Court observed that the subcontract required a notice of default to be delivered in order for Amar to be in breach, and since no notice was provided until after the parties completed their work, “Amar was not formally in breach… at any material time”. Thus, without having issued a notice of default, Kelson had no right to back charge Amar for costs beyond the figure agreed upon in the Change Order. [26]

In addition, the Court found that Kelson breached the subcontract by failing to pay Amar the remaining holdback due upon final payment after substantial completion and found Kelson had separate holdback obligations under the Construction Lien Act for its subcontracts with both Amar and Sjostrom. Thus, Kelson breached its subcontract with Amar by not making the payments.[27]

Further, in determining the earned and unpaid amount owing to Amar, Kelson argued that Amar underbid the labour portion of the sheet metal work. However, the Court emphasized that whether Amar underbid was immaterial, as Amar’s subcontract was a fixed price contract, not a cost-plus contract. On this basis, Kelson would not have to pay anything more than the fixed subcontract price agreed by parties.[28]

Moreover, the Court found that since the sheet metal labour was removed from Amar’s sub-subcontract scope of work through the Change Order, and since they were called back to the project site in order to perform work outside of their revised scope, Amar’s invoice constituted a valid extra.[29] Lastly, the evidence did not support a finding that Amar intended or agreed to be indemnified for expenses associated with the completion of sheet metal labour.[30]

The Court’s Determination

Based on all of the above, the Court concluded overall that Sjostrom and Kelson did enter into a separate sub-subcontract for Sjostrom to complete the remaining sheet metal labour in Amar’s scope of work, but that Sjostrom has failed to prove its claimed damages, as a result of which the Court dismissed Sjostrom’s action and discharged its lien. With respect to Amar, the Court concluded that the Change Order had removed all of Amar’s remaining scope of work, and Kelson breached its subcontract with Amar due to non-payment, such that Amar was entitled to judgment against Kelson.

Commentary

Notwithstanding that the fact pattern of this case was not especially unusual, Sjostrom nevertheless offers several takeaways with respect to how a party can best protect or advance its position in a construction dispute.

First, and as it relates to pleadings, it is crucial that parties take care when drafting such documents in order to ensure their pleadings align with the theory of their case. Here, the Court found inconsistencies between Kelson’s statement of defence and its subsequent submissions, which led to a finding that a direct contract existed between Kelson and Sjostrom. Such inconsistencies, as seen in this case, can lead to unexpected outcomes.

Second, it is imperative that parties understand their rights under their contract(s) and any particular actions required to enforce them. In this case, the subcontract between Kelson and Amar required a notice of default in order to ground a finding of breach of contract, and since Kelson did not provide such notice, the Court found that Amar was not in breach and that Kelson was not entitled to exercise any associated remedies. While this may be a somewhat unusual precondition depending on the form of contract used (whether it be a standard form or a bespoke contract), it nevertheless emphasizes the importance of ascertaining all relevant preconditions to taking a given position, and then complying with those preconditions.

Third, the Court provided helpful guidance in its discussion of the judicial assessment that applies in making claims for payment under certain forms of construction contract. A cost-plus basis for payment in particular – as well as time and materials basis – is inherently uncertain, and can vary quite significantly from any estimate given before the start of work. A court will consider whether the claiming party exercised diligence and was economical in the use of its labour and materials, and the claiming party will have to meet a high evidentiary burden (among other things).

In that regard, contractors operating on a cost-plus or time and materials basis would be well advised to be cautious and comprehensive in considering the basis for any estimate they give to a client, in order to have confidence that the work can be completed for an amount roughly equivalent to that stated in the estimate. The alternative, as Sjostrom shows, entails significant scrutiny by a court or other decision-maker (e.g. an arbitrator).

In that regard, parties must ensure that their time is tracked in a reliable and accurate manner. The reliability of time sheets, and other timekeeping methods, is crucial to establishing their validity as admissible evidence – not to mention the practical and relationship benefits of doing so. As the Court observed, time spent by labourers must be proven to a strict evidentiary standard, given the difficulty in verifying hours after the fact. In this case, the Court found that Sjostrom failed to provide sufficient evidence to prove that their time summaries were an accurate reflection of their work. This lack of reliable evidence left Sjostrom with no evidentiary foundation for any additional amount claimed. Similarly, it is important to ensure that change orders or side agreements are clearly documented and agreed upon, as well as disseminated to all relevant parties.

In any event, however, construction industry participants would be well advised to be candid with counterparties if and when the cost estimate will be exceeded (or when it is anticipated to be exceeded), so as to avoid unpleasant surprises and acrimony. Successful projects are often those which operate on the basis of a cooperative and collaborative relationship, and in that regard, financial candor is arguably no different.

[1] Sjostrom Sheet Metal Ltd v Geo A Kelson Company Limited 2023 ONSC 4959.

[2] Sjostrom at paras 1-3.

[3] Sjostrom at para 3.

[4] Sjostrom at paras 4-6.

[5] Sjostrom at paras 10-11.

[6] Sjostrom at para 14.

[7] Sjostrom at para 17.

[8] Sjostrom at para 21.

[9] Sjostrom at para 24.

[10] Sjostrom at paras 25-39.

[11] Sjostrom at paras 40-41.

[12] Sjostrom at paras 42, 44-46.

[13] Sjostrom at para 62.

[14] Sjostrom at para 63.

[15] Ibid.

[16] Sjostrom at paras 53 and 59.

[17] Sjostrom at para 74, Citing Infinity Construction Inc. v. Skyline Executive Acquisitions Inc., 2020 ONSC 77 at para. 114.

[18] Sjostrom at paras 74 and 75.

[19] Sjostrom at paras 80 and 81.

[20] Sjostrom at paras 82 – 84.

[21] Sjostrom at para 94.

[22] Sjostrom at para 96.

[23] Sjostrom at para 97.

[24] Sjostrom at para 102.

[25] Sjostrom at paras 104 -105, 117.

[26] Sjostrom at para 123.

[27] Sjostrom at paras 127-130.

[28] Sjostrom at para 135.

[29] Sjostrom at para 137.

[30] Sjostrom at para 143.

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