Are Construction Act trusts valid trusts for the purposes of the Bankruptcy and Insolvency Act?

In The Guarantee Company of North America v. Royal Bank, the Ontario Court of Appeal recently dealt with a priority dispute between creditors of a bankrupt company over the proper disposition of funds arising from certain construction projects. The Court of Appeal concluded that a Construction Act (the ‘Act‘) trust was, in fact, a valid trust at common law and therefore the trust funds did not form part of the bankrupt’s estate – in the result, subcontractors and suppliers to the construction project would be paid in priority to the company’s other creditors.

The Facts

A bankrupt company, A-1 Asphalt Maintenance Ltd. (“A1”), had four major unpaid paving contracts at the time of its insolvency. The bankruptcy judge directed the Receiver in Bankruptcy to establish a special account to receive these funds (the “Disputed Funds”) as well as a general account for other receivables.

Trust Funds

The Disputed Funds were statutory trust funds pursuant to the Act. Section 8 of that Act provides:

8 (1) All amounts,

(a) owing to a contractor or subcontractor, whether or not due or payable; or

(b) received by a contractor or subcontractor,

on account of the contract or subcontract price of an improvement constitute a trust fund for the benefit of the subcontractors and other persons who have supplied services or materials to the improvement who are owed amounts by the contractor or subcontractor.

(2) The contractor or subcontractor is the trustee of the trust fund created by subsection (1) and the contractor or subcontractor shall not appropriate or convert any part of the fund to the contractor’s or subcontractor’s own use or to any use inconsistent with the trust until all subcontractors and other persons who supply services or materials to the improvement are paid all amounts related to the improvement owed to them by the contractor or subcontractor.

The practical impact of this section is that funds received by a contractor or subcontractor on a construction project (such as the Disputed Funds) should not be put to any purpose other than paying its subcontractors and suppliers until all of those subcontractors and suppliers are paid in full.  To do otherwise constitutes a breach of trust.

Priority Dispute Claimants

The claimants to the Disputed Funds included A1’s bank (which held a general security agreement over A1’s assets), a bonding company (subrogated to the claims of suppliers and subcontractors of A1), and A1’s employees on the projects (represented by their union).

The dispute between the claimants was whether the Disputed Funds were part of A1’s estate and therefore available to all creditors (as was argued by the bank) or were properly trust funds that should be excluded from A1’s estate by reason of s. 67 of the Bankruptcy and Insolvency Act of Canada (“BIA”), as was argued by the bonding company and the union.  In the latter case, the Disputed Funds would be available only to the unpaid subcontractors and suppliers of A1. Section 67 reads as follows:

67 (1) The property of a bankrupt divisible among his creditors shall not comprise

(a) property held by the bankrupt in trust for any other person.

Interests at Stake

The Courts’ traditional view of statutory deemed trusts, exemplified in such cases as GMAC Commercial Credit Corporation v. TCT Logistics Inc., was that they were distinct from traditional common law trusts and, therefore, were not valid trusts for purposes of section 67 of the BIA.  As a result, funds such as the Disputed Funds were generally held to form part of a bankrupt’s estate and made available to all creditors, rather than the intended beneficiaries under the Act. In particular, it was largely settled that deemed trust funds that were commingled with other funds were not trust funds for the purposes of section 67 of the BIA. This was held to apply to trusts under the Act in particular, which are created without intention and which funds are frequently mixed with other funds (both trust funds from other projects, and funds that are not trust funds at all).

One result of the traditional line of cases was that the position of unpaid subcontractors and suppliers as trust beneficiaries under the Act would worsen if a contractor became bankrupt. Funds such as the Disputed Funds would cease to be held strictly for the benefit of unpaid subcontractors and suppliers and would instead form part of the estate of the bankruptcy and be distributed amongst all of the bankrupt’s creditors.

In this case, the bank was not a beneficiary of the Disputed Funds under the Act’s trust provisions, having supplied no services or materials to the projects. If the Disputed Funds were held to be valid common law trust funds, then they would pass to the bonding company and the union. On the other hand, if the Disputed Funds were not valid trust funds at common law, then the Disputed Funds would form a part of the general estate of A1 which the bank, the bonding company and the union would share on a pro-rata basis with any other creditors.

Traditional Common Law View of Statutory Trusts

The establishment of a valid trust at common law requires three things:

  1. certainty of intention;
  2. certainty of subject matter; and,
  3. certainty of object.

Trusts created by statute, in this case by the Act, are deemed to exist without regard to the intentions or actions of the parties.

The Court of Appeal’s Decision

In this case, the bank argued that a deemed trust under the Act lacks the required certainties of intention and subject matter. The Court of Appeal concluded that in this case, both certainties were present. In reaching that conclusion, the Court of Appeal distinguished the cases that had previously found statutory trusts to not be valid common law trusts that were excluded from a bankrupt’s estate.

First, the decision of the Supreme Court of Canada British Columbia v. Henfrey Sampson Belair Ltd. held that a statute can supply the required certainty, by placing the trustee (in this case, the contractor or subcontractor) under an imperative obligation to hold property in trust for another.

The certainty of subject matter is present wherever it is possible to determine precisely what property the trust is meant to encompass. In this case, the Receiver’s detailed accounting records made clear which funds were subject to the trust. Since the funds remained traceable, their commingling with other paving funds was not fatal to the creation of a valid trust at common law.

Significance

This case represents a significant development of the law as it applies to trust funds under the Act, and will improve the prospects for recovery by subcontractors and suppliers when projects or contractors encounter financial difficulties.  Importantly, the right to share in trust funds under the Act is not dependent on registering a construction lien.  Accordingly, if you receive a Notice of Bankruptcy (or some other notice under the BIA) regarding a party that owes you money on a construction project, you should seek legal advice immediately, regardless of whether or not you registered a construction lien. To learn more about this decision, and your rights on a construction industry bankruptcy, contact Duncan, Linton LLP in Waterloo at 519-886-3340 to speak with one of our knowledgeable lawyers.