Trusts and bankruptcy: Finally, some certainty in the Construction Act

  • February 04, 2019
  • Andrea Lee and Markus Rotterdam

In January 2019, when the Ontario Court of Appeal released its decision in The Guarantee Company of Canada v Royal Bank of Canada, 2019 ONCA 9, a collective sigh of relief went up from parties seeking to enforce Construction Act trust rights in the face of an insolvency.

Section 8 of the Act provides that amounts owing to or received by a contractor or subcontractor on account of an improvement constitute a trust fund for the benefit of the subcontractors and other suppliers of services or materials to the improvement. As trustee, the contractor or subcontractor cannot appropriate or convert any part of the trust fund to its own use or to any use inconsistent with the trust until all suppliers of services or materials to the improvement are fully paid.

In Ontario, however, when a trustee makes an assignment into bankruptcy, the question of whether the trust will survive the bankruptcy has historically been answered in the negative, leaving unpaid parties fighting to collect from whatever assets are available to the pool of other creditors.

In British Columbia v Henfrey Sampson Belair Ltd., [1989] 2 S.C.R. 24, the Supreme Court of Canada laid out the test to determine whether a statutory trust ought to be excluded from a bankrupt’s property for distribution to creditors pursuant to section 67(1)(a) of the Bankruptcy and Insolvency Act, which provides that “the property of a bankrupt divisible among his creditors shall not comprise property held by the bankrupt in trust for any other person.” The Supreme Court held that the three elements of a common law trust had to be present before a statutory trust could fall under s. 67(1)(a) BIA: certainty of intention, certainty of subject matter, and certainty of object.

In Royal Bank of Canada v Atlas Block Co. Limited, 2014 ONSC 3062, the court held that a supplier’s trust claim under the Act did not survive Atlas’s bankruptcy. Following Henfrey, the court held that section 67(1)(a) of the BIA did not extend to assets subject to a deemed trust created by provincial statute where such deemed trust did not otherwise have all the attributes of a valid trust at common law. Since the funds from the projects in Atlas Block were commingled with funds from other sources, there was no certainty of subject matter and consequently no common law trust. In the words of the court, “once co-mingling has occurred, that is the end of the matter.”

The court’s analysis turned on the fact that, as in Ivaco Inc. (Re), 2006 CanLII 34551 (ONCA), the Act did not set out specific obligations on the trustee, and therefore the subsequent receiver, to establish and maintain a separate account designated as a trust account. The court noted that a deemed trust was, in a sense, a legal fiction; that only a trust at common law was exempt from the bankrupt’s estate; and that if the province wanted to require that a party maintain funds in a separate account, it could have legislated that separation, but it did not do so.

The authors of Striking the Balance: Expert Review of Ontario’s Construction Lien Act, took that last comment to heart and, after reviewing various options, including requiring parties to open project trust accounts or project bank accounts, suggested amendments to the trust regime. The legislature eventually settled on what is now s. 8.1 of the Act:

(1) Every person who is a trustee under section 8 shall comply with the following requirements respecting the trust funds of which he or she is trustee:

  1. The trust funds shall be deposited into a bank account in the trustee’s name. If there is more than one trustee of the trust funds, the funds shall be deposited into a bank account in all of the trustees’ names.
  2. The trustee shall maintain written records respecting the trust funds, detailing the amounts that are received into and paid out of the funds, any transfers made for the purposes of the trust, and any other prescribed information.
  3. f the person is a trustee of more than one trust under section 8, the trust funds may be deposited together into a single bank account, as long as the trustee maintains the records required under paragraph 2 separately in respect of each trust.

(2) Trust funds from separate trusts that are deposited together into a single bank account in accordance with subsection (1) are deemed to be traceable, and the depositing of trust funds in accordance with that subsection does not constitute a breach of trust.

The recent Ontario Court of Appeal decision in The Guarantee Company of Canada v Royal Bank of Canada revisited the discussion concerning statutory trusts and bankruptcy. The conclusions reached by the court, read together with the requirements of the new s. 8.1 of the Act, should finally clarify this area of law.

In GCNA v RBC, the court considered the s. 8 trust in the context of the bankruptcy of a contractor, A-1 Asphalt Maintenance Ltd. Multiple liens were registered against various A-1 projects. At the time of A-1’s bankruptcy, it had four major ongoing projects, three with the City of Hamilton and one with the Town of Halton Hills. All four contracts had outstanding accounts receivable for work performed by A-1. The bankruptcy judge directed the receiver to establish a paving projects account and a general post-receivership account. The order provided that all receipts from the four paving projects were to be deposited into the paving projects account.

The City and the Town paid $675,372.27, which represented debts owing to A-1 by the City and the Town when A-1 filed its Notice of Intention, to the receiver, who deposited the funds into the paving projects account. It was common ground that those funds were subject to the s. 8 trust, but GCNA, the bonding company that had settled the liens and become subrogated to the claims, further argued that the funds had to be excluded from A-1’s property on bankruptcy pursuant to s. 67(1)(a) of the BIA. Not surprisingly, RBC, a secured creditor pursuant to a general security agreement, took the position that the funds formed part of A-1’s estate and were available to creditors.

The motion judge concluded that GCNA had failed to establish sufficient certainty of subject matter and that the funds were not held in trust within the meaning of s. 67(1)(a). She held that GMAC Commercial Credit Corporation – Canada v T.C.T. Logistics Inc. (2005), 74 O.R. (3d) 382 (C.A.) required segregation of funds to maintain a common law trust, and that even though the receiver’s accounting could identify the funds in the paving projects account, that was not enough to establish certainty of subject matter. The mere fact of commingling the funds from the various projects into a single account was held to have destroyed the certainty of subject matter. According to the motion judge, therefore, GCNA was only entitled to a pro rata share of the funds as a secured creditor.

GCNA appealed. In allowing the appeal, the Court of Appeal began by finding that Henfrey contemplated that a provincial statute could supply the required element of certainty of intention for a statutory trust and that the trust created by the Act did not give rise to an operational conflict with the BIA. Accordingly, the doctrine of paramountcy did not apply.

The court next concluded that the motion judge erred by finding that the requirement of certainty of subject matter was not met in this case. Citing from Eileen E. Gillese, The Law of Trusts, 3rd ed. (Toronto: Irwin Law, 2014), the court held that to satisfy the requirement for certainty of subject matter, it “must be possible to determine precisely what property the trust is meant to encompass. The subject matter is ascertained when it is a fixed amount or a specified piece of property; it is ascertainable when a method by which the subject matter can be identified is available from the terms of the trust or otherwise.”

The court held that the amounts owed by the City and the Town on account of the paving projects were debts, that a debt was a chose in action which could properly be the subject matter of a trust, and that consequently it did not matter that neither the City nor the Town had created segregated accounts or specifically earmarked the source of the funds they would use to pay the debts they owed for the paving projects. Sharpe J.A. wrote as follows:

Section 8(1) embraces “all amounts, owing to a contractor or subcontractor, whether or not due or payable”. That language designated precisely what property the trust is meant to encompass. A-1 owned those debts. They constituted choses in action which are a form of property over which a trust may be imposed. It follows that at the moment of A-1’s bankruptcy, the trust created by s. 8(1) was imposed on the debts owed by the City and the Town to A-1.

Finally, since the evidence clearly established that the funds paid for each paving project were readily ascertainable and identifiable, the fact that they were commingled into the same paving projects account did not deprive the funds of certainty of subject matter. Only when commingling is accompanied by conversion and tracing becomes impossible is the required element of certainty of subject matter lost.

Consequently, the court concluded that by operation of s. 67(1)(a) of the BIA, the funds satisfied the requirements for a trust at law and were not property of A-1 available for distribution to A-1’s creditors.

In light of cases such as Atlas Block, it was not entirely clear whether s. 8.1 of the Act alone would have achieved its goal of turning the s. 8 trust funds into common law trust funds. However, going forward, the requirement in s. 8.1 that a trustee must maintain written records respecting the trust funds, detailing the amounts that are received into and paid out of the funds, any transfers made for the purposes of the trust, and any other prescribed information, in conjunction with the Court of Appeal decision in The Guarantee Company of Canada v Royal Bank of Canada, should leave beneficiaries of the s. 8 trust in a good position to claim access to the trust funds in bankruptcy by excluding the funds from the property of the bankrupt and thus excluding them from the reach of other creditors.

Andrea Lee is a partner and Markus Rotterdam is Director of Research at Glaholt LLP