Provincially created trusts deemed valid

A statutory trust under the province’s Construction Lien Act is a valid trust that can survive bankruptcy, a panel of judges from the Court of Appeal of Ontario decided in a Jan. 14 decision, The Guarantee Company of Canada v. Royal Bank of Canada, 2019 ONCA 9.

Provincially created trusts deemed valid
Matthew Lerner says that following a recent Court of Appeal ruling the system of interlinking contracts in the construction industry will be better preserved. Photo: Laura Pedersen

A Statutory  trust under the province’s Construction Lien Act is a valid trust that can survive bankruptcy, a panel of judges from the Court of Appeal of Ontario decided in a Jan. 14 decision, The Guarantee Company of Canada v. Royal Bank of Canada, 2019 ONCA 9.

The decision, which overturns the lower court’s decision and parts from jurisprudence on the Commercial List, has upheld s. 8 of Ontario’s Construction and Lien Act.

A statutory trust under the Construction and Lien Act will survive bankruptcy, the decision says.

That will “protect the rights and interests of those engaged in the construction industry and to avoid unjust enrichment of those higher up in the construction pyramid,” says Matthew Lerner, a partner at Lenczner Slaght Royce Smith Griffin LLP, who represented The Guarantee Company of North America, which was awarded costs of $30,000 for the motion and $45,000 for the appeal.

“Previously, any proceeds that come into the hands of the contractor after a bankruptcy were treated as belonging to the secured creditor,” says Lerner. “Therefore, the subcontractors, the trade — the little guy — would be out of luck. And that is no longer the case. Because the system of interlinking contracts between contractors and subcontractors and trades is going to be preserved and recognized as still operating in a bankruptcy, such that they will get paid where there are proceeds available to fund the trust, and not the secured creditor.”

The decision, written by Justice Robert Sharpe, with Associate Chief Justice Alexandra Hoy, and Justices Michal Fairburn, Lois Roberts and David Doherty concurring, involved appellant The Guarantee Company of North America, and respondents on appeal including Royal Bank of Canada, A-1 Asphalt Maintenance Ltd. (Receiver of), IUOE Local 793 and LIUNA Local 837, and LIUNA Local 183, with the Attorney General of Ontario intervening on behalf of the appellant.

A-1 Asphalt Maintenance Ltd. was deemed bankrupt in 2014, amid four major projects, three with the city of Hamilton, Ont. and one with the town of Halton Hills, Ont., Sharpe wrote in the decision.

The two governments paid $675,372.27 to A-1 Asphalt Maintenance Ltd., which went into a “paving projects account,” the decision said.

A dispute arose over which creditors or employees had priority to receive the funds, if any, Sharpe wrote. In particular, the decision explored whether the funds were in a statutory trust created by Ontario’s Construction Lien Act, and if so, was that trust protected from creditors under the federal Bankruptcy and Insolvency Act.

“It raised the question, ‘Does the provincially created statutory trust continue to exist after a bankruptcy under federal legislation occurs?’” says Lerner.

The Court of Appeal decided there was nothing in the federal Bankruptcy and Insolvency Act that conflicts with the province’s construction rules, ordering that the $675,372.27 was not available for distribution creditors.

“Contractors are pretty capital-intensive enterprises,” says Scott Rollwagen, a partner at Lenczner Slaght who worked with Lerner on the case.

“They have to make promises to those lenders . . . That’s what they mean when they say to the people lower down the chain, ‘No, this money belongs to you, it doesn’t belong to the contractor for the purposes of being distributed to the creditors.’”

Another issue addressed by the court was that of “co-mingling,” says Paul Cavalluzzo, a founder of Cavalluzzo LLP in Toronto, who acted for the intervener, LIUNA Local 183.

The panel of judges wrote in the decision that it did not matter to the validity of the trust that the payments for the municipalities were not in “segregated accounts or specifically earmarked.”

“In a bankruptcy situation, if the trust funds become part of the bankrupt [company]’s assets then they are distributed to the creditors in accordance with the priorities set out in bankruptcy legislation. What usually happens is the banks scoop up everything and the workers are left with nothing,” says Cavalluzzo.

“There was some law in Ontario from the Ontario Superior Court that suggested when funds from different creditors of the bankrupt are co-mingled — basically, not segregated — that money’s not a valid trust, and therefore all of the trust monies would go to the bankrupt estate, to the prejudice of the workers. That line of cases has been, if not overruled, certainly it’s clarified now. So long as the funds are traceable in the bankrupt’s account, then a valid trust has been created, in favour of the workers, and those monies are protected.”

The co-mingling of the funds came to the fore as the court analysed whether A-1 Asphalt Maintenance’s statutory trust created by the Construction Lien Act met the “three certainties required for it to operate in bankruptcy,” the decision said.

In previous cases, trusts have been required to have certainty of intention, certainty of subject matter, and the certainty of objects included.

In British Columbia v. Henfrey Samson Belair Ltd., 1989 CanLII 43 (SCC), a panel of judges wrote that in most cases, “the trust property soon ceases to be identifiable.”

“The tax money is mingled with other money in the hands of the merchant and converted to other property so that it cannot be traced. At this point it is no longer a trust under general principles of law,” the 1989 decision said.

Raymond Slattery, managing partner at Minden Gross LLP in Toronto, says the decision shows co-mingling is not fatal so long as the monies have not been converted to another use.

“It provides some certainty in an area where there was a lot of uncertainty, because different courts in different provinces had taken different positions,” says Slattery, who acted for the receiver of A-1 Asphalt Maintenance. The receiver of the company did not take a position on the matter of The Guarantee Company of Canada v. Royal Bank of Canada, 2019 ONCA 9.

“There was some tension between the insolvency practitioners who took the view that the BIA provides a complete code of how to deal with creditors’ claims and the thinking was, ‘Why should one group of creditors, i.e., construction suppliers and workers, be treated differently from other creditors?’” says Slattery.

“Whereas the construction bar has always strongly taken the position that they are a special group, provincial legislation protects them and there’s a scheme of holdbacks and liens and trusts that protect people who provide value to property. Basically, the latter prevailed. Both schemes can live together.”

Sam Babe, a partner at Aird & Berlis LLP and one of the lawyers that represented Royal Bank of Canada, declined to comment, as the client was still reviewing the decision, which is within the leave to appeal period.

Brian Gray, a spokesman for the Ministry of the Attorney General of Ontario said in an email that the province could not comment further due to the appeal period. 

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