On January 14, 2019, the Ontario Court of Appeal released its much anticipated decision addressing the interaction between the trust provisions of the Ontario Construction Lien Act1 (CLA) and the Bankruptcy and Insolvency Act2 (BIA) in The Guarantee Company of North America v. Royal Bank of Canada, 2019 ONCA 9.

In its well-reasoned, unanimous, and thorough decision, a five-member panel of the Ontario Court of Appeal tackled the landscape of arguments and issues raised by the long-standing question of whether a trust created by provincial lien legislation survives bankruptcy. While this question was directly addressed in the Alberta context nearly four years ago in the landmark Alberta Court of Appeal decision, Iona Contractors Ltd v. Guarantee Company of North America3, it was considered open by some in the Ontario context.

The issue at stake was whether suppliers and subcontractors (or the surety subrogated to their position having made payments under a Labour & Material Payment Bond) can rely on the trust created by the CLA to exclude trust funds paid (or to be paid) to a bankrupt contractor by the owner from the "property" of the bankruptcy estate available generally to all creditors. If the funds are not impressed with a trust, and therefore form part of the bankrupt contractor's estate, those suppliers and subcontractors down the construction pyramid of the project (the Trust Beneficiaries), whose work generated the funds, must stand in line with the bankrupt contractor's other unsecured creditors, significantly reducing or even eliminating any entitlement of those Trust Beneficiaries to payment of the funds. Over the years, confusion over this issue has been caused by Royal Bank of Canada v. Atlas Block Co4, as well as two Saskatchewan Court of Queen's Bench decisions5 .

The Ontario Court of Appeal, in allowing the appeal and overturning the decision of the motions judge, found that the BIA and CLA are not in operational conflict and that a valid common law trust was created on the facts of this case. This is consistent with the finding in Iona, adopted by the Ontario Court of Appeal in its decision. As a result, the Court of Appeal ordered that by operation of s. 67(1)(a) of the BIA, the subject funds are not property of the bankrupt contractor available for distribution to its creditors, but rather "trust funds" under the BIA available to the Trust Beneficiaries.

Background

The appeal arose from a priority dispute between employees and certain secured creditors of a bankrupt paving company, A-1 Asphalt Maintenance Ltd (A-1). The disputing secured creditors were the Royal Bank of Canada (the Bank) and The Guarantee Company of North America (the Surety), subrogated to the rights of the Trust Beneficiaries under the CLA. At the time of A-1's bankruptcy, it had four major ongoing paving projects, three with the City of Hamilton (the City) and one with the Town of Halton Hills (the Town). All four contracts had outstanding accounts receivable for work performed by A-1. The Receiver was directed in the Initial Order to establish a "Paving Projects Account" and deposit all receipts from the four paving projects (the Funds) into that account.

The Bank took the position that the Funds form part of A-1's estate available to all creditors, entitling it to the Funds as a secured creditor with priority over all unsecured creditors including the Trust Beneficiaries. The Surety and Trust Beneficiaries took the position that the Funds were s. 8(1) CLA trust funds that must be excluded from A-1's property on bankruptcy, pursuant to s. 67(1)(a) of the BIA, entitling the Surety to the Funds in its subrogated position to the Trust Beneficiaries.

The Receiver brought a motion for advice and directions to resolve the priority dispute and served a Notice of Constitutional Question identifying the purported potential conflict resolved in the Iona decision between the CLA and BIA.

Arguments and Reasons for the Decision

Citing the Supreme Court of Canada decision in British Columbia v. Henfrey Samson Belair Ltd6, and the Alberta Court of Appeal decision in Iona, the Court of Appeal took as its starting point that trusts established by provincial law must meet the general principles of the law of trusts in order to be excluded from the bankrupt's estate. It is common ground that those principles are the three certainties: certainty of intention, object, and subject matter. The Surety and the Trust Beneficiaries argued that the three certainties are present in s. 8(1) of the CLA, while the Bank disputed both certainty of intention and certainty of subject matter.

Turning first to the issue of certainty of intention, the Court of Appeal considered whether allowing the CLA to establish certainty of intention is contrary to Henfrey. In determining that it is not, the Court of Appeal interpreted Henfrey as requiring courts to look at the deeming language of a statute to determine whether there is certainty of intention. In other words, it is possible for a statute deeming a trust into existence to provide the required certainty of intention. This requirement is satisfied where a court finds an intention that the trustee be placed under an imperative obligation to hold property on trust for the benefit of another. The Court of Appeal clarified that not only can the "imperative obligation" be created by statute for the purposes of the BIA, but that s. 8 of the CLA does so. As a result, certainty of intention exists. In resolving this issue, the Court of Appeal also determined that there is no operational conflict between s. 8(1) of the CLA and the BIA, rejecting the Bank's argument that the purpose of s.8(1) is to alter priorities upon bankruptcy. As such, the doctrine of paramountcy did not apply.

Next, the Court of Appeal considered the issue of certainty of subject matter. In reversing the motion judge's finding, the Court of Appeal found that the language of s. 8(1) designated precisely what property the trust is meant to encompass, i.e. "all amounts, owing to a contractor or subcontractor, whether or not due or payable". The Court of Appeal reasoned that the amounts owed by owners on account of the paving projects were debts, owned by A-1, and it is well-established that a debt is a chose in action which can properly be the subject matter of a trust.

In determining that the funds paid for each paving project were readily ascertainable and identifiable, the Court of Appeal also rejected the argument relied upon by the Bank and the judge in Atlas Block that simply being paid into a single account resulted in commingling, depriving the trust property of the required element of certainty of subject matter. Since the Funds had not been converted to other uses, and they did not cease to be traceable to the specific project for which they had been paid, the Court of Appeal determined that it did not matter that neither the City nor 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.

Thus, having satisfied the requirements for a trust at law, the Court of Appeal concluded that the Funds satisfied the conditions of a common law trust and were therefore not the property of A-1 available for distribution to its creditors. In so deciding, the Court of Appeal eliminated the confusion caused by the decision in Atlas Block and the Saskatchewan Court of Queen's Bench decisions, cited above, which interpreted Henfrey to find that deemed statutory trusts for the construction industry did not operate in bankruptcy.

Takeaways

This decision, adopting and following the Alberta Court of Appeal Iona decision, provides further comfort to subcontractors and suppliers (as trust beneficiaries) that the trust rights contained in provincial lien legislation provide an effective security for their statutory right to payment, even in the context of a receivership or bankruptcy. By ensuring that the trust funds on a construction project remain in the construction pyramid until payment to the trust beneficiaries has been satisfied, these cases uphold the integral role the trust provisions play in protecting the rights and interests of those subcontractors and suppliers at the bottom of the construction pyramid, ordinarily the stakeholders most financially vulnerable to the bankruptcy of a contractor. Lastly, this decision is important for its confirmation that commingling of construction funds, typical practice for many construction companies, may not be fatal to the finding of the common law trust where funds are not converted to other uses and remain traceable.

The Guarantee was represented by Rick Shaban and James MacLellan at the hearing of the Iona decision.

Footnotes

1 RSO 1990, c C 30 [CLA].

2 RSC 1985, c B-3 [BIA].

3 2015 ABCA 240, leave to appeal dismissed, [2015] SCCA No 404 [Iona]. For more information, read our bulletin from April 2016.

4 2014 ONSC 3062 [Atlas Block].

5 See Duraco Window Industries (Sask) Ltd v Factory Window & Door Ltd (Trustee of) (1995), 34 CBR (3d) 196 (Sask QB); Roscoe Enterprises Ltd v Wasscon Construction Inc (1998), 161 DLR (4th) 725 (Sask QB).

6 [1989] 2 SCR 24 [Henfrey].

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