Construction Trusts

1. Construction Trusts Duncan W. Glaholt

2. Part II - Trusts • s. 7 - Owner’s trust • s. 8 – Contractor’s trust • s. 9 – Vendor’s trust • s. 10 – Discharge • s. 11 – Reduction • s. 12 – Retainage • s. 13 -

3. Part II - Trusts • s. 7 • 7.--(1) All amounts received by an owner, other than the Crown or a municipality, that are to be used in the financing of the improvement, including any amount that is to be used in the payment of the purchase price of the land and the payment of prior encumbrances, constitute, subject to the payment of the purchase price of the land and prior encumbrances, a trust fund for the benefit of the contractor.

4. Section 7(2) • Where amounts become payable under a contract to a contractor by the owner on a certificate of a payment certifier, an amount that is equal to an amount so certified that is in the owner's hands or received by the owner at any time thereafter constitutes a trust fund for the benefit of the contractor.

5. Section 7(3) • Where the substantial performance of a contract has been certified, or has been declared by the court, an amount that is equal to the unpaid priceof the substantially performed portion of the contract that is in the owner's hands or is received by the owner at any time thereafter constitutes a trust fund for the benefit of the contractor.

6. Section 7(4) • The owner is the trustee of the trust fund created by subsection (1), (2) or (3), and the owner shall not appropriate or convert any part of a fund to the owner's own use or to any use inconsistent with the trust until the contractor is paid all amounts related to the improvement owed to the contractor by the owner.

7. Section 8(1) • 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.

8. Section 8(2) • (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.

9. Section 9(1) • Where the owner's interest in a premises is sold by the owner, an amount equal to, • (a) the value of the consideration received by the owner as a result of the sale, less, • (b) the reasonable expenses arising from the sale and the amount, if any, paid by the vendor to discharge any existing mortgage indebtedness on the premises, constitutes a trust fund for the benefit of the contractor.

10. Section 9(2) • (2) The former owner is the trustee of the trust created by subsection (1), and shall not appropriate or convert any part of the trust property to the former owner's own use or to any use inconsistent with the trust until the contractor is paid all amounts owed to the contractor that relate to the improvement.

11. Section 10 • Subject to Part IV (holdbacks), every payment by a trustee to a person the trustee is liable to pay for services or materials supplied to the improvement discharges the trust of the trustee making the payment and the trustee's obligations and liability as trustee to all beneficiaries of the trust to the extent of the payment made by the trustee.

12. Section 11 (1) Subject to Part IV, a trustee who pays in whole or in part for the supply of services or materials to an improvement out of money that is not subject to a trust under this Part may retain from trust funds an amount equal to that paid by the trustee without being in breach of the trust. (2) Subject to Part IV, where a trustee pays in whole or in part for the supply of services or materials to an improvement out of money that is loaned to the trustee, trust funds may be applied to discharge the loan to the extent that the lender's money was so used by the trustee, and the  application of trust money does not constitute a breach of the trust.

13. Section 12 • Subject to Part IV, a trustee may, without being in breach of trust, retain from trust funds an amount that, as between the trustee and the person the trustee is liable to pay under a contract or subcontract related to the improvement, is equal to the balance in the trustee's favour of all outstanding debts, claims or damages, whether or not related to the improvement.

14. Part II - Trusts • s. 13:

15. Section 13(1) In addition to the persons who are otherwise liable in an action for breach of trust under this Part, (a) every director or officer of a corporation; and (b) any person, including an employee or agent of the corporation, who has effective control of a corporation or its relevant activities, who assents to, or acquiesces in, conduct that he or she knows or reasonably ought to know amounts to breach of trust by the corporation is liable for the breach of trust.

16. Part II - Trusts • s. 13(2) The question of whether a person has effective control of a corporation or its relevant activities is one of fact and in determining this the court may disregard the form of any transaction and the separate corporate existence of any participant.

17. Part II - Trusts • s. 336 Criminal Code Every one who, being a trustee of anything for the use or benefit, whether in whole or in part, of another person, or for a public or charitable purpose, converts, with intent to defraud and in contravention of his trust, that thing or any part of it to a use that is not authorized by the trust is guilty of an indictable offence and liable to imprisonment for a term not exceeding fourteen years.

18. Forty Years of Fundamentals Minneapolis-Honeywell Regulator Co. v. Empire Brass Manufacturing Co. [1955] 3 D.L.R. 561 (S.C.C.)

19. Facts • Plaintiff supplied materials to a mechanical subcontractor • Empire Brass supplies materials to the same subcontractor • Empire Brass thought they could get a jump on the plaintiff and others by taking an assignment of the subcontractor’s receivables on four projects • Empire Brass collected on the assignments • Plaintiff and others empty-handed because, in theory, no money was ever “received” by the subcontractor • Question: Is this fair?

20. Decision Monies payable by an owner to a contractor are deemed to have been received by that contractor.

21. “For obvious reasons this [the lien] is but a partial security; too often the contract price has been paid in full and the security of the land is gone.  It is to meet that situation that s. 19 [contractor’s trust] has been added.  The contractor and sub-contractor are made trustees of the contract moneys and the trust continues while employees, material men or others remain unpaid.”

22. “I cannot interpret the word “received” in s. 19 as not including money paid to an assignee. The money “received” on account of the contract is the same as that paid by the contractor: payment is the correlative of receipt. The assignee acts through the right and power of the assignor; and the receipt by him is likewise that by the creditor. If this were not so, the entire purpose of the section could be nullified by an assignment contemporaneous with the contract.”

23. The reasoning of Rand J. in Minneapolis-Honeywell in 1955 anticipates the “purposive” interpretation theory of he Supreme Court of Canada that we see developing 40 years later

24. Next Major Development: Banks’ Liability for breach of trust • T. McAvity & Sons Ltd. v. Canadian Bank of Commerce (1959), 17 D.L.R. (2d) 529 (S.C.C.) • John M.M. Troup Ltd. v. Royal Bank (1963), 34 D.L.R. (2d) 556 (S.C.C.)

25. McAvity Facts: • McAvity constructs sewers and watermains for a contractor • Contractor runs out of money • Bank takes progress payments to reduce overdraft, pursuant to a general assignment of book debts

26. Question Is thebank liable for breach of trust? Answer: The bank is a stranger to the trust and can only be liable if it is a party to a breach of trust by someone who is a trustee, i.e. their customer

27. Troup Facts: • Troup and others were subcontractors • They did not file liens • The final holdback payment deposited into the contractor’s account was applied to reduce the contractor’s overdraft • Contractor ran high volume blended account for many jobs

28. Question: The bank knew its customer was a contractor Was this enough to fix it with liability for breach of trust? Answer: With a strong dissent by Justice Locke: NO

29. 40 Years Later • Arthur Andersen Inc. v. Toronto-Dominion Bank (1994), 17 O.R. (3d) 363 (Ont. C.A.) • Gold v. Rosenberg (1997), 152 D.L.R. (4th) 385 (S.C.C.) • Citadel General Assurance Co. v. Lloyds Bank Canada (1997), 152 D.L.R. 411 (S.C.C.)

30. Arthur Andersen Facts: • Busy high volume construction account • “Mirror accounting practice” implemented at bank’s suggestion, resulting in daily breaches of trust Conflicting interests: • Bank’s interest in efficient banking practices • Public’s interest in enforcement of statutory trusts for benefit of trades and suppliers

31. Arthur AndersenQuestion: • How do we resolve these competing interests? Answer: (a middle ground) • Issue is resolved as one of knowledge on the part of the bank in question. • When does a bank have sufficient knowledge of the source and application of a customer’s funds?

32. Gold / Citadel • Two decisions of S.C.C. released on the same day in 1997, neither of them is a construction case, but both deal with strangers to the trust • Two kinds of liability: • Knowing assistance • fault-based accessory’s liability • Knowing receipt • receipt-based liability demanding a restitutionary remedy

33. Revolution of trust law in the 90s The Overhead Cases

34. Ont. C.A. Trilogy: • Rudco Insulation Ltd. v. Toronto Sanitary Inc. (1998), 42 O.R. (3d) 292 • Dietrich Steel Ltd. v. Shar-Dee Towers (1999), 42 O.R. (3d) 749 • Tam-Kal Ltd. v. Stock Mechanical (2000), 50 C.L.R. (2d) 224

35. Rudco: Facts: • Contractor uses trust funds to pay general overhead expenses • Question? • Is this a permissible use of trust money • Answer: • Categorically: NO

36. Dietrich: Facts: • Contractor uses trust funds to pay for sitespecific overhead expenses related to a single job Questions: • Is this permissible? • Does section 35 Trustee Act provide a defence?

37. Answer: NO, and NO again!

38. Tam-Kal: Affirms Rudco & Dietrich, without much discussion Conclusions: 1. Don’t even think about it! 2. Most contractor operate in breach of trust every day anyway.

39. The Commingling Cases • Arborform Countertops v. Stellato (1996), 29 O.R. (3d) 129(Ont. Gen. Div.) • St. Mary’s Cement Corp. v. Construc Ltd. (1997), 32 O.R. (3d) 595 (Ont. Gen. Div.) • S.E. Rozell & Sons Inc. v. Groff (2000), 2 C.L.R. (3d) 58 (Ont. S.C.J.)

40. Arborform Facts: • Supplier manufactured and supplied countertops to improvement to be made to various properties • Supplier remains unpaid • Contractor pays itself out of its one, blended operating account by means of set-off for alleged deficiencies on several projects

41. Question:Is the company’s banking practice, on its own, a breach of trust? Answer: Yes.

42. Reasons: “I am satisfied that the authorities on this issue are clear, and I agree, that a failure to set up a proper system to receive, monitor and disburse trust funds is sufficient, in and of itself, to constitute a breach of trust. Indeed, a trustee need not intend to breach the trust nor must he or she act fraudulently in order to be found liable for the breach of trust. The law, in my view, is clear, a breach of trust occurs if the trustee carries on business through one general operating account into which trust moneys are deposited and are thereby intermingled with non-trust funds;

43. Reasons (cont’s) “if the trustee keeps inaccurate or incomplete records with respect to the receipt and disbursal of funds; and, generally, if the trustee deals with trust funds in a manner inconsistent with the trust. Moreover, in these circumstances, even ‘hard working, sincere people who tried to do the best they could in all the circumstances’ will be found liable for breach of trust.”

44. St. Mary’s Cement • Facts: • Plaintiff supplied concrete products to a number of projects upon which the corporate defendant was contractor • Corporate defendant went out of business • Plaintiff sued officers and directors • Contractor had operated two blended account for all projects • Contractor had no detailed accounting on a project by project basis

45. Question:Is the company’s banking practice, on its own, a breach of trust?Answer:Yes.

46. Reasons: The Act contemplates a separate trust fund for every project in which the contractor is involved and separate accounting for every trust fund. It is only by separately accounting for the moneys held in trust that a contractor can ensure that trust moneys are not in fact applied to other purposes. The fact that the Act does not expressly require that trust funds be kept separate from the general accounts of the contractor is not determinative of whether a failure to do so constitutes a breach of trust. A trustee has an obligation to protect the trust funds. Allowing trust funds to be intermingled with other moneys and used for general purposes is inconsistent with the trustee's duty to maintain proper control of the trust funds.

47. S.E. Rozell Facts: • Plaintiff is subcontractor • General contractor maintains one bank account for all aspects of its business • All receipts were commingled • Everything, including overheads, was paid out of this account • Plaintiff chose to sue personal defendants instead of corporate defendant

48. Question:Is the company’s banking practice, on its own, a breach of trust?Answer:Yes.

49. Reasons: “While it is true that s. 8 does not prohibit the commingling of trust funds with other funds, the weight of the case law seems to be to the effect that commingling places the trust funds at risk, and merely exposing them to that unnecessary risk is an act which is inconsistent with the high standards expected of a trustee.  The fact that, in the end, the risk is not realized is immaterial - good luck should not be a defence to a breach of trust.”

50. The Owner’s Trust Case Structural Contractors Ltd. v. Westcola Holdings Inc. (2000), 48 O.R. (3d) 417 (Ont. C.A.)