Construction Trusts

1
Construction Trusts

• Duncan W. Glaholt

2
Part II - Trusts

• s. 7 - Owners trust
• s. 8 Contractors trust
• s. 9 Vendors 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
  price of 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 subcontractors 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 contractors 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 the bank 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
  contractors account was applied to reduce the
  contractors 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
  banks suggestion, resulting in daily breaches of
  trust
• Conflicting interests
• Banks interest in efficient banking practices
• Publics 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 customers 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 accessorys 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 site
  specific 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. Dont 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. Marys 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
QuestionIs the companys 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 (conts)

• 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. Marys 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 companys banking practice, on
its own, a breach of trust?AnswerYes.
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 companys banking practice, on
its own, a breach of trust?AnswerYes.
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 Owners Trust Case

• Structural Contractors Ltd. v. Westcola Holdings
  Inc. (2000), 48 O.R. (3d) 417 (Ont. C.A.)

51
Facts

• Westcola owned office building in Toronto
• Largest tenant (government) occupied 75 of
  building
• Westcola retained Structural to renovate
  underground parking garage
• Payments from Westcola to Structural were to be
  certified by payment certifier
• Contract price doubled as work progressed

52
Facts (continued)

• Government lease ran out
• Government chose not renew because of ongoing
  ocnstruction
• Owners cash flow stopped
• Owner used rent payments from government
  exclusively to service mortgage debt, utility
  bills, maintenance costs, insurance and property
  taxes
• No personal benefit to landlord whatsoever
• Engineers certified substantial completion
• Unpaid contractor sued owner of company
  personally

53
Landlords Arguments

• It cannot be breach of trust merely to service
  mortgage and pay utilities, because without doing
  so, there would be no rents
• It would be grossly unfair to find the owner
  personally liable in such a case, because nobody
  could have foreseen such liability

54
Court of Appeals Response

• Rents became trust funds to the extent of
  certified but unpaid funds due to Structural
• Owner is personally liable for these trust funds
• Landlords attempt to draw distinction between s.
  7 (owners trust) and s. 8 (contractors trust)
  cannot prevail given the language of s. 7(4)

55
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.

56
Court of Appeal Reasons

• The appellants argue that the same
  considerations do not apply to s. 7, particularly
  where the funds are received on account of rent,
  without which the owner would be unable to
  provide the services required by its lease
  obligations. I do not see how this submission can
  prevail given the language of s. 7(4).
• That argument must be rejected. Westcola is
  essentially a landlord. Rent is not an incidental
  matter to it. Rent is its lifeblood, its raison
  d'être. To exclude rent from the trust in the
  case of a landlord would be to exclude Westcola
  from the application of s. 7. No justification
  has been suggested for such a step.

57
Where do we go from here?

• 1. Statutory amendment to require separate trust
  accounts?
• Discussion was initiated to amend the Act to
  require separate trust accounts
• According to Attorney Generals office, that
  discussion is on ice
• 2. Another option
• Adopt the New York Model and legislate a way of
  trust accounting that allows a single operating
  account to be used

58
The New York Model

• New York Lien Law expressly provides for a method
  of keeping books and records relating to trust
  funds
• This provides a defendant with at least a prima
  facie defence to a breach of trust action
• Summary judgments as seen in Westcola would be
  impossible if practices were adopted

59
Highlights of the New York Model

• 1. Some overheads are permissible, such as
  payroll taxes, unemployment insurance premiums,
  wage supplements, surety bond premiums.
• 2. Books and records shall include
• (a) detailed accounting of trust assets
  receivable (names, addresses, amounts, dates)
• (b) detailed accounting of trust accounts
  payable
• (c) detailed accounting of trust accounts
  received
• (d) detailed accounting of trust accounts made

60
Highlights of the New York Model

• 3. Create legal presumptions
• if accounting not followed presumed breach of
  trust
• If accounting followed presumed defence to
  action for breach of trust (i.e. no summary
  judgment)