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Construction Act Trust Claimants in Insolvencies - A Shift in Ontario Law

Urbancorp Cumberland 2 GP Inc. (Re), 2020 ONCA 197

Brendan Bowles, Partner and Markus Rotterdam, Director of Research

On March 11, 2020 the Court of Appeal released a precedent setting decision on the Construction Act trust remedy that would have undoubtedly received more attention than it did, had the decision not been released on the same day as the World Health Organization declared the novel coronavirus to be a global pandemic. Urbancorp Cumberland 2 GP Inc. (Re), 2020 ONCA 197, however, is required reading for anyone advising construction industry clients in an insolvency proceeding. Until recently, when lien or trust claimants sought advice from construction lawyers on their rights in an insolvency context, they used to be told that bankruptcy and insolvency legislation was federal, while lien legislation was provincial, that the former took precedence over the latter and that therefore they could not rely on the rights they would have had but for the insolvency.

That advice was based on case law such as Royal Bank of Canada v. Atlas Block Co. Limited, 2014 ONSC 3062, in which the court held that a supplier’s trust claim under the Act did not survive Atlas’s bankruptcy. Section 67(1)(a) of the Bankruptcy and Insolvency Act (the “BIA”) 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 of Canada, in British Columbia v. Henfrey Sampson Belair Ltd., [1989] 2 S.C.R. 24, 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.

Based on that Supreme Court decision, the court in Atlas Block held that s. 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 first Ontario Court of Appeal decision to breathe life back into the rights of Construction Act claimants in insolvency situations was The Guarantee Company of Canada v. Royal Bank of Canada, 2019 ONCA 9. The Court of Appeal found:

  • The Supreme Court in Henfrey contemplated that a provincial statute could supply the required element of certainty of intention for a statutory trust.
  • The trust created by the Construction Act does not give rise to an operational conflict with the BIA. Accordingly, the doctrine of paramountcy does not apply.
  • The mere fact that trust funds are paid into the same account does not mean that certainty of subject matter is lost. That only happens once tracing becomes impossible.
  • Therefore, trust funds under s. 8 of the Construction Act can satisfy the requirements of a common law trust, and they did in GCNA v Royal Bank.
  • Consequently, the s. 8 trust funds were not property of the bankrupt and were not available for distribution to the bankrupt’s creditors.

While GCNA v. Royal Bank concerned a contractor’s trust under s. 8 of the Act, Urbancorp Cumberland 2 GP Inc. (Re) concerned the scope and effectiveness of a vendor’s trust under s. 9(1) of the Act in an insolvency proceeding.

A condominium developer, the Cumberland Group, was granted protection under the BIA and continued under the Companies' Creditors Arrangement Act (the "CCAA"). It owned unsold condominium units in a project it constructed. Contractors which had supplied work and material to these units were owed just under $4 million. When the units were sold during the insolvency proceedings for more than $11 million, the contractors claimed that a s. 9 trust arose over the proceeds to the extent of the amounts owing to them.

The Monitor brought a motion under the CCAA for a determination by the court of whether the sale proceeds were impressed with a trust in the contractors’ favour. The motion judge held that they were not, finding that he was bound by the 2005 Ontario Court of Appeal decision in Veltri Metal Products Co., Re, 2005 CarswellOnt 3326 (C.A.). The motion judge held as follows:

Regardless of whether one could argue that Veltri does not give sufficient recognition to the position of lien claimants, the Court of Appeal has ruled that the prerequisites of a ss. 7 or 9 trust are not met where a Monitor ultimately receives the proceeds of sale to be held for creditors.

The motion judge found that the condominium sales were not made "by the owner", given the Monitor's control over the developer’s activities, especially with respect to the sales process, and that the proceeds of sale were not "received by the owner" but rather by the Monitor on behalf of creditors. Therefore, according to the motion judge, there was nothing to distinguish the case before him from Veltri and he was bound to dismiss the trust claims.

The contractors appealed, arguing that Veltri was either distinguishable or wrongly decided. They argued that each condominium sale was a sale by the developer as "the owner" because the sale agreements were entered into on the developer’s behalf by the Monitor as a representative, and that the consideration from the sales was "received" by the developer as "owner" since the sale proceeds were deposited into bank accounts opened on the developer’s behalf and not the Monitor’s. The contractors also argued that the "value of the consideration" exceeded both the expenses of the sale and the amount of mortgage indebtedness, resulting in a positive balance that could constitute a trust fund for their benefit.

Finally, the contractors served the Court of Appeal with the following Notice of Constitutional Question:

Does s. 9 of the CLA continue to have application following a bankruptcy or initial order under the CCAA?

Since the correctness of one of its earlier rulings was in issue, the court sat with a panel of five judges. Ruling on the constitutional question first, the Court of Appeal held that a BIA or CCAA proceeding does not prevent the recognition of a s. 9(1) trust and answered the constitutional question by recognizing the validity of a s. 9(1) trust in an insolvency.

Applying GCNA’s s. 8 analysis to the s. 9 context before it, the court held as follows:

35      In my view, the same reasoning applies to a s. 9(1) trust under the CLA. Section 9 is part of a series of provisions, including ss. 7 and 8, which provide for trusts in favour of specified persons (contractors or subcontractors) over specified funds in the hands of owners (s. 7), contractors (s. 8), and owners who are vendors (s. 9). The effect of s. 9(1) may include the protection of trust beneficiaries on the insolvency of the trustee (by giving them a priority over creditors), but to the extent that it creates a trust under the general law of trusts, it may do so effectively without conflict with the BIA.

36      Subsection 9(1) of the CLA creates a trust which comports with the general law of trusts. There is certainty of subject matter: s. 9(1) identifies precisely the subject matter of the trust as the value of the consideration on a specific sale by the owner of the owner's interest, less expenses of the sale and the amount necessary to discharge mortgage indebtedness. There is certainty of object: s. 9(1) identifies precisely the object of the trust as unpaid contractors who supplied work and material to the improvement which was sold. There is also certainty of intention: s. 9(1) deems the creation of a trust and s. 9(2) requires that trust funds not be appropriated to any purpose inconsistent with the trust: see Guarantee, at para. 20.

Just like in GCNA, there was no conflict between the language or purpose of the BIA, which excluded property held in trust from the definition of property of the bankrupt, and the trust provisions of the Construction Act, which created the kind of trust the BIA contemplated. Therefore, the doctrine of paramountcy did not render the s. 9 trust inoperative.

After answering the constitutional question, the Court of Appeal dealt with the decision in Veltri. In that case, a number of lien claimants had provided work or materials to a specific property that Veltri had leased. All of Veltri’s assets were sold to generate the proceeds at issue which included, but was not limited to, the leasehold interest. The leasehold interest had no value, and none of the purchase price was allocated to the leasehold interest. Finally, Veltri's lenders had security over all of Veltri's assets, and the debt to the secured creditors exceeded the purchase price of the assets. In those circumstances, the Court of Appeal rejected trust claims under s. 7 of the Act. 

In Veltri, no trust arose because the amount received from the sale of all the property was less than the amount required to discharge the lenders' security over them, and no proceeds were realized from the sale of the leasehold interest. A s. 9(1) trust only arises if the value of the consideration received by the owner from the sale of premises exceeds the amount of mortgage indebtedness. No trust arises if the value of the consideration is zero, or if the mortgage debt is equal to or greater than any sale proceeds.

The court in Urbancorp held that the result in Veltri ought to be confined to those facts:

I do not read these conclusions as turning on freestanding considerations of the Monitor having been involved in the sale, or the proceeds having been paid to the Monitor. In my view, the operative factors were that the sale in question was of assets that extended beyond the leasehold interest; that all of the assets sold were subject to the creditors' security; that the assets could not be sold without the creditors' consent; that the court order permitting the sale preserved the ability of those secured creditors to claim against the proceeds; and that the secured creditors were owed more than the amount received on the sale. Under these circumstances, Veltri "had no interest in or right to any of the net sale proceeds", and its temporary receipt of proceeds for the purpose of paying them to the Monitor (who had the responsibility of using them to pay the claims of the secured creditors) did not mean that the sale proceeds were trust monies in Veltri's hands or received by Veltri as owner under ss. 7(2) and (3) of the CLA.

Going forward, Veltri should not be read as standing for the proposition that the control by a CCAA Monitor of a sales process, or the receipt by the Monitor of the proceeds of sale, without more, prevents a s. 9(1) trust arising when the proceeds of sale of the improvement are shown to have a positive value that exceeds the mortgage debt on the property. 

GCNA and Urbancorp will have a profound impact on the rights of trust claimants under the Construction Act. There are limits of course, namely the priorities provided to mortgagees under the Construction Act still apply. Had there been a shortfall in the sale proceeds in Urbancorp the result likely would have been different.  But it is clear the pendulum has swung somewhat from the days of Veltri and Atlas Block. While unpaid contractors and their counsel used to reflexively stand back as soon as insolvency intervened, they can now rest assured that  their claims can survive insolvency and that the trusts funds they are entitled to will be excluded from the property of the bankrupt.