March 30, 2021
A Quistclose trust is a trust created where funds are advanced to another person (or corporation) for a specific purpose, on the condition that they be used only for that purpose, and returned if they are not used for that purpose. The name comes from a British case where the idea was first clarified.
This is distinguished from the more common situation where the advance of funds creates a debt.
Why is this important?
In insolvency or bankruptcy law, if the payor of the funds is a debtor, without a security interest, they must claim as a general creditor of the payee if insolvency occurs.
But if the payee is a trustee, the funds do not belong to them and the trust property may be recovered by the payor, rather than forming part of the assets available to be shared between creditors.
In the British case in question, funds were advanced to a corporation specifically to pay dividends, directing that the money be held in a separate account. Before the dividends could be paid, the corporation found that it did not have sufficient funds to continue operating, so entered voluntary liquidation. The bank holding the funds applied them against debts the corporation owed to the bank.
The person who advanced the funds wanted them back. The bank argued that the payment had created a loan, not a trust.
The court ruled that if the funds were advanced for the specific purpose, on condition of being returned, they look like a trust, not a debt. This view was favoured at least in part to encourage investors to support corporations that have existing debts. The court did however, impose a second requirement – that the bank have knowledge that the monies were trust funds.
Although Ontario courts have suggested that Quistclose trusts might exist in Ontario law, they are a bit like a unicorn – until recently, even those who believe in them could not say that they have actually seen one. There is now one decision of the Divisional Court (Ontario’s intermediate appeal court, below the Court of Appeal) that did find a Quistclose trust existed, and found in favour of the payor to “prevent an injustice”. Unfortunately, that decision fails to consider issues raised in the earlier Court of Appeal case approving the concept in Ontario. The Court of Appeal posed some difficult commercial concerns, including whether or not a Quistclose Trust ought to be registered under the Personal Property Security Act (PPSA) to give notice to the other creditors. Until that issue is resolved, the practicality of arguing that funds are subject to a Quistclose Trust is uncertain. In British Columbia, it has been held not to be subject to the PPSA.
Registering under the PPSA might seem like a simple step to protect the trust claim, except that a trust and a debt cannot existing at the same time, so a registration based on debt would be evidence that it was not intended to be a trust. We need clearer guidance on this issue.
What we do know is that if you are advancing funds for a specific purpose, and expect the funds to be returned if not spent:
- the documentation should clearly describe the funds as trust funds
- there should be a clear requirement that the funds be returned if not used for the specific purpose
- the funds should be required to be kept separate from the recipient’s own money
- notice of some form should be given to creditors, particularly the bank in which the funds are deposited – at least, the separate account should be labelled as a trust account.
Consider getting a lawyer to help you with the structure of the deal, and the documentation, before advancing funds. The risk of loss, and the cost of a law suit, more than justify the investment in preventative legal advice.