Construction Lien Trusts

December 20, 2020

By Brian Babcock

Payments for a construction project in Ontario are trust funds under the Construction Act (formerly the Construction Lien Act). Persons involved in a breach of trust may be ordered to personally pay the misdirected amounts. Hopefully, this will not be you, but one purpose of this article is to warn you of that risk. However, you also may find yourself on the other side, looking to recover against a shell company, and look to the bad actors.

This is a situation where using a corporation may not limit personal liability.

You may be aware of construction liens. You might even be aware that they apply to residential construction, not just commercial projects. The trust fund provisions are less well known.

The trust fund provisions of the Act are intended to protect suppliers and sub-contractors “down the chain”. Once their payor receives funds – whether from the owner, a general contractor, a bank loan or otherwise – they must be used to pay the suppliers, workers or sub-subcontractors. Only once everybody is paid may the person with the money retain any surplus for themselves. If the payor is a contractor themselves that is their profit or overhead, which cannot be deducted from the trust funds unless everybody else is paid first.

To give added teeth to this rule, the Act provides that every director or officer of a corporation which is a trustee under the Act or any person who has effective control of the corporation or its activities commits a breach of trust if they assent to or acquiesce in the conduct that they know, or ought to know, is a breach of trust.

Let’s unpack that a little.

First, “assent” and “acquiesce” are tests that make it very easy to become a party to the breach of trust. You do not have to initiate the breach. You do not even have to participate. You do not even need to actually know about the breach – if you should have known, your ignorance will not save you. A failure to account for the funds has been considered to be evidence of a breach of trust.  You only need to be in effective control, and do nothing to try to stop the breach.

Effective control is a question of fact:

  • A director with authority to sign cheques on behalf of the defendant may have effective control
  • Just signing cheques on behalf of a corporation indicates that the person had some knowledge of its workings and issues such as disputes over non-payment of invoices and may have effective control
  • An authorized purchasing agent with signing authority, who collected money, determined which invoices would be paid, signed cheques, and determined what jobs the company would bid on was found to have effective control

The Ontario Court of Appeal considered these provisions in the case of Central Lumber Limited v. Gentile. They had no difficulty upholding the trial judge’s reasoning in favour of the Plaintiff – the entire judgment is only seven paragraphs. The trial judgment is somewhat more detailed. It tells a tale of a convoluted scheme by one Defendant, Gallo, to obscure his identity in dealing with the lumber supplier for his new home. That supplier dealt with someone they knew only as “Peter”, who acted on behalf of a numbered company that said it was the contractor.

When the lumber was supplied, and a copy of a bank draft was produced payable to the lumber company, but not paid to them, things unravelled.

The case was complicated by the dispute as to whether Gallo and “Peter” were the same person, and certainly that extra layer of deceit may have cost Gallo any claims to moral high ground. Once that issue was resolved, the rest of the case is a straightforward application of the trust provisions.

To prove the existence of the trust, the supplier only had to prove:

  1. The contractor received monies on account of its contract or subcontract price for a particular project.
  2. The party alleging breach of trust supplied services and materials for that project.
  3. The contractor owes money to the party alleging breach of trust for those services and materials.

Gallo, as Peter, was found to have effective control of the contractor, though he did not appear to be an officer, director or shareholder. The judge found facts to indicate that:

  • he arranged the sale of the shares in the corporation from a friend to an unknown person who had nothing to do with the lumber supply;
  • insisted that the supplier deal only with him (as “Peter”);
  • sent emails to the supplier from his business email; and
  • had control over the funds.

You do not have to be deceitful like Gallo to be found to have assented to or acquiesced in the breach of trust. Innocently applying a bank construction advance to pay other bills is enough. Liability under the Construction Act does not require wrongdoing or an intention to breach the trust.

In addition to having to pay the trust amount, where there is an intention breach of trust, there may be criminal law consequences. Because the test for breach of trust in the Construction Act is not identically with the Criminal Code, it is not automatic, but in many cases, misappropriation of funds results in a finding of fraud.

These provisions apply to renovations as well as new construction.

Not knowing your obligations under the Construction Act may land you in hot water. If you are a payor, or may have effective control of the payor, you must take proactive steps to ensure that funds flow as planned.

If you are a contractor or supplier, being aware of the trust fund provisions may increase your odds of getting paid, especially if your payor, or the head contractor, is insolvent. In that case, tracing the funds to owners may be your best worst option.