Each province of Canada has enacted legislation which creates
methods unique to the construction industry for recovering payment
of outstanding debts. One of the methods is the creation of trust
funds and penalties for the misappropriation of those trust funds.
In many provinces, the legislation also pierces the corporate veil
and imposes personal liability on directors and officers for breach
Breach of trust legislation was first enacted by the Province of
Ontario. Other provinces subsequently followed with similar
Trust funds usually fall into one of the following
- Mortgage trusts. Monies received by an owner, such
as an advance under a building mortgage, which are to be used
in the financing of construction, constitute a trust fund for
the benefit of the contractor. However, the owner may use the
borrowed funds to pay for the land and to discharge prior
mortgages without breaching the trust.
- Certificate trusts. On most construction projects,
the architect issues progress certificates confirming that a
certain portion of the contractor's work has been completed and
placing a monetary value on it. The amount so certified, where
it is actually in the owner's hands or is received by the owner
at any time after certification, constitutes a trust fund for
the benefit of the contractor.
- Substantial performance trusts. Where substantial
performance of the contract has been certified, but the owner
has only made part payment of the certified amount to the
contractor, an amount equal to the unpaid price of the
substantially performed portion of the work that is in the
owner's hands, or that the owner subsequently receives, is
impressed with a trust for the benefit of the contractor.
- Draws trust. Any monies which are received by, or
owing to (whether or not due or payable), a contractor or a
subcontractor, on account of the contract or subcontract price,
constitute a trust fund for the benefit of the subcontractors
and other persons who have supplied services or materials to
the improvement. If, for example, a contractor becomes bankrupt
at a time when contract monies are in its hands, those monies
do not fall into the estate of the bankrupt but must be
distributed to the trust beneficiaries.
- Vendor's trust. In situations involving the
construction of a new house, it is common for a developer-owner
to conclude a sale of the property before the trades have
completed their work and been paid. Where an owner sells his or
her interest in the premises, the sale proceeds, less the
reasonable expenses arising from the sale, and the amount, if
any, paid to discharge any existing mortgages on the premises,
constitute a trust fund for the benefit of the contractor.
Once an owner receives trust monies, he or she is precluded from
appropriating all or part of those monies to his or her own use, or
to any use inconsistent with the trust. The legislation, however,
affords complete protection to an owner where the contractor is
paid all amounts owing. Once the owner makes payment in full to the
contractor, the owner's trust obligations are discharged. If only a
partial payment is made, then the owner's trust obligations are
only discharged to the extent of the payment made.
Examples of an owner's breach of his or her trust obligations
would be where an owner uses monies advanced under a building
mortgage on Project A to pay trades working on Project B; or where
the owner uses trust monies to reduce his or her bank
Similarly, where a contractor or subcontractor receives funds
impressed with the draws trust, the contractor or subcontractor
will not breach the trust so long as he or she pays all
subcontractors and other persons who have supplied services or
materials to the improvement all amounts owed to them. Once any
such payment is made, the contractor or subcontractor, as trustee,
is discharged from his or her trust obligations to the extent of
the payment made.
Liability for breach of trust
In cases where there has been a breach of trust by a
corporation, the court may be permitted by the legislation of some
provinces to pierce the corporate veil and to impose liability on
the directors and officers of the corporation, and on any person
having effective control of the corporation or its relevant
activities. Accordingly, because a corporation does not act or make
decisions on its own, a trust beneficiary might be well advised to
name, as defendants in an action for breach of trust, the persons
behind the corporation who may have caused the corporation to deal
with trust funds in an unauthorized manner.
What must be demonstrated is that those persons assented to or
acquiesced in conduct which they knew or reasonably ought to have
known amounted to a breach of trust by the corporation.
Courts in Ontario have recently considered the issue of whether
a contractor may use trust funds to pay overhead expenses (such as
staff pay and office rent) without breaching the trust. The
preponderance of authority holds that payment of general business
expenses constitutes a breach of trust so long as subcontractors on
the project remain unpaid.
The courts have also held that maintaining only one general bank
account, into which payments received in respect of various
projects are deposited and from which all business debts are paid,
amounts to a breach of trust on the part of the principals of the
corporation. Ideally, a separate bank account and separate
accounting records should be maintained for each project to avoid
liability for breach of trust. General business expenses should be
paid out of a separate general corporate account into which are
deposited only funds that are no longer impressed with a trust.
Given that ignorance of the law is no excuse, directors and
officers of corporations involved in construction in Canada should
take active steps to avoid inadvertent breaches of trust. In
addition, the corporation's directors' and officers' liability
insurance should be reviewed to ensure that breach of trust is not
excluded from coverage.
Harvey J Kirsh and Lori A Roth