Canada: Trust Provisions Of The Builders Lien Act

The Builders Lien Act, S. B. C. 1997, c. 45 (the "Act") establishes a statutory trust that operates independently of the lien and holdback. The ability of a person to assert a claim as a beneficiary of a statutory trust does not depend on the person having the ability to assert a valid lien claim. The Act, while maintaining the substance of the trust mechanism established under the former builders lien legislation, sets out some significant new developments. In particular, the Act re- defines what parties qualify as beneficiaries, clarifies what obligations a trustee owes, and authorizes the trustee to commingle funds from one trust fund with those of another trust fund or with any other monies.

Sections 10( 1) and (2) of the Act set out the trust provisions:

10( 1) Money received by a contractor or subcontractor on account of the price of the contract or subcontract constitutes a trust fund for the benefit of persons engaged in connection with the improvement by that contractor or subcontractor and the contractor or subcontractor is the trustee of the fund.

(2) Until all of the beneficiaries of the fund referred to in subsection (1) are paid, a contractor or subcontractor must not appropriate any part of the fund to that person's own use or to a use not authorized by the trust.

Where a contractor or subcontractor receives money from the owner on account of a contract or subcontract, the money is impressed with a trust in favour of persons engaged by that contractor or subcontractor in the connection with the improvement.

The reference to "money received" from an owner does not necessarily mean actual receipt in the hands of the contractor or subcontractor. The Courts have interpreted that term to mean that the trust is created when the funds leave the hands of the owner on account of the contract price, whether or not they are physically received by the contractor or subcontractor. But in order for the trust to arise without the contractor or subcontractor physically receiving the trust funds, the funds must be paid to a person to whom the contractor or subcontractor might have paid it or to whom it may be taken to have been paid on his behalf, such as an assignee of his book accounts, his trustee in bankruptcy or to the credit of a judgment against him.

No statutory trust arises in respect of money received by an architect, engineer or material supplier as those parties are defined in the Act (s. 10( 4)). Those parties may, however, be beneficiaries to a trust.

The contractor or subcontractor is the trustee of the fund and the beneficiaries are the persons "engaged" by that contractor or subcontractor in connection with the particular improvement. The former builders lien legislation defined the beneficiaries of a trust as being all of the parties in the construction pyramid, including the owner. A trustee would be discharged of his trust obligations when all of those parties in the construction pyramid below the particular contractor or subcontractor in question had received payment for work done or materials supplied on the contract. The scope of the beneficiaries to a trust has been narrowed under the Act. Now the trust only extends to those whom the contractor or subcontractor "engages in connection with the improvement" (s. 10( 1)).

It is not entirely clear how the Courts will interpret Section 10( 1) in relation to who qualifies as a beneficiary. It seems that the drafters of the Act could have used a more precise term than "engaged" to define the scope of the beneficiaries. For example, "contract" would have been far more certain. In several commentaries put out by the B. C. Government on the Act, it is suggested that the beneficiaries are now only those with whom the contractor or subcontractor directly contracts. However, on a plain reading of the language in Section 10( 1), it is possible that "engaged" could be interpreted to mean those engaged directly or indirectly by the contractor or subcontractor. A party indirectly engaged by a contractor or subcontractor could easily mean any party below the contractor or subcontractor in the construction pyramid. The Courts have yet to define who qualify as beneficiaries under the Act.

The Workers Compensation Board is no longer a beneficiary of the statutory trust.

There are two sources that define the duties of the trustee. The first is the specific obligations set out in the provisions of the Act. The rules found in the statute are supplemented by the general law of trusts.

Section 10( 2), as quoted above, sets out the primary statutory guidelines for a trustee. A trustee must not use trust funds for his own use or a use not authorized by the trust. Therefore, a trustee may not use the trust funds to meet obligations owed on other projects or for any other use not authorized by the trust until his obligations as trustee are completely discharged.

There are three primary uses authorized by the trust. The first is to pay the trust funds to a beneficiary to discharge all or part of the amount owing to that beneficiary. Second, a trustee who retains trust money in an amount equal to an amount already paid to a beneficiary for work or material does not violate the trust (s. 11( 4)( a)). Therefore, if a trustee pays, out of its own separate funds, for expenses for work or material supplied under a subcontract, the trustee may retain an equal amount for its own use (" work" and "material" are defined terms under the Act and, in particular, they relate specifically to an "improvement"). Third, according to Section 11( 4)( b), if the trustee borrows money that is used to pay for work or material supplied, the trust money may be applied to discharge the loan to the extent that the borrowed money was actually used to pay for work or material for a contract or subcontract.

According to case law, when making payments of trust funds to beneficiaries, the trustee may make a preferential payment of trust funds to one beneficiary to the exclusion of another beneficiary providing there is no risk that there will be a deficiency to pay all beneficiaries. Where there is a risk that all the beneficiaries may not be paid due to some deficiency, such as bankruptcy, beneficiaries are to share in the trust on a proportional basis.

Section 12 of the Act confirms prior case law holding that payments from money in a trust fund to a beneficiary must be applied by the beneficiary to the debt in respect of the improvement for which the trust funds are paid. The trustee's obligations to the beneficiary are reduced to the extent of the trust fund payment regardless of the beneficiary's actual allocation of the payment.

There is a vast body of law in relation to the general law of trusts. Some of the obligations imposed on a trustee that may be relevant in the builders lien context include the following:

1. the duty of impartiality as between beneficiaries;
2. the duty to account to the beneficiaries within a reasonable time after a request from the beneficiaries;
3. the duty to provide the beneficiaries with information relating to the trust documents on request of the beneficiaries. The Courts have liberally interpreted what constitute "trust documents", and therefore, contracts or subcontracts and related documents under which a trust arises may constitute "trust documents"; and
4. the duty to act in the best interests of the beneficiaries, while subordinating the trustee's own selfinterests.

The Act sets out one notable exception to the application of the general law of trusts that did not appear in the previous builders lien legislation. Section 11( 7) provides,

If a contractor or subcontractor commingles, with other money, any part of the fund referred to in section 10, that, of itself, does not constitute a breach of the trust created under section 10( 1) or a contravention of section 10( 2).

Commingling of funds occurs when a trustee combines trust funds and other funds into one common bank account. Trustees are not ordinarily permitted to commingle funds of a particular trust with any other funds. It is significant that the Act does not require that the trust funds be placed in a separate bank account. Case law considering the provisions of the former legislation had established a requirement to keep a separate bank account for each improvement.

It is important that when a contractor or subcontractor commingles trust funds with other funds that it keep scrupulous accounting records. Although the trust funds may be combined with other funds in a single bank account, the strict trust obligations still attach to those trust funds and they must only be used in accordance with the statutory trust. In other words, the contractor or subcontractor must be able to show precisely where and in what amount trust funds are received and subsequently allocated.

It is an offence under Section 11 of the Act for a trustee to act contrary to the garnishment provisions in Section 13( 2). The prescribed form sent to the garnishor (the party requesting that the funds be paid directly into court by the garnishee) provides the garnishor with notice that the funds remain subject to the trust created under Section 10 and makes it clear to all parties that the interest of the beneficiaries to the trust take priority over the interest of the garnishor.

Lenders often seek to attach funds deposited into the bank account of a contractor or subcontractor for the purposes of applying those funds to indebtedness owed to the lender by the contractor or subcontractor. This possibility arises where the contractor or subcontractor maintains a bank account at the bank or financial institution that has has provided financing for the improvement. In many cases, the deposited funds will be subject to a trust and the question arises as to whether appropriation by the lender in such a manner constitutes a breach of trust.

The law on this point is quite complex. In general though, if the lender receives funds in the ordinary course of business and in good faith, the lender will not be liable for a breach of trust. Section 11( 6) of the Act has incorporated this common law test into the legislation.

Applying funds on deposit to a revolving line of credit has been held to be in the "ordinary course of business". But where a lender is aware that the borrower is not in compliance with the builders lien legislation, the lender may be found in breach of trust by knowingly assisting the borrower in misappropriating trust funds. Furthermore, a bank may be liable if it assists a trustee in dishonest or fraudulent conduct.

A breach of the trust provisions will expose the trustee to a civil claim from the beneficiaries to the trust. The trustee will be liable to the beneficiaries for all funds received and misappropriated. Section 14 provides that a beneficiary may only bring an action against a trustee for breach of trust within one year after the happening of certain events:

Circumstances may arise in which a beneficiary to a trust chooses not to enforce the trust provisions against a trustee. Where the beneficiary is insolvent or is indebted to a person one level down in the construction pyramid and enforcement of the trust would simply have the effect of the trust monies flowing down to the person lower down, there may be no advantage for a beneficiary to enforce the trust. In certain circumstances, Section 10( 3) allows unpaid creditors to stand in the shoes of a beneficiary who chooses not to enforce the trust.

It is a criminal offence not to comply with the trust provisions of the Act. A trustee who fails to comply with the trust provisions may be guilty of a provincial offence under Section 11 of the Act or a criminal offence under Section 336 of the Criminal Code.

Liability arises under the provincial offence from the mere act of misusing the trust funds. The penalty is a maximum of a $10,000 fine or two years imprisonment, or both. A director or officer of a corporate trustee who has breached the trust provisions will also be liable if he or she "knowingly assented to or acquiesced in" the conduct that amounts to a breach of trust. In respect of the provincial offence, there is no requirement that there be any fraudulent or dishonest intent. A charge under Section 11 must be laid within three years from when the alleged offence took place.

Liability arises under the Criminal Code for a breach of trust where the trustee knew the funds in question were trust funds and the trustee was a knowing party to the use of those funds in an unauthorized manner. The penalty is a maximum of fourteen years imprisonment. Section 336 requires that the accused breached the trust with an "intent to defraud". The meaning of "intent to defraud" is somewhat narrow in scope. It does not require that the trustee intended to cause detriment to any particular beneficiary. In order for an individual to possess the requisite "intent to defraud", he or she must have intended to do the acts or affirm the acts that breached the trust while knowing such acts would defraud the trust. Although there is an element of dishonesty to the criminal offence, the focus is on the accused's intent to act in contradiction of the trust even though he or she knows that to do so would be a breach of trust.

A director or officer may be charged as a party to an offence under Section 336. A conviction may result if his or her conduct, knowledge and intent meet the requirements of Section 336.