In Waygar Capital Inc. v. Quality Rugs of Canada Limited, 2024 ONSC 24861, the Ontario Superior Court of Justice was asked, in somewhat unusual circumstances, to consider the intersection between federal insolvency legislation and provincial statutory trusts. The decision, which primarily revolved around the priority of various interests, and the primacy of a DIP Lending Order in the context of an ongoing CCAA proceeding, raised a question about the doctrine of federal paramountcy and its implications for trust claims under Ontario's Construction Act in such circumstances. Below, we review the Superior Court's decision, and the lessons it offers to stakeholders in construction-related insolvency proceedings.
Background
The Quality Sterling Group of Companies ("QSG") found itself in a financial crisis by mid-2023. QSG operated across Ontario, Alberta, and British Columbia, providing both materials and installation services to residential and commercial construction. Despite its market dominance, QSG faced financial difficulties throughout the year due to mounting debts and cash flow problems. By the summer of 2023, the company was unable to meet its financial commitments.2
QSG's struggles were closely tied to its primary lender, Waygar Capital Inc. ("Waygar"), which provided QSG with a revolving credit facility secured by QSG's accounts receivable. Over time, however, QSG's debt to Waygar ballooned to more than $50 million, with QSG's accounts receivable becoming its only valuable asset of any significance. At this point, QSG found itself at a critical juncture: it needed to either restructure its debt or face liquidation.3
In August 2023, Waygar and QSG filed competing CCAA applications in an attempt to direct the restructuring of QSG's its business and avoid a bankruptcy. In this context, relying on enforcement provisions in its credit agreement with QSG, Waygar "swept" $6M in cash in certain bank accounts held by QSG (which amounts it bears noting, may have been trust funds under s. 8 of the Construction Act, although this latter point was not addressed by the Court).
The Ontario Superior Court granted the customary stay of proceedings, which temporarily halted all creditor actions, including those of its suppliers (many of whom had asserted lien and trust claims prior to QSG initiating CCAA proceedings), allowing the company some time to stabilize its operations. This was followed by a $5 million debtor-in-possession (DIP) loan from Ironbridge Equity Partners, which was provided as part of a proposed transaction for Ironbridge to purchase QSG's assets. The purchase price was comprised of the $5M DIP loan, and QSG's accounts receivable. For reasons not explored in detail by the Court, the proposed transaction did not close.
In any event, the Court then issued an Initial Order that included a super-priority charge over all of QSG's property, including (1) a DIP Lender's Charge in connection with the DIP facility from Ironbridge to fund QSG's day-to-day operations, and (2) a lien charge in respect of all lien claims proven in the CCAA proceeding.
The Initial Order also resulted in the appointment of a Monitor, who was tasked with overseeing the restructuring process and ensuring QSG continued to operate during the proceedings.4 As part of this process, QSG paid for the continued supply of flooring material and installation services for QSG's projects on a cash on delivery basis, meaning that its suppliers' claims were from before QSG's filing for CCAA protection.
This Initial Order was subsequently amended and restated (resulting in an Amended and Restated Initial Order, or "ARIO"), which was issued on September 5, 2023. Among other things, the ARIO resulted in the following:
- A continued stay of proceedings;
- An order that any lien claim that had been preserved by registration against an owner's property be vacated, and it was instead deemed that the claimant filed a notice of their lien claim with the Monitor;
- An order that any lien claimant who delivered a timely notice of its lien claim was deemed to have preserved and perfected its lien for the purpose of provincial lien legislation;
- The removal of the lien charge as a super-priority charge, as it was "always contemplated that this would be replaced with a lien regularization order (discussed below); and
- Revised super-priority charges for (1) the DIP Lender's Charge, but only to the extent of the assets in the Borrower's Account, (2) the Administration Charge, (3) the Directors' Charge, (4) the DIP Lender's Charge (to a maximum of $7M), and (5) the Financial Advisor's Charge.
Both the Initial Order and the ARIO granted super-priority charges over QSG's assets, including its accounts receivable. However, this use of accounts receivable created tension with QSG's suppliers, who had provided materials and services to the company prior to the insolvency filing. These suppliers were owed approximately $11 million. The suppliers had statutory trust claims under section 8 of the Construction Act, which dictates that any funds received by a contractor for completed work are received in trust for the benefit of suppliers until they are paid in full.5 As noted above, this trust was already arguably violated by Waygar's sweeping of QSG's bank accounts on the day of the CCAA applications.
Despite these statutory trust protections, QSG, under the Monitor's supervision, used its accounts receivable to finance ongoing operational expenses, leaving the suppliers unpaid for work completed prior to the insolvency filing. In that regard, QSG deprived suppliers of trust funds, because those funds were used up such that they were longer traceable.
This prompted the suppliers to seek legal recourse. They requested a Lien and Trust Regularization Order (LTRO) from the Court (which order, readers will appreciate, has become relatively standard procedure in recent years). The LTRO would recognize their trust claims and allow them to enforce their rights, albeit as part of a scheme that neutralizes the operation of the Construction Act's framework in favour of a court-ordered, alternative scheme). Additionally, the suppliers sought a super-priority trust and lien charge (a "TLC") over QSG's assets, arguing that their claims should take precedence over the DIP Lender's Charge and other court-ordered priorities.6
While the Court granted the suppliers a TLC in December 2023, the question of whether this TLC could rank ahead of the DIP Lender's Charge and the other court-ordered super-priorities remained unresolved. The decision ultimately hinged on whether the suppliers' trust claims, created under provincial law, could override the prior Orders of the Court that granted priority to the DIP Lender and the other court-ordered super-priority holders. The LTRO (which the Court also referred to by its more common acronym, an "LRO") never materialized, as the hearing of this issue appears to have been repeatedly adjourned and never heard by the Court before QSG was placed into receivership. As a result, it appears that although the suppliers were able to perfect lien claims pursuant to the ARIO, they were unable to perfect their liens under the Construction Act as against project lands and/or holdbacks held by project owners (and were thus deprived of their ability to claim against owners to the extent of their holdback obligations).
The Superior Court's Decision
The Court's ruling focused on two critical issues: (1) the suppliers' argument that their statutory trust claims under the Construction Act should take priority over the DIP Lender's Charge, (2) and whether federal insolvency law, under the CCAA, allowed for such trust claims to be subordinated in favour of DIP financing.7
Trust Claims vs. DIP
The suppliers argued that QSG's accounts receivable were subject to a statutory trust under section 8 of Ontario's Construction Act, which states that any funds received by, or owing to, a contractor for an improvement constitute a trust for the benefit of unpaid suppliers and subcontractors. The suppliers maintained that these accounts therefore could not be used to satisfy other creditors' claims (including those of the DIP Lender, Ironbridge). The suppliers argued that the statutory trust should have been reserved solely to pay suppliers and subtrades for work completed prior to the insolvency proceedings.8
On the other hand, Ironbridge argued that the court-ordered DIP Lender's Charge, granted under the CCAA, should take precedence over the suppliers' trust claims. Ironbridge argued that without DIP financing, QSG would not have been able to continue its operations, leading to a collapse of the company's restructuring efforts and forcing an immediate liquidation. According to Ironbridge, the DIP loan was essential for keeping the business afloat, as it provided the liquidity QSG needed to operate during the CCAA proceedings.9
The DIP Lender further argued that the funds generated from QSG's accounts receivable were necessary to cover ongoing operational expenses during the CCAA proceedings. Ironbridge emphasized that if the accounts receivable could not be used to fund the company's daily activities, the size of the DIP loan required would have been significantly larger—more than $10 million instead of the $5 million that was secured. 10
The Court was faced with determining whether the suppliers' trust claims, grounded in provincial law under the Construction Act, could take priority over the DIP Lender's Charge, which was established under the CCAA (federal insolvency legislation). Of note, the Court was faced with deciding the issue in circumstances where the debtor, the DIP Lender and the Monitor had proceeded in the interim on the basis that the super-priorities previously ordered were valid.
Federal Paramountcy
The Court ruling in this case was grounded in the doctrine of federal paramountcy, which applies in case of a conflict between federal and provincial laws – federal law prevails in case of such conflict. In this case, the conflict arose between (1) the suppliers' trust claims under the Construction Act and (2) the DIP Lender's Charge established under the CCAA.
The Court recognized that the suppliers had valid trust claims under the Construction Act, but nevertheless found that the DIP Lender's Charge, which was created under the CCAA, took precedence due to federal paramountcy. The CCAA, as a federal statute, governs corporate restructuring and provides tools, such as DIP financing, to help insolvent companies remain operational during restructuring. The Court emphasized that without the DIP loan, QSG would not have been able to continue operations, and the company would have been forced into immediate liquidation. According to the Court, such an outcome would have been detrimental to stakeholders, including the suppliers, and ultimately would have severely limited the recoverable assets.11
Citing the Supreme Court of Canada's decision in Sun Indalex Finance, LLC v. United Steelworkers12the Court found that when federal insolvency law and provincial statutory trust claims are in conflict, federal law prevails. In Sun Indalex, the Supreme Court had determined that a DIP charge granted under the CCAA took priority over provincial statutory trust claims. The Court therefore concluded in this case that the suppliers' trust claims, while valid under provincial law, should not take priority over the DIP Lender's Charge (or any of the other super-priority charges) under the CCAA.13
The Lien and Trust Regularization Order (LTRO)
Despite the ruling in favour of the DIP Lender, the Court acknowledged the validity of the suppliers' trust claims under the Construction Act by granting them a TLC. However, this charge was subordinate to the DIP Lender's Charge, the Financial Advisor's Charge, and the Directors' Charge. The TLC provided the suppliers with a secured interest in QSG's remaining assets, but ultimately did not grant them the super-priority they sought.14
Commentary
Waygar offers a harsh reminder of the interplay between insolvency law and the protections afforded to contractors under the Construction Act. Notwithstanding that subtrades and suppliers are entitled to various statutory rights and remedies under the Construction Act, Waygar confirms that those rights and remedies can be imperiled in circumstances of an insolvency (or near-insolvency) giving rise to CCAA proceedings. This conclusion is particularly important in the present economic climate, where insolvency rates remain at a persistently elevated level.
In that regard, Waygar confirms the vulnerability of statutory trust claims in the federal insolvency process. While the Construction Act provides subcontractors and suppliers with statutory trust protections, these protections can be overridden by the court-ordered charges established under the CCAA. This is well-established in the case law, notwithstanding that construction industry participants may be more familiar with Guarantee Company of North America v Royal Bank of Canada, 2019 ONCA 9 and Re Urbancorp Cumberland 2 GP Inc, 2020 ONCA 197 (which confirmed the general proposition that Construction Act trusts remain operational in circumstances of BIA or CCAA proceedings where super-priority charges have not been ordered).
Accordingly, for subcontractors and suppliers, Waygar is an important reminder that relying solely on the protections of the Construction Act may not be sufficient in insolvency situations. The Construction Act's trust provisions, while powerful, are vulnerable to being subordinated to super-priority charges under the CCAA.
That being said, Waygar raises several other questions and concerns, as well as possibilities.
First, it appears that the suppliers in this case rightly felt aggrieved due to the manner in which proceedings unfolded. With respect to lien rights, it appears that the suppliers may have held off on pursuing (including preserving and perfecting) lien claims as against project owners, on the apparent assumption that the LRTO would be agreed to and ordered by the Court (which would not be unusual in insolvency proceedings). For reasons seemingly outside of the suppliers' control, the LRTO never materialized, resulting in the suppliers being deprived of their ability to pursue project owners to the extent of their holdback obligations and were instead left at the back of the line in relation to their claims against QSG. In retrospect, the suppliers should probably have objected to the Initial Order on the basis that, given the nature of QSG's assets, and the inevitability that trust funds would be consumed in keeping QSG operational, restructuring was not the appropriate remedy here.
Similarly, it bears noting that Waygar appears to have swept all of QSG's bank accounts (which presumably contained funds impressed with a s. 8 trust) before the CCAA proceedings even began, and in circumstances where Waygar's credit agreement with QSG specifically excluded holdback and trust funds. As a result, at that particular moment in time, it appears that Waygar could not rely upon any court-ordered CCAA arrangement in order to justify removing trust funds. It is unclear whether the Court's Initial Order (and later, the ARIO) purported to have retroactive effect in order to legitimize Waygar's transfer of any trust funds; to the extent it did not, then it would appear potentially arguable that the suppliers could claim that Waygar's transfer of trust funds (if any) ran afoul of the doctrines of knowing receipt and/or knowing assistance, thereby potentially grounding a claim by the suppliers against Waygar.
Ultimately, the suppliers' misfortune may have been an unfortunate incident of timing – as the Court itself observed, the result in this case was driven by the unique circumstances, which include the fact that that the suppliers' arguments were raised after the DIP financing and other court-ordered charges had been approved. While it is unclear how Waygar may have unfolded had these arguments been raised earlier, the Court's language suggests that this may have been a possibility.
In any event, Waygar should prompt subtrades and suppliers to adopt a more proactive approach to insolvency proceedings. By moving quickly to register liens or assert trust claims, claimants can strengthen their position in insolvency proceedings, even if the CCAA process later intervenes.
Another important takeaway is that suppliers and subcontractors should consider becoming more actively involved in the insolvency process itself. One intriguing hypothetical is the possibility that subtrades and suppliers could collectively provide their own DIP financing (including through the use of s. 8 trust funds (whether that be through the debtor's cash or accounts receivable)), thereby securing their own super-priority charge over other charges. While this may be difficult to conceive of in practice given the amount of funds necessary to support a DIP financing, it would appear plausible at least to the extent that a contractor's financial distress arises primarily from its accounts payable to subtrades and suppliers rather than to its lenders.
Ultimately, parties should view Waygar as a cautionary tale about the risks and benefits of insolvency proceedings. For companies facing acute cash flow crises, the CCAA offers a means to attempt to restructure debts and continue operations. However, this route also involves significant risks, particularly when it comes to maintaining relationships with key suppliers. A DIP loan may provide the immediate liquidity needed to keep operations going, but it can also complicate – or extinguish – existing trust and lien claims, potentially alienating key project partners who may be unwilling to continue providing materials or services without assurances of payment (thus imperiling the debtor's cash flows from its projects needed in order to remain a going concern).
Footnotes
1. 2024 ONSC 2486 Waygar..
2. Ibid at paras 1-2.
3. Ibid at para 10.
4. Ibid at paras 12-13.
5. Ibid at paras 22-23.
6. Ibid at para 5.
7. Ibid at paras 19-20.
8. Ibid at paras 23-24.
9. Ibid at para 27.
10. Ibid at paras 26-28.
11. Ibid at paras 27-29.
12. 2013 SCC 6.
13. Waygar, supra note 1 at paras 27-29.
14. Ibid at paras 9, 25.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
