January 15, 2010
By Robert Kennaley
McLauchlin & Associates

Robert KennaleyAs a landscape contractor, you no doubt have business loans that require regular payments. You probably also pay rent. If you make these payments with funds you receive from a project, before you pay your suppliers or subcontractors for that project, you are probably in breach of the trust provisions of the Construction Lien Act. The consequences of such a breach of trust can be severe.

Imagine the landscape contractor who seriously underbids a job, or simply runs into a problem client who cannot or will not pay. Imagine also that he received deposits or progress payments from his client, and that he makes his regular payments on machinery leases, bank loans and rent as he receives these payments. Because he either runs out of money, or does not receive further payments he is counting on, he does not have the funds to pay his suppliers or subcontractors for the services or materials they have provided. In this case, the trust provisions of the Act apply.

Provisions very real

The trust provisions of the Act are very real and should be taken seriously. Section 8 establishes a statutory trust in relation to monies received by a contractor or subcontractor in relation to an ‘improvement.’ The definition of improvement is very broad, and includes even the simplest of residential landscape projects. Simply put, a contractor who receives any monies under a contract relating to an improvement is a trustee, who holds these monies in trust for its subcontractors or suppliers beneath it in the construction pyramid.  The contractor is deemed to be a trust under the Act and is not free to use the trust monies as he pleases, until after his subcontractors and suppliers are paid.

Sections 7 and 8 of the Act provide that the contractor shall not appropriate or convert any part of the trust fund to its own use, or to any use inconsistent with the trust until the contractors, subcontractor or suppliers beneath it in the construction pyramid are paid all amounts owed in relation to the improvement. The company cannot use trust funds to pay mortgage or lease payments, trade debts in relation to other projects, general office expenses, or overhead. Similar provisions apply to owners or subcontractors who receive money on contracts or subcontracts in relation to an improvement.

Must account for funds

The trust funds must be preserved by the company and the trustee company must prohibit the distribution to any person other than the beneficiaries. The trustee contractor must also account for the trust funds. Once it is established that a contractor held monies in trust for a supplier or subcontractor who has not been paid, the onus shifts to the contractor to show that all expenditures of the fund were in accordance with the Act. Failure to keep proper records in order to do so, actually evidences a breach of trust. Again, similar provisions apply to owners and subcontractors under the Act.

Section 13 of the Act essentially provides that any director, officer or ‘operating mind’ of a company, who assents to, or acquiesces in conduct that he or she knows, or reasonably ought to know, amounts to breach of trust by the company, and is liable for the breach of trust. The emphasis is on knowledge of the conduct amounting to breach of trust. The individual need not know that the conduct amounts to breach of trust: liability does not require evidence of any wrong-doing, culpable conduct or intent.

Contractors must show every penny paid

In our example, the unpaid subcontractor or supplier is entitled to sue the landscape company for breach of trust. In fact, all the unpaid subcontractor or supplier has to do is establish that the landscape company was paid. At that point, the onus shifts to the contractor to show that every penny he received in relation to the job was paid to subcontractors or suppliers. This, of course, can be extremely difficult, particularly if the contractor has co-mingled funds, by combining monies received and paid from various jobs in the same bank account. If the contractor cannot meet his onus in this regard, the contractor will be liable for breach of trust.  

Could lose everything

Further, the directors and officers (and anyone else who assents to or acquiesces in the breach of trust of the landscape company) may be personally liable for the breach of trust of that company. This means that if the company can’t pay, the director/officer will have to pay. On a job which goes particularly bad, the officers, directors or other responsible persons could lose their shirts, or their houses. Even declaring personal bankruptcy will not help the director/officer: a breach of trust claim under the Construction Lien Act survives bankruptcy such that a judgment for breach of trust will follow the debtor until it is paid – perhaps for life.

So long as the subtrades and suppliers are paid, of course, there will be no problem. Problems, however, can develop quickly on a project and for a company. The lesson to be learned is two-fold: ensure that trades and suppliers are paid in accordance with the Act, and make sure proper records are kept of monies received on a project so that you can account for trust funds. Remember, even if all monies on a project went to suppliers and subcontractors on that project, a breach of trust claim might only be avoided if you can prove it. Also remember that the breach of trust provisions may assist a landscape contractor to obtain monies owed to it by an owner or contractor above it in the construction pyramid. As is often the case, the trust provisions provide a double-edged sword.
Robert Kennaley practices construction law in Toronto and Simcoe. He speaks and writes regularly across North America.  He can be reached for comment at 416- 368-2522, or at kennaley@mclauchlin.ca. This material is for information purposes and is not intended to provide legal advice in relation to any particular fact situation.  Readers who have concerns about any particular circumstance are encouraged to seek independent legal advice in that regard.