In the scheme of general commercial litigation, those involved in the construction industry are uniquely situated. The Construction Lien Act is an elegant statute which was created to provide a structured, timely and relatively inexpensive means of collecting construction debts. That is, as long as you do not fall into the many pitfalls which are specifically set out in the Act to further its very purpose. The most common ones relate to timing. In line with the elegance of the Act, lien claims must be "preserved" and "perfected" within strict time periods or be forever banned. In light of this rigid treatment the trust provisions of the Act provide a ray of hope to those who have failed to comply with its strict requirements for registering a lien. They also offer fair warning to those holding funds which may be impressed with a trust.

To Hold or Not to Hold – THAT is the Question

The Act creates several types of trusts.

If you are a contractor, amounts owing to you or received by you from the owner are trust funds for the benefit of your subcontractors and other persons who have supplied services or materials to the improvement. This also applies to subcontractors further down the construction pyramid who hire subcontractors of their own. A few caveats. The amounts owing must be on account of the contract related to the improvement. The potential beneficiaries must be owed funds by the (sub) contractor. Also, there has been some recent debate in the courts whether the services and/or materials supplied must otherwise fall into the scheme of the Act i.e. be lienable or whether some other connection to the project is sufficient.

If you are an owner, generally speaking, the Act creates the following trusts in favour of the contractor:

• (1) with respect to all amounts received by the owner (except where the owner is a Crown or municipality) for the financing of the improvement;
• (2) with respect to amounts that become payable on a certificate of payment, in the amount equal to the amount that is certified and is in the owner's hands or received by the owner thereafter;
• (3) with respect to amounts where substantial performance of the contract has been certified, an amount equal to the "unpaid price" of the substantially performed portion of the contract that is held by the owner or received by the owner thereafter.

So what, one might say, are the advantages of starting an action under the provisions of the Act rather than simply commencing an ordinary action for unpaid invoices against a party to a contract? Two specific advantages stand out.

Directors, Officers and "Other Persons" Cannot Hide Behind the Shell!

The Act specifically makes directors, officers and any other person (including an employee or agent of the corporate debtor) who has effective control of a corporation or its relevant activities liable for breach of trust if they assented to, or acquiesced in, conduct that he or she knows or reasonably ought to have known amounts to a breach of trust by the corporation. Therefore, where pursuing the principals of a corporate (and sometimes insolvent) debtor poses some difficulty in an ordinary action, the Act specifically allows the court to disregard the separate corporate existence if breach of trust can be proven.

You Get to the Front of the Line (Almost)!

Furthermore, where contractual creditors (in the absence of security) tend to be just one of the many unsecured parties with a potential claim in the bankruptcy, funds impressed with a trust under the Act do not become part of the bankrupt's estate. The funds must be distributed to the bankrupt's unpaid contractors and/or subcontractors and are out of reach of its other creditors (with the ever present exception of the Canada Revenue Agency).

Beneficiary Be Aware of Your Rights and Trustee Beware of Your Obligations!

It must be noted that the Act does allow some limited and proper disbursements to be made. However, in light of the trust considerations, trustees are well advised to beware of how they use the funds, especially when temptation looms to "pay yourself first" in times of economic trouble!

If you have any questions or comments regarding matters discussed in this newsletter, or you would like some assistance in developing preventative strategies, please contact:

Patricia Skringer
Litigation Group
Tel: 905.276.0403
E-mail: pskringer@kmblaw.com

The comments in this newsletter are of a general nature and are not designed to replace professional advice in specific situations. If you would like extra copies of this newsletter, or you know of anyone who would be interested in joining our mailing list, please contact Cheryl Woolcott at (905) 276-9111.