When a company declares bankruptcy, its assets are divided up among its creditors. It can be lengthy and involves a lot of paperwork and red tape. If the company enters into an agreement with another party and accepts money for work it cannot perform because of its bankruptcy, those funds should not be used to pay other creditors. This was the subject of a recent case before the Ontario Court of Appeal.

Payment for an incomplete service is ruled part of a bankrupt estate

Ayerswood Development Corporation is a general contractor that, in 2018, was hired for a building project in Guelph, Ontario. Ayerswood hired Sirius Concrete Inc. to build the concrete structure for three underground parking levels, twelve above-ground levels, the roof, and the project’s penthouse. Sirius’s work was disorganized and rife with delays and deficiencies. Although Ayerswood had been paying Sirius’s invoices, it withheld funds at a certain point until Sirius made progress with some of the problems holding the project back.

A meeting was scheduled with Sirius to discuss a plan moving forward. On the day of the meeting, representatives from Sirius failed to attend. One representative contacted Ayerswood to apologize. He expressed that the company needed more time to develop the plan. He also asked for payment of the outstanding invoice and explained that receipt of the invoice would guarantee the completion of the work. Ayerswood’s representative believed this and provided a cheque for payment. The next day, however, Sirius filed for bankruptcy and seemingly had no intention of completing the work.

The judge in bankruptcy court ordered that the amount Ayerswood paid to Sirius is part of Sirius’s bankruptcy estate for distribution to its creditors. Ayerswood’s position was that the funds were not Sirius’s property, and Ayerswood had a claim to a remedial or constructive trust over them. Ayerswood also believed that Sirius had collected the funds by means of deceit and that the concrete company had been unjustly enriched. Even with evidence demonstrating Ayerswood’s allegations, the bankruptcy judge held that it still could not lead to the imposition of a trust.

What is unjust enrichment?

Unjust enrichment, in simple terms, means that one person was enriched or received a benefit at the expense of another person. This can also be found when one person fails to compensate a party that gave them a benefit. This often happens in the context of a contractual breach. 

For instance, when a general contractor is hired to do work on a home renovation, the expectation is that they will be paid for their work once completed. If the homeowner terminates the contract after the work has started but before it is completed and refuses to pay for the work that has already been done, it is unjust enrichment. The homeowner can save funds on hiring another contractor because the new contractor may have less work. Or perhaps the contractor’s small work added value to the house. In either case, the homeowner benefits from the contractor’s work without paying for it.

What is remedial constructive trust?

A remedial constructive trust is a remedy court can order where a trust is imposed to help right a wrong. At the heart of remedial constructive trust is the principle of unjust enrichment. For this to be ordered, there needs to be a connection between the property in question (in this case, the funds Ayerswood paid to Sirius) and the unjust enrichment (Sirius was able to use those funds to pay its creditors without completing the work). There also needs to be no legal reason for one party to be enriched at the other’s expense.

Where unjust enrichment is established, a court may order a constructive trust as a remedy when a personal remedy would not be enough to compensate the wronged party.

The Bankruptcy and Insolvency Act allows the imposition of a constructive trust

At the initial hearing with the bankruptcy judge, it was held that Ayerswood could not establish a trust in relation to the funds. He did not cite any evidence to that effect, however.

The Court of Appeal began its analysis with section 67(1)(a) of the Bankruptcy and Insolvency Act. This section reads: “The property of a bankrupt divisible among his creditors shall not comprise… property held by the bankrupt in trust for any other person[.].” It has been established that when unjust enrichment arises from debtor misconduct before bankruptcy occurs, it is possible to impose a constructive trust in favour of a third party. When a constructive trust is effectively made, this means that the property in question cannot form part of the bankrupt estate and instead vests in the trustee by virtue of section 71 of the Bankruptcy and Insolvency Act:

71 On a bankruptcy order being made or an assignment being filed with an official receiver, a bankrupt ceases to have any capacity to dispose of or otherwise deal with their property, which shall, subject to this Act and to the rights of secured creditors, immediately pass to and vest in the trustee named in the bankruptcy order or assignment, and in any case of change of trustee the property shall pass from trustee to trustee without any assignment or transfer.

The imposition of a constructive trust was supported by case law

The Court of Appeal also considered case law that established the possibility of imposing a constructive trust in bankruptcy. Barnabe v Touhey held that, where the requirements for a constructive trust are met, “the beneficiary of the trust will receive payment out of a fund that would otherwise form part of the assets of the bankrupt estate.” Similarly, 306440 Ontario Ltd v 782127 Ontario Ltd acknowledged that a constructive trust comes with benefits that effectively trump the scheme set out in bankruptcy legislation. Namely, beneficiaries of a constructive trust are able to remove property they are entitled to from the bankrupt estate.

The Court of Appeal then assessed the claim of unjust enrichment. It found that Sirius had indeed been unjustly enriched. Given that a trust is a legally viable remedy in those circumstances, the bankruptcy judge erred in their conclusion to the contrary. Ayerswood’s appeal was allowed, and the matter was sent back to bankruptcy court to determine entitlement to the funds in question.

If You Have Misappropriated Funds, Contact The Business Lawyers at Tierney Stauffer LLP

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