What are the limits of the trust fund liabilities under the Construction Lien Act? Those liabilities do not just apply to a contractor or subcontractor engaged in a building project. Those liabilities may also apply to an officer or director or a person controlling the company.
But can an officer, director or controlling person be liable even if it is not proven that the contractor or subcontractor actually breached the trust fund obligations while that person was in office? And who has the burden of proving those facts? Those were the issues which the Ontario Court of Appeal dealt with in Belmont Concrete Finishing Co. Limited v. Marshall.
Section 8 and 13 of the Construction Lien Act
In Ontario, section 8 of the Construction Lien Act creates the basic trust fund obligation of contractors and subcontractors engaged in building projects. Under that section, monies owing to or received by a contractor or subcontractor on account of the contract or subcontract price constitute trust funds for the benefit of its subcontractors and suppliers of services and materials to the improvement. The contractor or subcontractor is not entitled to appropriate any of those funds for its own use until its subcontractors and suppliers are paid.
The trust fund obligations of contractors in section 8 are re-enforced by section 13 of the Act. That section imposes a liability on “every director or officer of a corporation” and “any person, including an employee or agent of the corporation, who has effective control of a corporation or its relevant activities.” Liability arises under section 13 if that person “assents to, or acquiesces in, conduct that he or she knows or reasonably ought to know amounts to breach of trust by the corporation of the obligations under section 8 of the Act.
The underlined words are the important ones. The statutory liability of the director, officer or controlling person depends upon a breach of trust by the corporation, and upon the person assenting to or acquiescing in that breach.
Between 2001 to 2003, the general contractor received funds for several projects. Those funds were trust funds under the Act. The general contractor dispersed them in breach of trust. As a result, the supplier Belmont Concrete Finishing was not paid.
At the end of May 2002, the respondent Marshall took control of the general contractor sufficiently for s. 13 purposes. Only after May 2002 was he in a position with the general contractor so that he could have known or reasonably should have known about, and could have assented to or acquiesced in, any breach of trust by the general contractor that took place after that date.
The trial judge made no finding as to when the general contractor’s breaches of trust took place, and whether they occurred before or after May 2002. The Court of Appeal held that there was no evidence to support the allegation that any breaches of trust occurred “on the respondent’s watch.”
Decision of the Court of Appeal
The Court of Appeal set out the three part test that applies to the potential liability of a person under section 13. The court said that, for that liability to be imposed upon a person, it must be shown that:
“(1) there is conduct by the corporation that amounts to a breach of trust;
(2) the person is a director or officer of the corporation, or in effective control of it; and
(3) the person knows or ought reasonably to know that the conduct amounts to a breach of trust and assents to or acquiesces in that conduct.”
The court then held that the supplier Belmont Concrete Finishing, which asserted that there had been a breach of the trust fund obligation by the contractor, had the burden of proving that breach. It was not Mr. Marshall, the court held, that had that burden of proof. The court explained its decision as follows:
“The appellants argue that the onus is on the respondent to fill this evidentiary void. I do not agree. Unlike s. 8 of the Act, s. 13 is not about liability as a trustee. It is about an individual’s liability for breach of trust by the corporation. The onus for the elements required by s. 13(1) is on the party seeking to attach liability to the individual…Since there was no evidence that any of the breaches of trust by the general contractor encompassed by the summary judgments took place after the end of May 2002, there was no basis to find that the respondent could be held liable for them under s. 13 of the Act.”
The Court of Appeal then considered whether Mr. Marshall could be held responsible for the payments that were made by the general contractor to him. The court concluded that, unless it were proven that the funds used to make those payments were trust funds – and there was no proof that they were -the mere fact that payments were made by the general contractor to Mr. Marshal could not support a claim under section 13. The court said:
“There is simply no evidence that the funds used for these payments by the general contractor were funds impressed with a trust in favour of the appellants. Without such evidence, the payments to the respondent cannot serve as the basis for his liability to the appellants for breach of trust under s. 13.”
Accordingly, the Court of Appeal dismissed the claim of the supplier against Mr. Marshall.
This decision shows the difficulties in proving a trust fund claim against an individual under section 13. Two hurdles have to be overcome.
First, the claimant must show that there were trust funds which were received or receivable by the contractor or subcontractor, and were diverted.
Second, the claimant must show that, at the time the trust funds were diverted, the defendant officer, director or control person was in a position to know that the funds were trust funds and were being diverted, so that he or she could be said to have assented to or acquiesced in the diversion of those funds.
Section 13 does not state any burden of proof. So the burden of proof is entirely a matter for the courts to decide. In the present case, the Court of Appeal declined to put the burden of proof of these elements on the defendant officer, director or control person because that person is not being sued for breach of trust. Rather, that person is being sued for assenting to or acquiescing in a breach of trust. So, while a trustee may have a burden of explanation, a person assenting to or acquiescing a breach of trust does not.
Some may question whether this allocation of the burden of proof is fair. It is true that, apart from claims against trustees, normally the burden of proof is on the claimant. But courts often place the burden of explanation on the defendant when the defendant has special knowledge of the circumstances. In the case of a claim against an officer, director or control person of a company, the claimant supplier has no knowledge of the facts relating to the receipt and disbursement of the trust funds by the contractor or subcontract, which are the key elements of the claim. One might say that the officer, director or control person should have the burden of proof at least during that person’s “watch.”
At the very least this decision shows that extra care must be taken during a building project or during an action to enforce rights under section 13, in order to find and preserve the evidence necessary to establish those rights. During the project, a supplier may be able to obtain information about the payments to the contractor or subcontractor. If payments fall behind, then the supplier or subcontractor should be pro-active in taking steps to preserve evidence of any improper diversion of trust funds, by making inquiries of and notifying the owner or superior contractor of the supplier’s claim.
If a trust fund claim is brought, then it may be brought under section 8 against the defaulting contractor or subcontractor, and under section 13 against the director, officer and controlling person. The claimant will have to conduct careful examinations for discovery and carefully demand production of documents. By doing so, it may be able to establish that trust funds were diverted and that the defendant director, officer or control person assented to or acquiesced in that diversion.
The bottom line is that the effective scope of section 13 is only as good as the evidence. That’s not a novel proposition but in the context of section 13 it’s a challenging one.
Belmont Concrete Finishing Co. Limited v. Marshall, 2012 ONCA 585.
Building Contracts – Construction Liens – Trust Funds – Officers, Directors and Controlling Persons
Thomas G. Heintzman O.C., Q.C., FCIArb December 1, 2012