1 6 CONSTRUCTION LAW REPORTS 3 C.L.R. (3d) Case Comment: Toro Aluminum Ltd. v. Revah Duncan W. Glaholt Markus Rotterdam * Does a person liable for breach of trust as an accessory under s. 13(1) of the Construction Lien Actt fall within the exception set out in s. 178(l)(d) of the Bankruptcy and Insolvency Act? 2 In other words, is personal liability under the trust provisions of the Construction Lien Act extinguished upon a discharge from bankruptcy? Adams J., in Re Francisco, 3 says that it is "at least arguable" that personal liability is extinguished upon discharge and Molloy J., in Toro Aluminum Ltd. v. Revah, 4 says "sometimes." Madam Justice Molloy's decision has since been followed by Greer J. in Re Zumbo. 5 The two relevant statutory provisions are s. 13(1) of the <Construction Lien Act and s. 178(1)(d) of the Bankruptcy and Insolvency Act. Construction Lien Act 13.-(1) In addition to the persons who are otherwise liable in an action for breach of trust under this Part, (a) every director or officer of a corporation; and (b) any person, including an employee or agent of the corporation, who has effective control of a corporation or its relevant activities, who assents to, or acquiesces in, conduct that he or she knows or reasonably ought to know amounts to breach of trust by the corporation is liable for the breach of trust. * Duncan W. Glaholt, Barrister and Solicitor, Glaholt & Associates, Toronto, Ontario. Markus Rotterdam, Researcher, Glaholt & Associates, Toronto, Ontario. ' Construction Lien Act, R.S.O. 1990, c. C.30 2 Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 3 Re Francisco (1995), 19 C.L.R. (2d) 146, 32 C.B.R. (3d) 29 (Ont. Bktcy.), affirmed (1996), 40 C.B.R. (3d) 77 (Ont. C.A.) 4 Toro Aluminum Ltd. v. Revah (1999), 3 C.L.R. (3d) 1 (Ont. S.C.J.) 5 Re Zumbo (2000), 2 C.L.R. (3d) 297 (Ont. Bktcy.).
Case Comment: Toro Aluminum Ltd. v. Revah 17 Bankruptcy and Insolvency Act 178. (1) An order of discharge does not release the bankrupt from (d) any debt or liability arising out of fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity... In Simone v. Daley, 6 which concerned a failed real estate transaction, the Ontario Court of Appeal held that not every breach of an obligation by a trustee falls within s. I78(1)(d) of the Bankruptcy and Insolvency Act. Blair J. (ad hoc) held:... I am not persuaded that the exception to a release of liability upon a bankruptcy discharge which is provided for in paragraph 178(1)(d) of the BIA should be extended to conduct which does not display at least some element of wrongdoing or improper conduct on the part of the fiduciary in question in the sense of a failure to account properly for monies or property entrusted to the fiduciary in that capacity or inappropriate dealing with such trust property. Had Parliament intended that any innocent breach of an obligation on the part of a fiduciary would give rise to a debt that would not be released by a discharge from bankruptcy it could very easily have said so, by providing that an order of discharge does not release the bankrupt from any debt or liability arising from a breach of fiduciary obligation. It did not do so.... I can only conclude that Parliament intended the words "misappropriation" and "defalcation" to bear their plain and ordinary meaning, as the context in which they are used suggests. In Simone the plaintiffs had orally agreed to purchase a home from the defendant with immediate possession, but a later closing. The plaintiffs moved in and began making payments to the defendant, which, according to the agreement, were to be applied against the purchase price. Before the closing date, the defendant experienced serious financial difficulties, resulting in his voluntary assignment into bankruptcy and the sale of the property by mortgagees under power of sale. The issue before the court was whether the payments to the defendant were a liability of the defendant that survived his bankruptcy. The Court of Appeal held that, although the defendant had breached his fiduciary duty, the breach did not amount to misappropriation or defalcation under the Bankruptcy and Insolvency Act; thus, the liability did not survive the bankruptcy. In Toro Aluminum, 6 Simone v. Daley (1999), 170 D.L.R. (4th) 215, 118 O.A.C. 54, 8 C.B.R. (4th) 143, 43 O.R. (3d) 511, 24 R.P.R. (3d) I (C.A.) 7 Si,nane, at p. 1 61 C.B.R.
18 CONSTRUCTION LAW REPORTS 3 C.L.R. (3d) Molloy J. considered the reasoning in Sinione in the context of a s. 13 Construction Lien Act case: 8 Based on the reasons of the Court of Appeal in Simone v. Daley, it cannot be said that any finding of liability under the trust provisions of the Construction Lien Act will constitute a liability falling within s. 178(1)(d) of the Bankruptcy and Insolvency Act. One can imagine situations in which there could be breach of the trust provisions in the CLA without any deliberate wrongdoing on the part of the trustee. For example, funds might be paid out to third parties due to inadvertence or an accounting error. Such conduct might not fall within the Court of Appeal test as articulated in Simone v. Daley. However, there will certainly be some breaches of trust under the Construction Lien Act which will fall clearly within s. 178(1)(d) of the Bankruptcy and Insolvency Act. An obvious example is where a trustee deliberately misappropriates trust money for his own use so as to defeat the claim of (sic) beneficiary. In between these two extremes, there is a spectrum of conduct which breaches the CLA, but which may or may not fall within s. 178(1)(d) of the Bankruptcy and Insolvency Act, depending on the extent to which there was any wrongdoing or improper conduct by his (sic) bankrupt in his fiduciary capacity. Molloy J. observed that not every breach of trust automatically falls within the meaning of s. 178(1)(d) of the Bankruptcy and Insolvency Act, that the determination of a breach of s. 13(1) of the Construction Lien Act does not necessarily involve a determination of wrongdoing or improper conduct, and that, consequently, such a breach does not automatically bring a bankrupt within the meani ng of the exception in s. 178(1)(d) of the Bankruptcy and Insolvency Act. In the authors' view, moral turpitude is, arguably, an element of "fraud, embezzlement, misappropriation or defalcation," as listed in s. 178(1)(d) of the Bankruptcy and Insolvency Act. However, for a discharge from bankruptcy to release a bankrupt from a debt incurred because of a breach of the statutory trust under the Construction Lien Act, it should also be required that there be no form of personal benefit, direct or indirect. In Molloy J.'s simple example of breach by payment to third parties through inadvertence or accounting error, both tests would be met. In the example, inadvertence on the part of the trustee is at issue, not his or her moral turpitude, and no personal benefit is suggested. But if a third party holds a bankrupt's personal guarantee and discharges that guarantee upon receipt of payment in breach of trust, then, on the writers' analysis, the bankrupt's discharge should not release the breach of trust, regardless of whether the bankrupt knew of the guarantee or its release. On this extended example, personal benefit alone should be sufficient to trigger the exception under s. 178(1)(d). Section 13 of the Construction Lien Act was explicitly drafted to pre- 8 Toro Aluminum, at para. 13
Case Comment: Toro Aluminum Ltd. v. Revah 19 vent clever but unscrupulous people from manipulating contract and corporate status to avoid personal liability. No test adopted under the Bankruptcy and Insolvency Act should open the door to such chicanery. Molloy J.'s decision is important for another reason. Recent decisions of the Ontario Court of Appeal have made it abundantly clear that breaches of trust under the Construction Lien Act do not necessarily require knowing misconduct. The result has been to expand significantly the scope of cases in which courts will find personal liability under s. 13 and, inevitably, the issue of discharge from personal bankruptcy can be expected to arise more often. As a result of Toro Aluminum, we may expect to hear more of the "but it was only a little breach" defence found in s. 35 of the Ontario Trustee Act, R.S.O. 1990, c. T.23. It is interesting to compare the treatment of s. 178 of the Bankrupcty and Insolvency Act in a s. 13 Construction Lien Act context with the treatment that s. 35 of the Trustee Act has received in the Court of Appeal in cases dealing with s. 13 Construction Lien Act liability. Section 35 of the Trustee Act is an otherwise solid and necessary piece of legislation, but it has uniformly failed as a s. 13 defence. Section 35 of the Trustee Act is as follows: 35. (1) If in any proceeding affecting a trustee or trust property it appears to the court that a trustee, or that any person who may be held to be fiduciarily. responsible as a trustee, is or may be personally liable for any breach of trust whenever the transaction alleged or found to be a breach of trust occurred, but has acted honestly and reasonably, and ought fairly to be excused for the breach of trust, and for omitting to obtain the directions of the court in the matter in which the trustee committed the breach, the court may relieve the trustee either wholly or partly, from personal liability for the same. (2) Subsection (1) does not apply to liability for a loss to the trust arising from the investment of trust property. [en. S.O. 1998, c. 18, Sched. B, s. 16(2)] This section became a perennial favourite of defence counsel acting on behalf of personal defendants charged with "objective" or technical breaches of trust, when no element of personal benefit was alleged or proven. It was popular because it reintroduced a "subjective" or conduct-based test for personal liability, whereas the court had stripped away such a requirement in the case of the sub-
20 CONSTRUCTION LAW REPORTS 3 C.L.R. (3d) stantive corporate breach. The section has proved to be cold comfort. In Ontario Electrical Construction Co. v. S.I. Guttman Ltd., 9 Hoilett J. held as follows: 10 I am of the opinion that s. 35 of the Trustee Act may not be invoked by the respondents in defence of their impugned conduct. To arrive at any other conclusion would be, in my view, to ignore the very raison d'etre of legislation of the genre of the Construction Lien Act. Legislation of that kind is usually designed to deal with a specific subject area; usually very specialized, often technical. The legislation in such cases usually establishes a complete code of procedure aimed at dealing with all the issues arising in that domain. It would be an improper reading of section 35 of the Trustee Act, i n my view, to construe it in such a manner as to diminish the rights of those clearly sought to be protected by the trust provisions of the Construction Lien Act. In a short endorsement, the Court of Appeal agreed. I I The same view was taken by the Court of Appeal in Dietrich Steel Ltd. v. Shar-Dee Towers (1987) L t d. 1 2 McKinlay J.A., for the court, held: 13 Assuming, without deciding the question, that s. 35 could apply to a breach of a specific statutory trust, I have difficulty in seeing how the provisions of s. 35 could apply to give relief to a contractor who becomes a trustee by virtue of the provisions of s. 8 of the Construction Lien Act. The whole purpose of the Act is to protect persons supplying services and materials to an "improvement" to real property, and s. 8(2) sets out specific duties of a trustee. The trustee must not appropriate funds to its own use or to a use inconsistent with the trust until all amounts owed money (sic) by the trustee for services or materials supplied to the improvement are paid. If we assume that a trustee passes the test of honesty required by s. 35, 1 do not see how the trustee could pass the test of reasonableness if it has acted contrary to the specific provisions of s. 8(2). To say that the trustee's actions could be reasonable in such a situation would be to subvert the whole raison d'etre of the Act. 9 Ontario Electrical Construction Co. v. S.!. Guttman Ltd. (1996), 29 C.L.R. (2d) 146, 16 E.T.R. (2d) 41, 10 O.T.C. 51 (Gen. Div.) 1 0 Ontario Electrical, at p. 155 C.L.R. "Ontario Electrical Construction Co. v. S.L Guttman Ltd. (1997), 104 O.A.C. 232 (C.A.) 12 Dietrich Steel Ltd. v. Shar-Dee Towers (1987) Ltd. (1999), 170 D.L.R. (4th) 475, 42 O.R. (3d) 749, 119 O.A.C. 69, 45 C.L.R. (2d) 178 (C.A.) 1 3 Dietrich Steel, at p. 187 C.L.R.
Case Comment: Toro Aluminum Ltd. v. Revah 21 The appellate court confirmed this reasoning in Structural Contracting Ltd. v. Westcola Holdings Inc. 14 How can we distinguish innocent breaches from culpable breaches of the statutory trust under the Bankruptcy and insolvency Act when we do not do so under the Trustee Act? Our Court of Appeal seems to be saying that there can be no "reasonable," i.e., innocent, conduct that otherwise amounts to a breach of a statutory trust. The ideas are contradictory. Why should an "innocent" breach of a statutory trust permit discharge from bankruptcy when it does not become a defence under the Trustee Act? If the direction of the Ontario Court of Appeal in the s. 35 Trustee Act cases is to be followed, there may be no such thing as an honest, reasonable, or fair excuse for breach of the statutory Construction Lien Act trust. t 4 Structural Contracting Ltd. v. Westcola Holdings Inc. (2000), 48 O.R. (3d) 417, 2 C.L.R. (3d) 165, 187 D.L.R. (4th) 407 (C.A.)