Carillion, the Companies’ Creditors Arrangement Act and Construction Lien Act Trusts: Confusion (again) regarding certainty of subject matter and commingling of funds

The Companies’ Creditors Arrangement Act (“CCAA“) proceedings involving Carillion Canada and related entities (collectively, “Carillion Canada”) have been an ongoing area of interest for the construction industry since proceedings began in early 2018. Recently, Ernst & Young, (in its capacity as Monitor of Carillion Canada in the CCAA proceeding) (the “Monitor“), brought a motion seeking a declaration that certain funds received in relation to various construction projects were deemed statutory trust funds pursuant to the Construction Lien Act (“CLA“) (and now the Construction Act).

The decision from the Commercial List of the Ontario Superior Court may, to a degree, result in uncertainty surrounding how these trusts operate in the context of insolvency, bankruptcy, and creditor protection proceedings, as well as the extent to which contractors on projects to which the CLA applies can mix trust funds with non-trust funds in certain types of bank accounts without the trust funds potentially losing their status as property separate from that of the insolvent.

Background

Carillion plc, the UK parent company of Carillion Canada, commenced insolvency proceedings in early 2018, which in turn precipitated Carillion Canada’s CCAA proceedings. Prior to that, Carillion Canada carried on business as a group of construction companies providing services on various projects throughout Ontario. In the course of providing services on Ontario construction projects (prior to the commencement of the CCAA proceeding), Carillion Canada received nearly $29 million in funds from project owners, which funds were impressed with a trust in favour of unpaid subcontractors and suppliers pursuant to section 8 of the CLA (the “CLA Trust Funds”).

Prior to the CCAA proceedings, HSBC’s UK entity (“HBSC UK”) provided banking services to Carillion Canada, including a cash sweep service whereby cash was “swept” daily from Carillion Canada’s local accounts and deposited into corresponding accounts in London, England (the “Cash Sweep“). More specifically, during the Cash Sweep: i) the net amount in the accounts of each member company of Carillion Canada were “swept” into an HSBC Canada account (the “Canadian Master Account”); ii) the net cash of the Canadian Master Account was “swept” into a corresponding account in the United Kingdom (the “UK Account”); and iii) the UK Account and certain bank accounts of other affiliated global Carillion entities (collectively, the “Pooled Accounts“) were offset against each other and appropriate interest charged or earned on the net balance. The CLA Trust Funds were included in the Cash Sweep and accordingly were subject to the offset and interest calculations relating to the Pooled Accounts. The Cash Sweep process was terminated upon commencement of the Canadian CCAA proceedings.

The Monitor requested of HSBC UK that it return the CLA Trust Funds on the basis that they constituted trust funds in Ontario. However, HSBC UK advised that it was entitled to set-off the funds in the UK Account against the negative balances in other equivalent accounts that had participated in the pooling exercise, but it agreed not to exercise its right of set-off without first providing fourteen days’ notice. As of the date of the Commercial Court hearing, HSBC UK had not delivered such notice.

The Monitor brought this motion seeking a declaration that the Trust Funds were subject to a trust pursuant to section 8 of the CLA, and an Order requiring HSBC UK to transfer the funds to the Monitor for distribution to the trust beneficiaries.

The Motion Judge’s Decision

The Court considered whether the alleged CLA Trust Funds satisfied the three certainties necessary to establish a trust at common law (being certainty of intention, certainty of subject matter, and certainty of objects). If so, pursuant to the Court of Appeal for Ontario’s decision in The Guarantee Company of North America v Royal Bank of Canada, 2019 ONCA 9, the CLA Trust Funds would not be subject to set-off by HSBC UK , as the funds would not have been the property of the insolvent.

To the contrary, as set out in a brief set of reasons dated March 2, 2021, the Court found that the CLA Trust Funds were not identifiable as they had been “irreconcilably commingled and converted among nine different bank accounts held by seven different companies in two countries.” The Court declined to accept the Monitor’s request that, in order to address this, the Court recognize a “proprietary interest” in the UK Account (into which the CLA Trust Funds had been swept) as this would result in an “impermissible floating charge” over that account. The Court noted that tracing in equity could not be used to create a “floating charge” over the UK Account and, further, tracing in equity “cannot be used to enforce a CLA trust in an insolvency proceeding where identification of specific trust property is impossible.” The finding that the alleged CLA Trust Funds could not be readily identifiable as they were not separately accounted for was found to be “fatal” to the Monitor’s position.

The Monitor’s motion was dismissed.

The Monitor has sought leave to appeal the Court’s decision to the Ontario Court of Appeal. Importantly, the Monitor has alleged in its materials filed on the motion for leave to appeal that the pooling of the Pooled Accounts was only “notional”, meaning that the funds in the UK Account (including the CLA Trust Funds) were not actually commingled with the funds from the other Carillion accounts. Although this was not addressed in the motion judge’s reasons, it may prove to be significant should the Monitor be granted leave to appeal.

Analysis

The motion judge’s decision raises a number of issues in respect of the application of the current jurisprudence regarding trusts.

Most fundamentally, the motion judge’s reasons may result in conflation of the ability to ascertain funds that are the subject matter of a trust with the ability to trace such funds. The latter issue engages the question of whether, or how, certainty of subject matter can be lost in certain circumstances. Fundamentally, the question is ultimately whether trust beneficiaries are able to trace the funds in order to seek a remedy in circumstances where trust property has been misappropriated.

As the Court of Appeal for Ontario clarified in two recent cases, The Guarantee Company of North America v Royal Bank of Canada, 2019 ONCA 9 and Urbancorp Cumberland 2GP Inc (Re), 2020 ONCA 197, the provisions of the CLA establish certainty of subject matter such that valid trusts are created vis a vis bankruptcy and insolvency legislation, and therefore such trust funds are excluded from the insolvent/bankrupt’s estate.

Here, the motion judge’s finding on this point is arguably contrary to these two decisions, given the motion judge’s finding that the Monitor was effectively seeking a floating charge over all of the funds in the UK Account rather than a proprietary interest in specific property, which finding apparently interdicted the Monitor’s attempt to establish certainty of subject matter and trace the res of the trust. That being said, it bears noting that this finding was premised upon the Court’s observation that the Monitor sought the recognition of a “proprietary interest” in the UK Account itself, rather than an interest in the CLA Trust Funds specifically; accordingly, the framing of the relief sought may have influenced the Court’s conclusion that the Monitor was, in essence, seeking an impermissible floating charge.

We are also respectfully of the view that the motion judge’s finding in relation to the “floating charge” issue, may have forestalled a more fulsome consideration of the analysis as to the tracing of the CLA Trust Funds from the original account to the UK Account. If there was indeed a valid statutory trust pursuant to the CLA, equitable tracing should have remained available to the Monitor (on behalf of Carillion Canada), which should have allowed for the tracing of the CLA Trust Funds into the UK Account (where the CLA Trust Funds were allegedly then notionally pooled with non-trust funds). That being said, it bears noting that the motion judge based this conclusion on the premise that such tracing could not occur “where identification of specific trust property is impossible” meaning this conclusion may have been based upon specific the factual findings in this case, and in particular on the specific banking arrangements involved. Unfortunately, the wording of the decision in this regard was somewhat lacking in clarity.

Similarly, common law tracing would remain available in circumstances of mixed bank accounts, so long as the property remained identifiable (which the motion judge found was not possible on the facts in this case)(see Foskett v. McKeown [2000] UKHL 29; and BMP Global Distribution Inc v Bank of Nova Scotia, 2009 SCC 15).

Finally, and perhaps most importantly for members of the construction industry, it remains to be seen what clarification, if any, the Court of Appeal may provide in relation to the issue of commingling of trust funds. The motion judge did not suggest as a general proposition that commingling eliminates the possibility of tracing. However, the motion judge did find on the facts that the extent of the commingling of the alleged CLA Trust Funds, which were “converted among nine different bank accounts held by seven different companies in two countries,” rendered tracing impossible as the CLA Trust Funds were not separately accounted for and therefore could not be identified.

As a general rule, however, tracing is available even if the trust property passes through several different bank accounts, and only ceases to be traceable if the property ceases to be identifiable (e.g. where the money is spent on other services, squandered on meals, or gambled away), which principle was affirmed in the Guarantee decision. The critical issue is therefore whether the extent of the commingling of trust funds can result in the property ceasing to be identifiable. In that regard, the Court in Guarantee observed that it is “only when commingling is accompanied by conversion and tracing becomes impossible that the required element of certainty of subject matter is lost.”

With that in mind, it appears that the critical issue may be primarily a factual one of the extent to which funds can be commingled before certainty of subject matter is lost. The Monitor has argued in its materials for leave to appeal that the CLA Trust Funds flowed up the Carillion banking pyramid and then sat in the UK Account because they were only “notionally” pooled; by contrast, HSBC UK has argued in its materials that there was extensive commingling in the form of funds being deposited and withdrawn between accounts at all levels of the Carillion banking pyramid (what HSBC UK refers to as a “fountain”). In our view, clarification of the extent to which funds can be commingled before certainty of subject matter is lost would be a helpful development.

Depending on the answer to the foregoing issue, it may be challenging to fully reconcile the current jurisprudence, resulting in practical difficulties for the construction industry in similar circumstances, or the issue may become simplified. In this regard, it must be appreciated that construction companies typically commingle CLA trust funds with other funds in a general bank account and need to know in advance the extent to which they can commingle such trust funds before running afoul of the law. If, out of an abundance of caution, construction companies err on the side of maintaining separate and distinct project-specific accounts, they would undoubtedly be faced with additional administrative costs. This, in turn, could have the effect of depleting funds that could otherwise be utilized in delivering construction services and materials, in the result potentially limiting contractors’ financial flexibility on projects that remain subject to the old CLA.

By contrast, the CLA’s successor, the Construction Act, requires that trust funds must be held in a bank account in the trustee’s name, and that the trustee must maintain written records with respect to the trust funds that details: (1) the amounts that are received into and paid out of the funds; and (2) any transfers made for the purposes of the trust. A separate trust account is not required for each project, such that trusts funds from different projects can be deposited into the same account and, importantly, are deemed to be traceable. Accordingly, contractors can take a measure of comfort in knowing that in respect of projects under the Construction Act, they will have greater protection from situations such as that which arose in relation to Carillion Canada’s insolvency.

We await with interest the results of the Monitor’s motion for leave to appeal.

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