Legal Blog

Lawyers & Trust Funds

Lawyers often go the extra mile to help their contractor clients, but, when money becomes available, particularly through their efforts, they quite reasonably expect to be paid for their efforts from the recovered money. Unfortunately, it does not always work that way, especially if the money recovered is characterised as trust money under the Construction Act.

Two cases illustrate this proposition: Great Northern Installation Services Ltd. v. King Road Paving and Landscaping Inc., a 2021 decision of the Ontario Court of Appeal and Electro-Works v. Fogler, Rubinoff LLP, a 2021 Ontario Superior Court of Justice decision.

Great Northern

We have already discussed the Divisional Court’s decision in Great Northern (see January 2020 newsletter). The lawyers involved appealed that decision to the Ontario Court of Appeal.

The trial judge held that the following amounts were due:

• The owner owed the general $79,000 after being credited for $106,000.
• The owner had holdback obligations to the subs of $97,000 ($18,000 by way of the basic holdback and $79,000 by way of the holdback arising from a written notice of lien).
• SC1 had a lien for $52,000 and SC2 had a lien for $54,000. Remember, there is no lien for interest.
• Since the aggregate of the liens of the two subs was more than the owner’s holdback, the subs had to share the holdback money pro rata: $48,000 to SC1 and $49,000 to SC2.
• The general owed SC1 $104,000, comprised of $52,000 for actual goods and services plus contractual interest (not lienable, but still due from the general) of $52,000. The interest amount was extraordinarily high because the general and SC1 had agreed upon interest at 2% per month, which was the equivalent of approximately 26% per year based on the compounding factor.

To make matters more interesting:

• Before the trial, the general had received an assignment of SC2’s lien rights pursuant to section 73 of the Act. Presumably, the general had paid a percentage of SC2’s lien to reduce the general’s risks at trial. Presumably, SC2 accepted less than the claimed amount so that it could be paid immediately rather than go through a trial.
• The general was not getting enough money from the owner to pay the subs in full. Accordingly, its lawyers were getting anxious and obtained a charging order against the money due to the general from the owner. A charging order is awarded to lawyers when, through their efforts, their client is to receive money from a lawsuit. Instead of being paid to the client, the money is paid to the lawyers for their fees.
• The only money the general was to receive came from the money due to the general as an assignee of SC2’s lien. It was to receive nothing from the owner because the owner’s actual liability to the general was less than what the owner was paying in holdback to the two subs.

Priority

The lawyers wanted the $49,000 that was being paid to SC2 for its lien plus another $5,000 for interest on that holdback that was due from the owner to the general – for a total of $54,000. This money would seemingly have gone to the general, but was subject to the lawyers’ charging order. SC1 wanted the $54,000 because, even after the owner had paid it $48,000 towards its lien, the general still owed it an additional $55,000, mostly because of the massive interest attached to the debt.

The Court of Appeal, upholding the Divisional Court decision, held that:

• 14(2) of the Act disallows interest on liens, but no such prohibition is set out in s. 8 for trust funds. Accordingly, under the trust fund provisions, a payee may include interest as part of the debt due to it.
• The general and, therefore, the lawyers, who stood in the general’s shoes because of the charging order, did not lead evidence to show that the amount paid for the assignment of SC2’s lien came from money that was not impressed with a trust. Therefore the exception in s. 11, which allows a trustee to pay money if in doing so it does not breach a trust, did not apply.

Consequently, because the general and SC2 did not complete the assignment in a manner that would not run afoul of the trust provisions, the lawyers, even with their charging order, got nothing for all of their efforts. We are empathetic to the plight of the lawyers, but assume that they acted for the general in preparing the assignment itself and therefore may have only themselves to blame.

Electro-Works

General commenced a lien action against owner. Some of its subcontractors also liened; general bonded off their liens. General also defended a trust action that sub brought. Sub had not been one of the subcontractors who had liened the project. The lawyers acted for general in both actions.

General then settled the lien action with owner and, by way of a consent order, owner paid $406,000 to general, through the lawyers in trust. The lawyers then paid the following sums:

• $144,000 to the subcontractors who had liened and were part of the settlement (OK because money is paid down to trust beneficiaries in accordance with the trust rules)
• $222,000 to general (OK because the general is now the trustee)
• $ 40,000 to itself for legal fees, upon direction from general (the disputed payment)

The lawyers then removed themselves as lawyers of record for general in the trust action. Ultimately, general settled with sub; general acknowledged that it owed sub $77,000 and agreed to a payment plan. General defaulted on the payment plan and sub obtained a judgment for the agreed amount plus a declaration that general was in breach of trust.

Sub then brought an application for an order that, when the lawyers paid themselves out of the settlement money in the lien action, they were in knowing receipt of trust funds that should have been earmarked for payment of all subcontractors, including sub.

Decision

The lawyers argued that only the Act could deal with liability for breach of trust. Particularly, s. 13 imposes personal liability, but only for officers, directors, and persons in control of the trustee and the lawyers did not fall within these categories. The judge held that the s. 13 provisions imposed liability in addition to the common law equitable remedy for knowing receipt of trust funds.

Since the lawyers knew of the trust action, they were bound not to pay the trust money to themselves until they knew that the action had been resolved. When general directed the lawyers to pay themselves, it directed money to be paid for purposes other than the purpose of the trust (i.e. other than for the payment of subcontractors and suppliers) and authorised, in effect, the payment of its overhead. This was a breach of the trust.

The judge had some sympathy for the lawyers. She noted that the lawyers could have ensured that they had no liability. All they had to do was advise general that they could not honour its direction to pay the funds to themselves; rather, general had to pay the lawyers in the normal course. Of course, by doing so, the lawyers would put themselves at risk of general not paying them at all, but they took on that risk when they agreed to act for general.

Image courtesy of viarami.

Written by Jonathan Speigel, the founding partner of Speigel Nichols Fox LLP, leads the litigation and construction practices.