Legal Blog

Survival

Section 178(1)(d) of the Bankruptcy and Insolvency Act provides that a discharge from bankruptcy does not release the bankrupt from any debt or liability arising out of fraud, embezzlement, misappropriation, or defalcation while acting in a fiduciary capacity. Assume that a subcontractor establishes a breach of a general contractor’s obligations under the trust provisions of the Construction Act and, perhaps, also establishes liability against one or more of its directors and officers under s. 13 of the Act. Can the sub properly claim that the breaches should result in a declaration that the judgment against the trustee contractor, and its directors and officers (if applicable), survives a subsequent bankruptcy? This question has been answered a number of times, most recently in Matthews Equipment Limited v. Yalda Contracting Inc., a 2021 decision of the Ontario Superior Court of Justice.

Default

An equipment rental supplier delivered equipment for the corporate contractor’s use on six construction projects. The contractor did not pay the aggregate amount of $72,000 for the rentals and the supplier commenced an action against the contractor and its two directors.

None of the defendants defended the action. The supplier noted them in default. Noting in default means that the defendants are deemed to have admitted all of the allegations contained in the statement of claim. Accordingly, the wording of the statement of claim is very important. It needs to set out all of the allegations, which, if deemed to be true, would support a judgment against the contractor, including a judgment against the individual directors. If the facts as pleaded are not sufficient to support a judgment in law on a motion for a default judgment, judgment will not be granted,

In this case, the supplier moved for judgment based on the allegations contained in the statement of claim.

Judgment

The statement of claim alleged the following:

• The supplier delivered its equipment to the construction sites.
• The contractor used them to make improvements to the projects.
• The supplier invoiced for $72,000 and the contractor improperly failed to pay the amount due.
• The contractor was paid at least $72,000 by the project owners.

Those facts were sufficient for the judge to grant judgment against the contractor for breach of contract. They were also sufficient to establish a trust in favour of the supplier, which shifted the onus to the contractor to prove that all money it received for the projects was used to pay beneficiaries of the trust. Given that the defendants did not defend, that evidence was not before the judge and the judge therefore held that the contractor breached its trust obligations under section 8 of the Construction Act.

Next, the judge had to determine whether, under section 13 of the Construction Act, the directors  assented to or acquiesced in the breach of trust and were therefore were personally liable for the contractor’s breach of trust. The statement of claim made that allegation and the judge therefore granted judgment against the directors.

Bankruptcy

The statement of clam requested a declaration that any judgment against the defendants survive their subsequent bankruptcies. We cannot report on the exact wording of the statement of claim, but presume that the declaration was requested because of the breach of trust.

A breach of trust does not necessarily support a finding under s. 178(1)(d) of the BIA. The breach could have been due to negligence, ignorance, or incompetence. Since the statement of claim seemingly had no allegations to demonstrate that the breaches arose out of fraud or misappropriation, the judge refused to grant the declaration.

The judge also noted that the courts have refused to grant a declaration pre-emptively (i.e., before a defendant actually becomes bankrupt). That, in itself, would have been sufficient for the judge to deny the declaration that the supplier sought. In effect, the judge was saying that the supplier has its judgment and if the contractor, or its directors, makes an assignment in bankruptcy, the supplier will then have its opportunity to obtain an order that the judgment survives the bankruptcy.

Declaration

The statements of claim that we draft also request a declaration that a judgment survives bankruptcy. It does so, not because we would claim it on a default judgment, but because it is probable that the defendants will defend the action and if, between the start of the action and final judgment, the defendants do become bankrupt, we can then deal with the bankruptcy and a possible declaration without having to amend the statement of claim.

We also insert the following demand: “a declaration that the breaches of trust resulted in debts or liabilities arising out of fraud, embezzlement, misappropriation, or defalcation while acting in a fiduciary capacity.” When moving for a default judgment, we ask only for this declaration; we do not request the bankruptcy declaration.

We allege the following in the body of the statement of claim, assuming a corporate trustee (Corp) and one director (Director):

• Director knew or, alternatively, is deemed to know, about the trust responsibilities of Corp under the Act. He knew or, alternatively, is deemed to know, that Corp had a duty to keep all monies it received from Owner in a separate bank account and that it did not do so. He knew or, alternatively, is deemed to know, that failure to pay Beneficiary’s invoices from the monies that Corp received from Owner was a breach of trust under the Act. He knew and did not care that Corp was not paying the Beneficiary from the Owner’s payments and that these payments were trust monies.
• Director participated in Corp’s breach of trust or was reckless or wilfully blind to the breach of trust.

Will these allegations be sufficient to obtain the declaration we seek? We can only say that they have in the past.

Costs

The plaintiff attempted to obtain an order for substantial indemnity costs (about 90% of actual legal fees and disbursements) rather than the usual partial indemnity costs (about 60% of actual legal fees and disbursements).

The judge awarded costs on a partial indemnity basis stating only that the defendants’ failure to defend or deliver any materials on the motion did not warrant an enhanced scale of costs. If this were the only argument, we fully agree with the judge, but we are perplexed that the judge did not mention the breach of trust and do not know whether the contractor argued it. Regardless, even if it had, the facts alleged still did not seem to warrant an enhanced scale of costs.

It is ironic that defendants who do not defend an action only have to pay partial indemnity costs (because of a lack of evidence that would demonstrate improper behaviour) while defendants who do defend, and thus allow the plaintiff to garner facts to demonstrate the defendants’ improper behaviour (that a judge would want to discourage), would be liable for enhanced costs.

 

Image courtesy of Tumisu.

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