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Trust Setoff and Maintaining Separate Accounts

Posted on September 13, 2016 | Posted in Construction

The defence of setoff arises in almost every construction dispute. One party (e.g. a general) claims that another party (e.g. an owner) owes money to it. The owner acknowledges that it may appear that it owes money to the general; however, it actually owes less or no money to the general because it has a valid claim against the general that offsets the amount the general is claiming.

We have discussed setoff numerous times (see newsletters of Nov. 1996 and 1998, Jan. 2000, Sept. 2009, and Mar. 2013), but interesting cases dealing with setoff continue to arise. One such case was Architectural Millwork & Door Installations Inc. v. Provincial Store Fixtures Ltd., a 2016 decision of the Ontario Court of Appeal.

 

Inter-Project Setoff

You are probably aware of setoff within a project (e.g. a sub claims monies due on contract while a general claims that it spent money completing deficiencies that the sub refused or neglected to rectify). However, the defence of setoff can be used, in appropriate circumstances, for claims on different projects (e.g. a sub claims for money due on project #1, but the general claims that the sub owes the general money on project #2).

Section 12 of the Construction Lien Act deals with setoff in the context of trust fund duties. It states that a trustee (e.g. a general) may retain from trust funds otherwise due to a beneficiary (e.g. a sub) an amount equal to “all outstanding debts, claims or damages” that the beneficiary may owe to the trustee “whether or not related” to the project on which the beneficiary makes its claim.

 

Dispute

 A general retained a millwork sub on two projects. The sub commenced an ordinary action for monies due. It did not claim that there was a breach of trust under the Act; it merely claimed that the general owed money to it relating to project #1. The general admitted that it owed the sub $62,000 on project #1. However, the general argued that it should not be forced to pay the sub because it had a claim against the sub relating to project #2. The general relied on the defences of legal setoff, equitable setoff, and section 12 of the Act.

Legal setoff allows two claims for debt to be set off against each other. It does not allow an unliquidated claim for damages to be set off against a debt. Equitable setoff is more expansive; it allows a party to set off a claim for unliquidated damages against a debt, but only if the competing obligations are “sufficiently connected that it would be unjust to permit one party to enforce payment without taking into account the commitment flowing the other way.” For example, it would be unjust for a general to be forced to pay a sub monies due on contract for a specific project if the general had a claim for deficiencies on that project against the sub.

The motions judge dealt with each of the defences in turn. He held that section 12 of the Act did not apply because the sub never claimed that there was a breach of trust, just that there was money due to it. Second, the general could not claim legal setoff because the sub’s claim was for a debt on project #1 and the general’s claim was for damages, as yet unproven, on project #2. Finally, equitable set-off did not apply because the two projects had nothing to do with each other and there had been no evidence that the general and sub had a history of running accounts joining all projects together.

The motions judge granted summary judgment in the sub’s favour and the general appealed.

 

Appeal

The Court of Appeal leaned towards the motion judge’s interpretation that, because the sub asserted no trust claim in the statement of claim, a claim for setoff under section 12, which deals only with trust responsibilities, was not responsive to the statement of claim’s allegations. However, the Court held that it did not have to decide that issue because it held that section 12 did not apply, regardless of the form of the statement of claim’s allegations.

The Court noted that section 12 does not give a trustee (the general) the right to put some or all of the trust funds retained to general use. The moment that the general does not set aside trust funds, the general loses the benefit of section 12 and any right of setoff under it. In this particular case, the general did not allege that it had retained trust funds relying on section 12; rather, the general had alleged, it seems improperly, that the owner had not paid it and therefore it had not paid the sub. Further, the general submitted no evidence that it operated a bank account for monies received and disbursed solely on project #1 or had held any of those monies by way of a separate trust. The Court therefore decided that section 12 did not apply to allow the general a defence.

The Court also agreed that equitable setoff did not apply. It held that the accounts on projects #1 and #2 “were unrelated and entirely separate because, among other things, payment on one project was not tied to the other, funds were segregated, and the projects were undertaken at different times, in different cities and for different owners.”

 

Commentary

In this case, the construction claimant, also the beneficiary of a trust under the Act, chose not to claim, in addition to a basic claim in contract, a breach of the Act’s trust fund provisions. This is unusual; it removes the possibility of a claim under section 13 of the Act against appropriate directors and officers of the trustee contractor for personal liability. Before there can be personal liability, the corporate contractor trustee must be adjudged to have breached its trust obligations.

The most important takeaway from this case is the concept that trust money must be set aside, usually by way of a separate bank account, before setoff becomes available under section 12 of the Act. Project monies may not be pooled into one general account, which is used not only to pay trust beneficiaries, but also to fund the general operations of the trustee contractor.

Although the courts have repeatedly stressed that trust monies must be segregated and not used for general purposes, to our knowledge few, if any, generals or subs comply with these obligations.

Accordingly, for the many generals and subs who do not comply, if they expect to make a claim for setoff relying on section 12 they would be well-advised to set aside the monies otherwise due to their beneficiary in a separate trust account.

 

Jonathan Speigel

 

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

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