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There have been a number of court decisions over the last year about whether the trust created in many provincial builder’s lien statutes will still apply in bankruptcy. The answer is quite murky.
This three-part series of articles will briefly outline what the issues are, the builder’s lien remedies that are (and are not) affected, and will close by offering suggestions for how to cope with the risk that these unsettled issues raise. The following article answers the question: What is the problem with a bankruptcy for builder’s lien trusts?
Put simply, the problem is that provincial legislation provides a number of remedies to creditors, but not all of those will still apply after bankruptcy.
There is some irony here, because insolvency is probably the exact time when creditor remedies would be the most useful.
This disconnect between rights before and after bankruptcy is simply a fact of life. The federal government makes the laws on what happens in bankruptcy, whereas provinces make the laws on what happens up until that time.
If a provincial law gives an advantage that is at odds with what the federal government wants to occur in bankruptcy, then what the federal government says in the Bankruptcy and Insolvency Act will win. Not all creditor advantages in provincial legislation will run afoul of this principle, but the builder’s lien trust is one where the answer to the question is at best unclear.
The detail behind the legal debate over whether builder’s lien trust provisions still apply after bankruptcy is too much to include here.
The point of this article is to highlight that the debate is happening. The following generalization about the court decisions will outline some of the confusion:
- Some court decisions have said that builder’s lien trusts never effectively segregate funds after bankruptcy;
- Some court decisions have said that these trusts probably do not effectively segregate funds after bankruptcy;
- Other court decisions have said that these trusts might still apply to segregate funds after bankruptcy, depending on what has happened with the money that was supposed to be subject to the trust; and
- None of the court decisions conclude that trusts always effectively segregate funds after bankruptcy, because even a trust that would otherwise apply for bankruptcy purposes can still be undermined by what happened with the money that was supposed to be subject to the trust.
There is a theme in the court decisions that is worth noting. Namely, how the bankrupt handled the construction trust funds before bankruptcy can be quite important in determining whether funds should be set aside for trust claimants after a bankruptcy.
The more that the trust funds are intermixed with other funds and cannot be accounted for separately, the harder it will be to try to argue that funds should be segregated later (whether in bankruptcy or otherwise).
This actually applies to any trust claim, but because of how people in the construction industry follow the trust provisions (or, more to the point, do not) this is often a real problem in a construction insolvency. There is also a further complication that can occur due to this type of intermixing by the bankrupt.
If there are project funds that become payable after the date of bankruptcy, some court decisions have found that the intermixing of construction trust funds before the bankruptcy means that the trustee in bankruptcy does not need to comply with the construction trust after the bankruptcy.
That would mean that the trust claims for funds received after a bankruptcy will be effectively wiped out in that sort of case. Part two of this series will take a look at the question of what is, and is not, affected by this bankruptcy issue.
Brendan Bissell is a member of Goldman Sloan Nash & Haber LLP’s Restructuring & Insolvency Group. Contact Brendan at bissell@gsnh.com. Send comments and Industry Perspectives ideas to editor@dailycommercialnews.com
Read part two of the series here: Trust no one: What affects lien trust claims in bankruptcy?
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