Chapter 12: Keeping Money Within the Construction Pyramid
12.1 | How does the Act advance the policy of ensuring that money intended to finance construction is in fact used for that purpose?
Keeping money within the pyramid
Commentary: a major purpose of the Builders Lien Act is to ensure that money flows from the top of the construction pyramid to the bottom, ensuring that all workers, contractors and subcontractors who have given value in relation to a project are paid. This object is frustrated if money received by a contractor or subcontractor is used for purposes unrelated to the project. The Act employs a number of devices to prevent this from occurring.
Most important is the “deemed trust” or “statutory trust” which imposes a trust on money received by contractors and subcontractors.
The Act protects creditors within the pyramid when funds are garnished.
The Act also confirms certain legal rules that limit the powers of a creditor to decide which of two or more debts owed by a debtor is to be credited with a particular payment.
Finally, the Act invalidates purported assignments.
12.2 | How is the deemed trust created?
Creation of the trust
Commentary: the trust is created by operation of law. Section 10(1) stipulates that money received by a contractor or subcontractor on account of the contract or subcontract price constitutes a trust fund. The contractor or subcontractor is the trustee of the fund and beneficiaries are the persons engaged directly by that contractor or subcontractor in connection with the improvement.
It is important to note that only those persons who have contracted directly with the “trustee” are beneficiaries of the trust. Persons lower in the pyramid are not beneficiaries. This contrasts with the position in respect of holdbacks which provide security for the liens of persons in the same chain of contracts right to the bottom of the pyramid.
[See Figure 15]
12.3 | What is the relationship of the trust to liens and holdback?
Relationship to other remedies
Commentary: the trust operates independently of the lien and holdback. Occasionally, rights under the trust may be invoked where lien rights provide an incomplete remedy.
[See paragraphs 14.6 and 14.7]
The ability to assert a claim as a beneficiary of the deemed trust does not depend on the person having or being able to assert a valid lien claim. For example, the time for filing a lien by a worker may have expired. But if the person who engaged the worker has funds that are impressed with the trust, the worker can still assert a claim to the funds as a beneficiary.
With one exception, holdbacks under the Act are not subject to the trust. The reason for this is that the trust can only operate where a particular payment or fund of money exists. As noted earlier, most holdbacks are “notional” in the sense that they are simply a debt owed by one party to another.
[See section 5 and paragraph 5.4]
The exception is the holdback retained by the owner from a contractor. This must be paid into a holdback account and does constitute an identifiable fund. The Act stipulates that the holdback account is held in trust for the contractor.
[See section 5(2)(b)]
12.4 | Are there any payments that are not subject to the trust?
Commentary: money received by an architect, engineer or material supplier is not subject to the trust.
[See section 10(4)]
12.5 | What are the duties of a contractor or subcontractor who is a trustee in relation to the fund?
Duties of trustee
Commentary: there are two sources that define the duties of the trustee. The first is the specific provisions of the Builders Lien Act that describe the characteristics of the trust and the responsibilities attached to it. The rules found in the statute are supplemented by the general law of trusts.
The rules found in the Act are supplemented by the general law of trusts. There is a vast literature on the law of trusts.
[See, for example, D.W.M. Waters, Q.C., Law of Trusts in Canada (Carswell)]
The most important rule set out in the Act is contained in section 10(2).
10(2) Until all of the beneficiaries of the fund referred to in subsection (1) are paid, a contractor or subcontractor must not appropriate any part of the fund to that person’s own use or to a use not authorized by the trust.
It is significant that the Act does not require that these trust funds be placed in a separate bank account. Trustees are not ordinarily permitted to commingle trust funds with their own money.
[See section 11(7)]
12.6 | What uses for the fund are authorized by the trust?
Used authorized by the trust
Commentary: the first, and most obvious, authorized use of the trust funds is to pay them to a beneficiary to discharge all or part of the amount owing.
Second, a contractor or subcontractor who retains trust money in an amount equal to an amount already paid to a beneficiary for work or material does not violate the trust.
[See section 11(4)(a)]
Third, if the contractor or subcontractor borrows money which is used to pay for work or material supplied, trust money may be applied to discharge the loan.
[See section 11(4)(b)]
12.7 | How does section 11(6) affect the position of a lender who receives funds impressed with a trust
Commentary: section 11(6) of the Builders Lien Act provides:
11(6) Subsection (4)(b) does not limit the rights of a lender who, in the ordinary course of business, receives money in good faith from a person on whom a trust is imposed under section 10.
The purpose of this section is to confirm a group of cases that define the rights of lending institutions in relation to money that is subject to a statutory trust.
The question typically arises when a subcontractor or contractor receives a progress payment and deposits it in an account in a bank or other savings institution. Frequently, the bank where the account is maintained is also the source through which the operations of the contractor or subcontractor are financed.
Where the bank is “nervous” about the size of its loan to the contractor or subcontractor and the prospects of repayment, it may attach the deposit which has just been made and apply it to reduce the debt. The question that arises in this case is whether the lender has participated in a breach of the trust arising under the Act and can be compelled to account for the money to the beneficiaries.
The law on this point is very complex but the result of the cases is that if the lender can satisfy a number of very stringent conditions, it will be held not have participated in the breach of trust and will be entitled to retain the payment.
Section 11(6) confirms these cases.
[See generally Coulson paragraph 7.56 to 7.65]
12.8 | What are the consequences when a contractor or subcontractor uses the money for purposes unrelated to the construction project?
Consequences of breach of trust
Commentary: a person who appropriates or converts any part of the trust fund is guilty of an offence under the Act and is liable to both a fine and imprisonment.
[See section 11(2)]
If the offence is committed by a corporation, any officer of the corporation who knowingly permitted the offence to occur is also guilty of the offence.
[See section 11(3)]
The offence must be prosecuted within three years of its occurrence.
12.9 | Does the statutory trust assist beneficiaries in any other ways?
Bankruptcy of trustee
Commentary: yes. Beneficiaries of the trust created under section 10, would be available only to the persons engaged in connection with the relevant project.
[See generally Coulson paragraph 7.19]
12.10 | What is garnishment?
Commentary: when a creditor sues to recover a debt and receives a judgment, payment is not automatic. The creditor may have to take further steps to attach property belonging to the debtor and see that its value is applied toward the discharge of the judgment debt. One of the steps a creditor might take is a procedure known as garnishment. This procedure is used to attach debts that are owed to a judgment debtor.
The remedy of garnishment uses special terminology to describe the parties and the process. The judgment creditor (the “garnishor”) causes a “garnishing order” to be issued, attaching money in the hands of a third party (the “garnishee”). The “garnishing order” requires that the money attached be paid into court by the “garnishee,” ultimately to be paid out to the judgment creditor.
12.11 | Why is garnishment disruptive in the context of a construction project?
Disruptive effect of garnishment
Commentary: the garnishment of money owed by one person to another in connection with a construction project would be disruptive in two different ways, depending on the identity of the garnishor.
When claim of the garnishor is unrelated to the building project, the use of garnishment to get money paid into court and then paid out to the garnishor, would allow money to escape from the construction pyramid, contrary to the policy of the Act.
When the garnishor’s claim arises out of the construction project, using garnishment would give the garnishor an advantage over other unpaid workers or subcontractors who are engaged by the same debtor.
Special rules in the Act limit the extent to which garnishment is available in these circumstances.
[See Figure 16]
12.12 | How does the Act limit the use of garnishment?
Limiting the use of garnishment
Commentary: it does this in two ways. First, money that is held in a holdback account established under section 5 of the Act is stipulated to be immune from garnishment. Any attempt by a creditor who reach these funds will be ineffective.
[See section 13(4) and Figure 16, Garnishment Case No. 3]
With respect to other holdbacks in the construction pyramid, the Act does not prohibit garnishment. Rather, it provides that where this money is garnished and paid into court, it becomes or remains subject to the trust created under section 10 the Builders Lien Act. This ensures that the interest of the beneficiaries of the trust take priority over those of the creditor/garnishor.
[See section 13(1) and Figure 16, Garnishment Case No. 1]
12.13 | Are there any special procedures to ensure this policy is realized?
“Notice to garnishee”
Commentary: yes. The garnishee must, at the time of payment into court, file with the Court Registry a notice in Form 4 and deliver a copy of the notice to the garnishor.
[See section 13(2); as to who is the “garnishee,” see paragraph 12.10]
Failure to file a notice as required is an offence.
[See section 11(1)(b)]
Once a notice has been filed, the money may not be paid out of court except with an order of the court.
12.14 | What does section 12 do and how does it keep money within the construction pyramid?
Section 12: appropriation of payments
Commentary: sometimes a debtor will owe two or more debts to a particular debtor. Where the debtor makes a payment, the debtor is entitled to specify the particular debt to which the payment is to be applied. Where the debtor does not identify the particular debt, then the creditor is free to choose the debt to which the payment will be applied.
In the context of a construction project, this rule would mean that a progress payment made for a certain project, might end up being applied to discharge an unrelated debt such as one owing with respect to another project.
[See Figure 17]
The law in this regard was changed in the 1980s by judicial decisions which held that the statutory trust created by the Act could not be defeated by an appropriation of the payment that was inconsistent with the trust.
[See Tempo Building Supplies Ltd. v. Villa Cathay Home Care Society, (1980) 67 B.C.L.R 44 (B.C. Co. CT); Ross Gibson Industries Ltd. v. Greater Vancouver Housing Corporation (1985) 67 B.C.L.R. 55 (B.C.C.A.)]
Section 12 confirms the result of these cases. It provides:
12 If a person makes a payment from money in a trust fund constituted in respect of a particular improvement, a person who receives the money must credit it against the debt in respect of the improvement.
The effect of section 12 is to prevent both the person making the payment and the person receiving the payment from appropriating the payment to a debt other than the one that relates to the project through which the money became available.
12.15 | What about assignments?
Commentary: the strategy of the Builders Lien Act is to limit the effect of assignments. Section 42(4) provides:
42(4) No assignment by the contractor or subcontractor of any money due in respect of the contract or subcontract is valid as against any lien or trust created by this Act.
This reinforces the policy of the Act to keep payments within the construction pyramid.