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The Feds Must Protect the Rights of Subcontractors In Bankruptcy Proceedings

The construction industry is littered with the bodies of the dead:  Comstock and Kappeler Masonry are but two of the construction companies that have ended up in bankruptcy protection.  Bankruptcy law affects the construction industry more than most.  That is why the construction industry needs to know about subtle changes in bankruptcy law that have put the industry at a disadvantage relative to other creditors, most notably banks. 

 

Bankruptcy in a Nutshell

 

When a company is assigned or petitioned into bankruptcy, the trustee in bankruptcy liquidates the bankrupt company's assets and collects its debts, insofar as it is economically feasible to do so.  The resulting pot of money, called the "estate" of the bankrupt, is divided up among the company's creditors according to the priority rules of the federal Bankruptcy and Insolvency Act.  Secured creditors of the bankrupt company (i.e. banks) typically get paid first.  If there is anything left over for the unsecured creditors they get paid the same number of cents on the dollar. 

 

Importantly, money held by the bankrupt company in trust for someone else does not form part of the estate of the bankrupt company.  That is where Ontario's Construction Act comes into play.  

 

Section 8 of Ontario’s Construction Act

 

Section 8 of Ontario’s Construction Act (formerly known as the Construction Lien Act) imposes a statutory trust upon any money paid to a general contractor for labour and materials.  The beneficiaries of the statutory trust are the subcontractors and suppliers who supplied labour and materials to the project.

 

In the good old days, the statutory trust created by the Construction Act gave subcontractors and suppliers a limited priority over other creditors of a bankrupt general contractor.  Any money paid by an owner to the trustee in bankruptcy were kept separate from the estate of the bankrupt general contractor because they were trust funds.  The trustee in bankruptcy would pay the trust funds to the subcontractors and suppliers on the project instead of paying the money to secured and unsecured creditors.  

 

Atlas Block Changed the Law

 

In the 2014 decision of the Ontario Superior Court of Justice in Royal Bank of Canada v. Atlas Block the Court ruled that only funds subject to a common law trust were to be kept separate from the estate of the bankrupt.  I won't bore you with the distinction between statutory and common law trusts.  The point is that funds impressed with a statutory trust of the type created by the Construction Act now form part of the estate of the bankrupt in spite of the trust.  In other words, as a result of Atlas Block, subcontractors and suppliers lost their limited priority over trust funds. 

 

A Local Example of Atlas Block In Action

 

The Kappeler Masonry bankruptcy illustrates how the Atlas Block case puts subcontractors and suppliers at a disadvantage relative to banks.  The trustee in bankruptcy collected $147,119 from the owner of a project Kappeler had worked on.  The trustee in bankruptcy asked the Court to approve payment of the $147,119 to Kappeler's bank, BMO.  Hargest Concrete Ltd. of Cambridge was a supplier of Kappeler Masonry on the project that had generated the $147,119 payment.  Hargest Concrete Ltd. objected to the proposed payment to BMO.  In the good old days, the $147,119 would have been paid to Hargest Concrete Ltd.  As a result of the Atlas Block precedent, the Court ordered the trustee in bankruptcy to pay the $147,119 to BMO. 

 

We Need a Legislative Amendment

 

The Federal government should reverse the effect of the Atlas Block decision.  It should amend the Bankruptcy and Insolvency Act to exclude funds impressed with a statutory trust pursuant to the Construction Act from the estate of a bankrupt general contractor. 

 

Giving banks priority over subcontractors and suppliers is bad public policy.  First, subcontractors and suppliers should have priority over funds arising from their labour and materials.  Second, Atlas Block gives banks an incentive to push general contractors into bankruptcy so they can jump to the front of the line.  Third, the law is now being applied differently in different provinces because judges in Alberta wisely declined to follow the Atlas Block precedent.  A legislative amendment is needed to bring uniformity to the application of federal law.  

 

In order to convince the Feds to amend the Bankruptcy and Insolvency Act we need as many voices as possible calling for change.  I encourage you to raise the issue with your national trade associations and your local MP. 

 

 

Ted Dreyer is a construction and insurance lawyer at Madorin, Snyder LLP in Kitchener.  It was previously published in the Grand Valley Construction Association Journal and is republished with permission.  This article should not be relied on as legal advice.  

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