Setting-off Against Trust Funds under Construction Act
Updated: Oct 3
A recent case reminds us that setting-off against trust funds in accordance with the Construction Lien Act/Construction Act is a bit more nuanced than one might think the setting-off would operate.
The Act allows for setting-off against monies held in trust subject to the holdbacks. A trustee under the Act can apply the sum the beneficiary owes it against the sum the trustee owes the beneficiary. The only condition is that the amounts must be related to the same improvement the mentioned monetary obligations derive from. However, where the beneficiary becomes bankrupt, the trustee can also apply unrelated debts against what it owes to the beneficiary.
In a recent case, a subcontractor attempted to set-off, however, the court reminded the subcontractor that to assert set-off it must retain the amounts it would like to set-off against. A trustee cannot go ahead and deduct amounts. As the Act does not allow for such a deduction.
The facts are simple. A material supplier delivered material to a subcontractor who was under contract with the general contractor to provide electrical contracting services for the development of a parking garage.
The supplier delivered supplies and an invoice was rendered. The subcontractor failed to pay the invoice and the supplier commenced an action against the subcontractor.
The subcontractor in its defence and counterclaim pled set-off against the amounts it owed to the supplier.
The subcontractor expended the amounts it received from the general contractor and admitted that it did not separate its trust funds from its general funds.
The supplier brought a summary judgment motion. The supplier moved to strike the defence and counterclaim on the basis that the subcontractor breached its trust obligation under the Act.
3 weeks before the hearing, the subcontractor placed $102,000 in trust with its counsel to “purportedly” to satisfy its trust obligations it owes to the material supplier. This was an attempt to cure the breach of trust, which ultimately worked! At least in the short term..
Court on Summary Judgement
The court agreed with the supplier’s position that for a trustee to be allowed to assert a set-off against trust funds, it must retain the funds which has been paid by the general contractor in respect of the material provided by the supplier. According to the court, under the Act there is no right to expend the funds but only to retain them.
The supplier further argued the curing of the breach of trust by subcontractor by virtue of paying monies held in trust by its counsel should not be acceptable.
The subcontractor in response argued that the monies paid to its counsel satisfies its trust obligation and therefore there is no on-going breach of trust. The subcontractor relied on a Manitoba decision where the breaching trust party “cured” the breach by creating a fund to satisfy its trust obligations to the beneficiary party. The Manitoba court viewed that it cannot dispose of the issues and that there were genuine issues that must be dealt with that cannot be dealt with on summary judgement.
The court relying on the Manitoba decision held that the monies paid into trust by the subcontractor serves to protect the subcontractor and supplier’s rights to the monies held in trust so that the substantive issues can be dealt with at trial on the merits of the case.
As a result, the court concluded that there is a genuine issue requiring trial with respect to the subcontractor’s failure to retain the funds in accordance with the Act. On this basis, the
summary judgement was dismissed.
The rule that can be taken from this decision is that breaching trustees can “cure” the breach to protect its right to set-off against trust funds by paying its counsel the amounts in question. Ignoring whether this rule accords with the policy of the Act, this decision gives breaching trustees another tool to push its beneficiaries under the Act to litigation and suffer no consequences – at least not on summary judgement.
The better rule, which I believe accords with the policy of the Act, is if you are asserting a set-off then you should retain the funds setting-off amounts. Do not use them for other purposes. The Act does not permit the trustee to apply set-off amounts for other purposes.
By doing this, the supplier will better protect its right to set-off rather than deducting the amounts and using this decision to reconstitute the trust fund at the risk of being hold personally liable for the trust fund. A rather risky proposition to conduct business in such a fashion.