The Ontario Divisional Court’s decision in T. Films S.A.. v. Cinemavault Releasing International Inc., 2016 ONSC 404 [1] is a reminder that “judgment proofing” is susceptible to attack under the statutory oppression remedy.[2]
Films S.A. involved a situation where T. Films S.A. retained Cinemavault Releasing International Inc. (“CRI”) to act as exclusive distributor of one of its motion pictures. The sales agency agreement, giving rise to this exclusive distributorship arrangement, contained a revenue sharing formula which required CRI to remit to T. Films S.A. a certain amount of the revenue derived by CRI’s distribution efforts. The distributorship arrangement between the parties began in 2006 and ended in 2011, when CRI ceased carrying on business.
Films S. A. claimed that CRI failed to remit the full amount of the revenues to which it was entitled under the distributorship agreement. In early 2012, T. Films S.A. commenced arbitration proceedings against CRI which resulted in an arbitral award being made in favour of T. Films S.A. In May of 2013, T. Films S.A. commenced court proceedings to enforce the arbitral award against CRI. These court proceedings included claims for, among other things, an oppression remedy against certain companies related to CRI and their common director and officer.
The basis of the oppression remedy claim was that on or about September 1, 2011, CRI restructured its business such that it ceased operations and was left without any assets. In particular, the restructuring involved related companies stepping in to collect CRI’s accounts receivable, being its only material asset, and replacing it as sales agent for another related company. In short, the restructuring resulted in T. Films S.A. being unable to collect its arbitral award as CRI had become judgment proof.
There was no dispute that the CRI business had been transferred for no consideration. More importantly, the directing mind of CRI and its related companies on cross examination refused to offer a specific purpose for the restructuring. As such, the court held that there was no bona fide business purpose for the restructuring and thus that its purpose was to defeat CRI’s claim. The restructuring was found to constitute oppressive conduct and the directing mind and related companies were held to be liable for the arbitral award made against CRI.
The court in T. Films S.A. did not devote any analysis to describing the minimum requirements for when “judgment proofing” crosses the line into oppressive territory. The answer may lie in the definition of “complainant” as only a “complainant” qualifies for judicial relief under the statutory oppression remedy.
A complainant is defined as a current or former registered holder of security in a corporation, and security is defined to include a registered debt obligation, a current or former director or officer, and any other “proper person” in the “discretion of the court”. Trade and judgment creditors (like T. Films S.A.), or any corporate stakeholder for that matter, will qualify as a “proper person”:
…if the act or conduct of the directors or management of the corporation which is complained of constituted a breach of the underlying expectations of the applicant arising from circumstances in which the applicant’s relationship with the corporation arose.[3]
The threshold for when “judgment proofing” crosses into oppressive territory is therefore when the judgment proofing is inconsistent with a reasonable expectation created in the complainant arising from the circumstances of the complainant’s relationship with the other party.
This was illustrated in the case of Bulls Eye Steakhouse.[4] In that case, the court found a tenant to be a complainant where the tenant obtained partial summary judgment against its landlord and, before damages could be assessed, the landlord sold its plaza, being its only asset, and used the net proceeds to pay amounts owing to its sole shareholder. The court noted that typically a contingent creditor cannot reasonably expect a defendant corporation will be operated simply for the contingent creditor’s benefit in the event the contingent creditor becomes a judgment creditor. However, in this case the tenant had a reasonable expectation of payment of any judgment from a sale of the plaza. This reasonable expectation had been created because previously the tenant brought a failed motion to appoint a receiver over the plaza and in the context of that proceeding the landlord had filed affidavit material giving rise to a reasonable expectation that net funds from a sale of the plaza would be available to satisfy any judgment obtained. As such, having found a reasonable expectation that the plaza would be available to satisfy any judgment awarded, the court held that the sale of the plaza and payment of the net sale proceeds to the sole shareholder crossed the “judgment proofing” line.
It is instructive to note that the Supreme Court of Canada has said that the following factors are to be considered in determining the existence of reasonable expectations to be protected by the court:
General commercial practice; the nature of the corporation; the relationship between the parties; past practice; steps the claimant could have taken to protect itself; representations and agreements; and the fair resolution of conflicting interests between corporate stakeholders.[5]
In conclusion, “judgment proofing” ventures into oppressive territory where a reasonable expectation, that an opposing party will not engage in “judgment proofing”, is breached.
Angelo C. D’Ascanio
[1] T. Films S.A.. v. Cinemavault Releasing International Inc., 2016 ONSC 404.
[2] See: Ontario Business Corporations Act, R.S.O. 1990, c. B. 16, as amended, section 248; and Canada Business Corporations Act, R.S.C. 1985, c. C-44, as amended, section 241.
[3] First Edmonton Place Ltd. v. 315888 Alberta Ltd. (1988), 60 Alta. L.R. (2d) 122 (Q.B.) at 152.
[4] 1413910 Ontario Inc. (c.o.b. Bulls Eye Steakhouse & Grill) v. McLennan (2008), 53 B.L.R. (4th) 115 (Ont. S.C.J.), additional reasons (2008), 53 B.L.R. (4th) 125 (Ont. S.C.J.), aff’d (2009), 309 D.L.R. (4th) 756 (Ont. C. A.)
[5] BCE Inc. v. 1976 Debentureholders, [2008] 3 S.C.R. 560 at para. 72.
The decision of the Ontario Superior Court in Robert Nicholson Construction Co. v. Edgecon Construction Inc. underscores the importance of ensuring that payments by owners and contractors to their subcontractors or suppliers are made in compliance with the trust provisions of the Construction Lien Act. Payments made to a third party outside of the construction “pyramid”, even when done in good faith and at the request of the intended recipients, can leave owners and contractors (and their directors/officers) liable for an unintended breach of the CLA trust provisions.
Background
The defendant Owners were developers of a retirement residence in Stratford, Ontario (the “Project”). The Owners entered into a construction agreement for the Project with a company called Edgecon Contracting Corp. (“Contracting”). E. Contracting entered into various subcontracts including subcontracts with two entities: Edgecon Construction Inc. (“Construction”) and a numbered company, 1809313 Ontario Inc. (“180″). The Owners dealt with both E. Construction and E. Contracting as their General Contractor for the Project.
E. Construction entered into a subcontract with the plaintiff, Nicholson. Unknown to Nicholson, the principal of E. Construction, Mr. Enzo Mizzi, also operated E. Contracting (the contracting party with the Owners) and 180.
During completion of the Project, the Owners and the General Contractor agreed, at Mr. Mizzi’s request, to pay an advance of approximately $1.8 million to 180, which had no contractual involvement in the Project. The amount paid to 180 included monies owing to Nicholson which went unpaid after Nicholson’s subcontract work was complete. 180 made payments to subcontractors to the Project but not to Nicholson.
Nicholson sued E. Construction and the Owners. Nicholson then moved for summary judgment against the Owners for breach of the trust provisions of the CLA.
Decision of the Ontario Superior Court of Justice
Nicholson argued that the Owners’ payments to 180 did not discharge the Owners’ statutory trust obligations under the CLA.
The Owners denied liability on the basis that they had paid all certified amounts to their contractual General Contractor, E. Contracting. The Owners also argued that the CLA creates separate trust relationships between: owner and contractor; contractor and subcontractor; and subcontractor and its subcontracts/suppliers. The Owners asserted that, as a result of Nicholson’s position in the construction “pyramid” as a sub-subcontactor, it had no legal standing to enforce the Owners’ trust obligations owed E. Contracting.
A significant component of the CLA is the creation of a statutory trust scheme. Owners, contractors and subcontractors are deemed to be trustees for all monies owing to other parties lower in the construction chain or pyramid. As the motions judge noted, an owner, as trustee for funds owing to the contractual general contractor, can discharge its trust obligations by complying with s. 10 of the CLA:
Once an owner pays the contractor all amounts certified by a payment certifier (less statutory holdbacks), the owner is absolved from any further liability in this regard. The wording of s. 10 makes this perfectly clear. It provides that (subject to holdbacks) once a payment is made by a trustee (here the Owner) to a person who has supplied services or materials to the improvement of a property (here the Contractor), such payment discharges the trust of the trustee (Owner). Importantly, the section then adds such discharge is as against “all beneficiaries of the trust to the extent of the payment made by the trustee”.
In rejecting the Owners’ arguments, the motions judge found that the use of the word “beneficiaries” in the CLA trust provisions was determinative:
[beneficiaries] denotes an intent by the legislature to say, in effect, “if you as a trustee (whether owner, contractor or subcontractor) make a payment to the party to whom you are in privity of contract, you are exempt from liability with respect to all other parties lower down the construction chain with whom you have no privity of contract.
The motions judge held that by agreeing to Mr. Mizzi’s request to pay 180 the funds properly payable to the contractual General Contractor, E. Contracting, the Owners had failed to make payment to a deemed beneficiary of the construction trust funds and in accordance with the trust provisions of the CLA.
The motions judge considered the underlying intention of the Owners in making the payment to 180 but concluded that intention was irrelevant for determining compliance with the CLA trust provisions:
While the Owners’ intentions may have been bona fides, made in good faith and even done in the expectation or intention of subcontractors getting paid sooner, such payment was made at their peril, and, most importantly, legally outside the scope and protection of the CLA.
The motions judge found that the Owners had breached their statutory trust obligations under the CLA and granted summary judgment in favour of Nicholson for its unpaid subcontract balance.
Discussion
There are several useful lessons to be learned from this decision. Of note, this decision confirms that the underlying intent for an extra-contractual payment is irrelevant for determining whether a party has discharged its CLA trust obligations. As the motions judge noted:
What may be a legitimate, bona fide business reason for an owner to make an extra-contractual payment in one situation might be an act done to perpetrate a fraud or otherwise avoid the enforceability of a construction agreement in another.
All paying parties in the construction “pyramid” must take precautions to ensure that payments are made to parties with whom they have a direct contractual relationship. Payments to non-contractual parties, even where such payments are requested by the downstream contractual parties to facilitate payments, should be avoided unless proper precautions can be taken to ensure a complete discharge of the payor’s CLA trust obligations.
Ensuring a complete discharge of trust obligations is required to avoid obligations by a paying party to all downstream parties in the construction pyramid. This decision confirms that an owner or general contractor will be liable to a subcontractor, sub-subcontractor (or any other downstream party) if payments are not made in strict compliance with the CLA trust provisions.