In the Matter of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, as amended And in the Matter of the Bankruptcy of The Graphicshoppe Limited, of the City of Toronto, in the Province of Ontario [Indexed as: Graphicshoppe Ltd. (Re)]
78 O.R. (3d) 401
[2005] O.J. No. 5184
Dockets: C42864 and M32603
Court of Appeal for Ontario,
Moldaver, Armstrong and Juriansz JJ.A.
December 5, 2005
Bankruptcy and insolvency -- Practice and procedure -- Trustee not requiring permission of inspectors in order to have capacity to bring legal proceedings -- Trustee's failure to seek or receive inspectors' permission to bring appeal not constituting basis for quashing appeal.
Bankruptcy and insolvency -- Property of bankrupt -- Trust property -- Bankrupt failing to remit its employees' pension plan contributions to plan administrator and instead commingling contributions with bankrupt's own funds in its single bank account in months preceding bankruptcy -- Bankrupt spending contributions and bank balance becoming negative at one point but positive on date of bankruptcy -- Employee contributions constituting trust funds when deducted from employees' salaries -- Trust funds converted into property that could not be traced -- Trust destroyed -- Money in bank account on date of bankruptcy not constituting trust money -- Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, s. 67(1)(a).
In the months preceding bankruptcy, the bankrupt deducted its employees' pension contributions from their pay and failed to remit them to the plan administrator. The contributions were commingled with the bankrupt's own funds in its only bank account. As the bankrupt continued to carry on business, the bank balance fluctuated and, at one point, became negative. On the date of bankruptcy, however, there was a positive balance in the account. The employees filed a proof of claim for the amount of their unremitted contributions with the Trustee, relying on s. 67(1)(a) of the Bankruptcy and Insolvency Act, ("BIA"). The Trustee disallowed the claim on the basis that the employees could not trace their money into property of the bankrupt on the date of bankruptcy, as the bankrupt had converted the trust moneys to other property or spent it on running its business, destroying the trust. The Registrar in Bankruptcy allowed the employees' appeal. The Trustee's appeal to the Superior Court of Justice was dismissed. The appeal judge found that there was certainty of subject matter under trust principles because the collective agreement specified a defined percentage to be deducted from each employee and held on trust. She rejected the Trustee's argument that the trust was destroyed by the fact that the bankrupt had commingled the pension contributions with its own funds. She refused to apply the lowest intermediate balance rule and instead found that she was bound to search for the method of allocating the loss which was the more just, convenient and equitable in the circumstances. She concluded that the employees could assert a proprietary interest over the mixed fund. The Trustee appealed.
Held, the appeal should be allowed. [page402]
Per Juriansz J.A. (dissenting): The appeal should not be quashed or stayed because the Trustee filed and proceeded with the appeal without the permission of the inspectors. The permission of inspectors is not required for a trustee to have capacity to bring legal proceedings. Rather, obtaining the permission of the inspectors simply protects the estate from becoming liable for costs.
The employees were able to trace their pension contributions to the account. In the circumstances, that provided a basis for the appeal judge to allow the employees to assert a trust interest. Commingling the pension contributions with the bankrupt's funds in one bank account did not destroy the trust. The appeal judge was not bound to apply the lowest intermediate balance rule.
Per Moldaver J.A. (Armstrong J.A. concurring): For the reasons given by Juriansz J.A., the appeal should not be quashed because the Trustee brought it without the permission of the inspectors.
The Trustee was correct in concluding that the employee contributions did not constitute trust funds at the date of the bankruptcy within the meaning of s. 67(1)(a) of the BIA. The bankrupt held its employees' pension contributions in trust when it deducted them from their pay. At that moment, the trust property was identifiable and the trust met the requirements for a trust under established principles of trust law. Shortly thereafter, however, the trust property ceased to be identifiable. The employee contributions were commingled with the bankrupt's funds and prior to the date of bankruptcy, they were converted into other property and were no longer traceable. As of the date of bankruptcy, none of the employee contributions that had been deposited into the bankrupt's bank account remained intact. Assuming that co-mingling of trust and other funds is not, by itself, fatal to the application of s. 67(1)(a), what is fatal is the conversion of trust funds into property that cannot be traced.
APPEAL by the Trustee in Bankruptcy from the judgment of Lax J. (2004), 2004 48711 (ON SC), 74 O.R. (3d) 121, [2004] O.J. No. 5169 (S.C.J.), dismissing an appeal from the decision of the Registrar in Bankruptcy allowing an appeal from a disallowance of a claim in bankruptcy.
British Columbia v. Henfrey Samson Belair Ltd., 1989 43 (SCC), [1989] 2 S.C.R. 24, [1989] S.C.J. No. 78, 38 B.C.L.R. (2d) 145, 59 D.L.R. (4th) 726, 97 N.R. 61, [1989] 5 W.W.R. 577, 75 C.B.R. (N.S.) 1, 34 E.T.R. 1, apld Ontario (Securities Commission) v. Greymac Credit Corp., 1988 56 (SCC), [1988] 2 S.C.R. 172, [1988] S.C.J. No. 77, 65 O.R. (2d) 479, 29 O.A.C. 217, 52 D.L.R. (4th) 767, 81 N.R. 341, 31 E.T.R. 1, affg (1986), 1986 2693 (ON CA), 55 O.R. (2d) 673, [1986] O.J. No. 830, 17 O.A.C. 88, 30 D.L.R. (4th) 1, 34 B.L.R. 29, 23 E.T.R. 81 (C.A.); Law Society of Upper Canada v. Toronto-Dominion Bank (1998), 1998 4774 (ON CA), 42 O.R. (3d) 257, [1998] O.J. No. 5115, 169 D.L.R. (4th) 353, 44 B.L.R. (2d) 72 (C.A.) [Leave to appeal to S.C.C. refused [1999] S.C.C.A. No. 77], distd Other cases referred to Bethlehem Steel Corp. v. Tidwell, 66 B.R. 932 (U.S. Dist. Ct. GA, 1986); Bryant Isard & Co., Ex parte Thorne (Re), 1925 437 (ON CA), [1925] 4 D.L.R. 157 (Ont. S.C.), varg 1925 390 (ON SC), [1925] 1 D.L.R. 847 (S.C.); Caisse populaire de Black Lake v. Cry-O-Beef Ltd., 1987 761 (QC CA), [1987] A.Q. no 1418, [1987] R.J.Q. 1715, 15 Q.A.C. 81, 66 C.B.R. (N.S.) 19 (C.A.), revg [1986] A.Q. no 1881, 64 C.B.R. (N.S.) 156 (S.C.); Cynar Dry Co. (Re), [2005] O.J. No. 47, [2005] O.T.C. 5, 8 C.B.R. (5th) 46, 136 A.C.W.S. (3d) 207 (S.C.J.); Devaynes v. Noble (1816), 35 E.R. 781, [1814-23] All E.R. Rep. 1, 8 L.J. Ch. 256, 1 Mer. 529 (Ch.) (sub. nom. Clayton's Case; Baring v. Noble); Diplock's Estate (Re), [1948] 2 All E.R. 318, [1948] Ch. 465, [1948] L.J.R. 1670, 92 Sol. Jo. 409, 484 (sub nom. Diplock v. Wintle) (C.A.); GMAC Commerical Credit Corp.-Canada v. TCT Logistics Inc. (2005), 2005 3584 (ON CA), 74 O.R. (3d) 382, [2005] O.J. No. 589, 194 O.A.C. 360, 7 C.B.R. (5th) 202 (C.A.); H.O. Ki rkham (Trustee of) (Re), 1938 197 (BC SC), [1938] B.C.J. No. 44, [1939] 1 W.W.R. 425, [1939] 1 D.L.R. 796, 53 B.C.R. 278, 20 C.B.R. 223 (S.C.); [page403] Hallett's Estate (Re) (1880), [1874-1880] All E.R. Rep. 793, 13 Ch. D. 696 (C.A.); Higginson v. Bryant, Isard and Co. (Trustee of), [1923] O.J. No. 693, 4 C.B.R. 41 (S.C.); In re Arthur Soucier (1939), 20 C.B.R. 298 (N.B.S.C.); In re Conrad (1963), 6 C.B.R. (N.S.) 275 (Que. S.C.); In re Grobstein (1929), 11 C.B.R. 250 (Que. C.A.) Lupton v. White (1808), 33 E.R. 817, [1803-13] All E.R. Rep. 356, 15 Ves. 432 (Ch.); Murdoch v. Murdoch, 1973 193 (SCC), [1975] 1 S.C.R. 423, 41 D.L.R. (3d) 367, [1974] 1 W.W.R. 361, 13 R.F.L. 185; Nierenberg (Re), [1979] O.J. No. 3352, 30 C.B.R. (N.S.) 267 (S.C.); Owen (Re) (1985), 1985 2312 (SK QB), 55 C.B.R. (N.S.) 161 (Sask. Q.B.); Pettkus v. Becker, 1980 22 (SCC), [1980] 2 S.C.R. 834, 117 D.L.R. (3d) 257, 34 N.R. 384, 8 E.T.R. 143, 19 R.F.L. (2d) 165; Plourde (Re) (1979), 31 C.B. rkR. (N.S.) 308 (Que. C.A.); Pratchler Agro Services Inc. (Trustee of) v. Cargill Ltd., 1999 12727 (SK QB), [1999] S.J. No. 415, 183 Sask. R. 157, 11 C.B.R. (4th) 107, 89 A.C.W.S. (3d) 432 (Q.B.); Rathwell v. Rathwell, 1978 3 (SCC), [1978] 2 S.C.R. 436, 83 D.L.R. (3d) 289, 19 N.R. 91, [1978] 2 W.W.R. 101, 1 E.T.R. 307, 1 R.F.L. (2d) 1, [1978] 1 A.C.W.S. 225; Reed (Re) (1983), 49 C.B.R. (N.S.) 21 (Que. C.A.), affg (1980), 35 C.B.R. (N.S.) 149, [1980] C.S. 391 (S.C.) (sub. nom. Reed v. Franco); T.O. Anderson & Co (Re), [1923] O.J. No. 285, 25 O.W.N. 257, 4 C.B.R. 289 (S.C.); Tlustie (Re), [1923] O.J. No. 663, 23 O.W.N. 622, 3 C.B.R. 654 (S.C.); Ward-Price v. Mariners Haven Inc. (2001), 2001 24088 (ON CA), 57 O.R. (3d) 410, [2001] O.J. No. 1711, 199 D.L.R. (4th) 68, 42 R.P.R. (3d) 39 (C.A.) Statutes referred to Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, ss. 30 [as am.], 67 [as am.], 136 [as am.] Pension Benefits Act, R.S.O. 1990, c. P.8 Social Service Tax Act, R.S.B.C. 1979, c. 388, s. 18 [as am.] Authorities referred to Gillese, E.E., and M. Milczynski, The Law of Trusts, 2nd ed. (Toronto: Irwin Law, 2005) Hayton, D.J., Underhill and Hayton Law Relating to Trusts and Trustees, 15th ed. (London: Butterworths, 1995) Law Reform Commission of British Columbia, Report on Competing Rights to Mingled Property: Tracing and the Rule in Clayton's Case (Vancouver, 1983) McConville, D.A., "Tracing and the Rule in Clayton's Case" (1963) 79 Law Q. Rev. 388 Ogilvie, M.H., "Pari Passu Distribution of Commingled Funds: Law Society of Upper Canada v. Toronto Dominion Bank" (2000) 15 B.F.L.R. 545 Scott, A.W., and W.F. Fratcher, The Law of Trusts, 4th ed. (Boston: Little Brown and Co., 1989) Smith, L., "Tracing in Bank Accounts: The Lowest Intermediate Balance Rule on Trial" (2000) 33 Can. Bus. L.J. 75 Waters, D.W.M., The Law of Trusts in Canada, 2nd ed. (Toronto: Carswell, 1984) Waters, D.W.M., et al., Waters' Law of Trusts in Canada, 3rd ed. (Toronto: Thomson Carswell, 2005)
Harvey Chaiton and George Benchetrit, for appellant. Andrew Hatnay and Clio Godkewitsch, for respondents. [page404]
[1] JURIANSZ J.A. (dissenting):-- This is an appeal by the Trustee in Bankruptcy ("Trustee") of Graphicshoppe Limited ("Graphicshoppe") from the judgment of Lax J. dated December 23, 2004. The question raised is whether former Graphicshoppe employees can recover their pension contributions that Graphicshoppe commingled with its own funds in a single bank account prior to its bankruptcy. The Trustee concedes that Graphicshoppe held the pension contributions as trustee when it deducted the pension contributions from the employees' pay. Lax J. dismissed the Trustee's appeal from the decision of the Registrar in Bankruptcy and allowed the employees to recover their pension contributions.
[2] I would dismiss the appeal. I conclude that the employees are able to trace their pension contributions to the account and, in the circumstances, this provided a basis for Lax J. to allow the employees to assert a trust interest.
I. Background
(a) Facts
[3] The pension plan that Graphicshoppe provided for its employees was a defined contribution plan administered by London Life. The employees contributed four per cent of their wages and Graphicshoppe contributed an amount equal to one per cent. Graphicshoppe deducted the employees' contributions from their pay and was supposed to remit those contributions, together with its own, to the plan administrator within 30 days of the month end. In the months preceding bankruptcy, Graphicshoppe failed to do so: between February 2003 and the date of bankruptcy, November 20, 2003, Graphicshoppe failed to remit $92,889.45 of the moneys that it had deducted from its 102 employees' pay.
[4] Graphicshoppe had one bank account that it used for all purposes. The employees' money deducted from their pay was commingled with Graphicshoppe's own funds in that account. As Graphicshoppe continued to carry on business the bank account balance fluctuated and, at one point, became negative. On the date of bankruptcy, however, there was $145,667.51 in the account. The closing balance resulted from transfers from Textron Financial Canada, which was factoring the company's receivables.
[5] The employees filed a proof of claim for $92,889.45 with the Trustee. They relied on s. 67(1)(a) of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 ("BIA"), which provides:
67(1) The property of a bankrupt divisible among his creditors shall not comprise
(a) property held by the bankrupt in trust for any other person, [page405]
[6] Section 67(1)(a) does not stipulate priorities between trust beneficiaries and creditors. Rather, it provides that certain property held by a bankrupt shall not be available for distribution among creditors.
[7] The employees were careful to claim a trust interest in the bank account only to the extent of their own pension contributions. They made no claim in respect of contributions the employer was supposed to have made to the pension plan on their behalf.
(b) Underlying decisions
[8] The Trustee disallowed the employees' claim on the basis that the employees must be able to trace their money into property in the possession of the bankrupt on the date of bankruptcy. Because Graphicshoppe had converted the trust moneys to other property or spent it on running its business, the trust was destroyed and the money in the account on the date of bankruptcy was not trust money.
[9] The employees appealed to the Registrar in Bankruptcy. On appeal, the Trustee did not dispute that Graphicshoppe initially held the employees' contributions as trustee. Rather, the Trustee's position was that, once Graphicshoppe spent the money on operating its business, the subject matter of the trust was no longer certain because it could no longer be identified.
[10] The Registrar concluded that there was a "common law" trust because the "three certainties" were established, namely: (1) certainty of intention; (2) certainty of subject matter; and (3) certainty of object. She found that the identical funds did not have to be in the bankrupt's bank account at the date of bankruptcy. She concluded that there was no tracing requirement and, provided that the employees' money was calculable or ascertainable, the "identifiable" aspect of the certainty of subject matter test was met.
[11] The Trustee appealed the Registrar's decision to the Superior Court of Justice. Lax J. dismissed the Trustee's appeal. She agreed with the Registrar that there was certainty of subject matter under trust principles, because the collective agreement specified a defined percentage to be deducted from each employee and held on trust. She rejected the Trustee's argument that the trust was destroyed by the fact that Graphicshoppe had commingled the pension contributions with its own funds.
[12] Lax J. then responded to the Trustee's argument that the lowest intermediate balance rule (sometimes referred to as the "LIBR") should be applied. She summarized the rule and its effect in the following terms [at para. 23]: [page406]
The Lowest Intermediate Balance Rule ("LIBR") has historically stood for the principle that where trust money has been mingled in a bank account and spent by a breaching trustee and new money originating from a different source is subsequently deposited into the mixed account, an injured beneficiary can only claim a proprietary interest over the lowest intermediate balance. It was assumed that the "new money" was not technically part of the injured beneficiary's trust and the application of LIBR prevented the beneficiary from recovering the full value of the trust.
[13] If the LIBR were applied in this case, the employees would be entitled to nothing, because Graphicshoppe's account had a negative balance after their funds were deposited into the account.
[14] Relying on this court's reasoning in Law Society of Upper Canada v. Toronto-Dominion Bank (1998), 1998 4774 (ON CA), 42 O.R. (3d) 257, [1998] O.J. No. 5115 (C.A.) ("LSUC"), Lax J. found she was not obliged to apply the lowest intermediate balance rule. Instead, she concluded [at para. 34]:
I am bound to search for the method of allocating the loss which is the more just, convenient and equitable in the circumstances. The contest here is between wronged trust beneficiaries, whose property was taken, and creditors of the bankrupt. In my view, it would be unjust and inequitable to apply the LIBR rule in these circumstances to deprive the employees of their own property and correspondingly benefit the creditors of the bankrupt's estate at their expense.
She therefore held that the employees could assert a proprietary interest over the mixed fund, dismissed the Trustee's appeal, and directed him to allow the employees' proof of claim and pay the amount of $92,899.45.
(c) Positions of the parties and issues
[15] The appellant submits, first, that there was no trust for purposes of s. 67(1)(a) of the BIA. While the Pension Benefits Act, R.S.O. 1990, c. P.8, creates a provincial statutory deemed trust, s. 67(1)(a) applies only to a valid trust under the general principles of the law of equity. In this case, the appellant submits that there was no longer such a trust in existence on the date of bankruptcy.
[16] While the appellant concedes that Graphicshoppe held its employees' pension contributions in trust when it deducted them from their pay, it submits that the trust was destroyed when Graphicshoppe commingled them with its own funds. For this proposition, it relies on the Supreme Court of Canada's decision in British Columbia v. Henfrey Samson Belair Ltd., 1989 43 (SCC), [1989] 2 S.C.R. 24, [1989] S.C.J. No. 78 ("Henfrey Samson") and this court's decision in GMAC Commercial Credit Corp.- Canada v. TCT Logistics Inc. (2005), 2005 3584 (ON CA), 74 O.R. (3d) 382, [2005] O.J. No. 589 (C.A.) ("GMAC"). [page407]
[17] The appellant's second argument is that there was no trust property remaining at the date of bankruptcy. The funds in the account were no longer traceable to or in any way attributable to the employees' pension contributions because Graphicshoppe had spent the employees' money. The money in the account was other money from a different source that had been later deposited. This was evident because the account had been in an overdraft position shortly before bankruptcy. The appellant submits that the money subsequently deposited into the account was not impressed with a trust under general principles of law.
[18] Finally, if the employees did have a valid trust over the money in the account on the date of bankruptcy, the appellant submits that Lax J. erred by failing to take into account a payment of $77,812.87 paid to the employees as wages for the period prior to bankruptcy.
[19] The respondents submit that the appeal should be quashed or stayed because the appellant filed and proceeded with the appeal without the inspectors' permission as required by s. 30 of the BIA.
[20] In regard to the merits of the appeal, the respondents submit that commingling trust assets with other assets does not, in and of itself, destroy a trust. In this case, the trust continued to exist after the funds were commingled, because the trust property was sufficiently identifiable even though the trustee withdrew and spent money from the account. They contend that the appellant effectively relies upon the LIBR, which was, they submit, rejected by this court's decision in LSUC.
[21] The respondents also submit that Graphicshoppe intended to replenish the trust funds that it improperly withdrew from the account. More specifically, they say that Graphicshoppe took the money to keep the company afloat when it was in financial difficulty but that, as new money came in, it replenished or restored the trust funds.
[22] As I will later explain, I agree with the respondents that the effect of the appellant's second argument is that the lowest intermediate balance rule should be applied. Therefore, the positions of the parties raise the following five issues:
(1) Should the appeal be quashed or stayed because the appellant proceeded without the permission of the inspectors?
(2) Did commingling the pension contributions with the employer's funds in one bank account destroy the trust?
(3) Was the judge bound to apply the lowest intermediate balance rule? [page408]
(4) Was the trust replenished?
(5) Did the judge err by failing to take into account the payment of $77,812.87 to the employees?
II. Analysis
(1) Issue one: Should the appeal be quashed or stayed because the appellant proceeded without the permission of the inspectors?
[23] Section 30(1) of the BIA provides:
30(1) The trustee may, with the permission of the inspectors, do all or any of the following things:
(d) bring, institute or defend any action or other legal proceeding relating to the property of the bankrupt;
[24] It is not disputed that the appellant filed and proceeded with this appeal without seeking the permission of the inspectors. Nevertheless, the permission of inspectors is not required for a trustee to have capacity to bring legal proceedings. Rather, obtaining the permission of the inspectors simply protects the estate from becoming liable for costs. A long line of jurisprudence makes it clear that trustees have the capacity to undertake litigation without the authorization of the inspectors, but if they do so they will be personally liable for costs if unsuccessful: T.O. Anderson & Co. (Re), [1923] O.J. No. 285, 4 C.B.R. 289 (S.C.); In re Grobstein (1929), 11 C.B.R. 250 (Que. C.A.); In re Arthur Soucier (1939), 20 C.B.R. 298 (N.B.S.C.); Re H.O. Kirkham (Trustee of), 1938 197 (BC SC), [1938] B.C.J. No. 44, [1939] 1 W.W.R. 425 (S.C.); In re Conrad (1963), 6 C.B.R. (N.S.) 275 (Que. S.C.); Plourde (Re) (1979), 31 C.B.R. (N.S.) 308 (Que. C.A.); Ree d (Re) (1980), 35 C.B.R. (N.S.) 149, [1980] C.S. 391 (Que. S.C.), affd (1983), 49 C.B.R. (N.S.) 21 (C.A.); Owen (Re) (1985), 1985 2312 (SK QB), 55 C.B.R. (N.S.) 161 (Sask. Q.B.); Caisse populaire de Black-Lake v. Cry-O-Beef Ltd., [1986] A.Q. no. 1881, 64 C.B.R. (N.S.) 156 (S.C.); and Pratchler Agro Services Inc. (Trustee of) v. Cargill Ltd., 1999 12727 (SK QB), [1999] S.J. No. 415, 11 C.B.R. (4th) 107 (Q.B.).
[25] The cases cited by the respondents do not refute this established principle: Higginson v. Bryant, Isard and Co. (Trustee of), [1923] O.J. No. 693, 4 C.B.R. 41 (S.C.); Tlustie (Re), [1923] O.J. No. 663, 3 C.B.R. 654 (S.C.); Bryant Isard & Co., Ex parte Thorne (Re), 1925 390 (ON SC), [1925] 1 D.L.R. 847 (Ont. S.C.); and Nierenberg (Re), [1979] O.J. No. 3352, 30 C.B.R. (N.S.) 267 (S.C.). These cases all deal with the requirement of inspector authorization when employing [page409] solicitors or accountants. The cases confirm that unauthorized costs must be borne by the trustee personally.
[26] In Cynar Dry Co. (Re), 2005 376 (ON SC), [2005] O.J. No. 47, 8 C.B.R. (5th) 46 (S.C.J.), the court set aside a release that a trustee had executed without first convening a meeting of inspectors to discuss the matter. However, the case is distinguishable from the jurisprudence set out above, because it dealt with the discontinuation of litigation rather than the commencement of litigation. While a trustee who initiates litigation without the inspectors' permission can reimburse the estate for any costs, there would be enormous difficulties encountered in requiring a trustee to compensate the estate for the consequences of the discontinuation of litigation. In my view, this distinction explains the result in Cynar Dry Co. (Re).
[27] Therefore, the respondents have not established that the appeal should be quashed or stayed.
(2) Issue two: Did commingling the pension contributions with the employer's funds in one bank account destroy the trust?
[28] As noted above, the appellant does not dispute that Graphicshoppe held the employees' contributions as trustee at the time it deducted the money from their pay. At that point, the three certainties required to establish a trust were satisfied.
[29] The appellant's first argument is that the trust was destroyed, because its subject matter became uncertain when the pension contributions were commingled with the employer's funds in one bank account.
[30] The appellant relies on the Supreme Court of Canada's decision in Henfrey Samson and, in particular, McLachlin J.'s statement at p. 34 S.C.R.:
The difficulty in this, as in most cases, is that the trust property soon ceases to be identifiable. The tax money is mingled with other money in the hands of the merchant and converted to other property so that it cannot be traced. At this point it is no longer a trust under general principles of law.
[31] The appellant also relies on this court's decision in GMAC, which was released after Lax J.'s decision. Feldman J.A., writing for the unanimous court, said at para. 20:
In my view, the facts in this case regarding how the funds were held and accounted for are not distinguishable from the Henfrey Samson Belair case, and consequently, the legal result must also be the same. The funds relating to the carriers' fees collected by TCT prior to January 24, 2002 lost their character as trust funds when they were not segregated and were co-mingled with other TCT funds.
[32] As I will discuss below, I do not regard Henfrey Samson and GMAC as changing the settled principles of trust law that: a [page410] trust is not destroyed when a trustee wrongfully mixes trust property with his or her own property; and the beneficiary may still be able to claim proprietary remedies in such a situation. Therefore, the more pertinent question is whether, on the facts of this case, the employees can claim a proprietary remedy despite the commingling of their funds with Graphicshoppe's. This question is addressed in the next section.
[33] Before discussing Henfrey Samson and GMAC, I will briefly review what was considered to be the state of trust law prior to these decisions.
(a) Settled principles
[34] As mentioned above, a fundamental concept of trust law is that, for a trust to come into existence, it must have three essential certainties: (1) certainty of the intention to create a trust; (2) certainty of the subject matter or trust property; and (3) certainty of the objects of the trust. If any one of these does not exist, the trust fails to come into existence: D.W.M. Waters et al., Waters' Law of Trusts in Canada, 3rd ed. (Toronto: Thomson Carswell, 2005) at p. 132.
[35] It is useful to bear in mind the distinction between the certainty of subject matter required to create a trust initially and the identification of property into which a claimant can subsequently "trace" trust property after it has been converted to other forms. The property that is the subject of the trust must be identified clearly in order for the trust to be validly created in the first place. That is certainty of subject matter.
[36] It has long been a principle of trust law that a trust is not destroyed when a trustee wrongfully mixes trust property with his or her own. In Lupton v. White (1808), 33 E.R. 817, [1803-13] All E.R. Rep. 356 (Ch.), where the trustee had mixed the trust's lead ore with his own, the Lord Chancellor said at p. 819 E.R.:
If the result is, that the Master cannot take the account, it is clearly not for him, without a further direction, to apply the great principle, familiar both at law and in equity, that, if a man, having undertaken to keep the property of another distinct, mixes it with his own, the whole must both at law and in equity, be taken to be the property of the other, until the former puts the subject under such circumstances that it may be distinguished as satisfactorily, as it might have been before that unauthorised mixture upon his part.
[37] It would be odd indeed if a trustee could, by its own wrongful acts in commingling trust property with its own, destroy the trust, cause its obligations to expire and make the trust property its own. As Lax J. noted, if that were the case, a wronged beneficiary could never assert even a personal remedy against a breaching trustee. [page411]
[38] "Tracing" comes into play after the trust has been created and there has been a wrongful disposition of trust property and the beneficiary claims what has been substituted for the original trust property. At this stage, the claimant must be able to identify property as the substitute for the trust property in order to claim proprietary relief. If tracing is no longer possible -- where, for instance, the plaintiff's money is spent on a dinner or squandered at the racetrack -- the claimant may still seek personal relief, but will no longer have an effective proprietary remedy.
[39] The right to trace into a mingled fund has long been part of the law of equity. One of the leading cases establishing the right to trace into a mingled fund is Re Hallett's Estate, which dates back 125 years: (1880), [1874-1880] All E.R. Rep. 793, 13 Ch. D. 696 (C.A.). In A.W. Scott & W.F. Fratcher, The Law of Trusts, 4th ed. (Boston: Little Brown and Co., 1989) at para. 515, the authors state that this case is commonly cited for the principle that, "where a fiduciary, even though he is not a trustee of an express trust, wrongfully mingles money of his principal with money of his own, his principal is entitled to a charge on the mingled fund".
[40] In the leading English text of Underhill and Hayton Law Relating to Trusts and Trustees, 15th ed. (London: Butterworths, 1995) at p. 869, David J. Hayton writes:
Once a wrongdoing fiduciary has mixed trust funds with his own in a bank account an equitable lien or charge will automatically attach to that account and therefore to moneys paid out of that account, whether into other accounts (so purchasing a chose in action) or to purchase a painting or Whizzo shares ...
[41] Canadian textbooks published since the Supreme Court's decision in Henfrey Samson continue to regard it as a settled principle that the equitable right to trace is available, even when the trustee has mixed trust property with his or her own property.
[42] For example, Eileen E. Gillese and Martha Milczynski in The Law of Trusts, 2nd ed. (Toronto: Irwin Law, 2005) at p. 173, state that:
Even if the trust property has changed in form, equity still follows the property so long as it can be ascertained to be the product of the original property. That is, the property must remain identifiable in order to be traced. To be identifiable, it must be the original property, or the product or sale of the original property. Equity permits the claimant to follow property into a mixed fund, or through such a fund into property purchased with monies from that fund, because the claim is against the traced asset itself and is not dependent on establishing some claim to the entirety of the converted asset.
(Emphasis added)
[43] In the 2005 edition of Waters' Law of Trusts in Canada, the authors carefully review the principles that apply to the remedies [page412] of a beneficiary for recovering trust property when trust property has been mixed with other property. They say, at p. 1279, that these principles "apply not only to notional mixtures such as bank accounts, but to genuine physical mixtures of indistinguishable things, like sawlogs or grain".
[44] In summary, certainty of subject matter is one of three certainties that must be established to create a trust. Where a trustee subsequently mingles trust moneys with other moneys in a mixed account, the beneficiary will be able to claim a proprietary remedy if the beneficiary's money can still be identified or traced. In other words, under traditional principles of trust law, commingling the trust property with other assets does not destroy the trust. Rather, it simply affects whether proprietary as opposed to personal relief is available.
[45] I now turn to the question of whether the Supreme Court of Canada in its decision in Henfrey Samson or this court in GMAC intended to interfere with these settled principles.
(b) Henfrey Samson
[46] Henfrey Samson was a constitutional case. The Supreme Court decided that s. 67 of the BIA, which excludes trust property held by the bankrupt from the bankrupt's estate, applies only to trusts arising under general principles of the law of equity and not to provincially created statutory "deemed trusts" that lack the attributes of such trusts. This is because the provinces lack constitutional competence to reorder the priorities stipulated by the BIA.
[47] The specific issue in Henfrey Samson was whether a trust created pursuant to s. 18(1) of the Social Service Tax Act, R.S.B.C. 1979, c. 388, was a trust for purposes of s. 67(1)(a) of the BIA. Section 18(1) provides that a person who collects sales tax "shall be deemed to hold it in trust for Her Majesty in right of the Province".
[48] The province took the position that sales tax that the bankrupt had collected, but failed to remit, was held in trust for the Crown pursuant to s. 18(1) and that, pursuant to s. 67(1)(a), the Crown was entitled to this amount out of the bankrupt's general estate before it was distributed to creditors.
[49] In this context, a majority of the Supreme Court of Canada held that provincially created "deemed trusts" are subject to the rights of secured creditors and entitled to priority only as Crown claims under s. 136 of the BIA. Section 67(1)(a) will only apply if a statutory "deemed trust" meets the requirements for a trust under the general principles of trust law.
[50] McLachlin J., writing for the majority, then turned her attention to whether, in the particular circumstances before the [page413] court, the "statutory trust" constituted a trust under general principles. In concluding that there was no trust, she commented at p. 34 S.C.R.:
I turn next to s. 18 of the Social Service Tax Act and the nature of the legal interests created by it. At the moment of collection of the tax, there is a deemed statutory trust. At that moment the trust property is identifiable and the trust meets the requirements for a trust under the principles of trust law. The difficulty in this, as in most cases, is that the trust property soon ceases to be identifiable. The tax money is mingled with other money in the hands of the merchant and converted to other property so that it cannot be traced. At this point it is no longer a trust under general principles of law.
(Emphasis added)
[51] The bankrupt had "mingled the tax collected with its other assets" and the province, in accordance with s. 18(2) of the Social Services Tax Act, claimed a trust over all of the bankrupt's assets equal to the tax not remitted. It is essential to note that the province did not, as did the employees in this case, identify an account into which the unremitted sales tax had been deposited or any other particular asset to which the tax money could be traced. McLachlin J. continued in the same paragraph [p. 34 S.C.R.]:
In an attempt to meet this problem, s. 18(1)(b) states that tax collected shall be deemed to be held separate from and form no part of the collector's money, assets or estate. But, as the presence of the deeming provision tacitly acknowledges, the reality is that after conversion the statutory trust bears little resemblance to a true trust. There is no property which can be regarded as being impressed with a trust.
[52] Section 18(2), which provides that the amount of taxes required to be collected and remitted "forms a lien and charge on the entire assets of" the deemed trustee, was of no assistance because it was provincial legislation that could not affect priorities under the BIA.
[53] In my view, McLachlin J. was simply reiterating the settled principle of trust law that a beneficiary of a trust has no proprietary remedy if property impressed with a trust cannot be identified through tracing. At p. 35 S.C.R., she went on to say:
If the money collected for tax is identifiable or traceable, then the true state of affairs conforms with the ordinary meaning of "trust" and the money is exempt from distribution to creditors by reason of [s. 67(1)]. If, on the other hand, the money has been converted to other property and cannot be traced, there is no "property held ... in trust" under [s. 67(1)].
[54] Therefore, I do not understand McLachlin J.'s comment at p. 34 as changing settled trust law that a beneficiary may still have a proprietary trust remedy, even though the trust funds have been commingled and converted to other property, provided that it is possible to trace the funds to identifiable assets. The [page414] point she was making is that, on the facts before the court in Henfrey Samson, as no specific property impressed with a trust could be identified at the time of the bankruptcy, the province's claim against the bankrupt's entire assets failed.
(c) GMAC
[55] Like Henfrey Samson, GMAC also involved a provincial statutory deemed trust and competing priorities on bankruptcy.
[56] TCT Logistics Inc. and its related companies ("TCT"), which were in the business of warehousing and transporting goods by truck, went into bankruptcy. On bankruptcy, there was a dispute between GMAC, which held a general security over all of TCT's assets, and carriers contracted to transport individual loads.
[57] Contrary to regulatory requirements, TCT failed to maintain a separate trust account for the moneys it received from its customers for the portion of its invoices that related to the charges of each carrier. The issue was whether, despite that regulatory non-compliance, the carriers' fees were trust funds within the meaning of s. 67(1)(a) of the BIA.
[58] The carriers' claims fell into two categories: (1) amounts owed to the carriers in the accounts receivable that TCT had collected before January 24, 2002 (the date an interim receiver was appointed), which had not been segregated; and (2) amounts owed to the carriers out of the accounts receivable of TCT that the interim receiver collected after January 24, 2002 and kept in a segregated account.
[59] This court held that the carriers' portions of the accounts receivable collected by the interim receiver after January 24, 2002 were held in trust for the carriers, but the funds collected before that date were not held in trust.
[60] Feldman J.A. concluded at para. 20 that "funds relating to the carriers' fees collected by TCT prior to January 24, 2002 lost their character as trust funds when they were not segregated and were co-mingled with other TCT funds". Before January 24, 2002, TCT's accounting system recorded the amounts TCT owed to the carriers, but there never was a separate fund that TCT could be said to hold in trust according to general principles. When the customer paid the invoice, TCT deposited the entire amount in its general account.
[61] The appellant in this case relies on Feldman J.A.'s comment at para. 20 to support the proposition that commingling destroys a trust. In my view, Feldman J.A.'s comment must be understood in its proper context.
[62] As discussed above, Henfrey Samson established that a provincial statutory deemed trust is not a trust for purposes of [page415] s. 67(1)(a) of the BIA. However, it is important to note, as did Feldman J.A., that provincial deemed trusts are effective in accordance with the provincial legislation when a person or business is solvent and operating. She cited Ward- Price v. Mariners Haven Inc. (2001), 2001 24088 (ON CA), 57 O.R. (3d) 410, [2001] O.J. No. 1711 (C.A.), in which Borins J.A. found that the fact that a provincially created "deemed" trust may have lacked the three certainties of intention, object and subject matter did not affect its essential character as a trust. This is in accord with McLachlin J.'s observation in Henfrey Samson, at p. 35 S.C.R.: "The provinces may define 'trust' as they choose for matters within their own legislative competence."
[63] As such, there was an effective statutory deemed trust prior to bankruptcy. However, once bankruptcy occurred, the carriers had to establish that the funds that had been held in deemed trust satisfied equity's requirements for a trust in order to trigger application of s. 67(1)(a) of the BIA. The three certainties were not satisfied, because the payments for the carriers' services were at all times commingled with other TCT funds. But for the provincial legislation, the money in TCT's bank account could not be said to be that of the carriers. Rather, but for the legislation, the carriers only had a claim for payment for the services they had provided.
[64] In my view, understood in context, Feldman J.A.'s comment at para. 20 does not support the proposition that commingling destroys a trust. Rather, she was addressing the particular issue before the court, which involved whether a provincial statutory deemed trust met equity's general requirements for a trust after bankruptcy occurred. She was not making a statement about the general requirements for trusts.
[65] Therefore, I conclude that neither GMAC nor Henfrey Samson alters the established principle of trust law that the mere commingling of trust funds with the trustee's own funds does not destroy a trust and, as such, does not in itself eliminate a beneficiary's right to claim a proprietary remedy.
[66] In this case, there is no doubt that the pension contributions were the employees' money, and it is conceded that Graphicshoppe held that money in trust upon deducting it from the employees' pay. I conclude that the commingling of the employees' money with its own in one bank account did not destroy the trust.
[67] The next question is whether the transactions that occurred after the commingling leave the employees without a proprietary remedy because they cannot trace into the funds that remained in the account on the date of bankruptcy. [page416]
(3) Issue three: Was the judge bound to apply the lowest intermediate balance rule?
[68] The submission upon which the appellant placed his greatest reliance is that the employees cannot trace their pension contributions to the balance remaining in the bank account at the date of bankruptcy. The appellant points to the course of transactions in the account to argue that the closing balance in the account was directly traceable to deposits made by a company factoring Graphicshoppe's accounts receivable and not to the unremitted pension contributions.
[69] While he did not use the term in this court, the appellant urges, as he did before Lax J., the application of the lowest intermediate balance rule. The appellant's argument that the employees cannot trace their money into the balance in the account on the date of bankruptcy is indistinguishable from the rule: deposits made to an account after it has been depleted cannot constitute trust money previously deposited.
[70] The appellant submits: "Justice Lax did not have the discretion to allocate the loss in a manner which she deemed to be just, convenient and equitable in the circumstances." In effect, the appellant submits that Lax J. erred in relying on this court's decision in LSUC and in not applying the LIBR.
[71] In my view, Lax J. properly relied on LSUC. Before reviewing that decision, however, it is necessary to review this court's decision in Ontario (Securities Commission) v. Greymac Credit Corp. (1986), 1986 2693 (ON CA), 55 O.R. (2d) 673, [1986] O.J. No. 830 (C.A.), affd 1988 56 (SCC), [1988] 2 S.C.R. 172, [1988] S.C.J. No. 77, because LSUC builds on Morden J.A.'s reasoning in that case. After reviewing the two cases, I will consider the application of the LSUC decision to the facts of this case.
(a) Greymac
[72] This case is significant because Morden J.A. reconceived the nature of a mixed bank account in the trust setting and, in so doing, declined to apply the applicable rule for tracing the trust claimants' respective interests in the remaining funds.
[73] It is unnecessary to review the complex facts of the case. It is sufficient to say that a trustee commingled the funds of two separate sets of beneficiaries with its own funds and then dissipated some of the funds. The case thus illustrates that commingling in itself does not destroy a trust.
[74] The two sets of beneficiaries disputed how the funds remaining in the accounts should be divided. The judge at first instance, Parker A.C.J.H.C., held that the total loss should be [page417] allocated first against the trustee's interest and that any remaining money should be allocated among the beneficiaries pro rata in proportion to their contributions. On appeal, this court upheld his decision.
[75] The appellants argued that the trial judge should have applied the "first in, first out" rule established by Devaynes v. Noble; Clayton's Case (1816), 35 E.R. 781, [1814-23] All E.R. Rep. 1 (Ch.). The rule in Clayton's Case is a tracing technique, which presumes that sums first paid into a bank account are the sums first drawn out, absent evidence of an agreement or any presumed intention to the contrary. On the facts in Greymac, if Clayton's Case had been applied to identify whose money had been paid out in the earlier withdrawals, the respondent beneficiaries' share would have been $353,408.66. Under the pro rata approach, which did not attempt to identify moneys withdrawn as belonging to a particular contributor, the respondent beneficiaries' share was $662,974.19.
[76] As noted in Morden J.A.'s reasons [at p. 691 O.R.], prior to his decision, Professor Waters had expressed the opinion that the application of the rule in Clayton's Case to withdrawals from mixed accounts "has been reiterated on sufficient occasions that it must be considered as finally settled in this country": The Law of Trusts in Canada, 2nd ed. (Toronto: Carswell, 1984) at p. 1050. Morden J.A. also noted [at p. 692 O.R.] that a Law Reform Commission of British Columbia Report stated: "[G]iven the preponderance of case authority in favour of the rule in Clayton's Case, we doubt whether courts will depart from it. There is a need for legislative action" (Report on Competing Rights to Mingled Property: Tracing and the Rule in Clayton's Case (Vancouver, 1983) at p. 44).
[77] Nevertheless, Morden J.A. concluded that the rule in Clayton's Case should have no place in the resolution of problems connected with competing beneficial entitlements to a mingled trust fund where there have been withdrawals from the fund. Instead, he held that the better approach is one that recognizes the continuation of the respective property interests in the total amount of the trust moneys or available property.
[78] In concluding that the rule in Clayton's Case should not apply to resolve the claims of competing beneficiaries, Morden J.A. considered the nature of a bank account and accepted that, as between the trustee and beneficiary, the bank account should be regarded as an asset in the trustee's hands. In contrast, as between the banker and the trustee, the account is a series of debts or personal liabilities inter se. In this respect, Morden J.A. accepted what D.A. McConville suggested in his [page418] article, "Tracing and the Rule in Clayton's Case" (1963) 79 Law Q. Rev. 388 at p. 401:
As between the trustee and the beneficiary the bank account is a piece of property or an asset in the trustee's hands. This is something quite distinct and independent of its position as between the banker and the trustee, where it is a series of debts or personal liabilities inter se.
A bank account should therefore be considered as two different things and consequently two different sets of rules apply to decide problems arising in respect of it. When it is necessary to consider it as a debt, rules as to appropriation of debts, including Clayton's Case apply, but when it has to be considered as a piece of property, rules as to competing titles and confusion of identical property are appropriate.
[79] What is of significance is that, instead of analyzing the course of transactions in a mixed bank account to attempt to identify particular money to which the beneficiaries could claim equitable title, Greymac granted the beneficiaries an equitable lien on the two bank accounts to secure the total amount of their contributions. Granting a lien over the accounts as a whole eliminated the need to trace moneys through the course of transactions within the account after the trust moneys were deposited.
[80] Morden J.A.'s decision marked a significant development in the law of equity. In his concluding remarks, Morden J.A. described the pro rata approach as an improvement and refinement of the rules of equity, comparable to the developing treatment of the constructive trust from Murdoch v. Murdoch, 1973 193 (SCC), [1975] 1 S.C.R. 423, 41 D.L.R. (3d) 367, through Rathwell v. Rathwell, 1978 3 (SCC), [1978] 2 S.C.R. 436, 83 D.L.R. (3d) 289, to Pettkus v. Becker, 1980 22 (SCC), [1980] 2 S.C.R. 834, 117 D.L.R. (3d) 257.
[81] The Supreme Court of Canada dismissed the appeal of this court's decision in Greymac. Dickson C.J.C. stated that the court agreed with the conclusion of the Court of Appeal and adopted the reasons delivered by Morden J.A. Thus, as I see it, the Supreme Court has unequivocally endorsed Morden J.A.'s reconception of a mixed account in the trust setting as an asset in the trustee's hands rather than a series of debts or personal liabilities inter se.
(b) LSUC
[82] In LSUC, Blair J. (ad hoc) builds on Morden J.A.'s decision in Greymac and, in particular, his conception of a bank account as an asset that should be viewed as a whole and not as a fund made up of separate, divisible parts. LSUC, too, advanced the law. In his conclusion, Blair J. quoted Jessel M.R. in Hallett's Estate (Re) in characterizing his approach as "the gradual refinement of the doctrine of equity" [p. 276 O.R.]. [page419]
[83] In LSUC, a real estate lawyer misappropriated some $900,000 of clients' money from his trust account at the TD Bank. The last misappropriation from the account occurred on September 24, 1991. On September 25, 1991, TD Bank deposited $173,000 into the trust account so that the lawyer could advance mortgage funds to one of its clients. On October 2, 1991, before the mortgage transaction was completed, the Law Society advised TD that it would be managing the account.
[84] Immediately after receiving the Law Society's notice, TD withdrew the $173,000 from the trust account (without the Law Society's authorization) and transferred it to another lawyer so that the mortgage transaction could be completed. That left the trust account with a balance of $66,242.68.
[85] The lawyer subsequently made an assignment in bankruptcy. His clients, including TD, had claims totalling $656,703.06.
[86] The Law Society brought an application with respect to the trust funds. The issue was whether all of the lawyer's clients, including TD, could claim against the entire balance in the account at the time it was frozen (i.e., $66,242.68 plus $173,000) or whether the victims of the misappropriation, which excluded TD, could claim only against the $66,242.68. Applying the lowest intermediate balance rule, only $66,242.68 would be available to the victims of the misappropriation since, according to the rule, their money had already been misappropriated from the account when TD made the subsequent deposit of $173,000.
[87] The application judge, Farley J., declined to apply the lowest intermediate balance rule. Instead, he held that all the beneficiaries should share pro rata in the entire balance of the account at the time it was frozen.
[88] On appeal, this court upheld the decision. Blair J. wrote for the court. He held that the court was not bound to apply the lowest intermediate balance rule. Instead, he held that, in the circumstances, it was more appropriate to apply the "pari passu ex post facto" approach. Under this approach, there is a rateable sharing of the funds remaining in an account on a proportionate basis among all the contributors to the account without reference to the dates of the contributions to and withdrawals from the account.
[89] Blair J. concluded that the pari passu ex post facto approach should be followed instead of the lowest intermediate balance rule, because it was easier to apply and because it was consistent with the nature and purpose of a "mixed" trust fund.
[90] Relying on Greymac, Blair J. regarded a mixed fund as a whole fund that constitutes an asset in the trustee's hands [p. 272 O.R.]: [page420]
What follows from this, it seems to me, is that a mixed fund of this nature should be considered as a whole fund, at any given point in time, and that the particular moment when a particular beneficiary's contribution was made and the particular moment when the defalcation occurred, should make no difference. The happenstance of timing is irrelevant. The fund itself -- although an asset in the hands of the trustee to which the contributors have recourse -- is an indistinguishable blend of debits and credits reflected in an account held by the trustee in a bank or other financial institution. It is a blended fund. Once the contribution is made and deposited it is no longer possible to identify the claimant's funds, as the claimant's funds. All that can be identified, in terms of an asset to which recourse may be had, is the trust account itself, and its balance.
(Emphasis in original)
[91] Blair J. contrasted the blended fund concept with the concept of the fund as an amalgam. Looking at a mixed fund as an amalgam, the contributions mixed in the account can be regarded as having, for certain purposes, a continued separate existence. As explained by Lord Greene M.R. in Diplock's Estate (Re), [1948] 2 All E.R. 318, [1948] Ch. 465 (C.A.), equity adopted a more "metaphysical approach" and "regarded the amalgam as capable, in proper circumstances, of being resolved into its component parts" [at p. 346 All E.R.].
[92] The mixed fund as an amalgam is the conceptual framework for equitable proprietary tracing of transactions within a mixed fund. Conceiving of the mixed fund as a blended whole renders the tracing of transactions within a mixed fund irrelevant.
[93] Blair J. noted [at p. 273 O.R.] that the concepts of the mixed fund as an amalgam and as a blended fund both enable equity to offer a remedy in relation to the remaining balance in the fund. However, the amalgam fund approach unnecessarily limits the reach of equitable proprietary remedies:
While "proprietary tracing" may serve as the equitable vehicle which enables a claimant to have recourse to a mixed trust fund in the first place, equity can move beyond the strictures of that doctrine to provide a remedy to the claimant once the connection to the fund has been made. The nexus is to be found in the concept of the equitable charge, lien or constructive trust. These concepts need not, in my view, be confined to any part of the fund because, by their very nature, they have always been applied against the whole of the fund.
(Emphasis in original)
[94] Blair J. therefore preferred the blended fund approach, which views a mixed account as an indivisible whole and makes available a wider range of equitable remedies. It was the trust fund that was depleted, not the Bank's money nor the money of any particular contributor [p. 274 O.R.]: [page421]
The fund is still the fund, and as Farley J. noted in this case, it is not the Bank's money or the money of any particular contributor that has been stolen; it is the fund which has been wrongfully depleted.
(Emphasis in original)
[95] Given this conception of the fund and after noting that all rationales upon which equity divides a shortfall amongst those entitled to claim against it involve fictions, Blair J. concluded that the application judge was not bound to apply the LIBR but rather, should seek to apply the method that was the most just, equitable and convenient in the circumstances. He agreed [at p. 275 O.R.] with the following reasons given by the application judge for not applying the LIBR:
I do not see it as fair, equitable or practicable in the circumstances (and more especially since the Bank effected an inappropriate and unauthorized self help remedy to the detriment of the other claimants) to invoke LIBR. It seems to me somewhat artificial (recognizing that all the rules involved in this area are artificial rules which must be applied with caution so as to maintain the closest approximation of fairness, equity and reasonability, while recognizing practicality) to invoke LIBR which by its very nature "rewards" those innocents who are later on the scene as compared with those innocents who have been taken advantage of earlier when it is fairly clear that the wrongdoer would continue to fleece all the innocents if given the chance. Recovery should not be so dependent on a fortuitous accident of timing.
(c) Application of LSUC
[96] The first question that arises is whether the reasoning in LSUC applies to this case. If it does apply, the second question is whether Lax J. committed a reversible error in applying it to the facts before her.
(i) Does the reasoning in LSUC apply to this case?
[97] The appellant attempted to distinguish LSUC on the basis that all the funds in the account in that case were trust funds, whereas in this case the account contained both trust funds and Graphicshoppe's own money.
[98] In my view, there is no principled basis on which to confine Blair J.'s reasoning and conclusions in LSUC to a situation where all the money in an account is trust money. Such a distinction would result in innocent beneficiaries being worse off when the trustee, who has acted wrongfully, adds his or her own money (as opposed to that of another innocent beneficiary) to a mixed fund. It would result in a late contributor who is a wrongdoer receiving a better recovery than a late contributor who is another innocent beneficiary.
[99] A number of academics support the view there is no good reason to apply separate rules for when a trustee takes trust [page422] money and wrongfully mixes it in his or her bank account as opposed to when a trustee mixes trust funds of various beneficiaries. Such a case is not different in any relevant way: see e.g., Lionel Smith, "Tracing in Bank Accounts: the Lowest Intermediate Balance Rule on Trial" (2000) 33 Can. Bus. L.J. 75 at 89; see also M.H. Ogilvie, "Pari Passu Distribution of Commingled Funds: Law Society of Upper Canada v. Toronto Dominion Bank" (2000) 15 B.F.L.R. 545.
[100] In Greymac, Morden J.A. indicated that the conception of a mixed bank account as an asset in the hands of the trustee is not limited to situations where all the money in an account is trust money. He accepted what McConville, supra, said at p. 403:
Nor should it make any difference that instead of a mixing taking place between one trust fund and the trustee's private money, the mixing is that of two or more trust funds either with each other or with private money as well.
[101] In this case the employees are the only trust claimants to the fund and there is enough money in the account to satisfy their claim. Thus, the issue of pro rata sharing with competing trust claimants does not arise as it did in LSUC and Greymac.
[102] Nor do I accept that LSUC does not apply because Graphicshoppe's account became overdrawn at one point. The appellant's argument that the money deposited into the account after it was overdrawn cannot be the employees' is simply an attempt to apply the logic of the LIBR. The logic is the same whether the lowest balance is negative, $1, or any other amount less than the trust funds.
[103] Under the approach applied by Blair J., the only things that matter are the contributions made and the closing balance in the account. The course of debits and credits within the account and the order in which they occurred do not matter. The closing balance of Graphicshoppe's account in this case might just as well have resulted from a different order of transactions without the balance becoming negative. What is clear is that, at all times, the account balance was higher than it would have been if the employees' misappropriated money had not been deposited in it. Both Greymac and LSUC considered it arbitrary to have losses allocated on the happenstance order of the transactions in an account.
[104] In LSUC, "proprietary tracing" was used as the equitable vehicle to establish recourse to the fund in the first place, the fund being conceived as an indistinguishable whole asset in the hands of the trustee. To quote Blair J. at p. 273 O.R., "equity can move beyond the strictures of [the doctrine of proprietary tracing] to provide a remedy to the claimant once the connection to the fund has been made"
(emphasis added). In finding such a [page423] connection on the facts before him, Blair J. then allocated the loss pro rata among the claiming beneficiaries.
[105] The requirement of a connection to the fund serves to contain the scope of the claim. An important difference between this case and Henfrey Samson is that in this case there is a connection between the employees' pension contributions and Graphicshoppe's bank account. In Henfrey Samson, the province did not establish a connection with any particular account or asset, but rather advanced a claim against the entire estate of the bankrupt. Here, the pension contributions can be traced to the bank account considered as an indivisible asset in the hands of Graphicshoppe.
[106] In conclusion, I do not accept the appellant's submission that the reasoning in LSUC does not apply to the facts of this case.
(ii) Should this court interfere with Lax J.'s overall conclusion?
[107] In rejecting the application of the lowest intermediate balance rule, Lax J. noted [at p. 132 O.R.]:
I am bound to search for the method of allocating the loss which is the more just, convenient and equitable in the circumstances. The contest here is between wronged trust beneficiaries, whose property was taken, and creditors of the bankrupt. In my view, it would be unjust and inequitable to apply the LIBR rule in these circumstances to deprive the employees of their own property and correspondingly benefit the creditors of the bankrupt's estate at their expense.
[108] On the basis of this reasoning, she dismissed the Trustee's appeal and directed him to allow the employees' proof of claim and pay the amount of $92,899.45.
[109] In my view, it was open for Lax J. to not apply the lowest intermediate balance rule and to find that the employees were entitled to reclaim their contributions in the amount of $92,899.45. I say this for two reasons.
[110] As already noted, in LSUC tracing was used to establish a connection to the fund, which was conceived of as an indistinguishable whole. Similarly in this case, and as already discussed, the employees' pension contributions can be traced to Graphicshoppe's bank account.
[111] Second, I agree with Lax J. that the equities of the situation favour not applying the lowest intermediate balance rule. Creditors should not expect to benefit from their borrowers' dishonest dealings with trust beneficiaries that have the effect of enhancing the borrowers' ability to repay their loans. As Jessel M.R. said in Hallett's Estate (Re), at p. 807 All E.R.: "No human being ever gave credit to a man on the supposition that he would misappropriate trust money and so increase his assets." [page424]
[112] Therefore, for these two reasons, I conclude that Lax J. did not err in allowing the proprietary claims of the employees in the amount of $92,899.45.
(4) Issue four: Was the trust replenished?
[113] As developed in the British cases, the lowest intermediate balance rule does not apply if the evidence establishes that dishonest trustees intended to replenish the misappropriated trust funds when they make subsequent deposits that raise the balance in the mixed account. I note, however, that some American decisions presume that such subsequent deposits are made with the intention to replenish the trust: see Bethlehem Steel Corp. v. Tidwell, 66 B.R. 932 (U.S. Dist. Ct., GA, 1986).
[114] This issue, however, was not considered by Lax J. and, given my conclusion that she did not err in dismissing the appellant's appeal, it is not necessary that I deal with it.
(5) Issue five: Did the judge err by failing to take into account the payment of $77,812.87 to the employees?
[115] Of the $145,667.51 in Graphicshoppe's account on the date of bankruptcy, the appellant paid $77,812.87 to the employees as wages for the period prior to bankruptcy. The appellant submits that, if the employees do have a valid trust claim, this payment should be taken into account to prevent them from receiving a double recovery from the same fund. It does not appear that the appellant advanced this argument before the Registrar or Lax J.
[116] In my view, this is not an issue that may be raised on appeal for the first time. In any event, the duty of the appellant was to allocate the funds first to trust claimants before making a distribution to creditors. Amounts paid out by the appellant to creditors do not affect the validity of the trust claims. The money the appellant paid to the employees as wages is not relevant.
III. Conclusion
[117] For these reasons, I would dismiss the appeal.
[118] MOLDAVER J.A. (ARMSTRONG J.A. concurring):-- I have read the reasons of my colleague Juriansz J.A. With respect, I am unable to agree with his analysis or conclusion, except as it relates to the right of the trustee in bankruptcy to pursue this appeal. In my view, the trustee in bankruptcy correctly determined that the employee contributions did not constitute trust funds under s. 67(1)(a) of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 ("BIA"). [page425]
[119] The salient facts are not in dispute. It is accepted that Graphicshoppe held its employees pension contributions in trust when it deducted them from their pay. At that moment, the trust property was identifiable and the trust met the requirements for a trust under established principles of trust law.
[120] Shortly thereafter however, the trust property ceased to be identifiable. The employee contributions were commingled with Graphicshoppe's funds and prior to the date of bankruptcy, they were converted into other property and were no longer traceable. On this point, it is clear from the record that as of the date of bankruptcy, none of the employee contributions that had been deposited into Graphicshoppe's bank account remained intact. We know that with certainty because prior to the date of bankruptcy, the account went into a negative balance. We likewise know that the funds in the account on the date of bankruptcy came from Textron, the company that was factoring Graphicshoppe's receivables. Replenishment is a non-issue on the facts before us.
[121] Against that backdrop, the central issue on appeal is whether the trustee in bankruptcy was correct in concluding that the employee contributions did not constitute trust funds at the date of bankruptcy within the meaning of s. 67(1)(a) of the BIA. With respect, I believe that he was.
[122] On the facts of this case, I am of the view that McLachlin J.'s majority decision in British Columbia v. Henfrey Samson Belair Ltd., 1989 43 (SCC), [1989] 2 S.C.R. 24, [1989] S.C.J. No. 78 ("Henfrey Samson"), vindicates the position taken by the trustee in bankruptcy. My colleague has reviewed the salient facts of that case and they need not be repeated. The passages that I consider to be apposite are found at pp. 34 and 36 S.C.R., pp. 741 and 742 D.L.R. They are reproduced below:
I turn next to s. 18 of the Social Service Tax Act and the nature of the legal interests created by it. At the moment of collection of the tax, there is a deemed statutory trust. At that moment the trust property is identifiable and the trust meets the requirements for a trust under the principles of trust law. The difficulty in this, as in most cases, is that the trust property soon ceases to be identifiable. The tax money is mingled with other money in the hands of the merchant and converted to other property so that it cannot be traced. At this point it is no longer a trust under general principles of law. In an attempt to meet this problem, s. 18(1)(b) states that tax collected shall be deemed to be held separate from and form no part of the collector's money, assets or estate. But, as the presence of the deeming provision tacitly acknowledges, the reality is that after conversion the statutory trust bears little resemblance to a true trust. There is no property which can be regarded as being impressed with a trust. Because of this, s. 18(2) goes on to provide that the unpaid tax forms a lien and charge on the entire assets of the collector, an interest in the nature of a secured debt. [page426]
Nor does the argument that the tax money remains the property of the Crown throughout withstand scrutiny. If that were the case, there would be no need for the lien and charge in the Crown's favour created by s. 18(2) of the Social Service Tax Act. The province has a trust interest and hence property in the tax funds so long as they can be identified or traced. But once they lose that character, any common law or equitable property interest disappears. The province is left with a statutory deemed trust which does not give it the same property interest a common law trust would, supplemented by a lien and charge over all the bankrupt's property under s. 18(2).
(Emphasis added)
[123] For present purposes, I am prepared to accept that Henfrey Samson falls short of holding that commingling of trust and other funds is, by itself, fatal to the application of s. 67(1)(a) of the BIA. Once however, the trust funds have been converted into property that cannot be traced, that is fatal. And that is what occurred here.
[124] It should be noted here that the facts of this case are very different from the facts in the two cases upon which my colleague so heavily relies, namely, Ontario (Securities Commission) v. Greymac Credit Corp. (1986), 1986 2693 (ON CA), 55 O.R. (2d) 673, [1986] O.J. No. 830 (C.A.), affd 1988 56 (SCC), [1998] 2 S.C.R. 172, [1988] S.C.J. No. 77 ("Greymac"), and Law Society of Upper Canada v. Toronto Dominion-Bank (1998), 1998 4774 (ON CA), 42 O.R. (3d) 257, [1988] O.J. No. 5115 (C.A.) ("LSUC").
[125] In LSUC, all of the funds in issue were trust funds. Even though the defalcating lawyer had made an assignment into bankruptcy, there was no issue about whether the funds in question formed part of the estate divisible among his creditors; they did not. Rather, in LSUC, the court was solely concerned with how best to allocate the funds remaining in the mixed trust account between competing beneficiaries.
[126] In the case at bar, we are only at the first stage of this analysis. That is, we are still trying to determine if any or all of the funds in the bankrupt's bank account at the date of bankruptcy were trust funds and therefore not part of the bankrupt's estate pursuant to s. 67(1)(a) of the BIA. At this preliminary stage, we are not concerned about calculating the amount each beneficiary may claim from the trust funds, if it turns out that some such funds do in fact exist. Instead, we are simply trying to determine what, if any, of the money in the Graphicshoppe's bank account at the date of bankruptcy was trust money and therefore did not belong to it. The reasoning in LSUC as it relates to the issue of how best to allocate the funds remaining in a mixed trust account between competing beneficiaries simply has no application to this preliminary question. The same thing can be said [page427] about the reasoning in Greymac, which, like the reasoning in LSUC, focused on the resolution of beneficiaries' competing proprietary claims to remaining trust funds.
[127] I would also add that throughout his reasons for judgment in LSUC, Blair J. (ad hoc at that time) clearly acknowledged that the issue before the court was confined to determining the best approach for resolving the claims of competing beneficiaries to funds remaining in a mixed trust account. Blair J. considered the pari passu ex post facto approach to be the best approach for that task because of the inconvenience that is often associated with having to apply the lowest intermediate balance rule in cases involving any significant number of beneficiaries and transactions, and because of the nature and purpose of a mixed trust fund. In Blair J.'s view, such a fund is in many ways a mechanism of convenience, in that it avoids the necessity, cost and cumbersome administrative aspects of having to set up individual trust accounts for each beneficiary. Blair J. reasoned that "a mixed fund of this nature should be considered as a whole fund, at any given point in time, and that the particular moment when a particular beneficiary's contribution was made and the particular moment when the defalcation occurred, should make no difference" (p. 272 O.R.).
[128] These reasons in support of the pari passu ex post facto approach have no application in a case where the concern is not how to allocate the shortfall of funds remaining in a mixed trust account between competing beneficiaries but is rather how to determine if funds in the hands of a bankrupt at the date of bankruptcy are actually, in whole or in part, trust funds for purposes of s. 67(1)(a) of the BIA.
[129] Finally, even if we were to ignore the fact that much of Blair J.'s justification for the pari passu ex post facto approach was tied to the special nature and purpose of a mixed trust fund and accept that this approach ought to apply to any kind of mixed fund, it nonetheless ought not to apply here, because I cannot accept that at the date of bankruptcy, the bankrupt's bank account in this case was, in fact, a "mixed" fund. Since it is clear on the evidence that the employees' pension contributions were totally dissipated before the moneys from Textron were deposited into the bankrupt's bank account, as a matter of fact there is no mixture here: see, on this point, Lionel Smith, "Tracing in Bank Accounts: The Lowest Intermediate Balance Rule on Trial" (2000) 33 Can. Bus. L.J. 75 at p. 90. I recognize that my colleague Juriansz J.A. says that this argument is simply an attempt to apply the logic of the lowest intermediate balance rule. With respect, assuming that characterization is correct, I do not see [page428] how applying this logic can be erroneous, when in this case it is solidly supported by fact.
[130] In the case at bar, the employees had a trust interest and hence a right to seek a proprietary remedy with respect to the pension contributions so long as they could be identified or traced. However, as McLachlin J. noted at p. 36 S.C.R., p. 742 D.L.R. of Henfrey Samson, once the contributions lost that character, any common law or equitable property interest disappeared. While this may seem harsh, it must be remembered that in the commercial context and particularly in the realm of bankruptcy, innocent beneficiaries may well be competing with innocent unsecured creditors for the same dollars. This raises policy considerations which the courts in Greymac and LSUC did not have to face.
[131] My colleague purports to distinguish Henfrey Samson on the basis that in this case there is a connection between the employees' pension contributions and Graphicshoppe's bank account, whereas in Henfrey Samson, the province did not establish a connection with any particular account or asset, advancing a claim against the entire estate of the bankrupt instead. My colleague states that in this case the pension contributions can be traced to Graphicshoppe's bank account, and that pursuant to the reasoning in LSUC, this bank account should be considered an indivisible asset in the hands of Graphicshoppe, over which the employees may assert a proprietary interest.
[132] With respect, I have already explained in these reasons why the reasoning in LSUC ought not to apply to the facts of this case, and I do not think it is necessary to elaborate on this issue any further. I would only point out that regardless of the particular facts in Henfrey Samson, it must be remembered that in that case a majority of the Supreme Court of Canada held that once moneys held on trust can no longer be traced, that is fatal to the application of s. 67(1)(a) of the BIA. In the case at bar, it is clear on the evidence that the pension contributions cannot be traced. Accordingly, the employees' claim under s. 67(1)(a) of the BIA must fail.
[133] For these reasons, I am satisfied that the trustee in bankruptcy was correct in holding that the pension plan contributions made by the employees did not constitute trust funds within the meaning of s. 67(1)(a) of the BIA. Accordingly, I would allow the appeal, set aside the order of Lax J. and in its place, substitute an order upholding the trustee's disallowance of the employees' proof of claim.
[134] With respect to costs both here and below, if the parties cannot agree, the appellant may file submissions with the court within 15 days of the release of these reasons. The respondents shall reply within ten days thereafter. The submissions shall not [page429] exceed five pages double- spaced. If so advised, counsel for the appellant may file a reply within five days of the receipt of the respondents' submission, limited to three pages double-spaced.
Appeal allowed.