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When is a Quistclose trust not a Quistclose trust? When you call it a “debt”

Posted in Aboriginal, Bankruptcy and Debt, Case Comments, Contracts
Kosta Kalogiros

In Ontario (Training, Colleges and Universities) v. Two Feathers Forest Products LP, 2013 ONCA 598, the Ontario Court of Appeal granted the appeal of an interim receiver, Pricewaterhousecoopers Inc., from a Superior Court of Justice decision where grant funds that were advanced by the respondent, Ontario’s Minister of Training Colleges and Universities (the “Ministry”), to a First Nations limited partnership in northern Ontario, but not spent before the partnership sought to dissolve and appoint the interim receiver, were held to be subject to a “Quistclose trust” for the benefit of the Ministry.

Background

Two Feathers Forest Products was a limited partnership, consisting of three First Nations limited partners and a general partner, created to develop and operate a planer mill and manufacturing plant and saw mill in Ontario (the “Partnership”). The Partnership applied to the Northern Training Partnership Fund, recently established by the respondent Ministry to support project-based skills training for northern Ontario residents, for a grant to provide skills training for Aboriginal and non-Aboriginal residents of northern Ontario in its two proposed plants.

The parties executed a detailed written agreement for the advance of the funds which provided, among other things, that:

  • the funds were to be used only for the purpose of carrying out the project (as defined in the agreement), which included the implementation of on-the-job training;
  • the funds were to be advanced and used in three categories: (i) on-the job training; (ii) classroom training; and (iii) other (further defined as “classroom and equipment lease”);
  • the funds were to be used only in accordance with the agreement, did not have to be advanced by the Ministry, and had to be segregated in an interest-bearing account if not immediately used (thereafter, any interest generated would be deducted from future advances from the Ministry); and,
  • unused funds were to be returned on 30 days’ notice of termination and demand from the Ministry.

The agreement, as would be highlighted by the Court of Appeal, also provided that monies owing to the Ministry “shall be deemed to be a debt due and owing to” the Ministry.

Ultimately, the Ministry advanced $1,895,870 under the funding agreement before two limited partners took steps to dissolve the partnership. At the Superior Court of Justice, the Application Judge held the unused funds advanced by the Ministry were subject to a Quistclose trust in favour of the Ministry as there was no intention that the Partnership would be able to freely dispose of the advanced funds. Rather, the funds were to be used only for the specific purpose of carrying out the project. The three certainties of a trust—certainty of intention, certainty of subject-matter and certainty of object—had been established.

The Decision: The Court avoids expanding the use of Quistclose trusts

As Feldman J.A. noted, this decision was the Court of Appeal’s first substantive foray into the Quistclose trust concept. Before addressing the case at hand, the Court reviewed the history of the Quistclose trust, from the concept’s genesis in Barclays Bank v. Quistclose Investments Ltd. [1968] UKHL 4 through its significant broadening in Twinsectra Limited v Yardley and Others [2002] UKHL 12 to capture those monies advanced by lender’s even for an abstract purpose (as opposed to an emergent purpose as originally contemplated in Barclay’s). As the Court did not feel the fundamental elements of the Quistclose trust were met, it did not address whether the Quistclose trust should be equally broadened in Ontario; however, as noted below, it appears the Court may have stayed its hand in fear of the various commercial consequences which could ensue from such an expansion.

In dealing with the Ministry’s agreement with the Partnership, the Court of Appeal held it could not support the application judge’s conclusion that “viewed objectively…the parties intended to enter into a trust arrangement” as, in its view, the terms of the agreement could not support such an intention. The Court was particularly persuaded by the agreement’s declaration that any unused funds constitute a “debt owing to the Ministry” and the perceived freedom the Partnership had to use the majority of the funds in the “other” category, described above.

With respect to the classification of the unused funds as a “debt,” the Court found that this characterization created an express agreement between the parties, that any funds owed back to the Ministry under the agreement constitute a debt and that for the Court instead to imply a trust would be contrary to the “cardinal rule” of interpreting written commercial contracts that parties “have intended what they said.” While the historical precedents of Barclays and Twinsectra did not expressly refer to the creation of a “trust,” they also did not expressly characterize the agreements as a “debt.”

The Court also held that the vast majority of the “other” funds appeared to be made available to the Partnership over the term of the funding agreement to set up the business more generally, including lease and equipment costs for the whole business. The Court held this granted the Partnership vast discretion to spend the largest part of those monies, unlike the historical authorities which had a more limited purpose of providing emergency funding or financing specific payments/purchases. In this regard, the Court analogized the case to a British Columbia Court of Appeal decision[1] that rejected the existence of a Quistclose trust where funds were loaned “[t]o facilitate further construction of [a] golf course and development of [a series of] home lots and source an irrigation solution for the golf course.” The Court agreed with the BCCA that such a general purpose restriction was insufficient to “give rise to any inference of an intention on the part of both parties …to create the specialized vehicle that is a Quistclose trust..”

The Court of Appeal summarized its decision succinctly as follows:

To summarize my analysis, the Ministry entered into a detailed funding agreement with Two Feathers setting out the terms under which the Ministry granted funding for Two Feathers to provide on-the-job skills training to residents of northern Ontario. Although the funds provided were intended to be used only for the purpose described in the funding agreement, there is no basis to infer a mutual intention that the funds were to be held on trust for the Ministry. To the contrary, under the budget attached to the funding agreement, the recipient, Two Feathers, had significant discretion to spend the majority of the funds as long as it was for the general purpose stated, as in the [BCCA] case. And most importantly, Article 17 of the funding agreement defines the relationship between the parties with respect to any funds that have to be returned to the Ministry under the agreement as a debt, not a trust. [emphasis added]

Potential Significance: No Quistclose trusts for grant funds?

The Ontario Court of Appeal is arguably off to a bumpy start in dealing substantively with the Quistclose trust. Its decision in this case serves more as a warning to those drafting agreements in the future than as a guide to parties trying to anticipate whether funds are impressed with an equitable trust. Unfortunately, the Court faced a difficult case in that the factual circumstances here were substantively unique from the prior jurisprudence which dealt with standard loans rather than governmental grants.

The Court was well positioned to address this case equitably, as one would expect in the Quistclose context, and in a manner which would encourage further special purpose government grants by protecting them from third party creditors. The Court opted instead to restrict itself to a strict technical interpretation which would see the protection of third party creditors over government grantors.

In the typical Barclays Quistclose trust scenario, funds are advanced for a primary purpose of facilitating a specific payment. The lender is said to have an equitable right to see that money applied toward the primary designated purpose. If that primary purpose is carried out, the funds used then convert into a debt owing to the lender. If, on the other hand, that primary purpose is not carried out, the question arises, according to Barclay’s: “if a secondary purpose (i.e., repayment to the lender) has been agreed, expressly or by implication; if it has, the remedies of equity may be invoked to give effect to it.”

In the present case, if the primary purpose of the grant were carried out, there would be no repayment obligation created. The grant would serve its purpose and the Partnership would have had the benefit of a government funded capital injection. The proceeds, as invested, would be open to all creditors during a bankruptcy/dissolution event. This distinguishing fact is of immense importance and may explain why the agreement defined the Ministry’s unused funds as a debt obligation—i.e., to expressly ensure that if the primary purpose was not fulfilled, the secondary purpose of repayment of the unused funds to the Ministry would exist.

The Court’s focus on the characterization of the funds as a “debt” in the case at hand fails to capture the distinction between a loan and grant, particularly the presumption that repayment is prima facie expected in a loan agreement, whether expressly stated or not. What was presumably an attempt by the Ministry to maintain a “right of repayment” in circumstances which otherwise do not give rise to such a right (in order to demonstrate the Ministry’s underlying secondary purpose of repayment), had the unintended consequence of placing the Ministry last in line among general creditors.

Considering that the use of a Quistclose trust is a construct of equity, and that legal and equitable rights can co-exist concurrently, it was open to the Court to look past the technical expression of the grant being a debt. Barclay and Twinsectra clearly dealt with agreements which were loans giving rise to debts. The legal relationship in those cases so clearly gave rise to a debt that it would have been superfluous to expressly state it in the agreement. Nevertheless, the court impressed these loans with a trust. The Court was in a position to do the same here and recognize a unique subset of “grant” Quistclose trusts, rather than the straight loan Quistclose trusts we are used to seeing.

The Court of Appeal’s finding that the Partnership had a vast discretion, akin to Cliffs Over Maple Bay was also arguably misguided. Most notably, the Court of Appeal failed to recognize the significant restrictions imposed on the funds and the power the Ministry retained over the funds, such as the need for a separate account, the deduction of interest earned from future advancements, the ability to withhold future advancements, and the ability to demand return of all funds on 30 days’ notice. None of these restrictions existed in the Cliffs Over Maple Bay Case and the BCCA even acknowledged the lack of these restrictions when rendering its decision in that case. The restrictions imposed in the present case could be said to evidence an intention on the part of the parties to create a specialized vehicle.

Conclusions: Court favours commercial certainty

The Court’s decision raises more questions than answers regarding Quistclose trusts. It suggests that parties must not define their agreements as express “debts” lest they lose the ability to seek the equitable relief offered by a Quistclose trust (yet a covenant for repayment which lacks the word “debt” will not fall prey to this same fate). It is therefore unclear, for instance, whether a Quistclose trust would have existed had the Ministry simply defined the agreement as a “Loan Agreement” without an express reference to the funds being due and payable to the Ministry which would subsequently convert to a grant, or if the Ministry had simply stated the Partnership was to “repay” the funds to the Ministry without using the precise word “debt.”

The Court’s decision arguably punishes grantors for express legal drafting likely aimed at ensuring specific purpose grant funds remain repayable to the grantor if the primary purpose for which the grant is advanced is not carried out (thereby mimicking the primary and secondary purpose of the Quistclose trust). Had the Ministry not expressly referred to the grant funds as a debt, it would have forfeited any legal interest in the funds altogether while simultaneously divesting itself of any hope for equitable relief via Quistclose trust. The foregoing makes it difficult to conceive of a scenario in which grantors may obtain the equitable relief afforded by Quistclose trusts and implicitly suggests that grantors must be express in their creation of trusts rather than turn to equity, as a specific purpose lender might in similar circumstances.

That said, the explanation for the Court of Appeal’s approach to this decision may be contained in its obiter comments regarding whether or not a Twinsectra type expansion of the Quistclose trust ought to be adopted in Ontario. Though the Court felt no need to consider the issue, it issued a warning to any future court faced with it:

… to consider a number of commercial consequences, one of the most significant of which is the potential effect on the creditors of the borrower (or grantee) of the subject funds. For example, as in this case, where funds are advanced to a business with no registration under the Personal Property Security Act, R.S.O. 1990, c. P-10, creditors will have no notice, and in many cases no knowledge, that they are dealing with a debtor whose money is subject to a trust and not available to general creditors. [emphasis added]

The Court effectively captured the single most pressing issue raised by the Quistclose trust in Ontario’s secured lending regime (i.e., general creditors not having notice). If one reads the Court’s decision while keeping in mind its underlying concern for commercial certainty and its fear of general creditors operating without notice of trusts, the decision begins to make more sense from a results based perspective. It explains, perhaps, why the Court opted to render a decision which favoured the Partnership’s receiver and other creditors over the Ministry, and why the Court was willing to take such a technical interpretation.

As a result of this decision, the future of the Quistclose trust remains in flux. Grantors must be especially attuned to this decision if they wish to maintain a beneficial ownership over proceeds advanced to other parties. It appears that grantors must create an express trust or run the risk of forfeiting any beneficial rights to funds advanced (whether the parties contemplate repayment or not). Only time will tell if the Court’s technical interpretation is geared solely towards grantors or if this decision signals a future in which the Quistclose trust is circumscribed in favour of Ontario’s PPSA regime.

Case Information

Ontario (Training, Colleges and Universities) v. Two Feathers Forest Products, LP, 2013 ONCA 598

Docket: C56138

Date of Decision: October 2, 2013



[1]Cliffs Over Maple Bay Investments Ltd. (Re), 2011 BCCA 180.