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Houlden and Morawetz On-Line Newsletter | Constructive Trust

Constructive trust imposed on loan repayment proceeds as part of stay of proceedings.


Houlden and Morawetz On-Line Newsletter



L.W. Houlden and Geoffrey B. Morawetz



Case Comment: Re Redstone Investment Corporation (Maplebrook Motion) — Constructive Trusts In An Insolvency Environment

By Aubrey E. Kauffman

On January 30, 2015 Regional Senior Justice Morawetz released his reasons in a motion brought by Maplebrook Capital Corp. (”Maplebrook”) in the CCAA/Receivership proceedings of Redstone Investment Corporation (”RIC”) (Redstone Investment Corp., Re (2015), 2015 ONSC 533, 2015 CarswellOnt 3286 (Ont. S.C.J.)). The decision is important for insolvency practitioners as:

(a) It imposed a constructive trust on certain proceeds held by a Receiver in favour of Maplebrook in order to prevent an inequitable and unjust result; and

(b) Although in obiter, RSJ Morawetz was prepared to accept the concept of a “Quistclose trust” and to find that the requirements of that trust had been met in the present case.

OVERVIEW OF THE FACTS

Maplebrook carried on business as a short-term lender to small and medium sized Canadian businesses. RIC was in a similar business. In 2013 RIC sourced five short-term loan transactions which Maplebrook agreed to finance (the “Assigned Loans”). Simplistically, the transactions were structured as follows:

(a) In connection with RIC’s loan to the ultimate borrower (the “Borrower”), RIC would obtain an assignable promissory note from the Borrower;

(b) RIC would in turn absolutely assign the promissory note and related security to Maplebrook in consideration for Maplebrook’s investment (which was in the same amount as the assigned promissory note);

(c) Notice of the assignment would not be given to the Borrower;

(d) Maplebrook would, in the assignment agreement, appoint RIC as its agent to collect and enforce the promissory note and security on Maplebrook’s behalf;

(e) RIC would then collect the lender fees, interest and principle in respect of the Assigned Loans and deposit those amounts, in full, into the Maplebrook account; and

(f) Thereafter Maplebrook would remit RIC’s share of the lender fee and interest spread.

The assignment documentation, which appointed RIC as the collection agent, did not expressly state that funds collected by RIC would be held in trust on Maplebrook’s behalf — indeed, the document was silent with respect to any mechanics dealing with collection of proceeds and payment to Maplebrook.

In addition to the Assigned Loans, there was also one aborted loan transaction (the “Pro-Hairline Transaction”). With respect to this transaction, Maplebrook advanced $750,000 to RIC for the purpose of acquiring a proposed loan to a company named Pro-Hairline (the “Pro-Hairline Advance”). The Pro-Hairline Advance was deposited into RIC’s general account and, immediately, forwarded by RIC (less some minor deductions) to RIC’s counsel to be held in trust pending completion of the loan transaction. Thereafter, RIC and Maplebrook decided not to proceed with the loan transaction. The funds were returned by RIC’s lawyers to RIC and deposited into RIC’s general account on March 25, 2014.

On March 28, 2014, RIC and a related company sought and obtained an Initial Order under the CCAA. The Initial Order appointed a monitor (the “Monitor”) and contained the typical broad stay of proceedings. On August 8, 2014 the CCAA proceedings were converted into receivership proceedings and the Monitor was appointed as receiver (the “Receiver”).

Shortly after the CCAA filing RIC received repayment of the principal and interest with respect to two of the Assigned Loans and some interest on a third Assigned Loan. These receipts were deposited into RIC’s general account. The remaining Assigned Loans (to two Borrowers) went into default (the “Loans in Default”).

Subsequent to the CCAA filing, Maplebrook made demand for an accounting of proceeds received with respect to the above transactions and for payment of amounts received. The Receiver refused to pay the amounts collected with respect to the Assigned Loans and the proceeds being held with respect to the Pro-Hairline Transaction taking the following positions:

(a) The Receiver acknowledged that, with respect to the Loans in Default the assignment document was effective in assigning the loans to Maplebrook. Accordingly, the Receiver acknowledged that these loans were the property of Maplebrook. The Receiver offered to consent to an order lifting the stay of proceedings in order to allow Maplebrook to terminate the agency relationship of RIC/the Receiver and thereafter to attempt to collect on the loans;

(b) With respect to the proceeds collected on the Assigned Loans the Receiver took the position that:

(i) The assignment document did not require that the proceeds collected by RIC, as agent for Maplebrook, be held in trust for Maplebrook and, accordingly, the relationship between Maplebrook and the RIC estate was that of creditor and debtor; and

(ii) In any event, upon deposit of the proceeds into RIC’s general account, any trust that may have existed was lost as a result of commingling.2

(c) With respect to the proceeds relating to the aborted Pro-Hairline Transaction, the Receiver took the position that;

(i) There was no agreement to hold those proceeds in trust when they were paid by Maplebrook to RIC; and

(ii) Even if there were a trust, such trust was ineffective upon the deposit of the proceeds into RIC’s general account. Maplebrook took the position that:

(a) The repaid Assigned Loans were identical in structure to the Loans in Default which the Receiver conceded were the property of Maplebrook;

(b) The absence of language creating an express trust was not fatal to the Court finding that there was a trust relationship when looking at all the surrounding circumstances;

(c) The Soulos test for finding a constructive trust had been met and that the commingling of funds in RIC’s general account was not fatal to the Court granting the remedy of a constructive trust;

(d) With respect to the proceeds held with respect to the Pro-Hairline Transaction, such proceeds were also subject to a constructive trust and, in addition, a Quistclose trust.

THE DECISION OF THE COURT

It is clear that the Court was influenced by the Receiver’s concession that the Loans in Default were the property of Maplebrook. The Court found that the repaid Assigned Loans had the exact same structure and were also the subject of absolute equitable assignments to Maplebrook.

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