Collecting for Trusts: Why Everything You Know is Wrong

Like any other entity, trusts amass assets and liabilities. When trusts need to pursue or recover assets, trustees have a broader toolkit than your average creditor.

We all know that at the heart of the trust construct lies the fiduciary duty, which requires trustees to safeguard trust assets. We are also more than familiar with the concept of trust funds, with many of BarTalk’s readers operating trust accounts in a law firm setting. At the intersection of these concepts lies a marked departure from the usual limitations on collections practices.

The pension and long-term disability trusts I work for have systematically developed this body of law over the years. In our plans, participating employers are required under collective agreements to remit contributions based on each hour worked by a member employee. The contributions are comprised of both an employer and employee portion and are impressed with a trust similar to statutory source deductions.

Occasionally, an employer will default on its contribution remittance, which includes its own funds but also funds that were deducted from the employee’s pay. And here’s where it gets interesting…

When faced with collections activity, a delinquent employer may well seek legal advice and be advised as follows:

1. Creditors will typically accept less than they are owed after negotiation

Where the creditor is a trust, this may not be true. Because the fiduciary duty requires trustees to preserve trust assets, it is difficult to justify accepting reduced amounts for expedience. However, trusts are subject to the same realities as other commercial actors and arguably have an even greater impetus to employ collections measures that are economical and proportionate. Trustee concessions may also directly compromise beneficiary entitlements.

Trustees are well advised not to accept compromises unless it is believed to be the best prospect of recovery (i.e. if there are likely insufficient assets to satisfy a judgment), and direct impacts to beneficiaries are either negligible or unavoidable. This often means that no compromises will be entertained, which may come as a surprise compared to standard commercial practice.

2. Directors and other principals are not liable for corporate debts

Failure to remit funds that are impressed with a trust (e.g. the contributions employers make to our pension and Long-Term Disability plans) is considered a breach of trust, engaging consideration of personal responsibility that does not apply to normal commerce. If an entity defaults on a non-trust obligation such as a loan payment, it is usually irrelevant which individual decided not to make the payment.

The nature of trust funds is such that the courts are inherently concerned with who misallocated or otherwise dealt improperly with the funds. Directors and officers can be deemed responsible for the breach even absent personal involvement in the transaction, if they failed to ensure adequate processes for respecting trust obligations in their business operations: Air Canada v M & L Travel Ltd., 1993 CanLII 33 (SCC).

While the nuances of trust accounting and tracing remedies are beyond the scope of this article, it can be critically important to require segregation of trust funds in contracts to preserve remedies.

3. Claims for trust funds will be extinguished through a bankruptcy process

This is the key component of bankruptcy from a debtor’s perspective but may not grant relief in all cases.

Our first approach is to always take the position that misallocated trust funds are not part of the bankrupt’s estate (Bankruptcy and Insolvency Act, s. 67(1)(a))—logically, since by definition trust funds belong to someone else—and should be returned to the trustees outside of any distribution that occurs within the bankruptcy. Our plans are often successful in this approach.

Alternatively, section 178(d) of the Bankruptcy and Insolvency Act provides that liabilities due to fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity are not extinguished by bankruptcy. Courts have applied this section to preserve claims for knowing assistance in breach of trust following discharge from bankruptcy: Hsu v International Private Vaults Inc., 2024 BCSC 335. Directors need not commit intentional fraud; it is enough that they were reckless or wilfully blind to the entity’s misuse of trust funds to be found personally liable.

The measures described above put trusts in a commanding position relative to other creditors, and our plans are often—and rightfully—able to fully recover owed contributions when other creditors are thwarted.

As the article title suggests, these approaches are exceptional, and opposing counsel may well advise their client on the “normal” progress of collections. In our experience, resolutions are more likely when the debtor is appropriately informed of their true potential exposure, i.e. the exceptions described above. Our standard approach then is to draw the debtor and counsel’s attention to these matters at the outset by providing a detailed explanation of these concepts in the demand letter, which includes citations for counsel’s benefit.

While this piece describes practices employed by sophisticated benefit trusts in respect of contributions, the same principles should apply to all trust property. So next time your trust client faces a challenging collections matter, you may wish to recall this article—and perhaps share a copy with the debtor’s counsel.