Trust claims against a borrower’s assets are something that no secured creditor wants to be confronted with. Such claims are often unexpected because they are, for the most part, undetectable. They lurk in the shadows, out of the reach of traditional due diligence measures and PPSA searches. As a result, even the most prudent of creditors can sometimes find themselves facing these undocumented and unquantifiable claims.

A trust claim against a borrower’s assets in a bankruptcy context carries significant consequences. If successful, such a claim means that the assets that are the subject of the trust claim cannot be considered property of the borrower on the date of its bankruptcy. As a result, a secured creditor may find itself in a position where the collateral that it believed it had taken a security interest over is not available to satisfy its loan.  However, as e3m Investments1 makes clear, certain protections are in place to avoid this situation.

In e3m Investments a group of investors (the “Appellants”) asserted that funds held in the account of e3m Investments Inc. (“e3m”), a registered investment dealer that subsequently filed for bankruptcy, were held in trust for the benefit of the Appellants and, as such, were not property of e3m’s estate on the date of its bankruptcy. e3m owed money to the Appellants pursuant to a damage award in a pre-bankruptcy civil claim against e3m (the “Judgment”).

Subsequently, the Ontario Securities Commission (the “OSC”) expressed concern over e3m’s ability to satisfy the Judgment. In response to an exemption request in a related transaction, the OSC imposed terms and conditions on e3m’s investment dealer registration, which “required e3m to ‘accumulate and maintain’ sufficient liquid assets in an account, called the Accumulating Account, to satisfy the Judgment plus costs and interest.”2 Nevertheless, e3m subsequently filed an assignment into bankruptcy.

In an attempt to improve their priority position in the bankruptcy proceeding, the Appellants asserted that the funds in the Accumulating Account were beneficially owned by them and therefore not a part of e3m’s estate.3 The Trustee in Bankruptcy of e3m’s estate, however, disallowed the claim. The Appellants subsequently appealed the disallowance to the Superior Court of Justice.

The main question before the Court was whether the Appellants had established the three certainties required for the formation of a trust: (i) certainty of intention; (ii) certainty of subject matter; and (iii) certainty of object. The Court ultimately ruled in favour of the Trustee, holding that the facts of the case did not support the certainty of intention required to establish a trust over the funds in the Accumulating Account. In other words, the Appellants were found to be nothing more than unsecured judgment creditors of e3m.

In this case, even though the funds were in a segregated account, the Court found that there was no independent intention to a create a trust in favour of the Appellants: (i) the separate Accumulating Account was only created in order to satisfy the terms and conditions imposed upon e3m by the OSC; (ii) those terms and conditions did not address the ultimate disposition of the funds within the Accumulating Account; (iii) the Appellants had no knowledge of the negotiations between the OSC and e3m leading to the terms and conditions; and (iv) the OSC had complete regulatory control to direct funds from the Accumulating Account for essentially any purpose the OSC might deem appropriate within its regulatory mandate (and not just to pay the Appellants).  The Court also expressed doubt about the OSC’s jurisdiction to create, without express legislative authority, what amounts to a preference for certain judgment creditors of a registrant over the interests of other creditors4.

This case serves as an important reminder to secured creditors that a stringent test is applied by courts to determine the establishment of a trust in a commercial context.5 The key take-away here is that judicial determinations regarding the three certainties, particularly, certainty of intention, are not made lightly. Certainty of intention requires absolute intention on behalf of the settler to create a trust. As this case shows, very clear facts are needed to support such a conclusion. Secured creditors should, therefore, take some comfort in the court’s aversion to establishing an undetectable commercial trust except in very limited circumstances. Secured creditors should also remain diligent and always keep potential trust claims in mind when contemplating financing terms.