Restructuring

NORTH OF THE BORDER UPDATE

This article has been contributed to the blog by Andrea Lockhart, an associate in the insolvency and restructuring group of Osler, Hoskin & Harcourt LLP.
The Ontario Superior Court of Justice recently considered the distribution of commingled funds among customers of an insolvent payroll processor in Cummings Estate v. Peopledge HR Services Inc., 2013 ONSC 2781. The debtor, Peopledge, was a provider of payroll processing, human resources and benefits services to 152 Canadian customers and 8 U.S. customers in respect of 9,926 Canadian employees and 482 U.S. employees. Subsequent to the commencement of receivership proceedings, the Receiver conducted a claims process for the identification and quantification of claims against the debtor. The Receiver ultimately received claims from five different categories of claimants: (i) customers asserting customer deposit claims in respect of payroll services, certain of which customers asserted such claims were trust claims; (ii) employee claims; (iii) claims of the Canada Revenue Agency for source deductions and harmonized sales taxes; (iv) secured claims with respect to professional fees funded in connection with the receivership; and (v) general claims, including supplier claims, equity claims and customer damage claims. The Receiver applied to Court for an order, inter alia, authorizing the distribution of funds to such claimants. One issue before the Court was whether the customer claims constituted trust claims, and if so, how such trust funds should be distributed. Balancing the interests of all stakeholders, the Court applied the remedy of a constructive trust over the payroll funds and authorized the distribution of such funds to customers on a pro rata basis.

The debtor deposited the payroll it funds received from its customers in either its Canadian consolidated account or its U.S. consolidated account, depending on whether the applicable employees were located in the U.S. or Canada. All such funds were commingled with other customer funds upon deposit. This arrangement was potentially in breach of some or all of the debtor’s contractual obligations to its customers, as some customer contracts expressly required the debtor to hold payroll funds in trust and other customers contracts required the debtor to segregate payroll funds in some fashion. Other customers did not have any written contract governing their relationship, although it appears that these customers also intended that payroll funds delivered to the debtor be segregated from the debtor’s other funds.

In considering the customer claims, the Court noted that payroll funds were deposited with the debtor for a specific and limited purpose – the payment of employee wages and remittances on behalf of the customer. The Court drew a parallel to a Quistclose trust, which was recognized by the U.K. House of Lords in Barclays Bank Ltd. v. Quistclose Investments Ltd., [1970] AC 567. Based on such case, an equitable trust may be imposed where funds are advanced for a specific purpose to ensure that such funds are used solely for such purpose or returned to the parties who advanced such funds. The Court also referred to the decision of the Supreme Court of Canada in Soulos v. Korkontzilas, [1997] 2 SCR 217, wherein the Supreme Court of Canada determined that a constructive trust may be imposed where dictated by good conscience. In this case, the Court noted that the debtor and its general creditors would be unjustly enriched by having access to the payroll funds, as it was never intended that they would have any beneficial interest in such funds. Exercising its equitable jurisdiction, the Court held that each of the debtor’s Canadian and U.S. consolidated accounts should be treated as trust accounts for customers who advanced payroll deposits to the debtor.

With respect to the appropriate method of distributing the commingled trust funds, the Court noted that Ontario cases had recognized both the pari passu ex post facto pro rata method (the “pro rata” method) or the Lowest Intermediate Balance Rule (“LIBR”). As described in a previous North of the Border Update, “Allocation of Funds Among Victims of A Fraudulent Investment Scheme”, the LIBR method provides that a claimant to a mixed fund cannot assert a proprietary interest in the fund in excess of the smallest balance in the fund during the period between the claimant’s original contribution to the fund and the time of its claim. Jurisprudence dictates that where possible, LIBR should be applied unless it is practically impossible to make the requisite LIBR calculations. As the debtor’s records in this case were not sufficient to permit LIBR calculations without entailing significant expenses, the Court held that the customer funds should be distributed on a pro rata basis.

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