Court headnote

Air Canada v. M & L Travel Ltd.
Collection
Supreme Court Judgments
Date
1993-10-21
Report
[1993] 3 SCR 787
Case number
22416
Judges
La Forest, Gérard V.; Sopinka, John; Gonthier, Charles Doherty; Cory, Peter deCarteret; McLachlin, Beverley; Iacobucci, Frank; Major, John C.
On appeal from
Ontario
Subjects
Trust
Notes
SCC Case Information: 22416
Decision Content
Air Canada v. M & L Travel Ltd., [1993] 3 S.C.R. 787
Ross Valliant Appellant
v.
Air Canada Respondent
Indexed as: Air Canada v. M & L Travel Ltd.
File No.: 22416.
1993: April 26; 1993: October 21.
Present: La Forest, Sopinka, Gonthier, Cory, McLachlin, Iacobucci and Major JJ.
on appeal from the court of appeal for ontario
Trusts ‑‑ Directors of closely held corporation ‑‑ Business of corporation a travel agency ‑‑ Agreement between travel agency and airline for ticket sales ‑‑ Receipts less commission to be forwarded to airline ‑‑ Notwithstanding separate trust account for money from ticket sales, money placed in travel agency's general account ‑‑ Business difficulties resulting in directors making independent and contradictory instructions to bank as to operating account ‑‑ Bank withdrawing amount owing it on line of credit to travel agency pursuant to terms of credit agreement ‑‑ Airline suing directors personally for monies owing it ‑‑ Whether relationship between travel agency and airline one of trust or of debtor and creditor ‑‑ If trust relationship, whether directors personally liable for breach of trust by corporation.
Appellant borrowed money on a personal loan, invested it in a travel agency and paid the interest from the agency's general banking account. He became one of the agency's two directors and its vice‑president. While both directors had signing authority, the day‑to‑day operation of the business was left to the other director. The travel agency, on becoming a member of IATA, signed a passenger sales agency agreement with IATA (conferring the right to sell air carrier tickets and receive commissions) and a passenger sales agency agreement with Air Canada (authorizing the agency to receive blank airline ticket stock for Air Canada and to issue tickets directly to the public). Funds collected from the sale of Air Canada tickets were to be held in trust by the travel agency and were to be paid twice a month to Air Canada. These payments were regularly made until March 1979.
The travel agency obtained an operating line of credit from a chartered bank in 1978. The monies advanced under the line of credit and interest thereon constituted a demand loan in favour of the Bank. Both directors personally guaranteed the loan and authorized the Bank to remove any monies owing on the loan at any time from the agency's general account. Although a trust account was set up by the managing director for the deposit of the airline funds held by the agency, these funds were maintained in the agency's general operating bank account.
A dispute arose between the directors in April 1979. The managing director discovered cancelled cheques for the instalment payments on appellant's personal loan. It was his understanding that appellant had agreed to cease making the payments for the time being and he stopped payment on the last instalment cheque. Appellant suspected the managing director of misappropriating funds and stopped payment on all cheques and withdrawals. At this time, the travel agency owed Air Canada $25,079.67 for ticket sales.
The travel agency was closed for 10 days. Both directors, through their solicitors, negotiated for the purchase by one of the other's interest and both, during this time, made efforts to pay Air Canada. Appellant testified that he opened a trust account, drew cheques for the monies that were still in the company account, withdrew the stop payment orders, and attempted to transfer the funds into the new trust account. The Bank refused to transfer the funds or to honour the cheques made out to Air Canada because of the conflicting instructions from the two directors. The Bank, after sending demand notices, withdrew the full amount owing it under the line of credit from the travel agency's general account.
Air Canada sued the travel agency and both directors personally for the money owed to it for ticket sales. Its claim against the travel agency was successful but the claim against the two directors was dismissed. Air Canada successfully appealed the judgment as it related to the two directors and judgment was entered against them as well. At issue here were: (1) whether the relationship between travel agency and respondent was one of trust, or one of debtor and creditor; and (2) if the relationship was one of trust, under what circumstances could the directors of a corporation be held personally liable for breach of trust by the corporation, and were those circumstances present here. The legal issue raised by this second ground of appeal concerned the standards for the imposition of personal liability to be applied to strangers who participate in a breach of trust. Although involving a corporation, the case fell to be resolved on trust principles, and does not raise general questions of the personal liability of directors for the acts of the corporation.
Held: The appeal should be dismissed.
Per La Forest, Sopinka, Gonthier, Cory, Iacobucci and Major JJ.: The relationship was conceded to be one of trust. The wording of the agreement evidenced an intention to create a trust. Respondent was the object of the trust and the money collected for ticket sales its subject matter. Given the intention to create a trust in the agreement between the travel agency and respondent, the absence of a prohibition on the commingling of funds could be considered but was not determinative of the type of relationship. The setting up of the trust account and the fact that the IATA agreement allowed the travel agency to affect Air Canada's legal responsibilities indicated a relationship consistent with a trust relationship. The travel agency breached the trust when it failed to account to the respondent for the monies collected through sales of Air Canada tickets.
The imposition of personal liability on a stranger to a trust depends on whether the stranger's conscience is sufficiently affected to justify the imposition of personal liability. A stranger to the trust can be held liable as a constructive trustee for breach of trust (trustee de son tort). The stranger, although not appointed a trustee, takes on him‑ or herself to act as trustee and to possess and administer trust property and becomes liable if he or she commits a breach of trust while acting as a trustee. This type of liability is inapplicable here because the directors did not personally take possession of trust property or assume the office or function of trustees.
Strangers to the trust can also be personally liable for breach of trust if they knowingly participate in a breach of trust. They either were acting as a trustee in receipt and chargeable with trust property (a constructive trusteeship termed "knowing receipt") or they knowingly assisted in a dishonest and fraudulent design on the part of the trustees (termed "knowing assistance"). Since the "knowing receipt" category did not apply here, the only basis upon which the directors could be held personally liable was as constructive trustees under the "knowing assistance" head of liability. This basis of liability raises two main issues: the nature of the breach of trust and the degree of knowledge required of the stranger.
The knowledge requirement for this "knowing assistance" type of liability is actual knowledge; recklessness or wilful blindness will suffice. A person will be deemed to have known of the trust if it was imposed by statute. If the trust was contractually created, then whether the stranger knew of the trust will depend on his or her familiarity or involvement with the contract.
The receipt of a benefit as a result of the breach of trust will be neither a sufficient nor a necessary condition for the drawing of an inference that a stranger knew of the breach. Constructive notice has been found to be insufficient to bind the stranger's conscience so as to give rise to personal liability. While cases involving recklessness or wilful blindness indicate a want of probity which justifies imposing a constructive trust, the carelessness involved in constructive knowledge cases will not normally amount to a want of probity, and will therefore be insufficient to bind the stranger's conscience.
Whether the breach of trust was fraudulent and dishonest must be considered, not whether the appellant's actions should be so characterized. The stranger will be liable if he or she knowingly assisted the trustee in a fraudulent and dishonest breach of trust. Therefore, it is the corporation's actions which must be examined. Where the trustee is a corporation, rather than an individual, the inquiry as to whether the breach of trust was dishonest and fraudulent may be more difficult to conceptualize, because the corporation can only act through human agents who are often the strangers to the trust whose liability is in issue. The appellant's actions were relevant to this examination, given the extent to which the travel agency was controlled by the defendant directors.
The breach of trust by the travel agency was dishonest and fraudulent from an equitable standpoint. The taking of a knowingly wrongful risk resulting in prejudice to the beneficiary is sufficient to ground personal liability. As a party to the contract between itself and the respondent, the travel agency knew that the Air Canada monies were held in trust for the respondent, and were not for the general use of the travel agency. It set up trust accounts, but never used them. It also knew that any positive balance in its general account was subject to the Bank's demand. By placing the trust monies in the general account which were then subject to seizure by the Bank, the travel agency took a risk to the prejudice of the rights of the respondent beneficiary, Air Canada. It had no right to take this risk.
Appellant participated or assisted in the breach of trust. He dealt with the funds in question ‑‑ he stopped payment on all cheques, opened a trust account, and attempted to withdraw the stop payment orders and to transfer the funds into the new trust account in order to pay the respondent. The breach of trust was directly caused by the conduct of the defendant directors. Their actions in stopping payment on the cheques to protect their own interests not only prevented payment on cheques issued to Air Canada but also precipitated the seizure by the Bank of the only funds available in the unprotected general account. The directors are personally liable for the breach of trust as constructive trustees provided that the requisite knowledge on the part of the directors is proved.
The knowledge requirement will not generally be a difficult hurdle to overcome in cases involving directors of closely held corporations. Such directors, if active, usually have knowledge of all of the actions of the corporate trustee. Here, however, the appellant was not as closely involved with the day‑to‑day operations as was the other director. He nevertheless knew of the terms of the agreement between the travel agency and the respondent airline because he signed that agreement and he knew that the trust funds were being deposited in the general bank account, which was subject to the demand loan from the Bank. This constitutes actual knowledge of the breach of trust because even without subjective knowledge of the breach of trust, given the facts of which he did have subjective knowledge, he was wilfully blind to the breach, or reckless in his failure to realize that there was a breach. Furthermore, appellant received a benefit from the breach of trust, in that his personal liability to the Bank on the operating line of credit was extinguished. Therefore, he knowingly and directly participated in the breach of trust, and is personally liable to the respondent airline for that breach.
Per McLachlin J.: The relationship between the corporation and Air Canada was one of trust, not debtor and creditor. Appellant was clearly liable as a constructive trustee for the breach of trust which the corporation committed respecting Air Canada's account.
A number of issues should not be decided here but rather left for consideration in cases in which they might arise. A stranger to a trust must know of his or her participation in a breach of trust to be personally liable for it. It was not necessary, however, to decide whether subjective knowledge (actual knowledge of the breach or wilful blindness and recklessness) or objectively determined knowledge (what a reasonably diligent person would have known) is necessary. The evidence here met the higher standard of subjective knowledge. It was also unnecessary to decide whether any breach could give rise to liability or whether the breach had to be fraudulent or dishonest because the breach here was fraudulent and dishonest in the sense that it involved a risk to the property to the prejudice of the beneficiary. Lastly, a decision as to whether liability could be imposed in the absence of personal benefit did not need to be made because appellant benefitted personally from the breach.
Cases Cited
By Iacobucci J.
Considered: Wawanesa Mutual Insurance Co. v. J. A. (Fred) Chalmers & Co. (1969), 7 D.L.R. (3d) 283; Henry Electric Ltd. v. Farwell (1986), 29 D.L.R. (4th) 481; Andrea Schmidt Construction Ltd. v. Glatt (1979), 25 O.R. (2d) 567; R. v. Lowden (1981), 27 A.R. 91; Stephens Travel Service International Pty. Ltd. v. Qantas Airways Ltd. (1988), 13 N.S.W.L.R. 331; M. A. Hanna Co. v. Provincial Bank of Canada, [1935] S.C.R. 144; In re Penn Central Transportation Co., 328 F.Supp. 1278 (1971), rev'd 486 F.2d 519 (1973); In re Montagu's Settlement Trusts, [1987] Ch. 264; Selangor United Rubber Estates, Ltd. v. Cradock (No. 3), [1968] 2 All E.R. 1073; Barnes v. Addy (1874), L.R. 9 Ch. App. 244; Baden, Delvaux & Lecuit v. Société Générale pour Favoriser le Développement du Commerce et de l'Industrie en France S.A., [1983] B.C.L.C. 325 (Ch.), aff'd [1985] B.C.L.C. 258 (C.A.); Belmont Finance Corp. v. Williams Furniture Ltd. (No. 1), [1979] 1 All E.R. 118; Carl‑Zeiss‑Stiftung v. Herbert Smith & Co. (No. 2), [1969] 2 All E.R. 367; MacDonald v. Hauer (1976), 72 D.L.R. (3d) 110; Scott v. Riehl (1958), 15 D.L.R. (2d) 67; Horsman Bros. Holdings Ltd. v. Panton & Panton, [1976] 3 W.W.R. 745; Trilec Installations Ltd. v. Bastion Construction Ltd. (1982), 135 D.L.R. (3d) 766; Austin v. Habitat Development Ltd. (1992), 94 D.L.R. (4th) 359; disapproved: In re Morales Travel Agency, 667 F.2d 1069 (1981); referred to: Myrta Forastieri v. Eastern Air Lines, Inc., 18 Avi. 17,145 (1983); Canadian Pacific Air Lines, Ltd. v. Canadian Imperial Bank of Commerce (1987), 61 O.R. (2d) 233, aff'd (1990), 71 O.R. (2d) 63 (note); Bank of N.S. v. Soc. Gen. (Can.), [1984] 4 W.W.R. 232; McEachren v. Royal Bank (1990), 78 Alta. L.R. (2d) 158; Henry v. Hammond, [1913] 2 K.B. 515; Air Traffic Conference v. Downtown Travel Center, Inc., 14 Avi. 17,172 (1976); Air Traffic Conference of America v. Worldmark Travel, Inc., 15 Avi. 18,483 (1980); International Sales and Agencies Ltd. v. Marcus, [1982] 3 All E.R. 551; Karak Rubber Co. v. Burden (No. 2), [1972] 1 All E.R. 1210; Lee v. Sankey (1873), L.R. 15 Eq. 204; Soar v. Ashwell, [1893] 2 Q.B. 390; Shields v. Bank of Ireland, [1901] 1 I.R. 222; Gray v. Johnston (1868), L.R. 3 H.L. 1; Coleman v. Bucks and Oxon Union Bank, [1897] 2 Ch. 243; Fonthill Lbr. Ltd. v. Bk. Montreal, [1959] O.R. 451; Groves‑Raffin Construction Ltd. v. Bank of Nova Scotia (1975), 64 D.L.R. (3d) 78; Lipkin Gorman v. Karpnale Ltd., [1992] 4 All E.R. 331 (Q.B.), rev'd in part, [1992] 4 All E.R. 409 (C.A.), rev'd in part on other grounds, [1992] 4 All E.R. 512 (H.L.).
By McLachlin J.
Referred to: MacDonald v. Hauer (1976), 72 D.L.R. (3d) 110; Henry Electric Ltd. v. Farwell (1986), 29 D.L.R. (4th) 481; Horsman Bros. Holdings Ltd. v. Panton & Panton, [1976] 3 W.W.R. 745; Trilec Installations Ltd. v. Bastion Construction Ltd. (1982), 135 D.L.R. (3d) 766; Andrea Schmidt Construction Ltd. v. Glatt (1979), 25 O.R. (2d) 567; Scott v. Riehl (1958), 15 D.L.R. (2d) 67.
Authors Cited
Pettit, Philip H. Equity and the Law of Trusts, 6th ed. London: Butterworths, 1989.
Sullivan, Ruth. "Strangers to the Trust", [1986] Est. & Tr. Q. 217.
Underhill, Sir Arthur. Law Relating to Trusts and Trustees, 14th ed. By David J. Hayton. London: Butterworths, 1987.
Waters, Donovan W. M. Law of Trusts in Canada, 2nd ed. Toronto: Carswell, 1984.
APPEAL from a judgment of the Ontario Court of Appeal (1991), 2 O.R. (3d) 184, 77 D.L.R. (4th) 536, allowing an appeal from a judgment of Flanigan Dist. Ct. J. Appeal dismissed.
Peter J. Bishop, for the appellant.
Guy L. Poppe and Harry G. Leslie, for the respondent.
The judgment of La Forest, Sopinka, Gonthier, Cory, Iacobucci and Major JJ. was delivered by
Iacobucci J. -- This appeal concerns the personal liability of directors of a closely held corporation for breach of a trust by the corporation. The appellant was one of two directors of a small travel agency which contracted with the respondent airline to sell Air Canada tickets. Two main questions are raised on this appeal. First, was the relationship between the corporation and the respondent airline one of trust? Second, if so, is the appellant director personally liable for the breach of trust by the corporation? The legal issue raised by this second ground of appeal concerns the standards for the imposition of personal liability to be applied to strangers who participate in a breach of trust. Although involving a corporation, the case falls to be resolved on trust principles, and does not raise general questions of the personal liability of directors for the acts of the corporation.
I. Background
In 1973, the defendant Phil Martin and one Ross Linton incorporated M & L Travel Limited (M & L) to carry on the business of a travel agency in Ottawa. In 1975, Linton withdrew from the business and Martin continued by himself. In 1977, Martin wanted M & L to become a member of the International Air Transport Association (IATA) so that he could receive larger commissions and issue tickets directly to customers. To become a member, M & L had to fulfil certain requirements. These included having working capital of at least $20,000 and the sponsorship of a major airline. Therefore, in the fall of 1977, Martin invited the appellant Valliant to become a shareholder and invest in M & L. In January 1978, Valliant invested $25,550 in M & L and acquired 50 percent of the issued shares. Valliant obtained this money through a personal loan on which he was required to pay monthly instalments of $752. The trial judge found that Martin had agreed that Valliant could withdraw this amount from M & L's account on a monthly basis until the personal loan was paid in full.
Martin became President of M & L and Valliant its Vice-President, and they were its sole directors. Each had signing authority, but Martin ran the day-to-day business. Valliant, who had no experience with the travel agency business, dropped in occasionally and worked full time, for a salary, only when Martin was ill or on vacation. In November 1978, Valliant brought his wife into the travel agency to deal with problems with M & L's books. She was given signing authority and worked part time for the agency until April 1979.
The IATA accepted the membership application of M & L based on sponsorship by Air Canada. M & L entered into two written agreements. The first was a passenger sales agency agreement between IATA and M & L, executed on September 14, 1978 and signed by Martin as President. This agreement conferred on M & L the right to sell air carrier tickets and receive commissions. Valliant was familiar with the contents of this agreement. The second agreement, also called a passenger sales agency agreement, was entered into between M & L and Air Canada on March 15, 1979 and was signed by Valliant as Vice-President. This agreement authorized M & L to receive blank airline ticket stock from Air Canada and to issue tickets directly to the public. Funds collected from the sale of Air Canada tickets were to be held in trust by M & L and paid twice a month to Air Canada. Until March 1979, these payments were regularly made. The agreement contained the following clause:
All monies, less applicable commissions to which the Agent is entitled hereunder, collected by the Agent for air passenger transportation (and for which the Agent has issued tickets or exchange orders) shall be the property of the Airline, and shall be held in trust by the Agent until satisfactorily accounted for to the airline. All such monies, less applicable commissions to which the Agent is entitled hereunder, shall be remitted to the Airline by the Agent in accordance with the Airline's accounting procedures.
On August 30, 1978, M & L obtained an operating line of credit of $15,000 from the Provincial Bank of Canada in Ottawa (the Bank). Martin and Valliant personally guaranteed the loan and authorized the Bank to remove from the general account of M & L any monies at any time owing on the loan. The monies advanced under the line of credit and interest thereon constituted a demand loan in favour of the Bank.
Also in 1978, Martin set up trust accounts on behalf of M & L for the deposit of the airline funds. For unexplained reasons, these accounts were never used. Instead, M & L maintained a general operating account with the Bank. Funds from all sources, including the sale of Air Canada tickets, were placed in this account. General operating expenses, the interest on the line of credit, Valliant's personal loan payments, and Martin's salary were all paid out of this account.
In April 1979, a dispute arose between Martin and Valliant. Martin, concerned about the poor cash flow position of the agency, went into the office on April 5, 1979. He found the cancelled cheques for the instalment payments on Valliant's personal loan. Martin thought that Valliant had agreed to cease making the payments for the time being, and therefore, Martin called the Bank and stopped payment on the last instalment cheque. He took the day's receipts and a number of cancelled cheques to his lawyer. On April 6, 1979, Valliant noticed the missing funds and documents, and suspected that Martin was misappropriating funds. He changed the locks on the doors and called the Bank and stopped payment on all cheques and withdrawals. At this time, M & L owed Air Canada $25,079.67 for ticket sales.
Between April 6 and April 16, 1979, the business of M & L was closed. Martin and Valliant, through their solicitors, negotiated for the purchase by one of the other's interest. During this time, both Valliant and Martin made efforts to pay Air Canada. Valliant, in particular, testified that he opened a trust account, drew cheques for the monies that were still in the company account, withdrew the stop payment orders, and attempted to transfer the funds into the new trust account. However, the Bank refused to transfer the funds or to honour the cheques made out to Air Canada because of the conflicting instructions from Martin and Valliant. The Bank, now aware of the financial and managerial difficulties facing M & L, sent a demand notice to Valliant, M & L, and probably Martin on April 23, 1979. On April 24, 1979, the Bank withdrew $15,184.11 from the operating account, satisfying in full the demand note relating to the line of credit personally guaranteed by both Martin and Valliant.
Air Canada sued M & L and Martin and Valliant personally for the $25,079.67 owed to it for ticket sales. At trial, Air Canada succeeded against M & L but the trial judge dismissed the claim against Martin and Valliant. The Ontario Court of Appeal allowed the appeal of Air Canada and entered judgment against Martin and Valliant as well.
II. Judgments Below
A. Ontario District Court (Flanigan Dist. Ct. J.)
The trial judge held that there was clearly a trust relationship between Air Canada and the travel agency, and that the travel agency had breached that trust by failing to protect Air Canada's interest. However, the more difficult question was whether Martin and Valliant were personally liable for breach of trust.
The trial judge stated that the only way in which liability could be imposed on the individual defendants is if they had taken it upon themselves to possess and administer trust property for the beneficiary as if they were trustees. Each individual would then be a trustee de son tort. However, the trial judge concluded:
... in this case there is no assumption, in my view, by the individual defendants to assume this trust. It is true, in signing the bank documents they gave the bank the right to do as they did but right up until the last moment they were trying each in their own way effectively or not, to protect the interest of Air Canada to keep their own interest alive by preserving the business of the travel agency. . . . So, I see nothing mala fides in the actions of the individual defendants and I think they were inept in some of their actions but, they were in no way, in my view, trustees that breached a trust so far as Air Canada is concerned.
Therefore, the trial judge dismissed the claim against the individual defendants.
B. Ontario Court of Appeal (1991), 2 O.R. (3d) 184 (Griffiths J.A.)
Griffiths J.A. began by noting that it was not contested that there was a trust relationship between Air Canada and M & L, and that M & L was liable for breach of that trust. He also agreed with the trial judge that the individual defendants in this case could not be classified as trustees de son tort. In Law of Trusts in Canada (2nd ed. 1984), Professor Donovan Waters states that to be held liable as a trustee de son tort, the trustee must have possession and control of the trust property. To have that possession and control, the trustee must have some legal right or title to the trust property. In this case, the trial judge properly found that neither Martin nor Valliant had assumed legal control or possession of the trust funds, since the funds were at all times administered in the name of M & L.
Griffiths J.A. held that M & L was clearly liable for breach of contract since it failed to remit the funds as required. However, as directors, Martin and Valliant could not be held personally liable for that breach of contract. It was therefore necessary, for Martin and Valliant to be potentially personally liable, that M & L also be found to have been in breach of trust. Griffiths J.A. concluded at p. 194:
... on the authority of Canadian Pacific Airlines Ltd. v. Canadian Imperial Bank of Commerce (1987), 61 O.R. (2d) 233, ... affd Ont. C.A., Robins, Krever and Carthy JJ.A., January 19, 1990 (. . . 71 O.R. (2d) 63 (note) . . .), that the agreement between Air Canada and the corporation clearly created a trust relationship between them with the result that any monies received by the corporation from the sale of Air Canada tickets were impressed with a trust.
Griffiths J.A. then went on to consider whether the directors could be personally liable for the breach by their corporation of a trust relationship created by contract. This issue, he noted, had not been considered in any reported Canadian or English cases. He reviewed several cases where the directors had been held personally liable for breaches of trust imposed by statute, including Wawanesa Mutual Insurance Co. v. J. A. (Fred) Chalmers & Co. (1969), 7 D.L.R. (3d) 283 (Sask. Q.B.); Henry Electric Ltd. v. Farwell (1986), 29 D.L.R. (4th) 481 (B.C.C.A.); and Andrea Schmidt Construction Ltd. v. Glatt (1979), 25 O.R. (2d) 567 (H.C.).
Griffiths J.A. also referred to Myrta Forastieri v. Eastern Air Lines, Inc., 18 Avi. 17,145 (D.P.R. 1983), a U.S. decision involving facts similar to the present case. In that case, the court held, at pp. 17,148-17,149 that:
Irrespective of good faith or intent, in an instance wherein the corporation had a duty to pay out funds from designated proceeds but such proceeds were used for other purposes, the directors were held personally liable because they had a duty to see that the funds were used for the agreed-upon purpose and they could not excuse themselves on the grounds that they did not dissipate or misappropriate the funds nor were in other respects derelict in their duty. . . .
. . .
We agree, therefore, that failure to remit funds collected by a corporate agent which belong to its principal airline gives rise to personal liability of those corporate employees who participate in the conversion. The imposition of such liability presumes, however, that the responsible persons actually had possession or control over the property such that it could be said that their conduct constitutes participation. Under the circumstances of the present case the joint control over the financial affairs and operations of this very closely held corporation by the two individual plaintiffs/counterdefendants supports a finding that if conversion occurred, it was a joint act of those two persons. They shared ownership of the corporation equally; they shared management of the business operations equally; they shared equally in the special compensation arrangements set up for themselves; and most important, they shared control over the corporate accounts since all checks issued required both their signatures. . . .
Griffiths J.A. concluded that Wawanesa v. Chalmers, Henry Electric Ltd. v. Farwell and Andrea Schmidt Construction Ltd. could not be distinguished on the basis that the trust was created by statute. Instead, he held, at p. 203, that:
What is significant in those cases is that the shareholders and directors that were held responsible were the sole owners and directors and were the sole directing and operating minds of the corporations. . . . For the purposes of this appeal, I adopt the reasoning of the United States District Court of Puerto Rico in Myrta Forastieri v. Eastern Air Lines, supra, that it is just and equitable to impose personal liability on directors who participate in the breach of trust by the corporation because, in effect, they have participated in a conversion of trust funds.
Griffiths J.A. then reviewed the facts which justified the imposition of personal liability in the case at bar. First, both Martin and Valliant had at least some control over the operation of the business, and both had signing authority. Second, it was Martin and Valliant as the operating minds of M & L who deposited the trust funds in the general operating account and paid operating expenses out of that account. Third, M & L had a duty to (at p. 204) "keep these monies separate, to earmark them as funds held for Air Canada and, at the very least, to advise the bank that such funds, separately maintained, were trust funds". Since this was not done, M & L committed a breach of trust. Finally, the Bank seized the funds from the account because Martin and Valliant had both stopped payment on cheques issued on the account: "The movement of these directors, acting solely in their own interest to stop payment on cheques, not only prevented payment on cheques issued to Air Canada, but precipitated the seizure by the bank of the only funds available in the unprotected general account" (p. 204). Therefore, Griffiths J.A. concluded at pp. 204-5:
In my view, this is an appropriate case to impose personal liability on Martin and Valliant for the breach of trust. They were the sole owners and operating minds of the corporation. They directed and authorized the deposit of funds from Air Canada sales in the general account without in any way designating these funds as trust funds. They permitted these funds to be intermingled with other funds and they drew cheques on these funds in complete disregard of the trust obligations imposed under the agreement with Air Canada, an agreement which conferred on the corporation of which they were the sole shareholders the important privilege of selling Air Canada tickets directly to the public. Martin and Valliant permitted Air Canada funds to be placed in a general account that was overdrawn without adequate controls and, in particular, without advising the bank that these funds were trust funds, with the result that these funds were exposed to appropriation by the bank to satisfy the corporation's loan guaranteed by Martin and Valliant. In failing to exercise proper control over the trust funds, both Martin and Valliant received a benefit in that their personal liability to the bank was extinguished.
The steps taken by Martin and Valliant to protect the interests of Air Canada were inept, and too little too late. In any event, these steps were taken to preserve the travel agency and not to protect Air Canada's interest. Griffiths J.A. therefore concluded that Martin and Valliant were both parties to the conversion of trust funds and should be held personally liable.
III. Issues
As mentioned at the outset, there are two main issues raised in this case. First, was the relationship between M & L and the respondent one of trust, or one of debtor and creditor? Second, if the relationship was one of trust, then under what circumstances can the directors of a corporation be held personally liable for breach of trust by the corporation, and are those circumstances present in this case?
IV. Analysis
1. The Nature of the Relationship between M & L and Air Canada
In this Court, the appellant initially argued that the relationship between M & L and the respondent airline was one of debtor and creditor, rather than one of trust. However, at the hearing, the appellant properly conceded that the relationship was one of trust. Given this concession, I will consider this question only briefly.
The appellant relied on the fact that the agreement between the airline and M & L did not require it to keep the proceeds of Air Canada tickets in a separate account or trust fund, or to remit the funds forthwith. Rather, M & L was permitted to keep such funds for a period of up to 15 days, and then for a further 7-day grace period. Furthermore, M & L was liable for the total sale price of all tickets sold, less its commission, regardless of whether it had actually collected the full amount from its customers. That is, M & L was free to sell Air Canada tickets on credit to its customers. Prior to his concession on this point, the appellant submitted that, in these circumstances, M & L was not a trustee of the sale proceeds of the Air Canada tickets.
In concluding that the relationship between M & L and the airline was one of trust, the Court of Appeal relied on Canadian Pacific Air Lines, Ltd. v. Canadian Imperial Bank of Commerce (1987), 61 O.R. (2d) 233. Although the Court of Appeal's decision in that case (1990), 71 O.R. (2d) 63 (note), was brief, the reasons of the trial judge, at p. 237, went into greater depth:
In order to constitute a trust, an arrangement must have three characteristics, known as the three certainties: certainty of intent, of subject-matter and of object. The agreement . . . is certain in its intent to create a trust. The subject-matter is to be the funds collected for ticket sales. The object, or beneficiary, of the trust is also clear; it is to be the airline. The necessary elements for the creation of a trust relationship are all present. I find that such a relationship did exist between CP and the two travel agencies.
This analysis is clearly applicable to the facts of the present case. That the intent of the agreement is to create a trust is evident from the following wording: "All monies, less applicable commissions to which the Agent is entitled hereunder, collected by the Agent for air passenger transportation (and for which the Agent has issued tickets or exchange orders) shall be the property of the Airline, and shall be held in trust by the Agent until satisfactorily accounted for to the airline." The object of the trust is the respondent airline, and its subject-matter is the funds collected for ticket sales.
While the presence or absence of a prohibition on the commingling of funds is a factor to be considered in favour of a debt relationship, it is not necessarily determinative. See R. v. Lowden (1981), 27 A.R. 91 (C.A.), at pp. 101-2; Bank of N.S. v. Soc. Gen. (Can.), [1984] 4 W.W.R. 232 (Alta. C.A.), at p. 238; McEachren v. Royal Bank (1990), 78 Alta. L.R. (2d) 158 (Q.B.), at p. 183; Stephens Travel Service International Pty. Ltd. v. Qantas Airways Ltd. (1988), 13 N.S.W.L.R. 331 (C.A.), at p. 341. In R. v. Lowden, supra, McGillivray C.J.A. stated as follows at pp. 101-2:
Undoubtedly a direction that moneys are to be kept separate and apart is a strong indication of a trust relationship being created. It does not appear to me, however, that the converse is necessarily so. In the case of a travel agent, how he handled the funds handed to him for the purchase of a ticket would, as far as the public is concerned, be something that they would not have reason to think about. It would be a matter of internal management. The fact that there is no specific discussion about moneys being kept separate and apart from other moneys does not detract from the fact that the money is paid for a particular purpose, namely the obtaining of tickets for specific flights or reservations at named accommodation for a particular period.
The appellant relied on the decision of this Court in M. A. Hanna Co. v. Provincial Bank of Canada, [1935] S.C.R. 144. In that case, the Court dealt with the relationship between a supplier of coal and its sales agent. The Court concluded that the relationship was one of debtor-creditor, citing the fact that the parties had specifically cancelled a portion of their agreement requiring the separation of the funds collected by the sales agent. The sales agent paid the supplier by cheques drawn on its general account. The supplier's acquiescence to this practice, and the fact that the agent had use of the funds before payment came due, indicated to this Court that the parties viewed their relationship as one of debtor-creditor. The Court relied on the following passage from Henry v. Hammond, [1913] 2 K.B. 515, at p. 521:
It is clear that if the terms upon which the person receives the money are that he is bound to keep it separate, either in a bank or elsewhere, and to hand that money so kept as a separate fund to the person entitled to it, then he is a trustee of that money and must hand it over to the person who is his cestui que trust. If on the other hand he is not bound to keep the money separate, but is entitled to mix it with his own money and deal with it as he pleases, and when called upon to hand over an equivalent sum of money, then, in my opinion, he is not a trustee of the money, but merely a debtor.
This decision was distinguished in Qantas, supra, at p. 348, by Hope J.A., dealing with facts similar to the present case:
As it seems to me, . . . the decision . . . has no relevance to the circumstances of the present case where, on the proper construction of the agreement, a trust was expressly created, and where the distinction between an express and a constructive trust does not affect the resolution of the rights of the parties.
Since there was clear language in the agreement that the funds were to be held in trust, Hope J.A. remarked that there would have to be extremely strong indications to alter the plain meaning of those words. On the question of the commingling of funds, Hope J.A. stated at p. 341 that "I do not understand why the absence of an express separate account provision should cut down the effect of the express provision for a trust...." This holding is

Court headnote

Air Canada v. M & L Travel Ltd. Collection Supreme Court Judgments Date 1993-10-21 Report [1993] 3 SCR 787 Case number 22416 Judges La Forest, Gérard V.; Sopinka, John; Gonthier, Charles Doherty; Cory, Peter deCarteret; McLachlin, Beverley; Iacobucci, Frank; Major, John C. On appeal from Ontario Subjects Trust Notes SCC Case Information: 22416 Decision Content Air Canada v. M & L Travel Ltd., [1993] 3 S.C.R. 787 Ross Valliant Appellant v. Air Canada Respondent Indexed as: Air Canada v. M & L Travel Ltd. File No.: 22416. 1993: April 26; 1993: October 21. Present: La Forest, Sopinka, Gonthier, Cory, McLachlin, Iacobucci and Major JJ. on appeal from the court of appeal for ontario Trusts ‑‑ Directors of closely held corporation ‑‑ Business of corporation a travel agency ‑‑ Agreement between travel agency and airline for ticket sales ‑‑ Receipts less commission to be forwarded to airline ‑‑ Notwithstanding separate trust account for money from ticket sales, money placed in travel agency's general account ‑‑ Business difficulties resulting in directors making independent and contradictory instructions to bank as to operating account ‑‑ Bank withdrawing amount owing it on line of credit to travel agency pursuant to terms of credit agreement ‑‑ Airline suing directors personally for monies owing it ‑‑ Whether relationship between travel agency and airline one of trust or of debtor and creditor ‑‑ If trust relationship, whether directors personally liable for breach of trust by corporation. Appellant borrowed money on a personal loan, invested it in a travel agency and paid the interest from the agency's general banking account. He became one of the agency's two directors and its vice‑president. While both directors had signing authority, the day‑to‑day operation of the business was left to the other director. The travel agency, on becoming a member of IATA, signed a passenger sales agency agreement with IATA (conferring the right to sell air carrier tickets and receive commissions) and a passenger sales agency agreement with Air Canada (authorizing the agency to receive blank airline ticket stock for Air Canada and to issue tickets directly to the public). Funds collected from the sale of Air Canada tickets were to be held in trust by the travel agency and were to be paid twice a month to Air Canada. These payments were regularly made until March 1979. The travel agency obtained an operating line of credit from a chartered bank in 1978. The monies advanced under the line of credit and interest thereon constituted a demand loan in favour of the Bank. Both directors personally guaranteed the loan and authorized the Bank to remove any monies owing on the loan at any time from the agency's general account. Although a trust account was set up by the managing director for the deposit of the airline funds held by the agency, these funds were maintained in the agency's general operating bank account. A dispute arose between the directors in April 1979. The managing director discovered cancelled cheques for the instalment payments on appellant's personal loan. It was his understanding that appellant had agreed to cease making the payments for the time being and he stopped payment on the last instalment cheque. Appellant suspected the managing director of misappropriating funds and stopped payment on all cheques and withdrawals. At this time, the travel agency owed Air Canada $25,079.67 for ticket sales. The travel agency was closed for 10 days. Both directors, through their solicitors, negotiated for the purchase by one of the other's interest and both, during this time, made efforts to pay Air Canada. Appellant testified that he opened a trust account, drew cheques for the monies that were still in the company account, withdrew the stop payment orders, and attempted to transfer the funds into the new trust account. The Bank refused to transfer the funds or to honour the cheques made out to Air Canada because of the conflicting instructions from the two directors. The Bank, after sending demand notices, withdrew the full amount owing it under the line of credit from the travel agency's general account. Air Canada sued the travel agency and both directors personally for the money owed to it for ticket sales. Its claim against the travel agency was successful but the claim against the two directors was dismissed. Air Canada successfully appealed the judgment as it related to the two directors and judgment was entered against them as well. At issue here were: (1) whether the relationship between travel agency and respondent was one of trust, or one of debtor and creditor; and (2) if the relationship was one of trust, under what circumstances could the directors of a corporation be held personally liable for breach of trust by the corporation, and were those circumstances present here. The legal issue raised by this second ground of appeal concerned the standards for the imposition of personal liability to be applied to strangers who participate in a breach of trust. Although involving a corporation, the case fell to be resolved on trust principles, and does not raise general questions of the personal liability of directors for the acts of the corporation. Held: The appeal should be dismissed. Per La Forest, Sopinka, Gonthier, Cory, Iacobucci and Major JJ.: The relationship was conceded to be one of trust. The wording of the agreement evidenced an intention to create a trust. Respondent was the object of the trust and the money collected for ticket sales its subject matter. Given the intention to create a trust in the agreement between the travel agency and respondent, the absence of a prohibition on the commingling of funds could be considered but was not determinative of the type of relationship. The setting up of the trust account and the fact that the IATA agreement allowed the travel agency to affect Air Canada's legal responsibilities indicated a relationship consistent with a trust relationship. The travel agency breached the trust when it failed to account to the respondent for the monies collected through sales of Air Canada tickets. The imposition of personal liability on a stranger to a trust depends on whether the stranger's conscience is sufficiently affected to justify the imposition of personal liability. A stranger to the trust can be held liable as a constructive trustee for breach of trust (trustee de son tort). The stranger, although not appointed a trustee, takes on him‑ or herself to act as trustee and to possess and administer trust property and becomes liable if he or she commits a breach of trust while acting as a trustee. This type of liability is inapplicable here because the directors did not personally take possession of trust property or assume the office or function of trustees. Strangers to the trust can also be personally liable for breach of trust if they knowingly participate in a breach of trust. They either were acting as a trustee in receipt and chargeable with trust property (a constructive trusteeship termed "knowing receipt") or they knowingly assisted in a dishonest and fraudulent design on the part of the trustees (termed "knowing assistance"). Since the "knowing receipt" category did not apply here, the only basis upon which the directors could be held personally liable was as constructive trustees under the "knowing assistance" head of liability. This basis of liability raises two main issues: the nature of the breach of trust and the degree of knowledge required of the stranger. The knowledge requirement for this "knowing assistance" type of liability is actual knowledge; recklessness or wilful blindness will suffice. A person will be deemed to have known of the trust if it was imposed by statute. If the trust was contractually created, then whether the stranger knew of the trust will depend on his or her familiarity or involvement with the contract. The receipt of a benefit as a result of the breach of trust will be neither a sufficient nor a necessary condition for the drawing of an inference that a stranger knew of the breach. Constructive notice has been found to be insufficient to bind the stranger's conscience so as to give rise to personal liability. While cases involving recklessness or wilful blindness indicate a want of probity which justifies imposing a constructive trust, the carelessness involved in constructive knowledge cases will not normally amount to a want of probity, and will therefore be insufficient to bind the stranger's conscience. Whether the breach of trust was fraudulent and dishonest must be considered, not whether the appellant's actions should be so characterized. The stranger will be liable if he or she knowingly assisted the trustee in a fraudulent and dishonest breach of trust. Therefore, it is the corporation's actions which must be examined. Where the trustee is a corporation, rather than an individual, the inquiry as to whether the breach of trust was dishonest and fraudulent may be more difficult to conceptualize, because the corporation can only act through human agents who are often the strangers to the trust whose liability is in issue. The appellant's actions were relevant to this examination, given the extent to which the travel agency was controlled by the defendant directors. The breach of trust by the travel agency was dishonest and fraudulent from an equitable standpoint. The taking of a knowingly wrongful risk resulting in prejudice to the beneficiary is sufficient to ground personal liability. As a party to the contract between itself and the respondent, the travel agency knew that the Air Canada monies were held in trust for the respondent, and were not for the general use of the travel agency. It set up trust accounts, but never used them. It also knew that any positive balance in its general account was subject to the Bank's demand. By placing the trust monies in the general account which were then subject to seizure by the Bank, the travel agency took a risk to the prejudice of the rights of the respondent beneficiary, Air Canada. It had no right to take this risk. Appellant participated or assisted in the breach of trust. He dealt with the funds in question ‑‑ he stopped payment on all cheques, opened a trust account, and attempted to withdraw the stop payment orders and to transfer the funds into the new trust account in order to pay the respondent. The breach of trust was directly caused by the conduct of the defendant directors. Their actions in stopping payment on the cheques to protect their own interests not only prevented payment on cheques issued to Air Canada but also precipitated the seizure by the Bank of the only funds available in the unprotected general account. The directors are personally liable for the breach of trust as constructive trustees provided that the requisite knowledge on the part of the directors is proved. The knowledge requirement will not generally be a difficult hurdle to overcome in cases involving directors of closely held corporations. Such directors, if active, usually have knowledge of all of the actions of the corporate trustee. Here, however, the appellant was not as closely involved with the day‑to‑day operations as was the other director. He nevertheless knew of the terms of the agreement between the travel agency and the respondent airline because he signed that agreement and he knew that the trust funds were being deposited in the general bank account, which was subject to the demand loan from the Bank. This constitutes actual knowledge of the breach of trust because even without subjective knowledge of the breach of trust, given the facts of which he did have subjective knowledge, he was wilfully blind to the breach, or reckless in his failure to realize that there was a breach. Furthermore, appellant received a benefit from the breach of trust, in that his personal liability to the Bank on the operating line of credit was extinguished. Therefore, he knowingly and directly participated in the breach of trust, and is personally liable to the respondent airline for that breach. Per McLachlin J.: The relationship between the corporation and Air Canada was one of trust, not debtor and creditor. Appellant was clearly liable as a constructive trustee for the breach of trust which the corporation committed respecting Air Canada's account. A number of issues should not be decided here but rather left for consideration in cases in which they might arise. A stranger to a trust must know of his or her participation in a breach of trust to be personally liable for it. It was not necessary, however, to decide whether subjective knowledge (actual knowledge of the breach or wilful blindness and recklessness) or objectively determined knowledge (what a reasonably diligent person would have known) is necessary. The evidence here met the higher standard of subjective knowledge. It was also unnecessary to decide whether any breach could give rise to liability or whether the breach had to be fraudulent or dishonest because the breach here was fraudulent and dishonest in the sense that it involved a risk to the property to the prejudice of the beneficiary. Lastly, a decision as to whether liability could be imposed in the absence of personal benefit did not need to be made because appellant benefitted personally from the breach. Cases Cited By Iacobucci J. Considered: Wawanesa Mutual Insurance Co. v. J. A. (Fred) Chalmers & Co. (1969), 7 D.L.R. (3d) 283; Henry Electric Ltd. v. Farwell (1986), 29 D.L.R. (4th) 481; Andrea Schmidt Construction Ltd. v. Glatt (1979), 25 O.R. (2d) 567; R. v. Lowden (1981), 27 A.R. 91; Stephens Travel Service International Pty. Ltd. v. Qantas Airways Ltd. (1988), 13 N.S.W.L.R. 331; M. A. Hanna Co. v. Provincial Bank of Canada, [1935] S.C.R. 144; In re Penn Central Transportation Co., 328 F.Supp. 1278 (1971), rev'd 486 F.2d 519 (1973); In re Montagu's Settlement Trusts, [1987] Ch. 264; Selangor United Rubber Estates, Ltd. v. Cradock (No. 3), [1968] 2 All E.R. 1073; Barnes v. Addy (1874), L.R. 9 Ch. App. 244; Baden, Delvaux & Lecuit v. Société Générale pour Favoriser le Développement du Commerce et de l'Industrie en France S.A., [1983] B.C.L.C. 325 (Ch.), aff'd [1985] B.C.L.C. 258 (C.A.); Belmont Finance Corp. v. Williams Furniture Ltd. (No. 1), [1979] 1 All E.R. 118; Carl‑Zeiss‑Stiftung v. Herbert Smith & Co. (No. 2), [1969] 2 All E.R. 367; MacDonald v. Hauer (1976), 72 D.L.R. (3d) 110; Scott v. Riehl (1958), 15 D.L.R. (2d) 67; Horsman Bros. Holdings Ltd. v. Panton & Panton, [1976] 3 W.W.R. 745; Trilec Installations Ltd. v. Bastion Construction Ltd. (1982), 135 D.L.R. (3d) 766; Austin v. Habitat Development Ltd. (1992), 94 D.L.R. (4th) 359; disapproved: In re Morales Travel Agency, 667 F.2d 1069 (1981); referred to: Myrta Forastieri v. Eastern Air Lines, Inc., 18 Avi. 17,145 (1983); Canadian Pacific Air Lines, Ltd. v. Canadian Imperial Bank of Commerce (1987), 61 O.R. (2d) 233, aff'd (1990), 71 O.R. (2d) 63 (note); Bank of N.S. v. Soc. Gen. (Can.), [1984] 4 W.W.R. 232; McEachren v. Royal Bank (1990), 78 Alta. L.R. (2d) 158; Henry v. Hammond, [1913] 2 K.B. 515; Air Traffic Conference v. Downtown Travel Center, Inc., 14 Avi. 17,172 (1976); Air Traffic Conference of America v. Worldmark Travel, Inc., 15 Avi. 18,483 (1980); International Sales and Agencies Ltd. v. Marcus, [1982] 3 All E.R. 551; Karak Rubber Co. v. Burden (No. 2), [1972] 1 All E.R. 1210; Lee v. Sankey (1873), L.R. 15 Eq. 204; Soar v. Ashwell, [1893] 2 Q.B. 390; Shields v. Bank of Ireland, [1901] 1 I.R. 222; Gray v. Johnston (1868), L.R. 3 H.L. 1; Coleman v. Bucks and Oxon Union Bank, [1897] 2 Ch. 243; Fonthill Lbr. Ltd. v. Bk. Montreal, [1959] O.R. 451; Groves‑Raffin Construction Ltd. v. Bank of Nova Scotia (1975), 64 D.L.R. (3d) 78; Lipkin Gorman v. Karpnale Ltd., [1992] 4 All E.R. 331 (Q.B.), rev'd in part, [1992] 4 All E.R. 409 (C.A.), rev'd in part on other grounds, [1992] 4 All E.R. 512 (H.L.). By McLachlin J. Referred to: MacDonald v. Hauer (1976), 72 D.L.R. (3d) 110; Henry Electric Ltd. v. Farwell (1986), 29 D.L.R. (4th) 481; Horsman Bros. Holdings Ltd. v. Panton & Panton, [1976] 3 W.W.R. 745; Trilec Installations Ltd. v. Bastion Construction Ltd. (1982), 135 D.L.R. (3d) 766; Andrea Schmidt Construction Ltd. v. Glatt (1979), 25 O.R. (2d) 567; Scott v. Riehl (1958), 15 D.L.R. (2d) 67. Authors Cited Pettit, Philip H. Equity and the Law of Trusts, 6th ed. London: Butterworths, 1989. Sullivan, Ruth. "Strangers to the Trust", [1986] Est. & Tr. Q. 217. Underhill, Sir Arthur. Law Relating to Trusts and Trustees, 14th ed. By David J. Hayton. London: Butterworths, 1987. Waters, Donovan W. M. Law of Trusts in Canada, 2nd ed. Toronto: Carswell, 1984. APPEAL from a judgment of the Ontario Court of Appeal (1991), 2 O.R. (3d) 184, 77 D.L.R. (4th) 536, allowing an appeal from a judgment of Flanigan Dist. Ct. J. Appeal dismissed. Peter J. Bishop, for the appellant. Guy L. Poppe and Harry G. Leslie, for the respondent. The judgment of La Forest, Sopinka, Gonthier, Cory, Iacobucci and Major JJ. was delivered by Iacobucci J. -- This appeal concerns the personal liability of directors of a closely held corporation for breach of a trust by the corporation. The appellant was one of two directors of a small travel agency which contracted with the respondent airline to sell Air Canada tickets. Two main questions are raised on this appeal. First, was the relationship between the corporation and the respondent airline one of trust? Second, if so, is the appellant director personally liable for the breach of trust by the corporation? The legal issue raised by this second ground of appeal concerns the standards for the imposition of personal liability to be applied to strangers who participate in a breach of trust. Although involving a corporation, the case falls to be resolved on trust principles, and does not raise general questions of the personal liability of directors for the acts of the corporation. I. Background In 1973, the defendant Phil Martin and one Ross Linton incorporated M & L Travel Limited (M & L) to carry on the business of a travel agency in Ottawa. In 1975, Linton withdrew from the business and Martin continued by himself. In 1977, Martin wanted M & L to become a member of the International Air Transport Association (IATA) so that he could receive larger commissions and issue tickets directly to customers. To become a member, M & L had to fulfil certain requirements. These included having working capital of at least $20,000 and the sponsorship of a major airline. Therefore, in the fall of 1977, Martin invited the appellant Valliant to become a shareholder and invest in M & L. In January 1978, Valliant invested $25,550 in M & L and acquired 50 percent of the issued shares. Valliant obtained this money through a personal loan on which he was required to pay monthly instalments of $752. The trial judge found that Martin had agreed that Valliant could withdraw this amount from M & L's account on a monthly basis until the personal loan was paid in full. Martin became President of M & L and Valliant its Vice-President, and they were its sole directors. Each had signing authority, but Martin ran the day-to-day business. Valliant, who had no experience with the travel agency business, dropped in occasionally and worked full time, for a salary, only when Martin was ill or on vacation. In November 1978, Valliant brought his wife into the travel agency to deal with problems with M & L's books. She was given signing authority and worked part time for the agency until April 1979. The IATA accepted the membership application of M & L based on sponsorship by Air Canada. M & L entered into two written agreements. The first was a passenger sales agency agreement between IATA and M & L, executed on September 14, 1978 and signed by Martin as President. This agreement conferred on M & L the right to sell air carrier tickets and receive commissions. Valliant was familiar with the contents of this agreement. The second agreement, also called a passenger sales agency agreement, was entered into between M & L and Air Canada on March 15, 1979 and was signed by Valliant as Vice-President. This agreement authorized M & L to receive blank airline ticket stock from Air Canada and to issue tickets directly to the public. Funds collected from the sale of Air Canada tickets were to be held in trust by M & L and paid twice a month to Air Canada. Until March 1979, these payments were regularly made. The agreement contained the following clause: All monies, less applicable commissions to which the Agent is entitled hereunder, collected by the Agent for air passenger transportation (and for which the Agent has issued tickets or exchange orders) shall be the property of the Airline, and shall be held in trust by the Agent until satisfactorily accounted for to the airline. All such monies, less applicable commissions to which the Agent is entitled hereunder, shall be remitted to the Airline by the Agent in accordance with the Airline's accounting procedures. On August 30, 1978, M & L obtained an operating line of credit of $15,000 from the Provincial Bank of Canada in Ottawa (the Bank). Martin and Valliant personally guaranteed the loan and authorized the Bank to remove from the general account of M & L any monies at any time owing on the loan. The monies advanced under the line of credit and interest thereon constituted a demand loan in favour of the Bank. Also in 1978, Martin set up trust accounts on behalf of M & L for the deposit of the airline funds. For unexplained reasons, these accounts were never used. Instead, M & L maintained a general operating account with the Bank. Funds from all sources, including the sale of Air Canada tickets, were placed in this account. General operating expenses, the interest on the line of credit, Valliant's personal loan payments, and Martin's salary were all paid out of this account. In April 1979, a dispute arose between Martin and Valliant. Martin, concerned about the poor cash flow position of the agency, went into the office on April 5, 1979. He found the cancelled cheques for the instalment payments on Valliant's personal loan. Martin thought that Valliant had agreed to cease making the payments for the time being, and therefore, Martin called the Bank and stopped payment on the last instalment cheque. He took the day's receipts and a number of cancelled cheques to his lawyer. On April 6, 1979, Valliant noticed the missing funds and documents, and suspected that Martin was misappropriating funds. He changed the locks on the doors and called the Bank and stopped payment on all cheques and withdrawals. At this time, M & L owed Air Canada $25,079.67 for ticket sales. Between April 6 and April 16, 1979, the business of M & L was closed. Martin and Valliant, through their solicitors, negotiated for the purchase by one of the other's interest. During this time, both Valliant and Martin made efforts to pay Air Canada. Valliant, in particular, testified that he opened a trust account, drew cheques for the monies that were still in the company account, withdrew the stop payment orders, and attempted to transfer the funds into the new trust account. However, the Bank refused to transfer the funds or to honour the cheques made out to Air Canada because of the conflicting instructions from Martin and Valliant. The Bank, now aware of the financial and managerial difficulties facing M & L, sent a demand notice to Valliant, M & L, and probably Martin on April 23, 1979. On April 24, 1979, the Bank withdrew $15,184.11 from the operating account, satisfying in full the demand note relating to the line of credit personally guaranteed by both Martin and Valliant. Air Canada sued M & L and Martin and Valliant personally for the $25,079.67 owed to it for ticket sales. At trial, Air Canada succeeded against M & L but the trial judge dismissed the claim against Martin and Valliant. The Ontario Court of Appeal allowed the appeal of Air Canada and entered judgment against Martin and Valliant as well. II. Judgments Below A. Ontario District Court (Flanigan Dist. Ct. J.) The trial judge held that there was clearly a trust relationship between Air Canada and the travel agency, and that the travel agency had breached that trust by failing to protect Air Canada's interest. However, the more difficult question was whether Martin and Valliant were personally liable for breach of trust. The trial judge stated that the only way in which liability could be imposed on the individual defendants is if they had taken it upon themselves to possess and administer trust property for the beneficiary as if they were trustees. Each individual would then be a trustee de son tort. However, the trial judge concluded: ... in this case there is no assumption, in my view, by the individual defendants to assume this trust. It is true, in signing the bank documents they gave the bank the right to do as they did but right up until the last moment they were trying each in their own way effectively or not, to protect the interest of Air Canada to keep their own interest alive by preserving the business of the travel agency. . . . So, I see nothing mala fides in the actions of the individual defendants and I think they were inept in some of their actions but, they were in no way, in my view, trustees that breached a trust so far as Air Canada is concerned. Therefore, the trial judge dismissed the claim against the individual defendants. B. Ontario Court of Appeal (1991), 2 O.R. (3d) 184 (Griffiths J.A.) Griffiths J.A. began by noting that it was not contested that there was a trust relationship between Air Canada and M & L, and that M & L was liable for breach of that trust. He also agreed with the trial judge that the individual defendants in this case could not be classified as trustees de son tort. In Law of Trusts in Canada (2nd ed. 1984), Professor Donovan Waters states that to be held liable as a trustee de son tort, the trustee must have possession and control of the trust property. To have that possession and control, the trustee must have some legal right or title to the trust property. In this case, the trial judge properly found that neither Martin nor Valliant had assumed legal control or possession of the trust funds, since the funds were at all times administered in the name of M & L. Griffiths J.A. held that M & L was clearly liable for breach of contract since it failed to remit the funds as required. However, as directors, Martin and Valliant could not be held personally liable for that breach of contract. It was therefore necessary, for Martin and Valliant to be potentially personally liable, that M & L also be found to have been in breach of trust. Griffiths J.A. concluded at p. 194: ... on the authority of Canadian Pacific Airlines Ltd. v. Canadian Imperial Bank of Commerce (1987), 61 O.R. (2d) 233, ... affd Ont. C.A., Robins, Krever and Carthy JJ.A., January 19, 1990 (. . . 71 O.R. (2d) 63 (note) . . .), that the agreement between Air Canada and the corporation clearly created a trust relationship between them with the result that any monies received by the corporation from the sale of Air Canada tickets were impressed with a trust. Griffiths J.A. then went on to consider whether the directors could be personally liable for the breach by their corporation of a trust relationship created by contract. This issue, he noted, had not been considered in any reported Canadian or English cases. He reviewed several cases where the directors had been held personally liable for breaches of trust imposed by statute, including Wawanesa Mutual Insurance Co. v. J. A. (Fred) Chalmers & Co. (1969), 7 D.L.R. (3d) 283 (Sask. Q.B.); Henry Electric Ltd. v. Farwell (1986), 29 D.L.R. (4th) 481 (B.C.C.A.); and Andrea Schmidt Construction Ltd. v. Glatt (1979), 25 O.R. (2d) 567 (H.C.). Griffiths J.A. also referred to Myrta Forastieri v. Eastern Air Lines, Inc., 18 Avi. 17,145 (D.P.R. 1983), a U.S. decision involving facts similar to the present case. In that case, the court held, at pp. 17,148-17,149 that: Irrespective of good faith or intent, in an instance wherein the corporation had a duty to pay out funds from designated proceeds but such proceeds were used for other purposes, the directors were held personally liable because they had a duty to see that the funds were used for the agreed-upon purpose and they could not excuse themselves on the grounds that they did not dissipate or misappropriate the funds nor were in other respects derelict in their duty. . . . . . . We agree, therefore, that failure to remit funds collected by a corporate agent which belong to its principal airline gives rise to personal liability of those corporate employees who participate in the conversion. The imposition of such liability presumes, however, that the responsible persons actually had possession or control over the property such that it could be said that their conduct constitutes participation. Under the circumstances of the present case the joint control over the financial affairs and operations of this very closely held corporation by the two individual plaintiffs/counterdefendants supports a finding that if conversion occurred, it was a joint act of those two persons. They shared ownership of the corporation equally; they shared management of the business operations equally; they shared equally in the special compensation arrangements set up for themselves; and most important, they shared control over the corporate accounts since all checks issued required both their signatures. . . . Griffiths J.A. concluded that Wawanesa v. Chalmers, Henry Electric Ltd. v. Farwell and Andrea Schmidt Construction Ltd. could not be distinguished on the basis that the trust was created by statute. Instead, he held, at p. 203, that: What is significant in those cases is that the shareholders and directors that were held responsible were the sole owners and directors and were the sole directing and operating minds of the corporations. . . . For the purposes of this appeal, I adopt the reasoning of the United States District Court of Puerto Rico in Myrta Forastieri v. Eastern Air Lines, supra, that it is just and equitable to impose personal liability on directors who participate in the breach of trust by the corporation because, in effect, they have participated in a conversion of trust funds. Griffiths J.A. then reviewed the facts which justified the imposition of personal liability in the case at bar. First, both Martin and Valliant had at least some control over the operation of the business, and both had signing authority. Second, it was Martin and Valliant as the operating minds of M & L who deposited the trust funds in the general operating account and paid operating expenses out of that account. Third, M & L had a duty to (at p. 204) "keep these monies separate, to earmark them as funds held for Air Canada and, at the very least, to advise the bank that such funds, separately maintained, were trust funds". Since this was not done, M & L committed a breach of trust. Finally, the Bank seized the funds from the account because Martin and Valliant had both stopped payment on cheques issued on the account: "The movement of these directors, acting solely in their own interest to stop payment on cheques, not only prevented payment on cheques issued to Air Canada, but precipitated the seizure by the bank of the only funds available in the unprotected general account" (p. 204). Therefore, Griffiths J.A. concluded at pp. 204-5: In my view, this is an appropriate case to impose personal liability on Martin and Valliant for the breach of trust. They were the sole owners and operating minds of the corporation. They directed and authorized the deposit of funds from Air Canada sales in the general account without in any way designating these funds as trust funds. They permitted these funds to be intermingled with other funds and they drew cheques on these funds in complete disregard of the trust obligations imposed under the agreement with Air Canada, an agreement which conferred on the corporation of which they were the sole shareholders the important privilege of selling Air Canada tickets directly to the public. Martin and Valliant permitted Air Canada funds to be placed in a general account that was overdrawn without adequate controls and, in particular, without advising the bank that these funds were trust funds, with the result that these funds were exposed to appropriation by the bank to satisfy the corporation's loan guaranteed by Martin and Valliant. In failing to exercise proper control over the trust funds, both Martin and Valliant received a benefit in that their personal liability to the bank was extinguished. The steps taken by Martin and Valliant to protect the interests of Air Canada were inept, and too little too late. In any event, these steps were taken to preserve the travel agency and not to protect Air Canada's interest. Griffiths J.A. therefore concluded that Martin and Valliant were both parties to the conversion of trust funds and should be held personally liable. III. Issues As mentioned at the outset, there are two main issues raised in this case. First, was the relationship between M & L and the respondent one of trust, or one of debtor and creditor? Second, if the relationship was one of trust, then under what circumstances can the directors of a corporation be held personally liable for breach of trust by the corporation, and are those circumstances present in this case? IV. Analysis 1. The Nature of the Relationship between M & L and Air Canada In this Court, the appellant initially argued that the relationship between M & L and the respondent airline was one of debtor and creditor, rather than one of trust. However, at the hearing, the appellant properly conceded that the relationship was one of trust. Given this concession, I will consider this question only briefly. The appellant relied on the fact that the agreement between the airline and M & L did not require it to keep the proceeds of Air Canada tickets in a separate account or trust fund, or to remit the funds forthwith. Rather, M & L was permitted to keep such funds for a period of up to 15 days, and then for a further 7-day grace period. Furthermore, M & L was liable for the total sale price of all tickets sold, less its commission, regardless of whether it had actually collected the full amount from its customers. That is, M & L was free to sell Air Canada tickets on credit to its customers. Prior to his concession on this point, the appellant submitted that, in these circumstances, M & L was not a trustee of the sale proceeds of the Air Canada tickets. In concluding that the relationship between M & L and the airline was one of trust, the Court of Appeal relied on Canadian Pacific Air Lines, Ltd. v. Canadian Imperial Bank of Commerce (1987), 61 O.R. (2d) 233. Although the Court of Appeal's decision in that case (1990), 71 O.R. (2d) 63 (note), was brief, the reasons of the trial judge, at p. 237, went into greater depth: In order to constitute a trust, an arrangement must have three characteristics, known as the three certainties: certainty of intent, of subject-matter and of object. The agreement . . . is certain in its intent to create a trust. The subject-matter is to be the funds collected for ticket sales. The object, or beneficiary, of the trust is also clear; it is to be the airline. The necessary elements for the creation of a trust relationship are all present. I find that such a relationship did exist between CP and the two travel agencies. This analysis is clearly applicable to the facts of the present case. That the intent of the agreement is to create a trust is evident from the following wording: "All monies, less applicable commissions to which the Agent is entitled hereunder, collected by the Agent for air passenger transportation (and for which the Agent has issued tickets or exchange orders) shall be the property of the Airline, and shall be held in trust by the Agent until satisfactorily accounted for to the airline." The object of the trust is the respondent airline, and its subject-matter is the funds collected for ticket sales. While the presence or absence of a prohibition on the commingling of funds is a factor to be considered in favour of a debt relationship, it is not necessarily determinative. See R. v. Lowden (1981), 27 A.R. 91 (C.A.), at pp. 101-2; Bank of N.S. v. Soc. Gen. (Can.), [1984] 4 W.W.R. 232 (Alta. C.A.), at p. 238; McEachren v. Royal Bank (1990), 78 Alta. L.R. (2d) 158 (Q.B.), at p. 183; Stephens Travel Service International Pty. Ltd. v. Qantas Airways Ltd. (1988), 13 N.S.W.L.R. 331 (C.A.), at p. 341. In R. v. Lowden, supra, McGillivray C.J.A. stated as follows at pp. 101-2: Undoubtedly a direction that moneys are to be kept separate and apart is a strong indication of a trust relationship being created. It does not appear to me, however, that the converse is necessarily so. In the case of a travel agent, how he handled the funds handed to him for the purchase of a ticket would, as far as the public is concerned, be something that they would not have reason to think about. It would be a matter of internal management. The fact that there is no specific discussion about moneys being kept separate and apart from other moneys does not detract from the fact that the money is paid for a particular purpose, namely the obtaining of tickets for specific flights or reservations at named accommodation for a particular period. The appellant relied on the decision of this Court in M. A. Hanna Co. v. Provincial Bank of Canada, [1935] S.C.R. 144. In that case, the Court dealt with the relationship between a supplier of coal and its sales agent. The Court concluded that the relationship was one of debtor-creditor, citing the fact that the parties had specifically cancelled a portion of their agreement requiring the separation of the funds collected by the sales agent. The sales agent paid the supplier by cheques drawn on its general account. The supplier's acquiescence to this practice, and the fact that the agent had use of the funds before payment came due, indicated to this Court that the parties viewed their relationship as one of debtor-creditor. The Court relied on the following passage from Henry v. Hammond, [1913] 2 K.B. 515, at p. 521: It is clear that if the terms upon which the person receives the money are that he is bound to keep it separate, either in a bank or elsewhere, and to hand that money so kept as a separate fund to the person entitled to it, then he is a trustee of that money and must hand it over to the person who is his cestui que trust. If on the other hand he is not bound to keep the money separate, but is entitled to mix it with his own money and deal with it as he pleases, and when called upon to hand over an equivalent sum of money, then, in my opinion, he is not a trustee of the money, but merely a debtor. This decision was distinguished in Qantas, supra, at p. 348, by Hope J.A., dealing with facts similar to the present case: As it seems to me, . . . the decision . . . has no relevance to the circumstances of the present case where, on the proper construction of the agreement, a trust was expressly created, and where the distinction between an express and a constructive trust does not affect the resolution of the rights of the parties. Since there was clear language in the agreement that the funds were to be held in trust, Hope J.A. remarked that there would have to be extremely strong indications to alter the plain meaning of those words. On the question of the commingling of funds, Hope J.A. stated at p. 341 that "I do not understand why the absence of an express separate account provision should cut down the effect of the express provision for a trust...." This holding is

Air Canada v. M & L Travel Ltd.

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