Constructive Trusts and the Rights of Creditors

Some of the leading Canadian cases dealing with constructive trusts have arisen out of common-law relationships. One common-law spouse (let’s say the common-law wife) contributed money or work to property owned by the other (the common-law husband). The relationship breaks down. The common-law wife who contributed the money or work sues the common-law husband, claiming that he has been unjustly enriched by her contributions. The court agrees. The court then imposes a constructive trust on the common-law husband’s property, giving the common-law wife an ownership interest. See for example Peter v. Beblow, [1993] 1 SCR 980.

But what if in the above example, the common-law husband has borrowed money from another person. Should the common-law wife’s claim have priority over the creditor? If the court imposes a constructive trust in her favor, she might get priority.

Suppose we take this a step further. The common-law couple is still together. The common-law husband runs into financial difficulty. He has given a lender security over a valuable asset that he held in his name only. The common-law wife says she contributed to the asset, and is entitled to an interest in the asset in priority to the lender.

This was one of the issues in Melchior v. Pricewaterhouse Coopers, 2007 BCSC 136, a recent Supreme Court of British Columbia decision.

Mr. Cable and Ms. Melchior lived in a common-law relationship for about 10 years. Mr. Cable had invented and patented a wood gluing apparatus and process. He also had the majority interest through a holding company in a wood production and sale business: Interact Wood Products Inc. Ms. Melchior also had a smaller interest in the holding company.

Both Mr. Cable and Ms. Melchior were involved in the business. In order to get some capital, Interact Wood Products borrowed $3.5 million from a private lender. He gave a personal guarantee, and gave the lender a security interest in his patent rights.

Sadly, the business failed. Both Interact Wood Products and Mr. Cable personally went bankrupt.

Ms. Melchior asserted a claim in the bankruptcy proceedings to an interest in the patent rights. She claimed that Mr. Cable held the rights as a resulting or constructive trustee for her. If she were successful, she would have the rights of a co-owner to the patent. She could set up another operation with Mr. Cable’s assistance, and use the patent rights. She could use the patent and compete against a co-owner.

One of the arguments Ms. Melchior made was that Mr. Cable, and his creditors, was unjustly enriched by her efforts in the business. To succeed she needed to prove the following:
1. Mr. Cable and his creditors were enriched by her work;
2. She suffered a corresponding deprivation; and
3. There was no juristic reason for the enrichment.

Mr. Justice Masuhara found against Ms. Melchior on all three counts.

First, Ms. Melchior was well paid for her work in the business. She drew salaries, and Interact Wood Products Ltd. covered some of her expenses such as some of her meals. Although she received benefits from the business, including the loan, she was insulated from most of the financial risks.

Secondly, the deprivation was the loss of business because of market reversals. It was not the type of deprivation against which the law of unjust enrichment afforded protection.

Thirdly, there were juristic reasons for the lender to benefit from its security ahead of any claims by Ms. Melchior. The lender made the loan in good faith on the basis of its agreement with Mr. Cable and Interact Wood Products Ltd. The patent was registered in Mr. Cable’s sole name. Ms. Melchior was aware of the terms of the loan agreements, but raised no objection to Mr. Cable giving the lender a security interest in the patent when the loan was made. Ms. Melchior did not assert any claim to an interest in the patent until after Interact Wood Products defaulted on the loan. She had no reasonable expectation to an interest in the patents.

Mr. Justice Masuhara distinguished between the cases where one common-law spouse is making an unjust enrichment claim against the other in the context of a breakdown in the relationship, and the claim by a common-law spouse to defeat a creditor of her common-law spouse. He wrote at paragraph 84:

The somewhat unique feature of this case is that while Ms. Melchior’s claim is a claim of unjust enrichment against her spouse, this is not a case where the court is being asked to divide the remnants of a spousal relationship that has come to an end. Rather, the sought after interest is in a business assets and the relief claimed is to enable Ms. Melchior and Mr. Cable to continue on together with their business by limiting the scope of security available to creditors of Mr. Cable, and in particular, 568 a secured creditor.

In a nutshell, the court found that it would have been unjust for the court to impose a constructive trust in favor of Ms. Melchior to the prejudice of Mr. Cable’s creditors.