Demystifying the deemed trust

References to deemed trusts have cropped up more and more frequently over the past few years in matters involving underfunded pension plans and plan sponsor insolvencies. Yet the precise meaning of this obscure bit of legal jargon remains a mystery to many. The aim of this article, then, is to begin to demystify the deemed trust.

Put simply, a “deemed trust” is shorthand for a particular deeming rule, or legal fiction, imposed by legislation. It operates off the well-established legal principle that where a person holds property in trust, that property will be excluded from the person’s estate in the event of bankruptcy, so that the trust beneficiary can claim such property ahead of the person’s creditors.

This principle is sound enough when applied to actual property which is being held in a true trust separate and apart from the trustee’s own property. But beginning around the 1970s, Canadian federal and provincial legislators decided it might be a good idea to extend this principle—and thus the protection it would afford to particular parties in the event of default—by treating certain amounts as if they were held in trust under statutes governing everything from tax collection to travel agents, notwithstanding that no assets had in fact been put aside and that no trust had in fact been created.

In particular, virtually every pension reform statute of the late 1980s and early 1990s created a deemed trust over specified categories of contributions which were not remitted to pension funds. The thinking was that current and retired employees of an employer which failed to remit contributions to its pension fund within the required statutory deadline should stand first in line with regard to such “missed” contributions.

While the basic objective of the statutory deemed trust concept is straightforward enough, in practice it has given rise to a number of issues. To begin with, there is the issue of the scope of the deemed trust provisions in any particular pension legislation. Canada being Canada, the precise wording of the deemed trust provisions typically varies slightly from one pension benefits statute to another.

For example, while the general thrust of the provisions to cover missed contributions is tolerably clear, the reference in some statutes to amounts that are merely “accrued” as opposed to “due” can muddy the waters as to when and over what amounts the deemed trust should apply.

Then there is the constitutional angle. At bottom, questions about which assets may be accessed by which parties in the event of a person’s bankruptcy are questions about insolvency, and insolvency has long been held to be a field of federal, as opposed to provincial, jurisdiction under the Canadian constitution. Under the so-called “paramountcy” doctrine of constitutional law, federal legislation will trump provincial legislation in regard to matters of federal jurisdiction. Courts all the way up to the Supreme Court of Canada have therefore held that a deemed trust created by provincial statute will effectively be ignored in the event the person ostensibly subject to the deemed trust goes bankrupt.

Ramifications
This has significant implications for provincially-registered pension plans of insolvent employers. Where such an employer seeks protection from its creditors under the Companies’ Creditors Arrangement Act (CCAA), and is temporarily excused by the CCAA court order from its obligation to make deficit reduction contributions to its pension plans, the amount of those missed contributions becomes subject to a deemed trust. That is to say, the pension plan ranks ahead of all the employer’s creditors in respect of such amount.

But if the employer corporation cannot successfully restructure and subsequently tumbles into actual bankruptcy, the deemed trust will essentially dissolve, and the missed contributions will henceforth rank only as unsecured claims against the remaining assets of the now-bankrupt corporation. Indeed, the Ontario Court of Appeal held in the 2006 Ivaco case that this “flipping” of the pension deemed trust’s priority did not constitute sufficient grounds for preventing an insolvent employer from being taken out of CCAA protection and put into bankruptcy by its secured creditors. (The Supreme Court agreed to hear an appeal from such decision, but the case then settled and so the Supreme Court hearing was cancelled.)

All of this is to say that the deemed trust provisions of provincial pension legislation are critical in a pre-bankruptcy situation but ultimately may prove to be of relatively limited effect. However, what of the minority of pension plans registered under federal pension legislation? Here there is no issue of constitutional paramountcy, such that the deemed trust created under the federal Pension Benefits Standards Act, 1985 cannot automatically be trumped by federal bankruptcy legislation.

That statement may be true as far as it goes. However, the federal Bankruptcy and Insolvency Act has recently been amended to create a new “super-priority” for certain types of missed pension contributions and not for others. The question thus logically arises as to whether such super-priority would have been necessary in the first place, if the federal deemed trust rules already took the missed contributions out of the bankrupt corporation’s estate altogether.

In the meantime, the effect of the deemed trust rules in any given situation must be carefully considered at least up until the point of bankruptcy, with regard to both federally-registered and provincially-registered pension plans. There is no doubt that the deemed trust is perceived by pension regulators as a powerful instrument in their enforcement arsenal and by lenders to financially-troubled plan sponsors as a significant concern. So continued close attention to and better understanding of these rules is the order of the day.