Understanding Article 3-A Trust Fund Claims in NY Construction Projects

By Kushnick Pallaci PLLC | www.nyconstructionlaw.com

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Introduction

Trust fund diversion is one of the most serious allegations a contractor or subcontractor can face in a New York construction dispute. Governed by Article 3-A of the New York Lien Law, trust fund claims can lead to personal liability for company officers, contractors, and even third-party recipients of construction funds. At Kushnick Pallaci PLLC, we have successfully litigated trust fund cases throughout New York—from Manhattan high-rises to Suffolk County subdivisions—defending clients against aggressive claims and preserving their rights.

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What Is Article 3-A of the NY Lien Law?

Article 3-A of the New York Lien Law creates a statutory trust over funds received for the improvement of real property. In simple terms, any money a contractor, subcontractor, or construction manager receives for a job is not theirs to spend freely—it must first be used to pay those who furnished labor or materials on that project.

These funds are held in trust for the benefit of:

• Subcontractors

• Material suppliers

• Laborers

• Design professionals

Until those obligations are paid in full, the funds must be treated separately. Any improper use is considered diversion, even if not intentionally fraudulent.

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What Constitutes a Trust Fund Diversion?

A diversion occurs when trust funds are used for any non-trust purpose before all lawful trust claims have been satisfied. Common examples include:

• Paying unrelated corporate expenses (rent, payroll, etc.)

• Transferring funds to a different project

• Commingling funds with other operating accounts

• Paying debts unrelated to the specific construction job

The diversion does not require fraudulent intent—just improper use of trust assets. That’s why even bookkeeping mistakes or cash flow juggling can lead to personal exposure.

A plaintiff bringing a claim must generally show:

1. The defendant was a trustee of funds under Article 3-A

2. There were valid trust claims that went unpaid

3. Funds were used for non-trust purposes before satisfying the trust claims

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Who Can Be Liable – Officers, Subs, Suppliers

One of the most far-reaching aspects of Article 3-A is that it extends liability to individuals, not just the corporate trustee. Under the statute and case law, potential defendants include:

• Corporate officers or directors who controlled the funds

• Bookkeepers or employees who directed payments

• Other contractors or suppliers who received diverted trust funds with knowledge

In some cases, even banks or lenders have been drawn in if they participated in or benefited from trust fund diversions. The law is aggressively enforced—especially in cases involving nonpayment and bankruptcies.

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Evidence Needed to Prove or Defend a Claim

Whether you’re bringing or defending a trust fund diversion claim, success often hinges on documentation and accounting.

Plaintiffs must show:

• That trust funds existed (e.g., payment from owner to GC)

• That they were unpaid beneficiaries

• That the funds were spent on non-trust purposes

Defendants must show:

• That all trust obligations were paid

• Or that non-trust payments were made only after trust obligations were satisfied

Common types of evidence include:

• Invoices and payment records

• Bank statements and wire transfers

• Subcontract agreements

• Job cost breakdowns

• General ledgers or QuickBooks entries

At Kushnick Pallaci PLLC, we often use detailed accounting analysis, project-specific ledgers, and expert testimony to rebut diversion claims and demonstrate compliance with Article 3-A.

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How Kushnick Pallaci PLLC Defends Trust Fund Allegations

Defending a trust fund diversion claim requires both legal precision and a forensic approach to the facts. Our firm routinely defends:

• General contractors accused of diverting funds

• Corporate officers facing personal liability

• Developers and owners sued under accessory liability theories

We use a multi-pronged strategy to:

• Challenge standing and trust fund existence

• Dispute the diversion element with detailed accounting

• Attack improper or inflated trust fund claims

• File counterclaims for breach of contract or overpayment

• Seek dismissal under CPLR based on failure to state a claim

Whether you're defending a six-figure claim or facing a demand for personal contribution, our firm brings deep experience in New York Lien Law litigation.

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Conclusion: Trust Fund Claims Demand Immediate Action

If your business is named in a trust fund diversion lawsuit—or you suspect that funds from your project are being misused—don’t wait. These cases escalate quickly and can expose contractors and officers to personal liability, even in the absence of fraud.

At Kushnick Pallaci PLLC, we represent construction professionals throughout New York in trust fund diversion defense, lien foreclosure cases, and breach of contract litigation. Let us help protect your business, your reputation, and your future.

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OSHA Settlement Set Aside Due to "Judge's error"

The Occupational Safety and Health Review Commission recently set aside a a settlement that had been approved by the administrative law judge despite the fact that the time to challenge the order had passed and the order had become final.  Apparently both the respondent and the Department of Labor (as well as the administrative law judge) failed to recognize that the settlement left one item on one of the citations open.  This resulted in the settlement not "fully resolving" all issues in the citations.  Thankfully for all involved, the OSHRC found justification for opening the order and remanding it for correction.

The case is a good reminder that mistakes happen and its always a good (great) idea to double check key documents to make sure they say what you think they say.  

The case was Secretary of Labor v. True Value Company.

Vincent T. Pallaci is the managing member of Kushnick Pallaci PLLC.  His practice includes defense of OSHA citations and other construction law issues.

Hope for contractors? Appellate Court Says Not Every Fall From Height Equals Strict Liability

New York's Labor Law drives up the cost of construction in New York because it drives up the cost of insurance in New York.  The main reason for this is the so called "strict liability" provided by the Labor Law when it comes to falls from heights.  But the Appellate Division recently reminded us that not every fall from a height results in automatic liability.

The case involved a fall of some 30 feet on the new World Trade Center.  Apparently a worker stepped on a pipe scaffold that gave way.   The plaintiff moved for summary judgment but the trial court denied the motion finding questions of fact.  Specifically, they questioned whether there were adequate anchor points from which the injured worker (who was wearing a harness with a double lanyard) could have tied off.  Sure the jury may ultimately find for the injured worker.  But cases like this provide a glimmer of hope for those trying to fight back against New York's Labor Law.

The case was Giordano v. Tishman Const. Corp.

Vincent T. Pallaci is the managing member of Kushnick Pallaci PLLC.  His practice includes defending contractors and owners against Labor Law claims and prosecuting claims against insurance companies that refuse to provide coverage to contractors and owners.

"Pay-when-Paid" provision struck down by Appellate Court

The District Court in Nassau County was faced with a claim by a contractor that sought to enforce a mechanic's lien and recover for alleged non-payment under a construction contract.   The contract at issue contained the following provision:

The obligation of Contractor to make any payment under this Agreement, whether a progress or final payment, or for extras or change orders, is subject to the express condition precedent of payment therefor by Owner and Owner's lender. Owner's and Owner's lender's determination of the percentage complete of Subcontractor's Work shall be final and binding and Subcontractor agrees that in no event shall Subcontractor receive payment from Contractor for a greater proportionate value of the Work than what is approved by Owner and Owner's lender.

The Appellate Term held that the provision was a "pay-when-paid" clause and thus, under long settled New York law, was void and unenforceable.  Unfortunately for this contractor-plaintiff the contract also contained a severability clause and six month limitations period.  Therefore, while the pay-when-paid portion was struck down, it did not void the entire agreement by virtue of the severability clause and the Court refused to strike down the six month limitations period.  Because the plaintiff failed to file its claim within six months, the claims were time barred and dismissed.  

The case was Polar Bear Mechanical, Inc. v. Walison Corp.

Supreme Court: Criminal Intent Required for Punitive Damages Under Article 3A

Lien Law Article 3A has become increasingly popular (or unpopular if you are the accused) in construction claims.  In general, Article 3A requires that contractors hold funds they are paid in trust for all beneficiaries of the project and that such funds not be used for a "non-trust purpose" until the claims of all beneficiaries are resolved.  Lien Law Section 77 vests the Court with the power to impose punitive damages in the appropriate case.  But not every case of a trust diversion warrants the imposition of punitive damages.

In Jorge v. Piola Property Management, the Nassau County Supreme Court was faced with a motion seeking to dismiss various portions of a home owner's claim against a contractor including a claim for punitive damages under Article 3A.  The Court granted the motion to the extend of dismissing the claim for punitive damages.  In doing so, it cited to controlling Second Department authority that says a trust diversion claim must include "criminal intent" in order to trigger punitive damages.  Essentially, this allows for a "good faith dispute" defense to the contractor.   Interestingly, the motion was a 3211(a)(7) motion to dismiss which appeared to have made while the case was in its infancy.  You have to wonder what the Court would do if facts come out in discovery showing that there was such "criminal intent."  Stay tuned...