Saturday, May 28, 2011

Appellate Division Rules Owner Has Standing to Bring Trust Diversion Claim

The Appellate Division, Second Department, recently ruled, for the first time, that owners of construction projects are beneficiaries of the trust created under Article 3A of the Lien Law and, therefore, have standing to bring claims against contractors, and their corporate principals, for diversions of trust funds. While the author of this blog has been bringing trust fund claims on behalf of owners against contractors and their corporate principals for many years, the decision in Ippolito v. TJC Dev. is the first reported decision in the Second Department to provide a definitive "yes" to the question of whether owners have standing to bring trust violation claims against the contractor and its corporate principals.

In Ippolito the owners argued that they were beneficiaries of the trust funds created under Section 70 (Article 3A) of the Lien Law. The trial court held that the owners lacked standing to bring trust diversion claims. However, the Appellate Division reversed and held that owners do, in fact, have standing as they are intended beneficiaries of the Lien Law trusts. The Court noted that "the primary purpose of article 3-A and its predecessors[is] to ensure that those who have directly expended labor and materials to protect real property [or a public improvement] at the direction of an owner or a general contractor receive payment for work actually performed. The Court went on to say that the trust commences "when any asset thereof comes into existence and continues until all trust claims have been paid or discharged, or all assets have been applied for trust purposes." In finding that the owners do have standing as beneficiaries of the trust fund to bring a claim for trust diversions the Court found that the funds paid by the owners to the general contractor "remained the property of the owners...until the proper payment of such funds by the contractor to the purposes of the home improvement contract, breach by the owners relieving the contractor of its obligation to perform or substantial performance of the contract." The Court goes on to note that the 1987 amendments to the Lien Law make it clear that article 3-A was intended to protect home owners as well as others.

The Ippolito decision was a landmark victory for owners of construction projects and will pave the way for owners to bring trust diversion claims against their contractor, and their contractor's corporate principals, when the contractor fails to use the money it receives towards completing the construction project. While Ippolito involved a home owner, the analysis by the Court clearly establishes that all owners, including commercial and public project owners, will have standing to bring trust diversion claims against contractors.

Under Ippolito the owner will have standing to bring the trust claim until: 1) until the proper payment of the funds paid to the contractor to the purpose of the home improvement contract; 2) until breach by the owner relieving the contractor of its obligations to perform; or 3) until substantial performance of the contract by the contractor. Of course this means that the contractor now knows of three defenses that it can assert to the trust diversion claim: 1) all funds were properly paid for purpose of the home improvement contract thus divesting the owner of standing to bring the claim; 2) the owner breached the contract and therefore relieved the contractor of its obligation to perform; and 3) the contract has been substantially performed. It would seem that these three defenses should be asserted as affirmative defenses to any trust diversion claim brought against the contractor.

It will be interesting to see how attorneys begin to use Ippolito to help owners recover against unscrupulous contractors. The owner now has a very powerful tool in that it can bring the trust diversion claim no only against the contractor but against the contractor's corporate principals. Since trust diversion liability is not dischargeable in bankruptcy, contractors face a significant threat when they chose to use trust funds received from the owner for non-trust purposes.

Vincent T. Pallaci is a partner in the New York construction law firm of Kushnick Pallaci, PLLC where he practices construction law across the state of New York. He can be reached at (631) 752-7100 or via e-mail at


  1. How can this ruling help subcontractors to obtain the money due them, via the GC?

  2. There are two interesting aspects to the decision. First, it confirms, that owners, as Lien Law trust fund beneficiaries, have standing to bring trust fund diversion claims against contractors. This of course is no help to the subcontractor. However, the second important aspect of the decision is that it confirms, for the first time at the appellate level in the Second Department, that corporate principals can be held personally liable for trust diversion claims.

    For many years I have been bringing trust diversion claims on behalf of subcontractors against general contractors and their corporate principals. However, until Ippolito, there were only a few lower level court decisions and a few appellate divisions in other departments (upstate) that specifically held that corporate principals could be held personally liable for trust diversions.

    So how can the decision help subcontractors recover the money due them via the GC? Perhaps the most common complaint that I hear from subcontractors is that the general contractor has been paid and has run off with the money without paying the general contractor. As many subcontractors know, if the general contractor was paid, the subcontractor has no lien rights. But the protection afforded is then that the subcontractor can pursue the trust diversion claim against the general contractor.

    Many subcontractors have had the experience of spending time and money chasing after a general contractor to recover a debt only to find out that the general contractor is judgment proof. The wonderful thing about trust diversion claims is that it gives the subcontractor a way to pursue not only the general contractor, but the general contractor's corporate principals. If the principal knows he or she will be personally on the hook for the debt there is a much greater chance the subcontractor will be paid.

    One of the biggest reasons that trust diversion claims can help a subcontractor get paid is that no only are trust claims grounds for personal liability of the general contractor's corporate principals, but trust diversion claims are no dischargeable in bankruptcy. I have fought corporate principals through bankrtupcy as they attempted to discharge trust liability and while you may need some patience, the trust claim eventually cannot be discharged and remains.

    When the GC's corporate principals know that they are personally liable and cannot discharge the debt in bankruptcy the subcontractor has an enormous amount of leverage in the dispute. Trust diversion claims, as opposed to simply bringing a claim for breach of contract, can help the subcontractor ultimatley recover on a debt that may otherwise have vasnished due to the GC going out of business or wiped out in bankruptcy.