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...

New York Construction Collections

Collection is a part of every business, but in the construction industry it sometimes seems like collection is 90% of the business with 10% devoted to the actual construction.  If you plan for collection from the beginning, you will significantly increase your chances of recovering the money you are due.

Step One

Plan for collection in your contracts.  The default rule in New York is that parties to litigation bear their own attorneys' fees unless the contract (or a statute) provides otherwise.  In your garden variety payment dispute no statute exists in New York that would provide you with an attorneys' fee award.  Therefore, your contract should provide that you can recover your costs of collection, including reasonable attorneys' fees, in the event you have to pursue litigation or arbitration.

Your contract should also explicitly state when payment is due.  You should be permitted to suspend work in the event you are not paid within a reasonable number of days after payment is due (e.g. 10 days) and charge interest at a reasonable rate (e.g. 1% per month) on all unpaid amounts.

One other area to consider in your contract stage is whether you are going to require a personal guarantee.  Personal guarantees will significantly increase the odds that you are able to recover any unpaid amounts.  Personal guarantees are more common in material supplier contracts than labor subcontractors but remember: contracts are a negotiation anything is possible if you ask.

Step Two

Actively monitor accounts and put a procedure in place for addressing unpaid balances.  This ties into your contractual obligations and helps to make sure you do not miss deadlines.  Your contract probably provides that you must provide notice before any steps can be taken to pursue a claim or suspend work.  Before you can send a notice you have to know that payment is past due.  Surprisingly, many in the construction industry will not do anything within the first few days of payment being bast due.  This is a mistake.  Once payment is past due, a notice should go out immediately to the debtor.  If applicable, the notice can go to those above it in the contract chain as well (e.g. the owner or general contractor).  Pre-lien notices are not required in New York like they are in other states but that does not mean that a letter right after payment is due is useless.

At this stage you also need to determine whether your project is covered by New York's prompt payment act.  If it is, there are additional obligations and rights for both creditor and debtor.  For example, if the debtor is not paying your full invoice, he must provide you with written notice within 10 days explaining why. The prompt payment act also provides for expedited arbitration.

If your payment letter goes ignored, its time to kick up the heat and move on to step three.  Remember, when it comes to construction collections there is a delicate balance.  You don't want to put on the pressure too soon because it could interrupt the project and cause bigger problems and could also damage valuable business relationships.  At the same time, you don't want to wait too long because a number of rights (explained below) could be impaired.

Step Three

Once the payment letter fails to trigger payment, you have three options to increase the pressure.  You can pursue one or all three and pursue them at the same time or in any order.  First, you have mechanic's lien rights and should exercise them at the proper time (see Article "To Lien or Not to Lien: That is the Question".  A mechanic's lien must filed within 4 months on a single family home, 8 months on any other commercial project, 30 days of completion and acceptance on a public project and 90 days for retainage.  A mechanic's lien puts pressure on everyone above you in the contract chain and usually provides security for your payment.

Second, if there is a payment bond, you should submit a payment bond claim.  Every bond is different in terms of how notice must be served and upon whom it must be served.  However, every bond has a provision stating that notice must be provided within X days of the claim going unpaid.  To be safe, a payment bond claim notice should go out on every project once payments are past due 30 days.

Third, exercise your rights under Article 3A of the Lien Law.  Article 3A is probably the must underutilized set of tools for construction collection.  Most people will immediately defer to their lien rights or to rights under a payment bond.  But liens and bonds don't always shake money loose.  Article 3A can be the biggest stick in the tool box.  Consider this: Article 3A provides for personal liability of corporate principals, potential punitive damages and attorneys' fees awards.  And don't forget, Article 3A liability is not dischargeable in bankruptcy.  Exercising your Article 3A rights means acting fast.  The first move is to serve a demand under Lien Law Section 76.  From there, your must file your 3A lawsuit within 1 year of the time that you completed the project (or if you are a subcontractor from the time that the GC completed the project).

Step Four

When all else fails, its time to commence litigation.  In construction litigation all attorneys are not created equally.  Some attorneys specialize in personal liability, others in bankruptcy, some in criminal law and, of course, some in construction.  Don't expect that because you know an attorney that he or she is the best for your construction collection claim.  An attorney with experience and knowledge of New York construction law will be able to most effectively utilize the Lien Law, including mechanic's liens and Article 3A, as well as the Prompt Payment Act (and a few other tricks of the trade) to maximize the chances you recover on your unpaid debt. Remember, don't wait - liens must be foreclosed upon within 1 year of filing and 3A trust diversion claims must be brought within 1 year.

Vincent T. Pallaci is a partner with the New York law firm of Kushnick Pallaci, PLLC where his practice concentrates on construction law.  With offices in Long Island and Buffalo, New York, KP provides counsel to the construction industry in every county in New York.

What is New York's Lien Law Section 76?

Trust fund diversions are dangerous.  You should know and understand Lien Law Section 76.

Court says mechanic's lien provides standing for subcontractor to pursue trust violation against owner

There is some dispute under New York law regarding whether a subcontractor has standing, as a beneficiary, to pursue a claim for trust diversions directly against an owner.  On March 5, 2013 the First Department made their opinion partially clear:  if the subcontractor has filed a mechanic's lien then, even in the absence of contractual privity, the subcontractor has standing to bring a claim under Article 3A of the Lien Law.  The decision was Rebar Lathing Corp. v. Century Maxim Constr. Corp.  The question remains whether a subcontractor may pursue a trust fund diversion claim against an owner if the subcontractor did not file a mechanic's lien.  Implicit in the First Department's ruling here is that the subcontractor may not.

It would seem to me that this decision is right on point and gels nicely with the stated intent of Article 3A of the Lien Law.  However, the implicit indication that lack of a mechanic's lien means no standing for a subcontractor to pursue a trust diversion claim is troubling.  If the purpose of Article 3A is to make sure that those entitled to payment on a construction project receive funds earmarked for that purpose, why would a subcontractor lack standing to pursue the trust funds from the owner directly?  Technically, the general contractor as trustee should pursue the claim on behalf of all beneficiaries but if the general contractor refuses is the subcontractor out of luck?  Stay tuned...

Vincent T. Pallaci is a partner with the New York law firm of Kushnick Pallaci, PLLC.  His practice concentrates on the areas of construction law, including prosecuting and defending trust fund diversion actions in New York.

New York Contractors Don't Miss Out on Getting Paid!

The biggest mistake contractors make is missing key deadlines for securing their payment rights.  Lien deadlines, payment bond deadlines and short lawsuit statutes of limitations are critical to securing your ability to recover payment.  This guide can help prevent you from missing the key payment deadlines.  

Maintaining Proper Trust Records to Avoid Lien Law Trust Liability in New York

         Contained within Article 3A of the New York Lien Law are some of the most dangerous legal requirements a general contractor will ever see.  Many general contractors have heard of the Lien Law “trust fund” obligations, but only a few actually understand what these obligations mean.  This lack of knowledge and understanding can expose an unwitting general contractor to extensive liability if the proper precautions are not taken.  In a nutshell, Article 3A of the Lien Law requires every “trustee” to keep all funds that he or she receives on a construction project in a “trust account” for the benefit of the trust beneficiaries (subcontractors, suppliers, materialmen, etc.).  Just who qualifies as a trustee is not always clear but, in general, a general contractor is always a Lien Law trustee.  A simple rule of thumb is that if you are receiving money on a construction project within the State of New York and you owe money to someone else for labor or materials that they supplied to you on that same project then you, most likely, are a Lien Law trustee and all of the monies that you receive on the project are “trust funds” subject to the rules and regulations set forth in Article 3A of the Lien Law.    

Lien Law trustees must pay all beneficiaries of the trust before they can use the funds for any non-trust purpose.  Most importantly, the trustee cannot use the funds for another project and cannot use the funds to take its own profit until all trust claims have been satisfied.  While the Lien Law does require that the general contractor maintain these funds in a trust account, it is generally accepted that a separate account is not needed for each project.  Rather, the general contractor must keep separate books and records for each project.  But, despite a popular misconception, keeping the funds in one account is not, in and of itself, a trust violation.  The general contractor, as a trustee, must maintain books and records that show: i) the name of the project; ii) the date and amount of payments received; iii) the date, amount and payee of each payment made from the trust funds; iv) a description of the reason for payment (labor, materials, insurance, etc.); v) all trust accounts payable; and vi) all trust accounts receivable.  The bookkeeping obligations are the same for the trustee, whether it is a $10,000 project or a $10,000,000 project. 

While Lien Law §74 permits the trustee to determine the order in which it pays trust claims, it must make sure that all trust claims are paid before using the funds for any other purpose.  For example, if trustee (GC) receives a $100,000 payment from Owner (O) on Project X and then pays $25,000 to Subcontractor A, $25,000 to Subcontractor B and $25,000 to Supplier C, each of those transactions must show up in the trust books and records.  Each would be a proper use of the Lien Law trust funds for Project X.  The remaining $25,000 from O on Project X, assuming no other beneficiaries have trust claims, can be used by the GC as it sees fit; whether that be to take profit, use on another project or something else.

In the above example, GC gets into trouble when Subcontractor D on Project X is still owed money but rather than pay Subcontractor D, GC takes $25,000 from Project X to order materials for Project Z.  This scenario results in a Lien Law trust violation.  The consequences can be disastrous for the trustee.  First, the Court has the ability to order the trust funds repaid (by the GC), if possible.  Second, diversion of trust funds is a crime for which the GC can be prosecuted, fined and sent to jail.  Third, diversion of trust funds exposes the GC’s corporate principals to personal liability.  Fourth, diversion of trust funds exposes the trustee to potential punitive damages and attorneys' fees awards.  The bottom line for a GC working in New York is that diverting trust funds can put it in a whole heap of trouble.  

Lien Law §75 requires the trustee (the GC) to maintain careful and accurate books and records of all trust transactions.  A trustee’s failure to maintain proper books and records creates a legal presumption that the trust laws have been violated and that a diversion has occurred.  While the presumption is not a final determination, overcoming it in litigation can be very difficult and, in many cases, impossible.  As a beneficiary of the trust, subcontractors and suppliers are permitted, under Lien Law §76, to demand that the GC provide them with a verified statement, in writing, showing each of the entries on the books and records of the trust account.  Alternatively, the beneficiary has the option to require the GC to open up its books and records for the project to the beneficiary and allow him or her to inspect the books and records on ten days notice.  Few general contractors would be comfortable with allowing a subcontractor or supplier to come into their office and inspect their financial books and records, but it is an unavoidable obligation of the trustee, and a right of the beneficiary. 

Another significant reason to be concerned about the Lien Law trust laws is that a general contractor’s corporate principals that are found to have participated in, or acquiesced to, the diversion are exposed to personal liability.  A judgment against the GC and its principals under Article 3A is not dischargeable in bankruptcy and can follow both the GC and its principals around for the next twenty years. 

Because of the significant liability to the GC, it is critical to maintain proper books and records for every job.  This is one area where cutting corners simply is not an option.  The personal liability, potential criminal charges, and inability to discharge the debt in bankruptcy should be enough to force every GC in New York to review its accounting practices and make sure that its financial officers, controllers, accountants and bookkeepers are aware of the obligations of a trustee under Lien Law Article 3A. 

Vincent T. Pallaci is a partner in the New York law firm of Kushnick | Pallaci, PLLC.  His practice focuses primarily on the area of construction law including New York Lien Law trust diversion claims.  For more information, contact Mr. Pallaci at vtp@kushnicklaw.com or (631) 752-7100.

Mortgage obtained to acquire property and air rights is not subject to Lien Law Article 3A

In Matter of Mayrich Constr. Co. v. Oliver LLC, the Appellate Division was confronted with a trust fund diversion claim against a borrower of mortgage funds.  The Court found that the mortgages at issue were obtained for the purpose of acquiring real property and rights noting that "neither [mortgage] contains an express promise...to improve real property."  Citing to Lien Law Section 70(1), the Court held that no funds were received by the borrower "under or in connection with a contract for an improvement of real property" and, therefore, found that Lien Law Article 3-A was not applicable.  The Court also noted that there mere recording of a mortgage during the statutory period did not render the proceeds trust funds nor did the presence of a Lien Law Section 13 covenant in the mortgage.

Vincent T. Pallaci is a partner at the New York law firm of Kushnick Pallaci, PLLC.  His practice concentrates primarily in the area of construction law.  He can be reached at vtp@kushnicklaw.com or (631) 752-7100.  You can also visit our firm site at www.nyconstructionlaw.com

New York Trust Fund Claim Barred By Statute of Limitations?

In Precast Restoration Services v. Global Precast Inc. the plaintiff, a subcontractor, sued a general contractor that hired it, along with the corporation principals of the general contractor, for diversion of trust funds under New York Lien Law Article 3A.  The principals and the corporation moved to dismiss the trust claims against them arguing, among other things, that the statute of limitations for bringing a trust violation claim against them had expired.

Lien Law Section 77(2) provides:

Such action may be maintained at any time during the improvement of real property...No such action shall be maintainable if commenced more than one year after the completion of such improvement or...after the expiration of one year from the date on which final payment under the claimant's contract became due, whichever is later...

While the general contractor and its corporate principals in this case did establish that more than one year had lapsed since the subcontractor's payment became due, they did not establish that the claim was brought more than one year after the improvement was completed.  As such, their motion to dismiss the trust violation claims against them, at least on these grounds, was denied.

When bringing a claim for violations of New York trust fund laws be sure to do so promptly to avoid expiration of the statute of limitations.  Keep in mind that the statute may be extended past one year after the completion of your own work.

Vincent T. Pallaci is a partner at the law firm of Kushnick Pallaci PLLC.  He practices construction law throughout the state of New York including prosecuting and defending trust diversion claims.  He can be reached at vtp@nyconstructionlaw.com or (631) 752-7100.

Just how does a contractor "divert trust funds"?

As contractors and attorneys become more aware of the requirements and obligations of Article 3-A of the Lien Law, otherwise known as the trust fund provisions, more and more questions arise about just what a contractor can, and cannot, do.  A simple answer can be found in Article 3-A of the Lien Law itself.  Particularly, Lien Law Section 72 says that:  "Any transaction by which any trust asset is paid, transferred or applied for any purpose other than a purpose of the trust as stated in subdivision one or subdivision two of section seventy-one, before payment or discharge of all trust claims with respect to the trust, is a diversion of trust assets, whether or not there are trust claims in existence at the time of the transaction, and if the diversion occurs by the voluntary act of the trustee or by his consent such act or consent is a breach of trust."  Not exactly clear and simple language but it is a good starting point for figuring out what a trust fund diversion is.  


Let's look at the first thing that has to happen for a Lien Law trust fund diversion to take place:  there must be a "transaction by which any trust asset is paid, transferred or applied."  In other words, the contractor has to take money that it received as payment for a construction project, we will call it "Project X", and use that money in some way.  Of course not all uses of the trust asset are improper or illegal.  So we look to the next element of the Lien Law trust fund diversion claim.  That money that the contractor received on Project X must be "used for any purpose other than a trust purpose."  The logical question then becomes what is a trust purpose?  Lien Law Section 72 points us towards the answer in Lien Law Section 71.  


There are two parts of Lien Law Section 71.  Sub part 1 of Lien Law Section 71 says that the trust funds that contractor is holding on Project X can be used and applied for "payment of the cost of improvement."  Quite simply that means contractor can use the trust funds for Project X to pay for costs of construction on Project X (for example he can use the trust funds to pay for supplies).  Sub part 2 of Lien Law Section 71 then gives us a nice list of exactly what types of things the contractor, as trustee, can pay with the Project X trust funds.  Section 72(2) says the funds can be used to pay:

(a) payment of claims of subcontractors, architects, engineers, surveyors, laborers and materialmen;

(b) payment of the amount of taxes based on payrolls including such persons and withheld or required to be withheld and taxes based on the purchase price or value of materials or equipment required to be installed or furnished in connection with the performance of the improvement;

(c) payment of taxes and unemployment insurance and other contributions due by reason of the employment out of which such claims arose;

(d) payment of any benefits or wage supplements, or the amounts necessary to provide such benefits or furnish such supplements, to the extent that the trustee, as employer, is obligated to pay or provide such benefits or furnish such supplements by any agreement to which he is a party;

(e) payment of premiums on a surety bond or bonds filed and premiums on insurance accrued during the making of the improvement, including home improvement, or public improvement;

(f) payment to which the owner is entitled pursuant to the provisions of section seventy-one-a of this chapter.

Each of the above items are fairly self explanatory.  Sub paragraph (f) deals with certain owner related payments that are not the normal situation so we won't spend any time in this article reviewing that particular item.  The remaining items really require no explanation.  

So we are almost there in determining just how a contractor engages in the diversion of trust funds.  We know the contractor must receive payment on Project X, must then use that money for a non-trust purpose and we know that the non-trust purposes are anything other than those set forth above.  The final element that puts the nail in the contractor's trust diversion coffin is when he uses the trust money for a non-trust purpose "before payment or discharge of all trust claims with respect to the trust."  In other words, all of the claims identified in Lien Law Section 71 as permissible ways to use trust funds must be fully satisfied before contractor uses the Project X money on any non-trust purpose. Once all trust claims have been paid, the remaining monies on Project X become the asset of the contractor and he may use them in any manner that he sees fit.  The contractor can use the former trust funds to fund Project Y, give his employees bonuses, buy new computers for the company, take a trip to China or buy a new yacht.  The point is it no longer matters once the trust claims have been satisfied.  

What contractors must become aware of is exactly what they can and cannot use their trust funds for and they must understand their obligations to keep accurate records of those trust uses.  Remember, failure to keep adequate and accurate records of the trust creates a presumption of a trust fund diversion that makes the contractor liable for a trust diversion simply because he cannot prove there was not a diversion.  

When in doubt, contractors should consult with their attorney and make sure that they have the proper checks and balances in place, and that they fully understand Lien Law Article 3-A, to make sure that they are protected and not exposing themselves to criminal and civil liability for trust fund diversions.  

Vincent T. Pallaci is a partner at the New York construction law firm of Kushnick Pallaci, PLLC where he practices construction law in New York State and regularly prosecutes and defends trust fund diversion claims.  He can be reached at (631) 752-7100 or vtp@kushnicklaw.com  

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 vtp@kushnicklaw.com

Court issues much needed guidance on responding to a Lien Law Section 76 demand

The Appellate Division of the Third Department has issued a decision providing some much needed guidance to those out there that are responding to a demand served pursuant to Lien Law Section 76.  In Matter of Bette & Cring, LLV v. Brandle Meadows, LLC, the Court reviewed a beneficiary's challenge of a response to a Section 76 demand served by a trustee.  Of note, the court stated the following: 

• Beneficiaries of the trust are entitled to exercise their rights under Lien Law Section 76 once per month.  Notably, complying with the demand in one month does not excuse a failure to properly comply in another month.  In this case, the trustee failed to respond properly to an earlier demand for a verified statement but claimed that by later allowing the beneficiary to review the books and records that it cured the initial improper verified statement.  The court disagreed and found that the later inspection of the books and records did not forgive the trustee's obligation to provide a proper verified statement that included all of the information required by the lien law. 
• Even if a matter is in arbitration the beneficiary of the trust still has rights under Lien Law Section 76.
• The verified statement must set forth the trust assets receivable.  A statement that "no funds are receivable without condition" is inadequate.  The trustee must identify the alleged conditions on the assets. 
• Allegations regarding a line of credit and trust payments made pursuant thereto must be particularized. 
• The funds received into the trust must be particularized. 
• Identification of trust payments must include the purpose for the payment and whether the payments were for "labor, materials, taxes, insurance, performance under contract or subcontract, interest charges on mortgages, or other particular trust claim or item of cost of improvement"
• If transfers are made pursuant to a "Notice of Lending", such transfers must be sufficiently identified. 

Because of the very particular items needed in response to a Lien Law Section 76 demand, and because of the potentially severe consequences of not responding or of responding improperly, I highly everyone consult with a construction attorney to make sure that their response is proper. 

Vincent T. Pallaci is a partner at the New York law firm of Kushnick Pallaci, PLLC where his practice focuses primarily on the area of construction law.  He can be reached at (631) 752-7100 or vtp@kushnicklaw.com

Court doesn't buy trust diversion claim: orders surety liable for damages for failure to perform under performance bond

In Mount Vernon City School District v. Nova Casualty Company, recently decided by the Appellate Division, Second Department, a school district hired an HVAC contractor to perform certain construction.  As part of the contract, the HVAC contractor obtained a performance bond from Nova Casualty.  Eventually the contractor failed to complete and the surety, Nova, also refused to perform under its performance bond.  The school district therefore completed the project on its own and then commenced an action against Nova for failure to perform under the performance bond. 

The decision is a little unclear on the facts but it appears that the HVAC contractor earned a $214,000 progress payment that, at the contractor's direction, was paid by the school district to the Department of Labor.  Nova argued that since those funds were used to pay other contractors on an unrelated project, they constituted diverted trust funds.  The court found that since Nova did not perform and never even attempted to take over the contractor's obligations and perform the contract, that it did not succeed to the rights of the owner or lien law trust fund beneficiaries.  The court also noted that since the $214,000 payment was undisputedly earned by the contractor, its payment was not a breach of the terms of the performance bond. Finally, the Court noted that while the General Obligations Law does allow a public entity to withhold such funds, it does not create a private right of action when the public entity does not retain the funds and, as such, Nova could not use that as a basis to claim that the $214,000 payment released it from its obligations under the performance bond.

This case provides a couple of good lessons for owners: 1) simply because you have a performance bond don't expect that your contract with be completed and you will be litigation free; and 2) if you do have a performance bond, and the surety won't perform, talk to an attorney fast and find out if you potentially have a claim against the surety. 

Vincent T. Pallaci is a partner at the New York law firm of Kushnick Pallaci, PLLC where his practice focuses primarily on the area of construction law.  He can be reached at (631) 752-7100 or vtp@kushnicklaw.com

General contractor can pay subcontractor's sub-subcontractors and vendors without violation Lien Law Article 3A

In Metro Foundation Contractors, Inc. v. Marco Martelli Associates, Inc., the Appellate Division affirmed the trial court's denial of summary judgment to a subcontractor that claimed the general contractor had violated New York's Prompt Payment Act (G.B.L. Article 35E) and New York's trust fund provisions (Lien Law Article 3A).  Apparently the general contractor determined that the subcontractor inexcusably defaulted under the subcontract and didn't pay the subcontractor.  However, the general contractor did pay the subcontractor's sub-subcontractors and vendors.  The subcontractor claimed these were improper payments and diversions of trust funds.  The Appellate Division confirmed that the sub-subcontractors and vendors were proper lien law trust fund beneficiaries and, as such, ruled that the general contractor did not divert funds by paying them directly (assuming the correct amounts were paid). 

The Court also notes that the Prompt Payment Act does not give a subcontractor that is not paid the drastic remedy of summary judgment without more proof.  While the decision is light on details, it sounds like the subcontractor argued that the mere non-payment violated the Prompt Payment Act.  What the Court says is that the subcontractor still has to prove its claim (i.e. it performed properly and was not paid).  This result is in line with the language of the Prompt Payment Act which specifically provides that a general contractor can withhold payment if there is a dispute over performance.  Of course if it later turns out that the general contractor fabricated the performance issue the subcontractor could still have a potential Prompt Payment Act claim.  Stay tuned...

Vincent T. Pallaci is a partner at the New York law firm of Kushnick Pallaci, PLLC where his practice focuses primarily on the area of construction law.  He can be reached at (631) 752-7100 or vtp@kushnicklaw.com

Maintaining Proper Lien Law Trust Records to Avoid Liability

The Lien Law trust laws, contained within Article 3A of the Lien Law, are something that most contractors have heard of, but very few understand.  This is unfortunate since the Lien Law trust laws are one of the few areas of the law that are, arguably, intended to protect contractors, or more particularly, subcontractors, suppliers and vendors (as opposed to owners).  In a nutshell, Article 3A of the Lien Law requires every "trustee" to keep all funds that he receives on a construction project in a "trust account" for the benefit of the trust beneficiaries. Just who is a trustee is not always clear but the following general guidelines may be helpful:  1) if an owner receives a construction loan the owner is a trustee; 2) a general contractor is always a trustee of funds received from the owner; 3) a subcontractor can be a trustee if he, she or it owes money to a sub-subcontractor, materialman, vendor or supplier; or 4) a sub-subcontractor and beyond can be a trustee under the same circumstances as a subcontractor.  A simple rule of thumb is that if you are receiving money on a construction project in the State of New York and you owe money to someone else for labor or materials that they supplied to you on that same project then you most likely are a Lien Law trustee and all monies that you receive are "trust funds."

Lien Law trustees must pay all beneficiaries of the trust before they can use the funds for non-trust purposes.  Most importantly, you cannot use the funds for another project and you cannot use the funds to take your profit until you have satisfied all trust claims.  While the Lien Law does require you to maintain these funds in a trust account, it is generally accepted that you do not need a separate account for each project.  Rather, you must keep separate books and records for each project.  But keeping the funds in one account is not, in and of itself, a trust violation.  Your books and records for the project should show the name of the project, the date and amount of payments received and the date, amount and payee of each payment made from the trust funds.  For example, if the general contractor (GC) receives a $100,000 payment from Owner (O) on Project X and then pays $25,000 to Subcontractor A, $25,000 to subcontractor B and $25,000 to supplier C, each of those transactions must show up on GC's books and records.  Each would be a proper use of the Lien Law trust funds.  The remaining $25,000 from O on Project X, assuming no other beneficiaries have trust claims, can be used by the GC as it sees fit whether that be to take profit, use on another project or something else.

In the above example, GC gets into trouble when Subcontractor D is still owed money but rather than pay Subcontractor D, GC takes $25,000 to order materials for Project Z.  This scenario results in a Lien Law trust violation.  The consequences can be disastrous for the trustee.  First, the court has the ability to order the trust funds repaid if possible.  Second, diversion of trust funds is a crime that you can be prosecuted for.  Third, diversion of trust funds exposes corporate principals to personal liability.  Fourth, diversion of trust funds exposes the trustee to potential punitive damages and attorneys' fees awards.  In summary, diverting trust funds can put you in a whole heap of trouble.  While troublesome for the trustee, everyone below him that was owed money and was not paid is offered the additional leverage of the trust claim in their pursuit of the money they are due on the project.

Lien Law Section 75 requires all trustees to maintain careful and accurate books and records of all of these trust transactions.  Failure to maintain proper books and records creates a legal presumption that the trust laws have been violated.  While not a final determination, overcoming this presumption in litigation can be very difficult and, in many cases, impossible.  As a beneficiary of the trust, you are allowed, under Lien Law Section 76, to demand that the trustee provide you with a verified statement, in writing, showing each of the entries on the books and records of the trust account.  In other words, if a general contractor tells you he hasn't paid you because the owner hasn't paid him you can demand to see his books and records for the project and the general contractor is legally required to disclose them to you.

Another significant reason to be concerned about the Lien Law trust laws is that a contractor, or contractor's principal, that is found to have diverted trust funds, and is found liable for that diversion, cannot discharge the claim in bankruptcy.  That means the debt will follow the contractor for at least 10 years, and more likely 20 years, and there will be no way for the contractor to get away from it.  While that is a long time to wait, it is an added security for the subcontractors that are not paid as they will be able to pursue their claim notwithstanding a bankruptcy.  Especially in the current economy where many general contractors are declaring bankruptcy, being able to pursue a claim despite the bankruptcy is a strong deterrent against general contractors diverting trust funds instead of paying their subcontractors. 

One very important caveat:  a Lien Law trust fund claim has a very short statute of limitations.  It must be brought within 1 year from the time that either the project was completed (if you are a general contractor) or 1 year  from the time that the payment was due from the general contractor or the project was completed, whichever is later (if you are a subcontractor).   Therefore, you must stay on top of anyone that owes you money and keep careful track of the money.  Don't be afraid to exercise your rights under Lien Law Section 76 if you have not been paid and you think someone may have diverted money on the project.  When in doubt, contact your attorney to find out what rights you have and to make sure you preserve any potential claims you may have.  A good construction attorney will be able to use tools such as the demand pursuant to Lien Law Section 8 or the demand for a verified statement pursuant to Lien Law Section 76 to help establish and set up a trust diversion claim for you. 

Vincent T. Pallaci is a partner in the New York law firm of Kushnick Pallaci, PLLC.  His practice focuses primarily on the area of construction law including prosecuting and defending claims for diversions of New York Lien Law trust laws.  KP has offices in the NYC metro area and in Buffalo, New York allowing it to provides legal services across the State of New York.