Lien Law Article 3A creates a trust for funds received by an owner over funds that he received on a construction project. The trust fund provisions were enacted in part to protect contractors, subcontractors and suppliers against owners who divert money for purposes other than for payment of labor and materials on the project. For example, an owner can be found liable for diversion of trust funds if he uses the funds received on one project to pay for labor and materials on another project or for non-project purposes. An owner may incur personal liability for diversion of trust funds which cannot be discharged in bankruptcy. The Lien Law trust fund provisions apply similarly to contractors and subcontractors who receive funds on a project.
An owner, as statutory trustee, must keep records of all monies received and distributed on a project. Under Lien Law Section 76, contractors, subcontractors and suppliers, as trust fund beneficiaries, can demand that the owner provide a sworn written statement showing all monies received and expended on the project.
In the case of Matter of Paik Construction, Inc. v Dienst, a court determined whether a contractor is entitled to a verified statement from the owner where there is a pending mediation before the American Arbitration Association and the owner disputes that any monies are owed to the contractor.
Paik Construction was hired by the owners, Jill and Daniel Dienst, to perform certain renovations to their apartment. The form of contract between the Diensts and Paik was an AIA agreement that provided that the parties mediate any disputes before proceeding to litigation. During the course of the project, the relationship between the parties broke down. While the contractor claimed that it was owed $425,000, the owners claimed that nothing was owed as a result of the contractor’s breach of the contract.
The contractor served the owners with a Section 76 demand for a verified statement, demanding that they set forth with specificity each and every payment received into the trust and each and every payment made out of the trust fund. When the owners did not respond, the contractor commenced a court proceeding to compel a response. In addition to several service of process related arguments, the owners argued that the contract between the parties required mediation before the initiation of any litigation, and that the contractor was not entitled to the verified statement or to bring a court proceeding seeking to compel its production until the parties’ completed the mediation required by the contract.
The court granted the contractor’s petition and directed the owners to comply with the demand for the verified statement. The court held the purpose behind the statute requiring an owner to provide a verified statement is to allow a contractor, as a trust fund beneficiary, to determine whether an owner diverted trust monies for non-trust purposes. The court noted that while the contract did, indeed, provide for mediation of the underlying dispute before litigation, the contractor’s right to the verified statement arises under Article 3A of the Lien Law and, therefore, is independent of the contract. Although the contractual dispute was submitted to mediation, it did not alter the owner’s Lien Law obligation to provide a verified statement.
A demand for a verified statement or demand for inspection of the owner’s books and records is an effective disclosure device that can be used by unpaid contractors, subcontractors and material suppliers. The right to an accounting is liberally granted by the courts, even if the owner denies that monies are owned to the contractor or there is a separate lawsuit by the contractor for collection of monies owed. It is only fair that job claimants, who have provided the wherewithal that made possible the construction of a project, should have the right to be informed as to whether the owners wrongfully diverted trust funds for the project for non-trust purposes.