By: Alexander A. Miuccio Gregory J. Spaun Published: September 2018

Contractor Held Liable for Diversion of Trust Funds

Article 3-A of the Lien Law, also known as the Lien Law trust fund provisions, provides that (1) funds receive by an owner of a construction project from a lender, (2) funds received by a contractor from an owner, and (3) funds received by a subcontractor from a contractor, are trust funds held by them as trustees to be used for the cost of improvements on a project.  The trust fund statutes are designed to prevent trust funds received on a project from being diverted for purposes other than for payment of labor and materials furnished to the project.  For example, a contractor can be found liable where it diverts payments that it receives on a project by paying creditors on another project.  Unpaid subcontractors and materials suppliers as trust beneficiaries on a project may commence a lawsuit against the contractor for diversion of trust funds.

Where trust monies are diverted, individual officers and directors of the contracting corporation may be personally liable for the unpaid claims of subcontractors and material suppliers if they knowingly participated in the diversion.   

In the recent case of H & L Ironworkers Corp. v. McGovern & Co. LLC, the court addressed the issue of whether the contractor was liable for a trust fund diversion.

Background

10 E. 53 LLC, the owner of a building and construction project in Manhattan, hired McGovern and Co. as a general contractor for the project.  H & L Ironworkers Corp. subcontracted with McGovern to perform work at the project.  H & L furnished labor and materials under the project, but was not paid.  McGovern received $17,590,802 from the owner for work performed on the project.

H & L sued McGovern and argued that it is entitled to summary judgment for trust diversion violations under Article 3-A of the Lien Law because McGovern as a trustee, diverted trust monies received from the project’s owner for purposes other than to pay for the costs of construction on the project.  H & L also sought to impose personal liability on Daniel G. McGovern, a managing member of the company, pointing out that he had financial control over the company.

McGovern opposed H & L’s motion by arguing that the evidence on the record does not support actual trust diversion.

Decision

The court granted summary judgment to H & L for trust fund violations by McGovern.  The court found that the trust funds received by McGovern were improperly diverted.  Specifically, McGovern’s bank records show that the project funds paid by the owner were deposited into McGovern’s bank account and $11,519,604 of trust money were paid to various contractors not connected with the project.  The court also found that McGovern paid $1,535,052 to labor union fringe benefits not related to the project.  In addition, the bank records also showed that the company transferred $1,176,236 to McGovern’s wife, $296,320 to McGovern’s brother and $92,418 to his attorney.

As for McGovern’s exposure to personal liability, the court ruled that there is no evidence at this stage of the proceeding to establish that McGovern knowingly diverted trust funds.  Accordingly, the court denied H & L’s motion for summary judgment on the issue of McGovern’s personal liability, but allowed H & L to conduct pre-trial discovery to determine whether McGovern knowingly diverted trust funds.

Comment

The trust fund provisions provide a valuable tool for collecting money for labor performed or materials supplied to the project.  This remedy may be the only source of recovery where a trust fund beneficiary failed to file a mechanic’s lien and labor and material payment bond rights are not available or where the contractor is insolvent.  It is worth repeating that an individual officer, manager or other control person of a corporation may be personally liable if it is shown that he/she knowingly participating in the diversion.  Notably, a judgment based upon a diversion is not discharged in bankruptcy.   

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