It is widely known in the construction industry that New York is a “trust fund” state, meaning that trustees of a construction trust fund have specific responsibilities under the Lien Law, and that there are significant penalties for diverting trust funds—including criminal penalties. While owners, contractors and subcontractors are universally acknowledged to be trustees, and payments made downstream are acknowledged to be trust funds, questions often arise as to a construction lender’s role in the trust fund scheme. In the recent case of ECD NY, Inc. v 616 First Avenue Developer, LLC, an appellate court shed some light on the lender’s role in the process, and when it may be able to be held liable under Article 3-A of the Lien Law.
In 2014, ECD NY entered into a contract with 616 First Avenue Developer where ECD was to perform excavation, sitework, foundation and structural concrete work for the construction of a 47 story mixed use building in Manhattan. 616 financed the construction through construction loans with various lender entities, and signed a building loan agreement on December 22, 2016. 616 secured the loan by assigning its leases and rents to the lenders. The lenders filed their Notices of Lending on January 27, 2017.
ECD undertook its work, and ultimately sued to collect what it claimed was its outstanding balance. ECD also sued 616’s lenders, alleging that they were trustees of the statutory trust, and that they improperly received trust fund assets such that they would be directly liable to the contractor on a diversion claim. The lenders moved to dismiss the lawsuit as against them, arguing that they were not trustees under the statute, and that they were insulated by the fact that they filed a Notice of Lending against the project.
The motion court denied the lenders’ motion (and also, it should be noted, granted 616’s motion to dismiss an unjust enrichment claim on the grounds that such a claim is precluded where, as here, there is a written contract governing the subject matter of the claim), finding generally that there were disputes that had to be the subject of discovery before dismissal could be assessed.
On the lenders’ appeal, the appellate court dismissed the cause of action for diversion of trust funds, noting that the statutory list of trustees includes owners, contractors and subcontractors, but not lenders. As to the cause of action for receipt of diverted trust funds, the appellate court was more nuanced. While holding that lease payments are not listed in the lien law as trust assets, the court was compelled to deny the motion because the Notice of Lending was filed 5 weeks after the building loan agreement, and there was no evidence that payments weren’t made by the owner between the signing of the building loan agreement and the date on which the Notice of Lending became effective. Accordingly, so held the court, discovery was necessary to flesh out this issue.
While the court was clear that the lender was not liable as a trustee, it did highlight that there are circumstances when lenders could be deemed to have improperly received trust funds based on the date of its filing of a Notice of Lending (which insulates the payments made to a lender, even though these payments are technically outside of those otherwise permissible under the trust statute). If payments are made to the lender before the Notice of Lending is effective, then a potential trust fund diversion exists.
There are often collectability issues on construction projects; for instance, your upstream contractor may not be solvent, there may not be a sufficient lien fund available to satisfy your claim, or there may be no payment bond on the project, amongst other reasons. Accordingly, it makes sense to attempt to bring in as many potential defendants as possible. Before doing so, however, one much make sure that there are viable claims against those potential defendants; courts have little tolerance for simply applying a shotgun approach.