By: Robert W. Bannon II Published: March 2016

Failure to Serve Proper Verified Statement of Trust Results in Contractor being Held Liable for Trust Fund Diversion

Article 3-A of New York’s Lien Law contains some of the most perilous legal requirements a construction contractor will face. Section 13 of the Lien Law makes it clear that the funds received on a construction project are trust funds for the benefit of contractors, subcontractors, laborers and suppliers. If those funds are not used exclusively to satisfy claims of contractors and suppliers for work performed on the project (“Trust Purposes”), contractors may be liable for trust fund diversion. Contractors have often heard of their obligations under Article 3-A, but usually lack a sufficient understanding of how to avoid the serious penalties that can arise from diverting trust funds (even inadvertently). New York’s construction trust fund statute is primarily intended to ensure that a contractor, subcontractor, supplier or worker (“Trust Beneficiaries”) involved in the improvement of real property, or of a public works project will be properly compensated for its services.

One overlooked tool in the arsenal of such beneficiaries to ensure payment is a Demand for a Verified Statement of Trust pursuant to Section 76 of the Lien Law. Under this section of the Lien Law, a beneficiary of lien trust funds on a construction project has the right to demand that the trustee provide a verified statement, in writing and under oath, setting forth the items contained in the books and records of the trust. A contractor has the statutory right to obtain a sworn statement from a trustee of the funds setting forth certain information including the dates and amounts of funds received and disbursed on the project, as well as the total amount of the funds still held. Moreover, a failure to serve a Verified Statement has been found by New York courts to be presumptive evidence that trust fund diversion occurred. A recent case shows the seriousness of the repercussions for failure to serve a proper Verified Statement.

In Anthony DeMarco & Sons Nursery, LLC v. Maxim Construction Service Corporation, et al., 130 A.D.3d 1409, (3d Dept 2015), the Appellate Division, Third Department, had an opportunity to examine the technical requirements of the Demand for a Verified Statement of Trust under Section 76 of the Lien Law. The underlying action involved a construction project at SUNY – Binghamton and a property owned by the Dormitory Authority of the State of New York. LeChase Construction Services, LLC (“LeChase”) was hired by the Owner as the general contractor. LeChase, in turn, hired Maxim Construction Service Corporation (“Maxim”) as the site contractor. Plaintiff subcontracted with Maxim to provide certain landscaping services for the project.

A payment dispute arose and Plaintiff commenced a lawsuit. Thereafter, Plaintiff served a Demand for a Verified Statement of Trust upon Maxim. Maxim failed to respond and Plaintiff filed a motion to compel a response, which was granted by the court. Maxim finally did serve a Verified Statement, but it was deficient. Plaintiff again moved to compel a response from Maxim. On that motion, the court found that Maxim’s response failed to comply with the requirements of Section 76 and, surprisingly, on its own motion awarded Plaintiff summary judgment on the issue of liability.  On appeal, the Appellate Division, Third Department, agreed with the lower court and noted that Maxim’s Verified Statement failed to set forth “the dates and amounts of the trust assets receivable, trust accounts payable or trust funds received”, failed “to provide a sufficiently detailed breakdown of the total amount of payments made with trust funds” and failed to “provide a complete accounting of its trust assets receivable”. Interestingly, the Appellate Division also noted that while Maxim did provide a dollar figure for open change orders submitted to LeChase, the response lacked the requisite level of specificity.           

A beneficiary that successfully establishes a trust fund diversion is entitled to recover the diverted trust funds and receive damages for breach of the trust including interest, costs and attorneys’ fees expended in asserting a claim. In some instances a trustee may even be required to pay punitive damages. It is also important to note that corporate officers of a trustee may be personally liable for diverting trust funds. Further, such liability is not dischargeable in bankruptcy and, in extreme cases, can result in criminal prosecution that can include fines and even imprisonment for grand larceny. Contractors can safeguard against accusations of trust fund diversion by keeping accurate books and project records for every project. Clearly, given the perils of an improper response, it is advisable to contact a construction attorney to assist with the preparation of a Verified Statement.

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