By: Robert W. Bannon II Published: September 2019

Contractor and Bank Accused of Trust Fund Diversion - Contractors Take Heed

Article 3-A of the New York Lien Law contains some of the most perilous legal requirements a construction contractor can face. Section 13 of the Lien Law makes it clear that the funds received on a construction project are trust funds held for the benefit of subcontractors and suppliers. If those funds are not used exclusively to satisfy claims of subcontractors and suppliers for work performed on the project, contractors, as statutory trustees, may be liable for trust fund diversion. Contractors have often heard of the obligations imposed by Article 3-A of the Lien Law, but may lack a sufficient understanding of those obligations to avoid the serious penalties that can arise from diverting trust funds (even inadvertently). New York’s construction trust fund statutes are primarily intended to ensure payment for labor and material furnished to a particular project.

In Price Trucking Corp. et al. v AAA Environmental, Inc. et al., (111 AD3d 1315 [4th Dept 2013]), a subcontractor brought suit alleging, among other things, that both the general contractor and its bank diverted trust funds. The general contractor, AAA Environmental, entered into a contract with the project owner, Norampac, to perform certain environmental remediation services. In furtherance of its general contract with Norampac, AAA Environmental entered into subcontracts with various entities, including Price Trucking. AAA Environmental had in place with First Niagara Bank an automatic transfer of funds from its operational account to pay down amounts owed on its line of credit. When funds earned on a particular project were deposited, they would be transferred that same night to reduce what was owed on the line of credit. Plaintiff, on behalf of itself and all similarly situated subcontractors on the project, sued AAA Environmental and First Niagara Bank for diversion of trust funds created by this financial arrangement. As alleged, by utilizing funds received from Norampac to satisfy a line of credit, both AAA Environmental and First Niagara Bank diverted trust funds. The Supreme Court, Erie County, upon Plaintiff’s motion for summary judgment, agreed and granted the motion as to the trust fund diversion claims against First Niagara Bank. On appeal, the Appellate Division, Fourth Department, determined that the bank was not a “statutory trustee” within the meaning of New York State Lien Law and, therefore, could not be held liable for trust fund diversion under that theory.

Contractors often rely on their relationship with local banks in order to ensure that they can receive continued financing and weather “slow periods” where payment is delayed. While First Niagara Bank was determined to not be a statutory trustee on the motion for summary judgment, the suit nevertheless was permitted to continue so that if the subcontractor could prove First Niagara Bank knew that it was receiving trust funds from a construction project, the subcontractor would be permitted to recover on its trust fund diversion claims as against First Niagara. Importantly, the trust fund diversion claims as against the contractor continued. While the Appellate Division determined that the Bank was not liable for trust fund diversion, the relationship between the contractor and its bank was clearly strained.

The consequences of trust fund diversion can be dire. A Court may order that the trust funds be repaid by the general contractor. Further, a diversion of trust funds exposes the trustee to potential punitive damages and attorneys' fees awards. It is also important to remember that corporate officers may be liable personally for diverting trust funds. Further, liability is not dischargeable in bankruptcy and, in extreme cases, could result in criminal prosecution that can include fines and even jail. Contractors should be certain what they can and cannot use trust funds for on a project. It is advisable to discuss with an attorney how monies received on a construction project can be disbursed consistently with the requirements of Article 3-A of the New York Lien Law. Moreover, contractors can further safeguard against accusations of trust fund diversion by keeping accurate books and records for every project.

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