Article 3-A of the New York Lien Law- Know your Rights

Clearly there's nothing more important to the continued success of a subcontractor than to be paid. Many subcontractors can be one bad job away from closing up shop if they are unable to collect on work performed. "Making it up" on the next job is no longer a viable strategy. Additionally, failing to receive payment from the contractor jeopardizes the subcontractor's relationships with its vendors and suppliers when it is unable to pay them.

This month's legal log is the first in a series about 'Getting Paid" in today's construction environment which can be harsh on subcontractors who do not properly protect themselves. Goldberg & Connolly emphasizes using the full panoply of tools the law uniquely affords subcontractors and suppliers. This first article addresses the protection provided by Article 3-A of the New York Lien Law (Article 3-A), known as the "Trust Fund Provisions".

There is helpful recent case law that has somewhat streamlined the trust fund procedures which will be discussed below. First, however, I would like to clarify some of the common misunderstandings regarding the use of Article 3-A.

Most contractors are generally aware of the existence of Article 3-A and that it is designed to insure that entities who have provided the labor or furnished the material on the project are all fully paid out of the project funds before the trustees (owner, general contractor, or upstream subcontractor) are permitted to use these funds for any other non-project-related purpose. Article 3-A does so by prohibiting the trustees from essentially "stealing from Peter to pay Paul."

In fact, Article 3-A provides a harsh penalty for owners, general contractors, and subcontractors, on both public and private construction projects, who use monies from one project to pay creditors on other projects or use the monies for their own purposes. The owner, general contractor or subcontractor who "diverts" project funds for purposes other than paying labor and material claims on that particular project is subject to civil liability and criminal penalties. Under the New York Penal Law, such a diversion would constitute larceny. The risk is real and we have seen contractors prosecuted for these violations.

First, there is a misconception in the industry that in order to take advantage of Article 3-A one must either have filed or have the right to file a mechanic's lien. This is not true. As part of New York Mechanic's Lien Law, Article 3-A is an independent remedy, like a payment bond claim, neither of which is dependent upon nor derived from the filing of a mechanic's lien even if mechanic's lien rights have expired.

A second misunderstanding is that the trust fund provisions of Article 3-A only apply to public works projects. This is also not true.

A third misunderstanding is that a trust fund beneficiary, such as a contractor, subcontractor or materialman, is only entitled to a written verified statement of all funds received by the trustees and all funds paid out by the trustees from those funds. However, the itemized statement of account is certainly not the beneficiary's only option.

Under the trust fund provisions of the statute, a trust fund beneficiary may demand to personally examine the books and records of the owner or contractor, in lieu of, demanding a written statement under oath setting forth an itemized accounting of all monies received, and each expenditure made on the project. This right to examine books and records is unqualified and is at the beneficiary's option. However, we have seen very few instances where this tool is properly taken advantage of. Either the trust fund beneficiaries are unaware of the option, or for reasons unknown, they opt for the verified statement in lieu of demand for partial inspection of books and records.

While inspecting the books may be more time-consuming than simply demanding a Verified Statement, such an option may be more effective than a Verified Statement, where the Trustee has more of an opportunity to be less than totally forthcoming. I would suspect that most Trustees would prefer to provide an Itemized Statement than to allow a potential competitor access to company books and records. For that reason alone, there may be a benefit to demanding onsite inspection of books and records versus demanding an Itemized Statement.

The other important benefit offered to the trust fund beneficiary's right to an accounting is the additional requirement set forth by statute for trustees to maintain accurate records of trust accounts by project. Failure to maintain such records is presumptive evidence that the trustee has diverted trust funds by permitting payments from the trust for some other purpose than (project-specific) trust purposes. All contractors, subcontractors and upstream subcontractors must keep accurate, project-specific records at all times. There need not be a separate bank account for each project, but there must be a separate accounting.

The fourth historic misconception is that trust fund litigation is a time consuming process not to be undertaken. In the past this may have been true because the issue of whether there was a diversion of funds on the part of the trustee was normally a question of fact which required a trial of that issue. However due to a recently decided appellate court decision, the establishment of a diversion may now be established "summarily", that is by motion, in lieu of a trial given the right set of facts. According to a New York appellate court decision, a trust fund diversion may be summarily established if the following criteria are met:

1. The trustee's have failed to keep the statutorily required books and records (which shall be presumptive evidence that the trustee used trust funds for purposes other than a purpose of the trust),

2. The trustee had ample opportunity to correct the documented deficiencies in its verified statement; and

3. Any reasonable explanation for the shortcomings the trustee has failed to provide to overcome the statutory presumption of an improper diversion of trust assets.

This is a very positive ruling for all subcontractors and suppliers in New York who now are more readily able to utilize Article 3-A to proceed with a trust fund diversion action on a more expedited and cost-effective basis.

G&C Commentary

Article 3A of the New York Lien Law, the construction trust-fund statute, provides powerful, relatively inexpensive tools for collecting money for labor performed or materials supplied on a construction project. At times, this may be the only source of recovery where mechanic's lien rights are no longer available or the claimant is not protected under a labor and material payment bond. At other times, when all lien rights have been timely protected, the Article 3A trust fund provisions can be used very effectively in conjunction with mechanic's lien rights.

Next month's article, in our "Getting Paid" series, will address the proper implementation and utilization of another powerful New York Lien Law weapon for obtaining payment on both public and private projects, the Mechanic's Lien.

Henry L. Goldberg may be contacted by email, hlgoldberg@goldbergconnolly.com or by telephone, 516-764-2800.

©Goldberg & Connolly 2016

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