Contractor, Don't Spend That Money! Lien Law Traps for the Unwary
Luz, Thomas J., Business Credit
One of the least followed and most perilous statutory schemes in the construction world is Article 3-A of New York's Lien Law. Many jobbers profess familiarity with the rules, which require them to hold payments for the improvement of real estate in trust for their subcontractors and suppliers. Yet many criticize the law's effect, expressing the sentiment that, since (in their view) no one else follows the rules, they don't intend to either. As many find out each year, failure to comply can be a grave error. The bottom line is that the law holds the contractors personally liable for failure to pay trust money to its beneficiaries, i.e., materialmen and subcontractors. This liability attaches regardless of whether the contractor conducts business as a corporation, limited liability company or any other entity purporting to limit the liability of the business's principals. In the civil liability context, the law reaches inside the corporation and pulls the principals out by the straps of their overalls.
Worse, in some cases, where the contractor uses trust money to pay himself, he may face criminal liability, regardless of the innocence of his intentions. Because the consequences of ignorance can be so severe, it pays to remember the basic principles of Article 3-A.
Lien Law Article 3-A is comprised of 12 sections. I will not bore you with an exposition of each section, but will instead review the Article's highlights in the context of a contractor's (and subcontractor's- subs aren't off the hook, here) obligations and the legal effect of a failure to comply.
Bear in mind that the intention of the law is to force contractors to self-finance construction jobs.While many contractors plan to spend the projected profit from the job on an ongoing basis, NewYork has rejected that approach in the most forceful manner.A contractor in New York is expected to retain all of the money from a project for the credit of those who worked on it, and live on other income in the interim. Only after the project's conclusion may he take his profit, if any.
Any funds or rights to receive funds in connection with a contract (original, modified, extra, etc.) received by a contractor or subcontractor "shall be a separate trust and the contractor or subcontractor shall be trustee thereof."i This includes assignments of funds due under the contract and proceeds of insurance payable because of destruction of the improvement to the property.ii The trust commences "when any asset thereof comes into existence, whether or not there exists at that time any beneficiary of that trust"iii This poses a particularly nasty trap. Even if the contractor has hired no subcontractor and purchased no material, funds received as an advance must be held for the payment of future subcontractors and the future purchase of material. Use of the funds for any other purpose (such as paying of past debts or the contractor's living expenses) is a trust violation, even though no one currently possesses the right to complain.
The trust continues "until every trust claim arising at any time prior to the completion of the contract or subcontract has been paid or discharged, or until all such assets have been applied for the purpose of the trust."iv Only on termination of the trust by payment of all trust claims may the contractor take ownership of the remaining assets.v A "trust claim" is any claim arising at any time for payments relating to the job.vi And, no matter when it is asserted, a trust claim is deemed to have existed at the time of the making of the contract.vii A contractor's trust obligations include payments of (a) subcontractors, architects, engineers, surveyors, laborers and materialmen; (b) payroll and sales taxes; (c) unemployment insurance and taxes; (d) union benefits; (e) surety bonds and insurance premiums; and (f) certain payments to the owner of the property. …