New York Legal Alert

Construction trust fund statutes have been enacted in several states as an added layer of protection for contractors and suppliers when faced with nonpayment. New York is one such state that has particularly strict requirements under its trust fund statutes — so strict in fact that a recent NY Appellate Court decision held that a property owner was still liable under the trust fund statutes, despite replenishing the funds with their own money.

NY construction trust fund statute

The New York construction trust fund requirements are codified under NY Lien Law §3-A et. seq. Under these statutes, when an individual receives money meant to be used for a specific construction project, the individual is deemed to be holding those funds “in trust” for the benefit of the contractors and suppliers (the beneficiaries) who provided labor and/or materials to the project. Any individual who uses those funds for any other purpose but to pay such contractors and suppliers can be held personally liable for diverting trust funds.

Recently, a New York Appellate Court highlighted how strict these laws are enforced, holding that a property owner can still be liable for diversion of trust funds — even if those funds were replaced.

Restoring trust funds in NY doesn’t relieve the party from liability

The case in question is Top Capital v. DiMarco Constructors, LLC

Project snapshot:

DiMarco, the general contractor, and subcontractors on a construction project brought an action in court against the owner, Top Capital to recover an allegedly unpaid balance due on the project. The action was brought under claims of breach of contract and diversion of construction trust funds. More specifically, they claim that over $17 million remained unpaid and that the property owner had diverted over $1.4 million in trust funds.

Diversion claim dismissed by trial court

The court established that the trust fund assets (i.e. the number of disbursements from the building loan) totaled around $13.3 million, and the parties agreed that the total amount of payments made on the project was roughly $13.2 million.

At trial, Top Capital moved to dismiss the diversion claims, based on the fact that the funds were ultimately restored. The court agreed with this argument, and the number of damages that could be claimed by DiMarco was reduced to roughly $100,000 (the difference between the number of trust funds disbursed $13.3 million and the number of payments made $13.2 million). DiMarco appealed.

Appellate court disagrees: Improper diversion cannot be “cured”

The appeals court was not persuaded by the “restoration argument,” for the simple fact that the trust funds were still improperly diverted. Use of trust assets for “any purpose other than the expenditures authorized in Lien Law §71 before all trust claims have been paid or discharged constitutes an improper diversion of trust assets, regardless of the propriety of the trustee’s intentions.”

Furthermore, allowing such a defense would, in the eyes of the court, “open the door to the practice of pyramiding’ in which [owners or] contractors use loans or payments advanced in the course of one project to complete another, one of the very evils that the Lien Law was intended to guard against.”

One last thing to note is that this decision wasn’t unanimous.

In a dissenting opinion, Justice Curran disagreed with this strict approach. If the fund was ultimately restored, then there’s essentially a “no harm, no foul situation,” and any payments made should be credited to the defendant. Warning against the potential for “double-recovery,” i.e. recovering amounts that exceed the trust fund amount. 

Furthermore, regarding the case at hand, the fear of “pyramiding” is not applicable. This case involved an owner of a single project, under one building loan; not payments to a contractor. Thus, there is no danger that “contractors [will] use loans or payments advanced in the court of one project to complete another” — the particular evil that Lien law article 3-A was intended to vitiate.

Closing thoughts from an attorney of record

We reached out to Richard Bell, Jr., who represented DiMarco in this case. Here’s what he had to say:

“The most important takeaway from the decision is that it appears to mark the first occasion that an Appellate Division has formally addressed whether a trustee can avoid civil liability under Lien Law Article 3-a, by alleging that any diverted funds were subsequently restored through payments from non-trust assets.”

“While restoration has long been recognized as a defense to criminal liability under Article 3-a, its impact upon civil liability was murky at best. By the Court rejecting the restoration defense in civil actions, particularly under the circumstances of this case, the DiMarco decision should provide clarity for future actions.”