USING FUNDS IN NEW YORK TO PAY OFF LIABILITIES ON OTHER PROJECTS IS ILLEGAL
In December 2022, a trial court in New York held a contractor and its principal liable to an owner for using funds earmarked for construction of a project to pay off liabilities due on other unrelated projects. Allen v. Zizzi Construction Corp., 2022 NY Slip Op 34234 (Sup. Ct. N.Y. County 2022).
In Allen, the owner advanced sums of money to the contractor expecting that it would be used to pay for work performed on the project. Instead, the contractor and its principal diverted the funds to pay off existing invoices and liabilities due on other unrelated projects. By doing so, the court held that the contractor and its principal violated Article 3-A of the New York Lien Law which creates “trust funds out of certain construction payments or funds to assure payment of subcontractors, suppliers, architects, engineers, laborers … and expenses of construction."
Specifically, Article 3-A was "intended to ensure that funds obtained for financing of an improvement of real property ... will in fact be used to pay the costs of that improvement" and nothing else. Moreover, any officer or principal who knowingly consents to applying Article 3-A funds for any other purpose “is guilty of larceny”. As damages, the corporation and principal were required to pay back over One Million dollars in funds to the Owner that were used to pay off liabilities on other projects.
Article 3-A of the New York Lien Law was created to ensure that contractors, subcontractors, suppliers, and laborers working on construction projects are paid for their work. The statutory trust applies to both private and public work. Under Article 3-A a separate trust is created for each construction project, and the contractor as trustee is required to maintain separate books and records for each one. New York Lien Law §§70(2), 75. In fact, the contractor/trustee does not acquire any property rights in the trust assets until all outstanding claims of Article 3-A trust fund beneficiaries have been paid or discharged. New York Lien Law §70(3).
The trust also flows down making each recipient of funds on a project [such as a subcontractor] equally responsible to make sure they reach their ultimate destination, i.e., payment for the work. Contractors should keep separate books and records for each project to protect themselves from potential Article 3-A claims and avoid, at all costs, using funds to pay off liabilities due on other projects. On the other end, unpaid subcontractors may have powerful rights under Article 3-A, including the right to examine the books and records of the trustee/general contractor and subsequently hold the contractor and its principals personally liable if, in fact, funds have been diverted for other purposes.
About the author: George Marco is an attorney practicing in the field of construction law. He also holds a Bachelor of Science in Mechanical Engineering and was previously employed as a Project Manager for a public improvement contractor.
Disclaimer: This article is for informational purposes only and not intended to serve as legal counsel.