Author: Rebecca Baldwin Mantello
Lien Law Article 3-A was enacted to help ensure payment to subcontractors who perform work on real property for owners and general contractors. It creates a statutory trust for funds received in connection with improvements of real property. An owner or general contractor is the fiduciary over the "trust." Where, prior to payment or discharge of all allowable trust claims, assets are used for purposes other than for project costs, there is a diversion of trust assets, and a breach of fiduciary duty. Thus, where subcontractors have not been paid for work performed, in addition to filing a mechanic's lien, they may also assert a cause of action for the diversion of trust assets.
A cause of action for diversion of trust assets can result in an award of interest from the time of the diversion. In addition, where the owner or general contractor is personally involved in the diversion, personal liability may attach. This is particularly beneficial to subcontractors where the owner or general contractor is a corporation that has become insolvent. Owners and general contractors have tried to avoid these results by discharging the mechanic's lien filed by the subcontractor, and claiming that the filing of the mechanic's lien and/or its discharge dispenses with the trust claim.
An owner or general contractor can no longer avoid a cause of action for diversion of trust assets by discharging a mechanic's lien. The Second and Third Departments of the Appellate Division have recently held that the deposit of trust funds with the County Clerk nor the filing of a bond to discharge the mechanic's lien will be construed as a "payment or discharge" of the subcontractor's trust claim (see N.Y. Professional Drywall of OC, Inc. v Rivergate Dev., LLC, 100 AD3d 216 [3d Dept 2012]; Holt Constr. Corp. v Grand Palais, LLC et al, 108 AD3d 593[2d Dept 2013]).
Such was the case in Holt Constr. Corp. v Grand Palais, LLC et al, 108 AD3d 593. There, the defendant owner, a development company, which had been rendered insolvent by its sole shareholder, sought to avoid personal liability for the diverted trust assets. The owner argued that it's filing of a bond to discharge the mechanic's lien dispensed with the plaintiff's trust claim. We successfully argued on behalf of the plaintiff, and the Second Department agreed, that the discharge of a mechanic's lien by the filing of a bond is not equivalent to payment or discharge of a trust claim pursuant to Lien Law article 3-A. We were able to secure individual liability against the sole shareholder for his personal involvement in the diversion of the trust assets. Interest on the judgment on the trust claim accrued from the date of the diversion, which was more than six years earlier. As a result, plaintiff's judgment on the trust claim exceeded what was recovered solely on foreclosing the mechanic's lien.
When pursuing their rights to be paid for work performed, subcontractors should avail themselves of all available remedies, including bringing causes of action to foreclosure on the mechanic's lien, breach of contract, quantum meruit, and, where appropriate, diversion of trust claims. While, ultimately, the subcontractor will not be entitled to a duplicate recovery, it is important to ensure that all of the subcontractor's rights are protected.