Appellate Division Rules Owners are Beneficiaries of Trust Funds

The Appellate Division, Second Department, recently ruled, for the first time, that owners of construction projects are beneficiaries of the trust created under Article 3A of the Lien Law and, therefore, have standing to bring claims against contractors, and their corporate principals, for diversions of trust funds. While the author of this blog has been bringing trust fund claims on behalf of owners against contractors and their corporate principals for many years, the decision in Ippolito v. TJC Dev. is the first reported decision in the Second Department to provide a definitive “yes” to the question of whether owners have standing to bring trust violation claims against the contractor and its corporate principals.

In Ippolito the owners argued that they were beneficiaries of the trust funds created under Section 70 (Article 3A) of the Lien Law. The trial court held that the owners lacked standing to bring trust diversion claims. However, the Appellate Division reversed and held that owners do, in fact, have standing as they are intended beneficiaries of the Lien Law trusts. The Court noted that “the primary purpose of article 3-A and its predecessors[is] to ensure that those who have directly expended labor and materials to protect real property [or a public improvement] at the direction of an owner or a general contractor receive payment for work actually performed. The Court went on to say that the trust commences “when any asset thereof comes into existence and continues until all trust claims have been paid or discharged, or all assets have been applied for trust purposes.” In finding that the owners do have standing as beneficiaries of the trust fund to bring a claim for trust diversions the Court found that the funds paid by the owners to the general contractor “remained the property of the owners…until the proper payment of such funds by the contractor to the purposes of the home improvement contract, breach by the owners relieving the contractor of its obligation to perform or substantial performance of the contract.” The Court goes on to note that the 1987 amendments to the Lien Law make it clear that article 3-A was intended to protect home owners as well as others.

The Ippolito decision was a landmark victory for owners of construction projects and will pave the way for owners to bring trust diversion claims against their contractor, and their contractor’s corporate principals, when the contractor fails to use the money it receives towards completing the construction project. While Ippolito involved a home owner, the analysis by the Court clearly establishes that all owners, including commercial and public project owners, will have standing to bring trust diversion claims against contractors.

Under Ippolito the owner will have standing to bring the trust claim until: 1) until the proper payment of the funds paid to the contractor to the purpose of the home improvement contract; 2) until breach by the owner relieving the contractor of its obligations to perform; or 3) until substantial performance of the contract by the contractor. Of course this means that the contractor now knows of three defenses that it can assert to the trust diversion claim: 1) all funds were properly paid for purpose of the home improvement contract thus divesting the owner of standing to bring the claim; 2) the owner breached the contract and therefore relieved the contractor of its obligation to perform; and 3) the contract has been substantially performed. It would seem that these three defenses should be asserted as affirmative defenses to any trust diversion claim brought against the contractor.

It will be interesting to see how attorneys begin to use Ippolito to help owners recover against unscrupulous contractors. The owner now has a very powerful tool in that it can bring the trust diversion claim no only against the contractor but against the contractor’s corporate principals. Since trust diversion liability is not dischargeable in bankruptcy, contractors face a significant threat when they chose to use trust funds received from the owner for non-trust purposes.

Vincent T. Pallaci is a partner at the New York law firm of Kushnick Pallaci, PLLC where his practice focuses primarily on the area of construction law.  He can be reached at (631) 752-7100 or vtp@kushnicklaw.com

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