Criminal Liability for Construction Trust Fund Diversion & Fraud
By Henry L. Goldberg, Legal Counsel, Subcontractors Trade Association
Partner, Moritt Hock & Hamroff LLP
Most contractors (GCs and subs alike) are aware of the existence of New York Lien Law Article 3-A, and that it is designed to ensure that entities who provide labor and material on construction projects are fully paid out of a project’s own funds. Before trustees at any level (general contractor or upstream subcontractor) are permitted to use funds on any other non-project-related purpose, all trust fund beneficiaries must be paid in full. This includes taxing authorities. Article 3-A prohibits trustees from, essentially, stealing from one job to pay for labor and/or material on another.
Trust fund “diversion” in violation of Article 3-A exposes the trust fund trustee to harsh penalties. Any owner, general contractor and/or upper tier subcontractor who, acting as a trustee, diverts project funds for any purpose other than paying labor and material claims on that particular project is subject to criminal prosecution for larceny. Under New York Lien Law §79-a, diversion would constitute larceny, as follows:
Any trustee of a trust … who applies or consents to the application of
trust funds received by the trustee as money or an instrument for the payment
of money for any purpose other than the trust purposes of that trust … is
guilty of larceny and punishable as provided in the penal law…
As criminal lawyers remind us, “larceny is larceny” – what degree of grand larceny is simply a matter of the dollars involved.
Unfortunately, many contractors view the potential for a criminal prosecution for the diversion of trust funds as an idle threat. This is based upon the historic reluctance of prosecutors to bring indictments, or otherwise get involved in what they perceived as a “private breach of contract” dispute, rather than a crime.
Desperate People Do Desperate Things
When a job goes “south,” the contractor (or other trust fund trustee) may be tempted to take the chance of using trust funds on one job to bring another job current. This is done believing that, if caught, it is unlikely that the trustee would suffer anything other than court ordered disgorgement of the diverted funds.
Recent cases, however, resulted in the aggressive prosecution of not just the offending construction companies, but their individual principals as well.1
Recently, Manhattan District Attorney Cyrus R. Vance, Jr. announced the indictments of three corporations and four individuals for collectively defrauding at least 40 subcontracting companies out of approximately $9.6 million by failing to pay the companies for work completed on 34 projects in Manhattan.
According to the indictment and statements made on the record in court, Artisan Construction (Artisan) was a mid-sized general contracting company specializing in interior construction and renovations of commercial and residential properties with offices located at 65 West 57th Street in Manhattan. Artisan was owned by James Galvin, 45, who also served as the president; Garret Branagh, 44, was the company’s chief financial officer. Artisan had 10 to 20 full-time employees, but relied on subcontractors to perform the work on various construction projects.
In addition to failing to pay subcontractors for their work, the defendants are also charged with forging documents and creating false business records in order to induce one of the property owners to continue making payments to the company.
Why Criminal Prosecutions Now?
One explanation might be that the sheer size and brazenness of these diversion-related criminal activities. Artisan and its principals allegedly defrauded scores of subcontractors and suppliers. Another reason why major prosecutions are now being undertaken might be the political pressure being applied to the district attorney’s offices at this time.
According to New York County District Attorney Vance:
This type of fraud is harmful to the entire New York City construction industry. It forces the small businesses that complete multi-million dollar projects they do not get paid for, to lay off employees or even declare bankruptcy. It also burdens the property owners with additional costs, and weakens the credibility of honest contracting companies.
Trust funds should always flow straight downhill, ultimately to the intended lower-tier trust fund beneficiaries. Any cross-payments between any two or more jobs is problematic. As a trustee of trust funds, you will have to provide, upon demand, an accounting under oath, (i.e. verified) pursuant to Lien Law §76 or risk significant exposure.
While you don’t have to keep separate bank accounts for each project, you do have to have a separate accounting for each project. To be safe, make certain you establish “Chinese walls” between all of your projects.
The criminal defendants in this case pursued their diversions and fraud to such an extreme extent as to virtually assure notice by the authorities. One can only hope that prosecutors will be more willing to fuel such investigations and prosecutions. The honest subcontractors and suppliers of our industry deserve no less.
©Moritt Hock & Hamroff LLP 2018
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