covid19

STA LEGAL LOG – OCTOBER 2019

It’s Not Just Trust Fund Diversions –
Accurate Books and Records Are Critical

By Henry L. Goldberg, Legal Counsel, Subcontractors Trade Association
Partner, Moritt Hock & Hamroff LLP

Robert J. Fryman
Partner, Moritt Hock & Hamroff LLP

In a recent Legal Log (February 2019), we discussed the effect of a contractor’s blatant diversions of trust funds in violation of Article 3-A of the Lien Law.  We now examine your obligation to not only properly utilize trust funds for project purposes only, but to keep accurate books and records detailing the use of trust assets.  Surprisingly, similar to an actual, blatant diversion, a contractor’s mere failure to keep accurate books and records can have significant legal ramifications. In fact, a legal presumption arises under the Lien Law that a diversion has occurred where a contractor fails to maintain the required books and records. This is a very powerful weapon in the hands of experienced counsel for a trust fund beneficiary. Also keep in mind that a mechanic’s lien is not required for the legal presumption based on poor record keeping to arise.

Under Article 3-A of the Lien Law, all contractors and subcontractors in receipt of construction project funds (each a “trustee” of the trust funds in their possession) have a duty to account for the trust funds at all times. The funds received are to be kept and tracked in a manner that separates them from funds for other projects. This is to ensure that the trust funds are not used to pay non-project expenses prior to the paying of all debts of that specific project. As is often said, construction trust funds must move “vertically, not horizontally.”

As indicated, if project funds cannot be accounted for with sufficient detail, the statute imposes a “presumption” against the trustee that funds have been diverted. If the trustee in control of the funds cannot overcome this presumption, a court can award summary judgment in favor of a claimant/trust fund beneficiary. Think about that. No direct proof of diversion would be required.

Recently, a New York appellate court examined a lower court’s grant of summary judgment in favor of a trust fund beneficiary against an “upstream” site work contractor/trustee involving a project for the Dormitory Authority at SUNY Binghamton. A site work subcontractor in turn hired a sub-subcontractor to provide landscaping services for the project. At the end of the project the landscaper claimed that it was owed $107,000 for labor and materials provided for the project.  It filed a mechanic’s lien and subsequently commenced a lawsuit against the site work contractor.

During the litigation, the landscaper demanded that the site work contractor provide a verified (i.e., sworn to under penalty of perjury) statement of all trust funds received and disbursed pursuant to Lien Law § 76. Initially, the site contractor failed to provide any response, but after the subcontractor made an application to the court, and the court issued an order compelling a response, the site contractor eventually produced a purported “verified statement.” However, the sworn statement produced contained numerous deficiencies and lacked sufficient specificity as to the disposition of the trust assets.

The verified statement showed that the site contractor received approximately $10,600,000 in trust funds from the general contractor. Remarkably, the statement only accounted for approximately $6,500,000 of trust funds spent, leaving over $4,000,000 unaccounted for.

The Lien Law specifies the books and records to be maintained by each level of trustee.  The appellate court’s decision found that the site contractor’s verified statement was deficient in several regards. First, the statement failed to set forth dates, or amounts, for many of the funds received and paid out of the trust account. Second, the statement did not break down, with detail, the $6,500,000 in expenditures to the various sub-subcontractors working on the project. Lastly, the statement failed to account for all of the trust assets received on the project.

The Lien Law expressly provides at §75 (4) that a trustee’s failure to keep the recorded records shall be presumptive evidence that the trustee had utilized trust funds received for purposes other than the trust.

Moreover, since the site contractor had ample time to supplement its verified statement to remedy its statutory deficiencies, and did not proffer a reasonable explanation as to why it could not do so, the appellate court agreed with the lower court that the site contractor had failed to overcome the statutory presumption of actual trust fund diversion.

 

 

MH&H Commentary:

The impact of the adverse presumption of poor record keeping cannot be overestimated. No proof of actual diversion, no trial was required, simply a judicial “cutting to the chase” and a summarily issued judgement against the site contractor/trustee for the full amount claimed. Worse still, it is not only the corporate entity that can be held liable, but the principals, officers and directors of the corporation may be held personally liable if the individuals had knowledge of and are found to have participated in the diversion of trust funds.

This case demonstrates the legal consequences of allowing the presumption of diversion to even arise. I can tell you from experience that it is very difficult to put the “genie back in the bottle.” The lack of accurate, detailed and contemporaneous records is very challenging and almost impossible to cure, years later and under oath. The temptation to not only directly “divert” funds, but to cut corners in your record keeping practices must be resisted. Don’t fall victim to the enforceable legal presumption of diversion and all that it entails.

As always, please feel free to forward any questions or comments. We enjoy the feedback.

# # #

Henry L. Goldberg, is a partner at Moritt Hock & Hamroff LLP, and the Chair of its Construction Practice Group. Please feel free to contact Mr. Goldberg directly at (516) 873-2000 or via email at hgoldberg@moritthock.com with any questions.

Robert J. Fryman, is a partner at Moritt Hock & Hamroff LLP. Please feel free to contact Mr. Fryman directly at (516) 873-2000 or via email at rfryman@moritthock.com with any questions.