NEW YORK SUPREME COURT ANALYZES WHETHER AN “OWNER” CAN ALSO BE A “CONTRACTOR” FOR LIEN LAW TRUST FUND DIVERSION PURPOSES

• Posted on: Jan 31 2020

In this Blog’s post entitled: “Real Property Owners and Contractors should be Aware of the Trust Fund Provisions of New York’s Lien Law,” the trust fund provisions of New York’s lien law were discussed.  A brief recap of this Blog’s prior post as it relates to this post may be informative.  Lien Law §71 recognizes two types of trusts – (1) the owner trust and (2) the contractor/subcontractor trust.  The assets of the owner trust “shall be held and applied to the cost of improvement.”  (Lien Law §71(1).)   Claimants under an Owner’s Trust include contractors, subcontractors, architects, engineers, surveyors, laborers and materialmen.  (Lien Law §71(3)(a).)  The types of assets that form an owner trust are set forth in Lien Law § 70(5), and include, inter alia, proceeds of building loans and insurance proceeds resulting from the destruction of the improvement.

The assets of the contractor/subcontractor trust must be used for the payment of certain obligations resulting from the improvement of real property such as: the claims of subcontractors, architects, engineers, surveyors, laborers and materialmen; payroll taxes; sales taxes; unemployment insurance; benefits and wage supplements; surety bond premiums and insurance premiums related to the project. (Lien Law § 71(2).)  Most frequently, trust assets in this category consist of the payments received by the contractor from the owner (in the case of a contractor trust) or received by a subcontractor from a contractor (in the case of a subcontractor trust) pursuant to the subject construction contract. (Lien Law § 70(6).) 

Trust fund assets can only be disbursed to appropriate trust fund beneficiaries.  A typical scenario illustrating the need for the protections afforded by the trust fund provisions of the Lien Law occurs when a contractor is paid by an owner on a present project but uses the payment to pay a subcontractor on a prior project.  Such diversionary payments could result in the inability to pay trust fund beneficiaries on the present project.  Despite happening routinely, such payments are prohibited under the Lien Law and could result in the inability of the contractor to pay all trust fund beneficiaries working on the current project. 

On January 28, 2020, the New York Supreme Court, Richmond County, decided Gilbane Building Co. v. New York Wheel Mezz, LLC, in which the court was tasked with determining whether an owner could also be deemed a contractor for Lien Law trust fund purposes.

The facts of Gilbane are straight forward.  The City of New York owned property on Staten Island that was being redeveloped for a variety of purposes.  One aspect of the development was the construction of a 630-foot tall Ferris wheel (the “Project”).  Defendant New York City Wheel (“Wheel”), as tenant, entered into a lease with the City, as landlord, for a piece of land on which Wheel was going to develop the Project.  The lease required Wheel to “perform (or cause to be performed)” certain construction on the Project.  Plaintiff, Gilbane Building Company, “undertook a Construction Management Agreement (“CMA”) in the initial sum of $197,345,036.00, under which Gilbane, as assignee, would provide construction services in connection with the Project.” 

Gilbane, who performed construction services and claimed to be owed $7,000,000.00, commenced action for Lien Law trust fund diversions after Wheel failed to pay it for some of its work.  According to Gilbane, it should have been paid from numerous sources of Owner and contractor trust fund monies that came into Wheel’s possession but were used for non-trust fund purposes.  The Defendants, including Wheel, moved to dismiss the complaint arguing that some of the allegedly diverted trust funds were from the contractor trust and that Wheel was an owner – not a contractor.  Wheel argued that it could not be both an owner and a contractor.  If Wheel was not a contractor, it could not have diverted funds from a contractor trust.  Since, inter alia, the trustee of the trust would also be liable for the diversions, a finding that Wheel was not a contractor would also be beneficial to any other individual that would be responsible for diversions

The Gilbane court then reviewed the purpose and history of the trust fund provisions of the Lien Law.  Quoting Mount Vernon City School Dist. V. Nova Cas. Co., 19 N.Y.3d 28 (2012), the Gilbane court stated that “once a trust comes into existence its funds may not be diverted for non-trust purposes and use of trust assets for any purpose other than the expenditures authorized by statute constitutes an improper diversion of trust assets, regardless of the propriety of the trustee’s intentions.”  Gilbane (internal quotation marks and brackets omitted). 

Focusing on the critical point at issue, the Gilbane court analyzed several cases that addressed the question of who is a “contractor” under the Lien Law.  Quoting McNulty Bros. v Offerman, 221 N.Y. 98, 105 (1917), the Gilbane court stated whether an individual or entity is a contractor under the Lien Law, would be viewed no differently than “one who would be so characterized in the common speech of men.”  “He is one who, in the usual course of trade, has undertaken to improve the property of another. If he happens to have some interest in the land himself his interest is an accident, and not the source and origin and occasion of his tenancy, either at his own expense or with contributions from the landlord, has covenanted for betterments.”  Gilbane (quoting McNulty, 221 NY at 105).  See also, Canron v. City of New York, 214 A.D.2d 115, 123 (1^st Dep’t 1995), aff’d, 89 N.Y.2d 147 (1996); Burns v. Electric Co. Inc. v. Walton St. Assoc., 136 A.D.2d 291, 295, aff’d, 73 N.Y.2d 738 (1988). 

In OTG JFK T5 Venture v. IBEX Const., LLC, 24 Misc. 3d 1244(A), another case relied upon by the Gilbane court, “the trial court found that the petitioner, OTG, was both an ‘owner’ and a ‘contractor’ under its sublease and that all of the facts demonstrated it had ‘the same type of oversight responsibilities as had been undertaken by the contractors in Burns and Canron.’”  OTG JFK.

After reviewing the relevant cases, the Gilbane court found that Wheel was both an owner and a contractor under the Lien Law.  The court found, inter alia, that Wheel: had many oversight responsibilities “that rendered it a ‘contractor’”; frequently had maintenance and supervisory personnel on sight; attended regular meetings; was responsible for approving requisition proposals; was responsible for approving subcontractors hired by Gilbane; reviewed trade contractors’ work and directed corrective measures.

Based on its findings, the Gilbane court denied the defendants’ motion to dismiss.  In addition, the court found the “remainder of Defendants’ motion is premature and Defendants have not eliminated all issues of material fact under CPLR §3211 regarding whether the identified funds are trust assets under Lien Law 3-A and whether, and to what extent, if any, trust funds may have been diverted.”  Gilbane (citation omitted).

TAKEAWAY

Under the trust fund provisions of the Lien Law, owners and contractors have specific duties and responsibilities, which, if not performed could result in liability.  Gilbane highlights the importance of knowing your specific role(s) on a construction project.  In Gilbane, Wheels may have violated its duties as a contractor with respect to contractor trusts without realizing that it held that role and had the related responsibilities.