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Real Property Owners And Contractors Should Be Aware Of The Trust Fund Provisions Of New York’s Lien Law

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  • Posted on: Oct 11 2017

Article 3-A of New York’s Lien Law establishes a system of trusts to ensure that certain individuals or entities that contributed services, labor and/or materials to a construction project for the improvement of real property are paid for their efforts.  This post is designed to generally familiarize owners and contractors with some of the trust fund provisions of the lien law.

The Lien Law generally recognizes two types of trusts.  (Lien Law §71.)  The first is the Owner Trust, of which the owner is the trustee.  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).)   In general, the assets of an Owner Trust consist of funds received by an owner for the improvement of real property.  Most frequently, trust assets in this category consist of construction loan proceeds.  (Lien Law §70(5).)

Second is the Contractor/Subcontractor Trust, of which the contractor or subcontractor is the trustee.  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(5).)

Any funds that are deemed to be trust fund assets under the Lien Law can only be disbursed to appropriate trust fund beneficiaries pursuant to the trust fund provisions of the Lien Law.  A typical scenario illustrating the need for the protections afforded by the trust fund provisions of the Lien Law is where a contractor receives payment from an owner on a present project but the contractor uses the funds to pay a subcontractor on a prior project.  Although this happens routinely, such payments are prohibited under the Lien Law and could result in the contractor’s failure to pay proper trust fund beneficiaries working on the current project.  An unpaid subcontractor can use the trust fund diversion as leverage against the diverting contractor.  The contractor likely diverted trust funds on the earlier project or else there would have been sufficient funds available to pay all trust fund beneficiaries on the prior project without resort to diversions on the current project.

Under the Lien Law, a contractor that pays itself before paying all trust fund beneficiaries is likely to be deemed to have committed trust fund diversions.  In this regard, pursuant to the Lien Law “… [e]very such trust shall commence at the time when any asset thereof comes into existence, whether or not there shall be at that time any beneficiary of the trust.”  (Lien Law § 70(3).)  This language makes plain that any money paid by an owner to the contractor must be held in trust for trust fund beneficiaries even if at the time of such payment, the contractor has not yet incurred any liability to any subcontractors on or materials suppliers to the project.

Under the Lien Law, while a trustee is not required to maintain separate bank accounts for each project and is entitled to commingle trust fund assets with its other funds, it must keep detailed books and records setting forth specific items relating to trust funds received and disbursed. (Lien Law §75.)

The law is clear that the assets of a Lien Law trust fund can only be used for Lien Law purposes–namely the payment of the costs of improvement. (Lien Law §71.)  Any other use of trust funds is deemed a “diversion of trust funds” pursuant to Lien Law §72.  “Diversions” may result in civil and/or criminal penalties against a trustee responsible for the diversion.

The failure of a trustee to maintain the detailed records required by §75 of the Lien Law constitutes presumptive evidence that the trustee “has applied or consented to the application of trust funds actually received by him…for the payment of money for purposes other than a purpose of the trust as specified in [§71 of the Lien Law].” (Lien Law §75(4).)

Pursuant to Lien Law §79-a, trust fund diversions also implicate the penal law and could subject the responsible party to a criminal charge of larceny. Thus, the Lien Law provides, in pertinent part:

79-a Misappropriation of funds of trust

  1. Any trustee of a trust arising under this article, and any officer, director or agent of such trustee, 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, as defined in section seventy-one, is guilty of larceny and punishable as provided in the penal law if

(a)  such funds were received by the trustee as owner, as the term “owner” is used in article three-a of this chapter, and they were so applied prior to the payment of all trust claims as defined in such article three-a, arising at any time….

There is, however, an exception to the criminal penalties contemplated by the Lien Law in situations in which trust assets are used to repay advances made by, among others, a trustee if those advances were used for trust fund purposes. Thus, §79-a(2) of the Lien Law provides:

  1. Notwithstanding subdivision one of this section, if the application of trust funds for a purpose other than the trust purposes of the trust is a repayment to another person of advances made by such other person to the trustee or on his behalf as trustee and the advances so repaid were actually applied for the purposes of the trust as stated in section seventy-one, or if the trustee has made advances of his personal funds for trust purposes and the amount of trust funds applied for a purpose other than the trust purposes of the trust does not exceed the amount of advances of personal funds of the trustee actually applied for the purposes of the trust, such application or consent thereto shall be deemed justifiable and the trustee, or officer, director or agent of the trustee, shall not be deemed guilty of larceny by reason of such application or by reason of his consent thereto.

There is, however, no similar exception to the civil penalties that may be imposed for trust fund diversions.  Thus, even in the absence of any improper motives on the part of a trustee and/or any of its officers, directors, agents and the like, the innocuous act of the repayment of advances used for trust purposes, could give rise to civil penalties under the lien law.

Pursuant to Lien Law §76, a trust fund beneficiary is entitled to review the books and records required to be maintained by a trustee and/or to demand a verified statement as to the entries on said books and records so that a determination can be made as to whether trust fund “diversions” exist. Thus, §76 (4) of the Lien Law provides, in pertinent part:

…after service of a request for a verified statement, the trustee shall serve upon the beneficiary named in the request a statement, subscribed by the trustee or an officer thereof and verified on his own knowledge, setting forth the entries with respect to the trust contained in the books or records kept by the trustee pursuant to [§ 75 of the Lien Law] and the names and addresses of the person or persons who, on behalf of or as officer, director or agent of the trustee, made or consented to the making of the payments shown in such statement.


Any owner receiving construction loan proceeds and any contractor or subcontractor receiving payments from an owner or contractor, as the case may be, should be aware of the trust fund provisions of New York’s Lien Law.  Trustees should keep appropriate and statutorily compliant records so that allegations of trust fund diversions can easily be refuted.  Moreover, maintaining such records enables the trustee to avoid the presumption of a diversion imposed by Lien Law §75(4) for failing to maintain proper books and records as discussed above.

Future articles will address each of these issues in more detail.

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