Lien Law Article 3-A Trust Fund Claims

This is the most powerful remedy in New York construction law and the one contractors understand least. Money received on a construction project in New York is not the recipient's money to spend as it chooses. It is a trust fund, held for the benefit of the people who supplied labor and materials to that project, and using it for anything else, including paying legitimate expenses on a different job, is a breach of trust.

The consequences reach past the company. Officers, directors, and anyone who participated in the diversion can be personally liable, the obligation is not readily discharged in bankruptcy, and knowing diversion is defined by statute as larceny.

The Law Offices of Albert Goodwin brings and defends trust fund claims in New York City.

How the Trust Works

Article 3-A of the Lien Law creates a statutory trust over funds received in connection with an improvement to real property. In broad terms:

• An owner who receives funds for the improvement, such as loan proceeds from a construction lender, holds them in trust for payment of the cost of improvement.
• A contractor or subcontractor who receives funds under a contract for an improvement holds them in trust for the payment of claims arising out of that improvement.
• The beneficiaries are those who provided labor or materials for that improvement: subcontractors, laborers, materialmen, and certain others, including those owed contributions to employee benefit funds and certain taxes arising from the project.

The trust attaches when the funds are received, and it continues until every trust claim on that project has been paid or discharged. Critically, the trust is project specific. Funds received on the Brooklyn job are trust assets for the Brooklyn job's beneficiaries. Using them to make payroll on the Queens job is a diversion, even though both are legitimate business expenses of the same company, and even though the contractor fully intends to make everyone whole.

This is the fact that catches honest contractors. Robbing Peter to pay Paul is standard cash management in a business where receivables arrive late. Under Article 3-A, it is a breach of trust.

What Counts as Diversion

Any use of trust assets for a purpose other than paying trust claims on that improvement, before all such claims are satisfied, is a diversion. Recurring examples:

• Paying subcontractors or suppliers on a different project;
• Paying the company's general overhead, rent, or office payroll;
• Paying the owner's personal expenses or taking distributions;
• Repaying a bank line of credit or an owner loan;
• Allowing a lender to sweep the operating account containing trust funds;
• Paying taxes or obligations unrelated to the project.

A contractor's own profit is not a trust asset once all trust claims on the project are paid, but the sequence matters: the profit comes out last, not first.

The Books and Records Rule

Article 3-A requires trustees to keep books and records showing, for each project, the trust assets received, the payments made, the transfers, and the trust claims. The rule that gives this teeth: failure to keep the required records is presumptive evidence that the trustee applied trust funds for purposes other than trust purposes.

That presumption decides many of these cases. A contractor who cannot show, project by project, what came in and where it went, starts the case having effectively conceded diversion, and bears the burden of proving otherwise. Contractors who maintain job-cost accounting with per-project ledgers can meet the requirement without difficulty. Contractors running everything through one operating account with no project-level allocation usually cannot.

Personal Liability

This is why trust claims matter so much more than ordinary contract claims. Officers, directors, partners, and managing members who participate in or direct a diversion may be held personally liable for the diverted amounts. The corporate form does not shield them, and unlike a veil piercing claim, no showing of domination, undercapitalization, or disregard of formalities is required. Participation in the diversion is enough.

Two further consequences follow. Knowing application of trust funds to a non-trust purpose is defined by the Lien Law as larceny, which introduces criminal exposure into what began as a payment dispute. And a debt arising from a defalcation while acting in a fiduciary capacity is generally not dischargeable in bankruptcy, meaning a contractor who closes the company and files personally may still be carrying the trust liability afterward.

Bringing a Trust Claim

Practical features that make these claims valuable to an unpaid subcontractor or supplier:

• The claim survives the company's insolvency, because it reaches individuals and traceable funds rather than depending on the company's balance sheet.
• It reaches parties who received the diverted funds, including in some circumstances transferees.
• Trust actions may be brought in a representative capacity on behalf of all beneficiaries of the same trust, which is why these are frequently pleaded as class actions.
• Discovery is aimed at accounting records, and the books and records presumption means a defendant's poor recordkeeping helps the plaintiff.
• An accounting can be compelled, requiring the trustee to demonstrate the disposition of every dollar received on the project.

There are procedural requirements and time limits governing when trust claims may be asserted, including limits tied to the completion of the improvement, and the representative nature of the action affects how it must be pleaded and resolved. These are not claims to file from a form. They should be evaluated alongside the lien and bond remedies, which run on their own deadlines. See mechanics liens and construction payment disputes.

Defending a Trust Claim

Trust allegations are now attached routinely to ordinary subcontractor collection cases, precisely because they create personal exposure and settlement pressure. That does not mean they are always well founded. Defenses that succeed:

• The funds were properly applied. With adequate job-cost records, a contractor can demonstrate that receipts on the project were used to pay that project's trust claims, which is a complete answer.
• The plaintiff is not a trust beneficiary, because it did not provide labor or materials to that improvement.
• The defendant was not a trustee and did not participate. Not every officer directs disbursements, and a person with a title but no authority over payments is differently situated from the one who signed the checks.
• No funds were received. There is no trust without trust assets. Where the owner never paid, there is nothing to divert, which is why these claims often collapse against a general contractor that was itself unpaid.
• The claim is time barred or procedurally deficient.
• The amounts were paid, or the claim has been satisfied from other sources including a lien or bond recovery, and a double recovery is not available.

How to Stay Out of This

1. Keep project-level accounting. Separate job cost ledgers showing receipts and disbursements per project. This satisfies the statutory requirement and defeats the presumption.
2. Consider separate accounts for large projects, or at minimum a documented allocation methodology.
3. Pay the project's trust claims from the project's receipts before applying funds anywhere else, including to overhead and profit.
4. Watch the lender. A bank sweeping an operating account that holds trust funds creates a diversion the contractor did not intend. Discuss account structure before it happens.
5. Do not take distributions while project trust claims are outstanding.
6. Get advice before triage. When cash is short and you are deciding who to pay, that decision is exactly the one that creates personal liability. It is worth a phone call first.

See also personal liability of officers, which covers the parallel exposure for payroll and sales taxes that arises in the same cash-crisis moment.

You can contact us by phone at 212-233-1233 or by email at [email protected].