Article by: Michael F. Higgins

In an uncommon but successful use of New York’s trust fund laws,¹ a general contractor forced to pay twice for supplies was entitled to obtain trust funds from the subcontractor that had failed to pay them the first time. The case² confirmed the contractor’s standing to assert trust fund diversion claims against the sub, finding it was a subrogee of the trust beneficiaries it paid, thus “standing in the shoes” of those beneficiaries under the legal doctrine of equitable subrogation. 

As most contractors know, the trust fund laws are meant to ensure that construction funds are used to pay for the construction of the intended project before they become available for other uses or projects. Any payments from an upstream party are automatically designated as “trust funds” to be used for the benefit of statutory beneficiaries. All parties, including owners, contractors, and subcontractors are required by the Lien Law to properly manage and account for trust funds and must document payments to specific project expenses. Use of those monies for any other purpose is a trust diversion permitting recovery against the diverter, including against corporate principals individually.³ Typically, beneficiaries are those downstream, including subs, suppliers and workers, who pursue the diverter via class action.⁴ 

The case here presented a different trust fund recovery scenario. The general contractor for a hotel construction project paid its HVAC subcontractor over $450,000 for advance deposits on specially manufactured equipment. No part of this sum was paid by the subcontractor to the suppliers before the sub abruptly abandoned the project. After the general contractor learned of the diversion, it was forced to pay the sub’s unpaid suppliers to avoid project shutdown, delay, filing of additional mechanic’s liens or payment bond claims, and its own breach of the prime contract. 

The general contractor sued the subcontractor for breach of contract, fraud and Lien Law trust fund diversion.⁵  The sub failed to provide proper documentation accounting for the trust funds under the Lien Law and, ultimately, the matter went to a bench trial on the trust fund diversion claims. The court ruled in favor of the general contractor against both the sub and its principal individually. 

On appeal, the appellate court affirmed, finding no reason to disturb the trial court’s determinations of evidence and credibility of witnesses. The court upheld the lower court’s conclusion that the general contractor had standing to assert the diversion of trust assets claims based on its status as subrogee of the sub’s suppliers, stating:

“…subrogee status was established here by the trial evidence showing that [general contractor] made involuntary payments to…subcontractor’s unpaid suppliers…”

Of significance to the court was the sub’s inability to credibly account for the funds’ whereabouts, upholding the lower court’s finding that the sub failed to rebut the Lien Law presumption of diversion with dubious explanations for the absence of the required books and records. 

The principal of the subcontractor was also found personally liable for knowingly participating in the trust diversion. The general contractor showed that the principal controlled the company’s bank account, that money was transferred to his wife’s law firm and then into the account of another company he managed. This diversion of trust assets makes any purported lack of knowledge implausible, said the court. 

Despite the obvious misdeeds of the sub, its principal, and his active participation in the diversion, the court upheld the lower court’s decision against imposing punitive damages, finding them unwarranted under the circumstances, apparently due to a failure of proof of criminal intent.

A contractor’s options for protection against a subcontractor’s intentional diversion are somewhat limited. The most important tool is to know your subcontractors, including their financial health and current workload. Be alert for unusual activities or behavior.

Here, the sub’s principal opposed the contractor’s standing policy of only making advance deposits directly to suppliers and ultimately persuaded the contractor to pay the funds to the sub instead. Resisting that personal appeal for such a policy exception obviously would have served this contractor better. 

While the decision was a good result⁶ for this general contractor, double payment situations are often a financial hardship for contractors and can be financially devastating.⁷ Many general “best practices” may help with early detection of a sub’s diversion, including active monitoring of sub payments and obtaining timely lien waivers. If you suspect a sub is misusing funds, pay only by joint check and seek an immediate accounting of trust funds from the sub under the Lien Law. 

1. New York Lien Law Art. 3-A. 
2. Flintlock Construction Services., LLC v HPH Services, Inc., 230 AD3d 446 (1st Dept 2024).
3. Diverting parties can also be subject to criminal prosecution. 
4. Although an owner has trust fund obligations and liability regarding construction loan proceeds, the more common diverters of trust funds are contractors. 
5. The general contractor also obtained assignments of claims from the suppliers, but the case focused on its trust diversion rights as a subrogee to suppliers’ rights under the trust fund statutes rather than on the assignments. 
6. The true quality of the result may depend on whether the sub and/or the principal has assets. 
7. Use of a trust fund diversion action will typically not extend to other types of “double payment” where liability is based upon joint, vicarious or derivative liability such as prevailing wage laws or the Construction Industry Wage Theft Act.