Construction and development projects brim with the potential for disputes. But before taking drastic measures, parties to such a dispute must carefully consider the consequences of their actions. New York’s Lien Law regulates important aspects of the relationships between owners, contractors, and subcontractors, including the proper use and disposition of construction financing. Failure to adhere strictly to the Lien Law’s requirements governing such funds can expose unwary contractors—and their principals—to fiduciary-duty liability, as the court made clear in 107 S. Albany St., LLC v. Scott, 211 A.D.3d 1380 (3d Dep’t 2022).
The Underlying Dispute
The plaintiff in this case, 107 S. Albany Street, LLC (the “LLC”), hired defendant Northeast Renovation, Inc. (“Northeast”) as the general contractor for the construction of an 11-unit apartment building on the LLC’s real property in Ithaca, New York. Michael Scott was Northeast’s President and owner. According to the LLC’s Complaint, the contract price for the project was roughly $1.275 million. Before substantially completing work, Northeast allegedly abandoned the job—but only after the LLC had paid Northeast the full $1.275 million contract price. The LLC further alleged that, under the Lien Law, Northeast had a fiduciary duty to hold this sum in trust and apply it solely to expenditures related to the project. Northeast purportedly diverted roughly $225,000 of that sum from its subcontractors, and Scott (the company’s President and owner) apparently consented to these diversions. As a consequence, the LLC alleged that it had to pay Northeast’s subcontractors itself, brought suit against Northeast and Scott, and asserted a breach of fiduciary duty claim against Scott individually.
Breach of Fiduciary Duty Under the Lien Law
Under New York’s Lien Law, construction financing that a contractor receives in connection with the “improvement of real property,” “home improvement,” or “public improvement” must be held in trust by the contractor:
The funds described in this section received by an owner for or in connection with an improvement of real property in this state, including a home improvement loan, or received by a contractor under or in connection with a contract for an improvement of real property, or home improvement, or a contract for a public improvement in this state, or received by a subcontractor under or in connection with a subcontract made with the contractor for such improvement of real property including a home improvement contract or public improvement or made with any subcontractor under any such contract, and any right of action for any such funds due or earned or to become due or earned, shall constitute assets of a trust for the purposes provided in section seventy-one of this chapter.
Lien Law Section 70(1).
The Lien Law requires that these construction-related trust funds be applied exclusively to certain types of expenditures that are enumerated in the statute itself, including payment of subcontractors:
Lien Law Section 71(2)(a).
Furthermore, the Lien Law expressly designates the misuse or “diversion” of such “trust funds” as a “breach of trust:”
Lien Law Section 72(1).
In other words, it is a “breach of trust” under the Lien Law for a contractor to disburse “trust funds” voluntarily in any manner except as expressly enumerated in the statute. As the Court’s decision in 107 S. Albany Street, LLC shows, the misuse of trust funds under the Lien Law exposes contractors and their principals to breach of fiduciary duty liability.
The Court’s Decision
Again, the LLC brought a breach of fiduciary duty claim against Scott individually, alleging that in his capacity as Northeast’s owner and President, Scott had authorized the diversion of trust funds and thereby violated the Lien Law. The trial court granted Scott’s motion to dismiss this claim, but the appellate court reversed:
This reversal is significant both legally and practically. As a matter of law, the appellate-court’s decision clarifies that contractors—including their principals—face fiduciary-duty liability under the Lien Law merely by consenting to the unauthorized use of construction financing. And as a practical matter, this decision serves as a stern warning to contractors (and others) involved in construction and development projects to handle construction funds with a heightened degree of care and attention.