New York Law Review

Tag: Lien Law Article 3-A

  • LeChase Data/Telecom Services, LLC v. Goebert, 6 N.Y.3d 281 (2006): Defining ‘Notice’ for Good Faith Purchasers under New York Lien Law Article 3-A

    6 N.Y.3d 281 (2006)

    Under Article 3-A of the New York Lien Law, a ‘purchaser in good faith for value and without notice’ of diverted trust assets is not necessarily required to have actual knowledge of the diversion; UCC 1-201(25) supplies the appropriate standard of notice, encompassing actual knowledge, notification, or reason to know based on the circumstances.

    Summary

    This case clarifies the standard of ‘notice’ required to disqualify a factor from the ‘good faith purchaser’ exemption under Lien Law Article 3-A. LeChase, a subcontractor, sued Business Funding Group (BFG), a factor who had been assigned accounts receivable from Light House, the general contractor. LeChase claimed that BFG had received payments from WorldCom (the owner) that constituted diverted trust funds. The court held that actual knowledge of the diversion is not required; ‘notice’ under UCC 1-201(25) is sufficient, meaning BFG either knew, received notification, or had reason to know of the diversion based on the circumstances. The Court found BFG had sufficient information in the work orders to be on notice that Light House was performing construction, not just design, and thus summary judgment was granted to LeChase.

    Facts

    Light House had a master agreement with WorldCom for telecommunications work. To secure working capital, Light House entered into a factoring agreement with BFG, assigning its accounts receivable in exchange for advances. Light House instructed WorldCom to pay invoices directly to BFG. LeChase subcontracted with Light House to perform construction work. LeChase completed its work but was not fully paid by Light House. LeChase then sued BFG, alleging diversion of statutory trust funds under Article 3-A of the Lien Law because BFG received payments from WorldCom for work LeChase performed.

    Procedural History

    LeChase sued Light House, WorldCom, and BFG for breach of contract and diversion of statutory trust funds. LeChase moved for summary judgment, arguing BFG received trust funds with knowledge of their trust nature. BFG cross-moved for summary judgment, claiming it was a ‘purchaser in good faith for value and without notice’ under Lien Law § 72(1). Supreme Court denied both motions, finding a triable issue of fact regarding notice. The Appellate Division reversed, granting BFG’s cross-motion, holding that LeChase needed to establish actual notice to overcome the good faith purchaser defense. The Court of Appeals reversed the Appellate Division.

    Issue(s)

    1. What standard of ‘notice’ applies to a ‘purchaser in good faith for value and without notice’ under Lien Law § 72(1)?

    2. Did Business Funding have sufficient ‘notice’ that it was receiving trust funds, thereby precluding it from claiming the good faith purchaser defense?

    Holding

    1. No, actual knowledge is not required. The standard of ‘notice’ under UCC 1-201(25) applies, because it encompasses actual knowledge, notification, or reason to know based on the facts and circumstances.

    2. Yes, because BFG had access to work orders detailing construction services, knew WorldCom construction managers had to approve invoices before payment, and had the right to Light House’s contracts. This information provided sufficient notice that BFG was receiving payments related to construction, negating the ‘good faith purchaser’ defense.

    Court’s Reasoning

    The Court reasoned that Article 3-A of the Lien Law aims to ensure payment to those who improve real property. Diversion of contract funds before payment of all trust claims is an improper diversion of trust assets. The Court distinguished prior cases, like I-T-E Imperial Corp. v. Bankers Trust Co., because those cases involved banks that were merely depositories of funds, not parties in a contractual relationship with the contractor. The Court stated that the subjective standard of notice applied in cases dealing with negotiable instruments (Articles 3 and 4 of the UCC) is not applicable here.

    The Court relied on UCC 1-201(25), which defines notice as either actual knowledge, receipt of notification, or reason to know based on the circumstances. Because BFG had a contractual relationship with Light House, possessed copies of work orders describing construction work, and knew that WorldCom construction managers had to approve invoices, it had sufficient information to be on notice that it was receiving trust funds. The Court also pointed out that BFG could have protected itself by filing proper Lien Law notices. As the Court explained, the master agreement “included construction among these services, and the work orders detailed the construction work.” Further, “Business Funding regularly contacted WorldCom’s construction managers, and knew that WorldCom would not pay an invoice from Light House until a construction manager signaled satisfactory completion of the work billed.”

  • RLI Ins. Co. v. N.Y. State Dep’t of Labor, 97 N.Y.2d 256 (2002): Surety’s Subrogation Rights Prevail Over Cross-Withholding for Unrelated Wage Violations

    RLI Ins. Co. v. N.Y. State Dep’t of Labor, 97 N.Y.2d 256 (2002)

    A surety that completes a public improvement project and pays all trust beneficiaries is equitably subrogated to the rights of the owner and beneficiaries, giving it priority over the Department of Labor’s cross-withholding for wage violations on an unrelated project, up to the amount of the surety’s expenses.

    Summary

    RLI Insurance Company, as a surety, completed a school renovation project after the original contractor defaulted and paid all subcontractors and suppliers. The Department of Labor (DOL) sought to cross-withhold funds due under this project to satisfy wage violations by the contractor on a prior, unrelated project. The New York Court of Appeals held that RLI, as surety, had superior rights to the remaining project funds under the principles of equitable subrogation and Lien Law Article 3-A, because it completed the project and paid all trust beneficiaries. This prevents the diversion of funds intended for the completed project.

    Facts

    D.C. White Company Inc. contracted with the Queensbury Union Free School District for renovations (the Queensbury Project) and obtained performance and payment bonds from RLI. White defaulted, and the School District terminated the contract. RLI, as surety, completed the project, expending over $176,000 to do so and paying all Lien Law Article 3-A trust beneficiaries. The School District owed $135,250 for the completed work.

    The DOL served the School District with a Notice of Withholding for $19,150.15 based on prevailing wage violations on the Queensbury Project and a Notice of Cross-Withholding for $27,000.23 based on wage violations on a prior, unrelated “Albany Project.” The School District released $89,099.62 to RLI but withheld the balance per DOL’s directives.

    Procedural History

    RLI initiated a CPLR Article 78 proceeding to compel DOL to withdraw its Notice of Cross-Withholding and to prevent the School District from releasing funds to DOL under that notice. The Supreme Court denied the petition, prioritizing DOL’s claim. The Appellate Division affirmed, reasoning that Labor Law § 220-b(2)(a)(1) intends to allow DOL to seize funds from any public entity holding funds owed to a contractor with wage violations, regardless of the project. The Court of Appeals granted leave to appeal.

    Issue(s)

    Whether a surety that completes a public improvement project and pays all trust beneficiaries has priority to remaining project funds over the Department of Labor’s cross-withholding of those funds to satisfy wage violations arising from an unrelated project.

    Holding

    Yes, because under equitable subrogation principles and Lien Law Article 3-A, a completing surety that has fully satisfied its obligations has a superior right to the remaining funds over DOL’s cross-withholding for violations on an unrelated project.

    Court’s Reasoning

    The Court reasoned that Lien Law Article 3-A creates a trust for funds received by a contractor for a public improvement, with the purpose of ensuring that those funds are used to pay for the costs of that improvement. These trust assets come into existence even before funds are “due or earned” by the contractor. Labor Law § 220-b(2)(a)(1) allows DOL to cross-withhold only from payments “due or earned,” meaning the Lien Law trust arises first.

    The Court emphasized the comprehensive nature of Lien Law Article 3-A, which includes even unmatured rights to future payment as trust assets. Because DOL’s right to cross-withhold attaches only to payments “due or earned” by the contractor, the article 3-A trust, which can arise earlier, takes precedence.

    The Court rejected DOL’s argument that RLI’s rights are limited to those of the contractor, explaining that RLI is equitably subrogated to the rights of both the owner and the trust beneficiaries, including laborers and materialmen. The court quoted Pearlman v. Reliance Ins. Co., 371 U.S. 132, 141 (1962): “the surety, having paid the laborers and materialmen, is entitled to the benefit of all these rights to the extent necessary to reimburse it.” Therefore, RLI’s rights are not limited to those of the defaulting contractor.

    The Court distinguished City of New York v. Cross Bay Contr. Corp., 93 N.Y.2d 14 (1999), noting that in that case, the surety had not yet completed payment of all valid claims. Here, RLI fully performed its obligations and is not competing with a conceded article 3-A trust beneficiary. Public policy also favored RLI’s position because forcing sureties to pay for obligations they did not bond would increase costs on public improvement projects.

    The Court concluded that the DOL’s right to *file* notices of withholding and cross-withholding remains intact. However, in this case, the balance due under the contract was less than the amount RLI expended to complete its obligations. Thus, RLI is entitled to vacatur of the cross-withholding.

  • Friederich & Sons Co. v. U.S., 26 N.Y.2d 103 (1970): Trust Beneficiary Status Under Lien Law Article 3-A

    Friederich & Sons Co. v. U.S., 26 N.Y.2d 103 (1970)

    Under Article 3-A of the New York Lien Law, a party can be a beneficiary of a statutory trust, and thus assert a claim to trust funds, even without having filed a mechanic’s lien, provided the claim arises from the improvement of real property and falls within the statute’s enumerated list of eligible expenditures.

    Summary

    This case addresses whether the United States, as a claimant for unpaid taxes related to a construction project, can assert a claim as a trust beneficiary under Article 3-A of the New York Lien Law in an action brought by the trustee for distribution of trust funds. The Court of Appeals held that the United States could assert its claim even though it had not filed a mechanic’s lien and the time for independent action may have expired, because the trustee initiated the action seeking adjudication of all rights to the fund. The court emphasized that Article 3-A explicitly grants beneficiary status regardless of lien filing.

    Facts

    A. Friederich & Sons Company was the general contractor for an apartment construction project. Colorcraft of Syracuse, Inc. was a flooring subcontractor, and Harry B. Harman furnished flooring material to Colorcraft. Harman, not fully paid, filed a mechanic’s lien and commenced a foreclosure action. Subsequently, Friederich, as trustee, commenced a separate action under Section 77 of the Lien Law seeking distribution of a $5,532.68 balance owed by the owner, acknowledging various claims against the fund, including tax claims by the United States.

    Procedural History

    Friederich initiated an action under Section 77 of the Lien Law seeking distribution of trust funds (Action No. 2). This action was consolidated with Harman’s foreclosure action (Action No. 1). Harman moved for summary judgment against the United States, arguing its tax claims were time-barred. Special Term denied Harman’s motion. The Appellate Division modified the order, dismissing the complaint against the United States, reasoning that the tax liens were not filed in the proper county. The United States appealed to the Court of Appeals.

    Issue(s)

    Whether the United States, as a claimant for unpaid taxes arising from the construction project, can assert a claim as a trust beneficiary under Article 3-A of the Lien Law in an action initiated by the trustee for the distribution of trust funds, despite not having filed a mechanic’s lien and the potential expiration of the time to file an independent action.

    Holding

    Yes, because Article 3-A of the Lien Law explicitly grants beneficiary status to certain parties, including those with tax claims arising from the improvement of real property, regardless of whether they have filed a mechanic’s lien, especially when the trustee initiates an action seeking adjudication of all rights to the trust fund.

    Court’s Reasoning

    The Court of Appeals reversed the Appellate Division’s decision, holding that the United States could assert its tax claim as a trust beneficiary. The court emphasized that a trust beneficiary under Article 3-A does not need to have a lien or be a lienor to assert a claim. The statute itself provides that certain persons are “beneficiaries of the trust” whether or not they have filed a notice of lien (§71, subd. 4). The court cited Aquilino v. United States of America, 10 N.Y.2d 271 (1961), for its instructive treatment of the scope of Article 3-A. The court noted that Section 71(2)(c) of the Lien Law expressly includes “payment of taxes” as a permissible expenditure of trust assets. Because the trustee initiated the action seeking adjudication of rights to the fund, no statutory bar prevented the United States from asserting its tax claims arising from the work creating the trust fund. The court also addressed Harman’s argument that the record lacked specifics regarding the tax lien, pointing to an affidavit from an Assistant U.S. Attorney detailing the type of tax, taxable period, amount, and connection to the construction project. The court found this sufficient to warrant the Special Term’s denial of summary judgment.