Another Fine MessCopyright (C) 2013 Kevin J. ConnollyIt is no secret that New York’s Lien Law is a complex statute. It has grown a moss-like jurisprudential coating that confirms the statute as a minefield of obscure traps that occasionally catches even the most distinguished of construction counsel and their clients. Coupling this statute and its jurisprudence with the cupidity of some contractors and the arrogance of some developers has produced some extraordinary tales.

The most recent “perfect storm” appears to be found in Bergassi Group v Consolidated Edison Company (2013 Ny Slip Opn 30398(U)). That case grew out of Con Ed’s award of a contract for patching roads that Con Ed had opened and trenched in laying utility lines. A subcontractor went unpaid, liens were filed and off to court marched the parties.

The tale, as related in the pleadings, begins with the award by Con Ed to Qualcom Construction of contracts to patch three roads--one in Westchester and two in the Bronx--that had been opened for utility work. Qualcom awarded a purchase order to NY Materials for the asphalt patch materials, as well as a subcontract to MVM Construction to perform the patching work. Apparently, the Con Ed contract required the issuance of payment and performance bonds, which were placed by lead plaintiff Bergassi Group.

Something went wrong. MVM and other subcontractors were not timely paid. They served lien notices on parties various and sundry, including Con Ed. Con Ed held up payments to Qualcom pending the resolution or bonding of the liens. It commenced an interpleader proceeding in Bronx County, and dismissed the proceeding when MVM produced surety bonds that satisfied Con Ed’s bureaucracy. Con Ed released some or all of the retained funds on the strength of the lien discharge bonds.

The bonds turned out to be bogus. The contractor’s principal appears to have fled the jurisdiction shortly before a bankruptcy petition was filed.MVM, joined by the material supplier and broker who placed the payment and performance bonds, sued Con Ed on a variety of theories. Con Ed responded with a motion to dismiss; plaintiff served an amended complaint; and Con Ed moved again for dismissal before joining issue. The Amended Complaint presented six causes of action:1. Breach of Fiduciary Duty;2. Negligence;3. Conversion;4. “Violation of Lien Law Article 3A;”5. Common Law Constructive Trust; and6. Prima Facie Tort.

This is not the usual pattern. In private improvement lien litigation, we are used to seeing the Unholy Trinity of Express Contract, Quantum Meruit, and Enforcement of Lien. None of those causes of action is pleaded. In public lien litigation, we still see those causes of action, though the enforcement mechanism for a public lien is not a judgment of foreclosure and sale (as it can be in private lien enforcement).

The Bonds

The bonds were, to be charitable, not quite right. There was a single bond, addressing the claims of three lienors, covering properties in the Bronx and Yonkers. To make matters more interesting, the bond was written to the Queens County Clerk. To add to the mess, the surety on the bonds was “Oceanic Indemnity,” a Bahamas corporation, and none of the supporting documents--most notably a certificate of qualification under Insurance Law 1111--was present. Nevertheless, Con Ed, ostensibly relying on the bonds, released the funds it was withholding and dismissed the 5239 Proceeding.

There was a time when all lien discharge proceedings required court intervention. First, a special proceeding was brought to fix the amount of the bond to be filed; then the owner or contractor would seek judicial approval of the bond, which would be granted by way of an order of discharge. Now, the amount of the bond is the principal amount of the claim plus ten per cent.; and if the bond is accompanied by a Certificate of Qualification issued by the insurance department, the discharge is effective as soon as the bond is filed.

Absent that certificate of qualification, the bond is not effective to discharge the lien until it is approved by the Court. No proceeding was brought by Qualcom to approve the bond. If any lien had been created, the bond was ineffective to do anything.

Public or Private?

Much of the confusion here stems from the distinction between public improvement liens and private improvement liens. Con Ed apparently believed that the liens were invalid because they were not filed with the County Clerk. Private improvement liens are so filed, while public improvement liens are filed with the public owner and its financial comptroller(s). However, Con Ed also put some faith in the bonds, which faith was misplaced.

The distinction is actually quite simple: “public improvement” is one performed on realty that is owned by the State, or a public corporation. Work was being performed on public roadways, and while the decision does not drill down to the question of which public corporations are involved here, it is implicit in the decision that the road work was a public improvement.

Sorting It Out

Justice Shenkman’s monumental memorandum decision is simply the best discussion available of the Trust Fund provisions of the Lien Law. The liens proper, on the other hand, are muddled (though not hopelessly).

The road work is a Public Improvement. Title to the roads is in the State or a public corporation (such as the County or City). No further inquiry is needed, and under Section 2(7) of the Lien Law, this is a Public Improvement.

To establish a Public Improvement Lien, one must file the notice of lien with the head of the State agency or public corporation, and with the financial officer of that entity in charge of the finances for the project.

None of the liens was filed with the State or public corporation. Unless these lienors can make a timely re-filing with the public officers, the liens will fail. Justice Shenkman’s decision seems quietly to recognize that at this time, none of the plaintiffs has a validly-filed lien. Whether they can redeem that problem is discussed below.

Where plaintiffs’ remedies lie, if at all, begin with Article 3-A of the Lien Law and its Trust Fund provisions. The Trust Fund can arise even when the claimant has no lien and no right to claim a lien.

In this case, the plaintiffs plead claims for breach Breach of Fiduciary Duty; Negligence; Conversion; “Violation of Lien Law Article 3A;” Common Law Constructive Trust; and Prima Facie Tort. In short, they are pleading the kitchen sink. The court held that the claim for prima facie tort was precluded by plaintiffs’ other claims and allegations, and dismissed the Article 3A proceeding with leave to re-plead as a class action, and otherwise sustained the complaint.

There are some significant obstacles to trust fund recovery. Among these are the limited class of beneficiaries. If, as alleged, Con Ed received funds that were earmarked for this project, then those funds were received in trust, for Qualcom. The plaintiffs’ claims as trust fund beneficiaries are against Qualcom. Con Ed does not owe duties as an Article 3A trustee to the plaintiffs.

Con Ed also asserts that it paid out the balance of retained funds to Qualcom, and therefore as a matter of law there was no diversion of trust funds. Payment to a contractor or material supplier is a permitted use of trust funds, and Con Ed had no duty to see to Qualcom’s use of the $500,000 trust fund. Moreover, as the “Owner,” it did not receive funds from one of the seven sources enumerated in Lien Law 70(5).

The problem in Con Ed’s argument lies in its not being the owner of the property. It is a contractor. Although the contracts between Con Ed and the Cities of Yonkers and New York have not been filed, there can be little doubt but that Con Ed had a contract of some kind with the public bodies. Indeed, in the absence of a “root” contract with the State or public corporation, there can be no public improvement lien.

Now What?

Let’s suppose there is no contract with the Cities. Con Ed was performing this work for its own benefit, in owning and operating steam distribution lines. There might not be ANY public money here. In that case, since a lien cannot be established against a public road, the claimant again hits a brick wall.

This overlooks the amendment of Lien Law Section 5, which now provides in part:

Where no public fund has been established for the financing of a public improvement with estimated cost in excess of two hundred fifty thousand dollars, the chief financial officer of the public owner shall require the private entity for whom the public improvement is being made to post, or cause to be posted, a bond or other form of undertaking guaranteeing prompt payment of moneys due to the contractor, his or her subcontractors and to all persons furnishing labor or materials to the contractor or his or her subcontractors in the prosecution of the work on the public improvement.

There is no sign that Con Ed filed a payment bond or other undertaking. It should have. That bond might have made the plaintiffs, or some of them, whole. The lienors probably had a mandamus claim against the Chief Financial Officers to require that the bond be posted. They may still have a valid mandamus claim.

If there is or was a contract with the Cities, then there is a public fund and the liens maybe valid. They do need to be re-filed, but that re-filing is timely until thirty days after completion and acceptance of the work by the public owner. The odds are that there is no “completion and acceptance” by the City of Con Ed’s work, and therefore these plaintiffs have unlimited time to re-file their liens.

It is not to be expected that the liens will “stick.” The “public money,” if ever there was any, is long gone. We are now deep into the thickets of the trust fund.

The critical language from the Courts decision shows how the plaintiffs’ trust claims can still reach Con Edison’s pocket:

"Although an owner's liability pursuant to Lien Law article 3-A requires the existence of an obligation on the part of the owner (see Lien Law 71[3]), the obligation may be one either imposed by contract 'or as the result of a mechanic's lien'" (Spectrum Painting Contr., Inc. v Kreisler Borg Florman Gen. Constr. Co., 64 AD3d 565, 576 [2d Dept 2009], quoting Quantum Corp. Funding v L.P.G. Assoc., Inc., 246 AD2d 320 [1st Dept 1995], Iv denied 91 NY2d 814 [1998]).[fn omitted] As noted by one commentator, "since an owner who has notice of an subcontractor's mechanic's lien may be required to pay twice if he makes payment to the prime contractor after the lien is filed, the filing of a lien frequently stops the flow of cash from the owner and can therefore operate as a significant pressure device even before litigation is commenced" (4C NY Prac., Com. Litig. in NY State Courts 104:20 [3d ed]).

Now the remaining question is whether the notice of lien served by the plaintiffs is sufficient to trigger trust fund liability. The existing cases do not provide much guidance. One factor to consider is the public policy underlying the trust fund, which is to guarantee that those who do the work will be paid. Remember, too, that the trust fund is broader than formal lien priority. Con Ed certainly had notice of the plaintiff’s claims. It undertook to hold the funds subject to court direction, and then released them upon tender of patently insufficient bonds. This may call for an investigation into just what sort of improper blandishments may have induced Con Ed’s risk managers to have made this mistake.

Here, too, the explicit undertakings and pleadings may have proven to be Con Ed’s undoing. Justice Shenkman placed great weight on the interpleader proceeding that Con Ed commenced, as well as on Con Ed’s representation that the retained sums would be held in trust for distribution to the subcontractors.

In short, we have here an epic saga in the making. There is more--much more--to be mined from Justice Shenkman’s masterful opinion, and likely there will be internecine proceedings.

Con Ed should be mindful that an award for breach of the trust fund will support an award of attorney’s fees.