Article by: Michael F. Higgins
If a general contractor advances payment to subcontractors for amounts not yet paid by the project owner, can the general contractor later reimburse itself those advanced funds when it settles claims with the owner? A recent appellate decision1 concluded that doing so would be a diversion of trust funds in violation of New York Lien Law Article 3-A.
The owner terminated the general contractor causing a payment dispute which involved subcontracted work. The general contractor paid subcontractors for portions of their completed work from the general contractor’s own funds. However, the general contractor did not pay the subcontractors in full. Thereafter, the owner and general contractor entered into a settlement. After learning that the general contractor intended to reimburse itself for the payments it had advanced, the subcontractors seeking to enforce liens they had filed commenced an action to enforce the trust and obtained an injunction prohibiting the general contractor from dispersing the settlement funds without further court order, while the parties continued to litigate the validity of the subcontractor’s liens.
New York Lien Law Article 3-A requires contractors receiving money from the Owner for the project to hold those funds in-trust and only use the funds for the costs to improve the property. The law was designed to prevent unscrupulous contractors from stealing the owner’s funds and leaving subcontractors without effective recourse. The majority of justices in a 3-2 decision concluded that the settlement funds constituted trust funds under Lien Law Article 3-A, held by the general contractor in its fiduciary capacity to be applied for expenditures arising out of the improvement of real property. The general contractor, the court held, had no authority to reimburse itself first for “costs of the improvements”, except if a balance remained after paying all subcontractors and trust fund beneficiaries. The court reasoned, when a general contractor reimbursed itself from the settlement amounts it was effectively paying its own debts, and not paying for the costs of improvement.
The two-justice dissent framed the question differently – “whether a trustee can apply subsequently received trust assets to reimburse earlier payments that were initially made with nontrust funds toward proper trust purposes.” Believing the answer should be yes, the dissent warned that the majority’s decision would discourage general contractors from ever using their own funds to timely pay subcontractors, incentivizing delayed payments until owner payment had been received, if ever received. In doing so, the majority decision undermines the goal of Article 3-A to ensure timely payment to subcontractors and those who have expended labor and materials to improve a property.
A careful contractor might avoid the harsh consequences of this case if lien waivers include language assigning subcontractor lien rights to the general contractor and explicitly permit recovery of any advanced funds. Additionally, when a general contractor is negotiating with a subcontractor under a pay-when-paid subcontract, it may be wise to seek a liquidating agreement that assigns the subcontractor’s lien rights to the general contractor.
The ramifications of this ruling will undoubtedly be exacerbated by the familiar West-Fair doctrine, under which pay-when-paid clauses can become unenforceable in New York when payments are delayed to subcontractors beyond a reasonable time. General contractors will be forced to become Owner’s financiers in the event of a prolonged dispute, because general contractors will not be able to avoid paying subcontractors. Additionally, general contractors will have difficulty recovering these advanced funds in any timely manner because they are prohibited from reimbursing themselves until subcontractors are paid in full. Careful attention to lien releases and liquidating agreements may help avoid or ameliorate these harsh consequences.
- L.C. Whitford Co. Inc. v. Babcock & Wilcox Solar Energy, Inc., 244 AD3d 1552 [3d Dept 2025]
