​In many construction and renovation projects, property owners hire a general contractor who is the primary point of contact for the job. The general contractor, in turn, brings in subcontractors, materials suppliers and other parties as needed. The property owner pays the general contractor, and the general contractor then gives the others the money they are owed. However, what happens when payments aren’t made? What are the legal rights and obligations of the various parties to either pay or receive the funds paid to the general contractor?

General contractors can use a variety of subcontractors and materials suppliers to complete a job, particularly on larger, more complicated jobs. These may include electricians, plumbers, fabricators, and other companies. Under New York law, a general contractor is obligated to use the funds collected from the property owner to pay subcontractors and materials suppliers in full. If they don’t, Article 3-A of New York’s Lien Law provides powerful remedies to subcontractors and materials suppliers to secure rights to payment.

In New York, funds paid to a general contractor are legally not the property of the general contractor. Instead, the money is considered to be held in trust for the subcontractors, materials suppliers and other parties involved in the project until the general contractor has paid them the amount they are owed. This protects the parties due money by giving them a priority status over other creditors of the general contractor.

As an example, federal income tax obligations are generally superior to other creditor claims. However, federal courts have held that priority status does not apply as against claims of subcontractors and materials suppliers to specific moneys paid to a general contractor for their work, because under New York Law, the general contractor is merely a trustee of the funds and has no property rights to the money.

This exception does not apply to payroll taxes. Taxing authorities are considered trust beneficiaries of payroll taxes owed for the general contractor’s employees who worked on the construction job (both the employer’s share and the amount withheld from the employee’s wages). While taxing authorities, subcontractors and materials suppliers are all beneficiaries of the trust funds, payroll taxes have super-priority in an action to enforce a trust fund claim. Therefore, those taxes must be paid first before subcontractors and materials suppliers are entitled to payment under Lien Law 7(8).

General contractors should be aware that, in addition to priority status, trust fund violations can be the basis for claims against individual principals of a general contractor. Thus, the principals can lose the liability protection of their corporation or LLC.

Trust fund beneficiaries also have the right to demand an accounting of the trust funds and can obtain additional damages, including attorneys’ fees, and potential criminal and civil penalties.

While this issue might seem to be of little importance to property owners, unpaid subcontractors and materials suppliers may file mechanic’s liens against properties. This is true even if the general contractor has been paid in full by the property owners, creating practical difficulties for owners until resolved. For this reason, property owners should only make payments to a general contractor if the payment application is accompanied by a conditional release of lien rights from the subcontractor.

If you are involved in a payment dispute related to a construction project, contact one of our attorneys to discuss how we can help you with your case.