Court Opinion

ID: 9445452
Source: CourtListenerOpinion
Date Created: 2023-08-03 21:29:22.246024+00
Date Added: 2024-06-11T17:30:16.204694
License: Public Domain

CLARK, Chief Judge
(dissenting).
We have before us for construction important New York remedial legislation for the protection of laborers and materialmen on building jobs. The evil aimed at is that of “pyramiding,” whereby a contractor parlays his speculations, using one undertaking as the basis of credit expansion for another, with lenders and security holders pretty well protected until, on ultimate disaster, those contributing labor or materials to a particular job are left holding an empty bag. And the remedy is the trust device first introduced in 1929 and now perfected by legislation of 1942, drafted, nurtured, and supported with complete documentation by that most distinguished embodiment of effective law reform, the Law Revision Commission of the State of New York. It is a matter of profound regret that my brethren have denigrated that source of precise and persuasive legislative history — so different from the usual confusion which such history tends to engender — which the Commission’s records afford. Rather, taking some vague judicial remarks on earlier legislation, they have reacted against what is thought to be unduly harsh (more accurately, stern) measures against contractors and have fashioned a wholly original construction of the statute which substantially guts it in its immediate application here. And that, federal judges should not do to state law.
The conclusion herein reached is based on a construction of the crucial statute, N.Y.Lien Law § 36-a,1 which denies to plaintiff, a supplier of materials on the *528particular improvement here involved, the intended benefit of the trust defined by the statute. But I am convinced that the plaintiff is correct in claiming such benefit; and for demonstration thereof I shall rely on the Commission’s scholarly “Act, Recommendation and Study relating to the Trust Fund Provisions of the Lien Law,” 271-336 (1942). I note that the detailed supporting Study, 295-336, was prepared under the direction of that eminent scholar, Professor John W. MacDonald, who long served as Executive Secretary and Director of Research of the Commission and who has just now been honored by appointment to the Commission itself. Quite properly I should incorporate all this material with its voluminous annotations in this opinion, but it may be sufficient to give its flavor by briefer citation and quotation. The Commission summarized the existing law (1941) thus:
“Legislation has been enacted in New York and several other states to prevent abuses which frequently arise in the pyramiding of building operations and to afford adequate protection to those who contribute services or materials upon an improvement of real property.2 *529Such legislation is based on the principle that funds received for an improvement should be applied to pay the cost of that improvement. It supplements the older remedy by lien upon the property improved, which is not available after all payments by the owner on his contract for the improvement have been made.3
“The first legislation was enacted in this state in 1929 at the time of the general revision of the Lien Law. It required that building loan mortgages contain a covenant by the owner to hold the moneys received thereunder as a trust to be applied first to the cost of improvement. Moneys so received were declared to constitute trust funds, a diversion of which was made punishable as a misdemeanor. Later the trust concept was extended to include moneys received by a contractor or subcontractor on account of an improvement, or upon an assignment of moneys due or to become due on a public improvement, as well as moneys received by an owner on a mortgage or conveyance, and proceeds of insurance on the improved property whether payable to an owner, contractor or subcontractor. Some of these statutes provide for the creation of a trust by covenant; others expressly declare the existence of a trust. Diversion of any such trust funds is now punishable as larceny.” 1942 Rep.N.Y.Law Revision Commission 283.4
The Commission, to end widespread uncertainty concerning interpretation of the existing, provisions, recommended legislation clearing up items of doubt. The critical part of the Commission’s work for purposes of this case concerned the scope of the trust fund. Thus it approved the view urged unsuccessfully by the present plaintiff — that all money paid or owing to the contractor for work on one improvement constituted a single trust res for the benefit of all those who worked on that improvement. This idea of a single trust for a single improvement permeates every page of the official report. Nowhere in the study do the authors suggest the construction adopted by my brethren — that each installment payment constitutes a separate trust fund for the benefit of those who worked on the improvement prior to the payment of that installment. Nowhere in the comprehensive report is there discussion of the intricate problems of statutory construction and judicial enforcement raised by the novel gloss upon the statute here advánced.
So the explanation in the Study of the time when the trust arises is couched in terms which cannot be squared with our present opinion:
“Closely allied to the problem of who are beneficiaries of the trust is the question as to when the trust arises. While it is elementary that there can be no trust without a beneficiary, the beneficiary may be designated by class rather than by naming' specific individuals. Future members of the designated class may enjoy the benefits of a trust. It would seem that the trust arises as soon as the trustee desig*530nated in the provision receives the fund, and that such trustee is a resulting beneficiary, who is entitled to any remainder of the fund after it has been distributed to claimants entitled to share in it. The trust would continue until all claims for services and material on the improvement (by the classes designated in the statutory provision) have been paid. It would seem that even if no such claimant existed at the moment of receipt of the moneys by the contractor (or other trustee as designated in the trust fund provisions) a trust would arise in favor of future claimants (i.e., members of the classes for whose benefit the provisions were enacted). The contractor, subcontractor or owner, who is trustee, is in a position to know or to determine whether all claims are paid, and if they are not paid, he is also in a position to know it, even in absence of the requirement that claimants must file a lien to share in the trust fund, or in the case of non-lienable claimants, in absence of the claim being reduced to judgment. If, however, the filing of a notice of lien is requisite to establish a claimant as a beneficiary, it would seem no trust would arise, unless such notice were filed before the fund passed out of the possession of the contractor (or other trustee designated by statute). Moneys transferred by the contractor before the filing of a notice of lien would be taken free of a trust, the trust having failed for lack of any beneficiary, i.e., lienor of the classes designated who filed notice of lien before the fund left the contractor’s hands.” 1942 Rep.N.Y.Law Revision Commission 325, 326.
The study group thus concluded that the interpretation urged by the plaintiff here was correct unless claimants were required to file notice of lien to qualify as beneficiaries. This idea had appeared in one Appellate Division case5 and was followed by us in our first opinion in Wickes Boiler Co. v. Godfrey-Keeler Co., 2 Cir., 116 F.2d 842. The Commission took great pains to wipe out these two decisions which had cast doubt on what it considered the proper construction of the statute. It criticized them by name in the Report explaining the proposed amendments,6 and it recommended that the various trust fund sections of the Lien Law be amended by the addition of the words: “Such trust may be enforced by civil action maintained as provided in article three-a of this chapter by any person entitled to share in the fund, whether or not he shall have filed, or had the right to file, a notice of lien or shall have recovered a judgment for a claim arising out of the improvement.” 7 The Legislature passed the amendments as requested, thus ratifying the Commission’s construction of the statute and rejecting the contrary interpretation of the first Wickes Boiler Co. case. It may be noted that we had already felt constrained to change our view there announced in our opinion on rehearing, Wickes Boiler Co. v. Godfrey-Keeler Co., 2 Cir., 121 F. 2d 415, certiorari denied Godfrey-Keeler Co. v. Wickes Boiler Co., 314 U.S. 686, 62 S.Ct. 297, 86 L.Ed. 549.
My brethren nevertheless adopt a construction of the amended statute which wars with its language, its legislative history, and New York case law,8 and *531which clashes with other parts of the statutory scheme. In their view each installment payment by the owner to the contractor constitutes a separate trust res for the benefit of the men who worked on the improvement prior to the moment of payment. In the present case they decided that the owner’s checks which the general contractor received after the plaintiff worked on the job may be traced into the defendant’s hands, but that the checks received by the contractor for this same improvement before the date on which plaintiff started work are not held for plaintiff’s benefit. The time at which a contractor receives an installment payment from the owner is now a critical fact in determining the rights of different claimants to the trust fund, although the trust fund may include money which is never paid by the owner to the contractor.9 My brethren ignore the result of their construction: preferring laborers who do the first stages of construction, such as digging the foundation, over the men who do the last parts of a job, such as painting the interior. The former group of workmen can presumably look to all subsequent installment payments for security, while the last group has but one payment against which they can proceed.10 The necessary effect of this decision is that ordinarily the early installment payments will never help the statutory beneficiaries, even though those beneficiaries do not have adequate satisfaction from later installments.11
The administrative complexity of my brothers’ plan is enough to condemn it. To avoid criminal liability a contractor must not divert an installment check *532to a nonbeneficiary unless he is sure that all persons who performed during the time period covered by that check will be satisfied. To know whether a check may be paid- to a nonbeneficiary the general contractor must now ascertain at his peril the precise claims of subcontractors, materialmen, laborers, • insurers, and sureties which arose in the period covered by that installment check. I doubt if he will feel more free to use the check than he would had the plaintiff’s construction of the statute been adopted.
So, too, the present decision means that in enforcement proceedings the plaintiff must prove the timing of each installment payment and the claims which are properly allocated to it — perhaps years - after the event. Not only must he prove the total claims of each statutory beneficiary, but he must now also break down the claims and allocate them to the correct installment payments — an unnecessary addition to the length and complexity of the proceedings. It remains to be seen whether such expensive litigation will be attempted by the persons whom the Legislature tried to help — workmen with small unsecured claims.
These amendments were the careful work of skilled draftsmen who had analyzed the prior statute and cases. They were adopted without change by the Legislature so that the Commission’s consistent scheme was not marred. Introducing new wrinkles at this late date causes nothing but mischief.
The statute’s natural reading is that all moneys paid or owing to the contractor for one improvement constitute a single trust fund for the benefit of men who worked on that improvement, and the manner and timing of the installment payments to the contractor are quite irrelevant. My brethren mention that here the owner had agreed to pay the contractor in installments as the job was completed, But not all contractors are paid in that fashion'; it is hardly proper to construe the statute as leading to variable consequences as the owner and contractor alter their scheme of payments. These two, parties are both strangers to the class of persons the statute is designed to protect, and nothing in the background suggests that their chance arrangements should control the scope of the trust fund.
My brethren cite Raymond Concrete Pile Co. v. Federation Bank & Trust Co., 288 N.Y. 452, 43 N.E.2d 486, as. requiring this result. Even if that case supported the defendant’s view, it would not help us here, inasmuch as the case involved the original trust fund provisions before the critical 1942 amendments. Since the opinion of the Court of Appeals was filed after the Law Review Commission completed its work,12 the Commission had no opportunity to say how much of that opinion remained good law after passage of the amendments. The Commission did approve the Appellate Division result,13 however, which the Court of Appeals reversed. The first ground of the final opinion— that the trust fund sections are only criminal and not civil — was clearly overruled by the amendments. The second ground — that funds cannot be traced into the hands of third persons who received them without notice of their trust character — was approved by the Commission14 and is still good law. But it does not bar recovery by the plaintiff in this case where the trial court carefully documented its finding that the *533defendant had notice that the moneys he received were diverted trust funds.15
The full remarks of the Court of Appeals show that it never approved the result we reach today. Its opinion was carefully sprinkled with such words as "on the pleadings and the proof as presented,” “There is no evidence in the case to indicate that * * “Without such evidence, there was no basis in the record for the judgment * "In the circumstances disclosed by the record * * * ”■ — which show that the result turned on insufficient proof of notice, and not on this novel construction of the statute.
The judicial hostility to the trust fund provisions, which we are evincing, but which have been conspicuously absent in the state decisions under the amended statute,16 seemingly stems from fear that the trust fund concept will prove too restrictive. Where third persons are being sued to recover diverted funds, the potential hardship of the statute is controlled by the requirement that the defendant have received the funds with notice of their trust character.17 As to contractors’ liability, the stern effect may be greatly exaggerated: My brethren suggest that the plaintiff’s reading of the statute would require contractors to husband all payments until the end of the job. But the Commission noted that the contractor may use the fund with impunity to pay any person who falls in one of the statutory classes.18 And the funds may be safely diverted to nonbeneficiaries, as the Court of Appeals observed,19 just as long as the contractor eventually paid the statutory classes out of other moneys. The contractor will face the danger of criminal liability only if he diverts trust funds without knowing how he is going to pay his materialmen and subcontractors. In other words the statute prevents “pyramiding.”
The record in the present appeal suggests that pyramiding still occurs in New York, and that persons like the plaintiff still need protection. The earlier state cases, down through the Raymond decision, did evince sufficient hostility to require the careful corrective provisions developed so ably by the Law Revision Commission. I suggest that it is to say the least anomalous for us now to take up the cudgels for the pyramider and raise obstacles to the enlightened Commission and legislative program which have never occurred to the state courts.
I think we should reverse and remand for further proceedings, as herein indicated.

. This is that one of the several trust fund sections recommended by the Law Revision Commission which is immediately pertinent here. It reads as follows:
“§ 36-a. Contractor who diverts funds guilty of larceny; civil remedy to enforce trust. The funds received by a contractor from an owner for the improvement of real property are hereby declared to constitute trust funds in the hands of such contractor to be applied first to the payment of claims of subcontractors, architects, engineers, surveyors, laborers and materialmen arising out of the improvement, and to the payment of premiums on surety bond or bonds filed and premiums on insurance accruing during the making of the improvement and any contractor and any officer, director or agent of any contractor who applies or consents to the application of such funds for any other purpose and fails to pay the claims hereinbefore mentioned is guilty of larceny and punishable as provided in section thirteen hundred and two of the penal law. Such trust mwy he en*528forced by civil action maintained, as provided in article three-a of this chapter by any person entitled to share in the fund, whether or not he shall have filed, or had the right to-file, a notice of lien or shall have recovered a judgment for a claim arising out of the improvement. For the purpose of a civil action only, the trust funds shall include the right of action upon an obligation for moneys due or to become due to a contractor, as well .as moneys actually received by him.” (The italicized words were added in 1942.)
'Art. 3-A, entitled “Enforcement of Trusts [New],” contains the seven sections now appearing, as N. Y. Lien Law, §§ 70-76. See “Note of Commission” referred to in note 12 infra.

: The following vivid description of the current abuses was quoted in the Study, 1942 Rep.N.Y.Law Revision Commission 298, 299, from Levitt’s Guide to the Mechanic’s Lien Law and Conditional Sales Law (written and published at the instance of The Association for the Revision of the. New York State Lien Law, 1930) ¶ 279, pp. 149-150:
“For years our larger centers of population harbored, and in fact, nurtured- a ■ type of builder - and contractor who thrived on operations commenced by them but never completed by them. A builder of that type, after commencing an operation, adopted the practice of mortgaging such operation far beyond the value of his equity, before the , contractor, materialman or subcontractor (intent only upon performing his contract, with no time or facilities for continuous searching or superhuman vigilance), realized his position. It must be noted that even care of an inconceivable nature, never prevented an overnight mortgage. Such builder would pocket the proceeds of these mortgages, while the men who contributed their material and labor, and made possible the very security for such mortgages, would be left holding the proverbial ‘empty bag.’ In fact, legitimate financial institutions unwittingly aided and abetted such unscrupulous builder by permitting him to divert even the building loan money. Time and again, such institutions learned to their sorrow, that the cost of completing an operation abandoned by such a builder, was greater than the amount named in the building loan mortgage.
“a — The honest builder, likewise, suffered by reason of the foregoing tactics, in that the honest builder found that he could not compete with one evading the payment of material and labor in the construction of a building. The honest builder, paying for an operation, could not, in selling the operation, compete with one who at times paid only about 25% of the cost.
“b — In the last analysis, even the dishonest builder, and may we say at this time, that a number of such builders may have been merely improvident, came to grief. The opportunity for diverting large sums of money with impunity, engendered a habit of pyramiding or mushrooming operations. By ‘pyramiding’ or ‘mushrooming’ we mean the use of mortgage monies from one operation for the purchase of additional land and the erection of buildings in other operations, thereby adding link upon link to this vicious chain. The concomitant result of such practice is now a matter of history. The deplorable condition in which the building trade now finds itself is directly traceable to that source — pyramiding— mushrooming. The dishonest or improvident' builder found himself possessed of a host of buildings, but at the same time, *529tottering on the brink of ruin. The writer has interviewed many such builders, who, with tears in their eyes, confessed that if the law, now in force, had been on our statute books a year or two ago, they would now bo men of substance, owning soundly financed buildings, which could be carried even during a falling market.”
The author then stresses the penalizing of legitimate contractors unable to “meet the competition of these fly-by-nights, whose estimates did not include payment in full for material and labor,” the burden on the renting public, the overproduction of buildings, and the express legislative intention that funds borrowed on the strength of an improvement should “reach its ultimate destination — material and labor — before such funds are taken by way of profits either by the owner, contractor or subcontractor.”

. This is still true. See Friedman, Protecting the Equitable Lien of the Subcontractor and Materialman, N. Y. L. J., Oct. 30, 3056, p. 4, and Oct. 31, 1956, p. 4.

. For fuller description of the various legislative steps after 1929 in refining the trust fund concept, see Study, 1942 Rep.N.Y.Law Revision Commission 300.

. New York Trap Rock Corp. v. National Bank of Far Rockaway, 260 App.Div. 1035, 24 N.Y.S.2d 426, affirmed 285 N.Y. 825, 35 N.E.2d 498.

. 1942 Rep.N.Y.Law Revision Commission 283, 284.

. 1942 Rep.N.Y.Law Revision Commission 287.

. Significantly, the two New York cases cited by the majority, People v. Kew Gardens Terrace, Inc., Co.Ct., 38 N.Y.S.2d 246, and Raymond Concrete Pile Co. v. Federation Bank & Trust Co., 288 N.Y. 452, 43 N.E.2d 486, both involved the construction of the trust fund sections as they appeared before the 1942 amendments. In Metropolitan Casualty Ins. *531Co. of New York v. Barr Wrecking Corp., Sup., 40 N.Y.S.2d 607, Justice Eroessel explained tlie difference between the statute before amendment construed in the Raymond ease, supra, and the statute under its present wording. Subsequent New York eases have recognized that the 1942 amendments strengthened the trust fund provisions and overruled earlier decisions. E. g., Ridgefield Supply Co. v. Rosen, 1 Misc.2d 675, 147 N.Y.S.2d 337; In re Einach’s Estate, 1 Misc.2d 537, 146 N.Y.S.2d 240; Waldman v. D. & V. Plumbing & Heating Contractors, Sup., 102 N.Y.S.2d 787; Wade v. Nassau Suffolk Lumber & Supply Corp., 275 App. Div. 864, 89 N.Y.S.2d 294; Application of Rafuse, Sup., 82 N.Y.S.2d 3, affirmed 274 App.Div. 944, 83 N.Y.S.2d 654; Rosicato v. Manera, 192 Misc. 607, 81 N.Y.S.2d 353.

. The last sentence of the amended § 36-a makes moneys owed but unpaid by an insurer or owner part of the trust res. See note 1 supra. See. 13(7) of the N.Y.Lien Law makes advances from the lender to whom the contractor assigned his contract part of the trust fund.

. The majority opinion does not make clear whether men who do the early stages of work have recourse only to the installment which immediately follows their work or whether they can look to all subsequent installments. If the former is the case, the one installment may be so burdened with creditors’ claims that statutory cestuis get loss than 100 cents on the dollar, while the next installment is so lightly taxed that nonbeneficiaries can enjoy diverted trust funds. An unscrupulous owner and contractor can time the payment of installments to help the lender at the expense of the cestuis.
If, on the other hand, the men who dig the foundation can look to all subsequent payments for security, they have a preference over painters, who could look only to the last installment. Making each payment a separate trust cannot fail to breed anomalies, since it makes cases turn on the happenstance of whether the owner’s check arrived before or after a materialman performed.

. This is most obvious whore the owner pays an installment in advance and there are no materialmen who have worked prior to the payment of that installment. It is also true in the present case where the contractor borrowed money to pay the men who did the early stages of work on the improvement. These men were paid from borrowed money, and the first installment check was diverted to the lender. But from the next installment check the contractor was obliged to pay both the lender and the second group of materialmen which led to his default. Upon the default only the second group of materialmen needed recourse to the trust funds, the first group having already been paid. But under my brothers’ rule, the first installment is for the exclusive enjoyment of the earlier group; and since they do not claim it, it may be diverted to nonbeneficiaries such as the lender.

. The case was decided July 29, 1942. The amendments were passed May 11, 1942. See Metropolitan Casualty Ins. Co. of New York v. Barr Wrecking Corp., Sup., 40 N.Y.S.2d 607, and the history of the amendments in the Assembly given in 1942 Kep.N.Y.Law Revision Commission 773, also id. 789, 790, setting forth the note defining the origin and purpose of the legislation which now appears as “Note of Commission” preceding N.Y. Lien Law § 70.

. 1942 Rep.N.Y.Law Revision Commission 316.

. 1942 Rep.N.Y.Law Revision Commission 315-317.

. Palmieri, J., at D.C.S.D.N.Y., 143 F.Supp. 641, 646, 647.

. Cases cited supra note 8.

. 1942 Rep.N.Y.Law Revision Commission 315.

. 1942 Rep.N.Y.Law Revision Commission 328, 329.

. Raymond Concrete Pile Co. v. Federation Bank & Trust Co., 288 N.Y. 452, 459, 43 N.E.2d 486.