Court Opinion

ID: 5487265
Source: CourtListenerOpinion
Date Created: 2022-01-10 02:17:39.766158+00
Date Added: 2024-06-11T08:33:42.134037
License: Public Domain

Chief Judge Lippman (dissenting in part).
In 1930, when the Legislature enacted the predecessor to article 3-A of the Lien Law, it recognized a need to prohibit the damaging practice of “pyramiding” in the construction industry. Because the majority facilitates the Mount Vernon City School District’s (the School District) participation in this long-prohibited practice and inexplicably ignores the surety’s right to be discharged from the performance bond where the School District breached the bond,1 thereby depriving the surety of the benefit of its bargain under basic contract principles, I respectfully dissent.
*41We have explained that “[i]n the case of a contractor, the so-called trust fund provisions of the Lien Law prohibit [ ] diversion, to purposes unrelated to a particular improvement, of contract payments from the owner which were intended to pay the expense of that improvement, including the cost of labor and materials” (Aquilino v United States of Am., 10 NY2d 271, 275 [1961] [discussing the predecessor to the current version of article 3-A]). In the same spirit, the successor and current provision, article 3-A’s prohibition on diverting trust fund assets serves the “remedial purpose of ‘ “insuring] that funds obtained for financing of an improvement of real property and moneys earned in the performance of a contract for . . . [an] improvement will in fact be used to pay the costs of that improvement” ’ ” (Matter of RLI Ins. Co., Sur. Div. v New York State Dept. of Labor, 97 NY2d 256, 263 [2002] [citations omitted and emphasis added]). The School District clearly thwarted the purpose of this rule by ensuring that the money earned in the performance of the heating, ventilation and air conditioning (HVAC) contract would be used to pay the costs of the Mahopac School District project.
Although a school district following the direction of the Department of Labor (DOL) may seem to be cast in a more sympathetic light than a surety seeking to disclaim liability for completing a project upon the default of a construction company, the majority misapprehends the nature of the Lien Law. As the majority acknowledges, it is of no import that the School District may have thought it was acting properly in following the directive of the DOL, because the rule prohibiting diversions of trust assets applies regardless of the intentions of the diverter (see RLI, 97 NY2d at 263). Additionally, while the majority properly acknowledges the surety’s rights to discharge under certain circumstances {see majority op at 36), it ignores that such circumstances arose in this case, triggering these rights, and concludes that the surety here was not entitled to discharge and was responsible for completion of the HVAC job.
Lien Law § 72 (1) provides that
“[a]ny transaction by which any trust asset is paid, transferred or applied for any purpose other than a purpose of the trust . . . before payment or *42discharge of all trust claims with respect to the trust, is a diversion of trust assets, whether or not there are trust claims in existence at the time of the transaction, and if the diversion occurs by the voluntary act of the trustee or by his consent such act or consent is a breach of trust.”
“Only after all trust claims have been paid or discharged does a beneficial interest in the remaining balance vest in the trustee owner or contractor” (RLI, 97 NY2d at 263). In Kemper Ins. Cos. v State of New York (70 AD3d 192, 196 [3d Dept 2009]), the court held in favor of the surety where the contractor defaulted and the State, having responded to an Internal Revenue Service (IRS) notice of levy by paying contract funds to the IRS in satisfaction of the contractor’s outstanding tax obligations, rendered the remaining trust funds insufficient to pay for the completion of the project. Just like the contractor in Kemper, DJH “[did] not have a sufficient beneficial interest in the moneys, due or to become due . . . under the contract, to give [it] a property right in them, except for whatever balance, if any, might later remain after all claims had been paid,” and the School District was not entitled to send the $214,000 anywhere other than for use on the HVAC project (id. at 197 [internal quotation marks and citations omitted]). When the surety in Kemper completed the job, the State’s payment “did not include the sum that had been turned over to the IRS, and the funds paid were insufficient to complete the work and cover [the surety’s] payments to laborers, suppliers, and others under the payment bonds, causing [the surety] to suffer a loss” (id. at 194). That the surety in this case did not complete the HVAC project makes no difference. The same principle applies here; when the School District made the payment to the DOL, Nova’s risk of suffering a loss increased and it was therefore relieved of its obligations. It makes little sense to require a surety to complete a job when it is fully aware that the project owner has already diverted (in this case nearly a quarter of the total) funds designated to pay for the project, in violation of the Lien Law, and there is a very real possibility that the surety would suffer a loss if it were to complete the job.
Here, the School District has most recently claimed that the payment of $214,000 to DOL was not a diversion of trust assets because all claims had been paid. Nowhere in the School District’s briefs to this Court is this argument mentioned. Rather, the School District argued that the “payment of the subject funds was for a trust purpose—to pay for work performed *43by DJH on the School’s project,” and accused the surety of “[trying] relentlessly to spin the [School District’s] payment ... as one for non-trust purposes, arguing that because the payment was apparently used by DJH and the DOL for a purportedly unrelated project it was, allegedly, for a non-trust purpose.” Then, at oral argument, the School District abruptly abandoned that view and partially adopted the surety’s position (which it had decried in its brief) that the funds were used for a non-trust purpose. The School District argued that all trust claims had been paid at the time the payment to DOL was made, and that DJH was free to spend those funds as it pleased, thereby implying that the funds were indeed used for a non-trust purpose, but that such use was allowed under the circumstances. The School District has either been unable or unwilling to commit to one of these two contradictory positions and that is because neither is reasonable. The majority saves the School District from its “flip-flopping” by concluding erroneously that “whether the School District’s payment of contract funds to DOL as DJH’s assignee violated the Lien Law is irrelevant to Nova’s surety obligation” (majority op at 37). It is difficult to fathom, however, that with respect to the incomplete HVAC project, all trust claims had been paid.
Contrary to the majority’s view (that the violation of the Lien Law is “irrelevant”) the School District’s violation of the Lien Law matters, and it matters a great deal. The majority first acknowledges that a surety is not obligated to complete a construction job if it can demonstrate that it has a right to discharge due to the actions of another party, then inexplicably goes on to state that Nova has no right to rely on the School District’s violation of the Lien Law as a basis for discharge because it is not a completing surety. But Nova does not claim that it is “subrogated to the rights of the article 3-A trust beneficiaries as a completing surety” (see majority op at 37), nor does it argue that it has the same rights as a completing surety, and it certainly does not “lack[ ] capacity to raise any alleged violation of the Lien Law” (id. ) as the majority suggests. Rather, Nova simply asserts, and rightly so, that it has the same rights as any other surety—rights that are enforceable well before any possibility of completion arises. Nova was no longer under any obligation to complete the HVAC project once the School District illegally diverted the funds to the DOL. Nova is, of course, entitled to raise the issue insofar as it supports Nova’s legitimate breach of contract defense that, in making the payment, *44the School District breached the performance bond and discharged Nova from its obligation to complete the project upon DJH’s default.
The Lien Law violation is highly relevant, especially where, as here, the performance bond contains a provision in essence prohibiting diversions of trust fund assets. The plain language of the performance bond demonstrates that the surety sought to insulate itself from “obligations of the Contractor that are unrelated to the Construction Contract.” That language is unambiguous and should be enforced. That the $214,000 was earned as a progress payment does not render the diversion any less a violation of the performance bond’s prohibition on reducing or setting off the balance of the contract price for any of DJH’s unrelated obligations. The majority is under the impression that because the funds paid were earned (and therefore did not represent prepayment or overpayment of contract funds) the performance bond was not violated. However, prepayment and overpayment are simply examples of actions that would have violated the School District’s obligations to the surety. They are not the only actions that would entitle the surety to discharge.2 Indeed, the majority fails to provide any explanation whatsoever regarding how the diversion of $214,000 that could have been applied toward the completion of the HVAC job did not harm the surety’s interests and did not violate the performance bond. By sending the funds elsewhere, the School District certainly satisfied DOL’s request but it also made it impossible for those funds to be used to complete the HVAC project, thereby increasing the risk that DJH would run out of money prior to finishing the job. The School District was not entitled, after having increased the risk of DJH’s default, to then recover from the surety on a breach of contract theory. As I cannot agree with the majority’s reasoning that Nova has not demonstrated its entitlement to be discharged from its obligations under the performance bond which the School District breached, I respectfully dissent and would modify the Appellate Division’s order to dismiss the School District’s complaint.
*45Judges Graffeo, Read, Smith and Pigott concur with Judge Cipajrick; Chief Judge Lippman dissents in part in a separate opinion in which Judge Jones concurs.
Order affirmed, without costs.

. The construction contract between DJH Mechanical Associates (DJH) and the School District was incorporated by reference into the performance bond and the School District had certain contractual obligations to Nova Casualty Company (Nova) (and vice versa) because the bond was executed for the School District’s benefit:
“[a] suretyship arrangement is, at its core, the confluence of three distinct, yet interrelated, obligations. These obligations are embodied in the tripartite relationship of principal obligor [here, DJH] and obligee [here, the School District]; obligee and secondary obligor [here, Nova]; and secondary obligor and principal obligor. When a secondary obligor is bound to pay for the debt or answer for the default of the principal obligor to the obligee, the secondary obligor is said to have suretyship status. In other words, in transactions giving rise to suretyship status, the secondary obligor [here, Nova] is answerable to the obligee [here, *41the School District] in some way with respect to a duty, the cost of which, as between the principal obligor and the secondary obligor, ought to be borne by the principal obligor” (Chemical Bank v Meltzer, 93 NY2d 296, 302 [1999] [citations omitted]).

*40
(n. cont’d)

. Indeed, the majority seems to acknowledge that this is not an exhaustive list (see majority op at 36 [noting that “where an obligee . . . increases the risks imposed on the surety by such acts as modifying the duties of the principal-contractor, extending the time for the principal’s performance, or making overpayments or premature payments, the surety may be discharged” (emphasis added)]).