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Our attorneys stay on top of changes in legislation, agency regulations, case law, and industry trends—then craft timely legal alerts to keep clients up to date on legal developments important to their business.

April 22, 2020

Construction Project Finance and COVID-19: How Owners, Contractors, and Other Industry Professionals Can Protect Their Rights, Avoid Disaster

In recent weeks, most construction projects in New York State have been shut down due to the COVID-19 pandemic. As discussed in prior legal alerts, New York State has permitted only limited, essential construction to continue. The economic turbulence in the foreseeable future will have a significant impact on the construction industry. Some contractors, architects, engineers, and other professionals will not be paid. Developers will be faced with the challenge of keeping projects afloat. There has never been a more important time for construction industry professionals to understand their rights and potential liabilities.

Presently, those who have been ordered to stop work are uncertain of when and if their invoices will be paid and may be contemplating filing a mechanics’ lien. The mechanics’ lien is the most well-known but often misunderstood tool for construction industry professionals seeking payment. Mechanics’ liens are rooted in a strong NYS public policy in that seeks to ensure those who provide valuable improvements to property are paid for their work. However, a mechanics’ lien does not create a right to be paid. Rather, if filed, served, and enforced correctly, it creates a security interest in the improvement and an additional avenue for recovery through the foreclosure and sale of the improved property.

Additionally, if the owner seeks to sell the property—a situation that may occur with greater frequency as the economy reels from COVID-19—a mechanics’ lien can provide contractors and others with valuable leverage. Mechanics’ liens can be a valuable tool, but only if filed timely and correctly, and only if various other preconditions to enforceability exist. The team at Barclay Damon has the knowledge and experience to assist contractors and other professionals who are questioning their options as well as owners wondering what to do when mechanics’ liens are filed against their property.

A lesser-known part of the Lien Law relates to using project funds for non-project purposes, including paying some overhead and expenses. Significantly, this can result in personal liability for individuals with control over company finances. Certain categories of funds including but not limited to proceeds of a construction loan and payments made by an owner to a general contractor are considered “trust funds.” An owner becomes the trustee of the funds when received. Subject to limited exceptions, trust funds may only be used to pay trust beneficiaries such as contractors and others. Likewise, a general contractor may not use money received from an owner for its own purposes or for other projects unless and until all subcontractors, material suppliers, and others have been paid. Trust funds received by a trustee must be held as such for all current and future trust claims on that project.

In other words, even if all project payments are current, trust funds must be reserved for future project liabilities to beneficiaries. Any owner or other construction industry professional in possession of project funds and presently trying to navigate the current economic crisis needs to understand its rights and liabilities before making critical financial decisions. Trust beneficiaries are entitled by law to demand verified accounting of trust funds from a statutory trustee and have a number of remedies available to them if funds are diverted. Trustees are obligated to maintain specific records regarding trust funds, and the failure to do so may give rise to the presumption of a diversion. Additionally, individuals in control of trust funds and who make decisions about their use on behalf of an entity can be held personally liable to beneficiaries for diversions. Therefore, even if a developer or contractor entity does not survive the economic fallout from COVID-19, certain individuals who acted on behalf of those entities may be held accountable.

We are living in a very uncertain time. Barclay Damon wants everyone to protect themselves, their families, and their employees from COVID-19. Project owners and construction industry professionals also need to protect their companies and projects by understanding their rights and potential liabilities. We are here to help.

If you have any questions regarding the content of this alert, please contact Jim Domagalski Construction & Surety Practice Area chair, at jdomagalski@barclaydamon.com; Michael Balestra, partner, at mbalestra@barclaydamon.com; or another member of the firm’s Construction & Surety Practice Area.

We also have a specific team of Barclay Damon attorneys who are actively working on assessing regulatory, legislative, and other governmental updates related to COVID-19 and who are prepared to assist clients. You can reach our COVID-19 Response Team at COVID-19ResponseTeam@barclaydamon.com.

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