1. Real Estate Law &
Industry Report
Reproduced with permission from Real Estate Law &
Industry Report, 4 REAL 494, 07/12/2011. Copyright
2011 by The Bureau of National Affairs, Inc. (800-372-
1033) http://www.bna.com
MECHANICS’ LIENS
Trust Fund Statutes Augment Lienor Payment Rights; but U.S. Law May Preempt
under the mortgage after a lien or ‘‘stop’’ notice is
filed.1 Other states provide that if the mortgage is re-
corded before notice of the construction project is re-
corded, then the priority of lien of the mortgage cannot
be assailed.2 Yet another provides that the mortgage
has priority with respect to the state of the land prior to
the work being performed, and the mechanics’ lienors
have priority with respect to the value of the improve-
ments performed.3
All of these statutes express a public policy in favor
of protecting a particular class of creditors—those who
render services and furnish materials to construct a
building. In some states, the protections extended to the
favored class include more than the right to establish
and enforce a lien: they include ‘‘trust fund’’ provisions
that interact with the lien law and other legal schemes
BY KEVIN J. CONNOLLY to weave a tapestry of complex and sometimes poorly-
understood policies. Much of the complexity flows from
awyers who practice construction law and convey-
L ancing need to be familiar with the lien laws of
their jurisdictions. The laws of all 50 states and the
District of Columbia have statutes that grant to at least
the fact that construction finance operates on multiple
levels. On one level, an owner or developer may borrow
money, giving a mortgage on the property as security.
On a different level—one of which owners, developers,
some persons who furnish materials and labor for con- and construction lenders are often blissfully ignorant—
struction a lien to enforce their right to be paid for their the contractors, subcontractors, and material suppliers
work. There is a remarkable diversity of lien law
schemes that varies along multiple dimensions, includ-
1
ing whether a lien can gain priority over conveyances New York Lien Law§ 13(1); California Civil Code § 3166;
that are recorded before notice of lien is given. Texas Property Code § 53.084; Nevada Revised Statute
§ 108.2275
The archetypal lien dispute revolves around the rela- 2
See, e.g., National Loan Investors, L.P. v. Burgher, 742
tive priority of liens and mortgages. Many states have So.2d 406, 24 Fla. L. Weekly D2030 (1999)
provisions that subordinate the lien of a mortgage to 3
LaSalle Bank NA v. Cypress Creek 1, LP, —N.E.2d. —,
mechanics’ liens to the extent that money is advanced 2011 WL 681797 (Ill. Sup. Ct.)
COPYRIGHT 2011 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN 1944-9453

2. 2
have their own financing, including factoring of their accounts receivable, and these lenders generally secure
accounts receivable and floating liens as security for re- an Article 9 Security Interest in the contractor’s ac-
volving lines of credit. counts. In many cases, the bank account that has been
pledged will include trust funds. Trying to untangle the
Statutory Trust. Construction Trust Funds, like me- competing interests of the trust fund beneficiaries,
chanics’ liens, are, with few exceptions, creatures of mortgagees, and factors can try the patience of even the
statute.4 The exceptions refer to those rare cases in most patient and enduring judge.
which a common law fiduciary relationship has been
found. The trust fund statutes are no less diverse than Cutting the Gordian Knot. Thus, at least one court has
the lien statutes that they supplement, but all of them chosen to resolve the Gordian knot of competing liens
have in common that some of the money received by and trust funds by slicing it apart with the sharp knife
some of the participants is received in trust. The precise of Federal Supremacy. In In re Hechinger Investment
terms of the trust are, likewise, highly variable, but the Co., 288 B.R. 398, 401-02 9B. Del. 1998), the Court held
gist of the law is that trust funds are supposed to flow that the Michigan Builders Trust Fund Act is preempted
downstream—from lender to owner, owner to general by § 147(b) of the Bankruptcy Code because it ‘‘ob-
contractor (GC), GC to subcontractors and material structed the accomplishment and execution of the
suppliers, and subcontractors to laborers and material [Code’s] full purposes and objectives.’’10
suppliers. Not every statute provides that all of these Potential lienors and beneficiaries of a construction
participants are beneficiaries of the trust, but some of trust funds may breathe a sigh of relief to note that
them are obligated to pay their ‘‘downstream’’ counter- Hechinger has been sharply criticized and has not
parties before using any of the money for any other pur- gained a following. There nonetheless remain a welter
poses (such as paying salaries to executives and divi- of traps and sources of confusion.
dends to owners).
In part, the impact of the trust fund lies in giving the Trust Fund Minefield. In a Texas case,11 a lender with
protected parties additional remedies that may be avail- a perfected security interest in the subcontractor’s bank
able notwithstanding the unavailability of a lien law accounts prevailed against the claim of a sub-
remedy.5 To judge from the volume of reported cases, subcontractor who had not perfected its own mechan-
however, the primary effect of the trust fund is felt in ics’ lien. Thus there is at least some authority that pre-
the enforcement of security interests other than real es- vailing on a trust fund claim requires the establishment
tate liens, and in bankruptcy court. As a general rule, of a mechanics’ lien.12 Some trust fund statutes are
assets held in trust are excluded from the estate of the broader than the strict liens granted to protected par-
trustee, and the attachment of security interest to a ties, while others require that a lien be established be-
trustee is dubious.6 fore a trust can be enforced.
One of the recurrent issues in these cases is whether Similar attacks have been mounted on the ground
the money in the trustee’s general bank account is sub- that the contractor’s payment of a subcontractor’s claim
ject to the trust, particularly since the funds will most was a preferential transfer.13 However, a substantial
likely have been commingled. The cases that have body of authority makes the attack on the preferential
reached this issue generally apply the ‘‘lowest interven- transfer meaningless, because the Trustee takes posses-
ing balance’’ rule for tracing funds.7 sion of the bankrupt’s estate subject to the construction
The issue most often addressed, and most readily re- trust and the subcontractor would have received the
solved, is the non-dischargeability of trust fund obliga- same amount of money under a Chapter 7 liquidation.14
tions. When one who received the funds in trust uses
them for a purpose not permitted by the statute, the di- 10
Accord, U.S. v. Pierce, 231 B.R. 890-891-92 (E.D.N.C.
version is generally treated as a defalcation. If there is
1998); but see v. J&D Masonry Inc., 2008 WL 4960157 (W.D.
personal liability for the diversion—and there usually is Mich 2008), holding that the Michigan Builders Trust Fund Act
so long as the trustee had notice of the trust—the obli- is not preempted by the Federal Fair Debt Collection Practices
gation is not dischargeable in bankruptcy.8 Act, and noting that ‘‘Hechinger stands against the great
One of these diversion cases is especially instructive weight of authority.’’ Accord, Selby v Ford Motor Co., 405
with respect to the rights of a factor.9 Many construc- F. Supp. 164 (D. Mich. 1975).
11
tion contractors borrow money on the security of their In re Waterpoint International, LLC., 330 F.3d 339 (CA5
2003).
12
See, however, U.P.S. v. Weben, 794 F.2d 1005 (CA 5
4
Robert F. Carney and Adam Cizek, ‘‘Payment Provisos in 1986) holding that the rights of a beneficiary of the trust fund
Construction Contracts and Construction Trust Fund Stat- arise from the receipt of funds and do not require the filing of
utes,’’ Construction Lawyer, Fall 2004, 5. a lien, either under the Lien Law or the Uniform Commercial
5
For example, the property of the Port Authority of New Code.
13
York and New Jersey is completely immune from lien rem- In re Globe Manufacturing Corp., 567 F.3d 1291 (CA 11
edies. However, the funds received by the general contractor 2009, applying Massachusetts law). Accord, In re M&T Electri-
were subject to New York’s trust fund statute, giving the sub- cal Contractors, 267 B.R. 434; (Bkrptcy D DC 2001); Ripley v.
contractors what proved to be an effective remedy. OTG JFK Bailey, 27 F3d 563 (CA4 1994): failure to file a mechanics’ lien
T5 Venture, LLC v. IBEX Const., LLC, 24 Misc.3d 1244(A), 901 defeated the subcontractor’s claim to trust funds. But see In re
N.Y.S.2d 901 (Table), 2009 WL 2855776 (N.Y.Sup.), 2009 N.Y. Regan, 477 F.3d 1209 (10th Cir. 2007) [right to access trust
Slip Op. 51874(U). funds not dependent on possession of mechanics’ lien or even
6
Trust Funds are not part of the estate of the debtor, In re on the right to file a lien so long as the money is received in
Frosty Morn Meat, Inc., 7 B.R. 988 (D. Tenn 1980). trust].
7 14
In re R.W. Leet, 372 B.R.846 (6th Cir. BAP 2007). In re N.A. Flash Foundation, Inc., 298 Fed. Appx. 355
8
In re Siegfried, 5 Fed. Appx. 856 (CA 10 2001); In re Patel, (5th Cir 2008); Wickes Boiler Co. v. Godfrey-Richter Co., 116
565 F.3d 963 (CA 6 2009). F.2d 842,(2d Cir 1940), mod. On reh’g 121 F.2d 415, cert. cen
9
LeChase Data/Telecom Services, LLC v Burgholzer, 370 314 US 86, 62 S.Ct. 297, 86 L.Ed. 549 (1941); In re Hervet
B.R. 58 (Bkrtcy Ct., W.D.N.Y 2007). Gelman Construction Co., 34 F. Supp. 109 (W.D. NY 1940); Al-
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3. 3
The general rule thus appears to be that once it is es- tions Act and ERISA. However, most courts that have
tablished that funds are subject to the statutory trust reached the question have held that neither the LMRA
fund rules, the rights of the beneficiaries are superior to nor ERISA re-empts the state construct trust fund law.16
the rights of secured parties, including sureties.15 How-
ever, if a surety is already obligated to pay the lienors— Conclusion. Practitioners who deal with construction
and such is the mission of the ubiquitous Payment projects and the liens that sometimes result need to
Bond—then the trust fund claims—to which the surety bear in mind that there may be more at work than the
is generally subrogated both under the terms of the relative priority of the mechanics’ liens and the mort-
bond as well as the common law—then the trust fund gages. Many states’ laws contain trust fund provisions,
becomes a shield against the claims of the contractor’s and while a variety of assaults have been mounted
creditors. If the money that creditors seek was in fact against them, the trust fund—when it exists—furnishes
subject to a construction trust, then the funds are not a contractor or supplier with remedies that are equally
subject to the creditors’ liens—or the creditor is held to apt in foreclosure, accounting, or bankruptcy. In a
take the collateral subject to the trust fund obligations. proper case, the trust fund enables contractors and ma-
One area in which pre-emption has sometimes been terial suppliers to recoup more than they can by fore-
found is the interplay between construction trust funds closing the lien—especially in today’s market, where
and federal labor law—particularly the Employee Re- depressed real estate values often make lien enforce-
tirement Income Security Act. Thus in Summit Bank v. ment a fool’s errand.
Local 98, Int’l Brotherhood of Elec. Workers, 2001 W.L.
849527 (E.D.Pa.), the court held that a trust fund claim
under the Pennsylvania Wage Payment and Collection Kevin J. Connolly is a shareholder in the firm
Law was precluded by the plaintiff’s contemporaneous of Anderson Kill & Olick, PC. His practice con-
assertion of claims under the Labor Management Rela- centrates on construction law, with particular
emphasis on risk management and mechanics’
liens.
bert Pick Co. v. Travis, 6 F. Supp. 486 (E.D.N.Y. 1933); B.F.
Farrell Co. v. Monahan, 377 Misc 552, 131 NYS2d 58 (1966)
[holding further that the trust fund was not part of the estate
and therefore debts pertaining to it could not have been dis-
16
charged whether or not a proceeding was brought to deter- Swift Electrical Supply v. Township of Lakewood (168
mine non-dischargeability]; In re I.T. Group, 332 B.R. 673 (B. F. Supp.2d 298 9d. N.J. 20010; Regan v. Tri-County Excavat-
Del 2005) [trust fund claimant under New York Lien Law has ing, 62 F.2d 501 (D. Pa. 195); Bellmead Development Corp. v.
superior claim on rust fund over trustee in bankruptcy]. N.J. Council of Carpenters Benefit Funds, 11 F.Supp2d 500
15
Interwork Systems Inc. v. Merchant Financial Corp., 604 (D.N.J. 1983); Laborers’ Trust Funds v. Marie Prince Hotel, 81
F3d 692 (2nd Cir 2010); Titan Indemnity Co. v. Triborough Haw. 487, 918 P.2d 1143 (1996); Forsby v. Bovi Lend Lease,
Bridge and Tunnel Authority, 135 F.3d 831, 834 (2nd Cir 1998). 184 P.3d 610 (Utah App. 2008).
REAL ESTATE LAW & INDUSTRY REPORT ISSN 1944-9453 BNA 7-12-11