The corporate veil is a fundamental concept of American jurisprudence that generally shields owners and officers from the lability of the corporation. Unless the corporate veil is pierced or otherwise avoided, owners and officers are not individually liable for the debts of the corporation. Since this legal barrier was first invented, lawyers have been coming up with new and creative ways to get around it. One such new and creative way was the subject of an opinion released last week by a federal district court in Manhattan.
The case involves an apartment renovation in Tribeca. After being paid nearly a million dollars, the contractor went bankrupt midway through the job leaving a number of subcontractors unpaid. The owner brought suit against the contractor’s officers in their individual capacity for fraud (based on false lien waiver affidavits), unjust enrichment, and breach of fiduciary duty. The court dismissed the fraud claim as impermissibly seeking to recover in tort for a breach of contract claim against the bankrupt contractor, and it dismissed the unjust enrichment claim as duplicative.
As to the breach of fiduciary duty claim, the court permitted the plaintiff to proceed. The court held that Article 3A of the New York Lien Law creates a trust as soon as a contractor receives funds for the improvement of real property. The contractor, as the statutory trustee, must hold and apply those funds for expenditures on the project, including the payment of subcontractors. Diversion of trust assets is a breach of trust that can give rise to a civil enforcement action by the beneficiaries of the trust. The court recognized a split of authority as to whether an owner is a beneficiary of the trust, but ultimately concluded, based on its reading of the New York Lien Law (and its legislative history), that the owner is a beneficiary of the trust and therefore entitled to bring suit for diversion of trust assets. This includes claims not only against the trustee/contractor but also against its officers in their individual capacity for knowingly participating in a diversion of trust assets.
The upshot is that the owner has claims against non-bankrupt individuals that may have sufficient assets to satisfy a judgment. It is a creative way around the corporate veil that contracting parties should consider when weighing claims against insolvent parties. A copy of the court’s decision is available here. Please contact John Mark Goodman if you have questions or need assistance with your construction claims.