Suppliers Must Take Affirmative Steps to Determine Source of Payments to Protect Construction Lien Claim Rights

In L&W Supply Corp. v. Joe DeSilva, et al., (Docket No. A-2960-10T2, December 19, 2012) (“L&W Supply”), a decision recently approved for publication, the Appellate Division provides guidance to material suppliers seeking to file construction lien claims.  The court held that, in certain circumstances, a material supplier must make further inquiry and attempt to determine the source of payments it has received from a particular contractor, so that it can allocate those payments to the correct project.  A supplier that fails to fulfill this duty may forfeit its rights under the Construction Lien Law, N.J.S.A. 2A:444-1 to 38 (the “Lien Law”).

In L&W Supply, L&W Supply Corporation (“L&W”), a supplier of drywall, studs and related materials, sold building materials on credit to a now-bankrupt subcontractor, Detail Contractors, Inc. (“Detail”), in connection with the construction of an assisted living facility in Wall Township (the “Project”).  Detail was one of several entities owned and operated by defendant Joe DeSilva.  DeSilva had open accounts with L&W for building projects other than the Project. 

Detail owed L&W $231,794.34 for materials supplied and delivered to the Project. L&W received payments totaling $217,000 from DeSilva and allocated $103,959.45 to the Project and the remaining $113,040.55 to other DeSilva project accounts.  This left a balance due and owing, by L&W’s calculations, of $127,834.89 for materials L&W delivered to the Project.  L&W then filed a construction lien for $127,834.89 against the Project and, subsequently, filed a complaint against Detail, DeSilva, the project owner, the general contractor and a bonding company seeking to enforce its lien claim.

The trial court granted summary judgment against the general contractor, the owner and the bonding company (collectively, the “Defendants”) for the full amount of L&W’s lien claim.  Defendants appealed.

In analyzing a material supplier’s duty to allocate the payments, the Appellate Division noted that the Supreme Court previously held in Craft v. Stevenson Lumber Yard, Inc., 179 N.J. 56, 63  (2004) that a materials supplier that seeks to file a construction lien has a duty to apply payments correctly against several open accounts of a materials purchaser, such as a subcontractor, if the supplier has “reason to know” that the payments came from a particular construction project.  The focus of the Appellate Division in L&W Supply was the obligation of the materials supplier “to ascertain the source of . . . payments and to apply them accordingly.”

In Craft, the Supreme Court held that a lien claimant has a “statutory duty to allocate [the materials purchaser’s] payments to the accounts from which they were derived.”  Here, Defendants contended that L&W was owed only $12,143.05 relating to the Project, far less than the $127,834.89 reflected in L&W’s lien claim.  Defendants claimed that L&W improperly applied the payments to other, non-Project accounts of DeSilva, thereby improperly increasing the size of the lien fund on the Project.  The Appellate Division found that the trial court did not adequately consider whether a dispute existed regarding the accuracy of L&W’s accounting and allocation of the payment funds.

The primary legal issue involved the lengths to which a supplier must go to fulfill its duty to allocate payments accurately.  Prior to Craft, the general rule was that a creditor may apply payments from a debtor in any manner it chose when payments were not specifically designated by the payor to be applied to a particular project.  After Craft, a supplier became obligated to inquire about the source of a contractor’s payments to the supplier.  A failure to do so may warrant a finding that the supplier should have known the source of the payment.  The supplier’s failure to take affirmative action to ascertain the source of funds does not affect the supplier’s right to collect all balances due, but rather only affects its right to encumber the real property of a project owner under the Lien Law.

The court held that “when the purchaser of materials has not provided specific, reliable instructions as to the allocation of its payment, or when the circumstances are such that a reasonable supplier would suspect the purchaser has not used an owner’s funds to pay for materials supplied for that owner, then the supplier must make further inquiry and attempt to ascertain the source of the payment funds so that it can allocate them to the correct accounts.  A supplier that fails to fulfill this duty sacrifices its right under the Construction Lien Law.”

Although L&W’s witnesses stated in a conclusory manner that the funds were properly allocated, L&W did not provide calculations or other details to show how those witnesses arrived at their conclusions.  The Appellate Division found that Defendants should have the opportunity to prove at a trial that L&W failed to make any inquiry about the source of funds, or that it had reason to suspect that L&W was not properly allocating DeSilva’s payments.

The lesson here is that to protect its construction lien claim rights, a supplier must take affirmative steps, and be prepared to substantiate those efforts at trial, to determine the project that was the source of the funds that the supplier received from a contractor purchasing on an open account.  The failure to take steps to determine the proper allocation of payments, to arbitrarily allocate payments or to not inquire as to a questionable allocation from the material purchaser, may result in a forfeiture of the supplier’s lien rights.

As the law continues to evolve on these matters, please note that this article is current as of date and time of publication and may not reflect subsequent developments. The content and interpretation of the issues addressed herein is subject to change. Cole Schotz P.C. disclaims any and all liability with respect to actions taken or not taken based on any or all of the contents of this publication to the fullest extent permitted by law. This is for general informational purposes and does not constitute legal advice or create an attorney-client relationship. Do not act or refrain from acting upon the information contained in this publication without obtaining legal, financial and tax advice. For further information, please do not hesitate to reach out to your firm contact or to any of the attorneys listed in this publication.

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