Got Those Supplier Ascertaining Allocation Blues?
In L & W Supply Corp. v. Desilva, 429 N.J. Super. 179 (App. Div. 2012), the Appellate Division of the New Jersey Superior Court concluded that, in certain circumstances, a construction lien claimant has an obligation to inquire into the source of funds paid for materials provided for construction projects or face the loss of the right to file a lien. The decision fills in some of the contours of the supplier’s duty set forth by the Supreme Court in Craft v. Stevenson Lumber Yard, Inc., which held that a supplier has a duty to allocate payments based on what he knows or should know about the source of the payments. The new decision has ramifications for suppliers and owners.
The Appellate Division held that when the purchaser of materials has not provided specific “reliable” instructions or when the circumstances are such that a reasonable supplier should suspect the purchaser has not used the owner’s funds to pay for materials supplied for that owner, then the supplier must “attempt to ascertain the source of the payment of funds so that it can allocate them to the correct accounts.” The court clarifies the lengths to which a supplier must go to ascertain the source of funds paid for materials by a subcontractor under the Construction Lien Law, N.J.S.A. 2A:44A-1, et seq. In other words, a supplier is not entirely free to allocate monies from a contractor who has multiple accounts with the supplier. If the supplier has a “reason to suspect” that the contractor’s allocation is “amiss”, then the supplier must make further inquiry and verify the source of the funds so that he may apply them correctly. Thus, passivity in the face of questionable circumstances may cause the supplier to forfeit its rights under the Construction Lien Law.
The L&W case arose in 2003 when, Meridian, as owner, entered in to a contract with Patock, as contractor, to build an assisted living facility. Detail, a subcontractor to Patock, contracted with L&W to supply materials for the project. L&W had sold materials to Detail’s principal, Joe DeSilva, for several of his business entities. One such entity was the subcontractor on the Meridian project, Detail. When Detail failed to pay L&W, L&W filed a construction lien.
L&W’s invoices to Detail for the Meridian project totaled $231,794.34. Detail paid L&W $207,000 and another DeSilva entity paid L&W $10,000. However, L&W only credited Detail $103,959.45 for the Meridian project and credited $113,040.55 to other open DeSilva accounts. L&W’s lien claim was for $127,834.89, the difference between what it invoiced Detail for the Meridian project and the amount it credited Detail for that project.
The trial court granted summary judgment for L&W against Patock and Meridian for the full amount of the lien claim. Patock and Meridian appealed.
The Appellate panel reversed, finding that L&W had an affirmative duty to make an inquiry into the source of the money Detail and Desilva had paid L&W and that there were issues of fact as to whether L&W had made such an inquiry. The Court said that if the purchaser has not provided specific and “reliable” instructions on allocation the seller has a duty to inquire and “verify” the source of the payments. The Court then went further and held that if the circumstances were such that a reasonable seller should suspect the purchaser was not using funds from a specific project for that project the seller must make “further inquiry.”
While the court’s goal was to address the issue of the “lengths to which a supplier must go to discharge” its duty to allocate payments, the opinion falls short. If a purchaser did not supply any instructions on allocations it has been clear since Craft that the seller had a duty to inquire. But the court creates confusion by imposing a duty to inquire when the instructions are not “reliable” without saying much about what are or are not reliable instructions. Likewise, the court invites further litigation over whether “circumstances are such that a reasonable seller should suspect the purchaser” has not allocated payments properly.
L&W Supply raises the burden on suppliers looking to file construction lien claims. Not only do they have the duty to make inquiry and ascertain the source of payment, but, arguably, they now have a duty to police their purchasers. This will benefit project owners and should limit the filing of improper construction lien claims. What remains to be determined is the additional burdens this obligation will impose on all involved in construction projects. For example, will lenders now require, in addition to the traditional lien waivers, affidavits that instructions on payment allocation have been provided? Will suppliers seek indemnity for improper allocation instructions?
A lesson for owners to take away from this case is how easily they can avoid being drawn into lien litigation when the dispute is between downstream parties, as it was in L&W Supply. The Appellate Division dismissed Meridian from the lawsuit because a lien discharge bond had been posted, which had the effect of transferring the lien from Meridian’s property to the bond. The bond was posted by Patock, the contractor, presumably under a clause in the Meridian/Patock contract requiring Patock obtain such a bond in the event one of its subcontractors or someone claiming thru a subcontractor filed a lien. Owners should always insist their contractors be obligated to post lien discharge bonds in such circumstances and not hesitate to enforce that provision when necessary.