Construction Materials Suppliers Beware: Ability to Enforce Construction Lien Against Property Owner Requires Inquiry as to Source of Customer's Payments, Says NJ Appeals Court

When a construction supplier sells materials on credit to a contractor with multiple open accounts, receives only partial payments without instructions from the contractor as to whose jobs/accounts the payments should be applied to, and later seeks to enforce a construction lien claim against a single property owner for the unpaid balance, the supplier must make inquiry as to the source of the funds obtained by the contractor to pay the supplier.   The suppliers duty in this regard extends to circumstances where a reasonable supplier should suspect the contractor has not used an owner's funds to pay for materials supplied for that owner.  The purpose in requiring a supplier to ascertain the source of its customer's funds is to ensure that the supplier has properly allocated its customer's payments to the correct jobs/accounts.   A supplier that fails to fulfill this duty sacrifices its rights under the Construction Lien Law, a NJ appeals court concluded in L&W Supply Corporation v. DeSilva Contractors, et al., Docket No. A-2960-12-10T2 (December 19, 2012).  

In issuing this ruling, the appeals court relied on precedent established by the New Jersey Supreme Court in Craft v. Stevenson Lumber Yard, Inc., 179 N.J. 56, 63 (2004).  In Craft, the Court held 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 payment funds came from a particular building project.  We now consider the obligation of the materials supplier "to ascertain the source of . . . payments and to apply them accordingly."  Id. at 76.  

SUMMARY OF NEW JERSEY CONSTRUCTION LIEN LAW

Like many other states, New Jersey offers protection to subcontractors, laborers and materials suppliers who do not receive payment for work or materials provided for the benefit of a property owner or general contractor by providing the right to record and enforce a construction lien against the property. The Construction Lien Law found at N.J.S.A. 2A:44A-1 to N.J.S.A. 2A:44A-38, allows a contractor or supplier who is owed payment for its work or materials to file a lien against the real property on which the improvements are constructed.  N.J.S.A. 2A:44A-3a.  The primary purpose of the Construction Lien Law to secure payment of monies due to contractors and suppliers of a construction project.   Thomas Grp., Inc. v. Wharton Senior Citizen Hous., Inc., 163 N.J.507, 517 (2000). 

    

A secondary purpose of the Construction Lie Law is to "protect owners" against paying more than once for the same work or materials.  Labov Mech., Inc. v. E. Coast Power, L.L.C., 377 N.J. Super. 240, 245 (App. Div. 2005).  To effect the second purpose, the statute limits the lien to the amount available in the "lien fund," which "shall not exceed the unpaid portion of the contract price of the claimant's contract for the work, services, material or equipment provided."  N.J.S.A. 2A:44A-9a. 

In the case of a supplier, the lien fund is defined as the lesser of (1) the amount of the prime contract price earned minus amounts already paid by the owner to the prime contractor, or (2) the amount the subcontractor has earned on the subcontract price minus amounts already paid by the prime contractor to the subcontractor.  N.J.S.A. 2A:44A-9b(2).  

When a lien claim is filed, the owner or prime contractor may pay the amount of a valid claim directly to the claimant and  credit that payment against the subcontract price.  N.J.S.A. 2A:44A-12.  Alternatively, the owner or prime contractor may post a surety bond for 110% of the lien amount and release the owner's property from the claim.  N.J.S.A. 2A:44A-31a, -32. 

In L&W Supply Corporation, the contractor's principal Joel DeSilva owned and operated several business entities  from which he purchased supplies from L&W on credit.  Thus, L&W maintained multiple credit accounts for the DeSilva entities.  For the disputed project in this case (called the Meridian), L&W filed a construction lien alleging that the DeSilva entity known as Detail Construction ("Detail") owed in excess of $100,000 on the Meridian job.  During the same time period where Detail was purchasing supplies from L&W on the Meridian job, DeSilva's other entities had purchased supplies from L&W for other projects.  

The trial court granting summary judgment in favor of L&W.  But on appeal, the Appellate Division  reversed, finding that L&W failed to make inquiry as to the source of the funds from which its customer was making payments.  

Viewing the summary judgment record most favorably to defendants, that is, crediting the certification and accounting of Patock's bookkeeper and viewing reasonable inferences against the L&W witnesses, Detail paid L & W $113,040.55 that was applied to non-Meridian projects. No specific evidence in the record indicates whether DeSilva directed that amount to be allocated to his other projects, and whether L & W had or did not have reason to suspect that DeSilva and his business entities may be misapplying payments to past-due accounts.  The conclusory certifications of L & W's witnesses do not resolve the factual dispute as to whether L & W "ascertain[ed] the source" of the funds from which Detail and DeSilva were making payments.  Defendants should have the opportunity to prove at a trial that L & W failed to make any inquiry about the source of the funds, or that it had reason to suspect that the DeSilva entities were not properly allocating their payments.

SOME SUGGESTIONS

The holding in L&W Supply Corporation places an extra burden on construction suppliers to pay attention to their bookkeeping practices when it comes to selling to repeat customers on credit.   Some practical suggestions for suppliers include maintaining separate credit accounts for each project, requiring the customer to write down the name of the property owner or job site on each purchase order, and repeating the property owner's name or job site reference on the memo portion of each customer check.  Accepting customer checks designated as "payment on account" should be avoided.