A prior holding by the Supreme Court of New Jersey in Craft v. Stevenson Lumber Yard, Inc., declared that a construction lien claimant has a “statutory duty” under the Construction Lien Law “to allocate payments to the accounts from which they were derived”. In other words, contractors, subcontractors, and suppliers are not permitted apply payments originating from an owner on one project to another project to do things like pay off older debt. The Appellate Division’s recent decision in L&W Supply Corp. v. Joe DeSilva enlarges that obligation to one of inquiry based on reasonable suspicion.
In L&W, the plaintiff was a material supplier that provided materials on credit to a subcontractor for multiple projects. It then filed a lien under the New Jersey Construction Lien Law and initiated litigation to enforce that lien and collect the amounts it was owed. L&W successfully moved for summary judgment based in part on representations by its own employees that it had not been paid for a project in which Meridian Health was the owner. While there were some procedurally related complications to the case, the Superior Court held that the grant of summary judgment was improper because Meridian was not permitted to challenge the lien on grounds that it had made payments to the subcontractor for the materials at issue and L&W misapplied the subsequent payments made to it by that same subcontractor to other projects.
The general rule in New Jersey is that a creditor is permitted to apply payments from a debtor in any manner it chooses if the payment is not designated for certain accounts. However, the Craft court narrowed this general rule in the context of the Construction Lien Law by stating that a creditor has an obligation to apply payments in a way that discharges the duty of the customer to a third party if that creditor knows or should know that the debtor is under an obligation to that third party. Stated differently, if a subcontractor or supplier knows or should know that a payment is being made to fulfill an obligation of the party making the payment to a third party to pay for debts relating to that project, it must apply the payment to that project regardless of other and/or older debts owed for purposes of the lien statute.
The recent holding by the L&W court answers the question of what responsibility the subcontractor or supplier has to determine where the payment made to it originated when it is not shared or there is a question about the payor’s designated allocation of the payment. After balancing an overly burdensome across-the-board affirmative obligation with one of the statute’s stated goals of protecting owner’s from having to pay for the same labor and/or materials twice, the Court concluded 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 should 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 payment funds so that it can allocate them to the correct accounts”. The failure to do so could result in the loss of lien rights.
What constitutes reasonable suspicion that the customer is paying with funds from another project? For that matter, how much inquiry is reasonable? It also overlooks the practical problem of how one would trace the payment back to the original owner through multiple levels of a project and what can be complex accounting records. It hardly seems appropriate to require a supplier to figure this out or prove it in court since it will require the time and cost of a forensic accountant in what is supposed to be a summary proceeding. These are just a few of the remaining questions.
It is likely safe to assume additional litigation over some of the many issues created or left unanswered by this case will be coming over the horizon soon.