A fundamental principle of New York construction law is that a subcontractor’s rights are derivative of the general contractor’s rights. Section 4 of the NY Lien Law, entitled “Extent of Lien”, embodies this principle: When a subcontractor files a mechanic’s lien, the lien can only be satisfied out of the funds due and owing from the owner to the general contractor at the time the lien is filed and any sum subsequently earned thereon. In a sense, the subcontractor’s mechanic’s lien operates as an attachment on the amount the owner owes the general contractor.
A significant amount of case law describes how the subcontractor’s mechanic’s lien fund will be calculated in the context of a garden variety mechanic’s lien foreclosure action as follows:
1. If any monies are due to the general contractor when the subcontractor’s lien is filed, that represents the lien fund; or
2. If nothing is due to the general contractor on the date the subcontractor’s lien is filed, a lien fund may later be created by funds that become due; or
3. If the general contractor is terminated and no monies are due to the general contractor at the time the subcontractor’s lien is filed, the lien fund may be created by the difference between the legitimate cost of completion and the undisputed contract balance at the time of termination; If the cost of completion exceeds the contract balance, no lien fund can be created.
However, a subcontractor’s situation does not always fall neatly into these three categories, and when that occurs, the “extent” of a subcontractor’s lien fund becomes murkier. For instance, issues may arise as to: (a) whether an owner’s termination of the general contractor for convenience has any impact on the calculation of the lien fund; (b) whether a lack of a formal contract between an owner and general contractor will preclude a subcontractor from establishing that a lien fund exists; or (c) whether the lien fund can be affected by a settlement agreement between the owner and the general contractor. This article will briefly explore these three issues.
The termination of a general contractor for convenience allows the subcontractor to explore more possibilities in its attempt to establish that a lien fund exists.
More often than not, an owner’s attorney who receives notice that a subcontractor has filed a mechanic’s lien on private property will claim one of two defenses: (1) there is no lien fund because the owner has paid the general contractor in full; or (2) there is no lien fund because the general contractor was terminated and the owner incurred costs to complete the project and/or correct the work performed by the general contractor.
The owner’s first response, if proven, is a complete defense to a lien action. The latter defense, however, does not clearly address how the lien fund is calculated when a general contractor is terminated for convenience. There is no New York case law that addresses this issue directly or comprehensively. Nevertheless, if the general contractor is terminated for convenience, it seems that courts should calculate the subcontractor’s lien fund another way. This is because a calculation based on the difference between the cost of completion and the contract balance at the time of the termination presupposes that the general contractor was terminated for cause.
Courts presented with this fact pattern may analogize to an owner’s rights to counterclaim for the costs of completing the project after the general contractor is terminated for convenience. Under New York law, where an owner “elects to terminate for convenience…whether with or without cause, it cannot counterclaim for the cost of curing any alleged default.” If the owner who terminates for convenience cannot recover completion costs from the contractor, a subcontractor can argue that the owner should also be precluded from offsetting its costs for completion against the available lien fund.
In addition to this case law, the specific contractual provisions governing the general contractor’s rights in the event the owner terminates for convenience could also play a pivotal role in the subcontractor’s endeavor to establish an available lien fund. Depending upon the contract’s terms, a subcontractor could argue that its lien attached to payment due and owing for work performed by the general contractor, the costs incurred by the general contractor as a result of the termination, or reasonable overhead and profit on work not performed. In our practice, particularly in our representation of subcontractors in mechanic’s lien foreclosure actions, such arguments have successfully created issues of fact to defeat an owner’s motion for summary judgment to cancel and vacate a subcontractor’s mechanic’s lien.
Thus, when a general contractor is terminated for convenience, a subcontractor who cannot point to a conventional source for a lien fund should not give up on its claim, as courts may be receptive to theories that go beyond these traditional sources.
Despite the lack of a written contract between the owner and general contractor, a subcontractor can successfully foreclose on its mechanic’s lien.
Under typical circumstances, an owner pays a general contractor pursuant to a written contract with a clearly outlined and agreed upon schedule of values and payment procedure. In turn, the written payment terms established between the owner and general contractor provide the subcontractor with the basis for assessing whether or not a lien fund exists. There are times, however, when the owner and general contractor have an informal relationship and never enter into a formal contract. Yet, a subcontractor’s mechanic’s lien cannot be defeated even in the absence of a formal written contract between the owner and the general contractor. In 104 Contractors, Inc. v. R.T. Golf Associates, L.P.et.al., 705 N.Y.S.2d 752, 270 A.D.2d 817 (4th Dept. 2000), the owner and general contractor never reduced their agreement to a formal written contract and, notably, never agreed to a maximum price on the contract. However, their course of conduct demonstrated that the owner made payments based upon a cost plus percentage formula. The court held that the subcontractor, who had filed a mechanic’s lien after the owner had already terminated the general contractor, was entitled to a mechanic’s lien based on the same arrangement. This follows the fundamental principle described above: A subcontractor’s rights derive from those of the general contractor.
The calculation of the lien fund can be impacted by a settlement between the owner and general contractor.
When it is unclear what amount, if any, is owed by the owner to the general contractor, the subcontractor must first wait for a resolution of that dispute. In Electric City Concrete Company, Inc. v. Phillips, 100 A.D2d 1, 473 N.Y.S.2d 608 (3rd Dept. 1984), the Third Department held that the amount of the lien fund can be decided by a settlement between the owner and general contractor, thereby diminishing the available lien fund. There, two separate mechanic’s lien foreclosure lawsuits were commenced and later consolidated with the owner’s breach of contract lawsuit against the general contractor. At a pre-trial conference, the subcontractor-lienors agreed to allow the trial between the owner and the general contractor to proceed first. During the trial, a settlement was reached between the owner and the general contractor which dictated the amount of the lien fund available to the subcontractors foreclosing their mechanic’s liens. The subcontractors were bound by the terms of the settlement reached between the owner and the general contractor as to the amount due and owing. As a result, the satisfaction of the subcontractors’ mechanic’s liens could only be satisfied out of the agreed upon amount between the owner and general contractor.
Although the unique facts and circumstances of each case may affect the size or existence of a lien fund available to a subcontractor, courts analyzing a subcontractor’s mechanic’s lien claim will ultimately look to the funds due and owing to the general contractor at the time the lien was filed to determine the existence of a lien fund.
Rosalie Valentino, Esq.
 See DiVeronica Bros. v. Basset, 213 A.D.2d 936, 937, 624 N.Y.S.2d 296 (3rd Dept. 1995); Electric City Concrete Co. v. Phillips, 100 A.D.2d 1, 473 N.Y.S.2d 608 (3rd Dept. 1984); Albert J. Bunce, Ltd. v. Fahey, 73 A.D.2d 632, 632, 423 N.Y.S.2d 58 (2nd Dept. 1979).
 Paragon Restoration Group, Inc. v. Cambridge Square, 42 A.D.3d 905, 839 N.Y.S.2d 658 (4th Dept. 2007) quoting Tishman Construction Corp., Inc. v. The City of New York, 228 A.D.2d 292, 293, 643 N.Y.S.2d 589 (1st Dept. 1996).