Violation of NY Lien Law Provision Does Not Discharge Surety’s Obligation Under Performance Bond

Mount Vernon City School Dist. v. Nova Cas. Co., 19 N.Y.3d 28 (N.Y. Ct. App. 2012)

On April 3, 2012, the New York Court of Appeals held that a compensated surety cannot rely on a violation of Article 3-A of the Lien law to discharge its obligations under a performance bond.  The Mount Vernon City School District (“Plaintiff”) hired a contractor who obtained a performance bond in Plaintiff’s name from Nova Casualty Company (“Nova”), a compensated surety, securing his obligation under the contract.  After he defaulted and Nova refused to pay additional funds to complete the project, Plaintiff sued Nova for breach of contract.  Nova moved for summary judgment claiming that Plaintiff violated Article 3-A of New York Lien Law when, per the contractor’s request, Plaintiff remitted $214,000 of his fee to the Department of Labor (“DOL”) thereby discharging Nova’s duty to perform.

Article 3-A provides that funds received by a project manager in connection with a contract for public improvements must be held in trust for payment of the contract’s beneficiaries.  See NY Lien Law §§ 70-72.  Nova argued that by remitting payment to the DOL, Plaintiff illegally spent trust funds, thereby discharging Nova’s obligation to pay.  The Court, in a 5-2 decision, did not decide whether Plaintiff’s actions violated the statute, holding instead that a non-performing surety is not a beneficiary of the trust and therefore cannot rely on a violation of the statute to discharge its obligation.  The Court further held that Nova failed to demonstrate prejudice arising from Plaintiff’s actions because its payment to the DOL consisted of funds due to the contractor.  In dissent, Chief Judge Lippman argued that regardless of whether Nova could use Article 3-A to recover damages, a violation of the statute still discharged its obligation to pay.