Are Contractors and Subcontractors Allowed to Rob Peter to Pay Paul When it Comes to Paying Subcontractors and Suppliers?

Construction going on in the city.

One of the main problems most contractors (and subcontractors) face is cashflow. When the economy is going well, most contractors still find their payments lagging 60 to 90 days behind the 30 days required by most construction contracts. When an owner fails to make timely payment, general contractors end up in arrears with their subcontractors, who end up in the arrears with their subcontractors (i.e. sub-subcontractors) and suppliers. Often well intended contractors (and subcontractors) may end up using monies received from one project to pay subcontractors (and/or sub-subcontractors) on another. The reasons for paying subcontractors from one project with funds received from another may be because the subcontractors on the second job have gone longer without payment and/or are more in need. The question is whether that is legal.

In Connecticut, it has recently become riskier for contractors to pay their subcontractors (and for their subcontractors to pay their sub-subcontractors and suppliers) with funds received from another project. Connecticut has long had prompt payment statutes which require contractors to pay subcontractors “not later than twenty-five days after the date the contractor receives payment from the owner” on private projects and “within thirty days after payment to the contractor by the state or a municipality” on public projects. Conn. Gen. Stat. § 42-158j; Conn. Gen. Stat. § 49-41a. These statues then similarly require subcontractors to pay their sub-subcontractors and suppliers within so many days after their receipt of payment from the contractor. Id. Nonetheless, neither Conn. Gen. Stat. § 42-158j nor Conn. Gen. Stat. § 49-41a require contractors and/or subcontractors to hold these monies in trust for the subcontractors (or sub-subcontractors) who performed the work for which payment has been received, but a recent Superior Court decision indicates that robbing Peter to pay Paul may amount to violation of the Connecticut Unfair Trade Practices Act (“CUTPA”). See Pointe Residential Builders BH, LLC v. TMP Constr. Grp., LLC, 2020 Conn. Super. LEXIS 249 (Conn. Super. Ct. February 18, 2020)

In some other jurisdictions, paying subcontractors with funds received from a different project is unquestionably wrongful, because the statutes require contractors to hold such monies in trust for the subcontractors that performed the work for which payment was received. For example, in New York, “Lien Law Article 3-A was designed to create trust funds out of certain construction payments or funds to assure payment of subcontractors …” Dick’s Concrete Co., Inc. v. K. Hovnanian at Monroe II, Inc., 20 Misc. 3d 1145(A), 1145. “Basically, any funds that a contractor receives or is owed from the owner pursuant to a contract to improve public or private real property are trust assets and the contractor holds these assets in trust for those parties with whom the contractor directly contracts, including subcontractors …” Id. Connecticut law has no such requirement. Gen. Stat. § 42-158j and Conn. Gen. Stat. § 49-41a simply do not impose a trustee type relationships between general contractors and subcontractors or between subcontractors and sub-subcontractors. (As discussed in a prior post, Gen. Stat. § 42-158j and Conn. Gen. Stat. § 49-41a certainly have teeth but they do not go as far as the laws in other jurisdictions, such as New York, which is why the recent holding in Pointe Residential Builders BH, LLC v. TMP Constr. Grp., LLC is interesting.)

By stating that the contractor holds monies received from the owner in trust for its subcontractors, the law is saying those monies belong to the subcontractors who performed the work for which payment was received. Because Connecticut law does not impose this kind of obligation, it is reasonable for Connecticut’s prompt payment statutes to impose damages for the failure to make payment to subcontractors, sub-subcontractors and suppliers, but a CUTPA violation seems like a stretch.

Until we have further judicial clarification, Pointe Residential Builders BH, LLC v. TMP Constr. Grp., LLC should be limited to cases that have the same facts. In that case, the subcontractor’s “business plan and practice to finance the Project, the Viking Project, and various other ongoing projects, was literally “robbing Peter to pay Paul,” with Pointe exposed to substantial risks well beyond the scope of the Contract. The scheme circumvented protections against overpayment written into the contract terms. Pointe’s conduct was not merely ‘intracorporate’ activity, but occurred in trade and commerce in the course of TMP’s primary business in which he personally participated. This conduct was deceptive, unethical and unscrupulous and constituted an unfair and deceptive business practice in violation of CUTPA.” Pointe Residential Builders BH, LLC v. TMP Constr. Grp., LLC, 2020 Conn. Super. LEXIS 249, 7-8 (Conn. Super. Ct. February 18, 2020). In other words, it was not simply a matter of a single instance of funds being misappropriated to cover debts from other projects. It was a regular business practice exercised across many different related companies. Most importantly, the subcontractor submitted requisitions for payment knowing the money was going to be applied to other debts. Id. at 2. Thus, for now, a single instance of paying a subcontractor with funds received from another job done without prior intent probably will not result in a CUTPA violation, but could still result in liability under the prompt payment statutes.

If you should have any questions about handling payments on your projects, please give me a call at (203) 640-8825.

Scott Orenstein