Sunday, May 28, 2006

Construction Liens: Statute of Limitations

Under the Michigan Construction Lien Act, does the time period for bringing an action to enforce a claim of lien differ when the lien has been bonded off?

Until recently, the answer was thought to be No.

Under Section 117(1) of the CLA, an action to enforce a claim of lien must be brought within one year from the date it was recorded. Even when a lien was bonded off, following the procedures in Section 116, courts in Michigan have regularly treated an action against the bond as the same as one against the property. See, McAlpine & Keating, Construction Liens in Michigan, Sec 5.10 (ICLE 1996 & Supp 2003).

In E. R. Zeiler Excavating, Inc. v Valenti Trobec & Chandler, Inc., 2006 Mich. App. LEXIS 1172 (April 18, 2006) the Michigan Court of Appeals addressed this question in a case of first impression.

The Michigan Court of Appeals found that an action based upon a bond furnished under Section 116 of the CLA is subject to the 6 year statute of limitations for contract claims, not the one year period for enforcement of construction liens. 2006 Mich. App. LEXIS 1172, *8-9. The Court noted:

"Although the facts and proceedings in this case are complicated, the legal analysis is straightforward. MCL 570.1116 is silent concerning any period of limitations for an action on a bond. Although MCL 570.1117 expressly provides for a one-year period of limitations, the provision applies by its plain language to the enforcement of construction liens and foreclosure thereon. We find no basis for extending the one-year period of limitations to actions on bonds filed under [*9] MCL 570.1116 contrary to the express statutory scheme established by the Legislature. We agree with Zeiler that the six-year period of limitations for contract actions, MCL 600.5807(8), applies to its claim against [the surety]."

The slip opinion for this case can be found here.

Commentary: This decision was contrary to the expectations of most construction attorneys. Substituting a surety bond for the property was not meant to enhance a claimant's rights by extending the time period within which to file suit. The Zeiler decision will make it more expensive for contractor's to bond off construction liens, and require that such bonds be maintained for up to six years. One alternative might be to specify a one year statute of limitations on the face of the bond; Michigan law permits parties to contract for shorter statutes of limitation.

Saturday, May 06, 2006

Michigan Builder's Trust Fund Act: H.B. 5196

On September 21, 2005, a new bill was introduced in the Michigan Legislature, which would expand the scope of the Michigan Builder’s Trust Fund Act (MBTFA) to include public projects. H.B. 5196 would modify Section 1 of the Act (MCL 570.151), which has been construed by Michigan courts for almost 25 years to apply only to private construction projects, not public ones. H.B. 5196 was introduced by Rep. Joe Hune (R-Howell) and it has been referred to the Committee on Government Operations.

Before deciding whether H.B. 5196 would be good or bad for the construction industry in Michigan, you should consider the current statute and how it is applied by the courts.

The MBTFA is a criminal statute.

On its face, the statute makes it a crime for contractors and subcontractors engaged in the building construction business, to use (appropriate) contract proceeds, with intent to defraud, for their own use before paying their laborers, subcontractors and materialmen (suppliers). The statute creates a trust fund; it provides that upon receipt of payment from the owner, a trust is created for the benefit of contractors, laborers, subcontractors and suppliers, and makes the contractor or subcontractor who receives the funds a trustee.

Among the reported legal decisions, the most common set of circumstances leading to criminal prosecution is the misappropriation of funds by a residential builder, which leaves subcontractors and suppliers unpaid, and homeowner's property subject to construction liens.

The MBTFA also provides a civil remedy.

The more common application of the MBTFA, however, is on the civil side of the law. Michigan courts have long construed the statute to provide a cause of action for unpaid subcontractors and suppliers. See, B F Farnell Co v Monahan, 377 Mich 552, 555; 141 NW2d 58 (1966), and National Bank of Detroit v Eames & Brown, 396 Mich 611; 242 NW2d 412 (1976).

To make out a civil cause of action under the MBTFA, a plaintiff must establish the following elements:
  • The defendant is a contractor or subcontractor engaged in the building construction industry;
  • A person paid the contractor or subcontractor for labor or materials provided on a construction project;
  • The defendant retained or used those funds, or any part of those funds,
  • for any purpose other than to first pay laborers, subcontractors, and materialmen, who were engaged by the defendant to perform labor or material for the specific project.
See, DiPonio Construction Co v Rosati Masonry Co, 246 Mich App 43, 49; 631 NW2d 59 (2001), lv app denied, 465 Mich 896 (2001).

"Intent to defraud" is not an element required to make out a civil cause of action under the MBTFA.
Common Claims.

The most common fact pattern in a Builder’s Trust Fund claim is one where owner or contractor has paid for the work performed, but the subcontractor or supplier has not been paid, even though a portion of the payment was earmarked for the subcontractor or supplier.[5] Earmarking can be shown through the contractor’s schedule of values, or a sworn statement. Builder’s Trust claims also tend to appear when a contractor is experiencing a severe cash flow restriction, or when a business fails, either with or without a bankruptcy.

In People v Whipple, the Michigan Court of Appeals found that "a reasonable inference of appropriation arises from the payment of construction funds to a contractor and the subsequent failure of the contractor to pay laborers, subcontractors, materialmen, or others entitled to payment." 202 Mich App 428, 435; 509 NW2d 837 (1993).

Personal Liability under the MBTFA.

Another important aspect of the MBTFA is the potential exposure of corporate officers. Personal liability may be imposed upon corporate officers, or members of a limited liability company, who participate in the receipt and disbursement of construction proceeds, which are then (mis) appropriated in violation of the statute. In this regard, the MBTFA is a legal vehicle to "pierce the corporate veil." But unlike traditional "piercing" claims, which must overcome the strong presumption of limited liability to reach individual shareholders, the MBTFA makes it easier to reach responsible corporate officers. This is largely because the MBTFA involves the creation of a trust, which increases the level of responsibility for those with fiduciary duties.

Persons at risk for being named in a Builder's Trust suit include sole shareholders, persons who handle the money, and the person who makes the payment (no payment) decision after reviewing the accounts payable report.

Burden of Proof; Statute of Limitations.

While most plaintiffs bear the burden of proof in a civil action, once the existence of a trust fund is established, the burden of proof under the MBTFA may shift to the contractor to account for the handling and disposition of funds he has received from the owner. There is a split of authority on this issue.

In federal bankruptcy courts, the defendant-trustee has the burden of proof. See, In re Little, 163 BR 497 (ED Mich 1994). In state court, however, the burden remains with the plaintiff. See, James Lumber Co Inc v J&S Const, Inc, 107 Mich App 793; 309 NW2d 925 (1981).

The statute of limitations under the MBTFA is six years. DiPonio Construction Co, supra at 56.

The Bankruptcy Code.

Another aspect of the MBTFA is the role it can play in a bankruptcy proceeding. There are two circumstances under which the MBTFA comes into play.

First, if a bankruptcy occurs before the monies are paid over to subcontractors and suppliers, the MBTFA provides the basis for arguing that money possessed by the contractor as trustee is not property of the contractor and not subject to appropriation by the bankruptcy trustee. The "beneficiaries" of the MBTFA can petition the bankruptcy court for an order releasing these funds from the bankruptcy estate.

The other circumstance under which the MBTFA and bankruptcy code converge is a petition objecting to the debtor's discharge. Ordinarily, unless a claim is excluded from the discharge order, it will be lost upon entry of the order. Under the bankruptcy code, certain claims are excluded from the debtor's discharge, but they must be affirmatively asserted as objections to discharge in the bankruptcy court proceeding. There are deadlines for raising such objections.

In the case of the MBTFA, a violation of the statute is deemed to be the breach of a fiduciary duty. Under the bankruptcy code, this is known as a "defalcation," and is one of the enumerated grounds for excluding a claim from discharge in bankruptcy. Said another way, a Builder's Trust Fund claim is not easily avoided through bankruptcy, but it does require that a creditor take affirmative steps to exclude a claim from discharge.

For More Information

Since the facts of each case are unique, this update cannot be taken as legal advice. For more information about H.B. 5196, and how it might affect you or your business, please contact Peter Cavanaugh or visit