eve rything you ev e r want e d to kn o w about m l new y n you ever wanted to know abo… ·...

3 TRANSITIONAL ANd NON-TRANSITIONAL MCLE CREdITS: This course has been approved in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 3 Transitional and Non-Transitional credit hours: 1 Skills; 1 Professional Practice.

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EvErything you EvEr WantEd to KnoW about

MEchanics LiEns in nEW yorK Prepared in connection with a Continuing Legal Education course presented

at New York County Lawyers’ Association, 14 Vesey Street, New York, NY scheduled for January 11, 2011.

P r o g r A m C o - s P o N s o r :

NYCLA Construction Law Committee

P r o g r A m C h A I r s :

Joel Sciascia, Pavarini McGovern LLC Ariel Weinstock, Katsky Korins, LLP

F A C u L t Y :

Kevin J. Connolly, Anderson Kill & Olick, P.C. Brian G. Lustbader, Mazur, Carp, Rubin & Schulman, P.C

Joel Sciascia, Pavarini McGovern LLC Ariel Weinstock, Katsky Korins, LLP

Information Regarding CLE Credits and Certification

Everything You Ever Wanted to Know About Mechanics Liens in New York

Tuesday, January 11, 1011 6:00 PM – 9:00 PM

The New York State CLE Board Regulations require all accredited CLE providers to provide documentation that CLE course attendees are, in fact, present during the course. Please review the following NYCLA rules for MCLE credit allocation and certificate distribution.

i. You must sign-in and note the time of arrival to receive your

course materials and receive MCLE credit. The time will be verified by the Program Assistant.

ii. You will receive your MCLE certificate as you exit the room at

the end of the program. The certificates will bear your name and will be arranged in alphabetical order on the tables directly outside the auditorium.

iv. If you arrive after the course has begun, you must sign-in and note the time of your arrival. The time will be verified by the Program Assistant. If it has been determined that you will still receive educational value by attending a portion of the program, you will receive a pro-rated CLE certificate.

v. Please note: We can only certify MCLE credit for the actual time you are in attendance. If you leave before the end of the course, you must sign-out and enter the time you are leaving. The time will be verified by the Program Assistant. If it has been determined that you received educational value from attending a portion of the program, your CLE credits will be pro-rated and the certificate will be mailed to you within one week.

vi. If you leave early and do not sign out, we will assume that you left at the midpoint of the course. If it has been determined that you received educational value from the portion of the program you attended, we will pro-rate the credits accordingly unless you can provide verification of course completion. Your certificate will be mailed to you within one week.

Thank you for choosing NYCLA as your CLE provider!

New York County Lawyers’ Association

Continuing Legal Education Institute 14 Vesey Street, New York, N.Y. 10007 • (212) 267-6646

Everything You Ever Wanted to Know About Mechanics Liens in New York

Tuesday, January 11, 1011 6:00 PM – 9:00 PM

Program Co-sponsor: NYCLA’s Construction Law Committee

AGENDA

5:30 PM – 6:00 PM Registration 6:00 PM – 6:05 PM Introductions and Welcoming Remarks Ariel Weinstock,, Katsky Korins, LLP 6:05 PM – 7:00 PM Mechanics’ Liens Basics Joel Sciascia, Pavarini Mc Govern LLC and Ariel Weinstock, Katsky Korins, LLP, Program Co-chairs

• Basic Requirements of Mechanics’ Liens • Common Contract Clauses (Including Lien Waivers and

Duty to Bond) • Recent Developments in NY Mechanics’ Lien Case Law

7:00 PM – 7:15 PM Distinctions Between Private Improvement Liens and Public Improvement Liens Kevin J. Connolly, Anderson Kill & Olick, P.C.

• Parties Entitled to File • Notice and Enforcement Differences • Pseudo-public Improvements

7:15 PM – 7:25 PM BREAK 7:25 PM – 8:15 PM Enforcement and Defense of Mechanics’ Liens

Brian G. Lustbader, Mazur, Carp, Rubin & Schulman, PC • Unique Nature of Proceedings • Special Matters to Plead • Necessary Parties • Defenses and Counterclaims

8:15 PM – 9:00 PM Trust Funds Kevin J. Connolly, Anderson Kill & Olick, P.C.

• Overview: Nature and Purpose of the Trust • Creation: What are Trust Funds; Who is the Trustee; Who

are the Beneficiaries • Recordkeeping Duties

• Permitted Use of the Funds • Construction Lending • Defenses to Charges of Diversion

New York County Lawyers’ Association

Continuing Legal Education

Everything Your ever Wanted to Know About Mechanics Liens in New York

Tuesday, January 11, 2011

6:00 PM – 9:00 PM Program Co-sponsor: NYCLA’s Construction Law Committee

Table of Contents 2010 State of the Construction & Surety Industry Report 1 William J. McConnell, Vertex Construction Services Lien Foreclosures 2 Brian G. Lustbader, Mazur, Carp, Rubin & Schulman, PC Trust Funds Under the New York Lien Law 3 Kevin J. Connolly, Anderson Kill & Olick

Faculty Biographies

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VERTEX® Construction Services, Inc.

www.vertexeng.com

2010STATE OF THE

CONSTRUCTION & SURETY INDUSTRY REPORT

prepared by:

William J. McConnell, PE President

contributions from:

Devon L. Wisner, LEED AP

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Table of Contents

I. Executive Summary……………………………………………………………………….3 II. State of the U.S. Economy…………………………………….…………………………..4

A. Definition of a Recession…………………………………………………….……4

B. Review of Key Economic Indicator…….…………………………………...…….5

C. Likelihood of a “Double Dip” Recession………….………………………………9

D. Political Climate and the Economy…………………........………………………10

III. State of the Construction Industry……………………………………………………….11

A. Contractor Profitability………………………………………………………......12

B. Materials & Labor Escalation………………………………………………..…..13

C. Construction Failure………………………………………………………....…...17

D. Construction Unemployment….………………………………………………….19

E. Construction Legislation……….………………………………………………....19

F. Market Sector Review…………….………..….................................................…20

G. Current Trends in the Construction Industry……..………………………………23

IV. State of the Surety Industry………………………………………….…………………...25

A. Surety Growth……………………………………………………………...……25

B. Surety Losses……………………………………………………………….…...26

C. Loss Cycle Review………………………………………………………...…….27

D. Surety Losses by Region…………………………………………………..….…29

E. Surety Consolidation…………………………………………………….….…...30

Appendix I: CV for William J. McConnell, PE

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October - 2010 I. Executive Summary

In mid September of 2010, the National Bureau of Economic Analysis (“NBEA”) reported that the recession which commenced in December of 2007 formally ended in June of 2009.1 This 18 month recession represents the longest economic downturn since World War II. The NBEA noted that the economy has yet to return to normal capacity, but it noted that the recovery started in June of 2009.

The slow recovery is largely a result of the continued credit crisis, state and federal

budget deficits, and lag in global markets. The national unemployment rate continues to hover around 10%; this is historically high, particularly since more than a year has passed since the recession ceased. The fear now is of a double dip recession that might result if unemployment starts to trend upwards.

The state of the construction industry is very poor. Nearly every construction sector was

down in 2009 and this trend continues in 2010. The few sectors that recorded marginal growth through August of 2010 are largely public works sectors and the increases are a result of stimulus funding; once the stimulus funded projects end, growth in these sectors will slow. The largest construction sector, Residential, is flat thus far in 2010. This is positive news considering the massive compression that took place over the past four years – this sector is less than one half of what it was in 2006.

Because more contractors are competing for less work, contractor failure rates are rising

sharply. In addition, contractor balance sheets are languishing. This combination spells trouble for surety industry performance over the next couple of years. Although the surety industry performed well in 2009, losses grew by nearly 50% from the prior year. In 2008, the surety industry recorded record breaking profits. The record low loss ratio in 2008 signifies the end of the third loss cycle in the last three decades and the start of the fourth loss cycle.

The fourth surety loss cycle will result in an upward trend in the loss ratios over the next

several years. Surety losses for this cycle will likely peak in 2012 and then trend downwards through 2016. For the third time in the last four years, the South region suffered the most losses. Between 2008 and 2009, losses in the South and in the Mountain region tripled. On a state by state basis, California, New Jersey, Michigan, Texas, and New York suffered the most losses. On a loss ratio basis, New Jersey and Michigan recorded 86% and 81%, respectively – no other states recorded loss ratios even close to these levels.

Surety consolidation over the past year was minimal, with the agreement between the

Hanover Insurance Group and ICW representing the largest deal. Because of the significant increase in net income for the property/casualty industry over the last two years, and the limited room for organic growth, insurance consolidation will likely continue over the next couple of years.

1 http://www.nber.org/cycles/sept2010.html

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II. State of the U.S. Economy A. What is the deal, are we still in a recession or not? Under the “two quarter rule2,” the U.S. economy is not in a recession as there has been four consecutive quarters of GDP growth. Under the two quarter rule, the recent recession ran from July-2008 to September-2009.

Quarter % GDP Growth 2007q4 2.9 2008q1 -0.7 2008q2 0.6 2008q3 -4.0 2008q4 -6.8 2009q1 -4.9 2009q2 -0.7 2009q3 1.6 2009q4 5.0 2010q1 3.7 2010q2 1.6 Source Data: http://www.bea.gov/

In addition, the Fed Reserve Chairman, Ben Bernanke, noted the “recession is very likely over” during a speech he gave on September 15, 2009. Chairman Bernanke did warn that unemployment would come down slowly – this has certainly been the case.

The federal government accepts the National Bureau of Economic Research (“NBER”)

position on the actual duration of a recession. According to the NBER, the U.S. economy fell into a recession in December of 2007, which represents the 23rd recession since 1900.3 In mid September of 2010, NBER reported that this recession formally ended in June of 2009.4 This is consistent with Vertex’s February-2009 projection that this recession would cease during

summer of 2009. This 18 month recession represents the longest economic downturn since World War II.

The NBEA defines a

recession at “a period of falling economic activity spread across the

2 BusinessDictionary.com 3 http://wwwdev.nber.org/cycles/cyclesmain.html 4 http://www.nber.org/cycles/sept2010.html

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economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”5 NBEA considers recovery as the start of the rising phase of the business cycle. NBEA further notes that “economic activity is typically below normal in the early stages of an expansion, and it sometimes remains so well into the expansion.”6 The NBEA noted that the economy has yet to return to normal capacity, but it noted that the recovery started in June of 2009.7

B. Review of Key Economic Indicators

1. U.S. Unemployment Rate – Slow Improvement

As of August-2010, the U.S. unemployment rate stands at 9.6%. The unemployment rate

peaked at 10.1% in October of 2009. Historically, unemployment peaks towards the end, or slightly after, a recession, and then swiftly trends downward. However, the unemployment rate after this past recession continues to remain historically high even after one year has passed since the October-2009 peak rate of 10.1%. The unemployment rate improvement, albeit minimal, is a result of improved private sector performance and short term U.S. Census assignments. Private sector job creation, however, is mitigated by public sector job loss.8 2. Gross Domestic Product

The U.S. economy grew at a 1.7% annual rate in the second quarter, marking the start of a slowdown in growth that has concerned the Federal Reserve. The fourth quarter of 2009 resulted in 5.0% GDP growth, and this slowed to 3.7% in the first quarter of 2010. The 1.7% growth in the second quarter of 2010 represents the third consecutive quarter of slowed growth – if this trend continues the economy will likely fall into a double dip recession. To put the GDP growth numbers in perspective, the average quarterly GDP growth between 1947 and 2010 was 3.3%. The historical high of 17.2% occurred in March of 1950 and the historical low of -10.4% in March of 1958.

3. Corporate Profits – Reasonably Healthy After the first quarter of 2010, corporate profits made up all lost ground since the start of

the recession. Second quarter corporate profits rose 4.6% at a quarterly rate.9 Corporate profits

5 Id. 6 Id. 7 Id. 8 See http://www.bls.gov /news.release/empsit.nr0.htm. 9 See http://www.bea.gov/national/index.htm#corporate

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continue to trend upwards and are 5.7% greater than they were at the start of the recession. An important thing to note is that this increase in corporate profits is largely a result of measures taken to reduce overhead, rather than from top line revenue growth.

4. The Consumer Price Index – Upward Movement The recent trend of the

Consumer Price Index (“CPI”) is upward; this upward movement comes on the heels of the largest CPI reduction in history.10 Over the last 12 months, the index increased 1.2%, mainly due to price increases in the energy sector. The cost of shelter, apparel, used cars and trucks, and tobacco is trending upward as well.

5. Consumer Spending Modest Increase

Consumer spending is trending upwards, which suggests that the U.S. economy might not

slip into a double dip recession. However, the noted reduction in disposable income suggests that individuals might now continue this upward spending trend. As seen stated by the U.S. Census Bureau, disposable personal income is decreasing over time, and spending is increasing over time; this is not a sustainable trend.11

6. Disposable incomes – Slow Decline The money left over after taxes dropped for the first time since January 2010 after

adjusting for inflation, showing how the lack of jobs may prevent spending from strengthening.12 Continued private sector employment improvements might improve real disposable personal income.

7. Stock Market - Flat The Dow Jones Industrial Average

(“DJIA”) started the year at 10,428. In my State of the Industry report for 2009, I predicted minimal to flat returns in 2010 based on historical trends. As of September 3, 2010, the DJIA was at 10,447. Hence, the market performed with a 0% return for the first eight months of the year. However, between

10 See http://www.bls.gov/cpi/home.htm#news and http://www.usinflationcalculator.com/ inflation/current-inflation-rates/ 11 See http://www.bea.gov/newsreleases/national/pi/pi_glance.htm 12 See http://www.bea.gov/briefrm/percapin.htm

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DJIA

Trend Line that follows the 1980s DJIA growth pattern

September and October, the market jumped 600 points. I anticipate that the market will pull back and will be more or less flat for the next twelve months. Until the U.S. economy records significant growth, investors will not realize substantive returns.

7. Federal Funds Rate – Flat

The federal funds rate is the interest

rate at which banks lend balances (federal funds) from the Federal Reserve to other banks, usually overnight. Simply put, it is the interest rate banks charge each other for loans. The federal funds rate is similar to Europe’s London Interbank Offered Rate, otherwise know as “LIBOR.”

Typically, the federal funds rate

steadily increases after a recession. However, the Federal Open Market Committee (“FOMC”) has yet to raise the rate, which remains at an all time low (0.00% to 0.25%). FOMC’s reluctance signifies their concern relative

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to the present state of the economy. In addition, financial institutions continue their reluctance to lend even though the cost of money is at an all time low – this is likely due in part to increased FDIC and SEC oversight and internal balance sheet concerns. An interest rate increase would only bolster this reluctance. Accordingly, the federal funds rate will likely remain at approximately 0.25% through the balance of 2010.

8. Regional Economic Analysis – Weak in Great Lakes, Far West, &

Southeast

A survey of regional GDP growth suggests that the economy in the Rocky Mountain, Plains, Northeast, and Northwest regions performed extremely well this year (highlighted in blue in the graphic to the right), while the economy in the Great Lakes, Far West, and Southeast regions lagged (highlighted in yellow on the graphic to the right).13 The Southwest and Southeast regions continue to feel the aftershocks of the collapse of the residential and commercial real estate markets - these markets continue to see a downturn in construction, manufacturing, finance, and insurance.

9. Bernanke’s Outlook - Cautious

On August 27, 2010, Fed Chairman Ben Bernanke indicated the central bank “will do all

that it can” to ensure a continuation of the economic recovery, and outlined steps it might take if growth slows (fear of double dip recession).14 Bernanke predicts that consumer spending will continue to grow relatively slowly, which will cause the economy to grow slowly as well.15

10. Overall State of the U.S. Economy – Below Average The U.S. economy is weak despite four consecutive quarters of GDP growth. I anticipated a “slow turn” in my 2009 report, but I did not anticipate it would be this slow. First, the U.S. unemployment rate remains high when compared to historical averages. Second, corporate profits increased significantly over the past year, but this growth was largely a result of overhead reduction, as opposed to top line growth. Third, consumer spending is up, but this trend will likely reverse due to a decline in disposable income. And fourth, the federal funds rate remains flat, which gives rise to FOMC’s concerns of a double dip recession if interest rates increase.

13 See http://www.bea.gov/newsreleases/regional/gdp_state/gsp_glance.htm 14 See http://www.federalreserve.gov/newsevents/speech/bernanke20100827a.htm. 15 Id.

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C. What is the Likelihood of a “Double Dip Recession?”

A “double dip recession” occurs when the GDP compresses after a quarter or two of positive growth.16 A double dip recession is otherwise known as a W-shape recession. “A double-dip recession refers to a recession followed by a short-lived recovery, followed by another recession.”17 Although GDP growth occurred over the past four consecutive quarters, the growth slowed from 5%, to 3.7%, to 1.7% during the past three quarters. Economists fear this slowdown in growth might signify that the third quarter will yield GDP reduction.

A double-dip recession is a worst-case

scenario. Fear that the economy will move back into a deeper and longer recession makes recovery even more difficult. Robert Shiller, a professor of economics and finance at Yale University, recently told the New York Times that “The danger (of a double dip recession) stems from the weakness and vulnerability of confidence — whose decline could bring markets down, further stress balance sheets and cause cuts in consumption, investment and local government expenditures.”18

The last double dip recession occurred in the early 1980s. The U.S. economy fell into

recession from January 1980 to July 1980, shrinking at an 8% annual rate from April to June of 1980. The economy then entered a quick period of growth over the first three months of 1981, where it grew at an 8.4% annual rate. As the Federal Reserve (under Paul Volcker) raised interest rates to fight inflation, the economy dipped back into recession from July 1981 to November 1982. The double dip recession of the early 1980s explains why the FOMC is reluctant to increase the federal funds rate.

The following is a list of the recessionary cycles since the Great Depression:

Aug-29 to Mar-33: 43 months Dec-69 to Nov-70: 11 months May-37 to Jun-38: 13 months Nov-73 to Mar-75: 16 months Feb-45 to Oct-45: 8 months Jan-80 to Jul-80: 6 months Nov-48 to Oct-49: 11 months Jul-81 to Nov-82: 16 months Jul-53 to May-54: 10 months Jul-90 to Mar-91: 8 months Aug-57 to Apr-58: 8 months Mar-2001 to Nov-2001: 8 months Apr-60 to Feb-61: 10 months Dec-2007 to Jun-2009: 18 months

In August of 2010, Mark Zandi, chief economist at Moody’s Analytics Inc., noted that the likelihood of the economy slipping back into a recession is now 33%, up from a 20% chance 12 weeks ago.19

16 See http://www.investopedia.com/terms/d/doublediprecession.asp. 17 Id. 18 http://www.nytimes.com/2010/05/16/business/16view.html 19 http://www.nytimes.com/2010/05/16/business/16view.html

Double Dip Recession

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One important statistic to keep in mind is that the U.S. economy has never slipped back

into a double dip recession after there has been four consecutive quarters of GDP growth. Typically, once the GDP gains momentum, it generally does not turn back. Accordingly, I don’t believe the economy will slip into another recessionary cycle.20 D. How will the Political Climate Affect the Economy?

The economy continues to be the number one issue for voters. The November congressional elections should be telling of the voter’s opinions of President Barack Obama’s performance. Public approval for the President’s handling of the economy is waning.21 Based on this increased skepticism on President Obama’s performance, he plans to take immediate measures to promote hiring and growth. Specifically, the President unveiled a $50 billion proposal on Labor Day weekend to improve the nation's highways, airports and railways, in an attempt to jump-start the sluggish economy.22

20 Keep in mind I am often accused of being an optimist. 21http://online.wsj.com/article/SB10001424052748703713504575475400690920676.html?mod=WSJ_newsreel_business 22 Id.

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III. State of the Construction Industry – Survival Mode for Contractors The state of the construction industry can be summed up in two words…not good. The value of put-in-place construction is down 33% from its peak in 2006, and it continues to decline. In 2006, put-in-place construction amounted to approximately $1.2 trillion; in 2010, put-in-place construction revenue is projected at $810 billion. Nearly every construction sector, with a few exceptions, continues to languish. The few construction sectors that realized growth in 2009 and thus far in 2010 are public works sectors. The growth in these sectors has been fueled by funds included in the $787 billion American Recovery & Reinvestment Act of 2009. As these funds dry up, growth in these public sectors will slow considerably, if not compress.

As noted earlier, the U.S. economy is in slow recovery mode. The construction industry might grow marginally in 2011. This growth should continue at a slow pace for the next 24 months, similar to that of the U.S. economy.

In the early 2000s, the construction industry rebounded swiftly due to massive growth in

the Residential construction sector, which at its peak contributed nearly $600 billion to construction revenue. This recovery, however, was largely a result of loose subprime lending practices, as discussed in my 2009 State of the Industry report. Investment banks and commercial banks are no longer susceptible to such temptations and the FDIC and SEC will closely police lending practices moving forward.

In 2007, the historic construction boom came to a screeching halt. As a result, material

prices dropped significantly due to decreased demand. Wage growth has slowed as well since 2008 particularly as construction unemployment soared. Currently, the construction industry unemployment rate stands at 17% (as of August 2010), which is considerably higher than the overall U.S. unemployment rate.23

In the 1990s, the Residential sector represented approximately 43% of all construction spending. Between 2000 and 2006, this category grew to well over 50% of the construction industry. In 2008, the Residential market share slipped to 32%; this represents its lowest percentage in over two decades. As a result of the drag in the Residential sector, put-in-place construction is down for the second straight year and it is no longer a trillion dollar industry. The U.S. Census Bureau estimates put-in-place construction at $811 billion for 2010, the lowest level since 2000. 23 http://www.bls.gov/news.release/pdf/empsit.pdf

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A. Financial Condition of Contractors - Poor The overall financial condition of construction contractors, as a whole, is poor. The following will address the average financial condition of general contractors, heavy contractors, and specialty contractors, respectively. The main source for financial data is Bizminer, which is recommended by the Department of Commerce. The Bizminer financial data I reviewed profiles approximately 182 thousand general contractors, 26 thousand heavy contractors, and 284 thousand specialty contractors. 1. General Contractors – Extremely Poor 2009 construction revenue for general contractors is approximately two-thirds of what it was in 2006. EBITDA for general contractors is approximately one half of what it was in 2006, as is operating income and profit margin. The most alarming statistics are the three-fold increase in accounts payable; the three-fold increase in the average number of days for each payable before payment is made (from 38 to 114); and the six-fold increase in liabilities as a percentage of net worth; and (4) the near 80% reduction in average net worth.

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Takeaways:

*The US Economy and the Construction Industry trend historically proportionally.

*When the Construction Industry outperforms the GDP, the Construction Industry subsequently corrects.

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2. Heavy Contractors - Poor With respect to revenue, heavy contractors faired much better than general contractors over the past four years; construction revenue for heavy contractors is only down 7% from peak revenue in 2006. Surprisingly, EBITDA, operating income, and profit margin are actually up from 2006 figures.

While current profit and loss figures are reasonably good, balance sheet figures are alarmingly bad. For instance, like general contractors, there is a three-fold increase in accounts payable, a three-fold increase in the average number of days for each payable before payment is made (from 42 to 119), and a near three-fold increase in liabilities as a percentage of net worth. Lastly, the average net worth of a heavy contractor dropped nearly 35% between 2008 and 2009. 3. Specialty Contractors - Poor Specialty contractors, on average, faired much better than general contractors and slightly better than heavy contractors. Construction revenue for specialty contractors is actually up 5% since 2006, EBITDA, operating income, and profit margin are all up from 2006 figures as well. It should be noted that operating income decreased slightly from 2008 to 2009.

While current profit and loss figures are reasonably good, there is reason for concern upon review of balance sheet figures. For instance, there is a two-and-a-half-fold increase in accounts payable, average number of days for each payable before payment is made (from 31 to 80), and liabilities as a percentage of net worth. Lastly, the average net worth of a specialty contractor dropped nearly 33% between 2008 and 2009.

In sum, contractor balance sheets, on average, are in poor shape. General contractors are fairing the worst, but heavy and specialty contractors are not far behind. While profit and loss performance is reasonably good (with the exception of declining revenue), such significant deterioration in contractor balance sheets has, and will continue to lead to a steady increase in surety claims. Although heavy contractors maintained reasonable revenue levels as of late, they are the most susceptible to failure as total liabilities far exceed those of general contractors and specialty contractors, due to capital equipment needs.

B. Materials & Labor Escalation - Modest Due to the reduction in demand for construction services over the past two years, nearly all construction material prices dropped in 2009. In 2010, material prices are up by 2.3% (as of August). The cost of skilled labor rarely declines, even through a recessionary cycle. Annual labor increases, however, do flatten during economic downturns, as has been the case over the past two years. The construction industry will likely pick up momentum in 2011 which will trigger increased material and labor escalation.

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Three of the notable construction cost indices include ENR’s Building Cost Index,

Skilled Labor Index, and Material Index; their performance over the past several years is as follows:

ENR Index 2006 2007 2008 2009 2010

• Building Cost Index (material & labor) 3.9% 2.7% 6.9% 0.0% 2.9% • Skilled Labor Index 3.6% 4.5% 4.0% 3.1% 3.2% • Material Index 0.8% -0.7% 7.6% -5.6% 2.3%

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Takeaways:

(1) Construction materials decrease through a recessionary cycle.

(2) 2002 through 2008 was a period of extreme material inflation.

Takeaways:

(1) The construction cost index is an index of contruction labor and materials.

(2) 2002 through 2008 was a period of steep inflation.

(3) The Construction Cost Index is increasing mainly due to labor cost increases.

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The following provides specific construction material escalation over the past several years.24

% increase / decrease (forecast)

Material 2005 2006 2007 2008 2009 2010 • Asphalt Paving 8.3 27.7 9.2 22.5 0.3 -3.7 • Cement 12.7 12.9 5.4 -5.0 -0.9 1.5 • Rebar 1.2 6.5 12.3 37.1 -36.5 8.5 • Construction Machinery 4.6 4.5 2.9 3.0 3.7 3.4 • Fabricated Pipe 9.9 5.4 -1.3 7.7 4.4 0.0 • Gypsum Products 14.3 18.5 -15.2 -9.9 -0.4 2.0 • Lumber, Softwood 2.9 -7.0 -9.9 -8.2 -9.6 3.8 • Plywood -5.9 -7.6 2.0 -0.7 -6.2 1.5 • Aggregates 6.8 9.2 8.7 6.5 4.6 2.8 • Sheet Metal 3.9 3.6 3.1 6.2 -3.0 -2.3 • Structural Steel 2.0 15.4 16.4 30.7 -10.9 3.2

[THIS SPACE IS LEFT INTENTIONALLY BLANK]

24 Source Data: ENR

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2005

2006

2007

2008

2009

2010

2011

2002

2005

2006

2007

2008

2009

2010

2011

2002

2005

2006

2007

2008

2009

2010

2011

2002

2005

2006

2007

2008

2009

2010

2011

2002

2005

2006

2007

2008

2009

2010

2011

2002

2005

2006

2007

2008

2009

2010

2011

2002

Asphalt Paving Portland Cement

30% 30%

25% 25%

20% 20%

15% 15%

10% 10%

5% 5%

0% 0%

-5% -5%

-10% -10%

-15% -15%

-20% -20%

-25% -25%

-30% -30%

Structural Steel Gypsum Products

30% 30%

25% 25%

20% 20%

15% 15%

10% 10%

5% 5%

0% 0%

-5% -5%

-10% -10%

-15% -15%

-20% -20%

-25% -25%

-30% -30%

Plywood Lumber

30% 30%

25% 25%

20% 20%

15% 15%

10% 10%

5% 5%

0% 0%

-5% -5%

-10% -10%

-15% -15%

-20% -20%

-25% -25%

-30% -30%

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FailureRate(%)

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

General ContractorsHeavy ContractorsSpecialty Contractors

30%

25%

35% 35%

CONTRACTOR FAILURE RATE

BizMinor Data

15%

10%

20%

(US Census Bureau recommends BizMinor for Failure Rate data)

30%

25%

20%

15%

10%

Forecast

C. Construction Failure Rate - Alarming

The number of contractor failures is skyrocketing. Between 2008 and 2009, the number of contractor failures doubled from approximately 15% to approximately 30%. The source of this failure data is BizMinor.

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1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

17%

16%

15%

14%Failure

Rate (%)

15%

13%

CONTRACTOR FAILURE RATE

US Census Bureau Data(stopped keeping contractor failure data in 2002)

Year

14%

13%

16%

17%

12%

11%

12%

11%

Takeaway: Failure Rate Peaks During Recessionary Cycles

1. General Contractors – Alarming In 2007, there were 523 thousand general contractors in the U.S. In 2009, only 351

thousand of these contractors survived. This represents a failure rate of 32.8%. In contrast, the failure rate between 2006 and 2008 was 16.8%.

2. Heavy Contractors – Alarming

In 2007, there were 62 thousand heavy contractors. In 2009, only 45 thousand of these

contractors survived. This represents a failure rate of 27.1%. The failure rate between 2006 and 2008 was 14.8%.

3. Specialty Contractors - Alarming

In 2007, there were 826 thousand specialty contractors. In 2009, only 564 thousand of these contractors survived. This is a failure rate of 31.7%. The failure rate between 2006 and 2008 was 14.7%.

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4. Traditional Failure Model after a Recessionary Cycle

• Change in Market Conditions leads to… • A Decline in Construction Spending leads to… • Increased Competition & Lower Profit Margins leads to… • Rising Debt to Equity Ratios leads to… • Cash Flow Problems and Ill-advised Expansion into New Market and/or New Regions

leads to… • Performance Problems leads to… • Insolvency

5. Traditional Survival Model after a Recessionary Cycle

(“Right Sizing”)

• Change in Market Conditions leads to… • A Decline in Construction Spending leads to… • Increased Competition leads to… • Budgeting for Lower Revenue and Lower Profits leads to… • Swift Reductions in Manpower and Equipment & Restructuring Debt to Long Term Debt

leads to… • Continued Focus on Core Markets and Core Regions leads to… • Long Term Success

D. Construction Unemployment - Alarming The key indicators for the construction industry are put in place construction revenue and construction unemployment rate. As the construction industry compressed by 33% since 2006, construction unemployment skyrocketed. The construction unemployment rate more than tripled over the past three years, from approximately 6% to approximately 21%. The rate surpassed the 20% mark in early 2010 but dropped back down to 17% in July, before increasing to 18% in August of 2010.25

E. Construction Legislation

The President proposed a second stimulus package on September 7, 2010. This stimulus package covers approximately $50 billion in infrastructure spending plus two sets of business tax incentives.26 Critics argue that this plan would do little to increase employment figures and boost the GDP. However, the White House feels the programs will reduce construction unemployment.

The President proposed the first stimulus package ($825 billion) on January 15, 2008,

which was subsequently modified down to $787 billion before it was passed by Congress. This first stimulus package provided funds to a broad range of construction programs, across many 25 Source Data: Bureau of Labor Statistics 26 http://www.reuters.com/article/idUSTRE68645X20100907

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federal departments and agencies. The bill covered transportation, highway, energy, school, water, environmental, housing, defense, and building projects.

This second stimulus package, if passed, will likely focus on shovel ready transportation

and highway projects. The President will likely have trouble getting this bill through Congress as certain Democrats and most Republicans will likely oppose any type of significant funding measure.

F. Market Sector Review

In 2009, nearly all of the 17 construction sectors maintained by the Department of Commerce realized negative growth. Transportation, Power, and Highway & Street were the only growth sectors in 2009, which is largely a result of stimulus funding. In 2010, each of these sectors is back to negative growth. 2010 performance as of August is similar to 2009 performance, as nearly every sector is down. The only growth sectors in 2009 include Sewage & Waste Disposal, Water Supply, and Conservation & Development. The noted growth sectors were largely funded by stimulus dollars in 2010; therefore, revenue in these sectors will likely flatten or drop in 2011.

The following is a brief 2009 performance review and 2010 forecast for key construction

categories.27

• Manufacturing – Not Good (projected 35% decrease in revenue in 2010; 10% increase in 2009; 69% increase in 2008): Manufacturing revenue dropped sharply in 2010 (35% decrease) as the capacity utilization rate for manufacturing remains low. Hence, the reduced demand for additional space has reduced the demand for new construction. Key Indicator(s): The threshold average for Manufacturing is 110 million square feet. (2010 projection: 35 million SF; 2009: 77 million SF; 2008: 85 million SF)

• Power – Not Good (projected 12% decrease in revenue in 2010; 10% increase in 2009; 44% increase in

2008):

The Energy sector was up 10% in 2009 in large part due to the funding provided by the Energy Policy Act of 2005. This funding, in large part, dried up in 2009 so 2010 revenue is down 12%. This sector will likely see moderate growth over the next couple of years due to the revitalization of the nuclear industry (discussed later in this report) and continued alternative energy construction.

Key Indicator(s): Federal/State legislation.

• Water Supply – Good (projected 7% increase in revenue in 2010; 7% decrease in 2009; 13% increase in 2008): The first stimulus package provided key funding for water supply projects. Very few water supply projects were shovel ready in 2009, therefore most of this funding was earned in 2010. Once this funding is exhausted, growth in this sector will slow due to shrinking tax revenue and growing deficits.

27 McGraw Hill Construction Outlook 2010 Report

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Key Indicator(s): Federal/State legislation; municipal funding; Growth of the Residential sector. • Lodging – Extremely Bad (projected 52% decrease in revenue in 2010; 29% decrease in 2009; 35%

increase in 2008): The lodging sector is the hardest hit sector of 2010. After five straight years of growth, the Lodging sector was down 29% in 2009 and down 52% in 2010. Due to decreased occupancy rates and decreased revenue per hotel room, hotel construction is down to 18 million square feet per year in 2010. This is a fraction of the 100 million square feet built in 2008. This section will likely increase modestly in 2011 as the economy improves.

Key Indicator(s): The threshold average for hotel construction is 60 million square feet. (2010 projection: 18 million SF; 2009: 28 million SF; 2008: 100 million SF; 2001 recession: ~40 million SF)

• Health Care – Not Good (projected 10% decrease in revenue in 2010; 4% decrease in 2009; 12% increase

in 2008):

The Health Care sector is down for the second straight year. This segment will likely improve modestly in 2011 as the economy slowly improves. Over the next decade, this sector should perform well due to the aging demographics of the U.S.

Key indicator(s): The threshold average for healthcare facility construction is 80 million square feet. (2010 projection: 71 million SF; 2009: 68 million SF; 2008: 104 million SF)

• Office – Extremely Bad (projected 31% decrease in revenue in 2010; 23% decrease in 2009; 16% increase

in 2008):

The office sector continues to decline for a second straight year. Office construction per millions of square feet per year is at its lowest level since 1960 and office vacancy rates are at the highest level since 1993. As of the second quarter of 2010, the national office vacancy rate was up to 17.4%, according to New York-based research firm Reis Inc. Until a good portion of the vacant space is absorbed, the office sector will continue to decline.

Key indicator(s): The threshold average for office construction is 200 million square feet (2010 projection: 55 million SF; 2009: 71 million SF; 2008: 180 million SF; 2001 recession: 155 million SF). The threshold for vacancy rates is approximately 12% - anything below is good, anything above is bad.

• Highway and Street – Good (projected 1% increase in revenue in 2010; 1% increase in 2009; 9% increase

in 2008):

Highway and street construction has been flat for the past two years, which is actually stellar performance when compared with other sectors. The first stimulus package, coupled with the SAFETEA-LU bill, prevented a revenue decrease for the past two years. If a second stimulus package is approved by Congress, this sector should continue to remain flat. If this stimulus bill fails, Highway and Street construction will likely lag in 2011 due to decreased tax revenue and budget deficits.

Key Indicator(s): Federal/State legislation; municipal funding; growth of the Residential sector.

• Sewage & Waste Disposal – Very Good (projected 18% increase in revenue in 2010; 5% decrease in

2009; 6% increase in 2008):

In 2009, the Sewage & Waste Disposal sector decreased in revenue by 5%; this was the first decrease in this sector in seven years. This sector bounced back strong in 2010 and growth is projected at 18%, largely as a result of funding from the first stimulus package. If Congress does not pass the second stimulus package, this sector will likely pull back in 2011. This sector is largely driven by residential construction

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growth, which is at a historically low level at this point. Hence, this sector might flatten out for years to come.

Key Indicator(s): Federal/State legislation; municipal funding; growth of the Residential sector.

• Educational – Not Good (projected 14% decrease in revenue in 2010; 2% decrease in 2008; 10% increase

in 2008):

Revenue for the Educational sector pulled back significantly in 2010 as a result of local and state budget deficits. This trend in the educational sector is alteration work rather than new builds. Educational revenue will likely decrease further in 2011.

Key indicator(s): The threshold average for the education sector is 200 million square feet. (2010 projection: 2009: 145 million ; 2008: 210 million SF;); Growth of the Residential sector.

• Amusement & Recreation – Average (projected 4% decrease in revenue in 2010; 13% decrease in 2009;

5% increase in 2008):

This category, which includes sporting areas, theaters, casino portion of hotels, and convention centers, is down for the second straight year. The decline slowed in 2010 due to the construction of several new baseball stadiums and convention centers. This trend will likely decline further in 2011.

Key Indicator(s): The threshold average for Amusement & Recreation 65 million square feet. (2010 projection: 39 million SF; 2009: 42 million SF; 2008: 64 million SF)

• Commercial – Extremely Bad (31% decrease in revenue in 2010; 36% decrease in 2009; 8% decrease in 2008): The retail market cooled off in 2008 after consistent growth over the past four years. Since 2008 commercial construction decreased drastically due to increased vacancies. The Commercial sector will continue to slow until vacancies improve and the financial condition of retail operations improves. Tenant improvement is a reasonably stable subsector as more tenants are renovating existing space rather than relocating.

Key indicator(s): the threshold for an average year is 250 million square feet per year (2010 projection: 79 million SF; 2009: 96 million SF; 2008: 207 million SF).

• Residential – Getting Better (projected 1% decrease in revenue in 2010; 29% decrease in 2009; 28%

decrease in 2008):

In 2008 I wrote that “the good news is the Residential market cannot get much worse (in 2009).” Boy, was I wrong. Although economists forecasted that the Residential segment would bottom out in 2009 with a 5% drop in revenue, the Residential sector decreased 29% in 2009. These projections were a year off as the Residential sector bottomed out in 2010 with a 1% decrease (through August) and revenue will likely start to climb in 2011.

Key indicator(s) – Single Family: The threshold for an average year in the Single Family sector is 1.2 million new units. The number of single-family homes peaked in 2006 with the construction of over 1.7 million units. In 2008, this figure dropped to 549 thousand units and in 2009 this figured dropped even further to 435 thousand units. 2010 estimates show a rebound of 525 thousand units. Key indicator(s) – Multi Family: The threshold for an average year in the Multifamily sector is 350 thousand new units. In 2008, contractors built 307 thousand multifamily units; this figure dropped to 132 thousand in 2009. 2010 estimates show a rebound of 140 thousand units.

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Construction Sector PerformanceUS Department of Commerce

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Residential 14% -4% 14% 3% 9% 11% 7% 4% 9% 13% 14% 11% 0% -19% -28% -19% -0.6%

Lodging 2% 50% 51% 18% 15% 8% 2% -8% -28% 1% 12% 1% 41% 58% 35% -46% -52%Office 3% 12% 14% 19% 19% 10% 18% -3% -22% -10% 6% 3% 18% 19% 16% -29% -31%Commercial 14% 12% 12% 8% 4% 7% 8% 1% -7% -2% 5% 8% 9% 16% -8% -38% -21%Health Care 4% 1% 2% 10% -1% 4% 8% 0% 14% 7% 9% 7% 12% 11% 12% -11% -10%Educational 6% 22% 1% 19% 5% 13% 13% 10% 12% 3% 2% 7% 7% 13% 10% -6% -15%Religious -1% 12% 4% 27% 14% 12% 9% 9% -5% 2% -5% -6% 0% -4% -6% -18% -16%Public Safety 4% 8% 12% 1% 11% 1% 3% -5% 0% -4% -6% 9% 6% 27% 25% -10% -8%Amusement & Recreation 12% 12% 8% 16% 5% 14% 4% 0% -1% 1% -2% -4% 25% 14% 5% -17% -4%Transporation -1% 3% 13% 0% 9% 2% 18% 6% 7% -2% 1% 1% 12% 16% 11% 10% -5%Communication 4% 9% 6% 5% 0% 47% 2% 6% -9% -31% 5% 6% 18% 22% -14% -12% -8%Manufacturing 23% 23% 8% -1% 8% -19% -2% -6% -45% -14% 4% -2% 18% 20% 69% -7% -35%Power -11% 5% -20% -2% 21% 3% 31% 8% 0% -4% -1% 11% 12% 34% 44% 6% -12%

Highway & Street 8% 1% 5% 9% 4% 10% 8% 12% 2% 2% 4% 14% 12% 6% 9% 6% 1%

Sewage & Waste Disposal 2% 12% 7% 6% 1% 12% 9% 9% 14% 1% 7% 12% 17% 6% 6% -2% 18%

Water Supply 6% 9% 3% 7% 4% 7% 13% 9% 12% 0% -1% 10% 7% 4% 13% -3% 7%

Conservation & Development 4% 8% 7% 8% 2% 10% 10% 18% -1% 2% 8% 22% 15% 2% -6% 15% 18%

Total 10% 4% 10% 6% 8% 9% 8% 4% 2% 5% 11% 9% 6% -3% -4% -13% -10%

Sector

Actual

G. Current Trends in the Construction Industry

1. Green Building Standards

In 2009, the American Society of Heating, Refrigeration and Air Conditioning Engineers, Inc. (“ASHRAE”) launched much needed standards for green construction. In 2010, the State of California started to mandate the disclosure of building energy use in all real estate transactions.28 Other states are also contemplating such a mandate. Washington DC currently requires that all commercial buildings that are 200 thousand square feet or more to disclose energy performance using ENERGY STAR software29.

Perhaps the most prevalent green trend of 2010 is to retrofit existing buildings for energy efficiency. Certain energy companies give rebates and the government provides incentives for energy efficiency, which has increased construction in these areas. This trend will likely carry through 2011 as the cost of existing building retrofits should decrease as workers gain more

28 http://www.energy.ca.gov/ab1103/documents/2010-05-17_workshop/2010-05-17_AB1103_Presentation.pdf 29 http://www.imt.org/rating-dc.html

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experience, material suppliers multiply, and new legislature continues to encourage energy efficiency and reduced carbon footprints.

2. Public-Private Partnerships (“PPP”)

PPP popularity modestly continued in 2010 as more states adopted PPP enabling legislation. In addition to transportation projects, some states are moving towards the regulation of PPP usage to facilitate much needed upgrades and improvements in the Education sector. PPPs are perhaps best suited for high speed rail projects, particularly if the proposed new heavy infrastructure bank passes through Congress, which would leverage $50 billion in public and private funds. In sum, PPPs will continue to gain popularity in the U.S. and will steadily become a more practiced form of project funding to address the nation’s infrastructure problems.

3. Building Information Modeling (“BIM”) BIM continues to be a trend and will most likely become less of a “trend” but more commonplace over the next decade. Initially, architects and general contractors promoted the use of BIM, and engineers resisted utilization. However, engineers, as a whole, are now starting to embrace BIM.

4. Green Building Materials

From engineered wood to denim byproducts used for insulation, 2010 brings with it a higher demand for eco-friendly materials. Green building materials were not as prevalent five years ago, but now with today’s demand and technology we are seeing an uptick in green building material usage.

6. Energy Trends

In 2010, the Obama Administration approved an $8 billion loan guarantee for the construction of two nuclear reactors in Georgia. If these two projects move forward, these would be the first plants to start construction in the U.S. in three decades. In addition, nuclear power construction could increase in popularity as more options become available for the storage of Spent Nuclear Fuel.

In addition to nuclear power, hydraulic fracturing or “fracking” has created a natural gas boom that is very relevant. Fracking is a technique that can be used in shale rich areas to produce natural gas. Proponents of fracking cite the ability to tap into an abundant, local, natural resource at minimal cost for natural gas, while its opposers cite the possibility of contaminated drinking water and the release of benzene (a human carcinogen) into the surrounding atmosphere.

In sum, fracking has the potential to continue trending upward if science can dispel said

concerns, and prove that the benefits outweigh the cost.

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IV. State of the Surety Industry

A. Surety Premium

The modern U.S. surety industry entered its 123 year in 2010. In 1887, the American Surety Company wrote its first surety bond and this started what is now a $5 billion industry. The Miller Act of 1935 (40 U.S.C. § 3131 to 3134) instantly popularized the contract surety product as this statute mandates that contractors that complete federally funded construction projects over a threshold amount ($100k) for federal owners must provide payment and performance bonds that run in favor of the federal owner. After the passage of the Miller Act, many states adopted “little” Miller Acts to ensure the incorporation of contract surety bonds on state funded construction projects over a threshold amount (varies state by state). Because contract surety bonds are mandated on federal and many state projects, the overall premium makeup for the contract surety industry is largely supported by public construction. Between 2001 and 2008, surety premium grew from approximately $3.4 billion per year to approximately $5.5 billion per year.30 In 2009, the surety industry started to feel the effects of the recent recessionary cycle as premium dropped to just under $5.2 billion and losses started to trend upwards. From 2001 through 2009, surety premium increased by approximately 52%. Similarly, public construction revenue increased from $202 billion to $315 billion per year during this time period; this represents an increase of approximately 55%. Hence, surety premium generally trends with public construction spending. Surety losses historically trend with the state of the U.S. economy, with a two year lag. From 2001 through 2009, private construction revenue decreased from $638 billion to $592 billion, which represents a decrease of 8%.31 Private construction peaked in 2006 at $911 billion.32 The compression of private construction revenue over the past four years is largely the result of compression in the residential industry. Private residential construction amounted to $612 billion in 2006; 2010 revenue for private residential construction is forecasted at $245 billion.33 Typically, the private residential construction sector is larger than all public construction. For the most part, the surety industry does not market its products to the private single family residential construction sector. If the surety industry could somehow penetrate this sector, there would be significant room for premium growth. In 2010, total construction is down by 10% through August of 2010. However, public construction is only down by 1% so surety premium will likely drop in 2010, but not significantly.

30 National Association of Insurance Commissioners Data. 31 http://www.census.gov/const/C30/total.pdf 32 Id. 33 Id.

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B. Surety Losses As a rule of thumb, surety providers profit when direct losses are 40% or less of direct written premium. Over the past three decades, the surety industry historically trends with overall economic market conditions, but the trend line lags that of the overall economy by several years. For example:

• The early ‘80s recession ended in 1982; surety losses peaked in 1986; • The early ‘90s recession ended in 1991; surety losses peaked in 1996; • The early 2000s recession ended in 2001; surety losses peaked in 2004; hence, • The late 2000s recession ended in 2009; surety losses should peak in 2012/2013.

This lag in surety losses occurs for several reasons. First, contractor backlogs typically

shrink during a recession. Backlog reduction often causes anxiety for owners of construction contractors. This anxiety is understandable in many instances. For instance, decreasing backlog for heavy contractors leads to drastic increases in debt to equity ratios as past equipment purchases are often made with the assumption that revenue will not decrease. When backlog decreases significantly, insolvency is a true threat. Hence, this anxiety often leads to the assumption of additional risks – such as expanding into new geographic markets and/or adding product lines. The additional risks associated with these types of decisions often leads to surety loss several years after the recessionary cycle ceased.

In addition, a recessionary cycle inevitably leads to more contractors vying for less work.

Where owners might solicit three to four bids from contractors during a booming economy, owners can solicit ten to fifteen bids during a down economy. The increased competition leads to a reduction in profit margins and an associated increase in risk. This additional risk translates into additional surety losses as work is performed. Because the work is obtained during the tail end of a recessionary cycle, the physical work is typically performed after the recession and losses generally result several years after the recessionary cycle.

Moreover, credit is always tightened during an economic downturn. This past recession

caused an unparalleled credit crunch for all industries. When credit is tight, contractors are forced to focus on liquidity, but this focus adjustment often comes too late. The importance of early debt restructuring and effective capital asset management cannot be understated. Refinancing to extend loan amortization and to take advantage of lower interest rates should be a constant focus for contractors. Payments can always be accelerated when the economy is booming if contractors want to reduce overall debt load and this restructuring provides contractors with a safety net during economic downturns. Regarding equipment, the lease to own trend makes a great deal of sense as contractors can turn in unneeded equipment during downturns, if necessary.

Contractors also resist downsizing, or shall I say rightsizing, until it is too late. As an

objective observation, the importance of constant rightsizing cannot be understated in the high risk business of construction. Most contractor problems could be cured with a continual focus on

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rightsizing to accommodate market conditions. This philosophy, however, is easier said that done. Construction is very much a team oriented business and personal relationships develop where it makes it difficult for construction executives to render a series of overhead cuts. This resistance to overhead reduction bleeds contractors of valuable cash and liquidity. Ultimately, this reluctance can spell disaster to contractors well after the end of a recession.

In sum, the additional risk taking measures that contractors often employ during

economic downturns causes an increase in surety losses several years after the end of a recession. In addition, refinancing efforts and overhead cuts often come too late. Based on these trends and historical loss patterns, the surety industry will experience increased losses over the next several years.

Direct Written Premium Direct Losses Loss Ratio

2009 2010 2011

Year

2005 2006 2007 20082001 2002 2003 20041997 1998 1999 20001993 1994 1995 19961989 1990 1991 19921985 1986 1987 19881981 1982 1983 1984

0.5 10%

0.0 0%

30%1.5

1.0 20%

2.5 50%

2.0 40%

70%

Surety Premium Written & Direct Loss Ratio

3.0 60%

FORECAST

Dolla

rs in

Billi

ons

Loss

Rat

io

5.5

5.0 100%

4.5 90%

4.0 80%

3.5

Surety Loss Ratio

Break Even Level

C. Loss Cycle Review

Since 1980, the surety industry suffered from three distinct loss cycles. During each loss cycle, the industry trends from several years of profitability to several years of loss, and then back to several years of profitability. Currently, the surety industry is in a fourth loss cycle. This fourth cycle started in 2008 when loss ratios hit a record low of 13%.34 In 2009, loss ratios increased significantly to 19% (approximate 50% increase year over year).35

34 Data Source: National Association of Insurance Commissioners 35 Id.

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Direct Written Premium Direct Losses Loss Ratio

LOSS CYCLE 31998 - 2008 (11 years)

2011 2012

LOSS CYCLE 42008 - 2016 (forecast)

LOSS CYCLE 11981 -1991 (11 years)

LOSS CYCLE 21991 - 1998 (8 years)

2009 2010

Year

2013 2014 2015 20162005 2006 2007 20082001 2002 2003 20041997 1998 1999 20001993 1994 1995 19961989 1990 1991 19921985 1986 1987 19881981 1982 1983 1984

0.5

0.0Lo

ss R

atio

100%

90%

80%

70%

60%

50%

40%

1.5

1.0

30%

20%

2.5

2.0

10%

0%

3.5

3.0

Surety Loss Cycles

Dolla

rs in

Billi

ons

5.5

5.0

4.5

4.0Surety Loss Ratio

FORCAST

• Cycle 1 (1981 – 1991): This eleven year cycle was the most volatile with loss ratios starting at 34%, trending up to a peak of 103% in 1986, and trending down to 27% in 1991.36

• Cycle 2 (1991 – 1998): The second cycle covered an extremely profitable period with the

loss ratio starting at 27% in 1991 and trending up to a peak of only 43% in 1996, and trending down to a mere 18% in 1998.37

• Cycle 3 (1998 – 2008): The third cycle started in 1998 with a loss ratio of 18% and

trended up to a peak of 73% in 2004, and trending down to a historical low of 13% in 2008.38

• Cycle 4 (2008 – 2016): The fourth cycle started in 2008 with a loss ratio of 13%; the

upward trend started in 2009 with a loss ratio of 19%. This ratio will likely trend up to approximately 50% in 2011/2012/2013. Thereafter, loss ratios should trend back down to approximately 20%.39

36 Id. 37 Id. 38 Id. 39 Id.

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D. Surety Losses by Region

The South region turned in the highest surety losses for third time in four years. This comes as no surprise as the premium for the South region is twice that of any other region. In 2009, the Northeast region and the Pacific region both had loss ratios of 23%; the South region had a loss ratio of 18%; the Midwest region had a loss ratio of 15%; and the Mountain region continued its trend with the lowest loss ratio at 8%. 2009 Regional Loss Data:

Region 2006 2007 2008 2009 Northeast: $221M $202M $180M $214M South: $377M $465M $113M $378M Midwest: $122M $110M $85M $117M Mountain: $ 69M $ 27M $13M $ 38M Pacific: $ 93M $133M $210M $221M

Contract Surety Loss Ratio Cycles

0%

20%

40%

60%

80%

100%

120%

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Year

Loss

Rat

io (%

)

Major Loss Cycle1981 - 1991 (11 years)

Minor Loss Cycle1991 - 1998 (8 years)

Major Loss Cycle1998 - 2007 (10 years)

Loss RatioForecast

2006 VERTEX PROJECTIONS

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Top 5 States with the Highest Loss Ratio in 2009:

1. New Jersey 86% 2. Michigan 81% 3. Arkansas 45% 4. Alabama 44% 5. Oregon 37%

Top 5 States with the Highest Loss in 2009

1. California $169M 2. New Jersey $134M 3. Michigan $59M 4. Texas $57M 5. New York $44M 5. Florida $44M

E. Surety Consolidation

For the past six years the market share of the top ten surety providers has hovered

between 65% and at 68% of the total market. This market share is massive when compared to other premium based products that property/casualty carriers offer. Little M&A activity took place in 2009 and thus far in 2010. The only surety related transaction involved the Hanover Insurance Group’s (13th largest surety in 2008) agreement with ICW Group (21st largest surety in 2008) to hire key underwriters and to gain access to ICW’s contract surety book of business.40 With this agreement, the Hanover Insurance Group is now the tenth largest surety provider.

Regarding merger and acquisition activity moving forward, experts predict that “as carriers continue to face a challenging rate environment with limited organic growth opportunities and excess capital, the appetite for growth through M&A will increase. We have seen a heightened interest in acquisitions from the buy-side with only modest interest in selling.”41 Accordingly, as we move into 2010, we would also expect M&A valuations for property casualty carriers to increase.

Over the past decade, the two largest M&A deals involved St. Paul and Travelers in

2004, and Liberty Mutual Group and the Safeco Corporation in 2008. As noted in my previous reports, most of the largest surety providers are property/casualty insurance companies. Surety

40 http://www.insurancejournal.com/news/west/2010/07/14/111582.htm 41 http://stoneridgeadvisors.com/Content/View_From_The_Ridge_December_2009.pdf

Year Marketshare

1980 21% of the total surety market


2004 67% of total surety market




MARKET SHARE OF TOP 10 SURETY PROVIDERS

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premium generally represents a small, albeit profitable (at least since 2004), percentage of overall revenue makeup.

To wit, the surety

industry wrote approximately $5.2 billion in premium in 2009, while the property/casualty industry wrote approximately $422 billion in premium during this same year.42 Because of the small contribution that surety groups makes to the overall property/casualty market (~1%), consolidation decisions are generally driven by property/casualty results. Accordingly, a review of the property/casualty market is important in predicting if consolidation of the surety market will continue.

2008 was a difficult year for property/casualty carriers, as it was for nearly every

industry. The steep decline in investment returns impacted balance sheets of property/casualty companies. In addition, the number of severe weather events increased substantially in 2008 after a two year lull. 2009 was significantly better than 2008 in terms of net income for property/casualty insurers. Property/casualty insurers, collectively, earned $28.3 billion in 2009 versus the $3 billion earned in 2008.43

Net Income for Property/Casualty Carriers:

2008: $3 billion 2009: $28.3 billion 2010: $33 billion (Based on $16.5 billion of net income earned in the first half of 2010.44) Through the first half of 2010, ISO noted that the property/casualty industry earned $16.5

billion of net income, this represents a significant increase from 2008.45 Although 2009 and 2010 results are favorable, low severity perils such as tornadoes, winter storms, hail, and flooding

42 http://www.iso.com/Press-Releases/2010/PROPERTY/CASUALTY-INSURANCE-INDUSTRYS-FULL-YEAR-2009-RESULTS-SHOW-STRONG-BUT-INCOMPLETE-RECOVERY-FR.html 43 Id. 44 http://www.iso.com/Press-Releases/2010/Property-Casualty-Insurers-Post-Strong-Results-for-First-Half-2010.html 45 Id.

1990 Top Surety Providers 2009 Top Surety Providers

1 F&D Group (now Zurich) 1 Travelers

2 USF&G Group (now Travelers) 2 Liberty Mutual Insurance Group

3 Reliance Insurance Group (now Travelers) 3 Zurich Insurance Group

4 Aetna Life & Casualty Group (now Travelers) 4 CNA Insurance Group

5 Fireman's Fund (now Kemper) 5 Chubb & Son Inc.

6 Seaboard Surety Co. (now Travelers) 6 Hartford Fire & Casualty Group

7 Continental Corp. (now CNA) 7 HCC Insurance Holdings Group

8 CNA Insurance Group 8 International Fidelity Insurnace Co.

9 Safeco Insurance Group (now Liberty) 9 ACE Ltd Group

10 Hartford Insurance Group 10 The Hanover Insurance Group

11 AIG 11 Great American Insurance Group

12 Chubb Group of Insurance 12 NAS Surety Group

13 St. Paul Group (now Travelers) 13 Lexon/Bondsafeguard Insurance

14 Amwest Group (out of business) 14 Arch Capital Group

15 Cigna Group (now ACE) 15 Chartis Group (AIG)

Only 5 out of the top 15 sureties remain in 2010

CONSOLIDATION OF THE SURETY INDUSTRY

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affected underwriting margins over the past two years.46 Regardless of these low severity perils, the industry is profitable and this profitability will likely lead to increased M&A activity.

_________________________________

Vertex is a worldwide provider of construction and environmental services. Vertex

Construction Services, Inc. provides engineering, consulting, construction management, general contracting, and expert services on: surety claims, construction defect claims, property / casualty claims, and construction claims. Vertex Construction Services, Inc. also provides construction management and general contracting services for public and private clients throughout the U.S. In 2010, Vertex was named one of ENR’s Top 100 Construction Management firms in the U.S. Vertex was also named one of ENR’s Top 50 Program Managers in the U.S. in 2010.

The Vertex Companies include: Vertex Construction Services, Vertex Environmental

Services, Vertex Air Quality Services, and Vertex Energy Services. For more information about The Vertex Companies, please refer to www.vertexeng.com. If you have any questions or comments regarding this report, please contact me at 303.623.9116 or [email protected]. VERTEX CONSTRUCTION SERVICES, INC.

William J. McConnell P.E. President

46 http://www.property-casualty.com/News/2010/9/Pages/High-Frequency-Low-Severity-US-Weather-Events-Chipping-Away-At-Insurers.aspx

About The Author Bill McConnell: Mr. McConnell cofounded The Vertex Companies in 1995 and is the President of Vertex Construction Services, Inc. As the President, Mr. McConnell is intimately involved in all aspects of the technical construction services offered by Vertex, most frequently working as an expert witness with Construction Claims. Mr. McConnell has represented surety companies on a myriad of projects as a Claims Consultant, providing services that include preparing affirmative claims, negotiating contract balances, and investigating payment bond claims. He is a highly sought after expert witness and has testified in both Federal and State Court. Mr. McConnell received his undergraduate degree in Civil Engineering from the University of Maine, earned a continuing education certificate from MIT and is in his final year of law school at the University of Denver. He is a registered Professional Engineer in the State of Colorado.

LIEN FORECLOSURES

By: Brian G. Lustbader, Esq. January 2011

A mechanic's lien against private property or against a public improvement may be enforced through a foreclosure action, a proceeding analogous to a mortgage foreclosure. See Lien Law § 41 (private improvement) and § 42 (public improvement). The foreclosure action provides the lienor with a method to compel payment from the property owner for the benefit received by the owner from the lienor's improvement to the property, even in the absence of contractual privity between the lienor and owner. A. Relationship of Lien Proceedings to Other Proceedinqs

A mechanic's lien foreclosure action is purely a statutory creature. Berger Mfg. Co. v. New York, 206 N.Y. 24, 99 N.E. 153 (1912). The Lien Law provides for two distinct remedies in a lien foreclosure action. First, the Lien Law provides for the foreclosure of the mechanic's lien in equity. Second, the Lien Law provides for the collection of the underlying debt at law. The lien foreclosure is both an action in rem and in personam. Cody v. Turn Verein of New York, 48 A.D. 279, 64 N.Y.S. 219 (1st Dep't 1900), aff’d, 167 N. Y. 667, 60 N. E. 1108 (1901). The rules and proceedings governing mechanic’s lien foreclosure actions parallel those governing other civil proceedings in New York State. See, e.g., CPLR 101 et seq. (governing civil actions in New York State). Because an action to foreclose a mechanic's lien is analogous to a mortgage foreclosure action, the provisions of New York's Real Property Actions and Proceedings Law generally apply to mechanic's lien foreclosure actions. Lien Law § 43. B. The Complaint

A plaintiff in a lien foreclosure action must allege in its complaint all of the facts essential to the lien foreclosure action. The complaint in the foreclosure action should account for the dichotomous nature of the action by asserting a cause of action at law on the underlying debt and contract, and a cause of action at equity for the foreclosure of the liened property or fund.

To assert a valid cause of action to foreclose its mechanic's lien, the plaintiff must allege the following:

1. That the lienor is licensed to perform the work or supply the material that form

the basis of the mechanic's lien;

2. The contract between plaintiff and the contractor/subcontractor for whom the plaintiff performed work;

3. If the plaintiff is a subcontractor, the terms of its subcontract as well as the terms of the principal contract upon which the plaintiff’s rights depend;

Article re Lien Foreclosure 1-2-11 4

4. The money due to the contractor or subcontractor through whom the plaintiff claims;

5. A description of the improved premises;

6. The ownership of the improved premises;

7. The owner's consent to the improvement;

8. The proper filing, perfecting and continuation of the Notice of Lien;

9. The filing of a notice of pendency or lis pendens;

10. Any undertaking or bond to discharge the mechanic's lien;

11. Any prior actions to recover the debt;

12. Personal liability of the defendants;

13. A prayer for the establishment and enforcement of a valid mechanic's lien; and

14. A prayer for a personal judgment.

76 N.Y. Jur.2d Mechanic's Liens, §§ 244-271 (1989).

As noted above, certain specialized allegations must be made by the plaintiff in its complaint. For instance, the plaintiff's complaint must allege the substance of the contract that forms the basis of the action. Kelly v. St. Michael’s_Roman Catholic Church, 148 A.D. 767, 133 N.Y.S. 328 (2nd Dep't 1912). If the plaintiff is a subcontractor, the plaintiff should allege the terms of its subcontract as well as the terms of the principal contract upon which the subcontractor's right to subrogation depends. Murphy v. Hardiman, 112 A.D. 670, 99 N.Y.S. 6 (4th Dep't 1906).

The lienor must also allege in its complaint facts showing the existence of a debt owed

to the plaintiff at the time the action is commenced. Moreover, the lienor who brings the foreclosure action must allege that the money owed to it, which forms the basis of its mechanic's lien, is owed by the owner to the contractor. 76 N.Y. Jur.2d, Mechanic's Liens, § 246 (1989); Maneely v. New York, 119 A.D. 376, 105 N.Y.S. 976 (lst Dep't 1907). This latter allegation is necessary because the right to foreclose a lien rests on the principal of subrogation. That is, the lienor steps into the shoes of the person with whom the lienor has contracted, and the lienor is entitled to recover so much of the debt that is owed to the lienor under the contract as is owed to the person that owes the lienor money.

Subsumed in this requirement is that to recover on the contract theory, or its cause of

action at law, the plaintiff must allege in its complaint the basic allegations necessary for any contract cause of action, namely, that a contract exists and that the plaintiff has performed, or substantially performed, its part of the contract, Vandegriff v. Bertron, 83 A.D. 548, 82

2

N.Y.S. 153 (4th Dep't 1903), and that any non-performance by it has been waived or excused, Stokes Bros. v. Drefs, 244 A.D. 524, 279 N.Y.S. 884 (4th Dep't 1935)).

C. Necessary Parties

Under the Lien Law, the plaintiff that brings a lien foreclosure action may be a mechanic's lienor, or assignee or legal representative of a mechanic’s lienor. Lien Law § 41 (private improvement), § 42 (public improvement). The Lien Law permits two or more lienors to join as plaintiffs in a lien foreclosure action against the real property or public fund. Lien Law § 44(5). This allowance may make pursuing the foreclosure action economically viable to lienors who would be financially unable to vigorously pursue their claims alone.

If the lienor is a partnership, the partnership may enforce the lien as the plaintiff in the foreclosure action. Ogden v. Alexander, 140 N.Y. 356, 35 N.E. 638 (1893). A partner of that partnership who purchases the interest of a retiring partner likewise may file and enforce the lien in his or her own name. Id.; 16 Carmody Wait, 97:217 (Baker, Voorhis & Co., Inc. 1990).

If a lienor is a foreign corporation licensed to do business in New York State, it may file and enforce its mechanic's lien through a mechanic's lien foreclosure action. If the foreign corporation was not authorized to do business in New York State at the time it entered the underlying contract, the corporation may not enforce its lien as a plaintiff in a lien foreclosure action. N.Y. Bus. Corp. Law § 1313(a) (McKinney 1990) (stating that a foreign corporation not authorized to do business in New York State may not maintain any action or proceeding in the State); Neuchate Asphalte Co. v. New York, 12 Misc. 26, 33 N.Y.S. 64 (Ct. Common Pleas., N.Y. Co. 1895), aff’d, l55 N.Y. 373, 49 N.E. 1043 (1898).

Because the object of the mechanic's lien foreclosure action is to subject the real property or public fund to the satisfaction of the lien, all those persons having an interest in the liened property must be joined as defendants. Therefore, under the Lien Law, all lienors must make certain persons defendants to a lien foreclosure action. These persons are called “necessary” parties and include all person having interest in the liened property, such as other lienors and those with ownership interests. Bierschenk v. King, 38 A.D. 360, 56 N.Y.S. 696 (2nd Dep't 1899). Specifically, the Lien Law prescribes that necessary parties to a lien foreclosure action are as follows:

1. All lienors having liens notices of which have been filed against the same real property or public improvement, or any part thereof, prior to the filing of the notice of lis pendens in such action, where by law the filing of a notice of lis pendens is proper or required.

2. All persons having subsequent liens or claims against such real property, by

judgment, mortgage or otherwise, filed, docketed or recorded prior to the filing of the notice of lis pendens, where by law the filing of a notice of lis pendens is proper or required.

3. All persons appearing by the records in the office of the county clerk or register to be

owners of such real property or any part thereof.

3

4. Where by law, a notice of lis pendens may not be filed in such action, all lienors having liens notices of which have been filed against the same real property, and all persons having subsequent liens or claims against such real property, by judgment, mortgage or otherwise.

5. The state, when the lien is one filed against funds of the state for which the public

improvement is constructed, or demolished. In such a case, the summons must be served upon the attorney general, who must appear in behalf of the people. Lien Law § 44.

By virtue of the above-quoted language, the owner of record of the liened property at the time of the foreclosure action is a necessary party. Lien Law § 44(3). However, if the owner of the liened property during construction work conveys the ownership interest in the property to another person before the commencement of the foreclosure action, the former owner is no longer a necessary party; instead, the new owner becomes the necessary party in ownership. Pierce v. Kinney, 75 Misc. 328, 135 N.Y.S. 537 (1912) rev’d on other grounds, 152 A.D. 638, 137 N.Y.S. 475 (3rd Dep't 1912); Admiral Transit Mix Corp. v. Sagg Bridgehampton Corp., 56 Misc.2d 47, 287 N.Y.S.2d 751 (2nd Dep't 1968).

Although not specifically listed in Lien Law § 44, the contractor is a necessary party defendant to a subcontractor’s lien foreclosure action. George W. Maltby & Sons Co. v. Charles P. Boland Co., 152 A.D. 596, 137 N.Y.S. 470 (3rd Dep't 1912) motion denied, 153 A.D. 933, 138 N.Y.S. 1117 (3rd Dep't 1912). Only by so joining the contractor to the lien foreclosure action may the foreclosing subcontractor obtain a personal judgment against the contractor on the subcontract and entitle the property owner to a personal judgment against the contractor on a related counterclaim. Frequently, however, the contractor is not initially made a party defendant by the foreclosing plaintiff subcontractor; instead, the defendant owner brings the contractor into the action with a third-party complaint. Hilton Bridge Const. Co. v. New York C. & H.R.R. Co., 145 N.Y. 390, 40 N.E. 86 (1895).

Similarly, other contractors and subcontractors, as well as sureties, may be proper party defendants. A subcontractor is a necessary party defendant if subcontractor has filed a lien against the property. Lien Law § 44. A surety is a necessary party defendant if the surety has a subsequent lien or claim against the property. Lien Law § 44(2). A surety is also a necessary party defendant if it has given a bond to discharge a mechanic's lien. See, e.g., Williams & Adams, Inc. v. McMahon McEntegart, 256 A.D. 313, 10 N.Y.S.2d 37 (1st Dep't 1939) (noting that a subcontractor is a proper party defendant if the subcontractor has filed a lien against the property before the filing of the lis pendens but also noting that under Lien Law § 44 a plaintiff to a foreclosure action does not have to make parties defendant those creditors of the owner whose claims were not recorded); Morton v. Tucker, 145 N.Y. 244, 40 N.E. 3 (1895) (surety that furnished bond to discharge lien is a necessary party defendant to'a foreclosure action). See generally Lien Law § 44 and § 44-1 governing necessary party defendants and necessary party defendant lienors. D. Trial and Proof

4

The trial of a private improvement lien foreclosure action generally is held in the county

where the liened property is located, the county where the Notice of Lien was filed. Nims v. Merritt, 29 Misc. 58, 60 N.Y.S. 549 (1899), aff’d, 45 A.D. 631, 61 N.Y.S. 1143 (1899), appeal denied, 47 A.D. 633, 62 N.Y.S. 1143 (1900). If, however, the action is one to foreclose a private improvement lien that has been bonded or to foreclose a public improvement lien, the action is transitory and need not be tried in the county where the liened property is located. H.W. Palen's Sons v. Nelson & Caulkins, Inc., 222 A.D. 357, 226 N.Y.S. 350 (3rd Dep’t 1928).

As an action at equity, the lien foreclosure action in New York is tried to the court without a jury. Kenny v. Apgar, 93 N.Y. 539 (1883). See CPLR 4102(c) (dealing with waiver of the right to a jury trial). See also, Heller v. Hacken, 40 A.D.2d 1012, 338 N.Y.S.2d 943 (2nd Dep’t 1972) (where plaintiff waived the right to a jury trial by deliberately joining causes of action for legal and equitable relief). A lienor, however, can secure the right to trial by jury by trying the validity of the mechanic's lien first at Special Term or by having the issued tried by a jury in advance of trial at Special Term. 77 N.Y. Jur.2d, Mechanic's Liens, § 284 (1989).

At trial, the plaintiff must prove through admissible evidence all of the allegations contained in the complaint other than those that have been admitted. Farabella v. Porter, 130 Misc. 680, 225 N.Y.S. 417 (Sup. Ct. Broome Co. 1927). For example, among other things, the plaintiff lienor must prove the claim upon which the lien was filed, Brescia Const. Co. v. Walart Const. Co., 264 N.Y. 260, 190 N.E. 484 (1934), as well as full or substantial performance of its contract, Jac Bldg. & Constr. Co. v Niccomini, 207 A.D. 426, 202 N.Y.S. 132 (1st Dep’t 1932), the consent of the property owner to the improvement, P. Delany & Co. v. Duvoli, 278 N.Y. 328, 16 N.E.2d 354 (1938), and each essential element of properly filing and perfecting the Notice of Lien, Brescia Const. Co. v. Walart Const. Co., 264 N.Y. 260, 190 N.E. 484 (1934). Moreover, if the plaintiff lienor seeks to obtain a personal judgment against a party to the foreclosure action, the plaintiff must prove facts establishing that party's liability. Brown v. Epstein, 166 A.D. 611, 151 N.Y.S. 527 (2nd Dep't 1915). In the case of a party with whom the lienor had entered into a contract, this of course means establishing the requisite contract allegations indicated above. In the case of the project owner, the lienor must establish that the owner knew of and consented to the improvements. In connection with the showing of substantial performance, a subcontractor must show not only that it performed but also that the “upstream” general contractor also substantially performed.

Perhaps most important is that the plaintiff lienor prove that when the plaintiff filed the Notice of Lien there was due and unpaid, or later became due and unpaid, a certain sum to the lienor; additionally, because the right to foreclose rests on principles of subrogation, the lienor is bound to show that an amount equal to or in excess of that amount due was also owed to the person with whom the lienor contracted. Herrman & Grace v. Hillmann, 203 N.Y. 435, 96 N.E. 741 (1911). For example, a plaintiff who is a subcontractor must prove that it was owed a certain sum by the contractor at the time the subcontractor filed its mechanic's lien; the subcontractor must also show that at the time it filed the mechanic’s lien, the contractor was owed an amount equal to or in the excess of the amount owed to the subcontractor. See ChittendenLumber Co. v. Silberblatt & Lasker, Inc., 288 N.Y. 396, 400, 43 N.E.2d 459, 460 (1942)(“[a]s no money was due from the general contractor to the subcontractor following

5

completion of the defaulted subcontract[,] the efforts of the creditor-lienors to recover under the Lien Law were futile”).

One further fact worth noting – enforcement of a mechanic’s lien does not waive the

lienor’s right to demand arbitration, assuming that right has been set forth in the lienor’s contract. E. Defenses and Counterclaims

(1) Defenses In response to a lien foreclosure, the owner, or other defendant(s) have numerous

defenses. The most important is payment. The lien fund is established by the amount yet to be paid, whether it is the amounts as-yet-unborrowed on a loan or the amounts remaining to be paid to a general contractor for a subcontractor’s work. For example, if the owner can show that it paid a higher-tier contractor for the lienor’s work, then the owner’s liability will be reduced by the amount of such payment. A similar obtains regarding the loan proceeds to an owner for a general contractor’s lien. And where the owner can show that it paid the general contractor’s subs directly, the general contractor’s lien will be reduced accordingly. Nastasi & Assocs. V. Tag Court Square, 61 A.D.3d 943, 876 N.Y.S.2d 901 (2nd Dep’t 2009).

In the home improvement context, where a license is required, the owner may assert the

defense that the lienor was not licensed because a home improvement contractor must have a license in order to file a lien, Todisco v. Econopouly, 155 A.D.2d 441, 442, 547 N.Y.S.2d 103, 104 (2nd Dep’t 1989) (“[i]n order for a home improvement contractor to recover damages for breach of contract under a quantum meruit theory, he must possess (1) a valid license at the time of performance for which he seeks compensation, and (2) a valid license at the time of pleading”). The uniformly applied rule in New York is that that an unlicensed contractor may not properly file a lien for work performed for which a license is required. Johnston v. Dahlgren, 166 N.Y. 354, 59 N.E. 987 (1901) (unlicensed plumber). As the licensing statute is designed to protect the public against fraud, the contractor’s contract is rendered unenforceable, so the lack of a license is fatal to the contractor’s contract claim and lien. J.M. Builders 7 Assoc. v. Lindner, 67 A.D.3d 738, 889 N.Y.S.2d 60 (2nd Dept. 2009) (due to contractor/lienor’s lack of valid home improvement license, court dismissed all causes of action based on home improvement work, including causes of action for breach of contract, unjust enrichment, account stated, breach of requirement of fair dealing and good faith, and lien foreclosure); J.D. Nicotra v. Manger, 64 A.D.3d 547, 882 N.Y.S.2d 303 (2nd Dept. 2009) (“[a] home improvement contractor who fails to possess and plead possession of a valid license as required by relevant laws may not commence an action to foreclose a mechanic's lien”); Hakimi v Cantwell Landscaping & Design, Inc., 50 A.D.3d 848, 855 N.Y.S.2d 273 (2nd Dep’t 2008) (landscaping contractor held to be subject to rule requiring home improvement contractors to be licensed). For the same reason, if the general contractor lacks the right to maintain a lien due to the lack of a home improvement license, that general contractor’s subcontractor cannot enforce a lien either, In re Rattner, N.Y.L.J., May 7, 1999, at 28, col. 6 (Sup. Ct. N.Y. Co. [Stallman, J.]) (subcontractor of an unlicensed general contractor held not to be entitled to file a

6

mechanic’s lien for the installation of windows in a cooperative apartment building), although the subcontractor would not lose its rights vis-à-vis the general contractor.

Other defenses include (1) statute of limitations, i.e., belatedly-filed lien – for a private

project, 8 months from the last day of work (4 months for a single-family residence), and for a public project, 30 days from the date of completion and acceptance [Lien Law §§ 10, 12], (2) res judicata, (3) release, and (4) the existance of an adequate remedy at law. All such defenses must be raised as affirmative defenses. CPLR 2518. See, e.g., Ebert v. Van-Mar Developers, Inc., 111 A.D.2d 495, 488 N.Y.S.2d 878 (3rd Dep't 1985) (payment as an affirmative defense); Romeo v. Chiangone, 126 A.D. 402, 110 N.Y.S. 724 (2nd Dep't 1908), aff’d, 196 N.Y. 546, 89 N.E. 1111 (1908) (the statute of limitations as an affirmative defense).

(2) Counterclaims The counterclaim most often asserted by defendants is that the lienor wilfully

exaggerated the amount of the lien. The Lien Law provides that if a lienor wilfully exaggerates the amount of the lien, that lien will be void and unenforceable. Lien Law § 39-a.

Intent, willfulness, a prerequisite of such a claim, may not be inferred. Such a

determination is based on credibility, i.e., that the contractor did not make an honest mistake as to the value of the lienable work but harbored a subjective and duplicitous intent. Pelc v. Berg, 68 A.D.3d 1672, 893 N.Y.S.2d 404, (4th Dep’t 2009) (affirming award of damages on wilful exaggeration counterclaim); Rosenbaum v. Atlas Design Contractors, Inc., 66 A.D.3d 576, 887 N.Y.S.2d 93 (1st Dep’t 2009) (affirming award of damages on affirmative wilful exaggeration claim). See also Goodman v. Del-Sa-Co Foods, Inc., 15 N.Y.2d 191, 257 N.Y.S.2D 142 (1965) (held that where the amount awarded is less than the lien amount, the court must determine which amount of the excess was as a result of wilful exaggeration); Durand Realty Co. v. Stolman, 197 Misc. 208., 94 N.Y.S.2d 358 (Sup. Ct. N.Y. Co. 1949) (party claiming wilful exaggeration must make separate showing to that effect), aff’d, 280 A.D.2d 758, 113 N.Y.S.2d 644 (1st Dep't 1952); T.A. Maloney Contracting Corp. v. William E. Blume Corp., 85 Misc. 2d 838, 380 N.Y.S.2d 585 (Sup. Ct. Queens Co. 1976) (noting that this section of the Lien Law is penal and should not be applied to liberally subject the lienor to damages).

More importantly, where the court finds that a lienor has wilfully exaggerated the

amount claimed in the lien, the lienor may not recover any amounts on its lien, not even for that part of the lien which was valid. Lien Law § 39. In addition, the lienor is liable for damages to the property owner or contractor for the amount of the exaggeration, plus the amount of certain expenses and attorney's fees. Lien Law § 39-a. Westbury S & S Concrete, Inc. v. Manshul Constr. Corp., 212 A.D.2d 596, 622 N.Y.S.2d 584 (2nd Dep’t 1995) (subcontractor was liable for damages pursuant to Lien Law § 39-a, where the subcontractor willfully exaggerated its mechanic’s lien); Hutchinson Roofing & Sheet Metal Co. v. Gillert Constr. Corp., 275 A.D. 1048, 92 N.Y.S.2d 76 (2nd Dep’t 1949) (lienor granted judgment for amount due on contract simultaneously with counterclaim for wilful exaggeration counterclaim). The property owner’s damages may include the amount of any premium expended on a bond to discharge the lien and the interest on any money deposited to discharge such lien, as well as reasonable attorney’s fees to discharge the lien and an amount equal to the difference between the stated sum in the

7

notice of lien for the amount due or to become due and the amount actually due or to become due. Lien Law § 39-a; Tully Construction Co., Inc. v. United Minerals, Inc., 221 A.D.2d 697, 633 N.Y.S.2d 91 (3rd Dep’t 1995) (counsel fees, costs, and sanctions may be awarded under Lien Law § 39-a only when the lienor seeks to enforce the lien). F. Obtaining a Judgment

The trial of a lien foreclosure action is designed to result in one decision that embraces all the liens, mortgages and interests connected to the subject property. Additionally, the judgment declares and adjusts the priority of each such interest. Holl v. Long, 34 Misc. 1, 68 N.Y.S. 522 (Sup. Ct. N.Y. Co. 1901). The court hearing and deciding the action may grant any other appropriate relief that is within its jurisdiction.

If the plaintiff fails to establish a mechanic's lien against a defendant, the court will issue a judgment declaring that the mechanic's lien is cancelled and is invalid. Upon filing a transcript of that judgment with the appropriate county clerk together with proof that the defendant served that lienor with Notice of Entry of the judgment, the mechanic's lien will be discharged as of record. Lien Law § 19(5).

If the lienor successfully establishes each element to enforce its mechanic's lien and obtains a judgment in its favor, that judgment typically will be a judgment of foreclosure and sale of the property. Nelson v. Hajek, 67 Misc. 128, N.Y.S. 1018 (Sup. Ct. App. Term, N.Y. Co. 1910). If the mechanic's lien is established only against the tenant of the liened property, the court may not order the sale of the fee interest in the property but merely order the sale of the tenant's leasehold interest. Cornell v. Barney, 94 N.Y. 395 (1884).

Even if the lienor fails to establish its lien against certain defendants, the lienor may still recover on contract or quasi-contract for the sums that can be established as due and owing. Lien Law § 54; E.J. Dayton, Inc. v. Brock,, 120 A.D.2d 560, 502 N.Y.S.2d 53 (2nd Dep’t 1986) (allowing plaintiff to recover in quantum meruit); A & E Plumbing, Inc. v. Budoff, 66 A.D.2d 455, 413 N.Y.S.2d 776 (3rd Dep't 1979) (plaintiff entitled to recover proven damages even where plaintiff's mechanic's lien was invalid because of wilful exaggeration).

Any such non-lien-foreclosure action must of course be maintained against the party in contractual privity with the lienor and not against more remote parties such as the property owner. This may be a problem if the contracting party is judgment proof, a not-infrequent occurrence. Thus, if a subcontractor loses its lien rights against the owner, and the general contractor is judgment proof, the subcontractor may have a right without a remedy.

If the basis of the foreclosure action is a public improvement lien, the judgment in favor of the plaintiff will not order that the public property be sold. Instead, the judgment will direct that the governmental entity or public corporation pay to the lienor so much of the amounts due to the lienor from the public funds as is due to the lienor from the contractor. Lien Law § 60; Westgate v. Shirley, 42 Misc. 245, 86 N.Y.S. 593 (Sup. Ct. Broome Co. 1903). In both public and private improvement lien foreclosure actions, if the lien has been previously discharged by

8

an undertaking (bond) or by a deposit, the judgment in favor of plaintiff will direct the payment by the surety or from the deposit.

If the judgment orders the foreclosure of the liened property or public fund, the judgment must “adjust and determine the equities of all the parties to the action and the order of priority of different liens....” Lien Law § 45. The intent of this section is that all controversies arising out of the liens filed against the property or against the fund be determined and resolved in one action. Gee Dee Painting Co. v. Boston Realty Corp., 217 N.Y.S.2d 407 (Sup. Ct. Kings Co. 1961).

An infrequently used section of the Lien Law provides that the judgment may direct

that, rather than selling the liened property, the owner deliver “bills, notes, securities or other obligations” to pay the debt upon which the lien is based. Lien Law § 57. If such a judgment is entered, only if the owner defaults on these obligations will the liened property be sold. Id. As evidenced by the lack of cases on the subject, this approach is used infrequently.

More frequently, when a valid mechanic's lien is established against the liened property or public fund, the judgment of foreclosure or sale will provide that the “premises, or so much thereof as may be sufficient to discharge the ... debt, the expenses of the sale and the costs of the action, and which may be sold separately without material injury to the parties interested, be sold by or under the direction of the sheriff of the county, or a reference." N.Y. Real Prop. & Pro. Law § 135(l) (McKinney 1990).

G. Obtaining an Execution

Upon entering the judgment of foreclosure and sale, the court has the power to appoint a referee to sell the property and to report in a manner similar to that used in mortgage foreclosure actions. Lien Law § 50. An execution on the judgment is obtained as it is obtained in other civil actions. See CPLR 5230, governing executions. The execution that issues upon the judgment will direct the appropriate person, usually the county sheriff, to sell the owner's title and interest in the liened premises. Lien Law § 50. H. Sale Upon Execution

The sale proceedings used in lien foreclosure sales are similar to the sale proceedings used in mortgage foreclosure actions. The judgment of sale will indicate what right, title and interest in the property is to be sold. The purchaser of the property is entitled to a deed. In some circumstances, the court may issue an order putting the purchaser into possession of the premises. O’Connor v. Schaeffel, 11 N.Y.S. 737 (N.Y. City Ct. 1890). However, an order will not issue to disturb a person who acquired rights in the premises subsequent to the filing of the Notice of Lien and before the commencement of the lien foreclosure action. Burnham v. Raymond, 64 A.D. 596, 72 N.Y.S. 300 (4th Dep't 1901); 97 Carmody-Wait 2d, Mechanic's Liens, § 364 (Baker, Voorhis & Co. 1990). I. Owner's Personal Liability

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The Lien Law permits the court to award a personal judgment against the property owner if the plaintiff (a) shows that the owner was aware of and consented to the lienor's improvements (or had a valid contract with the lienor) and (b) has demanded this form of judgment. Brigham v. Duany, 241 N.Y. 435, 150 N.E. 507 (1926); Lien Law §§ 24, 41, 58 and 64. The Lien Law also provides that an owner may, in some instances, be held personally liable to the plaintiff for any deficiency of proceeds from the sale of the foreclosed property to pay the plaintiff's claim. Lien Law § 58 (allowing for a deficiency judgment against “any person liable therefor”).

© 2011 Brian G. Lustbader, Esq.

Mr. Lustbader is Counsel to Mazur, Carp Rubin & Schulman, P.C., specializing in construction contract law and litigation. An Honors Graduate of M.I.T. and Columbia Law School, he is a member of the NYCLA Construction Law Committee and Co-Chair of the Real Estate Construction Committee of the Real Property Law Section of the New York State Bar Association.

10

Trust Funds Under the New York Lien Law

Kevin J. Connolly Anderson Kill & Olick Overview

Money that is received for the purpose of paying the cost of the improvement is charged with a trust, and the funds must be used to pay the cost of the improvement before being used for a different purpose.

The trust fund also provides a method by which an owner can sell or refinance the property even though a lienor might file up to eight months after the deed or mortgage is recorded: if the owner agrees to hold proceeds in trust, to pay potential lienors before using proceeds for any other purpose, then any after-filed liens will be subordinate to mortgage in question, and unable to gain priority over the deed.

Misapplication of trust funds is larceny and you can go to jail for making or consenting to such misuse of funds.

Trust funds are different from liens sensu strictu, because enforcing a trust requires privity of contract. A contractor’s trust is not answerable to a remote subcontractor. Instead, the claims must ascend the daisy chain. The remote subcontractor to wait for funds to flow down to the contractor directly above the sub in the food chain, since only then is there an enforceable trust.

Creation The trust comes into existence as soon as any assets are subject to

it. So we begin by understanding the sorts of things that are assets of the trust. It depends on who the trustee is.

Owner as Trustee.

Assets of the trust held by an owner are funds received or the right of action arising from:

• (a) a building loan contract; • (b) a building loan mortgage or a home improvement loan; • (c) a mortgage recorded subsequent to the commencement of the

improvement and before the expiration of eight months after completion of the improvement;

• (d) as consideration for a conveyance recorded subsequent to the commencement of the improvement and before the expiration of eight months after the completion thereof;

• (e) as consideration for, or advances secured by, an assignment of rents due or to become due under an existing or future lease or tenancy of the premises that are the subject of the improvement, or of any part of such premises, if the assignment is executed subsequent to the commencement of the improvement and before the expiration of eight months after the completion of the improvement or if it is executed before the commencement of the improvement and an express promise to make an improvement, or an express representation that an improvement will be made, is contained in the assignment or given in the transaction in which the assignment is made;

• (f) as proceeds of any insurance payable because of the destruction of the improvement or its removal by fire or other casualty, except that the amount thereof required to reimburse the owner for premiums paid by him out of funds other than trust funds shall not be deemed part of the trust assets;

• (g) under an executory contract for the sale of real property and the improvement thereof by the construction of a building thereon.1

In delineating those assets which are trust assets, the legislature recognized a distinction between loans secured by an encumbrance on real property that would have priority over a lien and those loans that would be subordinate to a lien or could be discovered prior to commencement of the improvement. While trust protection was needed to protect contractors, laborers, etc., when affected by encumbrances in the former category, there was no need to in the latter category as such encumbrances could be discovered prior to performance of work or the contractor, laborer, etc., could adequately protect themselves by filing a lien.

Thus, the legislature did not include advances made on unsecured loans within the definition of trust assets except for home improvement loans.2 Similarly, the legislature did not include sums due on a mortgage given to secure an antecedent debt or a loan secured by a mortgage made prior to the commencement of the improvement.3

Contractor as Trustee The assets of which a contractor is a trustee includes funds

received under or in connection with a contract or modification to such contract on a public or private improvement (including a home improvement) located in New York as well as any right of action for funds due or earned or to

1 Lien Law §70(5).

2 Lien Law § 70(5). Home improvement loan is defined as any loan obtained for financing a home improvement. Lien Law § 70(8).

3 See Lien Law § 70(5); In re C.H. Stuart, Inc., 17 B.R. 400 (W.D.N.Y. 1982) (proceeds of a mortgage for an antecedent debt are not trust assets).

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become due or earned on such contract or modification.4 However, while a subcontractor that has not received payment for work performed or materials supplied to a contractor is clearly a beneficiary of the trust assets received by the contractor, the statute does not make the owner a guarantor of payment to the creditors of the contractor. Nor is the contractor a guarantor of payment to the creditors of his subcontractor. Therefore, having disbursed trust funds to the subcontractor, the contractor may set up payment as a defense to an action brought by the subcontractor’s lender, whose claim to the same funds is based upon a duly recorded assignment.5 Factors beware: just filing a UCC financing statement does not give you first bite at the apple; notice of assignment under §§15, 16 of the Lien Law must be filed as well.

The trust does not prevent a contractor from compromising its cause of action for payment against an owner, at least in the absence of actual fraud.6

Trust assets also include any sums received by the contractor or right of actions for payment on the improvement:

• (a) under an assignment of funds due or earned or to become due or earned under the contract and

• (b) as proceeds of any insurance payable because of destruction of the improvement of real property or public improvement or its removal by fire or other casualty, except that the amount thereof required to reimburse the contractor for premiums paid by him out of funds, other than trust funds, shall not be deemed part of the trust assets.7

The Lien Law does not distinguish between assets received by a contractor on a public or private improvement with one exception.8 However, 4 Novid Contracting Co. v. Depot Constr., 41 A.D.2d 572, 340 N.Y.S.2d 663 (2d Dep’t

1973). Except for those assets delineated in § 70(1)(b), assets received by a contractor are not trust assets. See York Corp. v. 1955 Associates, Inc., 245 N.Y.S.2d 131 (2d Dep’t 1963). Where a landlord undertakes to improve space for a tenant, he is acting as an owner regardless of any arrangement concerning the sharing of the costs with the tenant. Raisler Corp. v. Uris 55 Water Street Co., 91 Misc. 2d 217, 397 N.Y.S.2d 668 (Sup. Ct. N.Y. County 1977).

5 Quantum Corporate Funding Ltd. v. L.P.G. Associates, Inc., 246 A.D.2d 320, 667 N.Y.S.2d 702 (1st Dep’t 1998), leave to appeal denied, 91 N.Y.2d 814, 676 N.Y.S.2d 127, 698 N.E.2d 956 (1998).

6 Apollo H.V.A.C. Corporation v.Halpern Construction, Inc., 55 A.D.3d 855, 867 N.Y.S.2d 115 (2nd Dept. 2008).

7 Lien Law § 70(6).

8 Lien Law § 70(1). See also Canron Corp. v. City of New York, 214 A.D.2d 115, 631 N.Y.S.2d 642 (1st Dep’t 1995) (while the city is entitled to rely on the shield afforded by Lien Law § 70[1], exempting the city from the obligation of a trustee,

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the assets must be received by a contractor on a transaction which is encompassed within the Lien Law definition of a public or private improvement. Thus, sums received or rights of actions for funds due or to become due or earned on federal improvements are not construed to be within the definition of trust assets.9

Subcontractor as Trustee The assets of a trust of which a subcontractor is a trustee are

comprised of funds received by a subcontractor under or in connection with a subcontract including any modifications thereof made with a contractor who contracted to perform a private or public improvement in New York as well as the subcontractor’s right of action for any funds due or earned or to become due or earned under the subcontract.10 The assets also include any sums received by the subcontractor or rights of action for payment thereof:

• (a) under an assignment or order for the payment of monies due or earned or to become due or earned under the subcontract; and

• (b) as proceeds of any insurance payable because of the destruction of the improvement of real property or public improvement or its removal by fire or other casualty, except that the amount thereof required to reimburse the subcontractor for the premiums paid by him out of funds other than trust funds, shall not be deemed part of the trust assets.11

As with a contractor, trust funds do not encompass payments received by a subcontractor or right of action for payment on real property belonging to the federal government.12 Sums posted to secure a lien are not trust assets.13 Thus, where a contractor posts security to discharge a

the city is not entitled to wield the exemption as a sword to defeat the protection otherwise afforded to a subcontractor by the statute; by taking assignment of funds due to the contractor under the construction contract, the city became the holder of trust funds).

9 I. Burack, Inc. v. Simpson Factors Corp., 16 N.Y.2d 604, 261 N.Y.S.2d 58, 209 N.E.2d 105 (1965). For a discussion on the definition of public and private improvements, see §§ 92.09 and 92.32 above.

10 Lien Law § 70(1)(7).

11 Lien Law § 70(7).

12 I. Burack, Inc. v. Simpson Factors Corp.,supra.

13 First Fed. Sav. & Loan Ass’n of Rochester v. Burdett Ave. Properties, Inc., 41 A.D.2d 356, 343 N.Y.S.2d 271 (3d Dep’t 1973), appeal dismissed, 33 N.Y.2d 765, 350 N.Y.S.2d 411, 305 N.E.2d 491 (1973). For a discussion on sums posted in connection with trust claims see Onondaga Commercial Dry Wall Corp. v. 150 Clinton St. Inc., 25 N.Y.2d 106, 302 N.Y.S.2d 795, 250 N.E.2d 211 (1968).

4

subcontractor’s lien, only the lienor has a right to such sums. However, when the subcontractor receives such sums, they become assets of the subcontractor’s trust subject to claims by those beneficiaries having trust claims against such sums.14

Trust Fund protection is intended to supplement the lien. In delineating those assets which are trust assets, the legislature

recognized a distinction between loans secured by an encumbrance on real property that would have priority over a lien and those loans that would be subordinate to a lien or could be discovered prior to commencement of the improvement. While trust protection was needed to protect contractors, laborers, etc., when affected by encumbrances in the former category, there was no need to in the latter category as such encumbrances could be discovered prior to performance of work or the contractor, laborer, etc., could adequately protect themselves by filing a lien.

Commencement and Termination of the Trust

When any qualifying asset comes into existence in connection with an improvement of real property, a trust springs to life under the Lien Law, regardless of whether beneficiaries exist at that same time and the trust will continue until every trust claim arising at any time prior to the completion of the contract has been paid or discharged, or until all such assets have been applied for the purposes of the trust.15

Trust claims are deemed to come into existence at the time the contract for the improvement is entered into or the transaction giving rise to a trust claim occurs.16 Thus, trust claims may exist prior to labor being performed or material furnished. A trust terminates when all trust claims are satisfied or all trust assets have been applied for a trust purpose. Therefore, the owner or contractor has no exercisable ownership right to the trust fund assets unless there is a balance remaining after all subcontractors and other statutory beneficiaries are paid.17

14 Lakeville Mfg. Co. v. Herman Homes, Inc., 28 Misc. 2d 798, 215 N.Y.S.2d 553 (Sup.

Ct. Queens County 1961), aff’d, 14 A.D.2d 551, 218 N.Y.S.2d 1016 (2nd Dep’t 1961).

15 Lien Law §§ 70, subd. 3; City of New York v. Cross Bay Contr. Corp., 93 N.Y.2d 14, 709 N.E.2d 459 N.Y.S.2d (1999).

16 Lien Law § 71(5).

17 AMG Industries Inc. v. A.J. Eckert Co. Inc., 279 A.D.2d 717, 719 N.Y.S.2d 192 (3d Dep’t 2001).

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Record-keeping duties Trustees who receive and disburse Lien Law Trust Funds are

required to maintain a dedicated set of single-entry books of account, in which they must record the receipt and disposition of trust funds in accordance with §75 of the Lien Law.

Beneficiaries of the trust are allowed to inspect the books; or, in the alternative, to receive a verified statement of the entries in the books; in either case upon ten days’ notice given in person or by certified or registered mail.

Failure to comply with the demand permits the beneficiary to initiate a special proceeding, upon three days’ notice, to compel delivery of the statement or to permit inspection and copying of the books. The proceeding may be summary and disposed of without a hearing where appropriate.

Under §75(4), failure to keep the books is presumptive evidence that trust funds were diverted.

Permitted Uses of the funds: Pay the Cost of the Improvement Defining “Cost of Improvement”

“Cost of improvement” is a term of art under the Lien Law. It relates to expenditures made by an owner.18 The definition includes many of the costs associated with making an improvement. However, the definition does not necessarily include the cost to purchase the land upon which an improvement is made. Those expenditures that are encompassed within the definition of “cost of improvement” fall into two broad categories: those associated with the labor performed and material furnished and those associated with the financing of the improvement.

Including Payment for Labor Performed and Material Furnished to Contractor, Subcontractor, Laborer, Materialman, Architect, or Surveyor

The definition of “cost of improvement” within the meaning of the Lien Law refers to those payments which may legitimately be made out of monies received by the owner through a building loan mortgage or a building loan contract, and refers to a private owner who is creating a fund to pay the cost of construction and not to the fund which is created to pay the cost of a public improvement.19 “Cost of improvement” includes any payment to a contractor, architect, engineer, surveyor, subcontractor, laborer or materialman for labor performed or material furnished for an improvement.224 18 Lien Law § 2(5).

19 In re John J. O’Rourke, Inc., 152 Misc. 575, 273 N.Y.S. 1020 (Sup. Ct. Onondaga County 1934).

224Lien Law § 2(5). A payment made by an owner to a subcontractor where payment was owed to the subcontractor’s contractor will be a cost of improvement.

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It also includes the payment of certain taxes arising out of the improvement, to wit: payroll taxes, including for those individuals or entities listed above, taxes withheld or required to be withheld, and taxes based upon the price or value of materials or equipment furnished.225 The definition further encompasses taxes and unemployment insurance and other contributions arising out of the employment of those listed above, including the payment of any benefits, wage supplements or amounts necessary to provide their benefits to the extent that the owner-employer is obligated by an agreement to provide such.226

Including Expenditures for Financing “Cost of improvement” includes the following expenditures by an

owner in connection with an improvement:

• 1. The fair and reasonable sums paid for obtaining a building loan and subsequent financing;

• 2. Premiums on a bond or bonds filed to discharge all liens or required by a building loan contract or by any lease mortgaged pursuant thereto, or required by any mortgage to be subordinated to the building mortgage;

• 3. Premiums on a bond or bonds filed to discharge a lien; • 4. Sums paid to take by assignment prior existing mortgages, which are

consolidated with building loan mortgages and also the interest charges on such mortgages;

• 5. Sums paid to discharge or reduce the indebtedness under mortgages and accrued interest thereon and other encumbrances upon the real estate existing prior to the time when a mechanic’s lien could attach;

• 6. Sums paid to discharge building loan mortgages whenever recorded; • 7. Interest on building loan mortgages and ground rent accruing during the

making of the improvement; • 8. Sums paid for taxes, assessments, and water rents whether existing prior

or accruing during the making of the improvement; • 9. Premiums on insurance accruing during the making of the improvement.227

SeeTeman Bros., Inc. v. New York Plumbers’ Specialties Co., 109 Misc. 2d 197, 444 N.Y.S.2d 337 (Sup. Ct. N.Y. County 1981) (where an owner pays a bank for monies borrowed from the bank by a subcontractor and such payment is made on the subcontractor’s behalf, such does not constitute a diversion). However, the holding in Teman would be in error if the subcontractor has a trust obligation to any trust beneficiary. For a discussion on a subcontractor’ trust obligation, see § 92.71 above.

225Lien Law § 2(5).

226Id.

227Id.

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Provided certain criteria are satisfied, “cost of improvement” also includes the utilization of the proceeds of any mortgage, including a building loan mortgage, to reimburse the owner for payments made prior to the initial advance under a mortgage for any of the above listed items.228 The criteria to be satisfied are first, that the payments must be itemized in the building loan contract or in the mortgage if it is not made pursuant to a building loan mortgage, and second, the payment must have been made subsequent to the commencement of the improvement.229

Identifying Expenditures Not Included Within Definition of “Cost of Improvement” Any expenditure not specifically defined to be within the definition

of cost of improvement will be excluded from such.230 Thus, central office administrative costs including rent, legal fees, payroll for bookkeeping, officer’s payrolls, etc., are not a “cost of improvement.”231 Neither is the repayment of a personal loan.232 Nor is the purchase price of the land upon which an improvement is made.233 The exception to the latter example would be if sums

228Id.

229Id.

230Gruenberg v. United States, 29 A.D.2d 527, 285 N.Y.S.2d 962 (1st Dep’t 1967) (inasmuch as “cost of improvement” only includes that interest paid on prior existing mortgages and building loan mortgages, other interest payments are not within the costs of improvement). Caristo Constr. Corp. v. Diners Financial Corp., 21 N.Y.2d 507, 289 N.Y.S.2d 175 (1968) (where owner pays a contractor’s lender, such is not a cost of improvement even though lender returns to the contractor a check in the same amount).

231Schwadron v. Freund, 69 Misc. 2d 342, 329 N.Y.S.2d 945 (Sup. Ct. Rockland County 1972); Niaztat Iron Works, Inc. v. Tri-Neck Constr. Corp., 62 Misc. 2d 228, 308 N.Y.S.2d 427 (Sup. Ct. Kings County 1970).

232Lien Law 2(5); Gerrity Co. v. Bonacquisti Constr. Corp., 136 A.D.2d 59, 525 N.Y.S.2d 926 (3d Dep’t 1989).

233People v. Rosano, 69 A.D.2d 643, 419 N.Y.S.2d 543 (2d Dep’t 1979). But see Amsterdam Sav. Bank v. Terra Domus Corp., 97 A.D.2d 41, 470 N.Y.S.2d 448 (3d Dep’t 1983) (where money is loaned in a building loan contract for land acquisition, such is a cost of improvement). The holding in Amsterdam Sav. Bank v. Terra Dormus Corp. is contrary to the language in the statute and has since been rejected. See Atlantic Bank of New York v. Forrest House Holding Co., 234 A.D.2d 491, 651 N.Y.S.2d 607 (2d Dep’t 1996) (if a lender fails to comply with the requirements of the Lien Law, its entire mortgage, including that part securing loan proceeds advanced for the purchase of the property, become subordinate to any subsequently filed mechanic’s liens).

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are paid to take by assignment a prior existing mortgage that is consolidated with a building loan mortgage.234

Defenses to charges of Diversion The affirmative defenses peculiar to the trust diversion actions are

those based upon (1) the filing of a “notice of lending” or an assignment; (2) restoration; and (3) a one year statute of limitations. Each will be separately discussed herein.

Raising Defense Based on Filing of Notice of Lending Overview of Notice of Lending

With several exceptions, trust assets may not be utilized as security for, or in consideration of, or to repay advances made to, or on behalf of a trustee.437 Except for one, all the exceptions involve an owner’s right to utilize trust assetsto pay for the cost of improvement.438 The one exception not involving an owner’s right to use trust assets to pay for a cost of improvement arises where a notice of lending or assignment is filed.439 Similar to an assignment, a notice of lending is a document that reflects advances made to a trustee on an improvement and the trustee’s obligation to repay such amount.440 Notably, the advance that was made and which is being reimbursed out of trust funds must have been expended to pay the cost of the improvement A notice of lending, similar to an assignment, is designed to satisfy two competing interests.441 On the one hand, financing is frequently needed to complete an improvement. If owners, contractors, etc., were unable to utilize payments to repay loans and lenders accorded the security interests in payments on the improvement, obtaining financing might be made impossible. On the other hand, the Lien Law seeks to protect contractors, subcontractors, laborers or materialmen performing labor or supplying materials.20

A lender who took, as additional security, an assignment of the building contract for a building loan was liable as a trustee under Lien Law Article 3-A for the claims of subcontractors. In receiving direct payment of the sale proceeds pursuant to the assignment and applying those proceeds to 234Lien Law § 2(5).

437For a discussion on the permitted use of trust assets, see § 92.71 above.

438Id.

439Lien Law § 73(1)(3)(d).

440Id.

441Id.

20 Lien Law § 3, 5.

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repayment of the loan, the lender diverted trust assets. The builder was under contract with a third party to construct the buildings and then transfer title to the third party. The mortgages contained a provision stating that they were subject to Lien Law § 13, and a building loan agreement was properly recorded pursuant to Lien Law § 22. As additional security for the building loans, the builder assigned all its right, title and interest in the contract with the third party to the bank. The subcontractors contended that they had not been paid. As a result of the assignment, sale proceeds were paid directly to the bank, which applied the proceeds to repayment of the building loan. The bank, as assignee, became a statutory trustee under Lien Law Article 3-A, and in order to defend the action brought by the subcontractors for diversion of trust assets on the ground that the trust funds were used to repay advances made to the builder, the bank was required to file a notice of lending in accordance with Lien Law § 73, which it concededly failed to do. The Court rejected the bank’s contention that its building loans had priority over the claims of subcontractors because it complied with Lien Law §§ 13(3) and 2. The repayment to itself of the loans made to the builder with knowledge of their trust status constituted a diversion of trust assets as a matter of law.21

Balancing the competing interests, the Lien Law permits a borrower-trustee to repay a loan utilizing trust fund monies, provided the borrower-trustee utilized the advances for a designated trust purpose.22 Therefore, no party is prejudiced. The trust fund beneficiary is protected as the advances must be utilized for a trust purpose. All funds received by a trustee pursuant to a notice of lending are deemed trust assets.23 In addition, the trustee-borrower may only assert the affirmative defense to the extent he utilized the advances for a trust purpose.24 Thus, in effect, a “wash” is created. The advances are required to be utilized for trust purposes protecting the contractor, subcontractor, etc., and sums received for payment of labor performed or material furnished may be used to repay the lender to the extent of the advances made.

The requirement that a notice of lending be filed further protects the individuals or entities performing work or supplying material.25 Such filing alerts the party to the amounts to be loaned as well as repaid.

Ascertaining When Affirmative Defense Based on Notice of Lending Is Available

21 Aspro Mech. Contr. v. Fleet Bank, 1 NY3d 324, 328 [2004]. 22 Lien Law § 73(2).

23 Lien Law § 73(5).

24 Lien Law § 73(5).

25 Lien Law § 73(3).

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An affirmative defense predicated upon a notice of lending will be sustained, provided certain pre-conditions are satisfied.26 The notice of lending must be timely filed and properly drafted.27 If the affirmative defense is asserted by a trustee, the trustee must demonstrate that the advances received and reflected in the notice of lending were utilized for a trust purpose.28 If the affirmative defense is asserted by the recipient of the trust assets reflected in the notice of lending, such transferee must establish that prior to making an advance, the trustee provided a written agreement that the trustee would receive and/or hold the right to receive such advances as trust funds to be first applied for a permitted trust purpose and that the trustee will so apply the advances before using them for any other purpose.29

Both the trustee and/or transferee must also establish that the advances were equal to or less than the amount stated to be advanced in the notice of lending.30 To the extent that the advances were more than the amount stated in the notice of lending, the affirmative defense will be unavailing.

may be ion with funds advanced on either public or private

Serving Writte

The affirmative defense predicated upon a notice of lendingutilized in connectimprovements.31

n Demand for Verified Statement of Amounts of Advances

26 Lien Law § 73(1)(2)(3). There is some authority to support the position that under

certain circumstances, a trust beneficiary may be equitably estopped from asserting the failure to file a notice of lending as a basis to defeat a defense proffered by a lender. See Glens Falls Ins. Co. v. Schwab Bros. Trucking, Inc., 29 A.D.2d 836, 287 N.Y.S.2d 708 (4th Dep’t 1968) (where a trust beneficiary had actual notice of the loan arrangement, the trust beneficiary may be estopped from relying on the lender’s failure to file a notice of lending). But see Continental Consortium Corp. v. P. & H Nat’l Indus., N.Y.L.J., Feb. 28, 1991, at 30, col. 4 (1991). The better rule would be that the principle of equitable estoppel should not be available. A defense of a notice of lending is an affirmative defense that should be required to be proven in totality. The transgressor would still have the defense of restoration available

27 Lien Law § 73(3).

28 Lien Law § 73(2).

29 Lien Law § 73(1).

30 Lien Law § 73(1)(2).

31 Lien Law § 73 does not distinguish between public and private improvements for the effectiveness of a notice of lending.

11

Where a notice of lending is filed, a trust fund beneficiary may make a written demand upon the trustee or transferor for a verified statementof the amounts of advances made.

n notice of lending will not be

mplies with the demand, such

Including Req

; r on whose

e

ent of real property, including a home

ted; the

undetermined be

e the notice is filed; and • (6) by the

and e

iption of

contract registration number. Such description would permit the contract to be properly identified so that it can be

32 The demand must be personally served or sent by registered or certified mail upon the trustee or transferor. Unless the trustee or transferor who was served with the demand responds to such withiten days of receipt, a defense predicated upon apermitted. If either the transferee or trustee cocompliance will be deemed sufficient for both.

uired Contents in Notice of Lending

The notice of lending must contain:

• (1) a statement of the name and address of the person making the advances• (2) a statement of the name and address of the person to whom o

behalf they are made, and whether he is owner, contractor or subcontractor; • (3) in the case of advances relating to one specific project for the

improvement of real property including a home improvement or one specificpublic improvement, a description, sufficient for identification, of thimprovement and of the real property involved for which the advances are made, and in the case of a notice of lending relating to several or undetermined projects for the improvemimprovement or for public improvements, a statement of each county wherein the real property is or may be situa

• (4) the date of any advance made on or before the date of filing for whichnotice is intended to be effective;

• (5) in the case of a notice of lending relating to several or projects, the date the notice will terminate, which termination date shall not more than two years after the dat

the maximum balance of advances outstanding to be permitted lender pursuant to the notice.33

The required description of the real property on a private improvement will be deemed sufficient if it includes the record owner’s name, the town or city in which the real property is located, as well as the streetnumber of the real property.460 If the real property is in New York City or thcounties of Nassau or Onondaga where the block system of recording or registering and indexing conveyances is utilized, then the block of the real property must also be specified.461 On a public improvement, the descrthe improvement should also include an identification of the contract by a description of the project and any

recorded by the financial officer.

32 Lien Law § 73(4).

33 Lien Law § 73(3)(b).

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If the notice of lending specifies a maximum amount to be loaned which is less than the amount actually advanced, the affirmative defense

f lending will be limited to the amount specified to be ing.34

of

e of Lending must identify the prior notice of lending whic

tive defense predicated upon a notice of lending for such ed. Otherwise, there would be no need to extend a

ents. An

not be effective as to the e more than five days prior to

ense predicated upon a notice of lending will not be sustained for any advances made more than five days before the date of the

of lending filed

Filing Notice of Lending In Connection With Private Improvements

predicated upon a notice oloaned in the notice of lend

Extending Notice of Lending

A notice of lending that contains an expiration date may be extended.35 it may be extended by the filing of a “Second or Third notice Lending.” The Second or Third notice of Lending must be filed within 60 days prior to the termination date of the notice of lending or second notice of lending. The Second or Third notic

h it seeks to extend and also contain all the items required to be contained in a notice of lending.

If an advance is made subsequent to the expiration of a notice of lending, the affirmaadvance will not be sustainnotice of lending.

Amending Notice of Lending

A notice of lending may be amended by the filing of an amended notice of lending. An amended notice of lending may not be utilized as a mechanism to protect advances or repayments made pursuant to a notice of lending which failed to substantially comply with the content requiremamendment may be utilized to increase the maximum amount of advances to be made. However, such an amendment willincreased amount with respect to advances madthe filing of the amended notice of lending.

Satisfying Requirements for Filing Notice of Lending Filing Notice of Lending No Later Than Prior to First Advance

A notice of lending must be filed not later than five days prior to the first advance if the trustee and transferee seek to totally avoid trust diversion liability based upon the affirmative defense of the filing of a notice of lending. A notice of lending will be effective for any advances made subsequent to its filing. The affirmative def

filing of the notice of lending.

There are different filing requirements for noticeson private and public improvements.

34 Lien Law § 73(1)(2).

35 Lien Law § 73(3)(c).

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In connection with a private improvement, the notice of lending must be filed in the county clerk’s office where the real property to be improved is located.36 If an advance is to be made in connection with multiple improvements, the notice of lending must be filed in each county where the real property is located.

Upon its filing, the notice of lending will be recorded by the clerk in the lien docket or other book designated for such purpose by the clerk. The notice of lending is indexed by the name of the trustee to whom or on whose behalf the advance was made. Consequently, any person performing work on an improvement may easily determine if a notice of lending was filed.

Filing Notice of Lending In Connection With Public Improvements

In connection with a public improvement, the notice of lending must be filed with the head of the department or bureau having charge of the improvement and the financial officer of each public corporation or other officer or person charged with the custody and disbursements of the funds for the improvement. If advances are made in connection with several improvements, a notice of lending must be filed with the head of each department and the financial officer of each public corporation or other officer or person charged with the custody and disbursement of the funds for each improvement.

Bringing Action to Enforce Trust Within One-Year Statute of Limitation The Lien Law provides that, except for an action by a trustee for

the final settlement of his accounts and his discharge and an action by a subcontractor or materialman, an action to enforce a trust must be commenced prior to the expiration of one year from the completion of the improvement.37 An action by a subcontractor or materialman must be commenced within one year of the completion of the improvement or within one year from the time the final payment is due under the contract, whichever is later.

For purposes of determining the time within which an action by a trust beneficiary must be commenced, completion of the project is defined to be completion of the entire improvement, not solely the completion of work by the trust fund beneficiary seeking to commence the action.38

36 Lien Law § 73(3)(a).

37 Lien Law § 77(2).

38 Utica Sheet Metal Corp. v. Myers-Laine Corp., 45 A.D.2d 116, 357 N.Y.S.2d 137 (3d Dep’t 1974); Northern Structures, Inc. v. Union Bank, 57 A.D.2d 360, 394 N.Y.S.2d 964 (4th Dep’t 1977); Raisler Corp. v. Uris 55 Water Street Co., 91 Misc. 2d 217, 397 N.Y.S.2d 668 (Sup. Ct. N.Y. County 1977); Wynkoop v. Mintz, 17 Misc. 2d 1093, 192 N.Y.S.2d 428 (Sup. Ct. Kings County 1958). However, this does not mean that a beneficiary can delay completion to enlarge the

14

An improvement will not be considered complete if punch list work remains. Completion means completion of all the work, not simply substantial completion of the project. 39 Thus, even if a trust fund beneficiary completes its work years before the improvement is completed, such trust fund beneficiary may commence an action to enforce a trust if such action is commenced prior to the expiration of one year from the time the last labor was performed or material was supplied completing the punch list on the improvement.40 The statute of limitations runs at the same time for all trust fund beneficiaries. Whether work has been completed may be an issue of fact.41

If the improvement is abandoned and work is not completed, then the trust fund beneficiary must commence the action within six years of the time the beneficiary completed his work.42

In computing the time in which trust fund beneficiaries must commence the diversion action, parties are accorded the benefit of the tolling provisions found in the Civil Procedures Law and Rules.43

Raising Affirmative Defense of Restoration

A lender or transferee may successfully assert an affirmative defense of restoration if they are able to establish that any amounts diverted were restored to the trust. 44 To substantiate such a defense, the lender or

statutory period nor should it include guarantee work as such is a separate obligation.

39 For a completing surety, the claim accrues when the project is completed. St. Paul Fire & Marine Ins. Co. v. State, 99 Misc. 2d 140, 415 N.Y.S.2d 949 (Ct. of Claims 1979). Though St. Paul defines accrual as substantial completion, the other case authority requires the work must be fully completed.

40 See Caristo Constr. Corp. v. Diners Financial Corp., 21 N.Y.2d 507, 289 N.Y.S.2d 175, 236 N.E.2d 461 (1968); Anthony Trinca & Assoc., Inc. v. Tilden Constr. Corp., 44 Misc. 2d 1094, 256 N.Y.S.2d 75, aff’d sub nom, Continental Casualty Co. v. Ruth Factors, 16 N.Y.2d 485 (1965); Fentron Architectural Metals Corp. v. Solow, 101 Misc. 2d 393, 420 N.Y.S.2d 950 (Sup. Ct. N.Y. County 1979).

41 Utica Sheet Metal Corp. v. Myers-Laine Corp., 45 A.D.2d 116, 357 N.Y.S.2d 137 (3d Dep’t 1974).

42 In re Grosso, 9 B.R. 815 (N.D.N.Y. 1981).

43 M. Gold & Son, Inc. v. National Commercial Bank and Trust Co., 63 A.D.2d 786, 404 N.Y.S.2d 765 (3d Dep’t 1978).

44 Travelers Indem. Co. v. Central Trust Co. of Rochester, N.Y., 47 Misc. 2d 849, 263 N.Y.S.2d 261 (Sup. Ct. Monroe County 1965); Schwadron v. Freund, 69 Misc. 2d 342, 329 N.Y.S.2d 945 (Sup. Ct. Rockland County 1972); Raisler Corp. v.

15

transferee must prove that non-trust assets in an equal or greater amount than the sums diverted were placed in or restored to the trust. Under such circumstances, the beneficiaries would not be injured. There would be no loss. The trust fund beneficiary would be placed in a position where it would receive the same amount as if no diversion occurred. The defense is available even where no notice of lending or assignment has been filed.

Where a general contractor utilizes trust assets to pay a subcontractor’s lender pursuant to an unfiled assignment, and the lender issues a check in the same amount to the subcontractor pursuant to a revolving credit agreement, the lender and general contractor will be liable for a trust diversion unless they can establish that the sums received by the lender were utilized to pay trust fund beneficiaries.45 If such is not established, the lender would have received trust assets and utilized them for a non-trust purpose, and the general contractor assisted in such diversion. The restoration defense only permits the curing of a technical diversion.

Even where a defense of restoration is established, the lender-transferee will be held responsible for the expenses of the action.46 Whether the defense of restoration is available to a trustee is debatable.47 Though no beneficiary would suffer a loss if a trustee replenished a trust with non-trust assets in an amount equal to any sums diverted, permitting a trustee to escape liability wouldencourage trustees to misuse funds. Furthermore, little purpose would be served by the Lien Law’s requirement that a notice of lending or assignment must be filed for a trustee to escape liability. Such filing permits a trustee to escape liability where he receives advances, uses such advances for trust purposes and utilizes trust assets to repay loans which is a non-trust purpose. If a trustee could simply restore assets to a trust without being exposed to liability, there would be little reason to file assignments or notices of lending.

Uris 55 Water Street Co., 91 Misc. 2d 217, 397 N.Y.S.2d 668 (Sup. Ct. N.Y. County 1977).

45 See Caristo Constr. Corp. v. Diners Financial Corp., 21 N.Y.2d 507, 289 N.Y.S.2d 175, 236 N.E.2d 461 (1968); Anthony Trinca & Assoc., Inc. v. Tilden Constr. Corp., 44 Misc. 2d 1094, 256 N.Y.S.2d 75, aff’d sub nom, Continental Casualty Co. v. Ruth Factors, 16 N.Y.2d 485 (1965); Fentron Architectural Metals Corp. v. Solow, 101 Misc. 2d 393, 420 N.Y.S.2d 950 (Sup. Ct. N.Y. County 1979).

46 Schwadron v. Freund, 69 Misc. 2d 342, 329 N.Y.S.2d 945 (Sup. Ct. Rockland County 1972).

47 Lien Law § 79-a(1). And see People v. Melino, 52 A.D.3d 1054, 860 N.Y.S.2d 660 (3rd Dept. 2008) (Criminal liability attaches to individual officers of the trustee if they control the activities of the trustee, as, e.g., chief executive officer, managing partner or actively-involved owner.)

16

Avoiding Criminal Liability in Connection With Misuse of Trust Funds A trustee and any officer, director or agent of the trustee who

misuses or consents to the misapplication of trust funds received by a trustee may be guilty of larceny.48 A trustee-owner will be guilty of larceny if trust assets are misapplied prior to the payment of all trust claims.49 A contractor or subcontractor-trustee will be guilty of larceny if he fails to pay a trust claim within 31 days of such claim becoming due. 50 However, a claim will not be considered due if it is disputed in good faith. Once a determination is made that such disputed claim is due, it must be paid within thirty-one (31) days or the trustee will be guilty of larceny.

The People are required to establish a true diversion of trust funds, i.e., that funds received in trust were expended for impermissible purposes. Where a contractor showed that all expenses for materials on the improvement were paid, that the balance paid by the owner in excess of the cost of materials was ascribed to his own labor and that no demand for payment of a trust claim had been made against the contractor (or, if made, was not duly and timely honored), the evidence was legally insufficient to sustain a conviction because there was no showing of larcenous intent: the contractor was terminated by the owner prior to completion of the work.

Not every breach of trust is per se larceny under Lien Law §79-a. “The Lien Law does not create a strict liability crime, and therefore a conviction of larceny by misappropriation of trust funds pursuant to Lien Law §79-a requires proof of larcenous intent.”51

A trustee will not be guilty of larceny if the charge arises out of misuse of the repayment of advances where such advances were utilized for trust purposes.52 Larceny will also not be found where a trustee can establish

48 Lien Law § 79-a(1). And see People v. Melino, 52 A.D.3d 1054, 860 N.Y.S.2d 660 (3rd

Dept. 2008) (Criminal liability attaches to individual officers of the trustee if they control the activities of the trustee, as, e.g., chief executive officer, managing partner or actively-involved owner.)

49 Lien Law § 79-a(1)(a).

50 Lien Law § 79-a(1)(b). See also, People v. Van Keuren, 31 A.D.2d 711, 295 N.Y.S.2d 892 (3d Dep’t 1968), aff’d, 27 N.Y.2d 556, 313 N.Y.S.2d 126, 261 N.E.2d 267 (1970) (where payment was made subsequent to the time allowed, a conviction for larceny will be sustained).

51 ARA Plumbing & Heating Corp. v. Abcon Associates, 44 A.D.3d 598, 843 N.Y.S.2d 154 (3rd Dept. 2007).

52 Lien Law § 79-a(2). The state has the burden to disprove such defense. People v. Chesler, 50 N.Y.2d 203, 428 N.Y.S.2d 639, 406 N.E.2d 455 (1980).

17

18

that he advanced, for the improvement, non-trust assets at least equal to the amount diverted.53

Failure of the trustee to maintain the required books or records is presumptive evidence of a criminal trust diversion.54 The People still have to prove every element of the crime beyond a reasonable doubt, but a trustee who fails to maintain the books may not have been aware of the trust impressed on the funds, and such a trustee avoids criminal liability by sheer happenstance. If nothing else, the maintenance of the required books serves to reinforce the trustee’s awareness of its responsibility as trustee.

53 Id; See also People v. Morgan, 135 A.D.2d 912, 522 N.Y.S.2d 311 (3d Dep’t 1987).

54 Lien Law § 79-a(3). The presumption creates a permissible inference. The state must still prove guilt beyond a reasonable doubt including criminal intent. People v. Rosano, 50 N.Y.2d 1013, 431 N.Y.S.2d 683, 409 N.E.2d 1357 (1980).

Kevin J. Connolly

Shareholder [email protected] New York T. 212-278-1471 F. 212-278-1733

Practice Areas

Real Estate and Construction Intellectual Property Insurance Recovery

Kevin J. Connolly is a member of Anderson Kill’s Real Estate and Construction practice group, concentrating on providing legal services to clients involved in construction projects. His practice centers on representing owners and developers of significant commercial, industrial and educational projects. Mr. Connolly also represents contractors, construction managers and design professionals. Recognizing that insurance is critical to the survival of any organization involved in construction, Mr. Connolly adds value and legal acumen to his clients through his understanding of and experience with insurance services. Mr. Connolly is rated "AV," the top rating, by his peers as listed in Martindale Hubbell. After surveying judges before whom Mr. Connolly has appeared and attorneys with whom Mr. Connolly has worked, Martindale-Hubbell gave Mr. Connolly their highest ranking signifying that his adherence to professional standards of conduct and ethics, reliability, diligence and other criteria relevant to the discharge of professional responsibilities are "very high" and that his "legal abilities are of the very highest standard." Since 2009, Mr. Connolly has been selected by his peers to Super Lawyers for Construction Law. Bar Admissions United States District Court for the Southern District of New York, United States District Court for the Eastern District of New York, New York and New Mexico Memberships American Bar Association (Forum on the Construction Industry), Association of the Bar of the City of New York (Construction Law Committee) Education

Fordham University School Law, J.D Fordham College, B.A. cum laude .

http://www.superlawyers.com/about/selection_process.html

Brian G. Lustbader, Esq. combines a stellar academic record and legal background with unique hands-on experience in the construction arena. An honors graduate in civil engineering from the Massachusetts Institute of Technology and thereafter from Columbia Law School, he began his legal career in the 1970s as a litigator of large and complex cases at a large New York City law firm, Rosenman Colin Freund Lewis & Cohen. He then practiced construction and commercial litigation for many years at firms focusing on construction law. In the early 1990s, Mr. Lustbader ran his family construction business, The P.J. Carlin Construction Company and its related companies, for several years. He returned to full-time practice of construction law in 1997 and joined Mazur, Carp & Rubin, P.C., in 2000. Utilizing his multifaceted perspective as contractor and lawyer, Mr. Lustbader has successfully mediated numerous construction disputes that were hopelessly mired in endless litigation, and is a practical transactional negotiator and draftsman. Mr. Lustbader’s diverse litigations and arbitrations have been similarly successful, including the successful prosecution of a >$100 million claim on behalf of a building developer-owner against a public agency tenant, and his creating new law in New York by obtaining outright dismissal of an improperly filed mechanic's lien by a developer. He is the author of articles published in New York Law Journal and other publications, and a frequent seminar leader and lecturer on construction litigation, contract drafting, bid protests and claims. He is also a member of the NYCLA Construction Law Committee and Co-Chair of the Real Estate Construction Committee of the Real Property Law Section of the New York State Bar Association.

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IN CONSTRUCTION

INTRODUCTIONAs General Counsel for PavariniMcGovern, Mr. Sciascia advises theCEO, Chairman and Vice Presidents onvarious matters, which include newbusiness opportunities, deal structuringand contractual risks, as well as workingwith Project Executives and ProjectManagers to resolve trade contractornegotiations and disputes. Mr. Sciasciareviews, negotiates and draftsconstruction management agreementswith owners and subcontract agreementswith trade contractors.

Mr. Sciascia is an adjunct professor atPolytechnic Institute of New YorkUniversity, where he teaches graduatecoursework in Contracts &Specifications.

EDUCATIONJD/Law/Fordham Law School

BS/Architecture/Arizona State University

MS/Construction - RE DevelopmentCore/Arizona State University

BAR ASSOCIATIONSNew York State Bar/April 1998

US Supreme Court Bar/May 2005

NY County Lawyers Association - Construction Law Committee - Chair

AWARDSThe Archibald R. Murray Public Service Award

Student Leadership Award - Habitat for Humanity/Fordham University School of Law

MEMBERSHIPSBoard/Greater NY Construction User Council

Board/Arizona State University Alumni Association/Greater New York Chapter

DEVELOPMENT EXPERIENCESavoy Senior Housing Corporation, New York, NY General Counsel & VP of Real Estate DevelopmentDeveloped proforma models to analyze various realestate transactions including development budgets,construction costs, operational income and expenses,investor IRR, lease-up, draws, and refinancing.Designed, coordinated and carried out due diligencework plans to ascertain physical, legal and marketrisks. Responsible for preparing business plans andmarket analysis for presentation to equity and debtcapital sources. Acted as owner's representative andmanaged architects, engineers, and subcontractors ona variety of old and new projects.

Took over $15 million in construction to completeconstruction of two assisted living facilities (150,000-SF) after construction manager failed to timelycomplete and was terminated. Terminated deficienttrades. Bid and negotiated completion contracts.Directed all work including Owner's separate trades.Coordinated as-built drawings, expeditors and Dept.of Building inspections. Obtained Certificates ofOccupancy. Worked with architects and engineers todesign and specify a ground up 70,000-SF assistedliving facility, then worked with architects andengineers to redesign the site as an apartmentbuilding. Oversaw outside counsel on over $17million in civil litigation. Handled various legalmatters, drafted and negotiated leases, obtainedDept. of Health licenses, as well as assisted in allaspects of development, zoning, financing, leasing,due diligence, and market analysis.

REAL ESTATE EXPERIENCEErnst & Young Kenneth Leventhal, New York, NY Senior Consultant/AttorneyAdvised clients on various real estate issues.Structured and modeled real estate transactions and

J o e l M . S c i a s c i a , E s q . I G e n e ra l C o u n s e l

400 FIFTH AVENUE

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IN CONSTRUCTION

Real Estate Investment Trust (REIT) initial public offerings using Excelsoftware. Developed tax liability and OP unit allocation models for REITroll-ups. Performed REIT acquisition and lending due diligence includinglease and mortgage review; asset, income and distribution testing; andorganizational requirement analysis. Developed REIT due diligence workplans, document requests and property service questionnaires. Researchedand wrote briefs on various real estate tax issues.

Goldberg Weprin & Ustin, New York, NY Acquired extensive limited liability company law experience; draftingoperating agreements, partnership conversions, and conveyancing.Drafted commercial mortgages, notes, and assignments. Performed duediligence for commercial acquisitions. Represented commercial lendersand residential and commercial purchasers at closings. Handledforeclosure and construction litigation, DHCR, and tax remission issues.

Max E. Greenberg Trager Toplitz & Herbst, New York, NYClosed condominium and cooperative loans for institutional lenders.Researched and wrote briefs on construction issues. Corrected deficientloan packages and prepared closing binders.

PAVARINI MCGOVERN EXPERIENCEAcademia ProjectsNY Law School Flagship Building, 185 West Broadway, New York, NYColumbia University, Campbell Sports Center, New York, NY

Mixed-Use Projects400 Fifth Avenue, New York, NYCassaNY, 60-77 West 45th Street, New York, NYShangri-La NY, 610 Lexington Avenue, New York, NYThe Smyth Hotel, 85 West Broadway, New York, NY

Residential Projects40 East 66th Street, New York, NY45 Park Avenue, New York, NY47 East 91st Street, New York, NY57 Reade Street, New York, NY70 Bedford Street, New York, NY110+Broadway, New York, NY124 Hudson Street, New York, NY2forty, 240 Park Avenue South, New York, NYThe Anthem, 220 East 34th Street, New York, NYArcadia, 408 East 79th Street, New York, NYArtisan Lofts, 143 Reade Street, New York, NYBarbizon/63, 140 East 63rd Street, New York, NYThe Hubert, 3-9 Hubert Street, New York, NY

K. Hov, Port Imperial North, West New York, NJMercer 40 Residences, 40 Mercer Street, New York, NYThe Pier Apartments, Jersey City, NJThe Urban Glass House, 330 Spring Street, New York, NYHospitality Projects330 Hudson Street, New York, NYThe East River Hotel, 410 East 92nd Street, New York, NYThe Standard, 848Washington Street, New York, NY

Commercial/Office Projects360 Madison Avenue, New York, NY505 Fifth Avenue, New York, NY580 Fifth Avenue, New York, NY598 Madison Avenue, New York, NY640 Fifth Avenue, New York, NYBank of America, 9 West 57th Street, New York, NYHarlem Park, 1800 Park Avenue, New York, NYLegal Aid Society, New York, NYWaterfront Corporate Center Phase II, Hoboken, NJ

Retail Projects1 East 57th Street, New York, NYThe Belnord, 225 West 86th Street, New York, NY

Healthcare ProjectsKings County Hospital Center, DASNY, Brooklyn, NY

Gov’t/Civic ProjectsQueens Family Court & City Agency Facility DASNY, Jamaica, NY

S c i a s c i a I Pa g e 2

Ariel Weinstock Ariel Weinstock has been in the real estate department of Katsky Korins LLP since 2007. His practice focuses on general real estate and construction matters. Ariel is a frequent lecturer for the New York County Lawyers’ Association and New York State Bar Association on general real estate and construction matters. Ariel represents clients in drafting and negotiations of construction agreements, including AIA-based construction documents, for both national and local clients on significant construction projects. Ariel has been involved in numerous real estate transactions including commercial and residential leases, sales, acquisitions and financings. Ariel currently serves as Vice-Chair of the New York County Lawyers’ Association Construction Law Committee and is also the Secretary of the Construction Law Committee of the New York State Bar Association’s Real Property Law Section.

KATSKY │ KORINS Ariel Weinstock Katsky Korins, LLP 605 Third Ave, 16th Floor New York, NY 10158 p 212.716.3281 - Direct f 212.716.3362 - Direct [email protected] BAR ADMISSIONS 2008, New York 2008, District of Columbia 2007, New Jersey COURT ADMISSION U.S. District Court of New Jersey

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