L&W Supply Corporation v. DeSilva, A-2960-10T2; Appellate Division; opinion by Ashrafi, J.A.D.; decided and approved for publication December 19, 2012. Before Judges Fuentes, Grall and Ashrafi. On appeal from the Law Division, Monmouth County, L-5358-06. DDS No. 11-2-8504 [18 pp.]

The Construction Lien Law, N.J.S.A. 2A:44A-1 to -38, allows a contractor or supplier who is owed payment for its work or materials to file a lien against the real property on which the improvements are constructed. It limits the lien to the amount in the “lien fund,” which, for a supplier, is defined as the lesser of (1) the amount of the prime contract price earned minus amounts already paid by the owner to the prime contractor, or (2) the amount the subcontractor has earned on the subcontract price minus amounts already paid by the prime contractor to the subcontractor. When a lien claim is filed, the owner or prime contractor may pay the amount of a valid claim directly to the claimant and credit that payment against the subcontract price or post a surety bond for 110 percent of the lien amount and release the owner’s property from the claim.

Craft v. Stevenson Lumber Yard Inc., 179 N.J. 56 (2004), held that a supplier that seeks to file a construction lien has a duty to apply payments correctly against several open accounts of a materials purchaser, such as a subcontractor, if the supplier has reason to know that the payment funds came from a particular building project. At issue here is the supplier’s obligation to ascertain the source of payments and to apply them accordingly.

Plaintiff L&W Supply Corporation sold $231,794.34 of building materials on credit to a now-bankrupt subcontractor, Detail Contractors Inc., one of several entities owned and operated by Joe DeSilva, who had open accounts with L&W for projects other than the Meridian project at issue. Patock Construction Co. Inc. was the prime contractor; Extended Medical Care Corp./Meridian Health/Meridian Nursing & Rehabilitation was the owner of the property and project; and Travelers Casualty and Surety Company of America was the surety.

Detail paid L&W $207,000; another DeSilva entity paid $10,000. L&W credited $103,959.45 to the Meridian project and the remaining $113,040.55 to other DeSilva accounts, leaving $127,834.89 owing on the Meridian project. When Detail failed to pay the balance due, L&W filed a construction lien against the project. At the time, the amount of the lien fund was substantially more than the lien claim.

After receiving notice of the lien claim, Patock and Travelers posted a construction lien bond. L&W filed this action against Patock, Meridian, Travelers, and DeSilva and his business entities.

The trial court entered judgment against Travelers for the $127,834.89 lien claim, and against Patock and Meridian for $158,373.42, i.e., the lien claim plus prejudgment interest.

On appeal, defendants argue that L&W had a duty to apply the balance of the $217,000 to the Meridian account and that they showed the existence of a genuine issue of material fact as to whether L&W properly discharged its duty to allocate payments correctly.

Held: When the purchaser of materials has not provided specific, reliable instructions as to the allocation of its payment, or when a reasonable supplier should suspect the purchaser has not used an owner’s funds to pay for materials supplied for that owner, the supplier must make further inquiry and attempt to ascertain the source of the payment funds so that it can allocate them to the correct accounts. Because defendant-owner raised a genuine issue as to whether L&W fulfilled this duty, summary judgment should not have been granted on its lien claim.

The panel says that because Craft imposes an affirmative duty on the supplier to allocate payments correctly, the supplier must inquire about the source of payments it receives. A failure to do so may warrant a finding that the supplier should have known the source of the payment. However, an inquiry would serve no purpose if the contractor has specifically instructed that its payments be allocated to particular accounts and the supplier has no reason to believe that the allocation is improper. The law should not generally require a supplier to challenge a materials purchaser without reason to suspect improper allocation of funds. However, if the supplier has reason to suspect that something is amiss in the material purchaser’s allocation of payments to different accounts, Craft requires that the supplier inquire further and verify the source of the payment funds.

The panel emphasizes that the duty imposed by Craft does not affect the supplier’s right to collect all balances due from the person or entity that purchased the materials, or from any other party contractually obligated to pay for the materials. The supplier’s failure to take affirmative action to ascertain the source of funds affects only its right to encumber the real property of the owner.

The panel says L&W’s witnesses asserted that it had discharged its duty to allocate Detail’s payments accurately but they did not provide details to show how they arrived at their conclusions. No specific evidence indicates whether DeSilva directed payment to his other projects, whether L&W had or did not have reason to suspect that he might be misapplying payments to past-due accounts, and whether L&W ascertained the source of the funds from Detail and DeSilva. Defendants should have the opportunity to prove at a trial that L&W failed to make any inquiry about the source of the funds or that it had reason to suspect that the DeSilva entities were not properly allocating their payments. Summary judgment should not have been granted on L&W’s lien claim.

As to Meridian’s challenge to the judgment against it, the panel says that because a surety bond had been posted, and the surety was a named defendant, Meridian was not a proper defendant on the lien claim. It should have been dismissed from the case with prejudice.

For appellants — Martin J. Arbus (Leonard S. Needle on the briefs). For respondent — Miller Law Offices (Larry L. Miller on the brief).