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"new statutory language
may have rendered certain applications of the section unconstitutional"
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In a law that became effective
August 1, 2000, the Minnesota Legislature empowered both homeowners
and subcontractors by amending Minnesota Statutes Section 514.02
to include new civil remedies. Previously, this statute only
allowed for criminal penalties. [See, Energy & Air Systems,
Inc. v. Kuettel, 580 N.W.2d 62, 64 (Minn. App. 1998).] The
new provisions allow these entities to pursue individual owners,
directors, and officers of a corporate contractor through a civil
action in cases where the owners of residential property paid
their contractor for their construction project, and the contractor
converted the funds for its own use, rather than pay its subcontractors
for the value of their contributed improvements to the homeowners'
property. This statute most likely does not apply to cases where
a contractor withholds payments from a subcontractor based upon
a good faith dispute about the quantity or quality of the subcontractor's
work.
As an additional benefit, the amendments to Section 514.02 enable
both homeowners and subcontractors to recover their attorneys'
fees and costs of investigation incurred in seeking judgment
against an unscrupulous contractor. These fees and costs appear
to be recoverable regardless of whether the improved property
is commercial or residential. Moreover, these fees and costs
should be recoverable under this statute by subcontractors, even
if they never filed a mechanic's lien against the subject property
or their filed lien is later found to be invalid under other
provisions of Chapter 514.
Consequently, revised Section 514.02 may reduce the number and
necessity of foreclosures by subcontractors. Previously, subcontractors
were usually required to pursue costly mechanics' lien foreclosure
actions under Chapter 514 to recover attorneys' fees and costs.
This was their only option to recover attorneys' fees in those
cases where they had no attorneys' fees clause in their contract.
Hence, this statute, as revised, may now be a formidable weapon
to add to one's litigation arsenal of authorities allowing the
recovery of attorneys' fees in civil actions. However, it is
anticipated that subcontractors commonly will continue to use
foreclosures in those cases where property owners simply refuse
or fail to pay for improvements made to their properties.
Even if a property owner partially or fully pays their contractor
for the value of all improvements made to their property, subcontractors
may still foreclose upon the property if the general contractor
in turn fails to pay its subcontractors. Previously, property
owners in this situation could seek only criminal penalties,
including restitution, against their general contractor or attempt
to prove an often-difficult case for fraud and pierce of the
corporate veil to recover their loss. If the corporate contractor
did not possess sufficient assets to reimburse the homeowners
for their property loss, the homeowners needed to seek recovery
of their damages from the state of Minnesota Contractor's Recovery
Fund.
FORMIDABLE ADVANCEMENT
Section 514.02 now provides for a presumption of fraud and
explicitly allows a corporate pierce. Accordingly, homeowners
and subcontractors can pursue shareholders, officers, directors,
or agents of a corporate contractor who may not be responsible
for the theft, but who knowingly received proceeds of the payment
as salary, dividends, loan repayment, capital distribution, or
otherwise. This is a formidable advancement, as it is often much
easier to locate and attach the bank accounts and other assets
of a number of individuals, as opposed to those of their protected
or under-funded corporate entities. Moreover, these new statutory
remedies are not dischargeable in a general contractor's bankruptcy.
Section 514.02, subdivision 2 indicates that the wronged subcontractor
or homeowner may provide "notice of nonpayment" to
the paid contractor for the subcontractor's contributed improvements.
If such notice is given, it must be in writing and must identify
the subject real estate improved, along with the description
of nonpayment. However, this notice does not appear to be a strict
requirement to allow the recovery of damages under the statute.
Nevertheless, it is recommended that notice of nonpayment be
provided in each case to ease the claimant's burden of proof,
where applicable. If the claimant can later establish that the
general contractor failed to pay in full within 15 days after
receiving the notice of nonpayment, such proof will be sufficient
to sustain the court finding that the general contractor knowingly
used the proceeds for a purpose other than the payment of the
subcontractor's labor and materials. The general contractor may
then only rebut such a presumption by establishing that it did
use all received proceeds to pay for improvements to the subject
property. A standard demand letter identifying the subject property
should be sufficient notice of nonpayment under the new statute.
CONSTITUTIONAL QUESTIONS
While this recent statutory amendment is a significant development
in favor of homeowners and subcontractors, some of the new statutory
language may have rendered certain applications of the section
unconstitutional. In 1974, the Supreme Court of Minnesota held
that, even though the prior language of Section 514.02 did not
specifically require a finding of a general contractor's fraudulent
intent before subjecting the contractor to criminal penalties,
it did not violate Article 1, Section 12 of the Minnesota Constitution
prohibiting imprisonment for debt. The Court found that the statute
inherently established a "fiduciary relationship,"
which, if violated through fraud, allowed criminal liability.
[See, State v. Reps, 223 N.W.2d 780, 785-786 (Minn. 1974).]
This basis for criminal liability was not the general contractor's
failure to pay a debt, but rather the contractor's knowing violation
of a fiduciary trust.
However, revised Section 514.02 now explicitly states that the
statute does not create a fiduciary liability or tort liability
on the part of the general contractor receiving payment. Consequently,
it is questionable whether the criminal penalty portions of the
statute remain constitutional. It is unclear why the Legislature
explicitly removed any fiduciary liability elements from the
statute, when prior case law clearly required this element for
supporting the constitutionality of the statute. Further, the
language of the statute is now inconsistent, given that the statute
still requires that the proceeds of payment received by contractors
be "held in trust for the benefit of those persons who furnished
the labor, skill, material, or machinery contributing to the
improvement."
The Legislature may have wished to avoid imposing upon contractors
duties similar to a lawyer's rigorous fiduciary responsibilities
and obligations in connection with handling client funds. For
example, subdivision 1 of the statute specifically allows contractors
to commingle proceeds from property owners with their own funds.
By doing so, the Legislature has arguably made the statute vulnerable
to additional constitutional challenges.
While some of the revisions to Section 514.02 may have constitutionally
weakened the statute's criminal penalties, the revisions should
still considerably benefit homeowners and subcontractors in civil
actions. These entities may now attempt to pierce the corporate
structure of any contractor that knowingly converts homeowners'
funds originally provided to pay subcontractors. Also, these
entities, commercial property owners, and their subcontractors
may now attempt to recover all of their costs and disbursements,
including attorneys' fees and costs of investigation, incurred
in pursuing contractors that converted their proceeds. |
BRIAN H. LIEBO is an associate
attorney with Hellmuth & Johnson, PLLC. He is a 1997 graduate
of the University of Minnesota Law School. Mr. Liebo focuses
his practice on construction and business litigation, creditors'
remedies, and representing townhome and condominium associations. |
