ConstructionPro Week, Volume: 3 - Issue: 44 - 10/31/2014

Should Shareholders Be Personally Liable for Diversion of Progress Payments?

By Bruce Jervis

If a contractor receives a progress payment covering work performed by subcontractors and then fails to use those funds to pay the subcontractors, it is almost certainly a breach of contract. A Missouri court recently ruled it was also civil conspiracy and fraud.

A Missouri construction company was a corporation owned by three shareholders. Those individuals diverted progress payment funds to their own use, leaving subcontractors unpaid. The three shareholders were held personally liable for actual and punitive damages. The court said intentional misrepresentation and misappropriation of the funds distinguished this situation from a “garden variety” breach of contract case.

There were aspects of this situation that understandably angered the court. The shareholders not only paid their own salaries and health insurance premiums, but they made car and cell phone payments without paying the subcontractors. They drew the corporate bank account down to $500 before filing for corporate bankruptcy.

On the other hand, this was not the first small, closely held business to play fast and loose with progress payment proceeds. Some of the payments, such as officers’ salaries, were legitimate corporate expenses. Holding corporate shareholders personally liable for punitive damages is a severe sanction. What is your opinion? Did the punishment fit the offense?

COMMENTS

Shareholders are not authorized to divert corporate funds. Corporate officers and directors will be held to account for redirecting funds. If the participants in this case wear both hats, they must be very careful to act within the authority of their corporate role. Ignorance of corporate law is no excuse.
Posted by: James Shiers - Friday, October 31, 2014 11:13 AM

The Subcontractor should be paid with the money asked for in the pay application. Owners salary should be last, they would have the money if they did not piss it away.
Posted by: Chuck Strickland - Friday, October 31, 2014 11:18 AM

This is not uncommon, it goes further in that some prime contractors always survive on their subcontractors and suppliers by delaying payment to them after getting their progress payment. I know some primes who are now having a hard time getting subs to provide quotes. Usually these are the same contractors that also that put the low sub's quote in their bid; then re-bid the sub work after getting the award. These type contractors also do the same when negotiating change orders. I see a trend in my clients to write subcontracts fairly and honestly, pay their subs per that contract, and keep their subs involved in the project management/progress process. We all wish more states would pass laws to forbid bid shopping, eliminate pay when paid clauses. Then the subcontractors have a better shot at staying solvent. The case stated is the "worst case" problem, others are just letting their subs finance the project; so they pad their profit greater than bid and avoid borrowing for their own business cash flow.

This is all one reason we (our firm and our clients) stay with federal contracts, there are more checks and balances. They thigs I stated still crop up. Payment and Performance Bonds are a better solution than mechanics liens.

Ron
Posted by: Ronald Vietmeier - Friday, October 31, 2014 12:06 PM

What is the statue of limitation for such claims
Posted by: Jerry - Friday, October 31, 2014 12:12 PM