Phillips Way, Inc. v. Presidential Financial Corp.

ADKINS, Judge. In this case, we must determine whether an accounts receivable lender is a “subcontractor” within the meaning of the Maryland’s construction trust fund statute, Md.Code. (1974, 1996 RepLVol.), § 9-201 et seq. of the Real Property Article (“Construction Trust Statute”). The Construction Trust Statute makes contractors and subcontractors liable in trust for monies paid to them for work done or materials furnished for a building by a subcontractor.

Phillips Way, Inc., appellant, contends that the Circuit Court for Baltimore City erred in dismissing its complaint against Presidential Financial Corpo ²¹² ration of the Chesapeake (“Presidential”), and its officers and managing agents, Richard Sinclair, Nicole Imhoff, and Amy Eads (collectively “appellees”), 1 under the Construction Trust Statute. On appeal, appellant presents two questions, which we have rephrased: I. Whether the circuit court erred by dismissing its complaint without conducting a hearing on the merits, and apparently without considering its written position on the merits.

II

Whether a cause of action was alleged against appellees under the Construction Trust Statute on grounds that either: (a) Presidential was a “subcontractor” within the defined meaning of the statute, or (b) Presidential exercised control over the disbursement of construction funds with knowledge that they were trust funds. We hold that none of the appellees were “subcontractors” within the meaning of the Construction Trust Statute. Presidential, however, can potentially be held liable under the statute if it exercised control over trust funds with knowledge that they were trust funds used to pay other debts of the subcontractor-trustee. Because these issues are reviewed as a matter of law based upon the pleadings, there is no need to address appellant’s first issue, whether the trial court erred in failing to consider appellant’s written opposition to appellant’s motion to dismiss.

See State v. Jones, 103 Md.App. 548, 606 , 653 A.2d 1040 (1995) (on questions of law, appellate courts apply the nondeferential de novo standard of review). FACTS AND LEGAL PROCEEDINGS Because this appeal is from the grant of a motion to dismiss, all of the recited facts are taken from the allegations in the ²¹³ amended complaint. 2 Appellant was the general contractor on two public construction projects at the Baltimore City Community College (“BCCC”) and Crofton Elementary School (“Crofton”) (collectively “the Projects”). Appellant entered separate subcontracts with Power, Alarm and Communications, Inc. (“PACS”) to perform electrical alarm and communication works on these projects. In furtherance of these subcontracts, PACS entered into a number of subcontracts.

On the BCCC project, PACS contracted with Capital Lighting and Supply, Inc., (“Capital Lighting”) to provide materials. On the Crofton project, PACS contracted with Capital Lighting to provide materials, with Baltimore Sound Engineering, Inc. (“Baltimore Sound”) to provide work and materials, and with Electrical Workers Union Local No. 26 (the “Union”) to provide labor. Presidential, an accounts receivable lender, advances money based upon the accounts receivables of borrowers. Presidential entered into a contract with PACS to lend money to PACS, with the loans secured by a security interest in PACS’ accounts receivable.

As general contractor, appellant made a number of payments for work performed on the two projects, by checks made payable jointly to PACS and Presidential, totaling $84,183.62. These payments were made “on behalf of Capital Lighting, Baltimore Sound and the Union, all of which provided work and/or materials to PACS on the Projects.” PACS transferred and indorsed these checks to Presidential for the purpose of paying creditors other than PACS’ subcontractors. Presidential had actual knowledge that these checks were being used to pay such other debts of PACS. PACS subsequently went out of business and never made payment to Capital Lighting, Baltimore Sound, or the Union.

Presidential has refused appellant’s request to return the funds or to use them to pay Capital Lighting, Baltimore Sound, and the ²¹⁴ Union. Capital Lighting, Baltimore Sound, and the Union have made claims against appellant’s payment bond on the Projects. On November 8, 1999, appellant filed suit under the Construction Trust Statute against appellees to recover the funds paid jointly to PACS and Presidential. On December 22, 1999, appellees filed a Motion to Dismiss or in the Alternative Motion for Summary Judgment (“Motion to Dismiss”), contending that no cause of action existed against them under the Construction Trust Statute.

They argued that, “[i]n its capacity as a lender for PACS, [Presidential] is not subject to the prescriptions of statutory provisions that govern trust relationships in the construction industry.” The parties agreed to extend appellant’s time for answering the motion to dismiss. On January 4, 2000, appellant sent a letter confirming their agreement with a copy to the circuit court. The parties then made a further agreement to extend the response time until January 21, 2000, and a confirming letter dated January 17 was sent to the court. Due to an inadvertence in the clerk’s office, these two letters were not entered into the record until June 15, 2000.

In accord with the parties’ agreement, appellant filed a response to appellees’ Motion to Dismiss on January 21, 2000. Despite the agreed-upon extensions, the circuit court signed an order granting appellees’ motion on January 14, which was docketed on January 27, 2000. The court noted that “no opposition ha[d] been filed” by appellant, and granted the motion “for the reasons stated in [appellant’s] supporting memorandum.” Prior to the docketing of this order, on January 21, 2000, appellant filed an Amended Complaint. On February 2, 2000, appellant filed a Request for Hearing and a Motion to Alter or Amend Judgment (“Motion to Alter or Amend”).

This motion requested that the court “rule upon said Motions after due consideration of all Oppositions, Replies and oral arguments.” ²¹⁵ A motions hearing was scheduled for March 10, 2000. On March 3, 2000, the circuit court entered an order denying appellant’s motion without explanation. 3 This appeal followed. DISCUSSION The Construction Trust Statute governs trust relationships among contractors in the construction industry. Section 9-201 provides, in pertinent part: (a) Definition.— For the purposes of this subtitle, “managing agent” means an employee of a contractor or subcontractor who is responsible for the direction over or control of money held in trust by the contractor or subcontractor under subsection (b) of this section.

(b) Moneys to be held in trust.—(1) Any moneys paid under a contract by an owner to a contractor, or by the owner or contractor to a subcontractor for work done or materials furnished, or both, for or about a building by any subcontractor, shall be held in trust by the contractor or subcontractor, as trustee, for those subcontractors who did work or furnished materials, or both, for or about the building, for purposes of paying those subcontractors. (2) An officer, director, or managing agent of a contractor or subcontractor who has direction over or control of money held in trust by a contractor or subcontractor under paragraph (1) of this subsection is a trustee for the purpose of paying the money to the subcontractors who are entitled to it. Any officer, director, or managing agent of a contractor or subcontractor who knowingly retains or uses trust funds for purposes other than paying the subcontractor for whom the money is held in trust is personally liable for damages. See RP § 9-202. “Owner,” “contractor,” and “subcontractor” “have the same meaning as in § 9-101 of [subtitle 1 governing ²¹⁶ mechanic’s liens].” RP § 9-204(c).

Section 9-101 provides the following definitions: (d) Contractor.—“Contractor” means a person who has a contract with an owner. (f) Owner.—“Owner” means the owner of the land except that, when the contractor executes the contract with a tenant for life or for years, “owner” means the tenant. (g) Subcontractor.—“Subcontractor” means a person who has a contract with anyone except the owner or his agent. The Court of Appeals has recognized that the purpose of the Construction Trust Statute is “to protect subcontractors from dishonest practices by general contractors and other subcontractors for whom they might work.” Ferguson Trenching Co., Inc. v. Kiehne, 329 Md. 169, 174-75 , 618 A.2d 735 (1993).

I. Presidential Is Not A “Subcontractor” Under The Construction Trust Statute Appellant contends that Presidential is per se hable as a trustee because it falls under the section 9-101(g) definition of “subcontractor.” The definition contained in section 9-101(g) is broad, and encompasses “a person who has a contract with anyone except the owner or his agent.” The Court of Appeals, however, has recognized that “[t]he extremely broad definition of ‘subcontractor’ is narrowed by § 9-101(b) which defines ‘contract’ as ‘an agreement of any kind or nature, express or implied, for doing work or furnishing material, or both, for or about a building as may give rise to a hen under this subtitle.’ ” National Elec. Indus. Fund v. Bethlehem Steel Corp., 296 Md. 541, 545 , 463 A.2d 858 (1983). Applying this restriction, Presidential is not a subcontractor as contemplated in section 9-101 because it neither did work nor furnished materials on the Projects.

Appellant contends that the section 9-101(c) definition of “contract” should not apply because section 9-204 “expressly imports three ... definitions from Subtitle 1—‘owner,’ ‘contractor,’ and ‘subcontractor,’ [and] the legislature specifically ²¹⁷ opted not to import the definition of ‘contract’ from Subtitle 1.” We are persuaded, however, by appellees’ argument to the contrary. It is a well-established rule of statutory construction that legislative intention “is to be discerned by considering [a statute] in light of the statutory scheme.” GEICO v. Ins. Comm’r, 332 Md. 124, 132 , 630 A.2d 713 (1993). In taking this broader perspective, we are persuaded that the definition of “subcontractor” in section 9-101(g) contemplates incorporation of the definition of “contract” from section 9-101(c).

To hold otherwise would create an illogical result by requiring an inconsistent definition of “subcontractor,” depending on whether the mechanic’s lien provisions of Subtitle 1 or the Construction Trust Statute provisions of Subtitle 2 are applicable. Moreover, utilizing the section 9-101(c) definition of “contract” is consistent with the purpose of the Construction Trust Statute—to protect subcontractors from dishonest general contractors and other subcontractors “for whom they might work.” Ferguson Trenching, 329 Md. at 174-75 , 618 A.2d 735 . If we followed appellant’s interpretation, any party doing business with PACS for any purpose could potentially face liability under the Construction Trust Statute if it received funds that were intended to pay subcontractors. A contracting business would be required to investigate PACS’ practices and ensure that any funds received that are earmarked for subcontractors are actually paid to subcontractors—or risk liability under the Construction Trust Statute.

Obviously, the Construction Trust Statute is not intended to impose such sweeping responsibilities and liabilities. Accordingly, we hold that Presidential does not fit the statutory definition of “subcontractor,” and therefore is not per se liable under section 9-201 for retaining the funds.

II

Appellees May Be Liable As Involuntary Trustees With Knowledge As an alternate theory of liability, appellant asserts that appellees stand in the position of “involuntary trustees” who ²¹⁸ hold the proceeds of the construction funds in trust because they accepted them with knowledge that they were construction trust funds. Appellant relies on Sandpiper North Apartments, Ltd. v. American Nat’l Bank and Trust Co. of Shawnee, 680 P.2d 988 (Ok.1984). Appellees oppose this theory of recovery, arguing that it would be against public policy to subject lenders to such liability because it would unduly impose upon lenders the obligation to monitor the financial records of their borrowers. Because we have found no Maryland case on point, we will examine the out-of-state authorities and treatises to explain our decision.

A. Out-Of-State Law Regarding Third Party Dealings With Trustees The only case that we have found to be factually apposite is Sandpiper North, cited to us by appellant. In that case, Sandpiper hired a general contractor, who in turn hired Midwest Engineering as a subcontractor. Midwest obtained financing from American National Bank and Trust Co., and “assigned to the Bank the proceeds of its subcontracts as security for loans made with the [contractor's knowledge.” Id. at 986. Under the agreement, Midwest and the bank were to be made co-payees of checks for work done on the projects.

After Midwest failed to keep the projects free of liens, the general contractor sued Midwest and the bank for restitution of payments not applied to discharge valid liens. The general contractor argued that under the Oklahoma construction trust fund statute, 4 “Midwest and the Bank became ‘co-trustees’ of all the progress payments made to Midwest.” Id. ²¹⁹ The court rejected the general contractor’s contention that liability under the statute extends to any party receiving any money. The court did, however, hold that the bank may be liable if it had knowledge that the funds were to be used as trust funds earmarked for subcontractors. The Legislature’s intent doubtless was that the named recipients be charged with a fiduciary duty over construction funds.

The term ‘recipient,’ within the context of these enactments, denotes one who is in control of the trust funds and is thus able to effect their disbursement.... If some person other than a statutorily identified recipient is found to have actually exercised control over disbursement of any money, knowing it to be a part of the trust funds, that person may be regarded pro tanto as an involuntary trustee. But the mere fact that one other than a statutory trustee is actually able, or has the opportunity, to control the application of some or all trust funds is alone insufficient to cast that person in the role of involuntary trustee. The involuntary trustee status may be imposed only on one who knowingly takes charge of the trust res, or any of its parts.

A lender may thus become liable qua trustee of a construction trust res over which it assumed to exercise control and from which money came to be wrongfully diverted or misapplied. Id. at 988 (emphasis in original). The court held that the Bank would be entitled to proceeds out of the trust fund to the extent that Midwest was permitted to keep funds as a lien claimant on the project. Sandpiper, 680 P.2d at 989 .

When we consider Sandpiper in light of general principles regarding third persons dealing with trustees, we find the reasoning in Sandpiper to be persuasive. Cf. Ins. Co. of North America v. Genstar Stone Products Co., 338 Md. 161, 184-85 , 656 A.2d 1232 (1995) (citing the quoted reasoning of Sandpiper with approval in the context of determining when a materialman would be treated as a trustee under the Construction Trust Statute).

George G. Bogert, in the The Law of Trusts and Trustees, (Rev.2d ed.1983), applies analogous rules of liability to third persons dealing with a trustee: ²²⁰ [T]he beneficiary has a right that no third person shall knowingly aid the trustee in committing a breach of his duties. There is no dispute with regard to this principle but there are many difficulties in deciding whether certain conduct amounts to participation in a breach.... If a third party takes part with the trustee in a breach of trust, the alternative remedies of a money claim or tracing of trust property may be applied to him.... Bogert, § 868, at 103-104.

Bogert identifies two elements for wrongful participation in a breach of trust: “(l)an act or omission which furthers or completes the breach of trust by the trustee; and (2) knowledge at the time that the transaction amounted to a breach of trust, or the legal equivalent of such knowledge.” Id., § 901, at 311. Bogert also has addressed the situation when, as here, the third person is an individual creditor of the trustee: There is general agreement that if a person who has a claim against the trustee in his individual capacity accepts from the debtor, in payment of the debt, or as security therefor, property which the creditor knows or should know is trust property, the recipient takes part in a breach of the fiduciary obligation. Id., § 904, at 332, 336. Section 288 of the Restatement (Second) of Trusts (1958) (“Restatement”) recognizes a similar rule. “If the trustee in breach of trust transfers trust property to a person who takes with notice of the breach of trust, the transferee does not hold the property free of the trust, although he paid value for the transfer.” With regard to the thorny question of what constitutes notice of the breach of trust, the Restatement explains: A person has notice of a breach of trust if (a) he knows or should know of the breach of trust, or (b) by statute or otherwise he is subjected to the same liabilities as though he knew or should have known of the breach of trust, even though in fact he did not know and had no reason to know of the breach of trust. ²²¹ Restatement, § 297.

Comment a of section 297 elaborates on what constitutes notice of a breach of trust. A third person has notice of a breach of trust not only when he knows of the breach, but also when he should know of it; that is when he knows facts which under the circumstances would lead a reasonably intelligent and diligent person to inquire whether the trustee is a trustee and whether he is committing a breach of trust, and if such inquiry when pursued with reasonable intelligence and diligence would give him knowledge or reason to know that the trustee is committing a