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Contractors Face Potential Criminal Penalties When They Accept Payment For Work Performed By A Subcontractor And, With Intent to Defraud, Fail to Notify The Payor Of The Contractor’s Debt To The Subcontractor, Resulting In A Loss To The Payor.

| Feb 2, 2014 | Uncategorized |


Contractors that subcontract for labor, services, materials, and/or machinery must not only satisfy their obligations to their subcontractors, but must also notify the project owner of those obligations. The failure to give such notice, with the intent to defraud, exposes the contractor to criminal liability if the owner suffers a loss as a result of the contractor’s failure to notify the owner of the contractor’s outstanding obligations.

In a June 2012 article in this space, we explained the difference between “pay if paid” and “pay when paid” clauses in construction contracts, and when the obligation to pay a subcontractor is triggered under each. That article, however, did not address the legal penalties a contractor may suffer if it accepts payment for work performed by its subcontractor, fails to pay the subcontractor, and intentionally fails to notify the owner, resulting in a claim, such as a mechanic’s lien, against the owner by the subcontractor. In brief, such conduct, when done with the intent to defraud, exposes the contractor to civil liability and also criminal penalties, including fines and imprisonment.

Rare is the construction project that does not involve at least one level of subcontractor. Many large projects utilize multiple levels of subcontracting, creating several links in the contractual chain connecting the owner of the project to the entity ultimately performing the work. On such projects, it is not uncommon for cost overruns, miscalculations, and financial difficulties to result in the failure to make full payment to one or more contracting parties. Often these failures lead to civil litigation for breach of contractual obligations and/or the assertion of mechanic’s liens against the property. When the failure to pay is arguably intentional and fraudulent, however, the penalties can also include a criminal conviction, fine, and imprisonment.

Beginning July 1, 2014, a major overhaul and reclassification will take effect in Indiana’s criminal code. The system that previously classified felonies by letter based on severity will be replaced with a new six level classification system. As part of this overhaul, a portion of Indiana’s Mechanic’s Lien statute will be amended to incorporate the new classification system. As of July 1, 2014, a violation of Ind. Code § 32-28-3-15 will now be a Level 6 felony, punishable by a sentence of between six months and two and one-half years in prison, and a fine of up to $10,000.00. I.C. § 35-50-2-7.

Indiana’s mechanic’s lien statute states that a person commits a Level 6 felony when he/she knowingly or intentionally performs labor, supplies services, or furnishes material or machinery in a construction project, accepts payment for the work, and at the time of accepting payment knows he/she is indebted to another for labor, services, materials or machinery used to perform the work, but fails to notify the party that made the payment of the outstanding debt, resulting in a loss to the party making payment. See Ind. Code § 32-28-3-15. While the foregoing sounds ominous and imposing, it is important to note that an essential element necessary to impose criminal liability under this statute is that the contractor must have the intent to defraud when he/she fails to notify the party making the payment of the contractor’s outstanding debt. See I.C. § 32-28-3-15(4).

In essence, the statute is designed to penalize those contractors who accept payment for work knowing that they are indebted to a subcontractor, fail to pay the subcontractor, and with intent to defraud fail to notify the party making the payment of the debt, resulting in a claim by the subcontractor against the paying party. For example, if a general contractor receives payment from an owner, but fails to pay its material supplier, the contractor may be exposed to criminal liability if, with intent to defraud, he/she failed to notify the owner of the outstanding obligation to the material supplier, and the material supplier ultimately prevails on a claim against the owner. See Miller v. State, 502 N.E.2d 92, 94 (Ind. 1986). Although this criminal liability provision appears in the section of the code addressing mechanic’s liens, it is important to recognize that a subcontractor or supplier need not perfect a mechanic’s lien against the owner’s property for the contractor to be criminally liable. Rather, the owner must merely suffer some loss as a result of the contractor’s failure to notify the owner of the outstanding debt to the subcontractor. Thus, any action by the subcontractor that results in a further obligation by the owner to the subcontractor will satisfy the requirement of the statute. Gamblin v. State, 568 N.E.2d 1040, 1046 (Ind. Ct. App. 1991). Again, it is critical to note that a mere mistake by the contractor is not likely to result in criminal liability. Rather, there must be evidence from which a jury could infer that the failure to notify the owner was done with the intent to defraud. See I.C. § 32-28-3-15(4).

In sum, while the potential for imposition of criminal liability on a contractor under certain circumstances is not new to the mechanic’s lien statute or Indiana law in general, the update to the criminal code reclassifies the level of felony applicable and sets new sentencing periods and fines for contractors who violate the statute. While contractors who act without the intent to defraud need not fear conviction under the statute, they should take care to avoid any appearance of intent to defraud, thereby avoiding the need to defend themselves against criminal allegations in the first place.