HENRY M. ZALESKI, Justice.
This is a representative action brought by Merit Plumbing and Heating (herein called "Merit") on behalf of itself and others entitled to share in trust funds claimed to have been received by the defendant, Eastern National Bank (herein called "Eastern") in connection with the improvement of certain property owned by the Board of Education of the Town of Babylon. The predicate for this proceeding is Article 3A of the Lien Law, Sections 70 et seq., which became effective September 1, 1959.
Specifically, insofar as his Court deems relevant to the basic issues, the facts are: On or about February 24, 1960 Merit as the prime contractor for the school job contracted with Norman J. Steel Construction Co., Inc. (herein called "Steel") as a subcontractor to perform certain labor and services, agreeing to pay therefor the sum of $82,000. Steel, in turn, also subcontracted part of the job which it had agreed to perform to several other contractors. Steel was adjudicated a bankrupt on August 30, 1960. On June 30, 1960, at the specific request of Steel, Merit addressed a letter to Eastern advising that there "is coming to Norman J. Steel Construction Co. the current requisition submitted to the Lindenhurst School District in the sum of $22,000. This check will be made out to Norman J. Steel Construction Company and Eastern National Bank. This check is due between July 15, 1960 and July 20, 1960 and will be forwarded immediately." Merit concedes that upon receipt of this letter a representative of Eastern telephoned the plaintiff to confirm its contents. Merit further admitted that since Steel had been paying out monies on the job and had requested that this check be made out to Eastern and Steel jointly, the inference derived therefrom was that "this man must have borrowed some money." On July 15, 1960, Merit received a check drawn jointly as aforesaid, which it turned over to Steel. At that time, Steel is claimed to have been indebted to Pelliceo Bros., Inc. in the sum of $26,852; to Andrew Carlson Sons, Inc. in the sum of $19,425; to Davis Construction Corp. in the sum of $500 and to D. Fortunato Inc. in the sum of $24,000. Carlson has assigned its claim to Merit for a consideration of $7,800 and Fortunato has likewise assigned its claim to Merit for $16,000. It should also be noted that Merit had filed with the School Board a completion or performance bond.
Much testimony was adduced at the trial with respect to the actual disposition of the check of $22,000. According to Eastern's testimony, Steel prior to the letter of June 30, 1960 was already then indebted to it for moneys advanced in the sum of $27,500; that Steel desired an additional sum of $5,000 for payroll purposes and that he had $22,000 due from Merit. Eastern in turn requested "a note or an assignment" and Steel then came in with the letter of June 30, 1960 as a result of which the additional.$5,000 loan was made. When the check was received Eastern repaid itself out of the proceeds for the last $5,000. loan, applied an additional $4,000 at Steel's request to his prior indebtedness and credited the balance of $13,000 to Steel's account. While Merit disputes the book-keeping aspect of the transaction and contends that Eastern applied the entire $22,000 to the account of Steel and then made a new loan of $13,000, this Court finds that out of the $22,000 proceeds the net result found $13,000 turned over to Steel and $9,000 retained by Eastern. The latter, therefore, in this Court's opinion, can only be charged with a diversion of funds, in such sum as it not only received but retained to the detriment of others. (American Blower Corporation v. James Talcott, Inc., 18 Misc.2d 1031, 194 N.Y.S.2d 630; aff'd, 11 A.D.2d 654, 203 N.Y.S.2d 1018).
Before determining whether. Eastern has diverted the sum of $9,000 to the detriment of Steel's subcontractors, it is necessary to examine the provisions of the statutes governing this matter. The Lien Law of this State contains a number of provisions defining specified funds as trust funds and was designed to protect those who had furnished services and materials. These provisions were mainly enacted between the years 1929 and 1934, and then clarified and extended by amendments in 1942. As a result of studies made in 1958 and 1959 by the Law Revision Commission, the present Article 3A was enacted effective September 1, 1959. No case, dealing with the particular provisions here invoked has been cited to this Court.
A review of the pertinent provisions made it clear that under Section 70, subdivision 6 and 7 two separate and distinct trusts are defined. Thus in subdivision 6 the "contractor" is made the trustee of funds received by it under a contract for improvement of real property while under subdivision 7 a subcontractor is the trustee also of funds received under the contract. These definitions applied to the instant case establish that Merit became the trustee of monies received from the School District of which Steel, among others, became beneficiaries. Such trust is inapplicable in this case.
Steel, however, did become a trustee of monies received, under subdivision 7 and it is with respect to this trust that this Court must decide whether a diversion of funds has occurred under Section 72 which in substance provides that "any transaction by which any trust asset is paid, transferred or applied for any purpose other than a purpose of the trust * * * before payment or discharge of all trust claims * * * is a diversion of trust assets" subjecting the transferee to the penalties provided in the preceding sections. Unquestionably, Steel as trustee of his trust, was guilty of a diversion of the entire sum of $22,000 since the statute reserved that sum for the benefit of his then unpaid subcontractors. Having already found that the bank used and applied only $9,000 of that sum in payment of its own debt or obligation, the question posed is whether liability may be asserted against Eastern as transferee of that amount.
[2, 3] This is not to say that Eastern did not possess a proper claim against Steel, but that claim, under the Statute, is subordinated to the claims of the materialmen who had performed their services and had the statutory right to rely upon the fact that payments made to Steel would be held as trust assets for their primary benefit. It should also be noted that the bank had every right to protect itself under Section 73 by `filing a "Notice of Lending" and then showing by way of affirmative defense that it had made advances to or on behalf of the trustee (Steel) which had actually been applied for the purpose of the trust. No such Notice of Lending was filed nor has any such affirmative defense been presented. Eastern concedes that it has no right to rely upon the affirmative defense provided by statute but argues that while constructive notice was not given, Merit had actual notice of the bank's claim and therefore may not contend that the failure to file a Notice of Lending was fatal to the bank's position. Merit, on the other hand, claims that its rights in the instant suit are derived solely from assignee materialmen who had no notice whatever of the advances made by the bank and perforce thereof, the bank can assert no greater claim against Merit in this representative action than it had against the assignees. Merit also argues that its liability under its performance bond is not a trust obligation but springs separately from that agreement. Therefore, in making payment to its assignors it was not paying trust claims against the trust of which it was a trustee. As to such trust claims Merit's position was at all times that of an assignee. It is important to distinguish the dual position of Merit in the posture of facts involved in this controversy. While it is true that actual notice might substitute for constructive notice, the fact is that the bank can derive no greater rights under the former. Had the bank duly filed its Notice of Lending, it was still required to affirmatively establish that the advances made were "actually applied for a purpose of the trust." (Section 73). There is no factual showing here that Steel used any part of the $5,000 advanced by the bank for such purpose or that any part of the bank loan against which the $4,000 was applied was similarly applied. Absent such showing there is no need to determine whether actual notice to Merit as an assignee precludes assertion of their rights.
By reason of the foregoing, it follows that a diversion of trust funds to the extent of $9,000 has taken place for which the defendant as transferee is accountable to those entitled to share therein. Merit's claim as assignee, however, is limited only to the extent of the consideration paid to its assignors.
The foregoing constitutes the required decision under Section 440 of the Civil Practice Act.
All motions made during the trial on which decision was reserved are now denied.
Submit judgment accordingly.