Most residential contractors who conduct their business through a corporate structure assume that their personal assets are shielded from the company’s liabilities and debts unless they are found to have committed a crime or misused the business for personal gain. Likewise, subcontractors and suppliers who work with such contractors may believe that their ability to seek payment is limited to claims against the business and not against the individual(s) controlling the business. Earlier this year, the Arizona Court of Appeals confirmed that individual officers and directors of a corporately structured residential contractor can be held personally liable for the company’s failure to pay its subcontractors and suppliers. Anyone who represents residential contractors, subcontractors or suppliers should take note of Arizona Tile, LLC v. Berger, 223 Ariz. 491, 224 P.3d 988 (App. 2010).
The case involved a countertop fabricator and installer, Design Surfaces, Inc., and its supplier, Arizona Tile. After Design Surfaces failed to pay, Arizona Tile sued the company as well as its officers and directors, Howard Berger and John McCarthy. After obtaining a judgment against Design Surfaces and garnishing what remained in its bank account, Arizona Tile pursued claims against Berger and McCarthy for breach of fiduciary duty arising out of A.R.S. § 33-1005.
The statute requires a “contractor” who receives payment from an “owner-occupant” for “labor, professional services, materials, machinery, fixtures or tools” to hold the money “in trust” for the person who provided the labor or materials. The statute also prohibits the contractor from using the money for any other purpose than to satisfy the subcontractor’s or supplier’s claim. The Court of Appeals found that Design Surfaces was obligated by the statute to hold funds it received from residential customers in trust for Arizona Tile. The court then addressed the more difficult issue of whether the officers and directors could be held personally liable for the company’s failure to pay.
In analyzing the personal liability issue, the court relied on a general principle of trust law which holds that an officer who causes a corporate trustee to breach its trust obligation is personally liable to the trust beneficiary for any loss caused by the breach. The court confirmed that the officer is personally liable even if he or she did not personally benefit from the transaction. Thus, in the residential contractor setting, the court found that, while officers and directors are not automatically liable for the company’s conduct, an officer or director is personally liable for failure to pay under 33-1005 if he or she participated in the decision(s) that led to the breach. Because Berger and McCarthy decided which accounts should be paid with the money received from Design Surfaces’ residential customers, the court affirmed the judgment against them for the company’s failure to pay Arizona Tile.
The court’s interpretation of A.R.S. § 33-1005 clears a path for recovery against individual officers and directors of corporately structured contractors under the following circumstances:
- the project for which the subcontractor or supplier provided labor or materials was an owner-occupied residential project;
- the contractor received payment for the subcontractor’s or supplier’s part of the job; and
- the officer or director personally participated in the decision to use the money for some other purpose.
As a practical matter, it should be noted that the court also held that attorneys’ fees were not available to the successful party because the claims against the officers and directors arose from statute, not contract. Thus, while the court’s ruling may invite more claims against corporate officers and directors, the attorneys’ fees analysis raises potential issues concerning the financial feasibility of such litigation.
Click here to read the October 2010 edition of Maricopa Lawyer.