ALBANY, N.Y.—Starting this week, scores of small businesses in New York may be forced to cease operations. Others could face liens on their property or have their income docked by the state.

For years, New York has threatened to go after businesses it says owe money to the fund that pays workers injured on the job. But the businesses say they are the victims of a fraud whose impact now totals nearly $1 billion.

The drastic action set to begin Tuesday by the state Workers' Compensation Board comes after 18 months of failed negotiations to get the businesses to cover part of the deficit caused by the bankruptcy of 17 group self-insured trusts.

A lawyer representing businesses in the eight trusts being targeted by the board said they would sue if the state proceeds.

“We either work with them,” said Rich Honen, an attorney with Phillips Lytle in Albany, N.Y., “or go to war.”

About 4,500 small employers around the state took part in the 17 trusts—funds formed by businesses in similar industries, like transportation, health care, manufacturing, government, retail and even cemeteries to pay workers' injury claims.

The trusts were managed by outside administrators responsible for setting premiums and making sure the companies they let into the trusts had roughly equal workplace safety records.

But they didn't, and the trusts failed. One administrator, Compensation Risk Managers, formerly of Poughkeepsie, N.Y., accounted for a majority of the bankruptcies. The state hit CRM with a $400 million fraud lawsuit, but got nothing as CRM and its parent company filed for bankruptcy.

Now the state is coming after the small businesses for the entire tab, saying the ones who joined the trusts were collectively responsible for workers' claims—a concept known as joint and several liability.

“That's kind of what they signed up for,” a Workers' Compensation Board spokesman said.

So far, 800 businesses in the eight trusts represented by Phillips Lytle have paid $48 million through repayment agreements with the state, the board said.

“All of this will be avoided if they simply contribute towards the workers compensation obligations of their own employees,” the spokesman said.

The board said workers' claims would continue to be paid. The total liability of the busted trusts was valued at $924.6 million in June. That number represents the estimated amount needed to pay future claims.

Mr. Honen said companies with employees currently drawing workers' compensation benefits would be the first targets, followed by companies whose claims are now closed.

Small businesses facing judgments say they are victims of a corporate Ponzi scheme and shouldn't be asked to pay more than they already have in premiums.

Precision Carpentry of Westchester, N.Y., belonged to the Elite Contractors Trust of New York, which was managed by CRM, but the trust went belly-up and now has a liability of $37 million. The state is asking the company to pay $355,000. The company doesn't want to pay, but a stop-work order would cripple its business.

“We feel stung,” said Sally Bartolotta, whose husband owns the business. “We feel this has been a giant Ponzi scheme. The state has shirked its responsibility from the start. We got audited statements from the beginning that said we were solvent. I don't understand how after eight years of oversight all of a sudden there's this huge, billion-dollar deficit and the Workers' Comp Board bears no culpability. It doesn't make sense to me.”

Jeremy Smerd is a reporter for Crain's New York Business, a sister publication of Business Insurance.