Construction and the Law in Texas
The Construction Trust Fund Statute is a criminal law that applies to all construction projects in Texas. This statute states that payments on construction projects are trust funds if the payments are made to a contractor or a subcontractor under a contract for construction involving improvements to real property in Texas. Further, loan receipts are also trust funds under the statute if they are borrowed for the purpose of improving real property in Texas and if the loan is secured by a lien on the property. The breadth of this statute is such that virtually all payments on construction projects are deemed trust funds. The only funds on a construction project that seem to be exempt from the statute’s reach are contractor’s fees paid under a written cost-plus agreement.
Once funds are received by a contractor, and the contractor assumes control over the funds’ direction and payment to subcontractors and suppliers, a contractor and its officers, directors, and agents are considered trustees by the statute. Any artisan, contractor, subcontractor, supplier, laborer, and materialman, for whom those funds are deemed payable, is a beneficiary of the trust funds. Finally, the statute applies equally to both public and private construction projects and exempts only banks or other lenders, title companies and closing agents, and sureties from application of this statute.
What Obligations Does the Trust Fund Statute Place on Contractors?
Only in residential contracts is a contractor required to maintain a separate construction trust account for deposit and payment of trust funds. For commercial contractors, the statute does not require maintenance of a separate account for construction trust funds, but doing so is a prudent idea. The use of a general revenue account for all business obligations and construction project accounts requires clear record keeping to avoid accidental misapplication of trust funds.
A contractor “who, intentionally or knowingly or with intent to defraud, directly or indirectly retains, uses, disburses, or otherwise diverts trust funds without first fully paying all current or past due obligations… to the beneficiaries of the trust funds, has misapplied the trust funds.” The comingling of funds in a general revenue account or a construction account used for multiple projects does not defeat a trust created by the statute or eliminate a contractor’s obligation with respect to the trust funds.
Therefore, a contractor can violate the statute by receipt and deposit of funds earmarked for one beneficiary on a project and intentionally paying those funds to a different beneficiary on the same or another project, even if there was not specific intent to defraud the intended beneficiary. Because funds received from an owner are deemed trust funds for the specific beneficiaries to whom funds are owed from a specific pay application, inattentiveness to detail, lack of proper record-keeping, or a failure of oversight to direct funds specifically to the intended beneficiary can lead to a violation of the statute.
So What Happens if There is a Misapplication of Trust Funds?
If misapplication of trust funds occurs, the statute provides for criminal penalties enforceable through criminal prosecution. A misapplication of trust funds of $500 or more amounts to a Class A Misdemeanor. A trustee who misapplies trust funds with the intent to defraud is guilty of committing a third degree felony.
Given the common and factually specific details surrounding payment disputes on construction projects, the statute has built into it certain affirmative defenses to a violation for misapplication of trust funds. A contractor has an affirmative defense to prosecution if the trust funds not paid to the beneficiary were used by the contractor to pay actual expenses directly related to the construction project. This defense can only be invoked after the contractor gives notice to the requesting beneficiary that the funds are being used to pay direct expenses and that the beneficiary is not entitled to such funds. For example, if a subcontractor fails to pay a supplier and a payment bond notice is received by the contractor, the contractor may pay the supplier and divert those funds from the requesting subcontractor after giving written notice to the subcontractor of the contractor’s intent to pay the supplier to release the bond claim.
Contractors are not subject to civil penalties or lawsuits from subcontractors and suppliers based on this statute. This statute is strictly a criminal statute found in the Property Code which gives beneficiaries of trust funds the right to file a criminal complaint based on an alleged misapplication of trust funds. Ultimately, the decision to prosecute a trustee for misapplication of trust funds rests with the district attorney presiding over any complaint.
However, the lack of civil penalty in a lawsuit for breach of contract or nonpayment or an action on a bond does not, in and of itself, render the statute toothless. Any contractors receiving written notices or complaints about a misapplication of trust funds should be wary of possible
criminal sanctions or penalties. These criminal sanctions and penalties apply not only to the company but to officers, directors, and agents of the company who have control or direction of trust funds. Therefore, an individual in a company that controls or directs payment of trust funds, as defined under this statute, and intentionally, knowingly, or with the intent to defraud a beneficiary can be subject to criminal penalties that can include jail time.
–As seen in the December 2012 issue of Texas Contractor.