It is pretty universally accepted that construction payments and construction loan receipts should be prudently held and distributed. However, this is more than just a sound business practice–a failure to appropriately hold and distribute construction funds could actually land you in jail and bogged down in litigation.
The Texas Construction Trust Fund Act (the "Statute"), found in Chapter 162 of the Texas Property Code, regulates construction payments and loan receipts. The Statute expressly states that construction payments are trust funds if (1) the payments are made to a contractor or subcontractor, (2) under a construction contract, and (3) for the improvement of specific real property in this state. This also applies to loan receipts. The party who receives these funds is a trustee.
A trustee who, intentionally or knowingly or with intent to defraud, retains, uses, disburses, or otherwise diverts trust funds without first fully paying all current or past due obligations incurred by the trustee to the beneficiaries of the funds, has misapplied the trust funds.
Sounds like common sense, right? It might be, but the penalties for failing to adhere to these requirements can be quite stiff. A trustee who misapplies trust funds over $500 in violation of the Statute commits a Class A misdemenor. If the trustee misapplies those trust funds with intent to defraud, they may be guilty of a third-degree felony.
Since potential felony liability for failing to pay subcontractors sounds pretty harsh, it’s important to know exactly what "intent to defraud" means. A trustee acts with "intent to defraud" when he retains, uses, disburses, or diverts trust funds with the intent to deprive the beneficiaries of the funds.
In addition to potential criminal prosecution, misapplication of trust funds can also create civil liability–and hence, litigation. Because the holder of the construction payment or loan receipts is a trustee, there may be a fiduciary relationship with the beneficiary–at least with respect to the trust funds. Fiduciary relationships bring with them heightened duties, including loyalty and the utmost good faith, candor, integrity of the highest kind, and fair and honest dealing.
By failing to pay, the intended beneficiary could bring a lawsuit asserting, among other claims, breach of fiduciary duties. This is notable because an intentional breach of fiduciary duty opens up the possibility for punitive damages.
The Statute does establish affirmative defenses to claims of misapplication of trust funds. It is a defense that the trust funds not paid to the beneficiaries were used by the trustee to pay its actual expenses directly related to the construction or repair of the improvement or have been retained by the trustee, after notice to the beneficiary, as a result of the trustee’s reasonable belief that the beneficiary is not entitled to the funds.
It is also a defense that the trustee paid the beneficiaries all trust funds they were entitled to receive no later than 30 days following written notice to the trustee of the filing of a criminal complaint or other notice of a pending criminal investigation.
The Texas Construction Trust Fund Act underscores the need for good business practices with respect to construction payments. This Statute increases the potential penalties that may arise for failing to appropriately manage these funds. The key is to handle construction payments and loan receipts with great care.
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9 comments:
Dallas Cty Asst DA said they won't file a Trust Fund case unless all civil remedies are exhausted. Unfortunately I can see their point since a GC can just pay up (and has 30 additional days to do so) as an absolute defense or show that he used MY money to pay for other work or subs on the project...or am I missing something?
True, there are some affirmative defenses to claims of mishandling trust funds. However, the threat of personal criminal liability is very daunting, particularly when a third party (a district attorney's office) controls your destiny. Plus, other jurisdictions may not take the same approach as Dallas County (who still might take a more hardline view, depending on the amount of funds at issue).
Walker: Thanks for your articles. In regards to Trust Fund Statutes can attorney fees be recovered if it is a case solely on the Trust Fund cause of action?
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If a sub contractor fulfills their contract and was not paid in full because the job went over budget and fund were used to cover other expense on the job , can that be consider a misapplication funds under the T.C.T.F.A by the contractor.
any case law to support
Can this ACT be used in a defense if contractor has not received funds to pay subcontractors or suppliers???...
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