Subcontractors have long celebrated—and general contractors long feared—the Texas Construction Trust Fund Act, codified in Chapter 162 of the Texas Property Code. The Act, which is (ideally) construed broadly to primarily protect subcontractors, provides that payments “made to a contractor or subcontractor . . . for the improvement of specific real property in this state” are trust funds, to be held in trust for subcontractors or suppliers of labor and materials. Tex. Prop. Code § 162.001(a). A contractor who receives such funds must therefore hold such funds in trust for the benefit of its subcontractors. If a contractor receives funds and “intentionally or knowingly or with intent to defraud, directly or indirectly retains, uses, disburses, or otherwise diverts trust funds without fully paying all current or past due obligations” to the subcontractor, the contractor has misapplied these funds. Id. at § 162.031(a). In short, it’s a law with teeth, designed to make sure that subcontractors get paid on the job once the contractor is paid by the owner.
However, the Act continues to be one of the of the most commonly misconstrued statutes in construction practice, and as a result contractors and subcontractors alike frequently find themselves incurring attorneys’ fees to assert claims and defenses that are inapplicable, or worse, severely prejudice their case risking dismissal under the Texas Rules of Civil Procedure. Here are some of the common pitfalls hidden within the Construction Trust Fund Act:
- Violators can be personally liable, even if they normally enjoy corporate protection. Business owners, officers or directors normally enjoy protection from liability for actions undertaken by corporations or companies. By the plain text of the Act, however, “a company owner, officer, director, or agent” can be a trustee under the Act. Prop. Code § 162.002. Contractors or owners should therefore note that any violation of the Act increases the exposure against any individual who actually has control over trust funds. This is important to keep in mind in the context of determining which parties to bring into a lawsuit, and also provides additional remedies in the event a corporation or company liable under the Act chooses to file bankruptcy.
- Owners can be liable—but only if the owner takes out a loan for the project. The Act provides that “loan receipts” can be considered trust funds if an owner takes out a loan for the purpose of improving specific real property, and the loan is secured by a lien on the property, either in whole or in part. Prop. Code § 162.001(b). An owner who receives such funds and diverts them in accordance with Chapter 162, rather than using them to pay contractors, creates liability under the Act. There is also some case law to suggest that a subcontractor may have a claim against the owner in such cases. See, e.g., Choy v. Graziano Roofing of Texas, Inc., 322 S.W.3d 276 (Tex. App.—Houston [14th Dist.] 2009, no pet.). Without receipt of loan funds, however, the owner does not commit a trust fund violation and there is no liability under the Act. Contractors who are not paid by the owner, or subcontractors who are not paid by the contractor, should therefore take care before asserting a trust fund action against the owner.
- Violations can result in criminal liability. Misapplication of trust funds constitutes a civil offense with a private right of action. More importantly, however, it can also give rise to criminal liability. Misapplication of trust funds amounting to $500 or more is a Class A misdemeanor, with up to one year of jail time. Such misapplication with an intent to defraud is a third degree felony, and can result in up to 10 years in prison.
- There’s an affirmative defense, but it has its limits. The Act provides an affirmative defense to a trustee who uses trust funds on “actual expenses directly related to the project” at issue. Prop. Code § 162.032(a). The Fifth Circuit takes a fairly broad view of what constitutes “actual expenses directly related to the project,” but the defense does have limits. The Fifth Circuit, for example, has stated that using trust funds to purchase “something frivolous, like a luxury company car” would constitute a violation of the Act. In re Monaco, 839 F.3d 413 (5th Cir. 2016). Owners or contractors subject to the Act should therefore exercise discretion on the use of trust funds that would be attributable to expenses unrelated to the project at issue.
There are plenty of other pitfalls and exceptions under the Act, particularly with residential projects that require specific accounting procedures. However, the basics of parties protecting their rights under the Act are fairly straightforward. For contractors to avoid trust fund liability, the path is simple: pay subcontractors timely and in accordance with each subcontract, and certainly once the owner has paid for the work. For subcontractors to take advantage of the Act’s protections, it is critical to know that the Act, while an important tool, is not a safe harbor for all instances of non-payment. Therefore, subcontractors need to be aware of other rights and remedies, such as lien rights under Texas Property Code Chapter 53 or Chapter 56, or other causes of action provided at law.
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