Do you know any criminals?
If you have worked in the construction industry for very long then the likely answer is, “Yes”! I’m not talking about folks that you believe are cheats, scoundrels and liars. Nope. Instead, I’m talking about contractors, subcontractors and owners that misapply funds for construction projects received for the benefit of those that furnish labor and materials. It is rare (in fact, I don’t know of a similar statute) to find a serious crime located outside of the Texas Penal Code. However, Chapter 162 of the Texas Property Code, commonly referred to as the “Texas Trust Fund Statute,” makes the misapplication of $500 or more a Class A misdemeanor. If a person intentionally misappropriates more than $500 then that act constitutes a third degree felony. Even failing to comply with banking and financial bookkeeping requirements constitutes a Class A misdemeanor! While it is difficult to convince a district attorney to prosecute white-collar financial cases, convictions have occurred. In 2014, a Tarrant County jury took just one hour to sentence a North Richland Hills contractor to prison for three years and assess a $10,000.00 fine. As noted by the Star-Telegram, Tarrant County has an economic crimes unit that investigates and prosecutes construction industry fraud.
What crime?
The Trust Fund Statute makes owners, contractors and subcontractors (and their officers and directors) trustees of the funds received for labor and materials used to improve real property. For example, a general contractor is only entitled to claim a very small portion of a payment received from an owner for project work. Most of the dollars received belong to the subcontractors and vendors. The statute makes the general contractor a trustee of the subcontractors’ and vendors’ money (trust funds). Because the money does not belong to the general contractor, if the money is knowingly, intentionally or fraudulently – retained, used, disbursed or diverted, without first paying past due obligations, the general contractor’s acts violate the trust fund statute and give rise to criminal and civil liability.
In addition to the misapplication of trust funds, the statute mandates keeping a construction account and bookkeeping records for each project. These records must detail the source and amount of funds, the dates and amounts of deposits and distributions and the retention of invoices and supporting documentation. This account should be kept wholly separate from the trustee’s own operating account. Failing to maintain the account constitutes a Class A misdemeanor punishable by a fine of up to $4,000, confinement in jail for up to one year or both.
Personal Civil Liability
However, the real hammer faced by trustees that misapply funds does not come from the threat of jail, creation of a criminal record or fines. Instead, most contractors and subcontractors exist as some type of corporate entity. That corporate entity generally creates a veil of protection for the corporation’s owners, directors and officers.
However, if an officer, director or agent directly or indirectly retains, uses, disburses or otherwise diverts trust funds then all corporate protection is lost and the beneficiaries of those funds can then sue the trustee as an individual making the trustee personally liable for corporate debts.
Defenses & Exemptions
Exceptions exist for banks, savings and loans, or other lenders as well as title companies, corporate sureties and closing agents. Trustees (owners, contractors & subcontractors) accused of violating the act can defend by proving that the funds not paid to beneficiaries were used to pay actual expenses directly related to the construction of the improvement, because the trustee has a reasonable belief that the claimant isn’t entitled to receive the funds or because other law permits withholding (e.g. retainage). It is also a defense that the trustee pays the beneficiaries all trust funds not later than 30 days following notice to the trustee of the filing of a criminal complaint or pending criminal investigation.
Leveraging the Liability
The liabilities created by the trust fund statute constitute another source of protection and collection tool for those in the construction industry. Untimely payment frequently results in demand letters. Notifying the trustee that if they diverted trust funds may provide the motivation required to effect payment to you. However, beneficiaries and the attorneys should proceed with caution in wording demands and should always avoid threatening criminal prosecution. Disciplinary Rule 4.04(b) prohibits presenting or threatening to present criminal charges solely to gain advantage in a civil matter. Contractual defenses to non-payment like defective work, breach of contract and contingent payment clauses will also defeat trust fund claims.