Misapplication of Construction Trust Funds

Danger Zone: Misapplication of Trust Funds

Ever find yourself in a situation where you aren’t sure where your next job or next payment is coming from? The current pandemic has made a lot of things uncertain, particularly when it comes to construction projects. What if the job shuts down? What if the state shuts down? Will you get paid? And if you have been paid, should you pay that money to your subs and suppliers when you don’t know when your next job or payment is coming in? The answer to these questions is simple: Pay your subs and suppliers for good and timely work if you have already been paid by the general contractor for that project. Not paying them could result in them accusing you of misapplying the construction trust funds. Our last blog discussed what to do when your trust funds have been withheld. What happens when you withhold the funds? Let’s take a look at the misapplication of trust funds.

To recap our last blog, misapplying construction trust funds means you have withheld or paid out funds from a specific project to another project, when you still owe debts on the project for which the funds were originally earmarked. Basically, you cannot rob Peter to pay Paul. You must use the funds received from a project, for that project, so long as you still owe debts for that project.

For example, you just finished the drywall and paint for a dental office, but haven’t been paid for it yet, and you still owe your laborers for their work on the Project. In the meantime, you were hired by a general contractor to perform drywall and painting services for an apartment complex. In order to complete your scope, you use a material supplier to provide you with the paint selections required under the contract. Once you have finished your scope for buildings one and two and submitted your pay applications that covered the cost of materials and labor for these two buildings, the job is put on hold for an undetermined amount of time. You don’t know when you will be called back to work. But you’re in luck, you just received payment from your work on that dental office! What do you do? Do you pay the suppliers and laborers who worked on the dental office? Do you pay off the balance owed to your paint supplier for the apartments? Or do you hold on to the funds because you don’t know if you’ll need it to pay your personal bills next month due to the job freeze?

The answer is: You must use the funds you received from the dental office, for debts you still owe for that project. So pay off your dental office laborers and suppliers first! If you use the funds for the apartments or your personal debts, you have misapplied the construction trust funds and may be held liable.

How is Misapplication of Construction Trust Funds Defined?

Misapplication of construction trust funds is defined under the Texas Property Code as:

“A trustee 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 incurred by the trustee to the beneficiaries of the trust funds, has misapplied the trust funds” Tex. Prop. Code Ann. § 162.031 (a).  Simply put, if the contractor uses money that should be paid to the subcontractors and does not pay the subcontractors, the subcontractor could have a claim against the contractor for the misapplication of construction trust funds.

Additionally, the owner of a company can be personally liable for the misapplication of construction trust funds. In order to be held individually liable, the Act requires that a beneficiary establish that an officer, director, or agent “directly or indirectly retains, uses, disburses, or otherwise diverts trust funds without first fully paying all current and past due obligations.”

So be aware, if you are someone that controls the money for the company, and then you misapply it, your subs and suppliers can not only come after your company but also you as an individual, which can have a negative impact on your credit and make your non-exempt personal assets vulnerable.

In addition, you may also be liable for criminal charges if you misapply construction trust funds.

Criminal Charges for Misapplication of Construction Trust Funds

The following are the penalties that could be faced by a trustee that misapplies trust funds:

  1. A trustee who misapplies trust funds amounting to $500 or more in violation of Chapter 162 of the Texas Property Code commits a Class A Misdemeanor, with a potential fine of up to $4,000 and up to one year in jail.
  2. A trustee who misapplies trust funds amounting to $500 or more, with intent to defraud, in violation of Chapter 162 of the Texas Property Code commits a third-degree felony which could result in potential fines up to $10,000 and jail confinement of no less than two years and no more than ten years.
  3. A trustee who fails to establish or (1) maintain a construction account and (2) maintain an account record for the construction account in violation of the requirements for both of these in contracts for residential construction contracts commits a Class A Misdemeanor, with a potential fine of up to $4,000 and up to one year in jail.

If you find yourself being accused of misapplying construction trust funds, all is not lost. You may be able to invoke several defenses to defeat this claim.

Contractor Defenses

The defenses include the following:

  • If the contractor used the funds to pay actual expenses related to the property;
  • If the Trustee has reasonable belief that the beneficiary is not entitled to the funds or the funds have been retained/authorized as required by Chapter 53 of the Texas Property Code; and
  • Trustee pays all the funds that a beneficiary is entitled to no later than 30 days following the written notice of a criminal complaint or other notice of a pending criminal investigation.

If you find yourself on the wrong end of a misapplication of construction trust fund claim, your first step is to verify your accounting to make sure all payments have been properly applied to the correct project, and any records of defective work are clear and recorded.

Conclusion

The Construction Trust Fund statutes are difficult to navigate on your own. Contact us here at The Cromeens Law Firm so we can help you walk through these statutes to make sure you are properly protected. Remember to sign up for our free Subcontractor Trust Funds Webinar next week, August 25th | 12pm. Kasey Niederhofer will teach you how those statutes can help you get reimbursed for what you’ve contributed to a construction project.

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