Inclement weather and natural disaster creates a plethora of business opportunities for contractors in the State of Texas. After property has sustained damage as a result of water, inclement weather or natural disaster, many property owners seek reimbursement for the cost of repair from the property insurance carriers. There are many avenues for contractors in our State to ensure that these proceeds are used to pay the outstanding obligation incurred by the property owner. Relief for contractors who are doing repairs as a result of an insurance claim can be found under the Misapplication of Construction Trust Funds Statute.
The Texas Property Code defines construction trust funds as construction payments if the payments are made to a contractor or subcontractor or to an officer, director, or agent of a contractor or subcontractor, under a construction contract for the improvement of specific real property in the State of Texas. Tex.Prop.Code §162.001. A contractor, subcontractor, or owner or an officer, director, or agent of a contractor, subcontractor, or owner, who receives trust funds, or has control or direction of trust funds, is a trustee of the trust funds. Tex.Prop.Code §162.002. Most importantly 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 § 162.031. Although the Property code clearly defines payments and loan proceeds as trust funds, insurance proceeds can also be classified as construction trust funds under three circumstances.
Assignment of Claim
The safest way for a contractor to protect their interest in payment when contemplating a project is to include in the contract for service, an assignment of claims. An assignment of claims is a clause within the contract itself that states, unequivocally, that the property owner assigns the rights to any claims, coverage, and or proceeds received in relation to the improvement made to real property under the contract.
Many times during the claims process the contractor will work directly with the insurance company in order to obtain estimates of the damage and/or work contemplated by the contract. During this process the contractor can provide the insurance company a signed assignment of claims so that they are aware and will then be able to work with the contractor directly in regards to payment. Once provided the assignment of claims, the payment process is simplified and all parties are aware of the existence of the contract for improvements and the owner can be held liable for any funds that are released from the insurance carrier for the property damage, that are then not subsequently paid to the contractor.
Another option for contractors is to include an agency clause within the contract. If the contractor is unsure if there are insurance proceeds or the property owner is reluctant to execute an assignment of claims, then an agency clause is a good option to consider. An agency clause is a statement within the contract indicating that the property owner acts as agent of the contractor in relation to any insurance claims, loan applications and payments received in relation to the improvements contracted for. Pursuant to the Texas Property Code, funds received by an agent of the contractor are indeed construction trust funds, and this clause would effectively turn any insurance proceeds received by the owner in relation to the project, construction trust funds. In the event these funds are received by the owner, and not subsequently paid to the contractor, the owner can be held liable for the misapplication of those funds. Additionally this clause can be listed as a disclaimer within the contract, and therefore owners who are reluctant to assign the entire claim, may be willing to enter into the agreement with the agency clause disclaimer.
Mortgage Company issued check
The last and most difficult way for insurance proceeds to be classified as construction trust funds is if the checks are issued with the contractor’s name. Many times if there is a mortgage loan on a property that sustains damages, then the insurance company is required to issue the funds directly to the mortgage holder. Pursuant to the terms of a standard Texas Deed of Trust, the homeowner is required to use these funds to make the repairs to the property. In order to protect their interests, the mortgage company may issue the check in the names of both the homeowner and the contractor. The act of issuing the check with the contractor’s name classifies the funds as construction trust funds pursuant to the Texas Property Code. In the event the funds are provided to the owner in this manner, the owner can be held liable for misapplication of construction trust funds. See In Re Coley, 354 B.R. 813 (Bankr. N.D. Tex. 2006).
It is important to note that the assignment of claims and agency clause are the two most secure and cost effective ways to ensure both a contractors entitlement to any insurance proceeds received by the homeowner in relation to the project. While a mortgage company’s involvement may give rise to construction trust funds, this option is a last resort, and is typically an investigative option used during discovery once litigation has begun for non-payment. Contractors can protect their interests on the front end by ensuring that all of their rights are fully accounted for within the contract for improvements. Hiring an attorney on the front end to ensure your rights are protected will save you costs in the end.