Storms are here, Contractors. How to protect Insurance Funds owed to you.

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 may also be treated as construction trust funds in some circumstances, though the law here is not fully settled.

Assignment of Claim

One strong way for a contractor to protect their interest in payment when starting a project is to include an assignment of claims in the contract. 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. An assignment of claims can make the owner contractually responsible to pay the contractor from any insurance proceeds they receive. It is important to know its limit in Texas. Most property insurance policies contain anti-assignment clauses, and Texas courts enforce those clauses even after a loss, so an assignment generally will not force the insurer to pay the contractor directly. The value of the clause is the owner’s contractual obligation to you, not control over the insurer.

Agency Clause

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. The idea behind an agency clause is that funds the owner receives as the contractor’s agent could be treated as construction trust funds under the Texas Property Code. No Texas court has squarely ruled on this, so treat it as a reasonable but untested position rather than a guarantee. It can still strengthen your contract, but do not rely on it alone to secure payment. If that theory holds, an owner who keeps the funds instead of paying the contractor could face trust-fund liability. Because it is untested in Texas, treat it as added protection, not a certainty. 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).

The assignment of claims and agency clause are two cost-effective ways to strengthen your claim to insurance proceeds, though each has the limits described above. Building these protections into your contract from the start is the most reliable approach. 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.