In an effort to minimize the amount of financial risk subs and suppliers take on, several states have enacted their own trust fund statutes. Each of the 15 states that have such statutes vary in their degrees of requirements and applicability. It’s important to understand the effects of these statutes since they have a significant impact on a project’s cash flow and remedies in case of non-payment.
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Arizona Trust Fund Overview
Arizona’s trust fund statute is narrowly tailored to specific construction projects. It does not contain any overly burdensome requirements but does impose some notable liability on behalf of the general contractor. The Arizona construction trust fund requirements are set out in Ariz. Leg. §33-1005. This statute states:
Monies paid by or for an owner-occupant to a contractor as payment for labor, services, materials… for which a lien is not provided… shall be deemed for all purposes to be paid in trust and shall be held by the contractor for the benefit of the person who furnished labor, services, materials…
Such monies shall neither be diverted nor used for any purpose other than to satisfy the claims of those for whom the trust is created and shall be paid when due to the person entitled thereto.
This effectively converts those payments received by the general contractor into trust funds. The money is “held in trust” in favor of those who furnished the corresponding labor or materials for which the payment is made. Which means it expressly prohibits the diversion or use of the funds for any other purpose, other than to satisfy the claims of those for whom the trust is created.
For further reading on trust fund statutes:
When does this requirement apply?
Unlike other state trust fund statutes, this is not a blanket rule for every construction project. This statute applies only to residential, owner-occupied construction projects. This limitation is intended to be a protection to payment where mechanics lien rights are otherwise not available. As §33-1002(2)(B) states;
“no lien shall be allowed against the dwelling of a person who became an owner-occupant prior to construction… except by a person having executed in writing a contract directly with the owner-occupant.”
Therefore, unless the contractor has a direct contract with the owner occupying the dwelling; they will be unable to file a mechanics lien. The trust fund statute is meant to add protection to lower tier participants on these projects. That’s because those subs and suppliers that aren’t protected by mechanics lien laws.
So it also stands to reason, that these requirements only apply to payments from the owner-occupant to the GC. If the owner is paying the subs directly, then this is clearly unnecessary.
Arizona construction trust fund requirements
When a prime contractor receives money from the owner on an Arizona residential project, the trust fund statutes are automatically applied. The payments are then held in a fiduciary capacity by the GC for the benefit of the subs and suppliers to the project. This not only imposes specific requirements on the prime contractor but also some significant liabilities.
Fiduciary duty imposed
It has been established that these statutes create an express or technical trust sufficient to establish a fiduciary relationship according to the case of In re Baird. A fiduciary duty is an obligation to act in the financial best interests of another party. However, unlike a lot of trust fund statutes, there is no requirement to keep the funds in a separate account.
Any violation of these requirements can expose the GC to personal liability for the unpaid amounts. Furthermore, it will also expose individual corporate officers, directors or owners to personal liability for misappropriation of funds.
Typically, corporate officers are shielded from the personal liability of their business. But it was established in Arizona Tile LLC v. Berger that if a high-tier contractor diverts money owed to you on a residential project, that company’s officers or directors cannot rely on personal liability protection that a corp or LLC normally provides.
Nor is the debt dischargeable in a bankruptcy court. The fact that the payments are converted into trust funds provides a certain level of protection. These funds are not only protected from third-party creditors, but also from any bankruptcy proceedings. That money is specifically held in trust for the benefit of the subs and suppliers who earned it.
Any statute that impacts the cash flow and payments on a construction project is worth noting. Without the protection of mechanics liens to fall back on, the Arizona legislature imposed this rule to protect lower tier party from the misappropriation of project payment funds.