There are a few states that have enacted trust fund statutes to protect payments to sub-tier project participants. California has no trust fund statute on the books. However, trust fund clauses in a construction contract have been upheld as enforceable in California. If drafted properly, they can provide the same benefits as a statutory trust fund.
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Construction trust fund statutes
As of this writing, only 15 states have enacted construction trust fund statutes to varying degrees. Some are blanket requirements like South Dakota. Some apply only to public projects (like in Washington). And some cover only very specific types of projects (like in Arizona); which only applies to owner-occupied, residential projects.
Just because there is no construction trust fund statute doesn’t mean that this practice is non-existent in California. Many construction projects in California have decided to add this provision into their contracts.
For further reading on construction trust fund statutes:
Express trust fund clauses
An express trust fund clause is a way to add protection to the project funds distributed by the owner. The effect of such clauses requires that the payments made from the owner to the general contractor are to be held in trust for the benefit of those who performed the work.
Drafting a trust fund clause
Trust fund provisions should be drafted carefully due to the impact on payments and liabilities. Generally, these clauses should meet the same criteria required by the state to create a normal trust.
According to California law, the trust document must clearly establish an intent to create a trust, designation of a trustee and identification of trust property (i.e., the payments from the owner) and identification of the beneficiaries (the subs and suppliers).
Additional considerations parties may want to include are provisions stating how the funds will be distributed, and if a separate account is necessary. Many state trust fund statutes require the funds that are held in the trust to be deposited in a separate trust fund account in order to avoid the commingling of funds.
These types of clauses are typically required by the owner, and in some cases drafted to impose the same requirements on subs to their subs or suppliers.
Trust fund clauses are enforceable in California
The question of whether such clauses are effective and enforceable in California was the subject of In re Gonzales. The provision, included in a subcontract, provided that all money received by the subcontractor from the GC constituted a trust fund for the benefit of the persons supplying labor and materials.
The clause further stated that the funds should not in any instance be diverted for any other purpose until all obligations arising hereunder have been fully discharged. The courts, in this case, determined that the trust fund provision was not only enforceable but also imposed a fiduciary duty on the part of the contractor receiving the funds.
Who benefits from trust fund provisions?
There are two main advantages to establishing a trust provision within a construction contract. First and foremost, the funds will be protected from third-party claims. Trust fund provisions basically allow parties to contractually bypass lenders and creditors and maintain their priority to payment. Trust funds are held exclusively for the best interests of the beneficiaries.
The second reason is the level of accountability the trust would provide. By imposing personal liability at each tier of the payment chain, everyone becomes responsible for ensuring payment on the project. This is clearly a benefit to lower-tier parties, but also to the owner as well. Owners who decide to include these provisions are proactively avoiding lien claims on their property. If everyone is responsible for ensuring payment, the threat of lien claims is eliminated.
Although there are no statutory trust fund requirements, the California legislature has enacted other laws to protect subcontractors from non-payment. Specifically, §218.7 which requires California GC’s to pay subcontractor wages.