Construction payment can get complicated. Given the nature of the industry, subcontractors have to rely on GCs to properly manage their money before the release of funds into the payment chain. To help minimize these risks many states have enacted construction trust funds statutes to protect subs and suppliers against non-payment.
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What are Construction Trust Fund Statutes?
Construction trust fund statutes attach a trust to any funds paid to a contractor (and in some states – the subcontractor, too) for the benefit of the subs who have supplied labor/materials to a construction project. Contractors are required to hold on to construction payments in a fiduciary capacity to ensure that the subs get paid what they’ve earned. Fiduciaries owe a duty of loyalty to those whose money is held in trust. Thus, where construction trust fund statutes apply, contractors owe a duty of loyalty to subcontractors for payments held in trust. That means they can’t use these funds for any other purpose until all existing and potential claims have been satisfied, including any legitimate business overhead expenses.
Although the language and specific requirements vary, most of the statutes follow the same general structure. A typical statute will look something like this:
“Any monies paid under a contract by an owner to a contractor, or by the owner or contractor to a subcontractor, for work done, materials furnished, or both, for or about a building by any subcontractor, shall be held in trust by the contractor or subcontractor, as trustee, for those subcontractors who did work, furnished materials, or both.”
For those of you in Texas:
- Texas Construction Trust Fund Accounts – What is Required?
- Texas Construction Fund Act: What You Need to Know to Avoid Criminal Penalties
Overview of State Specifics
As with everything in the legal world, requirements can differ significantly from state to state. An understanding of how these statutes apply to your project can go a long way. Some versions are incredibly detailed with strict requirements and limited applicability. Others are broadly worded, applying to virtually any job and requiring minimal extra requirements in regards to the funds themselves.
Let’s take a look at how these statutes can vary across the country.
When Do Construction Trust Fund Statutes Apply?
Some state statutes distinguish between public and private projects. For instance, Arizona has a trust fund statute that applies only to owner-occupied residential projects. Other states, such as Colorado and Oklahoma, state that the trust obligation only applies to funds that could be the subject of to a mechanics lien. It stands to reason that the trust obligations in these states would be inapplicable to public projects since mechanics liens do not attach to public property.
What Remedies are Available?
The type of remedies available to a subcontractor for the misappropriation of trust funds also hinges on what state where the project is located. States like Arizona provide for civil remedies such as attorney’s fees or interest on the trust (and recovery would need to be initiated by legal action). Other states, like Georgia, for instance, might only provide criminal penalties. In those cases, that means there’s no private cause of action for unpaid subs based on a construction trust fund. Some states will actually provide for both civil and criminal penalties.
Are There any Procedural Requirements?
A majority of states with construction trust fund statutes don’t specify any strict procedural requirements of how to manage the money itself. In Maryland, the statute expressly states that the funds don’t need to be in a separate account. Nor does it consider the commingling of trust funds with other money is not considered a violation. Conversely, the New York construction trust statute requires detailed accounting and record keeping to be compliant. And Texas goes further by requiring a completely separate account as well.
The Bankruptcy Dilemma
When a contractor files bankruptcy, it can seem virtually impossible to recover payment from them. What happens to a construction trust fund when a contractor files for bankruptcy when holding construction trust funds? If that contractor hasn’t paid money they’re holding in trust, can they avoid making the payment due to bankruptcy?
This problem is solved in the Bankruptcy Code. Section 541(d) states that “property in which the debtor holds only legal title, and not equitable title becomes part of the debtor’s estate.” If there is a valid trust in existence, “the property of the debtor held in trust at the time of filing bankruptcy petitions are excluded from the estate.”
Translation? Trust funds will be excluded from becoming part of the bankruptcy estate. This is a fail-safe provision to ensure that the contractor’s other debtors won’t be able to go after the construction trust fund!
It’s essential for anyone on a project, from owners to suppliers, to understand their state’s construction trust fund statute. After all, these statutes affect the cash flow on the entire project. They can provide useful remedies, but they are tied to significant obligations and penalties. Especially for the party charged with holding the funds in trust. Compliance with any procedural requirements is crucial to avoid liability under a construction fund statute.