Texas Construction Trust Fund Act: All You Need to Know

Along with mechanics liens, bond claims, stop notices, and prompt-pay statutes, state statutes penalizing the misallocation of funds are supposed to make sure construction industry participants are paid what they have earned. Misallocation of funds laws do this by providing penalties designed to keep the project’s funds in the right place – so that they go to the proper parties. Many states have laws regarding this known as construction trust fund statutes.

The Texas Construction Trust Fund Act codified this type of misallocation of funds provision and provides criminal penalties for missteps. Under the Act, certain construction payments are designated as funds held in trust for the benefit of the project participants, and in certain circumstances, a “construction account” is required.

Texas Construction Trust Fund Act requirements

The Texas Construction Trust Fund Act can be found under Texas Property Code §162.001 et seq., and defines most “construction payments” as trust funds. However, fees that are payable to the contractor are excluded from the definition of “trust funds” if:

(1) the contractor and property owner have entered into a written construction contract for the improvement of specific real property in this state before the commencement of construction of the improvement and the contract provides for the payment by the owner of the costs of construction and a reasonable fee specified in the contract payable to the contractor; and

(2) the fee is earned as provided by the contract and paid to the contractor or disbursed from a construction account described by Section 162.006, if applicable.

The outcome of designating payments as trust funds are that there must be beneficiaries of the trust fund, as well as trustees that have a fiduciary duty to those beneficiaries. Under the Texas act, a trustee is “a contractor, subcontractor, or owner or an officer, director, or agent of a contractor, subcontractor, or owner, who receives trust funds or who has control or direction of trust funds.”

Likewise, beneficiaries of the trust are defined as any “artisan, laborer, mechanic, contractor, subcontractor, or material-man who labors or who furnishes labor or material for the construction or repair of an improvement on specific real property” and any property owner on a residential construction project.

Construction account requirements

There are many requirements and exceptions in the statute, and while placing the funds into a “construction account” (with certain requirements) is required on homestead residential construction projects over $5,000, not much guidance is given to the practical setup of the account.

The rules for a construction account in the state of Texas are simply:

1. The account must be in a financial institution;
2. The statements from the financial institution must refer to the account as a “construction account”;
3. Only trust funds can be placed into or maintained within the account;
4. The contractor must maintain an account record  that tracks:
   • a.  information relating to the source and amount of the funds in the account;
   • b. the date the funds were deposited;
   • c. the date and amount of each disbursement;
   • d. the person to whom the funds were disbursed; and,
   • e. the current balance of the account.

While there are a lot of specific requirements, the practical method of creation of the account does not appear to be one. Provided the account is in a financial institution, is noted on statements as a “construction account,” an account record is kept, and only appropriate funds are contained therein, the account itself would appear to meet the requirements.

Project account record requirements

Along with the construction account record, the contractor must comply with requirements for maintaining a project account record for all of the contractor’s projects. The project account record must keep track of each project with respect to the project costs, invoices, and supporting information related to the project funds.

The rules for a project account record are:

1. It must specify the direct costs and indirect costs charged to the owner.
   (Direct and Indirect costs are defined by the Texas Property Code)
2. Retain all invoices and other supporting documentation received relating to funds that were disbursed from the construction account.
3. Ensure that all deposit and disbursement documentation include the construction account number or information that provides a direct connection between the documentation and the account.
4. Keep the above information for at least one year from the date of completion of the improvement.

Penalties

While a civil cause of action for beneficiaries related to a trustee’s misapplication of construction funds is not specifically contemplated by the Act, such suits are allowed by Texas court decisions. However, what may be the real “teeth” of the penalties associated with the Texas Construction Trust Fund Act isn’t the civil liability, but the criminal liabilities for the breach of its imposed duties.

The potentially applicable criminal penalties are set out below:

• Misapplication of trust funds amounting to $500 or more is a Class A Misdemeanor with a potential fine of up to $4,000 and up to one year in jail.
• Misapplication of trust funds amounting to $500 or more with intent to defraud is a Third Degree Felony with a potential fine up to $10,000 and jail confinement for no less than 2 years and no more than 10 years.
• On residential construction projects, failing to establish or maintain a construction account or failing to establish or maintain the proper account record for the construction account is a Class A Misdemeanor with a potential fine up to $4,000 and up to one year in jail.

The above penalties are especially powerful as the Act provides for personal liability, that is the owner/officer/director of a company may be personally liable for the breach of the imposed duties even if the construction participant was a corporation or LLC if a beneficiary establishes that the individual party “directly or indirectly retains, uses, disburses, or otherwise diverts trust funds without first fully paying all current and past due obligations.”

Bottom line

Payment problems on one project can lead to problems on other projects, and the need to keep parties paid can sometimes result in the urge to apply funds to the most urgent “fires” no matter where the funds originally came from and ‘make it up later’ when additional funds come in. This is a bad idea as the above penalties make perfectly clear.

The key take-away from the Texas Trust Fund Act is simple: keep a clear accounting of all funds in an out, and only apply the funds to the proper parties.  If you’re in the construction business in Texas, it’s important for you to keep your accounting house in order so that you can stay out of the big house!