What is a construction trust fund statute?
- Contractor Resources
Construction trust fund statutes are laws enacted by several states to protect payments on construction projects. This is accomplished by automatically creating a constructive trust for any funds disbursed to a party on a construction project that is meant as payment for any subs and suppliers to the project.
Although these trust fund statutes, at first glance, appear to only benefit subs and suppliers on a project, they were originally intended to protect owners and general contractors. (defense to payment/proper payments) risk of double liability.
How a Construction Trust Fund statute protects payments
When project funds are disbursed from the property owner to the contractor (or lender to the property owner), to pay subcontractors and material suppliers on the project, they are deemed to be “held in trust” for the beneficiaries. Depending on the state, this also applies to down the payment chain. (Ex. subcontractor payments to sub-subs, etc.)
There are three basic elements to a trust:
- Trustee: The party receiving money on a construction project
- Trust property: The construction funds paid for work and/or materials furnished
- Beneficiary: The subcontractors, material suppliers, laborers, etc. who supplied labor, services, or materials to the project
Fiduciary duty of trustees
Trustees owe a fiduciary duty to the beneficiaries, meaning that they must act only in the best interests of the beneficiaries. A trustee may not misappropriate, or otherwise misuse the funds, for any other purpose but to pay the subs and suppliers who earned the payments; i.e, the beneficiaries of the trust funds.
The trust property (project funds) are meant to be held in trust for the beneficiaries. In some states, the construction trust fund statute strictly prohibits the “commingling of funds.” In these states, the trustee must deposit the trust property in a separate bank account or they will be found in violation of the trust fund requirements. However, most states do not have any prohibition on commingling funds, but good record keeping will typically be required to ensure compliance with the statute.
Effect of bankruptcy
One of the main advantages of a construction trust fund is the fact that project funds will not be deemed the property of a contractor’s estate should they declare bankruptcy. That’s because the money is being held specifically for the beneficiaries.
Under 11 USC §541(d) of the Bankruptcy Code, “property in which the debtor holds, as of the commencement of the case, only legal title and not an equitable interest… becomes property of the estate.” If a valid trust has been formed by statute, then those funds will be exempt from third-party creditors when the trustee goes through bankruptcy court proceedings.
What states have a Construction Trust Fund statute?
Currently, there are 19 states that have a construction trust fund statute in their state laws. These states include Arizona, Colorado, Delaware, Florida, Illinois, Maryland, Michigan, Minnesota, Nevada, New Jersey, New York, Oklahoma, Pennsylvania, South Carolina, South Dakota, Texas, Vermont, Washington, and Wisconsin.
There are a few states, such as Arkansas, Georgia, and Virginia that do have some criminal statutes which impose liability for the misapplication of trust funds. However, in these states, the statute does not impose any trust obligations.
Lastly, many states allow for the creation of a trust through provisions in the construction contract (known as trust agreements). States providing for trust agreements include California, Maryland, Missouri, and Virginia.
Remedies for violation of a construction trust fund statute
The penalties and remedies for the misappropriation of construction trust funds, or any violation of the trust fund statute, vary from state to state. These penalties/remedies typically include one or more civil remedies, criminal penalties, or even potential personal liability.
Typical civil remedies include interest accrual on the unpaid amounts and attorney fees and court costs for an action to recover payment. In Wisconsin, for example, some circumstances warrant treble (triple) damages. Many state statutes also impose criminal penalties which can range from a misdemeanor to a felony, which comes with fines and imprisonment. Lastly, there are some state construction trust fund statutes that impose personal liability for the debt on the trustee or any directors or officers of the trustee company.