It is no secret that the Texas mechanics lien statute is a rather confusing and daunting piece of legislation. This is especially true for subcontractors as they bear the brunt of strict and complex notice requirements that must be met in order to qualify for mechanics lien protection. The statute requires notices to be sent for each month in which labor and/or materials were furnished to the project but are unpaid. Because the deadline for these notices are based on the month of the performed but unpaid for work, and are not necessarily calculated based on the month in which the payment was due, subcontractors may be required to send notices even when payment obligations have not arisen under the subcontract. Since the required notice contains mandatory language that some business practitioners may find aggressive, many subcontractors are hesitant to send the required notices for business relation reasons.
Mechanics liens are not the only protection that construction participants have to guard against nonpayment, however. Prompt pay statutes set forth the time periods in which payment must be made; statutory limits on retainage amounts set a hard cap on how much money can be withheld from a project participant; and, statutes penalizing the misallocation of funds work as a check to keep project funds in the right place for the benefit of the proper parties. Through the Construction Fund Act, the Texas legislature codified this type of misallocation of funds provision, and designated certain construction payments as funds held in trust for the benefit of the project participants.
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The Construction Fund Act
So, what does the Act say, and how does it purport to protect construction parties?
To begin, the Act defines “[c]onstruction payments . . . made to a contractor or subcontractor or to an officer, director, or agent of a contractor or subcontractor, under a construction contract for the improvement of specific real property in this state”, and loans “borrowed by a contractor, subcontractor, or owner or by an officer, director, or agent of a contractor, subcontractor, or owner for the purpose of improving specific real property in this state . . . [and] secured in whole or in part by a lien on the property” as “trust funds“.
The designation of the construction payments or loan proceeds as “trust funds” means that there must be “beneficiaries” entitled to receive payments from the trust, and “trustees” tasked with the fiduciary duty of making sure the beneficiaries are reaping the benefit of the trust. The Construction Fund Act specifically defines both the Trustees and the Beneficiaries of the trust created by the construction payment or loan proceeds, and both designations are defined broadly. A trustee under the Act 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, is a trustee of the trust funds”, and beneficiaries of the trust are defined as any “artisan, laborer, mechanic, contractor, subcontractor, or materialman who labors or who furnishes labor or material for the construction or repair of an improvement on specific real property”.
Similarly to other misallocation of funds statutes, the Act imposes civil or criminal liability for payment abuse or inappropriate use of the funds placed in trust. Since the trustees have a duty to apply the funds correctly their misuse can result in significant penalties.
Does It Really Help?
Sec. 162.031. MISAPPLICATION OF TRUST FUNDS, states that
A trustee who, intentionally or knowingly or with intent to defraud, directly or indirectly retains, uses, disburses, or otherwise diverts trust funds without first fully paying all current or past due obligations incurred by the trustee to the beneficiaries of the trust funds, has misapplied the trust funds.
Therefore, using cash from one job to pay participants on other jobs is a misapplication of the trust funds over which the trustee had control. Therefore, the contractor who does this, or, an “officer, director, or agent of a contractor” who has control over the funds, may be criminally liable for the misapplication. Criminal penalties can be imposed ranging from a Class A misdemeanor to a felony of the third degree depending on whether there was an intent to defraud. The statute also always for beneficiaries to recover funds that have been misapplied.
While this may be a piece of leverage that can be useful in obtaining payment, and should help construction funds remain in the appropriate place for the benefit of the proper parties, it is not a silver bullet, or a replacement for the security provided by mechanics lien or bond claim rights. Further, certain affirmative defenses are built into the statute, and the applicability of the Act can be limited.
Additional protections other than mechanics liens or bond claims are always welcome, and should be used fully by construction participants to ward-off nonpayment. However, these additional protections are likely best used in conjunction with mechanics lien or bond claim rights, not instead of them.