By: Christopher D. Cazenave, Partner, Jones Walker LLP
Construction trust fund statutes have been around for decades. At least 15 states have passed similar statutes. Other states, but not all, do not have an express statute but have interpreted state law to hold that payments received by a general contractor and deposited in a business account establishes a “trust fund.” See e.g., Cal. Bus. & Prof. Code § 7108.
The purpose of these laws is straightforward—protect contractors and suppliers against nonpayment for the labor and materials provided for the construction or repair of property. But while the purpose is straightforward, each state’s law differs by imposing different requirements, different privileges, and different remedies. This article provides an overview of how these statutes work as well as a sampling of important requirements and potential pitfalls that you should look out for when a construction trust fund statute applies to your project.
How do construction trust fund statutes work, generally?
A standard construction trust fund statute provides that:
Any moneys paid under a contract by an owner to a contractor, or by the owner or contractor to a subcontractor for work done or 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 or furnished materials, or both, for or about the building, for purposes of paying those subcontractors.
Md. Code Ann. Real Property § 9-201(b)(1) (2010).
The assets of the trust are the monies received by the owner or contractor to pay subcontractors and suppliers for the labor and materials provided for the benefit of the project. Owners or contractors who receive funds are considered “trustees” who hold trust assets for the benefit of “beneficiaries”—i.e., the subcontractors and suppliers. As trustees, owners and contractors who hold trust assets owe a fiduciary duty to subcontractors and suppliers for payments held in trust. A fiduciary duty obligates the trustee (e.g., the owner or contractor) to act solely in the interest of the beneficiary (e.g., subcontractors and suppliers).
Trust fund statutes typically serve as an additional protection beyond other rights and remedies that may be available such as mechanic’s lien claims, bond claims, and prompt-pay statutes. See e.g., Tex. Prop. Code § 162.002. In states that have a construction fund statute, officers and owners who receive and disburse funds may be subject to civil claims, criminal liability, or both. Further, debts incurred as a result of a violation of a trust fund statute are often non-dischargeable if the individual files for bankruptcy protection. See e.g., Stoughton Lumber Co., Inc. v. Sveum, 787 F.3d 1174 (7th Cir. 2015).
Does a construction trust fund statute apply to your project, and, if so, what do you need to look out for?
Construction trust fund statutes vary significantly state-by-state. Some states differentiate among public and private projects. Others distinguish between commercial and residential projects. Certain states require that trust assets be held in a separate account while others do not. There are also differing record-keeping requirements some of which are more onerous than others.
In addition, some construction trust fund statutes provide subcontractors and suppliers with ancillary rights to further ensure compliance. For example, New York’s statute imposes detailed record-keeping requirements requiring trustees to keep separate books for each project to provide a transparent, thorough ledger of funds received and disbursed for the project. Furthermore, beneficiaries in New York have a nearly limitless right to examine the trustee’s books or demand a verified statement that must account for how trust funds are being distributed. This right to demand an accounting continues through the entire project and can be exercised by beneficiaries on a monthly basis. New York Construction Law Manual, §§ 9.68 et seq.
Another factor to consider, which may affect a parties’ initial decision-making for project financing, is that not all funds received by an owner to improve property constitute trust assets. Again, in New York, funds received by an owner that are not secured by a mortgage or the owner’s own funds are not trust assets. Id. § 9.70. So for a solely owner-financed project in New York, a subcontractor would not have the right to examine books and records or demand an accounting from the owner. For contractors however, any funds that are received or owed by the owner that can be attributed to the contractor’s construction or repair of the project are likely trust assets.
Civil and criminal liability under trust fund statutes also varies significant from state to state. In Michigan and Colorado, violations can lead to personal liability and criminal liability. See MCL §§ 570.151 – 570.153; CRS §§ 18-4-401, 38-22-127. Georgia does not have an express construction fund statute but does have a criminal statute making it a crime for a contractor who is paid by the owner to fail to pay subcontractors or suppliers. See Wachovia Bank v. American Bldg. Consultants, Inc., 138 B.R. 1015 (Bankr. N.D. Ga. 1992).
In conclusion, the rules and requirements under a state’s construction trust fund statute vary in complexity, applicability, and attendant consequences for noncompliance. Depending on where your project is taking place, non-compliance with these statutes can entail significant financial liability and even criminal charges. It is important then for contractors to determine at the outset of a project whether a construction trust fund statute applies, and if so, to develop a plan to ensure compliance.
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