Texas Trust Fund Statute and Sham General Contractors

The Texas Trust Fund Statute makes general contractors into trustees who have a fiduciary duty to manage payments for the benefit of the subcontractors, who are the beneficiaries of the trust funds held by the general contractor. The most important thing to know about the Texas Trust Fund Statute is that it applies to anyone “who has control or direction of trust funds.” Tex. Prop. Code § 162.002. In other words, the statute dramatically expands liability beyond just the parties to the contract. Anyone who has control of the funds can be liable if the funds are misapplied. Funds are misapplied when the trustee knowingly diverts trust funds without first fully paying all obligations incurred to subcontractors. Tex. Prop. Code § 162.031(a). This means that even employees, family members, or staff of the general contractor can end up liable for the bad actions of the contractor if the employees had “control or direction” of the funds. See Direct Value, LLC v. Stock Building Supply, LLC, 388 S.W.3d 386, 392 (Tex. App.—Amarillo 2012, no pet.). However, the level of control necessary for Trust Fund Act liability to arise is more than just signatory authority over bank accounts. J.P. Morgan Chase Bank, N.A. v. Tex. Contract Carpet, Inc., 302 S.W.3d 515, 541 (Tex. App.—Austin 2009). Even a signatory to bank accounts does not have enough control to be liable under the Trust Fund Act if the person merely co-signs checks, but does not decide whether, when, how, and who will be paid; needs approval from another person to make payment decisions; and is not an officer of the company. Id. at 11-12.

The Texas Trust Fund Statute in Chapter 162 of the Texas Property Code serves as an additional source of protection, beyond the mechanic’s lien statutes, for mechanics and materialmen. It primarily benefits subcontractors. Under the Statute, construction payments are considered trust funds and the recipient is considered to be a trustee who holds the money for the beneficiaries. Tex. Prop. Code § 162.001(a). The trustee owes a fiduciary duty to the beneficiaries and must be able to show that the trustee acted towards the beneficiaries with the “utmost good faith,” the “most scrupulous honesty,” placed the beneficiaries’ interests before the fiduciary’s interest, did not use the advantage of the fiduciary’s position to gain any benefit for himself at the expense of the beneficiary, fully and fairly disclosed all important information to the beneficiary, made reasonable use of the confidence that the beneficiary placed in the fiduciary, and that the transactions in question were “fair and equitable.” Tex. Pattern Jury Charges PJC 104.2; Haut v. Green Cafe Mgmt., 376 S.W.3d 171, 182 (Tex. App.—Houston [14th Dist.] 2012). Costs and a reasonable fee that is earned under a written contract on specific property before the commencement of construction are not considered trust funds. Tex. Prop. Code § 162.001(c). Anyone who furnishes labor or material for the construction or repair of an improvement on specific real property is a beneficiary under the Trust Fund Statute. Tex. Prop. Code § 162.003. For residential construction contracts, the property owner is also a beneficiary. Id. § 162.003(b).

Exemplary Damages. Exemplary or, in other words, punitive damages can be assessed for breach of fiduciary duty. McGrede v. Coursey, 131 S.W.3d 189, 193 (Tex. App.—San Antonio 2004). The fear of potential punitive liability should serve as additional incentive to avoid violation of the Texas Trust Fund Statute. Attorney’s fees can be recoverable under Tex. Civ. Prac. & Rem. Code § 38.001(1), (2), or (3).

Private Cause of Action and Criminal Penalties. The Trust Fund Statute only provides for criminal penalties. Nevertheless, the Texas Supreme Court has “expressly indicated that a private civil cause of action exists under the Trust Fund Act.” Zurich Am. Ins. Co. v. Tejas Concrete & Materials Inc., 982 F. Supp. 2d 714, 724 (W.D. Tex. 2013); Dealers Elec. Supply Co. v. Scoggins Constr. Co., 292 S.W.3d 650 (Tex. 2009). A trustee who misapplies trust funds of over $500 commits a Class A misdemeanor, but if funds are misapplied with intent to defraud, then the violation becomes a third degree felony. Tex. Prop. Code § 162.032.

Bankruptcy. Bankruptcy is not a way to escape the Trust Fund Statute. Under Tex. Prop. Code § 162.001(d), trust funds do not become property of the bankruptcy estate.

Burden of proof. The general contractor accused of misapplication of trust funds under Tex. Prop. Code § 162.031(a) has an affirmative defense in § 162.031(b). The affirmative defense is that the “trust funds not paid to the beneficiaries of the trust were used by the trustee to pay the trustee’s actual expenses directly related” to the project. In Kirshner v. State, 997 S.W.2d 335 (Tex. App—Austin 1999, writ refused), the court held that the contractor has the burden of proof on the affirmative defense and that the beneficiaries do not have the burden of tracing the contractors’ funds to show whether the funds went toward actual expenses directly related to the project. Accordingly, the general contractor should keep detailed records that are separate for each project, so that the contractor can trace all funds expended to actual expenses of a particular project. Also, if the trustee/general contractor withholds funds due to a reasonable dispute over whether the beneficiary/subcontractor is entitled to the funds, then the trustee/general contractor must give notice to the beneficiary. Tex. Prop. Code § 162.031(b). The trustee/general contractor cannot just ignore the beneficiary/subcontractor’s request for payment.

Equitable Subrogation. A contractor or owner who pays unpaid subcontractors of subcontractors can be equitably subrogated to trust fund claims of the paid off subcontractors. The contractor or owner can then pursue whoever failed to pay the subcontractor. Tag Invs., Ltd. v. Monaco (In re Monaco), 514 B.R. 477, 485 (Bankr. W.D. Tex. 2014).

Sham Contracts:

Under Section 53.026 of the Texas Property Code, the owner of real property cannot escape liability by setting up a corporation to act as the owner’s general contractor, and thus, escape liability to subcontractors and suppliers. Specifically, the Property Code provides that if the property owner has the ability to control the person or entity that acts as a general contractor, then the subcontractor is considered to “be in a direct contractual relationship with the owner” and “has a lien as an original contractor.” Tex. Prop. Code § 53.026.

Copyright 2017, Ian Ghrist, All Rights Reserved.

Disclaimer: This blog is for informational purposes only. Do not rely on any part of this blog as legal advice. Instead, seek out the advice of a licensed attorney. Also, this information may be out-of-date.