Contingent payment clauses like "pay-if-paid" can provide those higher up on a construction project chain with an unfavorable advantage over material suppliers when attempting to collect funds. Fortunately, construction trust fund statutes can help suppliers retain leverage despite these clauses and increase their chances of getting paid in full.
A construction trust fund statute follows a general rule, which states that payments made to anyone in the contractual chain are held "in trust" for contractors and suppliers down the line. Failure to do so will result in a "breach of trust" along with a "breach in fiduciary duty." Fiduciary duties exist in law when a person or entity makes a commitment to act in the best interest of another person and their assets.
Not every state has a construction trust fund statute. To date, 15 states do: AR, CO, DE, FL, GA, IL, MD, MI, MN, NY, OK, SD, TX, WA and WI. The statutes vary by state. During a recent NACM Construction Thought Leadership Discussion Group session, Katy Baird, attorney at Andrews Myers PC (Houston, TX), explained that trust statutes include three important factors:
- A trustee—the party that receives the money (owners, general contractors, directors, officers, etc.).
- A trust property—the money paid for work performed, materials furnished or both for the project.
- Trust beneficiaries—subcontractors or suppliers that did the work or furnished the materials.
Suppliers can file claims against the trustee under the construction trust fund statute, depending on the state, if they have reason to believe that payment for materials furnished or work performed under a construction contract were misappropriated.
According to Baird, filing these claims also provides suppliers with the opportunity to hold individual owners or managers personally accountable by including their names in the initial demand letter—notifying individual C-suite members of the potential suit that may be coming their way. This may prompt more urgency from upper-level management.
"Hopefully, the threat of using these trust funds at the onset of your demand process will be enough to force payment," Baird said.
Additionally, some states may enforce a trust fund statute on funds acquired through a loan that is secured by a lien on the property prompting payment from the lender. For example, in Texas, both lenders and individual owners can be held liable under the state's Construction Trust Fund Act.
"In general, the key takeaway from the Construction Trust Fund Act is that you get to force individual liability and bring the true stakeholders of the company to the table and to the dispute," Baird said.
Depending on the severity of the trustee's misappropriation of funds, trust beneficiaries can file either a civil or criminal lawsuit against the trustee. If the trustee is found guilty, Baird describes some remedies the courts in Texas may impose on the perpetrator:
Civil Remedies
- Veil piercing—individual liability for the trustee
- Exemplary damages—for holding funds too long
- Non-dischargeable bankruptcy—removing the trustee's ability to eliminate debt through bankruptcy
Criminal Remedies
- Class A misdemeanor:
- The misapplication of $500 or more
- Failure to maintain a construction account
- Failure to maintain account records
- Third-degree felony for the misapplication of $500 or more with the intent to defraud
Baird states that proving intent to defraud can be difficult. However, she did provide an example of a situation that may help beef up your case if you suspect that is the trustee's intention.
"If an owner knows they're supposed to pay you, it may not rise to the level of fraud," she said. "But if they are intentionally holding those funds to prompt you to take a discount on your project and they've sent you emails where they're saying, "Hey, if you cut us a break, we'll pay you $50,000 out of the $75,000 that you're owed," that is a misapplication of trust funds."
If your state has enacted a construction trust fund statute that can help you prove an unlawful act by your customer's upper-level management, check out NACM's exclusive Lien Navigator for details (subscription required).
Furthermore, contact NACM Education Director Tracey Lerminiaux at This email address is being protected from spambots. You need JavaScript enabled to view it. if you would like to be a part of NACM's Construction Thought Leadership Discussion Group. The group meets monthly via Zoom to share ideas, network and learn from each other and other experts in the credit industry.
-Bryan Mason, NACM editorial associate