02 Jul Making Things Personal: A Guide to the Texas Construction Fund Act… by Aaron J. Maher

Before taking on a construction project, whether you’re a subcontractor, general contractor, or property owner, it’s important to understand the functions and powers of Chapter 162 of the Texas Property Code, also known as the Texas Construction Fund Act (the “Act”). Broadly speaking, the Act functions to protect those who furnish materials and/or labor on a project from wrongful non-payment by requiring that certain funds be held in trust throughout the construction process.  For purposes of exploring the functions and powers of the Act, this article will focus on enforcement of the Act from the perspective of a subcontractor.

Assume you’re an electrician who’s been subcontracted for a commercial build.  You show up to the project, provide certain materials and run the building with electricity.  Further assume your work is without flaw, or at least without material error such that the building’s electrical components function properly.  You submit your invoice(s) to the general contractor for payment, and the general contractor submits its draw to the property owner and receives payment, but then payment isn’t forthcoming to you.  What you didn’t know is that the general contractor’s officers used the payment from the property owner to fatten their pockets and develop other projects, not pay you.  What do you do? One (1) common option is to file a lien, and assuming further non-payment from the general contractor or property owner, timely file suit to foreclose on the lien.  Another option, which can go hand in hand with filing suit to foreclose on the lien, is to file suit under the Act asserting misapplication of trust funds by the general contractor.

To succeed on your claim against the general contractor for violation of the Act, you, as the plaintiff, must establish four (4) necessary elements: (i) the general contractor received payment for your services on the project; (ii) the general contractor was a trustee of the funds paid for your services; (iii) you were a beneficiary of those funds; and (iv) the general contractor intentionally, knowingly, or with intent to defraud, diverted and misapplied the funds by not paying you for your services.  This article will address each element provided above in turn.

Section 162.001(a) of the Texas Construction Fund Act

Section 162.001(a) of the Act governs if construction payments constitute trust funds.  Section 162.001(a) states that construction payments are “trust funds” if the payments are 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.  Said in plain English, and focusing on the hypothetical this article seeks to address, payments made from a property owner to a general contractor under contract for the construction or improvement of a property are trust funds for purposes of the Act.  Here, under the circumstances provided above, the funds paid from the property owner to the general contractor for your services are trust funds.  But is the general contractor a “trustee” under the Act?

Section 162.002 of the Texas Construction Fund Act

Section 162.002 of the Act provides that “a contractor or subcontractor, or owner of an officer, director, or agent of a contractor or subcontractor, or owner, who receives trust funds or who has control or direction of trust funds, is a trustee of the trust funds.”  In this hypothetical, not only is the general contractor a “trustee”, but its officer(s), director(s) or agent(s) who received and had control of the funds are also personally considered “trustees”.  This wrinkle is important as it acts as a pseudo veil piercing mechanism to impose personal liability against individuals for wrongful misapplication of construction funds.  Okay, so you’ve established the general contractor (and its officers) are trustees of the trust funds.  What’s next?

Section 162.003(a)(b) of the Texas Construction Fund Act

To succeed with your claim, you need to establish that you’re a beneficiary entitled to payment of the trust funds at issue.  Under Section 162.003(a) of the Act, individuals such as laborers, materialmen, and subcontractors that provide labor or materials for the construction or improvement on property are considered beneficiaries of trust funds paid or received in connection with their services.  Here, as an electrical subcontractor who provided both labor and material for the project, you are considered a beneficiary of the trust funds.  Note that, with respect to residential builds, under Section 162.003(b) of the Act, a property owner is considered a beneficiary of trust funds. 

162.031(a)(b)(c) of the Texas Construction Fund Act

The final element to succeed with your claim under the Act requires proving the trustees, here, the general contractor and its officers, misapplied the trust funds.  Section 162.031(a) of the Act, which governs the 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 paying all current or past due obligations incurred by the trustee to the beneficiaries of the trust funds, has misapplied the trust funds.”  Here, the crucial part is proving the element of intention—that you were purposefully not paid by the general contractor.  Evidence of intention may not be outright and readily available.  However, through discovery, such as by written request or by oral deposition, you can obtain or illicit documents and testimony that address intention, thereby satisfying this element.  Under the facts provided above, because the general contractor’s officers used the payment from the property owner to fatten their pockets and develop other projects instead of paying you (which you would generally determine through discovery), you can prove the intention element necessary to succeed with your claim against the general contractor and its officers personally under the Act. 

Though not applicable to the circumstances at hand, it is important to note that Section 162.031(b) of the Act provides an affirmative defense to claims for misapplication of trust funds if the trust funds that were not paid to the beneficiary were used by the trustee to pay the trustee’s actual expenses directly related to the project, or have been retained by the trustee after providing notice to the beneficiary as a result of the trustee’s reasonable belief that the beneficiary is not entitled to payment, or that the funds have been retained as authorized or required by statute.  Additionally, it is also an affirmative defense under Section 162.031(c) of the Act that the trustee paid the beneficiary the claimed funds no later than thirty (30) days after written notice to the trustee of a pending or filed criminal complaint or investigation.  This point is important as it emphasizes that, in addition to civil monetary penalties, misapplication of trust funds can result in criminal liability as well (see Section 162.032).

By Aaron J. Maher, Attorney at KMD Law