Big Fines and Jail Time – How to Avoid Misusing Construction Funds, Part 2
Builders must be careful with money received from owners and keep good financial records on each project. Chapter 162 of the Texas Property Code, commonly referred to as the Texas Trust Fund Act (Act), is intended to protect those furnishing labor or materials for the construction or repair of property by declaring that funds are held in trust for all parties in the construction chain.
In Part 1 of this article, I discussed the severe consequences for builders that misapply trust funds. In this article, I will discuss its bookkeeping and financial requirements, possible personal liability of officers and directors of a corporate builder, and defenses available to builders.
Pursuant to the Act, bookkeeping records and a construction account are required for certain construction projects. As to the construction account, a builder that enters into a written contract with a property owner to construct improvements to a residential homestead for an amount exceeding $5,000 is required to deposit the trust funds in a construction account in a financial institution.
The construction account and the statements from the financial institution must refer to the account as a “construction account.” Further, the construction account must be separate for each project, contain only trust funds, and must be separated from the builder’s main operating account.
Failing to maintain the account constitutes a Class A misdemeanor punishable by a fine of up to $4,000, confinement in jail for up to one year or both.
As to the bookkeeping records, a builder must maintain the following:
- the source and amount of the funds in the construction account and the date the funds were deposited;
- the date and amount of each disbursement from the account and the person to whom the funds were disbursed;
- the current balance of the account; and
- records that specify direct and indirect project costs. A “direct cost” means a cost included under a construction contract that is specific to the construction of the improvement (e.g. material incorporated into the improvement). An “indirect cost” means a cost included under a construction contract that is not specific to the construction of the improvement (e.g. project management). The builder is charged with retaining all invoices and other supporting documentation relating to funds that were disbursed from the construction account.
The Act also mandates that all deposit and disbursement documentation include the construction account number or information that links it to the account. The retention period for the required bookkeeping records is until at least the first anniversary of the date of completion of the project. Failing to comply with certain banking and financial bookkeeping requirements can be a Class A misdemeanor.
While this law creates possible criminal penalties, it also creates personal liability for officers and directors in a corporate builder. Many builders do business as a company or other entity to help prevent personal liability for project debts.
Pursuant to the Act, however, if an officer, director or agent directlyor indirectly retains, uses, disburses or otherwise diverts trust funds, then all corporate protection is lost, and the beneficiaries of those funds can then sue the trustee individually for what would otherwise be a corporate debt.
One Texas case held that to prove personal liability pursuant to the Act, the beneficiary must establish that an officer, director, or agent “directly or indirectly retains, uses, disburses, or otherwise diverts trust funds without first fully paying all current and past due obligations.” Direct Value, L.L.C. v. Stock Bldg. Supply, L.L.C., 388 S.W.3d 386, 393 (Tex. App.—Amarillo 2012, no pet.).
If a builder is sued by a beneficiary of trust funds, the builder has several defenses. The most common defenses are contractual defenses such as the work at issue is defective, the beneficiary breached its contract, and that payment to the beneficiary is contingent upon payment to the builder by the owner.
It is also a defense if
- a builder can prove that the funds not paid to beneficiaries were used to pay actual expenses directly related to the construction of the improvement,
- the builder has a reasonable belief that the claimant isn’t entitled to receive the funds, or
- because other law permits withholding (e.g. retainage).
It is also a defense to a criminal charge if the builder pays the beneficiaries all trust funds not later than 30 days following notice to the builder of the filing of a criminal complaint or pending criminal investigation.
It is important that a builder comply with the Texas Trust Fund Act, but doing so can sometimes be confusing. If you have questions about the Act or other legal requirements for builders in Texas, let the attorneys at Brackett & Ellis assist you. Please visit our website at ftworthconstruction.lawyer or give us a call at 817-338-1700.
