In the construction industry, the contract between parties is the principle source for determining the parties’ respective obligations. Project managers, superintendents, and other project-related personnel are routinely trained to review and understand contracts and administer projects in accordance with an industry understanding of the Contract. When juggling multiple projects, contractors are required to properly manage payments received to avoid violating Texas Property Code 162, commonly known as the Texas Trust Fund Act. This article will explain what payments are considered construction trust funds, who qualifies as trustees and beneficiaries, when a construction account is required, and how to avoid misapplication of construction trust funds.
If payments are made to a contractor, under contract for the improvement of specific real property in the state of Texas, those payments are considered construction trust funds.1 Qualifying trust funds can come directly from an owner or the owner’s lender. The party who receives the funds and has control or direction of the funds, is considered a trustee. This could be a contractor, subcontractor, owner, officer, director or agent of the contractor or sub.2 For example, when pay application payments are deposited to a contractor’s account, the contractor becomes a trustee of the owner’s construction trust funds and has control and direction to spend the funds as necessary to advance the project.
According to the Texas Trust Fund Act, artisans, laborers, mechanics, contractors or subs who furnishes labor or material for the construction, repair, or improvement of property in Texas are considered beneficiaries of any trust funds paid or received in connection with the improvement.3 Beneficiaries of construction trust funds can be any of the vendors listed in the contract. Additionally, a property owner of a residential construction contract is also a beneficiary of trust funds.
When a property owner executes a contract exceeding $5,000 for residential improvements, the contractor must deposit the trust funds in a separately labeled “construction account”. 4 Failure to label a trust fund account may be a minor offense, but mismanagement of the construction account could result in penalties. As a trustee, the contractor must maintain a record of the construction account that provides: 1) the source, the amount and the date the funds were deposited; 2) the vendor receiving a disbursement, the amount and the date of the disbursement; and 3) the remaining balance of the account.
The contractor must maintain a record of direct and indirect costs charged to the owner. Deposits and disbursements should include the construction account number so the transactions can be properly identified and documented. Finally, the contractor may not destroy account details until a year after the date of the improvement is completed.5
Simply attaching AIA continuation sheets to pay applications fails to provide transaction level details regarding sources, amounts, dates, recipients of disbursements and remaining balances. Similarly, QuickBooks files may also fail to provide adequate transaction level details unless properly administered. Bank statements would suffice if they show remaining balances after each disbursement and if the construction trust funds are not comingled with other unknown, unrelated deposits. It becomes increasingly difficult to definitively establish a current balance of trust funds if a single construction account is used for multiple jobs or if the account is used to cover expenses for another project. Therefore, to simplify the management of construction trust funds, separate bank accounts should be used for each project exceeding $5,000.
Misapplication of trust funds occurs when a trustee knowingly uses or diverts trust funds without first fully paying all current or past due obligations to the beneficiaries.6 Signing pay applications and receiving construction trust funds, obligates contractors to use those funds to pay its subs and vendors. Diverting amounts under $500 to another job could result in a class A misdemeanor while diverting funds over $500 could result in a felony of the third degree. In conclusion, it’s very important to avoid comingling project funds by maintaining adequate and accurate accounting records.