Trust Funds

Construction payments made to a contractor, subcontractor, or to an officer, director, or agent of a subcontractor or contractor pursuant to a construction contract for the improvement of specific real property are deemed to be trust funds for certain purposes.

Similarly, loan receipts are trust funds if the funds are borrowed by a contractor, subcontractor, or owner for the purpose of improving specific real property, and the loan is secured in whole or in part by a lien on the property.

However, if a contractor and property owner have entered into a written construction contract for the improvement of specific real property in Texas before the commencement of construction, and the contract provides for the payment by the owner of the costs of construction and a reasonable fee specified in the contract payable to the contractor, the fee paid to the contractor is not considered trust funds.

What the Trust Fund Law Means in Plain English

A property owner pays a general contractor, that general contractor pays a subcontractor, and that subcontractor pays its workers and suppliers. That chain of payments is what Texas law envisions, and the trust fund statute is built around enforcing it.

The law recognizes that the chain sometimes breaks. A general contractor may receive payment from the owner and divert it to other projects, other debts, or personal expenses, leaving subcontractors unpaid. In response, Texas law makes those payments a trust fund: the money belongs to the workers and suppliers, not to the party who temporarily holds it.

Two Sources of Trust Funds

There are two sources of trust funds under Texas law. First, all money paid to a contractor or subcontractor under a construction contract for the improvement of specific real property in Texas constitutes a trust fund. Second, all funds borrowed by an owner, contractor, or subcontractor for the purpose of improving such real property, and which are secured in whole or in part by a specific lien on the realty to be improved, are trust funds.

Any subcontractor, contractor, owner, or any officer, director, or agent of any of those parties to the contract that receives trust funds or payments or has control or direction over them is a trustee of the trust fund. Moreover, a trustee may be personally liable to a beneficiary of the trust for misapplication of the trust fund.

What “Misapplication” of Trust Funds Looks Like

A contractor who misuses trust funds is liable under the trust fund provisions. In practical terms, trust fund misapplication includes: using project funds to pay overhead or debts on other projects; using project funds for personal expenses; paying other creditors before paying the subcontractors on the specific project; and selectively paying some subcontractors while leaving others unpaid from a limited pool of project funds.

If the funds are transferred to some innocent third party without knowledge that the funds are trust funds under the statute, a claimant to the trust funds may not sue to collect the funds in the hands of the innocent third party.

Personal Liability: Reaching Beyond the Corporation

A critical feature of Texas trust fund law is that personal liability attaches to the individuals who control the funds, not just to the company that received them. Any officer, director, or agent of a contractor or subcontractor who has control or direction over trust funds and who participates in their misapplication is personally liable to the trust fund beneficiaries.

This means that if a construction company is insolvent, dissolved, or has no assets, all common situations when subcontractors finally pursue collection, the claim can still be brought against the individuals who made the decisions about where the money went. The corporate shield does not protect against personal liability for trust fund misapplication.

Criminal Penalty for Trust Fund Misapplication

Knowingly or intentionally misapplying construction trust funds is not merely a civil wrong. It is a criminal offense under Texas law. Chapter 162 sets its own criminal penalties in Section 162.032. Misapplying $500 or more is a Class A misdemeanor, and doing so with intent to defraud is a third-degree felony. Failing to keep a required construction account or its records is also a Class A misdemeanor. Section 162.033 allows the State to prosecute under a different statute when the same conduct is an offense elsewhere in Texas law, so a large diversion can be charged as theft under Penal Code Section 31.03 instead, which carries higher punishment ranges. Which statute applies depends on how the case is charged.

The possibility of criminal prosecution, in addition to civil liability, is a significant element of trust fund cases. Contractors who have misapplied trust funds should understand that their exposure is not limited to a civil judgment.

When the Trust Fund Statutes Do Not Apply

The statutes creating and governing the trust fund do not apply to the following: a bank, savings and loan, or other lender; a title company or other closing agent; or receipts under a construction contract if the full contract amount is covered by a corporate surety payment bond. Thus, the trust fund statutes will not defeat a bank’s priority as a secured creditor over a materialman.

The Residential Homestead Account Requirement

A contractor who enters into a written contract with a property owner to construct improvements to a residential homestead for an amount exceeding $5,000 must deposit the trust funds in a properly designated construction account in a financial institution.