A tale of Texas Construction Trust Account woe. You’re a contractor running a business doing interior remodels for clients in a major metropolitan Texas area. You sign up clients with a contract developed by our friends at LegalZoom and get your team to work. Three months into your remodeling project with Mr. and Mrs. “you thought they were happy” Clients, you get this letter:
“Consistent with the requirements of §162.006 and §162.007 of the Texas Property Code, Mr. and Mrs. “you thought they were happy” Clients demand a full and complete accounting of all funds you have received from any source relating to this project.”
What should you do? Should you ignore it? Should you respond? Fear sets in, you call your crew, and you stop the work. Mr. and Mrs. “you thought they were happy” Clients become Mr. and Mrs. “irate and angry” Clients and they sue you alleging breach of fiduciary duty, breach of contract, and perhaps fraud.
Of course, this could all have been avoided through an understanding of what your requirements are when it comes to reporting and financial accountability for remodelers in the State of Texas.
The Texas Construction Trust Fund Act states that contractors agreeing to do more than five thousand dollars’ worth of work must put the client’s funds for each such job in a “construction account” at a financial institution. Tex. Prop. Code § 162.006. A “Construction account” means an account in a financial institution into which only trust funds and funds deposited by the contractor that are necessary to pay charges imposed on the account by the financial institution may be maintained. For lawyers, this is similar to our Interest on Lawyers Trust Account (“IOLTA”) requirements.
Problem 1: Instead of following The Texas Construction Trust Fund Act you have been putting all of your clients’ funds in an Operating Account and you have been utilizing your operating account to pay all of your bills, salaries, and construction invoices for all projects you are working on. What should you do?
Solution: Start by segregating your clients’ funds in an entirely separate account for each project and title that account [YOUR COMPANY NAME]’s Construction Trust Account for [Mr. and Mrs. Happy Clients].
Problem solved, but wait, there’s more you should do to protect yourself and your clients. Under Texas Property Code Sec. 162.001, construction payments are trust funds if the payments are 1) made to a contractor or subcontractor or to an officer, director, or agent of a contractor or subcontractor, and 2) under a construction contract for the improvement of specific real property in the State of Texas. The Texas Property Code Sec. 162.002 further states that a contractor […] or owner or an officer, director, or agent of a contractor […] who receives trust funds or who has control or direction of trust funds, is a trustee of the trust funds.
Why is that important? Under the Texas Construction Trust Fund Statute, you are a trustee for the funds received from Mr. and Mrs. “you thought they were happy” Clients for the benefit of the Mr. and Mrs. “you thought they were happy” Clients as well as subcontractors and suppliers on the project. Tex. Prop. Code § 162.003. Further, under Texas Prop. Code §162.005 as a trustee you act with “intent to defraud” when you, as the trustee:
(A) retain, use, disburse, or divert trust funds with the intent to deprive the beneficiaries of the trust funds;
(B) retain, use, disburse, or divert trust funds and fails to establish or maintain a construction account as required by Section 162.006 or fails to establish or maintain an account record for the construction account as required by Section 162.007.
Problem 2: I didn’t intend to deprive Mr. and Mrs. “you thought they were happy” Clients, but I failed to maintain an account record for the construction account as required by Section 162.007. What do I do now?
Solution: Start today and compile the accounting required under Section 162.007.
For each and every project you should maintain an account record that specifies the direct costs and indirect costs to your Client, and contains:
(A) the source and amount of the funds in the account and the date the funds were deposited;
(B) the date and amount of each disbursement from the account and the person to whom the funds were disbursed; and
(C) the current balance of the account.
You should also:
- Retain all invoices and other supporting documentation received relating to funds that were disbursed from the construction account.
- Ensure that all deposit and disbursement documentation includes the construction account number or information that provides a direct connection between the documentation and the account.
- Keep all of that information for one year following the completion of the project.
Problem 3: I have a Construction Trust Account that I named properly, but separating my client’s funds into different trust accounts for each project is cost prohibitive. Can I put all my clients’ funds in one trust account?
Solution: To properly protect your company and you client’s you should, whenever possible open individual accounts for each project. However, under Texas Prop. Code §162.031 (d) “[a] trustee who commingles trust funds with other funds in the trustee’s possession does not defeat a trust created by [the Texas Property Code Chapter 162]”.
Good news! If you have 1) segregated your client’s funds away from your operating account and 2) kept up with your accounting requirements as illustrated above, you are working in the right direction to abide by the Texas Construction Fund Statute.
We are asked frequently “does a contractor really need to do all of that”? The short answer is “yes”. As a contractor you could be both civilly and criminally liable when handling funds in a manner inconsistent with the requirements of the Texas Construction Trust Fund Statute.
While the Texas Construction Trust Fund Statute does not create an express civil cause of action, the duties it imposes on owners, contractors, and subcontractors, and their owners, directors, employees, and agents, with regard to the handling of trust funds can result in a cause of action in favor of beneficiaries harmed by a misapplication[1]. Courts have even extended personal liability to the individual liability to contractors based upon the defendant’s control or direction over the funds and not whether the individual defendant wrongfully received those funds.[2]
Further, under the Texas Property Code §162.001(c), misuse of trust funds of $500 or more with intent to defraud is a third-degree felony. Further, failure to establish or maintain a construction account in violation of sections 162.006 or 162.007 is a class A misdemeanor.
Save yourself the headache of running afoul of the Texas Construction Trust Fund rules and provide your clients with clear, transparent accounting from the outset. Your relationships with your clients will improve and possibly turn Mr. and Mrs. “you thought they were happy” Clients into Mr. and Mrs. Happy Clients.
[1] C & G, Inc. v. Jones, 165 S.W.3d 450, 453–54 (Tex. App.—Dallas 2005, pet. denied); McCoy v. Nelson Utilities Services, Inc., 736 S.W.2d 160, 165 (Tex. App.—Tyler 1987, writ ref’ d n.r.e.).
[2] Id.
