Construction Trust Fund Statutes: When Unpaid Project Funds Become Personal Liability

New York: Lien Law Article 3-A

New York has the most developed construction trust statute in the country.

• The trust. Section 70 identifies the receipts and rights to payment that constitute trust assets. For owners, coverage depends on the statutory source and conditions of the funds. An owner holds a separate trust for each improvement. A contractor or subcontractor holds a separate trust for each contract or subcontract, and each trust begins when its first asset comes into existence. (N.Y. Lien Law § 70.)
• Beneficiaries. Subcontractors, laborers, suppliers and others with trust claims are beneficiaries. A qualifying beneficiary need not have filed, or even had the right to file, a notice of lien. (N.Y. Lien Law § 71.)
• Diversion. A transaction applying trust assets to a nontrust purpose before all trust claims have been paid or discharged is a diversion. If the diversion results from the trustee's voluntary act or consent, it is also a breach of trust. (N.Y. Lien Law § 72.)
• Enforcement. A beneficiary's action must be brought as a representative action on behalf of all beneficiaries, following class action procedure as nearly as possible, although the court may waive the numerosity requirement. Remedies include an accounting, recovery of diverted funds, injunctions and damages. The action must be commenced no later than one year after completion of the improvement. For a subcontractor or material supplier, the deadline is the later of that date or one year after final payment under the claimant's contract became due. (N.Y. Lien Law § 77.)
• Larceny. Section 79-a imposes larceny liability on a trustee, officer, director or agent who applies, or consents to applying, covered trust funds to a nontrust purpose when the statutory conditions are satisfied. For an owner trustee, the provision addresses such application before all trust claims are paid. For a contractor or subcontractor trustee, it additionally requires failure to pay a trust claim within 31 days after it becomes due. A good-faith dispute avoids liability on that basis if the claim is paid within 31 days after final determination of the dispute, and the statute protects qualifying reimbursement of advances actually used for trust purposes. (N.Y. Lien Law § 79-a.)

See our New York lien law guide.

Illinois: The Lien Waiver Trust

Illinois's provision is narrower. When an owner, contractor, subcontractor or supplier of any tier requests or requires a lien waiver in exchange for payment or a promise of payment, the money it receives as a result of that waiver is held in trust for the party that furnished the work or is otherwise entitled to the payment. A separate account is not required, and commingling alone is not a violation. A covered party that knowingly retains or uses those trust funds for a purpose other than paying the persons for whom they are held is liable to a person who successfully enforces the section for the damages that person sustained. (770 ILCS 60/21.02.)

The practical lesson: an Illinois subcontractor that signs a lien waiver to release the general contractor's draw, and is then not paid, may have a trust claim in addition to its lien and contract claims. See our guide to lien waivers in Illinois.

Colorado: Trust Funds and Civil Theft

Qualifying funds disbursed to a contractor or subcontractor under a building, construction or remodeling contract, or on a construction project, are held in trust for the protected subcontractors, laborers and material suppliers identified in the statute, including qualifying claimants against a principal and surety. A claimant need not have perfected a mechanics lien or remain able to perfect one. The statute contains exceptions for good-faith disputes and setoffs, for a performance or payment bond furnished by the contractor or subcontractor, and for a written release executed by the property owner. It requires separate project accounting records but not a separate bank account. (C.R.S. § 38-22-127(1)-(4).)

A violation of the trust requirements may constitute theft under § 38-22-127(5), but liability requires proof of the elements of theft under § 18-4-401, including the required mental state. A trust violation alone does not establish theft. When theft is proven, the civil theft statute allows recovery of three times actual damages or $200, whichever is greater, plus costs and reasonable attorney's fees. (C.R.S. § 18-4-405.)

Two Colorado Supreme Court decisions frame the statute. In re Regan, 151 P.3d 1281 (Colo. 2007), held that a claimant does not need a perfected lien, or a lien it could still perfect, to pursue the trust remedy. Yale v. AC Excavating, Inc., 2013 CO 10, 295 P.3d 470, held that a member-manager's voluntary survival loans were not trust funds because, under the circumstances, they capitalized the business rather than funded a construction project. The court considered the totality of the circumstances, including the purpose and conditions of the disbursements. Because those funds were not trust assets, the theft claim based on their alleged diversion failed. See our Colorado lien law guide.

New Jersey: Public Improvement Payments

Money paid by a New Jersey public entity to a contractor under a public improvement contract is a trust fund in the contractor's hands until all labor, material and other charges connected with the work are paid. (N.J.S.A. 2A:44-148.) This provision applies to public projects; it is not a general private-construction trust statute. See our New Jersey lien law guide.

Washington: Public Works Retainage

Washington's provision is a public works retainage system, not a trust over payments a contractor receives. On covered public improvement contracts, the public body must reserve retainage of up to 5 percent as a trust fund for the protection of persons who furnish labor and materials, and for specified state tax obligations. Persons performing labor or furnishing supplies toward completion of the contract have a lien on the retained funds. They must give notice within 45 days after completion of the contract work, in the manner prescribed by RCW 39.08.030. To preserve enforcement against the retainage, a claimant generally must also commence a foreclosure action within four months after filing the claim. Federally funded transportation projects and contracts where a bond replaces retainage are treated differently. (RCW 60.28.011, 60.28.030.) The former section, RCW 60.28.010, was repealed in 2009. See our Washington lien law guide.

Quick Reference

Trust Fund Claims in Bankruptcy

Trust fund statutes become especially important when a contractor's owner files for personal bankruptcy. A debt for "fraud or defalcation while acting in a fiduciary capacity" may be excepted from an individual debtor's discharge. (11 U.S.C. § 523(a)(4).) The creditor generally must file a timely complaint in the bankruptcy court to obtain that determination. (11 U.S.C. § 523(c)(1).)

Two central issues are whether the individual debtor acted in a qualifying fiduciary capacity and whether the debtor committed fraud or defalcation in that capacity. The creditor must also establish a debt owed by that individual and satisfy the applicable procedural requirements. Ownership of the contracting company alone does not establish personal liability. Whether the debtor acted in a fiduciary capacity is a question of federal bankruptcy law; a state statute that labels funds a "trust" is relevant but not conclusive.

Defalcation requires knowledge that the fiduciary conduct is improper or gross recklessness concerning its impropriety. Gross recklessness includes consciously disregarding, or being willfully blind to, a substantial and unjustifiable risk that the conduct violates a fiduciary duty, where that disregard represents a gross deviation from lawful conduct in the circumstances. Negligence or an innocent mistake is not enough. Bullock v. BankChampaign, N.A., 569 U.S. 267 (2013). See our guide to protecting your claim in a contractor bankruptcy.

How to Use a Trust Fund Claim

1. Preserve your lien and bond rights first. A trust claim is an additional remedy, not a substitute. Serve notices and file liens on time.
2. Document the project payments. Pay applications, owner payment records, joint checks and lien waivers show what the contractor received for your work.
3. Identify who received or controlled the money. In Texas and New York, the individuals who directed the funds can be personally liable when the statutory conditions are met.
4. Use the statute in your demand. A demand letter can identify the trust statute and the individuals' potential exposure. See our guide to demand letters for bad debt.
5. Act quickly in bankruptcy. For a claim under § 523(a)(4), the creditor generally must file an adversary complaint within 60 days after the first date set for the § 341(a) meeting of creditors. A motion to extend that deadline must be filed before it expires. Different rules may apply to certain debts that were not properly scheduled and to complaints outside § 523(c). (Fed. R. Bankr. P. 4007(c).)
6. Check coverage and defenses. Check whether the funds and claimant fall within the statute and whether a statutory exception or defense applies. Qualifying expense payments and good-faith disputes may matter under particular statutes, but they are not universal defenses.

The Bottom Line

A contractor that receives your project money and spends it elsewhere may not be able to hide behind its corporate form. Where a trust fund statute applies and its conditions are met, the people who controlled the money may answer for it personally. If a contractor has collected for your work and not paid you, contact us to have an attorney in our network review whether a trust fund claim is available, and see our collections services.

This article provides general information and is not legal advice. Trust fund statutes have specific coverage rules, defenses and limitations periods, and criminal provisions are enforced by prosecutors, not private parties. Confirm the current statute and consult counsel before asserting a trust fund claim.