Texas Home Builder Magazine
January/February 2009

by Walker M. Duke

Recently, we were told that the U.S. is “officially” in a recession. This is no surprise to anyone in the construction industry, particularly in the residential sector. As a result, money has tightened. Most builders can probably recount at least one incident when they’ve been on one end or the other of a payment dispute on a project recently. Regardless of whether your company is seeking payment or owes funds to another party, there are two state statutes every builder should be familiar with to minimize liabilities and limit financial headaches: the Texas lien statute and the Texas Construction Trust Fund Act.
Texas Liens: Preparation and Perfection Are the Keys Imagine that your company is working on a project and your portion of the job is about half finished, but the party you contracted with is a month and a half behind on payments. This is a lucrative contract (if you get paid) and you would like to finish out your work. Additionally, it is a high profile project you’d like to use as an example of what your company can do. But these late payments are creating all kinds of cash flow problems. What can you do to protect your right to payment?

One of the best tools a builder has to ensure payment on a construction project is the lien. They secure payment for labor and materials and extend it to the house, fixtures and general improvements. Liens also secure payment for specially fabricated materials, even if they have not been delivered.

Under the Texas Property Code, a person can have a lien if (1) they furnish labor or materials or specially fabricate materials for construction or repair of a house, building or improvement, and (2) the person furnishes the labor or materials or specially fabricates the material pursuant to a contract with the owner, contractor or subcontractor. In short, if a contractor built or improved a structure, they can probably protect their interests with a lien.

The key to creating a valid lien is its proper “perfection.” If a lien is not properly perfected, it offers virtually no protection and, even worse, could result in a hefty penalty. To perfect a lien on residential construction, the original contractor must first have entered into a written contract with the owner (signed by both spouses if the owner is married). This step must be taken before the work has begun. And before the contract is executed, the original contractor must also provide the owner a disclosure statement that provides guidance to the owner about the construction process. This disclosure must follow the language of Section 53.255 of the Texas Property Code.

After payment has become delinquent, a lien affidavit must be filed in the county of the to-be-liened property by the 15th day of the third month after the indebtedness accrued. The lien affidavit is fairly simple, but the Texas Property Code requires a few things be included, such as a general description of the work or materials furnished, a description of the property to be liened, the name and address of the owner, and a statement of when and how notice of the claim was sent to the owner. Additionally, the lien affidavit must contain specific language set out in the Property Code regarding notice.

The rules are slightly different for subcontractors. They must file the lien affidavit (and identify each month in which the work or material was furnished) and must also give the original contractor and the owner written notice of the unpaid balance no later than the 15th day of the second month following each month in which all or part of the labor or materials were provided.

For subcontractors, the best practice is to send out a notice to both the general contractor and owner every month after payment is late. Too often, a subcontractor simply waits and waits for payment. Then, by the time they realize payment is not coming, it is too late to file a lien. If the timing requirements are not satisfied, a lien cannot be filed; the penalties in Texas for wrongfully filing a lien can be as high as $10,000.

Properly perfecting liens does take a little advance planning, but it can be a very efficient and cost effective tool to ensure that your company is paid for the work it performed and materials it provided.

Texas Construction Trust Fund Act: The Potential Liability You Never Knew You Had What if you are on the opposite side of the payment predicament and it’s your company making the payments? Then, you and your company must be sure to follow the Texas Construction Trust Fund Act. Failure to comply with its provisions could result in financial headaches and personal felony liability.

Under the Texas Construction Trust Fund Act (Chapter 162 of the Texas Property Code), construction payments and loan receipts made for the improvement of specific real property are trust funds, and the party who receives these funds or has control of them is a trustee. For residential construction projects exceeding $5,000, the trust funds must be deposited in a construction account at a financial institution and must be appropriately managed.

A trustee who intentionally, knowingly or with intent to defraud retains, uses or otherwise diverts trust funds without first fully paying all current or past due obligations to the beneficiaries of the trust has “misapplied” the funds. On its face, this may sound like common sense and good business practice. This may be true; however, penalties for failing to maintain the Act’s requirements can be harsh. A trustee who misapplies trust funds over $500 commits a Class A misdemeanor. And if the trustee misapplies those trust funds with intent to defraud, they may be guilty of a third-degree felony.

These criminal sanctions bring the potential for personal liability since trustee status does not stop at the corporate veil-a court may consider an officer, director or agent of the party who receives or controls trust funds, a trustee. Texas courts have been willing to find individuals who had control or direction over trust funds and misapplied them personally liable, even if they were acting on behalf of their companies.

Misapplication of trust funds can also create civil liability, and hence, litigation. Trustees may have a fiduciary relationship with the beneficiary-at least with respect to the trust funds. Fiduciary relationships create heightened responsibilities for the trustee on behalf of the beneficiary, including loyalty, the utmost good faith, candor, high integrity, and fair and honest dealings. This is notable because an intentional breach of fiduciary duties opens up the possibility for punitive damages.

There are, however, affirmative defenses to claims of misapplication. One defense is that the trust funds were used by the trustee to pay its actual expenses directly related to the construction of the improvement. Another defense is that the funds have been retained by the trustee, after notice to the beneficiary, upon a reasonable belief that the beneficiary is not entitled to the funds.

Additionally, a trustee can assert the defense that it paid the beneficiaries all trust funds they were entitled to receive within 30 days of receiving written notice that the trustee filed a criminal complaint or other notice of a pending criminal investigation.

Overall, the Texas Construction Trust Fund Act underscores the need for sound business practices when it comes to the handling of construction funds. If funds are being held back for a legitimate reason, it is particularly important to document the facts and advise the party who is expecting payment in writing. Because of the serious potential sanctions for failing to comply with the Act, knowing your duties and obligations in advance will help prevent liabilities down the road. With the construction industry in a tumultuous period, your company will likely face a number of challenges it did not have a few years ago. Payment issues will likely be one of them. Familiarity with the Texas lien laws and Construction Trust Fund Act will help you address these issues and minimize their impact or perhaps avoid them entirely.

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