User menu

Ethical Implications of the Construction Trust Fund Act

Fri, 07/22/2016 - 13:28 -- admin25

by Hershel R. Chapin

The Construction Trust Fund Act (CTFA) inhabits an often overlooked corner of the crazy quilt of Texas law—Chapter 162 of the Texas Property Code. Yet, this powerful statute may be one of the single greatest malpractice traps for Texas attorneys who practice within the intersection of business, construction litigation, and creditors’ rights law. For the reasons below, it is incumbent on Texas attorneys to interrogate the precise nature and origin of funds whenever a construction case involves (or could involve) pre-payment.

The CTFA defines “construction trust funds” expansively as money lent or paid to someone for the purpose of improving specific real estate property in Texas. This law penalizes certain holders of “construction trust funds” for diverting the funds from their intended purpose(s). Corporate agents and control persons who mishandle funds covered by the CTFA are subject to personal liability and/or criminal penalties regardless of the nature of their corporate shield. Tex. Prop. Code §§ 162.031, 162.032; Dealers Elec. Supply Co. v. Scoggins Constr. Co., 292 S.W.3d 650, 657 (Tex. 2009). It should be noted, however, that the statute does not penalize persons merely for failing to budget adequately for construction labor or materials, so long as funds were spent appropriately. A paradigmatic example of a CTFA violator is a contractor who receives funds to improve one house but who instead spends them on another project or perhaps on a personal expenditure.

The CTFA includes multiple technical, statutory presumptions, which can have the effect of generating strict liability for covered persons who neglect to hold construction trust funds in a specially designated “construction account” and/or to adequately account for the dispositions of such funds. A violation of the CTFA could be deemed a “fraud or defalcation while acting in a fiduciary capacity,” under Section 523(a)(4) of the U.S. Bankruptcy Code, which means that civil liability incurred under the CTFA against an individual could be considered non-dischargeable in bankruptcy under aggravating circumstances. Bullock v. Bank Champaign, N.A., 569 U.S.  , 133 S. Ct. 1754, 1759-60, (2013). Kahkeshani v. Hann (In re Hann), 544 B.R. 326 (Bankr. S.D. Tex. 2016). In other words, persons cannot necessarily escape the grasp of the CTFA by seeking bankruptcy protection.

Therefore, as a requisite of competency under Tex. Disciplinary R. Prof. Conduct § 1.01, every Texas lawyer who represents: 1) a contractor who receives or might receive a deposit prior to delivering goods/services, 2) a beneficiary of funds given to a general contractor including trade creditors or materialmen, or 3) anyone else who may even be remotely connected with such persons, must be familiar with the CTFA’s coverage, affirmative defenses, and consequences.

Additionally, because the CTFA is a criminal statute, the lawyer who is approached by a client or prospective client seeking counsel with regard to a wrongful distribution of construction trust funds should be wary of aiding or abetting a crime, and may have an affirmative obligation to report the client’s or prospective client’s activity if she cannot be talked into the appropriate course of conduct. See Tex. Disciplinary R. Prof. Conduct §§ 1.02(c)-(f), 1.02 Comments (7)-(8). If the same lawyer were called upon to provide evidence or to testify against the client or prospective client, the attorney-client privilege or duty of confidentiality could not be relied upon protect the attorney from being compelled to so testify, or failing so, to be subject to a criminal charge of obstruction of justice. Tex. Disciplinary R. Prof. Conduct §§ 8.04(a)(4), 3.04(a).

Another professional implication for lawyers involving the CTFA is the receipt of legal fees that could potentially be labeled “construction trust funds.” A constructive trust could conceivably be imposed on a lawyer’s bank account(s) to recover funds for the benefit of one or more creditors if such funds represented wrongful distributions that are directly traceable to construction payments. Also, because lawyers are imputed to have knowledge of the CTFA (whether they actually do or not), the moment the attorney knows or should know that retainer funds may be encumbered by a CTFA claim, the attorney is obligated to freeze the funds pending a resolution of their status pursuant to Tex. Disciplinary R. Prof. Conduct §§ 1.14(b)-(c). Therefore, the CTFA provides numerous avenues for lawyers to be implicated in the conduct of clients regardless of the well-meaning intentions of lawyer or client.

The CTFA is an example of why lawyers must always poke their noses in their clients’ (or prospective clients’) business and maintain a high level of awareness and diligence, lest they be the unwitting architects of misfortune.

Hershel Chapin is the managing attorney of H. R. Chapin, Attorney & Counselor, PLLC. He may be reached at hchapin@gmail.com.

Back to Top