The Contractor’s Trust Fund Statute: A powerful remedy for developers

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Mike Cross
Partner, Ogborn Mihm LLP, Denver

The Contractor’s Trust Fund Statute, C.R.S. § 38-22-127, is an extremely powerful remedy available to owners and developers of a construction project, yet it rarely is utilized. The purpose of this article is to illustrate the benefits and nuances of this largely unknown statute.

In an effort to protect against “dishonest or profligate contractors,” the Colorado General Assembly amended the mechanic’s lien statute in 1975 to include the Trust Fund Statute. A situation had become all-too-common: unscrupulous contractors diverted funds from a construction project to pay the (often older) liabilities of a different project. The squeaky wheel gets the grease. When those contractors ran out of money, subcontractors and suppliers went unpaid, liens were recorded against the property and developers often were required to provide payment for a second time. The Trust Fund Statute was meant to prohibit and penalize such conduct.

The Trust Fund Statute provides: “All funds disbursed to any contractor or subcontractor under any building, construction, or remodeling contract or on any construction project shall be held in trust for the payment of subcontractors, laborer or material suppliers, or laborers who have furnished laborers, materials, services, or labor, who have a lien, or may have a lien, against the property, or who claim, or may claim, against a principal and surety under the provisions for which disbursement is made.”

Pursuant to this statute, contractors must hold construction proceeds in trust for those who have contributed to a construction project as well as those who might do so in the future. Contractors cannot use these funds for any other purpose, even legitimate business overhead expenses, until all the existing and potential claims have been fully satisfied. The contractor does not have to maintain a separate deposit account for the construction proceeds, but must be able to fully account for every dollar of the funds. Any contractor who violates the Trust Fund Statute “commits theft, as defined in section 18-4-401, C.R.S.” The Civil Theft Statute entitles the aggrieved party to “three times the amount of the actual damages sustained” as well as “costs of the action and reasonable attorney fees.” This is a severe penalty. If a contractor uses construction proceeds for any purpose other than paying subcontractors and suppliers, even legitimate business overhead expenses (e.g., office space leasing), and the project subsequently runs out of money, that contractor could be liable for three times the amount spent on those expenses, plus attorney fees.

Further, this liability can be imposed on the individual owner(s) or manager(s) who made the decision to use trust funds for purposes other than paying subcontractors and suppliers. It is not a requirement that the individual personally gain from the diversion. Accordingly, an owner/operator, a vice president, a chief financial officer – anyone who controls the contractor’s finances and makes the decision to use trust funds for a purpose other than paying contractors, suppliers or laborers – could become personally liable for the company’s violation of the Trust Fund Statute.

It is no defense to assert that the contractor believed that future receivables would replenish the construction proceeds. The only question is whether the contractor properly held in trust the specific construction proceeds for the particular project. It is a defense, however, if the contractor had a good faith belief that a lien or claim was not valid or if the contractor claimed a setoff. Additionally, the Trust Fund Statute does not apply if a performance or payment bond is in place.

Should a developer prevail on a claim for violation of the Trust Fund Statute, it does not necessarily mean that it has the right to retain the damages awarded. The owner/developer becomes the constructive trustee of any funds collected and must hold those funds in trust for the benefit of any subcontractors, laborers and material suppliers who are unpaid and have a claim or may have a claim to those funds. In other words, the owner/developer steps into the shoes of the contractor against whom the award was entered and undertakes the trust obligations. If money remains after all existing and potential claims have been satisfied, the developer may be entitled to those funds. For instance, if the owner/developer paid claims to ensure continuation of the project or if the award of treble damages and attorney fees rendered the award larger than the amount of claims outstanding, the owner/developer may apply to the court for release of the funds.

The Trust Fund Statute imposes strict requirements on contractors and provides powerful remedies. Understanding these remedies will greatly empower owners and developers. Illustrating the trust creation, the fiduciary duty imposed, the duty to account, the right to treble damages and attorney fees, and the potential personal liability often will bring even the most entrenched parties toward resolution and avoid disruption on construction projects.

Featured in CREJ’s Dec. 6-19, 2017, issue.

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