Many states have a construction trust fund statute that requires all funds disbursed to any contractor or subcontractor under any building, construction, or remodeling contract to be held in trust for the payment of the subcontractors, laborers, and material suppliers, and not to be used for any other purpose.
This means that, in addition to the contractual obligations between the owner, general contractor, subcontractors, and materials suppliers, a construction trust fund statute creates a fiduciary duty (the highest duty recognized by law) for persons holding construction funds (contractors and subcontractors) by classifying the funds as trust funds. This not only creates personal liability for the trustee holding the funds (contractor or subcontractor), but also for any other directors or officers of the company that controlled the finances.
These significant legal consequences exist because the construction funds don’t belong to the person holding them—they belong to the person or entity to whom they are ultimately owed (subcontractor or materials supplier) and for whom they are earmarked. The person or entity to whom the funds are disbursed (contractor or subcontractor) is holding the funds in trust for the benefit of the subcontractors and materials suppliers who provided the labor or materials to improve the land or buildings. And the duty and debt owed under a construction trust fund statute cannot be discharged in a bankruptcy filing.
If construction project payments are used for any purpose other than paying persons providing labor and materials for the construction project, it is considered theft and may be charged as a criminal offense. There is no requirement of bad faith or malicious intent by the trustee who failed to hold the funds in trust for the labor or materials supplier for whom the funds were intended.
For example, using the construction trust funds for one project to fund other projects, or to pay for legitimate business expenses or overhead costs, or to pay personal expenses is a violation of the construction trust fund statute—and ignorance of the law and the trustee’s responsibilities under the law is no excuse.
In some states a person holding construction trust funds must keep the funds in a separate bank account. Other states do not require a separate bank account, but require the general contractor (trustee), for example, to maintain separate records of account for each project or contract.
In Michigan, the Public Act 497 of 1980, commonly known as the Michigan Builder's Trust Fund Act, governs the handling of construction trust funds. This statute mandates that a contractor or subcontractor who receives funds for a construction project holds those funds in trust for the payment of laborers, subcontractors, and material suppliers. The funds are not to be used for any other purpose, such as financing other projects, paying business overhead, or covering personal expenses. The Act creates a fiduciary duty for the individuals in control of the funds, making them personally liable for misappropriation. This liability extends to officers or directors of a company who have control over the financial decisions. Misuse of the trust funds is considered a breach of fiduciary duty and can lead to civil and criminal penalties, including charges of theft. The Michigan Builder's Trust Fund Act does not specifically require that trust funds be kept in a separate bank account, but it does require that contractors maintain accurate records of the funds and their use. Ignorance of the law is not a defense, and the obligations under this statute cannot be eliminated through bankruptcy proceedings.
