Contractors may have defense to Texas Construction Trust Fund Act

Posted on Oct 17, 2016

In this case TAG entered into a contract with Buildings by Monaco, Inc. ("BBM") to build a luxury home in San Antonio, Texas. BBM served as the general contractor, and was to receive progress payments once they submitted an application and swore that all subcontractors and supplies had been paid and lien releases obtained. 

BBM made the certifications but TAG began to receive lien notices. TAG hired a new contractor to take over and settle the liens. TAG then reimbursed the new contractor and sought payment from BBM. Four years later Mr. Monaco and BBM both filed chapter 7 bankruptcy. TAG objected to the discharge of their debt as to Mr. Monaco for his misapplication of trust funds,

The Texas Construction Trust Fund Act (CTFA) holds liable any "trustee who, intentionally or knowingly or with intent to defraud, directly or indirectly retains, uses, disburses, or otherwise diverts trust funds without first fully paying all current or past due obligations incurred by the trustee to the beneficiaries of the trust funds. Tex. Prop. Code Sec. 162.031. The statute also extends liability to officers of the "trustee," TAG alleged in bankruptcy court that the debt Monaco owed was nondischargeable under 11 U.S.C. Sec. 523(a)(4).

That statute excepts from the discharge those debts that are "for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." The bankruptcy court ruled for TAG rendered judgment for them and against Monaco for $171,942.03. After some legal wrangling, the district court affirmed the bankruptcy court. 

The Fifth Circuit Court of Appeals reversed and rendered, ruling for the contractor. It held that the CTFA contained an affirmative defense, which applied in this case. Sec. 162.031(b) provides that "it is an affirmative defense to prosecution or other action..that the trust funds not paid to the benefiaries of the trust were used by the trustee to pay the trustee's actual expenses directly related to the construction or repair of the improvement." TAG Investments, Ltd v. Monaco, 5th Cir. 2016.

Evidence had shown that BBM spent every cent it received for third-party expenses, salaries, overhead and supervision, and in addition had even used $70,000 in profit to pay for expenses incurred on the project. Therefore the court ruled that Monaco should not have been held liable for misapplication of construction trust funds under the CTFA and that the debt claimed by TAG should have been discharged.

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