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December 6-19, 2017

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Law & Accounting

T

he Contractor’s Trust

Fund Statute, C.R.S. §

38-22-127, is an extreme-

ly powerful remedy available to

owners and developers of a con-

struction project, yet it rarely is

utilized. The purpose of this arti-

cle is to illustrate the benefits and

nuances of this largely unknown

statute.

In an effort to protect against

“dishonest or profligate con-

tractors,” the Colorado General

Assembly amended the mechan-

ic’s lien statute in 1975 to include

the Trust Fund Statute. A situa-

tion had become all-too-common:

unscrupulous contractors divert-

ed 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 prop-

erty 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 pro-

vides: “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 sub-

contractors, laborer or material

suppliers, or laborers who have

furnished laborers, materials, ser-

vices, or labor, who have a lien, or

may have a lien, against the prop-

erty, or who claim, or may claim,

against a principal and surety

under the provisions for which

disbursement is made.”

Pursuant to this statute, contrac-

tors must hold construction pro-

ceeds in trust for those who have

contributed to a constructionproj-

ect as well as those who might do

so in the future. Contractors can-

not use these funds for any other

purpose, even legitimate busi-

ness overhead expenses, until all

the existing and potential claims

have been fully satisfied. The con-

tractor does not have to main-

tain a sepa-

rate deposit

account for

the construc-

tion proceeds,

but must be

able to fully

account for

every dollar of

the funds.

Any con-

tractor who

violates the

Trust Fund Statute “commits

theft, as defined in section 18-4-

401, C.R.S.” The Civil Theft Stat-

ute 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 sub-

contractors and suppliers, even

legitimate business overhead

expenses (e.g., office space leas-

ing), 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 sup-

pliers. It is not a requirement

that the individual personally

gain from the diversion. Accord-

ingly, an owner/operator, a vice

president, a chief financial offi-

cer – 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 contrac-

tor properly held in trust the spe-

cific 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 con-

tractor claimed a setoff. Addition-

ally, 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 neces-

sarily 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/devel-

oper steps into the shoes of the

contractor against whom the

award was entered and under-

takes 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 continua-

tion of the project or if the award

of treble damages and attorney

fees rendered the award larger

than the amount of claims out-

standing, 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 poten-

tial personal liability often will

bring even the most entrenched

parties toward resolution and

avoid disruption on construction

projects.

s

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

Mike Cross

Partner, Ogborn

Mihm LLP, Denver