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TOP 10 PRACTICAL TIPS ON RESOLVING CONSTRUCTION CLAIMS

BY

RANDALL K. LINDLEY

CHELSEA L. HILLIARD

BELL NUNNALLY & MARTIN LLP

3232 McKinney Avenue, Suite 1400 Dallas, Texas 75204 (214) 740-1400

A SEMINAR SPONSORED BY:

NACM SOUTHWEST

March 23, 2012

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Copyright © 2012 by Randall K. Lindley Bell Nunnally & Martin LLP

3232 McKinney Avenue Suite 1400 Dallas, Texas 75204 (214) 740-1400

Printed in the United States of America

This publication is for educational purposes only and cannot be relied upon as legal advice. It has been prepared with the "understanding that the publisher is not engaged in rendering legal, accounting, or other professional services. Although prepared by professionals, this publication should not be utilized as a substitute for professional services in specific situations. If legal advice or other expert assistance is required, the service of a professional should be sought." From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers.

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TABLE OF CONTENTS

A. Top 10 Practical Tips on Resolving Construction Claims ……………………………..4

1. Perfected Claims – Be the Squeaky Wheel …………………………………..….5

2. The Claim: Threaten to Foreclose ………………….………...... 6

3. The Perfected Payment Bond Claim: Threaten to File Suit against the Surety ………………………………………………..…...7

4. Disputed Claims – Notice Letter Problems …………………………………...…9

5. Disputed Claims: Lien Affidavit Problems ………………………………….…..10

6. Disputed Claims: Proof of Delivery of Performance of Labor ………………………………………………………….…...13

7. The Fight for Retainage ………………………………………………………...... 15

8. Unperfected Claims: Send a ―Trust Fund‖ Demand Letter …………………………………………………………….………...16

9. Unperfected Claim: Use Business ―Good Will‖ / and Request for Joint Check ……………………….………………………….…20

10. Only Assert Legitimate Claims: Be Aware of the Fraudulent Lien Statute …………………………………….……………..20

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TOP 10 PRACTICAL TIPS ON RESOLVING CONSTRUCTION CLAIMS

By: Randall K. Lindley and Chelsea L. Hilliard

The name of the game for credit managers is not merely to properly assert a construction claim, it is to obtain payment of the construction claim. Each party in the construction chain of title has their own goals and expectations with respect to the project.

The owner wants the project completed in accordance with the plans and specifications and in a timely manner. The general contractor, subcontractor(s), and supplier(s) want to be paid for their labor and materials provided in the construction process. As the construction process proceeds, these contractors and suppliers assert claims for payment as authorized by the Texas Constitution, the Texas Property Code and the Texas Government Code.

Compliance with the statutory notice, lien and claim policy procedures is a hotly contested topic among parties in the construction chain. The claim of general contractors, subcontractors and suppliers generally fall into the following three (3) hierarchical categories:

Perfected claims;

Disputed claims; and

Unperfected claims.

At the top of the list, a claimant with a ―perfected claim‖ has crossed the t’s and dotted the i’s on sending out notice letters and asserting the lien and/or payment bond claim. The perfected claim is, for obvious reasons, the easiest type of claim to obtain payment. Below the perfected claim is a ―disputed claim,‖ or one that has been asserted, but for some reason, the owner or general contractor or owner contends that the claim fails

4 to comply with the statutory requirements. Below the disputed claim is an ―unperfected claim,‖ or a claim for payment on a construction project, without the appropriate statutory notices and/or claims were not asserted.

1. PERFECTED CLAIMS -- BE THE SQUEAKY WHEEL

Basically, there are several types of squeaky wheels. The first squeaky wheel squeaks. It is an annoying noise that must eventually be addressed. The second type of squeaky wheel is more akin to an unbearable ―air horn.‖ While this squeaky wheel analogy is used in jest, practically speaking, this terminology has no better place than in the resolution of construction claims.

In practice, the squeaky wheel conversation with the project manager for the general contractor is as follows:

Hi, my name is Payme Now. I am the credit manager for Jones Supply. Jones Supply was a subcontractor to Rooster Mechanical related to the construction project at the Brinker Apartment Complex. As you know, Rooster Mechanical failed to pay us and we had to send the statutory notice of our claim to you and the owner. I just wanted to follow up with you concerning the payment for our unpaid .

Does the general contractor continue to hold monies that are due to Rooster Electrical?

Has the owner paid you, as general contractor, all monies due for the work performed by Rooster Electrical?

We would like to release our claim, will you pay us directly?

As illustrated above, the first buttons to push with respect to the general contractor focus on what funds they continue to hold from which you can obtain payment and using additional labor and/or material requirements for the job as leverage to insist on payment.

(In other words, does the general contractor require additional work from the creditor – can you refuse this work until payment is made?) If the creditor believes that the general

5 contractor is not providing enough focus or attention to this claim, the creditor can engage counsel to ―politely request a response and/or information.‖

If the project is a public job and involves a surety, the surety will typically send two letters as follows:

An acknowledgment letter; and

A ―request for documents‖ letters (in the form of a proof of claim)

Although it is duplicative of the notices previously sent, sending the surety all documents that support the productive claim (invoices, notice letters, purchase orders, proof of delivery) is an important step. The next step is to request a time commitment from the surety on its decision making and check issuance process. The specific questions to ask the surety are as follows:

What additional documents do you need before you can issue a check for this matter?

Please let me know when we can expect payment.

PRACTICAL TIP: ON PRIVATE PROJECTS, CALL THE OWNER AND GENERAL CONTRACTOR AND ASK FOR PAYMENT FROM TRAPPED FUNDS AND ON PUBLIC PROJECTS, CALL THE SURETY AND REQUEST PAYMENT.

2. THE LIEN CLAIM: THREATEN TO FORECLOSE

A mechanic and materialman’s lien claim may only be foreclosed judicially. To prevail, the lien claimant must file a lawsuit and obtain a judgment that forecloses the lien and orders the sale of the property subject to the lien. TEX. PROP. CODE ANN. § 53.154

(Vernon 2007). The lawsuit to foreclose the lien must be brought within two years after the last day the claimant may file the lien affidavit or within one year after completion of the project, whichever is later. TEX. PROP. CODE ANN. § 53.158(a) (Vernon 2007). For a residential construction project, the lawsuit must be brought to foreclose the lien within one

6 year after the last day the claimant may file the lien affidavit or one year after completion of the project, whichever is later. TEX. PROP. CODE ANN. § 53.158(b) (Vernon 2007).

The Texas Property Code was amended last year to provide that a Court shall award costs and attorney’s fees in any proceeding to:

(1) foreclose a lien,

(2) enforce a claim against an indemnity or surety bond, or

(3) declare any such lien or claim invalid or unenforceable in whole or in part. TEX.

PROP. CODE ANN. § 53.156 (Vernon 2012). The intent behind this amendment was to require Courts to award attorney’s fees when there is a clear winner, rather than requiring each party to be responsible for its own fees and costs. Palomita, Inc. v. Medley, 747 S.W.2d

575, 577 (Tex. App.—Corpus Christi 1988, no writ) (court stated the ―primary intent of the legislature in adopting 53.156 and 53.157 was to allow subcontractors to recover attorneys fees.‖). This new mandatory attorneys’ fees language, however, does not require a residential property owner to pay costs and attorney’s fees for mechanic’s arising out of a residential construction contract. TEX. PROP. CODE ANN. § 53.156.

In addition, a copy of the demand letter to the surety threatening to foreclose the lien is provided as a hand-out to this presentation.

PRACTICAL TIP: SEND THE LETTER THREATENING TO FORECLOSE THE LIEN

3. THE PERFECTED PAYMENT BOND CLAIM: THREATEN TO FILE SUIT AGAINST THE SURETY

A payment bond beneficiary who has provided public work labor or materials under a public work contract covered by a Chapter 2253 payment bond may sue the principal or surety, jointly or severally, on the bond. TEX. GOVT. CODE ANN. § 2253.073(a) (Vernon

2008). To prevail, the payment bond beneficiary must prove:

(1) that it is a payment bond beneficiary under Chapter 2253;

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(2) that it fulfilled the requirements of Chapter 2253 by performing its contract, either by carrying out the public work labor required or delivering the materials ordered;

(3) that the work performed or the materials furnished was incident to, or used on, the construction project covered by the bond;

(4) that the claim was properly filed and notice given; and

(5) that the claim was not paid before the 61st day after the date the notice of claim is mailed.

See H. Richards Oil Co. v. W. S. Luckie, Inc., 391 S.W.2d 135, 137 (Tex. Civ. App.—Austin,

1965, writ ref’d n.r.e.); Tex-Craft Builders, Inc. v. Allied Constructors of Houston, Inc., 465

S.W.2d 786, 793 (Tex. Civ. App.—Tyler Mar 25, 1971, writ ref’d n.r.e.); see also Employers’

Liability Assur. Corp. v. Young County Lumber Co., 64 S.W.2d 339, 344 (Tex. 1933) (holding that failure to file claim barred recovery on bond).

If the payment bond beneficiary prevails, it may recover the unpaid balance of its claim at the time the claim was mailed or the suit was brought, and the trial court may award reasonable attorney fees. TEX. GOVT. CODE ANN. § 2253.073(b) (Vernon 2008).

However, the trial court has the discretion to reduce or deny the payment bond beneficiary’s fee recovery. TEX. GOVT. CODE ANN. § 2253.074 (Vernon 2008); C. Green

Scaping, L.P. v. Westfield Ins. Co., 248 S.W.3d 779, 789 (Tex. App.—Fort Worth 2008, no pet.).

In the event a party asserts a Chapter 2253 bond claim which remains unpaid, a lawsuit must be commenced before the expiration of one year after the date the notice of a claim is filed. TEX. GOV’T CODE ANN. § 2253.078 (Vernon 2000).

An example of a form letter threatening to sue the surety on the payment bond is provided as a hand-out to this presentation.

PRACTICAL TIP: SEND THE LETTER THREATENING TO SUE THE SURETY

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4. DISPUTED CLAIMS – NOTICE LETTER PROBLEMS

There are three general types of problems that occur with notice letters: the notice letter is:

Untimely;

Sent to the wrong party; and/or

Fails to include the statutory language.

Timeliness is key. As evidenced by the holding in Morrison Supply Co. v. MW

Hamilton & Co., even a notice that is only ten days late, is ten days too late. 411 S.W.2d

790 (Tex. App.—Amarillo 1967, no writ). Because the statute specifies that the notice must be in writing and must be delivered within the prescribed time period, Texas courts have held that even actual notice of the claim is insufficient without proof of a timely delivered written notice. Tex. Constr. Assocs., Inc. v. Balli, 558 S.W.2d 513 (Tex. App.—Corpus

Christi 1977, no writ) (―timely written notice is a necessary condition precedent to perfecting a claim…‖).

Know who the key parties involved are. It is important to make sure that you have properly identified the true owner of the property and that is who you have forwarded the notice to. Under Texas law, the party seeking to enforce its lien claim has the burden to prove that it properly perfected its lien claim by sending the notice to the actual owner of the property. Robert Burns Concrete Contractors, Inc. v. Norman, 561 S.W.2d 614 (Tex.

App.—Tyler 1978, writ ref’d n.r.e.) (delivery of notice must be to the proper owner and claimant failed to show that title had ever passed to new owner to which claimant had sent notice).

Including the statutory language is also essential to properly asserting your lien claim. The notice letter must include all of the language required by the statute to be valid.

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For example, in First Nat’l Bank in Graham v. Sledge, the Texas Supreme Court held that a notice letter that did not contain the ―statutory warning‖ language was not valid and thus could not be used to perfect a lien claim. 653 S.W.2d 283, 287 (Tex. 1983). There, the Court went on to explain that in order for a notice to be valid, it must contain a warning that alerts the owner to the fact that if they fail to pay the claim or otherwise settle, that they may be held personally liable and their property be subjected to a lien. Id.

On a whole, a notice letter must technically comply and conform to the statute’s technical requirements. Failure to meet these requirements may result in the claim being held invalid, and thus, unenforceable. Yeager Electric & Plumbing Co., Inc. v. Ingleside

Cove Lumber and Builders, Inc., 526 S.W.2d 738 (Tex. Civ. App.—Corpus Christi 1975, no writ) (proof of notice to owner must be pled to succeed in suit to foreclose a lien and show that the requisite statutory notice was in fact given). Likewise, in Herrington v. Luce, the court articulated that the giving of the notice letter to the owner is a condition precedent to the validity of a lien claim by a subcontractor. 491 S.W.2d 478 (Tex. Civ. App.—Tyler 1973, no writ).

PRACTICAL TIP: CHECK AND DOUBLE CHECK YOUR DATES, NAMES AND ADDRESSES ON THE FRONT END TO AVOID NOTICE DEFECTS.

5. DISPUTED CLAIMS: LIEN AFFIDAVIT PROBLEMS

In order to properly assert a statutory lien there are several steps that must be completed by the claimant. Thus, there are also several problems that can result along the way, which can result in the lien being legally invalid. Some of the problems with the lien affidavits include:

Failing to file the affidavit in a timely manner

Failing to identify the amount claimed

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o Accounts must show facts required by statute to establish liens, and affidavit and account. In the case of Pacific Indem. Co. v. Bowles & Edens Supply Co., the court held that the affidavit must contain a description of the amounts due that is sufficient to show that labor has been performed, that certain sum is due therefor, and when it was due. 290 S.W.2d 353 (Tex. App.—Dallas 1956, writ ref. n.r.e.).

o In Gill Sav. Ass’n v. Int’l Supply Co., Inc., the court held that the requirement to accurately describe the amounts due and owing in the affidavit did not go so far as to require the lien claimant to prove the value of the materials supplied. The court explained that this was not an essential element of a supplier’s claim and would not render proof of amount of claim inadequate. 759 S.W.2d 697 (Tex. App.—Dallas 1988, writ denied).

Failing to identify the owner

Failing to describe the labor and/or materials

o ―General contractor responsibilities‖ was sufficient description of labor to satisfy substantial compliance test. In re Orah Wall Financial Corp., 84 B.R. 442 (Bkrtcy. W.D. Tex. 1986).

o Mathews Const. Co., Inc. v. Jasper Housing Const. Co. 528 S.W.2d 323 (Tex. App.—Beaumont 1975, writ ref. n.r.e.).

o Must include the months in which the work was performed to perfect lien. Milner v. Balcke-Durr, Inc., 2006 WL 2190516 (App. 3 Dist. 2006, unreported).

Failing to adequately describe the real property

o Metes and bounds survey not necessary to be legally sufficient. Rather, land description is legally sufficient when it contains ―nucleus of information‖ that would enable party familiar with locality to identify the premises with reasonable certainty. Blanco, Inc. v. Porras, 897 F.2d 788 (5th Cir. 1990).

o Need not be any more particular than what is required for the conveyance of land – both are designed to require a description from which the land may be certainly found and identified. Rheem Acceptance Corp. v. Rowe, 332 S.W.2d 353 (Tex. App.—Amarillo 1959, writ ref. n.r.e.).

o Even if it identifies the wrong county, so long as it furnishes a ―nucleus of description‖ it will be sufficient, where it provided proper address of property and identified owner as being located at the same address. AMS Const. Co., Inc. v. Warm Springs Rehab. Found., Inc., 94 S.W.3d 152, 163 (Tex. App.—Corpus Christi 2002, no pet.).

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Failing to include a Jurat

o To be an ―affidavit‖ it must contain a jurat. An acknowledgement is not sufficient. Crockett v. Sampson, 439 S.W.2d 355, 359-60 (Tex. App.—Austin 1969, no writ).

Failing to send a copy of the lien affidavit

o Section 53.055 of the Texas Property Code

o In re Rose, 22 F.Supp. 988, 992 (W.D. Tex. 1938) held that even though the lien affidavit substantively complied with the statutory requirements, the failure of filing the lien affidavit on time was fatal to any recovery thereon as it ―constituted no notice.‖

o Copy of the filed affidavit must be sent via registered or certified to the owner or reputed owner at the owner’s last known business or residence address not later than the fifth (5) day after the date the affidavit is filed with the county clerk.

o If not an original contractor – must also send a copy of the affidavit to the original contractor at the original contractor’s last known business or residence address – same time frame.

Failing to file the lien affidavit on time

o Better to be early rather than late. Contractor could perfect its mechanics’ lien even though he sent a copy of the lien affidavit to property owner before the affidavit was actually filed with the county clerk, where owner received copy no more than five days after lien was filed, copy was an exact copy of what was filed, and filing of affidavit occurred within a few days of notice being sent to owner. Arias v. Brookstone, L.P., 265 S.W.3d 459 (Tex. App.—Houston [1st Dist.] 2007, pet. denied).

o Truss World, Inc. v. ERJS, Inc., 284 S.W.3d 393, 395-98 (Tex. App.—Beaumont 2009, no pet.) (statute does not prohibit giving notice before the lien affidavit is filed).

Although Texas courts repeatedly state that ―substantial compliance‖ with the Texas

Property Code is sufficient in order to perfect a lien claim, the author recommends that strict compliance is always the best rule. First Nat’l Bank v. Sledge, 653 S.W.2d 283, 285

(Tex. 1983). Basically, this means that technical mistakes in a lien affidavit may not be

12 fatal to the validity of the lien as long as the claimant has substantially complied with the statutory requirements. One example is the recent case of Mustang Tractor & Equipment

Co. v. Hartford Accident & Idenmnity Co., where the Court held that a supplier’s lien was valid even though it failed to provide a statement of the dates and method of mailing of the notice of the owner required by Tex. Prop. Code § 53.054. 263 S.W.3d 437 (Tex. App.—

Austin, 2008, pet. denied). The Austin Court of Appeals held that the lien substantially complied with the lien statutes despite the complete omission of this required information.

If a mistake is made, argue ―substantial compliance.‖ In an ideal world, however, you never want to rely on substantial compliance to establish the validity of your lien claim.

PRACTICAL TIP: AS A LAST RESORT, ASK COUNSEL IF YOU HAVE A BASIS TO ARGUE SUBSTANTIAL COMPLIANCE

6. DISPUTED CLAIMS: PROOF OF DELIVERY OR PERFORMANCE OF LABOR

Depending on whether the claim relates to a public project or a private project, either the surety or the owner will require proof of delivery (of materials) or performance (of labor) before paying a disputed claim. It is important for a claimant that sold materials to have a system in place to document shipment to, and delivery at the project site. Some businesses make their own deliveries. In such a case, requiring a signature by the project manager at the job site is ideal. Other businesses use vendors (truckers) to make deliveries. In both instances, a specific signatory process to create documentary evidence that the materials at issue were in fact delivered to the job site on a specific date is very important.

A showing of actual delivery to the job site is necessary:

o Unless the owner directs delivery of the materials to a place other than the job site – sufficient to construe delivery of the materials as it gives the owner complete ownership and control over the materials once at that location. Trammel v. Mounts, 4 S.W. 377 (Tex. 1887).

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o Not necessary that the materials be immediately used or incorporated into the project, delivery to the job site is sufficient to start the statutory clock. First Cont’l Real Estate Inv. Trust v. Cont’l Steel Co., 569 S.W.2d 42 (Tex. Civ. App.—Fort Worth 1978, no writ).

If a claimant provided ―services‖ at the project site, the evidence of the performance of such services can be documented through log sheets and other reports reflecting the dates personnel performed tasks at the project site. Since ―services‖ are harder to prove delivery of, per se, it is important to document when the materials and machinery, used by the artisans and laborers in providing their services, are delivered or dropped off at the project site.

For example, in Fidelity and Deposit Co. of Maryland v. Indus. Handling Eng’rs,

Inc., the court held that delivery of a platform lift to the building site constituted ―delivery‖ under the statute so as to fix the date from when the time to file a lien claim began, even though the machinery was not usable at the time it was delivered to the job site. 474

S.W.2d 584 (Tex. Civ. App.—Houston [14th Dist.] 1971, no writ).

However, in First Nat’l Bank of Electra v. Fed. Supply Co., where oil drilling company was ordering and receiving materials at the job site (related to the drilling of a single well) on an ―as needed basis,‖ the court determined that the tolling of the time to file a lien claim began running from the last date the materials were delivered to the lienor at the project site. 260 S.W. 881 (Tex. Civ. App.—Amarillo 1924, no writ). In explaining the holding, the court articulated that like a contract for personal services ―under a contract where no definite time is agreed upon for completion of the work or end of the labor‖…that in ―such cases limitation commences to run from the time of the completion of the work or labor.‖ Id.; citing Matthews v. Wagenhaeuser Brewing Ass’n, 19 S.W. 150 (Tex. 1892).

Thus, in cases where materials are being delivered to the project on an ―as needed basis‖ or where services are being rendered without a contract providing for a definite completion

14 date, Texas courts will consider the materials or services as a whole and begin the limitations period from the last date the materials or services were provided.

PRACTICAL TIP: MAKE SURE YOUR BUSINESS HAS A SYSTEM IN PLACE TO PROVE DELIVERY

7. THE FIGHT FOR RETAINAGE

Once the owner has retained the required 10%, the next issue is how those funds are to be distributed among the various claimants. It is a common misconception of many claimants that if they comply with the lien laws, and properly perfect their lien claim, they will be paid in full. The owner’s liability, however, is limited to the amount of funds trapped after of a fund-trapping letter, plus the 10% statutory retainage. In many cases, the total amount of lien claims far exceeds the amount of funds trapped and/or retained by the owner. Texas Property Code Section 53.104 outlines how this pool of funds should be distributed among claimants.

Individual artisans and mechanics are entitled to a preference to the retained funds to the extent their claims are for wages and fringe benefits earned. TEX. PROP. CODE ANN.

§ 53.104(a) (Vernon 2007). Note, this preference only applies to claims for wages and fringe benefits. Section 53.104(b) specifies that the remainder of the claimants ―share proportionately in the balance of the retained funds.‖ TEX. PROP. CODE ANN. § 53.104(b)

(Vernon 2007). Therefore, if the total amount of claims exceeds the total amount of retained funds, each claimant will receive a prorata share, or a percentage, of the total claim amount.

Section 53.105 clarifies that if the owner fails to retain the required 10% for thirty

(30) days, the claimant is entitled to a lien in the amount of the 10% that the owner should have retained. TEX. PROP. CODE ANN. § 53.105 (Vernon 2007). The maximum amount of the lien is the amount required to be retained under statutory retainage method, plus the

15 amount of trapped funds. Ambassador Dev. Corp. v. Valdez, 791 S.W.2d 612, 622 (Tex.

App.—Ft. Worth 1990, no writ).

The claimant should verify that all other lien claims are valid and properly perfected by reviewing each lien affidavit as well as the required notices. A claimant can often increase his or her prorata share of the retained funds by identifying invalid claims, and making the owner aware of the defects that make the claim invalid.

PRACTICAL TIP: ANALYZE COMPETING LIEN CLAIMS TO POINT OUT DEFECTS TO OWNER

8. UNPERFECTED CLAIMS: SEND A “TRUST FUND” DEMAND LETTER

A. Texas Construction Trust Fund Statute

Chapter 162 of the Texas Property Code provides that construction payments are

―trust funds‖ if they are made to a contractor or subcontractor under a construction contract for the improvement of real property in Texas. TEX. PROP. CODE ANN. §

162.001(a) (Vernon Supp. 2010). Similarly, loan borrowed by a contractor, subcontractor or owner for improvements to real property in Texas are ―trust funds.‖ TEX.

PROP. CODE ANN. § 162.001(b) (Vernon Supp. 2010).

The party in the construction chain (i.e. the contractor, subcontractor or owner), as well as the individual officers, directors or agents of said party, who receives or has control of the trust funds, is deemed the trustee of the trust funds for the benefit of unpaid subcontractors or materialmen. TEX. PROP. CODE ANN. § 162.002 (Vernon 2007) & TEX.

PROP. CODE ANN. § 162.003 (Vernon Supp. 2010). To the extent these parties and individuals misapply the trust funds, they may be personally liable to the unpaid subcontractors and materialmen. Nuclear Corp. of Am. v. Hale, 355 F.Supp. 193, aff’d, 479

F.2d 1045 (5th Cir. 1973). It is important to note that a private cause of action for misapplication of trust funds exists without showing intent to defraud. Id.; North Texas

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Operating Eng’rs Health Benefit Fund v. Dixie Masonry, Inc., 554 F.Supp. 516 (N.D. Tex.

1982).

While claimants should always assert lien and bond claim rights because they are easily the most effective remedy available, circumstances often arise where notice deadlines are missed and these rights are lost. A claimant’s ability to assert a claim under the trust fund statute is entirely independent of its lien claim rights. The Court in McCoy v. Nelson

Utils. Servs., held that a materialman was not required to perfect a lien claim in order to recover under the trust fund statute. 736 S.W.2d 160 (Tex. App.—Tyler 1987, writ ref. n.r.e.). In McCoy, the materialman (without any contractual relationship with the owner or the contractor) recovered a judgment against the owner of the property, the general contractor and the individual owners of the general contractor for the amount of misapplied trust funds. Id. at 166.

In this day and age of difficult economic times, many owners and contractors find themselves in a position where they choose to ―rob Peter to pay Paul‖. When a claimant is confronted with this scenario, the Texas Trust Fund Statute is a viable remedy.

The trust fund statute applies ―regardless of whether a construction contractor is covered by a statutory or common law payment bond,‖ i.e., regardless of whether the contractor has furnished a payment bond under the Government Code. TEX. PROP. CODE

ANN. § 162.004(c) (Vernon Supp. 2010). The statute also applies to a residential property owner under a residential construction contract. TEX. PROP. CODE ANN. § 162.003(b)

(Vernon Supp. 2010).

However, the trust fund statute does not apply to:

(1) a bank, savings and loan, or other lender;

(2) a title company or other closing agent; or

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(3) a corporate surety who issues a payment bond covering the contract for the construction or repair of the improvement.

TEX. PROP. CODE ANN. § 162.004(a) (Vernon 2007).

Additionally, the latest amendment to the trust fund statute provides that a fee payable to a contractor under a ―Cost Plus‖ contract is not considered trust funds if:

(1) the contractor and property owner;

(2) entered into a written construction contract that provides for the payment by the owner of the costs of construction and a reasonable fee specified in the contract payable to the contractor;

(3) for the improvement of specific real property in Texas;

(4) before construction of the improvement begins; and

(5) the fee is earned as provided by the contract and paid to the contractor or disbursed from a construction account described by Section 162.006, if applicable.

TEX. PROP. CODE ANN. § 162.001(c) (Vernon Supp. 2010). The old version of this statute was open to the interpretation that all payments made under a ―Cost Plus‖ contract were exempt from trust fund status. The amendment clarifies that the exemption only applies to the Contractor’s Fee under a Cost Plus Contract. Id.

It is a defense to a trust fund claim if the trustee uses the funds to pay actual expenses directly related to the construction. TEX. PROP. CODE ANN. § 162.031(b) (Vernon

2007). For example, if an owner fires an original contractor before paying the full contract price but subsequently hires a new original contractor and pays the new contractor the remaining funds, the owner is not liable to any subcontractors who remain unpaid by the terminated contractor since the trust funds were used to complete the project. The Texas legislature recently clarified that construction trust funds do not lose their trust fund status when a contractor commingles trust funds with its other funds. TEX. PROP. CODE

ANN. § 162.031(d) (Vernon Supp. 2010).

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A judgment based on a violation of the Texas Trust Fund Statute is likely non- dischargable in bankruptcy. In re Munton, 352 B.R. 707 (9th Cir. 2006). As a related issue, the legislature recently amended the Texas Trust Fund Statute to protect subcontractors from having to repay trust funds due to a contractor’s bankruptcy. See TEX. PROP. CODE

ANN. § 162.001(c) (Vernon Supp. 2010). As a general rule, where a debtor pays a creditor and then declares bankruptcy within 90 days of the payment, the bankruptcy trustee can seek to have the creditor pay the money back into the bankruptcy estate. 11 U.S.C.A. §

547(b) (West Supp. 2010). The transaction is voidable based on the rationale that the payment was made as an improper preference of one creditor over others with equal rights to recover the debtor’s assets through the bankruptcy.

The amended statute makes clear that construction trust funds paid to a creditor under the trust fund statute ―are not property or an interest in property of a debtor who is a trustee‖ under the statute. Id. The practical effect of this amendment is that a subcontractor who holds a mechanic’s and materialman’s lien, receives payment, and then releases its lien is protected from having to repay the trust funds to a subsequently bankrupt contractor’s bankruptcy estate as a voidable preference. See id.

The bankruptcy courts have yet to interpret this amendment to the statute, but a similar outcome was already supported by prior federal case law. Echoing a bankruptcy court opinion from the Western District of Texas, the Fifth Circuit previously held that a trustee in bankruptcy cannot avoid, as a preference, a transfer of construction trust funds from a contractor to a subcontractor within 90 days of the contractor’s bankruptcy filing. In re N.A. Flash Found., Inc., 298 Fed. Appx. 355, 359-61, 2008 WL 4763328, at *4-5 (5th Cir.

2008) (Not for Publication); see Cunningham v. T & R Demolition, Inc., 301 B.R. 195, 199-

200 (Bankr. N.D. Tex. 2003) (recognizing that payments made under the Texas trust fund

19 statute are not voidable preferences); In re HLW Enters. of Tex., Inc., 157 B.R. 592, 596-98

(Bankr. W.D. Tex. 1993) (holding that transferred funds were trust funds under Chapter

162 and therefore not the property of the debtor).

PRACTICAL TIP: SEND A TRUST FUND DEMAND LETTER

9. UNPERFECTED CLAIM: USE BUSINESS “GOOD WILL” / AND REQUEST FOR JOINT CHECK

One alternative to sending the trust fund demand letter is to simply call the general contractor and request payment. When the general contractor states there is no contractual privities (i.e. no obligation), then explain that the trust funds being held by the general contractor are earmarked for the materials or services provided by the supplier or subcontractor are intended to flow to the supplier or subcontractor. At this point, the supplier can suggest that a joint check be issued made jointly payable to the contractor and/or the subcontractor.

10. ONLY ASSERT LEGITIMATE CLAIMS: BE AWARE OF THE FRAUDULENT LIEN STATUTE

Section 12.002 of the Texas Civil Practice & Remedies Code, often referred to as the fraudulent lien statute, provides as follows:

(a) A person may not make, present, or use a document or other record with:

(1) knowledge that the document or other record is a fraudulent court record or a fraudulent lien or claim against real or personal property or an interest in real or personal property;

(2) intent that the document or other record be given the same legal effect as a court record or document of a court created by or established under the constitution or laws of this state . . . evidencing a valid lien or claim against real or personal property or an interest in real or personal property. TEX. CIV. PRAC. & REM. CODE ANN. § 12.002 (Vernon 2002 and Supp. 2010) (emphasis added).

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The potential damages for violation of this statute are the greater of $10,000, or the actual damages caused by the violation, plus court costs, attorneys’ fees and even exemplary damages in an amount determined by the court. Id.

However, a person claiming a lien under Chapter 53 of the Property Code is not liable under the fraudulent lien statute for the making, presentation or use of a document or other record in connection with the assertion of the claim, unless the claimant acts with intent to defraud. Id. Thus, a Chapter 53 lien claimant will not be liable for filing a fraudulent lien if the claimant merely made an inadvertent or good faith mistake or error in the filing of a mechanic’s lien. From a practical perspective, this exception allows a

Chapter 53 claimant to correct such mistakes or errors in its lien filings without fear of exposure to potential liability under the fraudulent lien statute.

For example, in Taylor Elec. Servs., Inc. v. Armstrong Elec. Supply Co., the court determined that an individual had violated the fraudulent lien statute where he filed a lien against the project for an amount in excess of what he was owed. 167 S.W.3d 522, 531-32

(Tex. App.—Fort Worth 2005, no pet.). Specifically, the court found that the lienor’s claim for $12,452.04 failed to reflect a $7,732.99 payment he had received prior to filing that claim, and thus, was fraudulently asserted. Id.

HIRE A FIRE-BREATHING ATTORNEY

When all else fails and you have not had success with the alternative methods of obtaining payment discussed above, engaging counsel to send demand letters and/or file a lawsuit may be an effective approach.

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