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Contractors are especially vulnerable in an insolvency scenario. They are vulnerable because typically the insolvent contractor is the center of a combination of dangerous factors. First, the insolvent contractor normally has numerous creditors, some of whom are well funded and already burned. So, the insolvent contractor may have well funded enemies with grudges. This is more or less the definition of exposure. How he treats them personally is extremely important. Second, like most contractors, the insolvent contractor has probably operated his business from a single operating account with nothing more than a checkbook to show whose money was spent on which job. This is especially troubling because the contractor often uses money that he received for one job to pay the expenses of a different job. When he does this, he violates the contractors' trust fund statute. The contractors' trust fund statute provides that the contractor holds the money that he receives for a job in trust for the benefit of subs, laborers and suppliers who worked or supplied materials on that job. The contractor cannot use any of that money to pay expenses that are not directly related to that particular job. The allegations generally allege that the contractor underbid a job in order to get it, and then funded it through the use of money received for other jobs. |
The real problem with this scenario is that in Texas a violation of the contractors' trust fund statute can be a felony. It is a difficult statute to prosecute and there are statutory defenses, but just being charged with a crime can be life-changing. There are only two criminal convictions on record in the Texas Courts of Appeal, but that number does not reflect the number of convictions that were not appealed. Contractors should do whatever is necessary in order to avoid exposure to prosecution. So, the reorganization or the winding down of a contractor with a history of violations requires significant care and experience with a goal of first avoiding a criminal prosecution and, second, either reorganizing or winding down the business fairly and effectively. Third, in the event that the contractor files a personal bankruptcy, improperly addressed trust fund violations by his corporation can follow him into his personal bankruptcy. They can result in a challenge to his discharge. If he does not file a bankruptcy, the trust fund statute results in a private cause of action against the officer responsible. We advise contractors to set up their books to mirror the contractors' trust fund statute through the use of an actual trust. This accomplishes several things.
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