WHAT IS A CONSTRUCTION TRUST & BREACH OF CONSTRUCTION TRUST CLAIM?

Construction trusts protect funds during construction projects by placing a fiduciary duty on the person or entity handling the funds for the project. When this fiduciary duty is breached, it opens the door for a beneficiary to sue for a breach of construction trust claim. These claims can have a huge impact on construction litigation because, if successful, the claim can pierce a corporate veil and result in a judgment against the managers or owners of a corporate entity. Breach of construction trust claims often arise when a general contractor takes profit from the construction funds before all subcontractors have been paid.

 

STATUTORY CREATION

Sections 42 O.S. §§152-153, titled “Proceeds of Building or Remodeling Contracts, Mortgages or Warranty Deeds as Trust Funds for Payment of Lienable Claims” and “Payment of Lienable Claims,” lay out the construction trust.

Section 152 explains under what circumstances and to whom a fiduciary duty applies:

 

1) The amount payable under any building or remodeling contract shall, upon receipt by any contractor or subcontractor, be held as trust funds for the payment of all lienable claims due and owing or to become due and owing by such contractors or subcontractors by reason of such building or remodeling contract.

2) The monies received under any mortgage given for the purpose of construction or remodeling any structure shall upon receipt by the mortgagor be held as trust funds for the payment of all valid lienable claims due and owing or to become due and owing by such mortgagor by reason of such building or remodeling contract.

3) The amount received by any vendor of real property under a warranty deed shall, upon receipt by the vendor, be held as trust funds for the payment of all valid lienable claims due and owing or to become due and owing by such vendor or his predecessors in title by reason of any improvements made upon such property within four (4) months prior to the delivery of said deed.¹

 

Section 153 explains further elements of the construction trust and who can be held liable for a breach:

 

1) The trust funds created under Section 152 of this title shall be applied to the payment of said valid lienable claims and no portion thereof shall be used for any other purpose until all lienable claims due and owing or to become due and owing shall have been paid.

2) If the party receiving any money under Section 152 of this title is an entity having the characteristics of limited liability pursuant to law, such entity and the natural persons having the legally enforceable duty for the management of the entity shall be liable for the proper application of such trust funds and subject to punishment under Section 1451 of Title 21 of the Oklahoma Statutes. For purposes of this section, the natural persons subject to punishment shall be the managing officers of a corporation and the managers of a limited liability company.

3) The existence of such trust funds shall not prohibit the filing or enforcement of a labor, mechanic or materialmen's lien against the affected real property by any lien claimant, nor shall the filing of such a lien release the holder of such funds from the obligations created under this section or Section 152 of this title.²

Courts have made it clear that construction trusts are based solely on statute:

 

The lien statutes of Oklahoma afford an abundance of protection for mechanics and materialmen, but likewise, such subcontractors must perfect a lien prescribed by law to fall within the protection afforded by §§152 and 153, because “the construction trust fund statutes reflect by title and content they are an integral part of the lien laws” of this State … Since a lien did not exist at common law, it must hence be strictly confined to the ambit of the enactment giving it birth. A lien that is not provided for by the clear language of the statute cannot be created by judicial fiat. The terms prescribed by statute cannot be ignored. They are the measure of the right and of the remedy.³

 

Because construction trusts are a statutorily created fiduciary duty, they should not be confused with constructive trusts or the fiduciary duties found in common law as they may have different elements and remedies.

 

STANDING

Breach of construction trust claims may be asserted by any beneficiary of the construction trust, such as the property owner, subcontractor, material providers or lenders.⁴ Defendants have argued the breach of construction trust claim cannot be asserted by the property owners since a property owner cannot place a lien on their own property. Courts have adamantly rejected this argument.

In ruling in favor of a property owner, the Oklahoma Supreme Court held:

 

Our decisions … place us squarely in the majority camp which recognizes that owners enjoy the protection offered by construction trust fund statutes. These courts reason that the primary purpose of such statutory schemes is to protect the owner involved in a fiduciary relationship with the contractor. The property owner is considered the direct beneficiary of the statutorily created trust because of the owner's potential for double liability if the contractor does not pay laborers and materialmen ... Although these decisions are not binding, we do note that two federal courts considering the effect of our lien statutes have determined that owners are intended beneficiaries of the statutory trust provisions.⁵

 

Financial lending institutions that assert control over loaned funds may even be found liable of a breach of the construction trust. Many lending institutions monitor certain customers, especially high risk. However, the Oklahoma Supreme Court has held that if a lending institution begins actually assuming control of the funds and disbursement, they may become an involuntary trustee of the construction trust funds and be held liable if the funds are misapplied.⁶

 

ELEMENTS

The elements for a construction trust claim are: “(1) the trustee received trust funds, (2) not all valid lienable claims were paid and (3) trust funds were applied to a purpose other than payment of valid lienable claims.”⁷

However, many in the construction business have poor accounting records and often deal in cash, resulting in these elements being difficult or impossible to prove. If that is the case, a claimant may establish a prima facie claim by only showing “that valid lienable claims remain unsatisfied and that trust funds are either unaccountable or have been applied to purposes other than payment of valid lienable claims …”⁸

 

WHAT IS A LIENABLE CLAIM

Lienable claims are based on liens found within Title 42. The Federal Bankruptcy Court has said, “Applying basic rules of construction, it would seem that a lienable claim is a claim that is capable of becoming a lien on the building or improvement being constructed.”⁹

This is important to note because if strictly construed by a court, a court could hold that no lienable claim exists after the time to file a lien has passed without a lien actually being filed. If so, this holding would be fatal to a breach of construction trust claim. “Under Oklahoma law, one who furnishes material or labor to a contractor may obtain a lien by filing a sworn statement of lien in the county clerk's office within 90 days after the material or labor was furnished. Okla. Stat. tit. 42 §143. A claim not so perfected loses its ‘lienable’ character.”¹⁰

 

LIMITATIONS

The breach of construction trust can only be used for claims that may result, or have resulted, in a lien being placed on the property. The claim will not cover other potential damages incurred due to an action of a defendant. This may lead to the need for other claims being asserted along with the breach of construction claim.

Courts have limited the fiduciary duty specifically to lienable claims:

 

Oklahoma law is clear that the statutory duty imposed on a general contractor to hold funds in trust for the payment of subcontractors creates a fiduciary relationship between the owner and the contractor. The fiduciary duty, however, exists only to the extent that there are lienable claims due and owing by reason of a building or remodeling contract.¹¹

 

This statutorily imposed duty to pay lienable claims should be distinguished from the common law duty of a fiduciary to account. Since it is only express or technical (e.g., statutory) trusts which are implicated by §523(a)(4), the only relevant fiduciary duty here is that prescribed by the construction trust fund statutes, i.e., to pay lienable claims. If there are no lienable claims, there is nothing for which the contractor must account under these statutes.¹²

It is clear from this line of cases that the construction trust statutes are only limited relief to a plaintiff. The statute only provides damages for the amount that is lienable.

Oklahoma construction trust fund statutes do not impose a fiduciary duty on a contractor to account (i.e., explain the disposition of) to a homeowner for all construction funds paid to him. Rather, the contractor's fiduciary duty, as prescribed by the statutes that created the trust, is to pay lienable claims. A contractor who fails to pay suppliers of labor or materials is not guilty of breach of a fiduciary duty to the homeowner unless the unpaid laborers file timely liens which are not satisfied by the contractor.¹³

 

BENEFITS OF SUCCESSFUL CLAIM

The two teeth of the breach of construction trust claim are 1) the claim can be asserted against the managers or owners of a business entity personally and 2) the personal judgment is non-dischargeable by the individual through bankruptcy.¹⁴

A breach of the “fiduciary duty by failing to pay suppliers and subcontractors with funds entrusted to [a contractor] for that purpose, to the extent that [the owner] is required to pay those subcontractors or suppliers to clear her title to the Residence, [the contractor] is liable to [the owner] and that debt is non-dischargeable.”¹⁵

 

TIPS FOR REPRESENTATION

If a construction trust beneficiary asks about remedies, you need to find out immediately when a statute of limitations may run for a lien to be filed regardless of who you may be representing. If you are representing a subcontractor or material supplier, it is recommended to file the lien as soon as possible to ensure you preserve the breach of construction trust claim. Once the lien is filed, your client will have one year to file suit.¹⁶ This will give some time to sort out and negotiate with others involved.

For attorneys representing general contractors, great record keeping is a must. It is also recommended the general contractors create an escrow account for each project and pay directly out of the account. It is also recommended they not take out any profit until they can verify enough will remain in the escrow to pay all subcontractors and material suppliers.

 

ABOUT THE AUTHOR

Chase McBride is a lawyer located in Pryor. He has a J.D. and MBA, along with a certificate in law and entrepreneurship from the OU College of Law.

 

 

 

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1. 42 O.S. §152.
2. 42 O.S. §153.
3. Shawver & Son, Inc. v. Tefertiller (In re Tefertiller), 1989 OK 60 at ¶10, citing Riffe Petroleum Co. v. Great Nat. Corp., Inc., 614 P.2d 576, 579 (Okl. 1980).
4. Carey Lumber Co. v. Bell, 615 F.2d 370,373 (5th Cir. 1980).
5. Stevens v. Harris (In re Harris), 2002 OK 35 at page 14.
6. See Sandpiper North Apts., Ltd. v. Am. Nat'l Bank & Trust Co. of Shawnee, 1984 OK 13.
7. Sandpiper North Apts., Ltd. v. Am. Nat'l Bank & Trust Co. of Shawnee, 1984 OK 13 at ¶24.
8. Id.
9. Id. at page 13.
10. Id.
11. Murphy Oil USA, Inc. v. Wood, 438 F.3d 1008.
12. Duncan v. Neal (In re Neal), 324 B.R. 365, 372.
13. Duncan v. Neal (In re Neal), 324 B.R. 365, 373.
14. Id.
15. Owens v. Bolger (In re Bolger), 351 B.R. 165, 169.
16. 42 O.S. §149.