Wednesday, March 2, 2011

Mountain Law: Contractors: Beware the mechanic's lien trust fund statute

In Colorado, the mechanics lien trust fund statute results in many a contractor facing serious consequences for not properly paying their subcontractors and suppliers. Noah Klug of the The Klug Law firm recently published an article for the SummitDaily.com, entitled Mountain Law: Contractors: Beware the mechanic's lien trust fund statute, which lays out the requirements and consequences of the mechanics lien trust fund statute. The article follows here:
A common practice of contractors is to juggle funds between various projects as a way of managing cash-flow issues and trying to keep demanding subcontractors and material suppliers satisfied. When this system breaks down and money is not available to pay current bills, contractors can face serious consequences under a Colorado law known as the Mechanic's Lien Trust Fund Statute. Here is an overview.

The Trust Fund Statute provides that funds received by contractors on a project are held in trust for the benefit of subcontractors and material suppliers. If a contractor receiving the funds does not pay the subcontractors and material suppliers when due, he will be personally liable for the funds (even if he is operating through an entity). The liability extends to anyone who controlled the finances. The statute permits a court to award judgment for three times the amount that was unpaid plus litigation costs, interest and attorney fees.

The Trust Fund Statute requires a contractor to pay subcontractors and material suppliers before paying his own operating expenses. In other words, it is not a defense for a contractor to claim that he did not have money to pay subcontractors and material suppliers because the money was used for other project expenses.

The Trust Fund Statute applies to all funds disbursed on a project even if they were not intended to pay subcontractors and material suppliers. For example, if funds are disbursed to a builder who also owns the land for the purpose of paying a land loan, the builder can be liable for those funds if subcontractors and material suppliers do not get paid.

The Trust Fund Statute is designed to protect subcontractors and suppliers from dishonest or profligate contractors, but the statute does not require a showing that the defendant contractor was dishonest or profligate. Even an honest contractor can be liable under the statute if he becomes over-extended.

The Trust Fund Statute permits claims to be made against contractors by subcontractors, material suppliers and also property owners who hire contractors. An owner has a claim against her contractor even if there are no unpaid subcontractors or material suppliers if the contractor accepts payment and then fails to do the work required.

Contractors cannot avoid their liability under the Trust Fund Statute by filing bankruptcy because bankruptcy protections do not extend to funds held in trust. So, is there any way a contractor can limit liability under the Trust Fund Statute? Yes. First and foremost, contractors must keep detailed records of all expenditures. They will be able to avoid liability for all amounts that were properly paid to subcontractors and material suppliers, so they should make sure that they can document these amounts. Rather than maintain a single bank account for all projects from which all funds are deposited and withdrawn, it is a better practice to maintain individual bank accounts for each project to show the funds that were distributed on that project. This is particularly important when a contractor uses the same subcontractors and material suppliers on multiple projects.

Second, it appears that subcontractors and material suppliers can waive their rights under the Trust Fund Statute in their contracts with the contractor. Contractors should consider adding waivers to their contracts (and, of course, subcontractors and materials suppliers should resist this). It is unclear under Colorado law whether an owner can contractually waive a claim under the statute.

The Trust Fund Statute can be a powerful weapon against contractors who fail to pay subcontractors and material suppliers, but contractors can limit their exposure through careful accounting and requiring contract waivers.

Noah Klug is principal of The Klug Law Firm, LLC, a general law practice in Summit County emphasizing real estate, business law and litigation. He may be reached at (970) 468-4953 begin_of_the_skype_highlighting              (970) 468-4953      end_of_the_skype_highlighting or Noah@TheKlugLawFirm.com.

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