Texas Construction Trust Fund Act: Why Paying Yourself Before Paying Subs Can Be a Crime

The Texas Construction Trust Fund Act (Chapter 162 of the Texas Property Code) imposes a fiduciary duty on contractors who receive construction payments. Under the statute, those payments are held in trust for the benefit of subcontractors, suppliers, and laborers who did work on the project. Diverting trust funds to other purposes — paying another project, paying the contractor's overhead, paying the owners' personal expenses, or paying unrelated creditors — is a trust fund violation with civil and potentially criminal consequences.

The statute's practical effect is significant. Officers and directors of construction companies can be personally liable for trust fund violations even when the corporation is the contractor. The corporate shield doesn't protect individuals who knowingly misappropriate trust funds. And in severe cases, the violation can be prosecuted as a criminal offense. Texas contractors facing cash flow pressure need to understand what the statute actually requires before making payment decisions that could turn into personal liability.

What Counts as Trust Funds

Trust funds under Chapter 162 are construction payments — money paid under a construction contract for labor, materials, or services furnished for improvement of real property in Texas. The statute applies broadly:

The statute does not apply to payments unrelated to construction (rent, non-construction goods, corporate services not tied to a construction project). The question of whether a specific payment is a trust fund depends on the payment's source and purpose.

Who's the Trustee and Who's the Beneficiary

The contractor receiving a trust fund is the trustee. The subcontractors, suppliers, and laborers who provided labor or materials for the specific project are the beneficiaries. Each tier functions similarly — a sub who receives payment becomes a trustee for the sub-subs and suppliers who worked under them.

The statute extends personal liability to officers, directors, and agents of a corporate contractor who have "direction or control" of trust funds. This is the personal liability hook: someone who personally decides how trust funds get distributed can be personally liable for improper distribution even though the corporate entity is the formal trustee.

Permitted Uses

Trust funds must be used for beneficiaries' benefit — paying the subs, suppliers, and laborers who earned payment for work on the project. The statute specifies permitted uses:

The "actual expenses directly related to construction" carveout is important. A contractor can legitimately use trust funds to pay fuel for the project's trucks, rent for equipment on the project, insurance attributable to the project, and reasonable overhead directly tied to the project's execution. The line between permitted direct project costs and diverted funds can be fact-specific.

Prohibited Diversions

What isn't permitted is using trust funds for purposes unrelated to the specific project. Common prohibited diversions:

The most common trust fund violations involve contractors who use Project A's payment to cover Project B's obligations when Project B is struggling. The contractor's rationale is usually that it's all the same company, and the money will get reallocated later. The statute doesn't allow it. Each project's funds are trust funds for that project's beneficiaries, and shifting them across projects is a violation.

Civil Consequences

An unpaid subcontractor or supplier can sue under Chapter 162 for trust fund violation. The remedies can include:

The personal liability provision is the statute's teeth. A contractor who uses corporate trust funds to cover other obligations can have personal assets reached by unpaid subs even when the corporation files bankruptcy. Courts apply the individual liability provisions rigorously when the facts show officer involvement in the diversion.

Criminal Consequences

Chapter 162 violations can also be prosecuted criminally. Misapplication of trust funds greater than $500 is generally a misdemeanor; misapplication of $500 or more with intent to defraud is a state jail felony, and misapplication of large amounts can escalate to higher felony categories. Criminal prosecutions under Chapter 162 are less common than civil suits but do occur — particularly in egregious cases where substantial trust funds were diverted and the contractor became insolvent.

For officers and directors of contractors, the criminal exposure is a meaningful risk consideration. Payment decisions that could be viewed as intentional diversion of trust funds create potential personal criminal liability separate from the civil consequences.

Bankruptcy Implications

Trust fund violations can affect bankruptcy discharge. Under 11 U.S.C. §523(a)(4), debts from fraud or defalcation in a fiduciary capacity are generally not dischargeable in bankruptcy. A contractor who misapplied trust funds may be personally liable for the amount and may not be able to discharge that debt in personal bankruptcy — leaving the individual on the hook even after a corporate Chapter 7 or Chapter 11.

This amplifies the statute's effect on officers. A trust fund violation that's also a §523(a)(4) defalcation follows the individual through bankruptcy. Texas contractors in financial distress who expect bankruptcy to wipe out trust fund liability often find the debts survive.

Defenses and Safe Harbors

The statute does provide some defenses. Most importantly, the contractor can argue that the funds used were not actually trust funds for the specific project — separating project payments from other cash flow if the accounting supports it. Other potential defenses:

The good-faith defense requires the contractor to show they reasonably believed the funds weren't trust funds or that the disbursement was proper. Courts have mixed results on how forgiving this defense is in practice. Better is to avoid the issue by maintaining clear accounting and following trust fund rules rigorously.

Compliance in Practice

Contractors operating in Texas can structure their operations to comply with Chapter 162 and minimize the risk of trust fund violations:

Retainage and Trust Funds

Retainage — amounts withheld from progress payments to be released at substantial or final completion — is trust fund property. When retainage is eventually released, it carries the same trust fund status as the original payment. A contractor holding retainage from a completed project still has trust fund obligations to the subs whose work earned the retainage.

This catches contractors who hold retainage for periods beyond when it would normally be released. If the contractor uses retainage funds for other purposes while delayed in releasing them, they're in the same trust fund violation territory as if they'd diverted progress payments.

Bottom Line

The Texas Construction Trust Fund Act imposes fiduciary duties on contractors holding construction payments — the funds belong in trust for subcontractors, suppliers, and laborers on the specific project. Diverting trust funds to other projects or non-project uses creates civil liability (including personal liability for officers and directors), potential criminal liability, and potential non-dischargeability in bankruptcy. The statute's teeth are the personal-liability and bankruptcy-survival provisions — a trust fund violation can follow an individual officer through corporate insolvency and personal bankruptcy. Texas contractors manage this exposure by maintaining clean project accounting, paying subs promptly from project funds, and treating trust fund compliance as a legal requirement rather than a best practice. Cash flow pressure never justifies trust fund diversion — the statute applies regardless of the contractor's financial condition.