Construction contracts often require contractors to receive and hold payments in trust for the benefit of paying labor and materials furnished on a project. The purpose of the trust is to protect downstream contractors and suppliers from the risk of nonpayment of their claims against a financially distressed contractor.
Trust Contract Provision
A typical trust provision provides:
All sums received by Contractor under this Contract are received by Contractor in trust for the express use and purpose of paying in full for all labor and/or material furnished to Contractor in the performance of this Contractor. No title to any payment shall vest in Contractor until Contractor has first paid in full all labor and/or material furnished under the Contact.
What does the Trust do?
When payments to a contractor are required to be placed in a trust, the trust creates a property right in favor of subcontractors and suppliers in order to assist them in getting paid. In essence, the funds do not belong to the contractor. They instead belong to the subcontractors and suppliers who were hired by the contractor. In theory then, before the contractor has a right to those funds, the contractor must pay its subcontractors and suppliers.
By way of example, assume a contractor fails to make payments to its subcontractors and suppliers. The progress payments which had been made were deposited in the contractor’s bank account, but the bank took those monies in payment of the general contractor’s bank loan. If those funds had been held in trust, an argument could be made that the contractor had no interest in those funds until all subcontractors and suppliers had been paid.
Trust Fund Statutes
A number of states, such as Michigan and Colorado, have trust fund statutes. These statutes typically require that the funds received by an upstream contractor be protected until paid to the subcontractors and suppliers. The statutes also provide notice that the funds in a contractor’s bank account may be subject to a trust for the benefit of subcontractors and suppliers. Finally, these statutes often contain penalties for breaching the trust. Nebraska and Iowa do not have trust fund statutes.
Take Away: Trust fund provisions in a contract present subcontractors and suppliers an additional avenue to pursue payment should a contractor fail to make timely payment.