Texas Construction Trust Fund Act: Trustees, Misapplication, and Penalties

The Texas Construction Trust Fund Act, Chapter 162 of the Texas Property Code, treats money paid on a Texas construction project as trust funds belonging to the workers and suppliers who earned them, not as the contractor’s own income. A contractor who spends those funds on anything else before paying the people owed for labor or materials commits misapplication, which can bring civil liability, a Class A misdemeanor, or a third-degree felony if the diversion was intended to defraud.

What Money the Act Covers

Two kinds of money become trust funds under the Act. The first is any payment made under a construction contract for improving real property in Texas. The second is loan proceeds borrowed to improve specific real property, as long as the loan is secured at least partly by a lien on that property.¹ Once a dollar falls into either category, the contractor cannot treat it as personal revenue.

There is one carve-out. A contractor’s fee is not trust funds if two conditions are met before work begins: the contractor and property owner signed a written contract that separates construction costs from a reasonable fee, and the fee has been earned under that contract.¹ Without that written cost-plus structure in place from the start, the entire payment is trust money.

Who Is a Trustee and Who Is a Beneficiary

Any contractor, subcontractor, or property owner who receives or controls construction trust funds is automatically a trustee under the Act. So are the officers, directors, and agents of those parties.² You don’t need to sign a trust agreement or acknowledge the role. The moment the funds come into your hands or under your control, the law treats you as a fiduciary.

Because the trustee definition reaches individuals, incorporating as an LLC or corporation does not shield the person who directed the diversion. A subcontractor who was never paid can pursue the officer or bookkeeper who controlled the money, not just a company that may be insolvent or dissolved.

Beneficiaries are the people who provided labor or materials for the construction or repair of real property in Texas: contractors, subcontractors, laborers, and suppliers connected to the job. Property owners also qualify as beneficiaries when the project involves a residential construction contract, which gives homeowners trust-fund protection over payments made for a home renovation, including funds held in a construction account.³

The Core Rule: Pay Beneficiaries First

A trustee who retains, spends, or diverts trust funds for any other purpose while current or past-due obligations to beneficiaries remain outstanding has committed misapplication.⁴ “Current or past due obligations” covers debts for labor or materials on the project that are owed no later than 30 days after the trustee received the funds.⁵

In practical terms, a contractor cannot use Project A’s payments to cover Project B’s expenses if Project A’s subcontractors and suppliers haven’t been paid. Overhead, personal purchases, and unrelated business debts all come after the beneficiaries. The priority is not optional, and it does not bend because cash flow is tight or because the contractor is in a dispute with the owner upstream.

Mixing trust funds with personal or business funds does not end the trust. The trust relationship survives commingling,⁴ so depositing project payments into a general operating account and then paying unrelated bills from it is still misapplication.

Construction Account Rules for Residential Homestead Projects

On residential homestead projects where the contract price exceeds $5,000, the Act adds a layer of recordkeeping. The contractor must deposit trust funds into a dedicated construction account at a bank, credit union, or savings institution, and the periodic statement must identify the account as a “construction account.”⁶ Only trust funds and fees needed to cover institution charges may go in.⁵

The contractor must also maintain detailed records tied to the account: the source, amount, and date of every deposit; the date, amount, and recipient of every disbursement; a running account balance; and project-by-project tracking of direct and indirect costs charged to the owner. Invoices and supporting documents must be retained, every entry must reference the construction account number, and nothing may be destroyed until at least one year after the project is completed.⁷

Failing to set up or maintain the account is itself a Class A misdemeanor, apart from any misapplication charge.⁸ It also carries a second, worse consequence covered in the next section.

What Counts as Misapplication and “Intent to Defraud”

Misapplication requires that the trustee act intentionally, knowingly, or with intent to defraud when retaining, spending, or diverting the funds without first paying all current or past-due obligations to beneficiaries. The diversion may be direct or indirect, so routing money through intermediaries or related accounts does not create a loophole.⁴

The Act’s definition of “intent to defraud” is broader than most contractors expect. It covers the obvious case of diverting funds to cheat beneficiaries out of payment, but it also covers two situations that do not require proof the trustee planned to steal: failing to maintain a construction account when one is required, and submitting a false affidavit about payment status under the mechanic’s lien statutes.⁵ Sloppy bookkeeping on a residential job can turn a misdemeanor into felony exposure.

Criminal Penalties

Misapplication of $500 or more in trust funds is a Class A misdemeanor, punishable by up to one year in jail, a fine up to $4,000, or both.⁸⁹

When the misapplication of $500 or more is committed with intent to defraud, the charge is a third-degree felony,⁸ carrying two to ten years in prison and a fine up to $10,000.¹⁰ Because “intent to defraud” includes failing to maintain a required construction account, the felony threshold sits lower than many contractors assume.

Failure to establish or maintain the construction account or its records is also an independent Class A misdemeanor, even without any actual misapplication.⁸

Defenses, Including a 30-Day Cure

The Act provides two affirmative defenses. The first applies when trust funds that were not paid to beneficiaries went to actual expenses directly related to the project, or were withheld because the trustee had a reasonable belief, after giving notice, that the beneficiary was not entitled to payment, or were retained as allowed under the mechanic’s lien statutes in Chapter 53.⁴

The second is a cure. If the trustee pays all owed trust funds to the beneficiaries within 30 days of receiving written notice of a criminal complaint or pending criminal investigation, the misapplication charge can be defeated.⁴ This 30-day window is the single most important deadline in the statute for a contractor who realizes they have run afoul of the Act. Miss it and the strongest available defense is gone.

What Happens in Bankruptcy

Trust funds held under the Act generally do not become part of a contractor’s bankruptcy estate. Federal bankruptcy law excludes property in which the debtor holds only legal title but not an equitable interest.¹¹ A statutory construction trust gives the equitable interest to the beneficiaries and leaves the trustee with bare legal title, so the funds remain available to the workers and suppliers rather than being swept into the pool for general creditors. The Act reinforces this by stating directly that trust funds paid to a creditor under Chapter 162 are not property of a debtor who is a trustee.¹

Bankruptcy also will not erase a debt created by misapplying trust funds. Federal law bars discharge of debts arising from fraud or defalcation while acting in a fiduciary capacity.¹² A contractor who diverted trust funds was acting as a fiduciary under Texas law, and the resulting debt can follow them through bankruptcy. The creditor must show the contractor knew the diversion was improper or acted with gross recklessness, but in most trust-fund cases the records tell that story on their own.

1
State of Texas. Texas Property Code 162.001 – Construction Payments and Loan Receipts as Trust Funds
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State of Texas. Texas Property Code 162.002 – Contractors as Trustees
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State of Texas. Texas Property Code 162.003 – Beneficiaries
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State of Texas. Texas Property Code 162.031 – Misapplication of Trust Funds
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State of Texas. Texas Property Code 162.005 – Definitions
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State of Texas. Texas Property Code 162.006 – Construction Account Required in Certain Circumstances
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State of Texas. Texas Property Code 162.007 – Management of Construction Accounts
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State of Texas. Texas Property Code 162.032 – Penalties
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State of Texas. Texas Penal Code 12.21 – Class A Misdemeanor
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State of Texas. Texas Penal Code 12.34 – Third Degree Felony
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Office of the Law Revision Counsel. 11 USC 541 – Property of the Estate
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Office of the Law Revision Counsel. 11 USC 523 – Exceptions to Discharge