The Good, The Bad, and The Ugly – The Michigan Builders’ Trust Fund Act

Posted by: Hilger Hammond On: 3rd October 2016 | no responses.

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This article was originally posted in Michigan Infrastructure and Transportation Assocation (MITA) publication, Cross-Section, Summer 2016 edition.

By Mark Rysberg

Contractors performing work on State and Federal construction projects are likely familiar with prompt payment acts. These laws generally require contractors and subcontractors to pay their downstream subcontractors shortly after receiving payment for such work. As the economy has improved, many contractors are finding opportunities in the private sector. The work may be similar, but the rules that apply are vastly different. These differences present pitfalls for the unwary contractor that may result in criminal and civil penalties. One such hazard exists under the Michigan Builders’ Trust Fund Act, which exposes contracting entities and its officers, directors, and employees to individual liability. The consequences for violating the Michigan Builders’ Trust Fund Act could result in substantial financial penalties and prison.i

The purpose of the Michigan Builders’ Trust Fund Act is to prevent fraud in the construction industry, and to ensure that the subcontractors, suppliers, and materialmen that did the work received the payments their work generated.ii

However, courts have recognized that:

[T]he date of its passage, 1931, identifies the act as one of a genre of Depression-era measures intended to afford relief to subcontractors and materialmen in the construction industry.

During the boom period of the 1920’s, speculative builders often undertook to construct projects too large for their available capital to finance, and they frequently paid suppliers and materialmen on older projects with funds received as payment on more current operations. With the advent of the crash of 1929 and the consequent widespread insolvency of many building contractors, these pyramided empires also collapsed and many subcontractors and suppliers were never paid. Subcontractors and materialmen on private projects were left only with mechanics’ liens as remedies, and these were often ineffective.

[S]tatutes like the Michigan Act of 1931 were enacted to afford a “supplement to the Mechanics’ Lien Law,” providing a more effective remedy for private project suppliers against their principal contractors than they had previously.iii

Despite its shrouded history, the Michigan Builders’ Trust Fund Act is a tool for those engaged in the construction industries to collect funds, protect funds from third-parties, and to prevent projects from becoming entangled with problems arising from misuse of project funds.

The Good—It Is Your Money

The backbone of the Michigan Builders’ Trust Fund Act is the imposition of trust status over payments received on private construction projects.iv In its simplest sense, when money is held in trust it creates a property right in favor of the trust beneficiaries. This means that funds impressed with trust status under the Michigan Builders’ Trust Fund Act do not belong to the contractor or subcontractor that receives them.v Rather, the funds belong to the subcontractors, suppliers, and laborers who were engaged by the upstream contractor or subcontractor. As a result, funds subject to the Michigan Builders’ Trust Fund Act are not subject to liquidation in bankruptcy or setoff by lenders.vi Should bankruptcy or default occur, a beneficiary can follow any diverted funds and recover them from third-parties.vii The property rights created by the Michigan Builders’ Trust Fund Act are both a sword and shield intended to guarantee that the funds reach the intended.

The Bad—Officer and Employee Liability

At its core, the Michigan Builders’ Trust Fund Act is a criminal statute that provides civil remedies.viii Accordingly, the use of funds received on a construction project for any purpose other than to pay those who performed the work exposes the individuals and corporate entities that participated in using those funds to criminal and civil liability. In that sense, it is the people involved in causing a violation of the Michigan Builders’ Trust Fund Act who pay the price.

Importantly, the existence of a corporate or quasi-corporate entity does not provide the defense it might otherwise in a breach of contract situation.ix The individuals involved in the processing and decision making regarding the use of project payments are at high risk of personal liability.

The Ugly – Prison, Punitive Damages, and Attorneys Fees

The Michigan Builders’ Trust Fund Act carries significant exposure to criminal and civil liability. On the criminal side, the statute is a felony punishable by up to 12 months in jail and 60 months of probation—per violation.x

Several violations of the Michigan Builders’ Trust Fund Act were punished with lengthy incarceration relative to the amount of money involved.xi

For example, an individual builder was sentenced to 12 months in jail and 60 months of probation for withdrawing $2,000.00 from her account as profit on the project while the project subcontractors were owed at least $1,000.00 resulting in an overdrawn account.xii Other cases reveal criminal sentences ranging from three months to three years.xiii Importantly, these situations involved small construction projects with the amounts received and amounts owed as compared to larger commercial projects.

On the civil side, liability can arise for a violation of the Michigan Builders’ Trust Fund Act or related remedies for statutory conversion. Statutory conversion provides the possibility to recover three times actual damages plus attorney fees, costs, and interest.xiv It is easy to understand the magnitude of exposure when one considers the monthly payables owed to subcontractors, suppliers, and laborers and then multiplies that figure by a factor of three.

Although the risks created by the Michigan Builders’ Trust Fund Act are significant, they may be avoided by prudent business strategies. The key to managing these risks is to understand that they originate in all aspects of construction process. Contract drafting, contract administration, billing, paying vendors, managing cash-flow, financing, and dispute resolution all present opportunities to mitigate these perils. As a result, sensible contractors will make sure that employees involved in those aspects of the construction process understand the Michigan Builders’ Trust Fund Act so they may identify trouble areas and seek resources to assist in avoiding potential problems. Along those lines, engaging professionals can provide insight when developing best practices. Accountants, insurance agents, and attorneys that are familiar with the Michigan Builders’ Trust Fund Act can help prevent and mitigate problems. In short, the Michigan Builders’ Trust Fund Act is an important consideration for successful management of a construction company when entering or expanding work in the private sector.

iM.C.L. § 570.151 et seq.
ii General Ins. Co. v. Lamar Corp., 482 F.2d 856, 860 (CA6 1973) (internal cites omitted); see, National Bank of Detroit v. Eames and Brown, 396 Mich. 611, 619-620, 242 N.W.2d 412 (1976).
iii General Ins. Co. v. Lamar Corp., 482 F.2d 856, 860 (CA6 1973) (internal cites omitted); see, National Bank of Detroit v. Eames and Brown, 396 Mich. 611, 619-620, 242 N.W.2d 412 (1976).
iv M.C.L. § 570.151
v Selby v. Ford Motor Co., 590 F.2d 642 (CA6 1990).
vi Selby v. Ford Motor Co., 590 F.2d 642 (CA6 1990); Blair v. Trafco Products, Inc., 142 Mich. App. 349; 369 N.W.2d 900 (2005).
vii Blair v. Trafco Products, Inc., 142 Mich. App. 349; 369 N.W.2d 900 (2005).
viii M.C.L. § 570.151 et seq.
ix People v. Brown, 239 Mich. App. 735; 610 N.W.2d 234 (2000).
x M.C.L. § 570.152
xi See, People v. Brown, 239 Mich. App. 735; 610 N.W.2d 234 (2000); and People v. Miller, 78 Mich. App. 336, 259 N.W.2d 877 (1977).
xii People v. Brown, 239 Mich. App. 735; 610 N.W.2d 234 (2000).
xiii See, People v. Wedel, No. 290324 (Mich. Ct. App., Feb. 23, 2010); People v. Looze, No. 234195 (Mich. Ct. App., Oct. 25, 2002); People v. Currier, No. 269564 (Mich. Ct. App., Sept. 13, 2007); People v. Bazeley, No. 191440 (Mich. Ct. App., July 11, 1997); People v. Hall, No. 3118830 (Mich. Ct. App., Sep. 29, 2009); People v. Miller, 78 Mich. App. 336, 259 N.W.2d 877 (1977).
xiv M.C.L. § 600.2919a.

The Michigan Builders’ Trust Fund Act – Officer and Employee Liability

Posted by: Hilger Hammond On: 30th November 2015 | no responses.

2015-11-30_11-29-17By: Mark A. Rysberg

The Michigan Builders’ Trust Fund Act (“MBTFA”) creates liability for officers and employees of contracting companies; however, some confusion remains about what triggers that liability. The Michigan Court of Appeals recently clarified that individual liability is controlled by participation in the decision to act in a manner that violates the MBTFA. What that means for employees and officers is simple. If you participate in the retention, use, or distribution of project payments, you are at risk that a claim may be made against you personally in the course of a construction payment dispute. While you may not be able to control whether a claim is made, you can take simple steps to minimize your exposure and the cost of defending such a claim.

First, understand the MBTFA.

The MBTFA is a Michigan statute that prohibits using construction project payments for any purpose unless and until all of the subcontractors and suppliers you engaged for that project have been paid. In other words, the MBTFA prohibits, among other things, using progress payments, or parts thereof, to finance overhead, operating expenses, and unrelated project costs. What that means in a practical sense is that MBTFA liability can be triggered by something as simple as approving what bills are paid or signing a check. Understanding that you may be exposed to a MBTFA claim for doing your job is an important step.

Second, comply with the MBTFA.

The best way to prevent exposure to liability under the MBTFA is to comply with the MBTFA. But, MBTFA violations can happen inadvertently from poor business planning regarding operational finances and company capitalization. Complying with the MBTFA can be complicated and may seem impractical given the nature of the construction industry; however, accountants and attorneys with construction industry expertise can evaluate existing practices and help limit potential exposure.

Third, be prepared for potential MBTFA claims.

Obtain appropriate insurance coverage. One of the biggest dangers of an MBTFA claim is the defense cost. MBTFA claims are complex and typically require expert analysis to show that the MBTFA was not violated. As a result, such claims can get expensive quickly. Fortunately, defense costs may be insurable through a director’s and officer’s policy. Consulting with an insurance professional who understands the MBTFA is an important step toward being prepared for an unforeseen MBTFA claim.

Dealing with a MBTFA claim can be expensive and time consuming. Many construction industry professionals are not aware that they may be exposed to individual liability arising from their job. Professionals with expertise in the construction industry can assist with understanding, complying, and preparing for MBTFA claims. Being proactive about the MBTFA is simply good business.

If you found this article useful, you may also wish to read “The Michigan Builders’ Trust Fund Act – Understanding the Obligation.”

The Michigan Builders’ Trust Fund Act – Understanding the Obligation.

Posted by: Hilger Hammond On: 22nd May 2014 | no responses.

michbuildersBy: Mark A. Rysberg

Typically, the terms of a construction contract set out the obligations of the parties involved in a specific construction project. However, one obligation exists independent of the language of those contracts—the obligations imposed under the Michigan Builders’ Trust Fund Act (MCL 570.151 et seq). In brief, the Michigan Builders’ Trust Fund Act (“MBTF”) creates a trust over funds paid to a contractor or subcontractor to ensure that those funds are, in turn, paid to lower tier subcontractors and suppliers for the labor and materials they provided to a specific project. If such funds are not paid to those persons, a contractor or subcontractor may face civil or criminal liability. In large part, the obligations under the MBTF are consistent with contract concepts in that, when a subcontractor or supplier performs the work, payment will follow. However, when disputes arise regarding whether work was properly performed, the contract remedies can be inconsistent with the obligations of the MBTF such that a contractor can be acting in compliance with the contract while simultaneously violating the MBTF.

In Performance Contracting, Inc. v DynaSteel Corp., the Sixth Circuit Court of Appeals recently addressed whether the MBTF “must be tethered to a contract or whether it may ever apply by its own force . . . irrespective of a contract.” In that case, the Sixth Circuit Court of Appeals concluded that the MBTF applies irrespective of a contract. In reaching that conclusion, the Court relied on other cases applying the MBTF for the proposition that “it is clear that a contractor or subcontractor may remain in compliance with the terms of its construction contracts while simultaneously violating the builders’ trust fund act.” The practical implications of that decision can cause significant issues when considering implementing contractual remedies during contract performance disputes.

For example, many construction contracts allow for a contractor to withhold payment to cure defective work or performance. However, exercising that contract right may trigger liability under the MBTF in a situation where the contractor has requested and received payment for the work of its subcontractors and suppliers and thereafter decides to withhold those payments due to deficient work. The potential conflict between such contract provisions and the obligations under the MBTF is critical to making strategic decisions during dispute resolution. Therefore, when faced with potentially defective work or possible contract payment claims, it is important to be proactive in seeking professional advice on these points.

The Michigan Builders’ Trust Fund Applies to Construction Projects in Other States

Posted by: Hilger Hammond On: 11th January 2013 | no responses.

Michigan Builders' Trust Fund ActBy Mark Rysberg

Performing work in states other than Michigan requires understanding the laws of the state in which the project is located.  However, Michigan contractors are required to comply with the Michigan Builders’ Trust Fund Act (“MBTFA”) despite a project being located in a different state.  That is because the MBTFA relates to construction funds and whether the misuse of those funds occurred in Michigan rather than the location of a specific project.

That means a Michigan contractor working on an out-of-state project must comply with the MBTFA and any similar construction trust fund act in the state where the project is located.  That also means out-of-state owners, suppliers, laborers, and subcontractors could apply the MBTFA to ensure payment from Michigan contractors.  Michigan contractors, and those working with Michigan contractors, should be aware of the obligations and liabilities imposed by the MBTFA regardless of where a construction project is located.