Chapter 7 - § 7.3 • THE TRUST FUND STATUTE

• Jurisdiction: Colorado

§ 7.3 • THE TRUST FUND STATUTE

Owners, lenders, subcontractors, and suppliers have a degree of protection under the Colorado trust fund statute, which provides that all funds disbursed to any contractor or subcontractor be held in trust for the payment of subcontractors, materials suppliers, or laborers who have a lien, or who may claim a lien.¹⁶ An owner may assert a trust fund claim against a contractor whom he or she has paid even if he or she has not yet paid the unpaid subcontractors. Upon recovery of funds from the contractor, he or she holds those funds in a "constructive trust" for payment of the subcontractors.¹⁷ An unpaid supplier or subcontractor may utilize the trust fund language, where the contractor has received funds from the owner and has failed to make payment to a supplier or subcontractor for the materials supplied or work done. It is not necessary to file a mechanics' lien to assert a trust fund claim.¹⁸ The trust fund provision is inapplicable if the contractor or subcontractor involved has furnished a performance or payment bond.

Contractors and subcontractors are required to maintain separate records of account for each project or contract but need not segregate such funds so long as they are not expended for other purposes. Violation of the trust fund provisions may subject the violator to criminal penalties and the individuals who personally participate in trust fund violations may be civilly liable as well.¹⁹ In a civil case, the creditor also has a right to recover all attorney fees and treble damages for any violation of the trust fund statute pursuant to C.R.S. § 18-4-405. The person violating the trust fund statute may be found criminally responsible for the conduct as the misuse of trust funds is considered theft under the criminal code.²⁰

A violation of the trust fund statute by a general contractor or subcontractor can also prove useful in the bankruptcy setting. If a violation has occurred, the unpaid creditor can file a complaint objecting to the discharge of the debt in the bankruptcy court under 11 U.S.C. § 523. Violation of the trust fund statute is a defalcation while acting in a fiduciary capacity, thus resulting in the debt being non-dischargeable under 11 U.S.C. § 523(a)(4), which states as follows:

§ 523. Exceptions to discharge

(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt —

. . .
(4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny; . . .

The objecting creditor need not file a mechanics' lien to prevail on its objection to discharge of the debtor under the Colorado trust fund statute.²¹ If the court then finds that the debt is not discharged, the debtor will emerge from bankruptcy perhaps with only one debt owed — that being to the creditor who was not paid because of the trust fund violation.

Funds paid by a governmental agency are also considered trust funds under C.R.S. § 38-26-109. The statute is virtually identical to the trust fund statute contained in the mechanics' lien statute under C.R.S. § 38-22-127. Both statutes impose liability on the persons who violate the statute, including treble damages and attorney fees as well as criminal liability for theft under C.R.S. § 18-4-401.

A review of the evolution of the case law involving the Colorado trust fund statute — including bankruptcy court authority — follows:

In re Specialized Installers, Inc.

In re Specialized Installers, Inc.²² held that an owner had a right to pursue trust fund and non-dischargeability claims in the bankruptcy court.

People v. Collie

People v. Collie²³ was tried in the Denver District Court and was the first trust fund case to result in a criminal conviction. Mr. Collie was an independent construction and landscaping contractor. His conviction was upheld on appeal. The prosecution was based on the theft statute incorporated into C.R.S. § 38-22-127(5).

People v. Mendro

People v. Mendro²⁴ made it easier to prove a charge of criminal theft based on a violation of the trust fund statute. Mendro was the owner of a remodeling business located in Colorado Springs. The evidence showed he took money from various clients as advance payments for work to be performed, but used a considerable portion of that money to pay his ongoing operating expenses and bank loans, rather than on jobs for those specific customers. Mendro was charged with felony theft under C.R.S. § 18-4-401 for violating the trust fund statute. The court found that the defendant was not aware of the trust fund statute's requirement that the customers' money be held in trust to pay material suppliers and laborers. The court acquitted the defendant of the theft charges. The Colorado Supreme Court reversed, holding that the trial court erred in relying on People v. Piskula.²⁵ The court noted, "We have since rejected this suggestion that all theft by deception prosecutions require proof of intent to defraud, and have held instead that 'the General Assembly has established alternative mental state requirements for the offense of theft by deception.'"²⁶ Since the prosecution had based its case on the criminal theft statute, proved all elements of that statute, and proved that Mendro knowingly used the money in a manner inconsistent with the trust fund statute, the court found that Mendro should have been convicted. The court held that the trial court erred in requiring the prosecution to prove a culpable mental state element beyond that required in the criminal theft statute, and in requiring the prosecution to show that the defendant knew the requirements of the trust fund statute.

People v. Erickson

In People v. Erickson,²⁷ Erickson was charged with a violation of the trust fund statute. At trial in Summit County District Court, the court refused to allow the defendant to testify as to monies he paid out from the funds given to him by the owner. The basis of the trial court's decision was that these items were not listed on two draw statements. However, it was clear that Erickson used some of the money to pay creditors on the subject project and not for any other project. Based upon this latter point, the Colorado Court of Appeals reversed the trial judge's decision. The appellate court held that since the defendant only wished to testify as to what payments he made to various materialmen and subcontractors on the subject construction project, the trial court's decision was reversible error.

People v. Anderson

In People v. Anderson,²⁸ Anderson was charged with taking at least $10,000 from James and Aileen MacDonald. The issue was theft as defined in C.R.S. § 18-4-401(1):

(1) A person commits theft when he knowingly obtains or exercises control over anything of value of another without authorization, or by threat or deception, and:
(a) Intends to deprive the other person permanently of the use or benefit of the thing of value; or
(b) Knowingly uses, conceals, or abandons the thing of value in such manner as to deprive the other person permanently of its use or benefit; or
(c) Uses, conceals, or abandons the thing of value intending that such use, concealment, or abandonment will deprive the other person permanently of its use and benefit; or
(d) Demands any consideration to which he is not legally entitled as a condition of restoring the thing of value to the other person.

In analyzing the evidence offered at the preliminary hearing, the district court considered only the "intent to permanently deprive" element of C.R.S. § 18-4-401(1)(a) to the exclusion of the "knowingly using" element of C.R.S. § 18-4-401(1)(b). In the context of theft of construction project trust funds, the "knowingly using" element of mental culpability in C.R.S. § 18-4-401(1)(b) does not require a conscious objective to deprive another person of the use or benefit of the construction trust funds, but instead requires the offender to be aware that his or her manner of using the trust funds is practically certain to result in depriving another person of the use or benefit of the funds. "By failing to consider the prosecution's evidence under the 'knowingly using' element of mental culpability in section 18-4-401(1)(b), the district court erred. . . . We are satisfied that the evidence, when so considered, establishes probable cause to believe that the defendant committed the crime of felony-theft."²⁹ Under C.R.S. § 38-22-127(1), what is critical to the theft of construction project trust funds disbursed to a contractor for the payment of claims for work on a construction project is the offender's act of knowingly misusing the funds so received, and not the homeowner's ultimate success in defending against claims that should have been previously paid by the contractor.

In re Regan

In In re Regan,³⁰ a roofing contractor, Eagle Roofing, Inc., received funds from a general contractor for work performed on the job. At the conclusion of the project, Eagle had been paid in full, but one of Eagle's suppliers, Fowler & Peth, Inc., had not been paid and was owed the amount of $48,185.03. Fowler did not file a mechanics' lien, but did pursue its claim in the bankruptcy court, asserting a trust fund claim seeking the non-dischargeability of the debt under 11 U.S.C. § 523(a)(4). The court addressed three issues in its opinion. The court first found that under the trust fund statute, the debt owed to Fowler arose while Eagle was acting in a fiduciary capacity, even though no lien had been filed. The court focused on the words in the statute, "who have a lien, or may have a lien against the property" and concluded that this language provides "wronged laborers and material men with a second source of protection and relief, separate and apart from the traditional mechanic's lien practice."³¹ The court then examined the issue of a defalcation under the Bankruptcy Code and found that because Eagle utilized trust funds to pay other company expenses...