“Thus, the Trust Statute provides a powerful tool to prevent a dishonest contractor from merely closing up shop to avoid liability for its malfeasance.”
The Maryland Construction Trust Statute was established in 1987 to protect subcontractors from the dishonest practices of general contractors and other subcontractors for whom they provide construction services or supplies.
At its core, the Trust Statute pierces the dishonest contractor’s corporate veil to hold its officers and directors personally liable for the misuse of construction project funds. Although enacted over 25 years ago, the Maryland state and federal courts continue to further define the scope and proof required for the imposition of this extreme remedy.
Codified in Sections 9-201 through 9-204 of the Maryland Real Property Code, the Trust Statute establishes a trust relationship between any contractor that has been paid by the project’s owner and the subcontractor performing the work for whom the contractor receives payment. Section 9-202 provides: “Any officer, director, or managing agent of any contractor or subcontractor, who knowingly retains or uses the moneys held in trust under Section 9-201 of this subtitle, or any part thereof, for any purpose other than to pay those subcontractors for whom the moneys are held in trust, shall be personally liable to any person damaged by the action.”
Therefore, a subcontractor who establishes that an individual in control of the contractor was paid by the owner for the subcontractor’s work, but knowingly diverted those funds to someone other than the subcontractor, can hold the controlling individual personally liable. Furthermore, an owner or contractor whose downstream contractor or subcontractor diverts funds can likewise bring an action against the controlling individual if called upon to pay twice.
Thus, the Trust Statute provides a powerful tool to prevent a dishonest contractor from merely closing up shop to avoid liability for its malfeasance. However, as a creature of statute, the Trust Statute is not without its limitations; in fact, it was not until 2008 in Walter v. Atlantic Builders, Inc., that the Court of Special Appeals issued the first Maryland reported decision imposing liability under the Trust Statute. One of the largest obstacles the typical claimant must overcome is proving that the funds were traceable to the subcontractor, which may not be a simple task. The Trust Statute neither requires that the project funds be placed in a separate account nor prohibits the controlling individual from comingling funds. In the 2008 decision of Selby v. Williams Construction and the 2010 decision of Collins/Snoops Associates, Inc., the Maryland Court of Special Appeals found that the “mere insufficiency of funds to pay all down-the-chain subcontractors or suppliers [was] not a basis for the imposition of personal liability.” The funds must be specifically earmarked for the subcontractor and subject to tracking in order for personal liability to be imposed.
Another limitation on the Trust Statute is that it only applies to certain types of construction projects. In addition to excluding most single-family home construction and home improvement projects from its ambit, the Trust Statute limits itself to property subject to the Maryland Mechanic’s Lien Law. For that reason, in the 2002 decision of Jaguar Technologies, Inc. v. Cable-La, Inc., the U.S. District Court for Maryland denied a Trust Statute claim on a utility development project because the project did not involve any buildings and was therefore not subject to the Maryland Mechanic’s Lien Law. Furthermore, it is unclear whether the Trust Statute applies to construction projects owned by the Federal Government. While in U.S. ex rel. Allied Building Products Corp. v. Federal Ins. Co., the U.S. District Court for Maryland held that the Trust Statute did not apply to federal construction projects, in an unreported opinion from this last August in Shade Construction Co., Inc. v. Talbot, the U.S. District Court indicated that it would consider reversing Allied Building if this issue were to come before the Court again.
With the recent downturn in the construction industry, practitioners may face an increase in the prevalence of Trust Statute claims. Contractors and subcontractors who receive project funds must take steps to ensure that earmarked funds are paid to the proper recipient. In addition, claimants under this Act should be aware that the Maryland state and federal courts have recognized several limitations to stating a claim for personal liability. If, however, imposition of personal liability on the controlling individual is obtained, because the diversion is in violation of a statutory trust, the personal liability may be non-dischargeable in bankruptcy. The significant liability ramifications of diverting earmarked funds is, therefore, a reason for all participants at every level of construction projects in Maryland to be aware of the unique rights and responsibilities that the Trust Statute creates.
Robert J. Dietz is Of Counsel with BrigliaMcLaughlin, PLLC, where he practices construction, government contracts, and surety law.