Construction Trust Fund Statutes: How Using Project Money Wrong Becomes Personal — and Criminal

Here is the mental model most contractors carry: the owner pays the GC, the GC pays you, and once the money hits your account it's yours — subject, of course, to paying your own subs and suppliers as ordinary business debts. In most industries that model is right. In construction, in a substantial group of states, it is dangerously wrong. Trust fund statutes provide that payments received for a construction project are held in trust for the parties who furnished labor and materials to that specific project. You are not the owner of that money. You are its trustee.

The difference is not academic. A trustee who applies trust money to anything other than the beneficiaries' claims — even temporarily, even with every intention of making it right next month — has diverted trust funds. The statutes were written precisely because construction's cash-flow culture normalized paying yesterday's bills with today's draws, and when a contractor fails, the subs and suppliers on its last projects are left holding losses for work the owner already paid for. See our companion piece on why the payment chain runs so slow in the first place.

Texas is the loudest example. Under Property Code Chapter 162, construction payments made to a contractor or subcontractor — or to an officer, director, or agent — for improving specific real property are trust funds, and the subs and suppliers on that project are the beneficiaries. A trustee who, with intent to defraud, misapplies $500 or more commits a third-degree felony; misapplication without the fraud element remains a Class A misdemeanor. Retainage receives its own dedicated protections.

Two features make Chapter 162 genuinely frightening for the unwary. First, personal liability attaches to the individuals who had control or direction of the funds — the corporate form does not absorb the exposure, which is exactly the legislature's point. Second, 'intent to defraud' can be supplied by statutory presumption: using trust funds while project bills go unpaid can itself support the inference. There is a safe harbor for paying 'actual expenses directly related to the construction' — but its edges are litigated, and an owner's draw or the office lease is a bad place to test them.

New York's Lien Law Article 3-A builds the trust even more comprehensively: funds received by an owner, GC, or subcontractor in connection with an improvement are trust assets until every trust claim — subcontractors, suppliers, laborers, certain taxes — is satisfied. Beneficiaries can bring class actions on behalf of all claimants, trustees owe per-project bookkeeping duties, and diversion claims reach through the payment chain in ways that catch upstream and downstream parties alike.

Two teeth stand out. Criminally, diversion of trust funds is prosecutable as larceny. Civilly, New York courts have made clear that liability for diversion does not require fraudulent intent — using the money out of order is itself the wrong, whatever you meant by it. A 2024 appellate decision reiterated the framework and the narrow paths out, such as restoring diverted funds before claims mature. If Texas punishes the fraudulent operator, New York's civil regime doesn't even wait for fraud.

Some form of construction trust fund doctrine — statutory or judicial — exists in a substantial minority of states, commonly cited to include Michigan, New Jersey, Maryland, Oklahoma, Wisconsin, Colorado, Arizona, Minnesota, Washington, South Dakota, Vermont, and Delaware, with wide variation in who is protected, whether retainage is covered, and whether criminal penalties attach. The details differ enormously; the theme does not: project money is impressed with obligations to the people whose work generated it.

For multi-state contractors this is a compliance-map problem, and it interacts with everything else in your payment stack: prompt-payment acts set when money must move; lien statutes secure it against the property; trust fund statutes govern what you may do with it while it sits in your account. A contract clause cannot waive most of these regimes — which is exactly why a jurisdiction-aware review flags the project state's rules rather than assuming the contract's own text is the whole story.

Almost nobody wakes up planning to divert trust funds. The violation happens in a Tuesday cash meeting: Project A's draw landed, Project B's payroll is Friday, Project A's suppliers are net-30 anyway — move the money, square it next month. In ordinary commerce that's textbook working-capital management. Under a trust fund statute, it can be a completed diversion the moment the transfer clears, with personal exposure for whoever directed it. If next month never comes — a slow pay, a failed job, a pulled credit line — the 'temporary' becomes the state's exhibit A.

The defensive practices are unglamorous and effective: segregate, or at least separately account for, project funds in states that require or reward it; pay project bills from project money first; document that every disbursement from a draw maps to that project's costs; treat retainage as untouchable; and when cash is genuinely short, take advice before moving money, not after. Officers and controllers should understand that they are the 'trustee' these statutes mean — this is one of the few places in construction where the LLC does not stand between the company's problem and your house.

Trust fund statutes matter most at the worst moment: when a contractor upstream of you fails. In ordinary bankruptcy, unpaid subs and suppliers stand in line as unsecured creditors, often recovering pennies. But money impressed with a statutory trust is generally not property of the bankruptcy estate at all — it belongs to the trust's beneficiaries, and courts have repeatedly allowed beneficiaries to trace and recover diverted trust funds outside the ordinary creditor line.

The same logic powers the statutes' most feared feature: claims against the individuals who diverted the funds can survive the company's bankruptcy — and where the diversion is a 'defalcation while acting in a fiduciary capacity,' the resulting personal debt may be nondischargeable in the officer's own bankruptcy under federal law. In other words, the corporate failure that erases ordinary debts does not necessarily erase this one. For unpaid beneficiaries, that is powerful, underused leverage; for trustees, it is the strongest reason to treat project money as sacred even when — especially when — the company is struggling.

Trust fund statutes are where construction payment law stops being about interest and attorney's fees and starts being about felonies. They exist because the industry's cash-flow habits kept burning the smallest parties in the chain, and legislatures responded by making project money legally sticky: it belongs to the project's people until they're paid. Cross the line in Texas with intent to defraud and it's a third-degree felony; cross it in New York and the civil claim doesn't even ask about intent.

Two practical takeaways. If you're downstream and unpaid, these statutes are leverage most subs never use — a trust-fund demand letter reads very differently from another past-due notice. If you're upstream moving money between projects, get a compliance check before habit becomes evidence. Either way, know which regime your project sits in before you sign — it's exactly the kind of state-specific, non-waivable rule a jurisdiction-aware first pass should surface automatically. And this article is information, not legal advice: the statutes' edges are precisely where you want a construction attorney.