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Sunday, 11 November 2012 17:09

Old law could have real consequences for contractors

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WEST MICHIGAN — In the construction industry, general contractors’ financial juggling in tough economic times could put individuals and entire companies on the line for big civil and criminal penalties.

The Michigan Builders Trust Fund Act could be a serious pitfall for general contractors that might be undercapitalized, over leveraged or using revolving lines of credit from the banks to finance their operations.

Under the law, what might seem like simply cash flowing the company is actually a violation.

While some general contractors might think contract agreements and payment applications with subcontractors and others are the most important documents in their organizations, it’s just not the case, said Mark Rysberg, an attorney with Hilger Hammond PC, a Grand Rapids-based law firm that specializes in construction law.

It’s not often that projects unravel as a direct result of trust fund act violations, but lawsuits pursued under the act typically stem from a string of bad business or when a company is hurting financially, lawyers say. Since trust fund act violations can’t be adjudicated in bankruptcy court, violators can land in criminal courts and can face serious jail time.

“It’s really just a way for people to finance their operations, and it has come up more often because of economic pressure on the construction industry,” Rysberg said. “There aren’t a lot of people out there doing it intentionally to try and skirt the trust fund act, but when there is only so much money going around, someone has to decide who is getting paid and who isn’t.

“You do whatever you need to, to survive.”

Rysberg is currently in the process of writing a book on the trust fund act and how it fits into current industry landscape.

As the economy stretches thin the number of projects, contractors at small to medium sized companies can over leverage themselves in hopes of landing a big job that can pay all the bills. However, that big project might be a long way off or could never actually come. That’s when money juggling can happen, which could lead to the practice of using funds from project A to pay for project B, company overhead or other expenses.

“The act runs parallel to and independent of any contract agreements that general contractors so often rely on,” Rysberg said. “While a general contractor could be in compliance with any contracts they have, they could still be in violation of the (trust fund) law.”

The trust fund act, a depression-era statute, was originally established in 1931 as a way to protect laborers, subcontractors and materialmen from nonpayment for work done on a project. The law essentially makes the general contractor a trustee for any funds from a project’s owner that should be paid to subcontractors for work billed on the project.

For example if a project owner pays a general contractor $100,000 and the subcontractor has billed the general contractor for that $100,000, by law, the money must be paid to the subcontractor first before the general contractor pays even its owns employees or any other expenses. Once that money is withheld or used elsewhere, that is a violation, Rysberg said.

The fundamental problem, Rysberg said, is people either don’t know or simply ignore the law. When work is slow, contractors can get cash strapped and have to start shuffling money around, he said.

The reach of the law extends to everyone within a company who is making financial decisions. Personal, civil and criminal liability can even make it to the president, CEO, CFO and COO level, said Chris Predko, an attorney with Warner, Norcross and Judd LLP.

“There are probably more violations than we ever hear about because nobody really does the investigations to see if a contractor has enough money — or nothing is found out until someone sues,” Predko said. “Contractors need to know about this law. … It’s not irrelevant because the penalties out there are harsh.”

In one case, which he acknowledges was an outlier, Rysberg said an individual was sentenced the three years in prison for a trust fund violation based on the misappropriation of $2,500.

“Generally, the situation is a small group of people making poor decisions with money,” he said.

There are also a lot of actions that ratchet up the risk for a violation to occur. Since contractors are at the center of distributing funds for construction projects, they need to take stock of their vulnerabilities, Rysberg said.

Even common building practices like frontloading a project, which is essentially asking the owner to provide more money upfront on a project, makes a violation that much more likely to occur, he said.

“I’d guess that at least 90 percent of people who don’t have an attorney come in and evaluate what they’re doing are violating the trust fund,” Rysberg said.

Companies should get familiar with the law, know their annual liquid capital for operations, figure out what is an average size project and closely monitor any operational credit agreements, Rysberg said.

Read 4587 times Last modified on Sunday, 11 November 2012 20:49