Many of us have heard the phrase “robbing Peter to pay Paul” in reference to a situation where you shouldn’t take money previously allocated for one expense only to spend it on another expense. Michigan has a statute that codifies this saying, called the Michigan Building Contract Fund Act, also known as the Michigan Builders’ Trust Fund Act (“the MBTFA”). It is different than the Michigan Construction Lien Act, and much different than the Homeowners’ Construction Lien Recovery Fund (which no longer exists).
The purpose of the MBTFA is to prevent fraud in the construction industry, and to ensure that the subcontractors and suppliers that did the work received the payments their work generated. In short, you cannot take funds from one project to fund another project until you have first paid off all of the subcontractors and suppliers.
The MBTFA dates back to the Great Depression. During the Roaring 20’s, builders often undertook construction projects that were too large for their available capital to finance. In order to cover expenses, they frequently paid subcontractors and suppliers on older projects with funds received as payment on more current projects. When the economy crashed, beginning in 1929, this pyramid collapsed, and many subcontractors and suppliers were never paid for work that they had completed.
The way the MBTFA isused today is much broader than perhaps initially intended. When it was passed, the MBTFA was solely a criminal statute, holding someone who violates the MBTFA criminally responsible for breaching the statutory trust. Today, the MBTFA has been interpreted to allow for civil remedies, and has expanded even further to civil liability for those in charge of the finances who breached the statutory trust. In addition, the debts are also not dischargeable in a bankruptcy proceeding.
At its core, the MBTFA imposes a statutory trust on payments received on private construction projects. In short, when a property owner pays a contractor for work completed on a job, the contractor holds that money “in trust” for the benefit of the subcontractors and suppliers. As a result, this statutory trust creates a property right in favor of the subcontractors and suppliers, in order to assist them in getting paid (and to, in theory, prevent the owner from paying twice for the same improvement). In addition, all funds subject to the statutory trust under the MBTFA do not belong to the contractor, but instead belong to the subcontractors and suppliers who were hired by the contractor. In other words, before the contractor has a right to any of the funds paid by the owner, the subcontractors and suppliers must first be paid.
As outlined, there are criminal and civil consequences for those involved in using funds imposed with the statutory trust for any purposes other than to first pay the subcontractors and suppliers. There is no corporate shield to hide behind in this situation. A violation of the MBTFA is a felony punishable by up to 12 months, per violation. In addition to the criminal liability, there are also civil consequences. For years Joel Baar has argued that a violation of the MBTFA is also a statutory conversion which provides the possibility of recovering three times the actual damages plus attorney fees and court costs. The potential of triple damages often results in many violators of the MBTFA quickly discovering the funds to remedy the situation.
Understanding the MBTFA, the Michigan Construction Lien Act, as well as the contract documents can help minimize the risk of a violation of the MBTFA. However, as is often the case, open communication in the form of sworn statements, lien waivers, payment requests, etc. will be even more helpful.
If you have any questions about the MTFA, please give us a call. We are happy to help!