With thinner profit margins and restricted cash flows, Wisconsin contractors increasingly find themselves in a predicament where juggling funds between multiple projects or using project funds to get a different project underway seems like a good idea. In some industries, mingling project and company cash flow is a necessary and prudent business practice. In Wisconsin’s construction industry, however, that practice subjects not just the company, but the individual officers, project managers and accountants, to possible criminal penalties, civil liability and forfeitures.
Construction Trust Funds
Wisconsin’s construction trust fund statute, Wis. Stat. §779.02(5), provides severe consequences for both intentional and unintentional misuse of construction trust funds, declaring such misuse “theft by contractor.” Under this law, all funds paid by an owner for improvements to land are considered trust funds in the hands of the contractor and must be held for the benefit of its laborers, subcontractors and suppliers. Theft by contractor occurs when a prime contractor or subcontractor uses the trust funds for any other purpose, even if for the same project, before it has paid “all claims due or to become due or owing from the prime contractor or subcontractor for labor, services, materials, plans, and specifications used for the improvements.”
Generally, this means that when a prime contractor receives a payment draw from the owner that includes subcontractor’s work or supplier’s materials, the prime contractor must pay from that draw the amounts due each subcontractor and supplier. Similarly, each subcontractor is also under an obligation to pay its sub-subcontractors and suppliers in the same manner. When there is a deficiency in the funds received, a contractor must disburse funds proportionately.
Consequences for Misuse
Any contractor, including its officers, directors, members, partners or other agents, that intentionally commits theft by contractor can be criminally prosecuted for theft and suffer harsh consequences including fines, imprisonment or both. This is true regardless of whether the contractor or individual benefits personally from such misuse. Counties all over Wisconsin are becoming more and more serious about prosecuting these crimes.
Although operating as a corporation or limited liability company generally shields company officers, employees and agents from personal liability for company debts, when an individual has committed theft by contractor, they may be held personally liable for three times any actual damages plus attorneys’ fees of the injured owner, in addition to the amount actually misappropriated. This is true even when the individual is a supervisor generally overseeing project payments or where a subordinate is simply disbursing project funds at the direction of his or her superior.
Also, note that theft by contractor often occurs when a contractor is facing insolvency and the potential financial liability often cannot be discharged in bankruptcy.
Practice Tips
In the midst of difficult economic times, it is now, more than ever, prudent that contractors, subcontractors and suppliers review their project accounting practices to ensure proper controls are in place to prevent theft by contractor. The following are a few tips to aid you in preventing misuse of construction trust funds:
Project Financing. Before committing to a project, ensure that your business and the project are adequately funded. This includes ensuring there is adequate capital to begin the project and that your business, and the project, can continue if payments are interrupted or delayed.
Monitor Cash Flow. Monitoring project and company cash flow is critical to ensure that your business is not placed in a position where it is tempted to, as the saying goes, “rob Peter to pay Paul.” Once this occurs, contractors rarely are able to dig themselves out of the hole.
Keep Project Accounts Separated. Segregating project funds into separate project specific bank accounts is a simple way to monitor project cash flow and prevent commingled project trust funds from inadvertently being used on another project or for another purpose, such as can happen where automatic payment withdrawals are set up from a general checking account.
Project Accounting. Maintain current project accounting records, with up to date records of all project payments, invoices, costs and accounts payable. Simple accounting errors or misplacing invoices can lead to improperly using trust funds for other expenses. In the event of a deficit in payments received for a project, a contractor must distribute the available funds proportionately, including those amounts for self-performed work. Contemporaneously processing change order paper work and obtaining owner signatures helps to keep cash flow from changes or extras from becoming stagnant.
Title Companies. Employing title companies to administer individual project escrow accounts delegates decision-making to an impartial entity and further reduces the chances of both intentional and inadvertent misuse of trust funds.
Document Disputes. Thoroughly document, in writing, all payment disputes and ensure that only the disputed portion of payments are withheld from subcontractors or suppliers. Respond in writing to all demands for payment, detailing the reasons for non-payment.
Brian R. Zimmerman is an attorney with Hurtado S.C., Counselors at Law, practicing in construction, real estate and corporate law. For more information or specific questions about Wisconsin’s theft by contractor law, contact Mr. Zimmerman at bzimmerman@hurtadosc.com or 414-727-6250.
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