When non-payment occurs, suppliers and service providers often first seek relief by suing for breach of contract. Unfortunately, many companies are undercapitalized or otherwise “judgment proof.” A personal guaranty might mitigate this risk by providing an additional target, but guarantees are often difficult to obtain. Even if one is signed, the guarantors may lack assets, perhaps deliberately so. Judgement proof debtors and guarantors are especially frustrating when the case involves misappropriations of construction project funds or wrongful transfers of assets. Texas law provides at least two statutory tort claims in these circumstances: the Texas Uniform Fraudulent Transfer Act (TUFTA) and the Texas Construction Trust Funds Act (the Trust Fund Statute).
A TUFTA claim may be established in one of three general ways:
- The transfer is made with actual intent to hinder, delay, or defraud creditors;
- A transfer is made while insolvent without receiving reasonably equivalent value; or
- A transfer is made while insolvent to an “insider”
The actual statutory language is more complex than the above general descriptions, and it depends upon numerous terms of art defined by the statute and case law. However, the practical purpose of each type of claim is simple: TUFTA prevents a debtor from avoiding the claim by improperly transferring funds and assets to avoid having to pay the creditor.
If that happens, TUFTA may provide additional targets to pursue for the debt. In particular, TUFTA claims impose liability against the transferee of an improper transfer. Such transferees commonly include individuals who own and operate the debtor entity. Thus, TUFTA can provide an avenue for personal liability.
The Trust Fund Statute
Under the Trust Fund Statute, construction project payments are deemed to be “trust funds,” and the recipients throughout the chain of contract are “trustees” who hold the funds for the benefit of their subcontractors and suppliers, who are labeled “beneficiaries” under the statute. Trustees also include an “officer, director, or agent” of a contractor, subcontractor, or other party in the chain of contract who receives trust funds. This creates personal liability for any such individuals who “misapply” the trust funds.
As with TUFTA, an analysis under the Trust Fund Statute can be complex and depends upon various statutory terms, but the idea is clear. Project funds must be used for the project, especially to pay the downstream suppliers and subcontractors, and nothing else.
Preventing and Identifying Wrongful Conduct
Suppliers and subcontractors must be proactive to prevent this type of wrongful conduct from happening. Below are steps that can be taken:
- Joint check agreements – These agreements require you and your customer to be paid jointly with one check.
- Credit applications containing: (1) representations about solvency; (2) trade references; (3) bank information; and (4) terms and conditions such as interest and attorneys’ fees that deter non-payment. This document will provide information enabling you to do a credit check and beneficial terms and conditions.
- Court records – Searching these records will provide the customer’s litigation and bankruptcy history allowing you to see if there are previous (or current) allegations of wrongful conduct.
- Property records – These records will show whether the customer has liens filed against it by taxing authorities, judgment creditors, and other creditors. Further, they will show if the customer has filed a lien for non-payment against someone else.
- Texas Secretary of State – These records will show if the entity is tax forfeit or otherwise not in good standing, and they will show UCC filings against the personal property of the customer.
This is a classic example of where “an ounce of prevention is worth a pound of cure.”