Trust Fund Laws-Trust Fund Agreements
In the event of debtor insolvency or bankruptcy, any creditor wants to have that "something else" to make the creditor different from the general unsecured creditors. Payment bonds, personal guarantees, mechanic’s liens, or security agreements help creditors to avoid general unsecured status. General unsecured creditors will have to participate in the bankruptcy process and hope that the debtor will have unencumbered assets for a distribution. Secured creditors may be able to stay out of bankruptcy court and therefore have a much better chance of getting their money.
Suppose a bankrupt debtor is the executor on his brother’s last will and testament. The bankrupt debtor is also the trustee on his niece’s college tuition trust fund. The bankruptcy debtor’s creditors cannot attach this college trust fund, because it is not the bankruptcy debtor’s money. The money belongs to the niece. The trustee has only "legal" title. The niece is the "beneficiary" of the trust and has "equitable" title to the money.
Some states have trust fund statutes or laws to protect subcontractors and suppliers in the construction industry, including Maryland, New Jersey and Michigan. When a general contractor receives payment from the construction project owner, the general contractor holds funds in trust for the benefit of the subcontractors and suppliers. In the event of bankruptcy by the general contractor, the trust funds held for the benefit of subcontractors and suppliers do not become a part of the bankruptcy estate. The subcontractor may need to get appropriate bankruptcy orders, but is entitled to payment directly from an owner.
In states with a Trust Fund Statute, general contractors hold funds in trust for subcontractors. Subcontractors hold funds in trust for suppliers and sub-subcontractors. The ability to trace funds may be a limiting factor. A supplier must show that its materials went into a construction project in order to establish mechanic’s lien rights. Similarly the supplier must show that funds held by a general or subcontractor came from the construction project, in order to establish trust fund rights.
In some states, such as Maryland, the officers and directors of a company holding trust funds are also personally liable to make sure that trust funds get to the proper subcontractor and supplier beneficiaries. This works very much like personal liability for federal income withholding taxes. In addition to having secured creditor status if the trustee contractor files bankruptcy, the trust beneficiary supplier may also have a personal guarantee from the officers and directors of the bankrupt debtor.
TRUST FUND AGREEMENTS
Even in states without trust fund laws, it is possible to create a trust fund relationship by agreement. This works just like a bank trust trust fund or the college tuition trust fund for the niece.
Joint check agreements can create trust relationships. The status of joint check agreements are often debated in bankruptcy. Some courts have held that a joint check agreement is just another unsecured contractual promise. Other courts, however, have held that funds held pursuant to a joint check agreement are funds held in trust, similar to trust fund laws. The conclusion will very much depend on the wording in the joint check agreement. As discussed in earlier newsletters on our website, the wording and effect of joint check agreements vary tremendously.
It is possible, however, to add trust language to a joint check agreement, to a credit agreement, or to any contract stating:
Customer agrees that all funds owed to or received by Customer from anyone, resulting from the labor or materials supplied by Seller shall be held in trust for the benefit of Seller ("Trust Funds"). Customer agrees to promptly account for and pay to Seller all such Trust Funds. Customer agrees that it has no interest in Trust Funds held by anyone and irrevocably assigns to Seller its account receivable from anyone to the extent that sums are justly due from Customer to Seller under this Agreement.
We believe that this language will create special creditor status on two different bases. This language contains traditional "assignment" language, creating a Uniform Commercial Code security interest. The joint check agreement, credit agreement, or other contract may also be recordable as a Uniform Commercial Code Financing Statement, if the agreement contains the name and address of the debtor, name and address of the secured creditor, and other financing statement requirements.
In addition to a UCC Security Agreement, this language also creates a trust fund relationship that should work just like the trust fund laws. Your debtor agrees that all funds received from a construction project are held in trust, to the extent funds result from your labor or materials. If your debtor files bankruptcy, these funds will not be property of the bankrupt estate. As long as the creditor can trace the funds, the creditor will not need to share with the general unsecured creditors and should be able to keep these funds as the trust beneficiary.
Examples of full credit agreements, proposals, quotes, and joint check agreements can be found on our website www.FullertonLaw.com You can also see recent newsletters on joint check agreements and other subjects as well as our 300 page Survival manual including mechanic’s lien and payment bond rights in Virginia, Maryland, DC and Pennsylvania. Please keep in mind that these trust fund agreements are in large part an innovation on the part of this firm. There is very little case law to provide certainty on results. Every set of facts must be considered carefully by a legal professional.