As most in the construction business already know (or should know), when a contractor receives funds on a construction project – whether from new home sales, a lender, or almost any other source – Colorado law requires the contractor to hold those funds “in trust” to pay its subcontractors, laborers, and suppliers. This is commonly known as the Mechanic’s Lien Trust Fund Statute, C.R.S. § 38-22-127. And until the contractor pays those people in full, using the funds for any other purpose violates the statute and exposes the contractor to monetary penalties and, potentially, to civil and criminal theft charges as well. What is more, incorporating the construction business does not guaranty protection against personal liability for violating the statute. Owners and co-owners who control the company’s finances and decisions may be personally liable and subject to the same civil and criminal consequences.
So what happens if times get tight and the owner of a construction business wants to lend his or her own money to the business just to “keep the lights on” and pay some basic operating costs? Precisely how that loan (or capital investment) is made, and its terms, will dictate whether the funds must be held in trust and whether using them for any other purpose will subject the owner to civil and criminal liability.
At particular risk are those contractors working on a project-by-project basis or that form a company for a single project, because a presumption may arise that any funds disbursed to the company are “trust” funds to be held for subcontractors on that project. Therefore, avoiding liability requires structuring the loan (or capital investment) in a manner that clearly indicates its general business purpose. For example, an LLC’s members or managers can capitalize the business through a capital contribution, or a loan, or both. A “survival loan” or voluntary contribution given to capitalize the business itself may be used to pay for any of the company’s obligations, including general operating expenses (e.g., taxes, utilities, rent, etc.). However, expressly earmarking those same funds for use on a specific construction project or under circumstances suggesting an intent to use the funds for any construction-related activity likely falls within the Trust Fund Statute and must be held in trust. Therefore, contractors should seek legal advice before investing in or re-capitalizing their own construction business operations.