The Revitalized Construction Trust Statute

By Alan L. Fishbein, Esquire

A newly revised version of the Maryland Construction Trust Fund Statute has been adopted by the Maryland legislature and on May 18, 1995 Governor Paris Glendening signed into law Senate Bill 68 which makes some very significant changes in Maryland's Construction Trust Statute. The Maryland Construction Trust Statute was first enacted by the Maryland legislature in 1987. It is found in the Maryland Real Property Article, Sections 9-201 through 9-204 of the Maryland Annotated Code. The statute was designed to protect the rights of subcontractors and material suppliers by requiring a general contractor or subcontractor who received money from an owner, or general contractor in the case of a subcontractor, to hold the money in trust for the express purpose of paying either the subcontractors or the sub-subcontractor's and/or material suppliers. Frequently, especially during the 1990's, which have been especially tough on developers, owners, general contractors, subcontractors and material suppliers, a general contractor or subcontractor will receive payment from an owner, or in the case of a subcontractor from the general contractor, and use the money for its own purposes rather than paying the bills to the subcontractors who supplied the work or the sub-subcontractors and/or material suppliers. The statute was first enacted to impose personal liability on any officer, director or employee of a contractor or subcontractor who with the intent to defraud retained or used money held in trust for any purpose other than to pay the subcontractors or material suppliers for whom the money was due. The statute when first enacted further stated that the use of the money by a contractor or subcontractor or any officer, director or employee of the contractor or subcontractor for any purpose other than to pay the subcontractors who performed the work or furnished materials was to be considered prima facie evidence of intent to defraud in a civil action brought against the individual. This statute was designed to create personal liability for those individuals who might otherwise hide behind a corporate shield while diverting monies intended for the subcontractors and/or material suppliers who had performed the work on a project.

Two problems arose with the statute as originally drafted. In 1993 the Maryland Court of Appeals in a decision Ferguson Trenching Co. v. Kiehne, 329 Md. 169, 618 A.2d 735 (1993) held that the mere proof that trust funds were diverted by a contractor for a purpose other than paying subcontractors on that particular job was not conclusive evidence of proof of intent to defraud and that the president of the corporate contractor did not have the intent to defraud when he used the money he had received from the owner to pay other debts of the corporate contractor rather than the subcontractor who supplied the work. This decision significantly weakened the presumption of intent to defraud that was the strong weapon that the legislature had originally intended to provide as part of the Maryland Construction Trust Statute.

In addition, the United States Bankruptcy Court for the District of Maryland in a series of decisions beginning with In Re Lawrence W. Marino, Jr., 115 B.R. 863 (Bankruptcy D. Md 1990) held that violations of the Maryland Construction Trust Statute would not by itself constitute a fraud to prevent an individual, who was a corporate officer, from discharging such debts in a personal bankruptcy proceeding. Normally debts that are fraudulently incurred are not dischargeable in a bankruptcy proceeding. However, the United States Bankruptcy Court for the District of Maryland in a series of opinions substantially curtailed the effect of the statute.

By the new language signed into law by the Governor last spring the Ferguson opinion has been circumvented by the statute now stating that "An officer, director, or managing agent of a contractor or subcontractor who has direction over or control of money held in trust...is a trustee for the purpose of paying the money to the subcontractors who are entitled to it." This language is now codified at Section 9-201(B)(2) of the Real Property Article of the Annotated Code of Maryland. In addition the intent to defraud language has been eliminated from Sections 9-202 and 9-203. Under the new statute there is personal liability for any officer, director or managing agent who knowingly retains or uses the money intended for any purpose other than to pay the subcontractors for whom the money is held in trust. Thus, the new law makes those individuals who control the funds of a corporation personally liable as trustees. As a result the knowing use for the funds for any purpose except to pay the subcontractors or material suppliers will result in personal liability. Although untested, this new language may also significantly alter the bankruptcy cases in Maryland which have previously held these debts to be dischargeable in bankruptcy.

The changes in this statute should have a significant impact on the construction industry if the language of the statute is given force by the Maryland Appellate Courts in subsequent decisions which will develop after the adoption of the statute last spring. There will also be a significant impact if the Bankruptcy Court in Maryland now holds that the Construction Trust Statute creates personal liability for individuals who act on behalf of corporations as a trustee which may then make the debts non-dischargeable and individuals participating in such schemes will be personally liable even after receiving a discharge in a bankruptcy case of all of their other obligations.

The Maryland Construction Trust Statute does not apply to contacts for the sale of a single family residential dwelling nor a home improvement contract by a contractor who is licensed under the Maryland Home Improvement Law.

Thus, a newly revised powerful weapon has been revived by the Maryland legislature and Governor Glendening. The construction industry in Maryland will be profoundly impacted by this statute.