Construction Trust Fund Claims Under Chapter 162: When Diverting Payment Becomes a Criminal Offense

By Hank FasthoffJuly 5, 2026

A general contractor receives a $500,000 progress payment from the owner. Instead of paying the subcontractors and suppliers who performed the work, the contractor uses the money to cover payroll on another project, make a truck payment, or fund personal expenses. By the time the subcontractors realize they're not getting paid, the money is gone.

Texas Property Code Chapter 162, the Construction Trust Fund Act, was designed to prevent exactly this. It treats construction payments as trust funds held for the benefit of the subcontractors, suppliers, and laborers who furnished the labor and materials that generated those payments. A contractor who diverts trust funds without first paying the people who earned them may be committing a criminal offense, depending on the amount and the intent, on top of the contract breach.

What Are Trust Funds Under Chapter 162

Construction payments made to a contractor or subcontractor under a construction contract for the improvement of specific real property in Texas are trust funds. § 162.001(a). From the moment a contractor receives a progress payment from the owner, that money belongs in trust to the subcontractors and suppliers who furnished labor or materials on the project.

Loan receipts are also trust funds. If an owner borrows money to finance a construction project, and the loan is secured by a lien on the property being improved, the loan proceeds become trust funds under § 162.001(b). An owner who receives loan proceeds earmarked for construction and uses them for something else has diverted trust funds.

One important exclusion applies. Fees earned by the contractor under a written contract before the commencement of construction aren't trust funds, as long as the fees are reasonable and the contract provides for them. § 162.001(c). Overhead and profit built into the contract price are the contractor's compensation, not trust funds, but only if they're documented in the contract and earned before construction begins.

Who Is a Trustee

A trustee under Chapter 162 is any contractor, subcontractor, or owner who receives trust funds, or any officer, director, or agent of a contractor, subcontractor, or owner who has control or direction of trust funds. § 162.002.

That definition is broad, and it's broad on purpose. It reaches beyond the contracting entity to the individuals who manage the money. If you're the company's bookkeeper, the project manager who approves invoices, the owner's spouse who writes the checks, or an officer who directs which vendors get paid and which don't, you may be a trustee. Personal liability under Chapter 162 isn't limited to the company that received the payment. It extends to every individual who controlled or directed how the funds were used.

Corporate protection doesn't shield you. An LLC or corporation normally protects its owners from personal liability for business debts, but Chapter 162 creates a separate statutory obligation that attaches to individuals based on their control of trust funds. A company owner who diverts trust funds can be personally liable for the misapplication, and that liability can't be avoided by operating through an entity.

Who Is a Beneficiary

A beneficiary of construction trust funds is any artisan, laborer, mechanic, contractor, subcontractor, or materialman who furnishes labor or material for the construction or repair of an improvement on specific real property in Texas. § 162.003(a). If you poured concrete, hung drywall, delivered lumber, or performed any other labor or supplied any material on a construction project, you're a beneficiary of the trust funds that the contractor received for that project.

Beneficiaries include subcontractors at every tier, not just those with a direct contract with the general contractor. A supplier who sold materials to a sub-subcontractor is a beneficiary of trust funds received by the GC from the owner, even though the supplier's contract is two tiers removed from the GC.

What Constitutes Misapplication

Under § 162.031(a), a trustee misapplies trust funds when the trustee intentionally or knowingly or with intent to defraud, directly or indirectly retains, uses, disburses, or otherwise diverts trust funds without first fully paying all current or past due obligations incurred by the trustee to the beneficiaries of the trust funds.

In plain terms, if a contractor receives $200,000 from the owner for work that includes $80,000 owed to a drywall subcontractor and $40,000 owed to a material supplier, and the contractor uses those funds to pay debts on a different project or for personal expenses instead of paying the drywall sub and the supplier, the contractor has misapplied trust funds.

"Intent to defraud" is defined under § 162.031(a) as either retaining or diverting trust funds with the intent to deprive the beneficiaries of those funds, or using funds after signing a lien waiver that represented the funds would be used to pay current or past due obligations to beneficiaries. A contractor who signs a conditional lien waiver representing that payment will flow to subcontractors, receives the payment, and then uses it for something else has acted with intent to defraud under the statute.

Diversion across projects is the most common form of misapplication. A contractor who's behind on Project A uses payments received on Project B to cover Project A's debts. Project B's subcontractors don't get paid because their money went to Project A, even though they did their work properly and on time. Chapter 162 treats each project's funds as a separate trust. Money received for Project B can't be used to pay obligations on Project A without first satisfying all of Project B's beneficiaries.

Criminal Penalties

Misapplication of trust funds carries both civil and criminal consequences.

Misapplication of $500 or more is a Class A misdemeanor, punishable by up to one year in jail and a fine of up to $4,000. § 162.032(a).

Misapplication of $500 or more with intent to defraud is a third-degree felony, punishable by two to 10 years in prison and a fine of up to $10,000. § 162.032(b).

On residential construction projects, failure to establish or maintain a construction account or failure to maintain proper account records is also a Class A misdemeanor. § 162.032(c).

Criminal liability attaches to the individual who controlled or directed the trust funds, not just the entity. A company owner, officer, or director who diverted funds or directed someone else to divert them faces personal criminal exposure regardless of the company's corporate structure.

The Construction Account Requirement

For residential construction projects, § 162.006 and § 162.007 require the contractor to maintain a separate "construction account" for each project. A construction account is an account at a financial institution into which only trust funds and funds necessary to pay account charges are deposited. Commingling trust funds with the contractor's general operating funds in the same account violates the statute.

While Chapter 162 only mandates separate construction accounts for residential projects, maintaining separate accounts for each project is good practice on commercial projects as well. Separate accounts make it easier to demonstrate that funds received for a particular project were used to pay that project's obligations, which is the core defense to a misapplication claim.

Affirmative Defenses

A trustee can defend against a misapplication claim by proving that the trust funds were used to pay the trustee's actual expenses directly related to the construction or repair of the improvement. § 162.031. "Actual expenses" includes the contractor's project-related overhead, equipment costs, supervision, and other costs directly attributable to the project.

In In re Monaco, 839 F.3d 413 (5th Cir. 2016), the Fifth Circuit took a relatively broad view of "actual expenses directly related to the project" but noted limits. A luxury company car, for example, wouldn't qualify. In Kirshner v. State, 997 S.W.2d 335 (Tex. App. - Austin 1999), the court held that the trustee bears the burden of proving the affirmative defense, and that beneficiaries don't have to follow the contractor's funds to show where they went.

A second defense applies when the trustee has a reasonable basis to dispute whether the beneficiary is entitled to the funds. Under § 162.031(b), the trustee must give the beneficiary notice of the dispute. Withholding payment under a good faith dispute with proper notice isn't misapplication, but withholding without notice is.

A third defense under § 162.032(d) allows a trustee to avoid criminal liability by paying the beneficiaries in full within 30 days after a criminal complaint is filed or notice of a pending criminal investigation is received. This provision provides trustees a last chance to make beneficiaries whole before criminal prosecution proceeds.

Owner Liability

Owners become trustees under Chapter 162 only when they receive loan proceeds for the project. § 162.001(b). If an owner finances construction through a loan secured by the property being improved, the loan proceeds are trust funds, and the owner has a fiduciary obligation to use them to pay the contractor. An owner who diverts loan proceeds to pay non-construction expenses has misapplied trust funds.

Without receipt of loan funds, however, an owner doesn't commit a trust fund violation by failing to pay the contractor. An owner who doesn't pay the GC may be liable for breach of contract, but the owner isn't a trustee under Chapter 162 unless the owner received construction loan proceeds.

Civil Remedies

Chapter 162 doesn't create a private cause of action in its text, but Texas courts have allowed civil suits by beneficiaries against trustees for misapplication of trust funds. These claims are often combined with breach of contract, fraud, and unjust enrichment claims in construction payment litigation.

Civil trust fund claims are particularly valuable because they pierce the corporate structure. A subcontractor who can prove that an individual officer or owner of the GC controlled or directed the diversion of trust funds can pursue that individual personally, even if the GC entity is insolvent or has filed for bankruptcy. Personal liability under Chapter 162 survives the company's financial failure, which makes trust fund claims one of the most powerful remedies available to unpaid subcontractors.

2025 Legislation

SB 1612, passed by the 89th Texas Legislature (effective September 1, 2025), expanded Chapter 162 in two significant ways. First, it extended trust fund protections to the 10 percent statutory retainage (Reserved Funds) required under Texas Property Code § 53.101. Before SB 1612, only the 90 percent of construction payments that weren't retained were trust funds. Now the full 100 percent of construction payments, including retainage, are trust funds. Second, SB 1612 added § 162.034, which requires courts to award costs and reasonable attorney's fees to a beneficiary who prevails in a civil action brought against a trustee under Chapter 162.

Practical Recommendations

Keep separate accounting for each project. Even on commercial projects where a separate construction account isn't legally required, maintaining project-level accounting makes it easy to demonstrate that funds received for a project were used to pay that project's obligations.

Pay subcontractors and suppliers from the same pool of funds you received from the owner for their work. Don't use Project B's payments to cover Project A's debts. Cross-project fund transfers are the most common form of trust fund diversion, and they're the easiest to prove.

If you're a subcontractor who suspects trust fund diversion, document everything. Obtain copies of pay applications the GC submitted to the owner, confirm whether the owner paid those applications, and compare the owner's payments to what the GC paid (or didn't pay) downstream. If the GC received payment for your work and didn't pay you, Chapter 162 may provide both a civil claim against the individuals who controlled the funds and a basis for criminal referral.

Understand that individual liability is real. If you're a company owner, officer, or director who has control or direction of construction payments, Chapter 162 imposes a personal fiduciary duty on you that your corporate structure won't shield you from. Diverting trust funds is a potential criminal offense with prison exposure, well beyond its contractual consequences.