              THE    ATTORNEY    GENERAL
                        OF TEXAS

                         August 24, 1988




Honorable John T. Montford         Opinion No.   JM-945
Chairman
State Affairs Committee            Re: Interpretation of 1987
Texas State Senate                 amendments to chapter    162
P. 0. Box 12068                    of the Property    Code re-
Austin, Texas   78711              garding construction   funds
                                   or trust funds   (RQ-1402)

Dear Senator Montford:

     YOU ask seven questions about the provisions         of
chapters 53 and 162 of the Property Code as amended by House
Bill No. 1160 in 1987. Acts 1987, 70th Leg., ch. 578, at
2283. House Bill 1160 mad-e various provisions       for the
protection of subcontractors    and other beneficiaries   of
funds paid or held under construction     contracts, and its
provisions operate in conjunction with the overall scheme of
Texas Mechanic's, Contractor's,   or Materialman's Lien Law,
chapter 53, Property Code.

     Chapter 162, as amended by House Bill No. 1160,
provides that construction  payments or loan receipts held
for the purpose of paying for improvements of real property,
are Vrust funds"1 which may not be used or diverted by the
holder until those who have furnished labor or materials for
such improvements have been paid.

     Section 53.085, added by House Bill No. 1160, provides
that a seller, or a person who has furnished labor or mater-
ials for an improvement shall, upon request and as a condi-
tion of final payment, furnish the purchaser an affidavit



     1.   Section 162.004(b) of the Property Code provides:

        The Texas Trust Act (chapters 111 through 115) does
     not apply to any trust created under this chapter, nor
     does this chapter affect any provision    of the Texas
     Trust Act.




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stating that he has fully paid those who have furnished  him
labor or materials for the improvement.  If he has not fully
paid, the affidavit must state how much is owed for such
labor or materials and to whom.

     Your first question is:

           Do the 1987 ,amendments to Chapter  162,
        Property Code, affect prior law concerning
        the applicability of that chapter to trans-
        actions involving banks, savings and loans,
        or other lenders. If so, in what ways do
        they change prior law?

We answer your first question     in the negative.    Section
162.004(a)(l) of the Property Code provides that chapter 162
of the code does not apply to 'Iabank, savings and loan, or
other lender."    This provision,  formerly part of article
5472e, V.T.C.S., was recodified in the Property Code without
substantive change in 1983. Acts 1983, 68th beg., ch. 576,
S 7 at 3730.   Nor was section 162.004(a)(l) amended in 1987
by House Bill No. 1160. See RevublicBank D llas, N.A
Interk 1. U.L     691 S.W.%605     (Tex. 1985:   (consid&izg
sectio: 162.00;(a)(l)   as formerly incorporated in article
5472e, V.T.C.S.).

     Your second question is:

          Do   'expenses directly   related to    the
       .construction or repair of the improvement'
       under Section 162.031(b),     Property   Code,
       include the trustee%      overhead and other
       expenses which, though not readily traceable
       to a particular job, are necessary to obtain-
       ing or completing the job (e.g., office rent,
       employee   salaries,   workers'   compensation
       insurance,   liability  insurance, communica-
       tions bill, etc.)?

Section 162.031 was amended by House Bill No. 1160.      Prior
to that amendment section 162.031 read:

            (a) Except as provided by Subsection (b),
        a trustee who, with intent to         defraud,
        directly   or   indirectly   retains,    uses,
        disburses, or otherwise diverts trust    funds
        without first fully paying   all obligations
        incurred by the trustee to the beneficiaries
        of the trust funds, has misapplied the trust
        funds.




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P


              (b) A trustee mav use trust funds to vav
           the trustee's  reasonable  overhead exwenses
           that are directlv related to the construction
           or revair of the imvrovement.       (Emphasis
           added.)

    Section 162.031 now reads:

               (a) A trustee    who,   intentionally
           knowingly or with intent to defraud, direct::
           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   t.he tNSt     funds,    has
           misapplied the trust funds.

               (b) 1                                  to
           prosecution or other action brought under
           Subsection (a) that the trust funds not vaid
           to the beneficiaries of the trust were used
           bv the trustee to vav the trustee's    actual
           exnenses dlrectlv related to the construction
           or revair of the imvrovement or have been
           retained by the trustee, after notice to the
           beneficiary who has made a request for pay-
           ment, as a result of the trustee's reasonable
           belief that the beneficiary is not entitled
           to such funds or have been retained as
           authorized or required by Chapter 53.

               (c) It is also an affirmative defense to
            prosecution or  other action brought under
            Subsection (a) that the trustee paid the
            beneficiaries all trust funds which they are
            entitled to receive no later than 30 days
            following written  notice to the trustee of
            the filing of a criminal complaint or other
            notice of a pending criminal   investigation.
            (Emphasis added.)

    The bill analysis to House Bill No. 1160 indicates that
    section 162.031 was amended in response to the difficulties
    experienced by prosecutors in obtaining convictions.

         In McElrov V.   State, 720 S.W.2d 490 (Tex. Crim. APP.
    1986), the Court of Criminal Appeals    affirmed the Dallas
    Appeals Court's reversal of a conviction under the provis-
    ions of section 162.031 as they appeared in former article
    5472e, V.T.C.S.    The Court of Criminal Appeals held that




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those provisions required the state to plead and prove that
trust fund moneys had not been paid out for reasonable
overhead expenses.   The court declined to reach the issue of
the constitutionality, for purposes of criminal prosecution,
of the %-easonable overhead" language, which two concurring
judges in the lower Dallas court had found "vague on its
face and thus void and unenforceable.11 ' &B      McElrov
State, 667 S.W.2d 856, 869      (Tex. App. - Dallas      1981;
(concurring opinion). The concurring opinion relied on the
reasoning in Parks v. Libbv-Owens-Ford Glass Co., 195 N.E.
616, 622 (Ill. 1935): "[What is] deemed reasonable by one
employer might well be considered unreasonable by another.")

      House Bill No. 1160 changed the words of the provision
from "reasonable overhead" to "actual expenses,"   apparently
in an effort to avoid a later judicial determination     that
the provision was void for vagueness.    House Bill No. 1160
also made the "actual expenses" provision     an affirmative
defense, placing on criminal defendants the burden of prov-
ing~ that expenditures were for "actual expenses" rather than
requiring the state to prove that expenditures were not for
actual expenses.    The words "directly related,"    however,
were not altered when the prior language ltreasonable over-
head directly   related" was changed to "actual expenses
directly related."

      We do not believe that the requirement that expenses be
"directly related" to the construction      or repair of the
improvement means that expenses must necessarily be readily
traceable to the improvement.     In considering   the phrase
"reasonable overhead directly    related" in former article
5472e, V.T.C.S.,    the court    in North Texas      Overating
meers      Health Benefit Funds v. Dixie Masonarv. In c., 544
F.Supp. 516 (N-D. Tex. 1982) stated, at 520:

        The expenses that cannot readily be traced to
        a   particular   project   are    nonetheless
        'directly related' if the job could not have
        been obtained or completed without them.

           .   .   .   .

           It only remains to be determined if     the
        method used to allocate expenses to each   job
        is proper.

The court did not further discuss what would be a proper
method of allocating expenses, finding only that no evidence
had been presented "that the method used was unreasonable or
unfair . . . .II Id. at 520.




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          Discussions in both the House and Senate indicate the
     intended scope of the l'actual expenses" language added by
     House Bill No. 1160.

            Representative     Robnett:

               Do you intend that it is o.k. for a
            builder to pay his superintendent, secretary,
            computer,  pick-up tNCk,     office or    any
            administrative  expenses and other similar
            expenses related to the construction    of a
            home out of these trust funds?

             Representative    Parker:

               I think, yes, I certainly do and I [want
            to] direct your attention,   Buzz -- I think
            it's important -- to that 'directly related'
            now. I think there has to be a -- maybe you
            might need to ask a 'but for' question.  And
            'but for' the construction would I need to
            spend this money. And if it's related to
            construction, I think it's exempted.    I do
-.          not think it presents a problem.2

          House Floor Debate (Point of Order - Tape 112, Side     B,
     5-30-87).

             Mr. Johansen   [Executive Vice President      of
             Texas Association of Builders]:

                 [W]hen you have a multiplicity of loans
             and a multiplicity of houses under construc-
             tion it's almost impossible to track that
             money through and to prove that X draw was
             paid on X house when you have other on-going
             expenses and overhead -- overhead items that
             you need to pay.

             Senator Parker:

                [Builders got in trouble under the old
             law] because they refused to keep .decent
             records . . . what is so difficult   about



          2. Representative     Parker was the sponsor of House Bill
     No. 1160.




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Honorable John T. Montford - Page 6       (JM-945)




        [it]. It ought not to be that hard to figure
        out some proportion of your overhead -- total
        overhead that goes to per day, per month, per
        man hour worked.

Senate Committee Hearing, Tapes 2 and 3, 5-19-87.

     In light of the foregoing, we conclude, in response  to
your second question, that the words of section     162.031,
"actual expenses directly related to the construction     or
repair of the improvement,"    include overhead   and other
expenses which, though not readily traceable to a particular
job, are necessary  to obtaining or completing the job, so
long as the expenses are 10actual,l'A,    have in fact been
incurred.

     Your third question is:

           Way a contractor,   subcontractor or owner
        who becomes a trustee also be a beneficiary
        of the trust if he has furnished labor or
        materials: and, may he pay himself      as a
        beneficiary on the same basis that he pays
        the other beneficiaries?

     We refer again to the language of section        162.031,
quoted in full above in the discussion        of your second
question. We believe that the language in subsection (a) of
section 162.031 -- "obligations   incurred by the trustee to
the beneficiaries" -- indicates that for purposes of chapter
162, a trustee of a given trust fund is not also to be
considered a beneficiary   of .the trust fund.    It would be
anomalous to provide that a person could llincurllobligations
to himself.     Moreover,  if a trustee     could also be a
beneficiary of the trust fund he held, there would be no
reason to provide in subsection    (b) that a trustee may set
up as an affirmative defense to an action for diversion      of
trust funds the fact that the funds were used to pay the
Vrustee's actual expenses directly related to the construc-
tion or repair."     If the trustee could be considered       a
beneficiary of the trust funds he held, his payment of his
own actual expenses on the project from the trust fund would
be a lawful payment to a beneficiary under subsection      (a),
and the provision of subsection (b) that such payment may be
set up as an affirmative defense would be unnecessary.
Thus, we conclude that the statutory scheme of chapter      162
does not contemplate that a trustee of funds thereunder
might also be considered a beneficiary of such funds within
the meaning of the chapter's provisions.




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Honorable John T. Montford - Page 7      (JM-945)




     Your fourth question is:

           If a trustee has paid all current or past
        due obligations  to beneficiaries   of trust
        funds, may remaining trust funds be used for
        any purpose, whether related or unrelated to
        the construction  of the repair or improve-
        ment?

     Subsection   (a) of section    162.031, quoted  in the
discussion regarding your second question, indicates that if
a trustee has "first fully [paid] all current or past due
obligations incurred by the trustee to the beneficiaries,"
he may then retain, use, disperse or otherwise divert moneys
in the fund without   thereby misapplying the funds.     The
words "current or past due" were added to the section's
provisions by House Bill NO. 1160.3

     In the House discussion  on House Bill No. 160 on   May
30, 1987, the following exchange took place:

        Representative   Parker:

           I assume if you pay your current or past
        due obligations, then I assume that if the
        rest is profit, I assume that you can use
        that.

        Representative   Heflin:

           So there would be no way that a person
        would have to set aside the profit  for a
        particular project until that project was
        absolutely complete,  if he stayed current
        with his obligations.




     3. Section 162.005(2) defines current or past due
obligations as "those obligations incurred or owed by the
trustee for labor or materials furnished    in the direct
prosecution of the work under the construction    contract
prior to the receipt of the trust funds and which are due
and payable by the trustee no later than 30 days following
receipt of the trust funds."




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Honorable John T. Montford - Page 8         @M-945)




        Representative      Parker:

           I can tell you absolutely that that is not
        the intent of the bill.

     In response to your fourth question,    it is apparent
from the ,House discussion    in connection with the added
"current or past due obligations** language,   and from the
plain meaning of the provision itself, that money  remaining
in the fund after payment of current and past due obliga-
tions can lawfully be diverted to other purposes     by the
trustee.

     Your fifth question is:

           Does the notice requirement    in Section
        162.031(b), Property Code, apply only to the
        affirmative defense of funds retained by the
        trustee or does it also apply to the defense
        of use of funds to pay actual expenses
        directly  related to the construction     or
        repair?

     Section   162.031(b)    of the code states in part:

            (b) It is an affirmative     defense . . .
        that the trust funds not paid to the bene-
        ficiaries of the trust were used by the
        trustee to pay the trustee's actual expenses
        . . . or have been retained bv the trustee,
        after otice to the beneficiarv who has made
        a reguist  for payment, as a result of the
        trustee's   reasonable    belief   that    the
        beneficiary is not entitled to such funds or
        have been retained as authorized or required
        by Chapter 53.   (Emphasis added.)

Prop. Code 5 162.031(b). The underlined phrase stating the
notice requirement modifies only "have been retained."  The
notice requirement in section 162.031(b) does not apply to
the other two affirmative defenses there provided for: that
the funds were used to pay the trustee's actual expenses
directly related to the project, or were retained under the
provisions of chapter 53 of the Property Code.




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Honorable John T. Montford - Page 9     (JM-945)




    Your sixth question is: -

          Does Section 53.085, Property Code, create
       a duty for a contractor to require affidavits
       from all persons     who furnish labor     or
       materials on a property?

     Section 53.085, which was added by House Bill No. 1160,
1987, provides:

           AFFIDAVIT REQUIRED.   (a) Any person who
        furnishes labor or materials for the con-
        struction of improvements on real property
        shall, upon request and as a condition       of
        final payment   for such labor or materials,
        provide to the requesting      party, or its
        agent, an affidavit stating that such person
        has paid     each   of   his   subcontractors,
        laborers, or materialmen     in full for all
        labor and materials provided to him for the
        construction.   In the event that the person
        has not paid each of his subcontractors,
        laborers, or material-men in full, the person
        shall state in the affidavit the amount owed
        and the name of each subcontractor,   laborer,
        or materialman to whom such payment is owed.

           (b) The seller of any real            property
        shall, upon request by the purchaser or its
        agent prior to closing of the purchase         of
        such real property, provide to such purchaser
        or its agent, a written affidavit         stating
        that the seller has        paid each of       his
        contractors, laborers, or materialmen in full
        for all labor and materials provided to the
        seller for any construction of improvements
        on the real property   and that the seller     is
        not indebted     to any     person,   firm,    or
        corporation   by    reason     of    any     such
        construction.  In the event that the seller
        has not paid      each of his       contractors,
        laborers, or materialmen in full, the seller
        shall state in the affidavit the amount owed
        and the name of each contractor, laborer, or
        materialman to whom such payment is owed.

            (c) A person, including a seller, commits
             offense   if the person   intentionally,
        Eowingly,    or recklessly makes a false or
        misleading statement   in an affidavit  under



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Honorable John T. Montford - Page 10   (Jm-845)




        this section. An offense under this       section
        is a Class A misdemeanor.

     Subsection (a) of section 53.085 authorizes a person
such as a contractor to request, as a condition of final
payment, that "any person who furnishes labor or materials"
for a construction project    furnish him an all-bills-paid
affidavit or an a~ffidavit stating which bills remain unpaid.
There is no indication    in the statutory language that a
person such as a contractor is reauired to request or obtain
such affidavits.

     Before paying a subcontraator, for example, a contract-
or is entitled under section 53.085 to request that the sub-
contractor as a condition   of final payment   furnish such
affidavit to the contractor,    but the section does not
require that the     contractor   request  or obtain    such
affidavit.

     Similarly, if the contractor is seeking payment     from
the,owner, for example, the owner is entitled, but is not
required, under section 53.085 to request such affidavit
from the contractor as a condition of payment.   In this case
as well, there is nothing in section 53.085 to indicate that     .-
the request for the contractor's affidavit    creates a duty
for the contractor    to in turn request affidavits      from
subcontractors, materialmen or others doing work under the
contractor.   He may, but is not required, to request such
affidavits.   We therefore answer your sixth question in the
negative.

     Your seventh, and last, question is:

           In making an affidavit, does a contractor
        impliedly represent that it is based on re-
        ceiving affidavits from each of the persons
        from whom such affidavits may be required?

     We believe  it follows from our discussion    regarding
your sixth question that the answer to your seventh question
is ~No.~   Since a contractor   furnishing an affidavit    on
request to the owner, for example,     is not required     to
request affidavits from subcontractors, etc., working   under
him, the contractor's affidavit cannot be read as impliedly
representing that it is based on the affidavits       of his
subcontractors, etc. A contractor may make his affidavit
based on information obtained through other means than the
affidavit  procedure  which under section 53.085 he         *
entitled,  but not required,    to use.    Of course,     tit:
contractor's affidavit may, if the contractor so chooses,



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      .
          Honorable John T. Montford - Page 11   m-945)


,--

           xv   sly represent that it-is based on the affidavits     of
          zhoLzsunder the contractor whose affidavits he has obtained.
          It might, moreover, be wise for the contractor to obtain the
          affidavits  of those under him and expressly        base his
          affidavit on the affidavits he has obtained, so as to avoid
          a penalty under subsection      (c) of section 53.085 for
          "intentionally, knowingly, or recklessly11 making "a false or
          misleading statement."  But again, there is nothing in the
          controlling statutory provisions   which reouires   the con-
          tractor to obtain the affidavits of those under him, or
          which makes the contractor's  affidavit a representation   by
          implication  that he has in fact obtained        such   other
          affidavits and has based his affidavit on them.

                                 SUMMARY
                       The 1987 amendments to chapter 162 of
                  the Property Code do not affect prior law
                  concerning the applicability of that chapter
                  to banks,   savings   and loans, or    other
                  lenders.

                       In section  l62..031(b) of the Property
                  Code "actual expenses directly related to the
                  construction or repair of the improvement,"
                  include overhead and other expenses which,
                  though not readily traceable to a particular
                  job, are necessary to obtaining or completing
                  the job, so long as such expenses         are
                  "actual," i.e., have in fact been incurred.

                       A contractor, subcontractor or owner who
                  becomes  a trustee of construction      funds
                  within the meaning of chapter 162 may not
                  also be considered   a beneficiary   of such
                  funds within the meaning of that chapter.

                       If a trustee has paid all current or
                  past due obligations to beneficiaries        of
                  trust funds under Property Code         section
                  162.031, he may use remaining trust   funds for
                  other lawful purposes whether       related or
                  unrelated to the project in connection     with
                  which the trust fund was created.

                       Section    162.03‘1,   subsection   (b),
                  requires notice to a beneficiary who has made
                  a request for payment only where the trustee
                  has retained    funds as a result of      the
 ,--              trustee's    reasonable   belief   that   the




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Honorable John T. Montford - Page 12    (JM-945)




        beneficiary is not entitled to such funds.
        The notice requirement  in subsection (b) is
        not applicable   to the other     affirmative
        defenses provided for in that subsection.

             Section 53.085 does not require, but
        only entitles, a contractor to request, as a
        condition of final payment, affidavits   from
        all persons who have furnished      labor or
        materials on the project.

             In making  an affidavit   under section
        53.085, a contractor does not, by virtue  of
        that section,  impliedly represent  that his
        affidavit is based on affidavits from those
        persons from whom the contractor is entitled
        to request affidavits.




                                     JIM     MATTOX
                                     Attorney General of Texas

MARYKKLLKR
First Assistant Attorney General

mu MCCREARY
Executive Assistant Attorney 'General

JUDGE ZOLLIE STEAKLHY
Special Assistant Attorney General

RICK GILPIN
Chairman, opinion Committee

Prepared by William Walker
Assistant Attorney General




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