Appeals Court Warns Contractors Against Toying With Trust Funds

Lance E. Duroni
lduroni@kmksc.com
(414) 962-5510

A Wisconsin appellate court recently reinforced Wisconsin’s theft-by-contractor law, leaving no doubt that contractors may not play fast-and-loose with their obligation to hold in trust money received for payment to subcontractors and suppliers.

While a subcontractor or supplier who is not paid can bring a breach of contract claim, a theft-by-contractor claim is often preferable, as it can permit recovery of attorneys’ fees and up to three times the damages suffered. This type of claim can be a powerful tool to secure payment, and a recent decision by the Wisconsin Court of Appeals has sharpened this tool.  

In a decision last fall, the Wisconsin Court of Appeals reversed a lower court and held a contractor (American Sewer Services, Inc.) and its owner liable for theft-by-contractor. In finding that American Sewer had improperly converted money belonging to a subcontractor (Century Fence Company), the court rejected American Sewer’s defense that it was “solvent and always able to pay” pending resolution of a legitimate gripe about Century’s work.

The Century Fence decision should give caution to contractors who may try to manufacture a pretext for withholding payment from subcontractors, and should buoy subcontractors who feel they have been denied payment without cause. The theft-by-contractor statute does indeed have teeth, according to Century Fence, and subcontractors can use the threat of the statute’s enhanced penalties as leverage in disputes with contractors who withhold payment.   

American Sewer served as prime contractor on a job to replace a water main for the City of Waukesha, and subcontracted with Century to provide around $11,000 of pavement-marking services. The city paid the full $11,000 to American Sewer for Century’s work, but American Sewer withheld the money and claimed it only owed Century $3,007 because there had been less work for the subcontractor than anticipated.

American Sewer placed the $11,000 into an account used to pay general business obligations, reasoning that it could keep the approximately $8,000 balance to cover work that it had performed, but for which it had not billed the City. Century received the $3,007 only after it filed a lawsuit, and recovered the remaining balance only after prevailing on its breach of contract claim. While it also brought a theft-by-contractor claim, the lower court ruled that Century was a “hair’s breadth” short of proving that claim.

In partially reversing that decision and reviving the theft-by-contractor claim, the Court of Appeals stressed that American Sewer “could do only one thing with the trust funds and that was to pay [Century].” The court sharply criticized American Sewer for “holding hostage” the money in a bid to get Century to “to accept less than the contracted price by forcing the subcontractor to choose between hiring lawyers and initiating an expensive lawsuit or agreeing to the lesser amount.”

The appeals court also rejected another aspect of American Sewer’s defense—that it was justified in keeping the money because Century ended up doing less work than originally anticipated. As Century’s contract provided for a lump sum payment for the entire job, which it completed, the Court of Appeals held that any dispute about how much work that ultimately amounted to was immaterial.

“American [Sewer] had no legitimate ground for withholding payment simply because it, after-the-fact, may have regretted not negotiating the contract differently,” the appeals court explained. Accordingly, the court reversed the dismissal of Century’s theft-by-contractor claim and remanded the case for further proceedings.  

One important lesson from the case is that subcontractors should pay close attention to the underlying contract in any dispute over payment from their prime contractor. The purported basis for withholding payment may well be foreclosed by the contract itself.

But the primary take-away from Century Fence is that theft-by-contractor claims—and the potential enhanced penalties they carry—are a real threat to contractors who withhold payment from subcontractors without cause. Liability cannot be avoided by simply complaining about the subcontractor’s work, and contractors cannot feel secure in keeping trust funds for themselves and sorting out the details later. Subcontractors, meanwhile, have serious leverage when payment disputes arise with their contractors—namely, damages that can be multiplied by up three times their loss and recovery of attorneys’ fees. Theft-by-contractor claims can even result in criminal charges being filed in the most egregious cases. The message of Century Fence is clear—contractors who receive funds in trust for a subcontractor must provide those funds to the subcontractor, or suffer the consequences.

KMK offers a wide array of legal services to businesses in the construction industry, including handling construction liens and construction bond claims. If you are having a dispute with a contractor over payment, would like a review of the contracts you have in place, or need any advice concerning payment for construction work, please contact KMK Attorneys Lance E. Duroni (lduroni@kmksc.com) or David M. Henry (dhenry@kmksc.com). Both can be reached at (414) 962-5110.