The Great Recession is still fresh in many people’s minds. Those involved in the construction industry certainly recall how those economic problems resulted in tightening cash-flow and the demise of contractors such as Lamar Construction. The present crisis is causing similar concerns. When those topics come up, many business owners and professional service providers look to cash-flow management techniques to lead decision making through this difficult time. However, cash-flow management techniques that work for some industries can lead to serious problems when implemented in the construction industry due to the fact that private construction projects in Michigan are subject to the Michigan Builders’ Trust Fund Act (“MBTFA”).
The MBTFA is a criminal statute that prohibits taking construction payments from one project and using those funds to pay for other work or general operating costs. It works by impressing project payments with trust status. This means that the payments received by contractors and subcontractors on private construction projects are not their property unless and until all of the lower-tier subcontractors, suppliers, and laborers have been paid in full. In other words, contractors and subcontractors do not have discretion about how to use these funds. Rather, the funds must be paid to the subcontractors, suppliers, and laborers that performed the work which generated the payments. This obviously impacts how contractors and subcontractors manage their cash-flow and operating capital. Here are some things to consider when analyzing cash-flow within the context of the MBTFA.
First, identify the projects where the MBTFA applies. The MBTFA applies to private construction projects but does not apply to public projects. Generally speaking the identity of the owner will be your guidepost for deciding whether a particular project is public or private. Projects where the owner is a governmental entity should be classified as public projects. Everything else would be private work. When in doubt, contact your legal counsel or simply treat a project as if the MBTFA applies.
Second, determine the amount needed to pay trust fund beneficiaries. This is a simple task for contractors and subcontractors with healthy accounting reporting capabilities in place. Simply look to your account payables report for each project where the MBTFA applies. This is the amount of your MBTFA exposure for a specific project.
Third, identify whether there is a shortage or surplus of trust funds. This can be accomplished simply by comparing the aggregate amounts reported as account payables on MBTFA projects with the amount of your cash-on-hand. This will help you prioritize payments and allocate future cash-flow.
Lastly, manage cash-flow in compliance with the MBTFA. Prioritizing vendor payments can sometimes become a strategy for managing cash-flow issues. This can be a dangerous strategy for the unwary. Many cash-flow management strategies make no distinction between trust funds and general funds or between trust fund beneficiaries and general or secured creditors. These are important distinctions as in general terms MBTFA beneficiaries should be paid before funds are used to finance operations or to pay secured or unsecured creditors.
In conclusion, this is a challenging time for those engaged in the construction industry. The majority of contractors and subcontractors in Michigan are unable to work due to Governor Whitmer’s executive order requiring many construction projects to simply shut down. This has led to concerns about diminishing operating capital and disruptions to project cash-flow, which, in turn, is causing some to consider deploying cash-flow management strategies. This is a good step. However, any cash-flow management strategy must consider the implications of the MBTFA and how to navigate through those issues. If you have any concerns or questions about how the MBTFA effects your business, contact legal counsel.