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Remodeler Fraud: Robbing Peter to Pay Paul


Remodeler Fraud: Robbing Peter to Pay Paul

The line between doing business and committing fraud is thinner than you think 

By By James F. McClister November 3, 2017
remodeling business and fraud-cash-remodeling work-money
Photos: top and bottom right, Tomislav forgo / stock.adobe.com; right, Joshua Rainey / stock.adobe.com; bottom left, Jo Ann Snover / stock.adobe.com
This article first appeared in the November 2017 issue of Pro Remodeler.

Home repair fraud is so common a problem that many states’ attorneys general publish pamphlets about it to warn consumers. The irony is that most remodelers don’t know much about fraud or the laws and penalties associated with it.

Many of the problems start with the well-known scenario of “robbing Peter to pay Paul”: A remodeler uses the first payment from a new job to cover the expenses of another ongoing project. The practice is not uncommon in remodeling, particularly among small companies that don’t sit on a lot of capital. And, as long as a succession of projects is scheduled, it can help to sustain a remodeler’s business—albeit it in a precarious legal gray area. 

But if the remodeler suffers an unexpected setback—getting blindsided by some emergency expense, for example—suddenly the company is two miles into fraud territory and surrounded by risk. 

With that in mind, here are some of the basic legal concepts that dictate the civil and criminal liabilities associated with home repair fraud cases. And while we couldn’t biopsy the individual quirks of each state’s system, we did look at the big differentiators, including mechanic’s lien laws and the contractor trust fund statute, also known as “theft by contractor.”

The Basics

The fundamentals of construction law are straightforward and intuitive: generally, you need to have a written contract for each job; you need to pay your bills on time; you need to carry insurance; and so on. 

That said, there are a lot of differences in licensing requirements among states and jurisdictions. For instance, in Delaware, unless a project is over $50,000, the presiding contractor doesn’t need to be licensed; whereas in Massachusetts, anyone supervising a construction crew, even a crew of one, needs a license. In Colorado, the state requires a general business license but not a contractor license; those are handled at the local level, and not every municipality mandates them. Some states go as far as requiring that remodelers demonstrate a certain competence in the law—such as in Georgia, where all general contractors must pass a two-part business and law exam. Yet even though the laws are different, many of their instruments are similar. (Last year, HomeAdvisor published a state-by-state overview of the requirements, which can be found here.)

Mechanic’s Liens 

Mechanic’s liens are a legal claim against a property that’s been improved or remodeled. Although they are available to GCs, they are more frequently used by subcontractors and suppliers. 

To understand why a mechanic’s lien is relevant in this context, let’s go back to the idea of robbing Peter to pay Paul. The practice itself isn’t illegal, or not exactly, says Renee Schwerdt, owner of Pittsburgh-based law firm Plumb & True Legal Consulting and Representation. “If the contractor is able to start and finish the project on time and in accordance with the contract, the use of the deposit is unlikely to cause an issue,” Schwerdt says, clarifying that in certain locations, such as Wisconsin, merely the act of misappropriating money paid by a property owner can be enough to constitute illegality. 

But if subcontractors, laborers, or material suppliers aren’t paid on time—a common result of the Peter-Paul scenario—the remedy can be a mechanic’s lien which, once filed, will remain in place until it’s reconciled. (If there are multiple liens on a property, each claim will have to be prioritized by the court.)

Mechanic’s lien laws are controversial. They place homeowners at significant financial risk if the general contractor doesn’t pay the people he’s supposed to cover. That’s why many states have passed “defense of payment” laws that protect homeowners from having to pay for work twice: once to the general contractor and once again to a subcontractor the GC hasn’t paid. It’s the most important distinction when considering the differences in mechanic’s lien laws between states. 

“It’s referred to as the New York system,” says attorney James Fullerton of Fullerton & Knowles, in Clifton, Va. The laws differ from state to state, but tend to follow New York’s lead, which says that if a homeowner can prove he’s paid a general contractor in full, it’s a complete defense against lien action. A separate but direct effect of those laws, however, is that the subcontractor will likely not be paid. 

Not all states have defense of payment laws. Some, such as Maryland and Florida, are what many call “double-jeopardy states.” In these scenarios, homeowners can be made to pay the subcontractor even if they’ve already paid the general contractor for the same job. If that happens, the homeowner’s only recourse is to sue the GC, or to file charges under a contract trust fund statute, if their state has one. 

Contractor Trust Funds

Twenty states have contractor trust fund statutes on the books, according to research from law firm Clark Hill in Washington, D.C. Typically, the statute requires that money paid by a homeowner be deposited into a secure trust, of which the general contractor is made trustee (that is, the person legally responsible for making sure everyone gets paid). The specifics vary across states. For example, in Texas, money paid must be deposited into a construction account with a financial institution for projects that cost $5,000 and over. In Michigan, if a GC misappropriates project funds for personal reasons, the GC then opens himself to personal liability. In Wisconsin, the contractor is liable if he uses client money for anything other than the job it was meant for, regardless of whether the contractor completes the job or not. 

But while the details differ, the intent of the laws is the same: to give homeowners a defense against mechanic’s liens, and to give subs, workers, and suppliers additional defense against contractors who can’t, or won’t, pay them.

contractor trust fund states

The Damages

Contractors are vulnerable to both civil and criminal charges. Civil charges are typically brought by individuals, and the penalties can be severe. For example, in Minnesota, the state’s licensing agency has the authority to revoke a contractor’s license and levy a fine of up to $10,000 per violation. It can add up fast. 

"Frivolous lawsuits certainly happen. But while filing them requires little to no proof, succeeding in them does." -Renee Schwerdt, owner, Plumb & True Legal Consulting and Representation

Virtually anyone can file a civil lawsuit, and it’s not all that tough to get in front of a judge. “Frivolous lawsuits certainly happen,” Schwerdt says. “But while filing them requires little to no proof, succeeding in them does—not only of intent but 
of damages.” 

That latter part is particularly important because in our Peter-Paul scenario, if a remodeler used client money to pay off debts, but still finished the project in a timely manner (and paid everyone who needed to get paid), there wouldn’t be any damages to claim. 

Historically, criminal charges are rare, according to Patrick J. Lee-O’Halloran, partner at the Edina, Minn.-based firm Thompson Tarasek Lee-O’Halloran. “I don’t have the right as a private citizen to sue someone in criminal court,” he says. “You have to get the prosecutor interested in [the case].” And that can be difficult, though not impossible. 

Prosecutors handle hundreds of cases per year, and often several at once, so they’re selective. To get their attention, a contractor would first need to have violated an actual law, not just a contract, and there would also need to be sufficient proof of ill intent and enough damage to warrant the use of state resources. 

Still, contractors unlucky or unethical enough to face criminal charges could very well end up in jail. Just this year, in February, a New Mexico construction company owner was sentenced to 18 years in prison for misappropriating client payments to other projects. The state originally asked for 27 years. 

“The best idea for a contractor in those situations is to contact an attorney or their state’s licensing authority, explain the problem, and ask how to unwind the problem without stepping on any minefields,” Lee-O’Halloran says. If the issue is solely one concerning payment, the problem can usually be solved with “some amount of time and money.”

If legal action hasn’t already been taken—Lee-O’Halloran urges contractors to treat these issues as customer-service problems: “They can be a lot tougher to unwind if they reach a criminal investigator.” 

written by

James F. McClister

James McClister is managing editor for Professional Remodeler.

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