THE LAW AND CIVIL ENGINEERING – FEBRUARY 2020 NEWSLETTER
Diversion of Funds Received for Construction of Improvements Is a Crime
by Eugene Bass
Most contractors are aware of the prompt payments laws in effect that require payments to be made to general and subcontractors within a limited period of time. In addition to the possibility of civil penalties for non payment, a contractor who receives payment and then either does not complete the work or uses the money to pay bills for other jobs may also be guilty of violation of the Penal Code.
The California Penal Code provides that a person who receives money for the purpose of obtaining or paying for services, labor, materials or equipment and willfully fails to apply such money for such purpose by either willfully failing to complete the improvements for which funds were provided or willfully failing to pay for services, labor, materials or equipment provided incident to such construction, and wrongfully diverts such funds to use other than that for which the funds were received, shall be guilty of a public offense and shall be punishable by a fine not exceeding ten thousand dollars, ($10,000), or in a county jail not exceeding one year, or by both such fine and such imprisonment if the amount diverted is in excess of two thousand three hundred fifty dollars ($2,350). If the amount diverted is less than or equal to two thousand three hundred fifty dollars ($2,350), the person shall be guilty of a misdemeanor.
A general contractor was prosecuted for violation of the Penal Code that prohibits diversion of money received for construction of improvements. In defense of the charges, the contractor argued that in order to be guilty of the crime, it had to have the specific intent, at the time of receiving the money, not to complete the improvements or to pay the subcontractors. The contractor admitted that it diverted funds from one job to pay costs incurred on other jobs but that it always intended to complete the job for which funds had been paid and to pay the subcontractors.
The appellate court disagreed with the contractor and held that the law was violated if the diversion of money was the cause of failure either to complete the improvements or to pay the subcontractors for services, labor, materials or equipment. It was not necessary at the time of diversion that the contractor intended or desired that the improvements not be completed of that the subcontractors not be paid.
In theory, a contractor should have sufficient resources or borrowing capacity to not have to use money from one job to complete another job. The reality is often different, however, and funds are “diverted.” And, if the contractor does not run out of money and fail to complete the job or pay for subcontractors and other job costs, most likely, no one complains. But, the contractor should be aware that if a job goes bad and the owner has paid but the contractor used the money on other jobs, there is the potential not only for a civil lawsuit and a major headache from the contractors license board, but a criminal prosecution as well.