Sid P. Mody
Prosecutors rarely try construction fraud as False Statement to Obtain Property or Credit, but doing just that netted a Tarrant County general contractor three years in the pen for bilking his subcontractors of over $125,000.
The expected use of the False Statement to Obtain Property or Credit statute1 is typically mortgage fraud, where a defendant might lie on a loan application to induce a bank to lend him money. But this statute and its elements can be used effectively on a broader scale. At the end of February, I used §32.32 to prosecute Keith Baxter Alexander, a general contractor, for construction fraud—it’s easier than a standard theft charge. With a False Statement to Obtain Property or Credit, a prosecutor must prove only two things: that a false statement occurred and that it was to obtain property or credit. Whether the defendant actually received that property or credit isn’t really at issue, so a prosecutor doesn’t have to get into tracking the money as much as in a theft case.
In 2006, Keith Baxter Alexander was the owner of K.B. Alexander Company of Texas, Inc., a general contracting company. He was hired by Ed Kent, the owner of a used-car dealership, to oversee construction for EZ Ed’s Auto in Fort Worth. As the general contractor, Alexander hired various subcontractors (often called “subs” in the industry)—everyone from concrete workers to electricians (13 subs in all). Alexander had a contract between himself and the dealership owner, plus other contracts between himself and the subcontractors.
Ed Kent would pay Alexander for the work completed every month, and Alexander was to pay the subcontractors who had worked during that period. In reality, though, he was not paying the subcontractors the full amount, if at all, and the scheme came to light only after construction on the dealership was finished and the owner discovered that mechanics liens had been placed on his property. (Mechanics liens are subcontractors’ only secured recourse when they are bilked out of their wages.) To get some of these liens off of his property, the owner decided to pay the subcontractors directly. Some of the subs filed civil suits against the defendant for the amount still owed, but Alexander filed for bankruptcy to fend off the various claims against his company. After he went through bankruptcy, he turned around and created another construction company and started doing the same thing over again. In all, Alexander had withheld $125,000 from his subcontractors, and when his business filed for bankruptcy protection, his subs were (effectively) out their rightful wages.
Kent, the auto dealership owner, filed a complaint with our office, asking if this could be a criminal offense. When these types of cases come across our desks, they might appear to be civil issues at first, but prosecutors should look closely at each pay application to see what language it includes (because the general contractor signs it)—it just might show that the criminal offense of false statement has occurred. After a review and analysis of the pay applications (monthly invoices a general contractor submits to a client to keep track of what work was done during the month—more about these below), we felt comfortable taking the case to the grand jury with the charge of False Statement.
Generally most false statements to obtain property or credit will also fall under a simple theft statute, but not all thefts are false statements. In construction fraud, §32.32 is a lot easier statute to convey to a jury (because pay applications document all of the money month to month); jurors just have to follow a simple concept, that if an individual makes a false statement on a document that gets someone else to turn over money, then a crime has occurred. This charge prevents the defense from claiming the defendant merely used “bad business practices.” On a theft case it’s a lot easier for the defense to claim bad business practices and that the defendant intended to pay the subcontractors at the time the owner went to make a draw on the bank. In a False Statement, proving intent is not difficult because once the State proves the statement the defendant made on the pay application is false, all prosecutors have to worry about is addressing the numbers on the pay application and showing that they don’t add up.
As a prosecutor, I always add as many counts as I can in the indictment because you never know what you will need; that way, you always have the option to waive counts. Generally in these cases I would not only include Count 1 on False Statement but also Count 2 on Theft. I would also add separate counts of theft and list each subcontractor as an injured party.
One other note about a theft vs. false statement charge: Like any financial-crime case, it takes a long time to even find out if a criminal act has occurred because of the sheer amount of paperwork to examine, and quite frankly the defendant is usually smarter than average. In this case, the EZ Ed’s Auto build happened in 2006. Between the subcontractors placing liens on the property, to civil claims, to the criminal case finally coming to our office, the five-year statute of limitations on theft had already passed, so I was limited to a False Statement on this case (this charge has a seven-year statute of limitations).
Many people have heard stories about subcontractors not being paid for a job, but they may not contemplate that a general contractor can be charged with a felony if he continues to receive money from a customer and doesn’t turn it over to his subs.
To understand how such actions constitute a crime, it’s helpful to know how the financial side of construction projects works. A general contractor is required, when building a piece of property, to turn over a pay application to the owner. Pay applications are standard industry documents showing what work has been completed on the property during a given time period (usually a month). Once a subcontractor submits to the general contractor the work he has completed or will complete in that time period, the general contractor converts that to a percentage (say, 25 or 50 percent) and inserts it into the pay application, which is then submitted to the owner so the owner can pay that month’s salaries and expenses.
Generally on the second page of the pay applications is a dollar amount that the general contractor is charging the property owner for a specific subcontractor’s work. A lot of times, the general contractor will mark this cost up by 15 or 20 percent to get more money for himself (this is common practice—and not necessarily criminal—to pay the general contractor for the administration of a job).
The pay application also includes the “Previous Application Paid” number, which identifies all of the money that has been already paid to the general contractor (and then to the subs) for the work completed thus far on the property. If the amount previously paid out doesn’t match what the subcontractors actually received, then a false statement—a crime—has occurred. The property owner, when looking at the Previous Application Paid number, will obtain a draw from the bank for additional money for which the general contractor is asking for the next month. A crooked general contractor has to keep lying and increasing the number of the Previous Application Paid number every time he submits a new pay application or the owner won’t make a draw on the bank.
The “certification paragraph” on these pay applications (right above the general contractor’s signature) becomes very important. In the case against Keith Alexander, the certification paragraph read, “The undersigned contractor certifies that to the best of the contractor’s knowledge, information, and belief … all amounts have been paid by the contractor for work for which previous certificates for payment were issued and payments were received from owner, and that current payment shown herein is now due” (emphasis added) His signature on these pay applications—when he knew they were falsified—was a smoking gun of his guilt.
Going after a crooked contractor
When a subcontractor performs work but isn’t paid in full, one option is to put a mechanics lien against the property. A subcontractor must file the lien by the 15th day of the fourth month following completion of its work and must also give notice to the owner of the property by the 15th day of the third month of performance. Getting these mechanic’s liens and giving timely notice can be difficult for subcontractors because they are required to perfect their lien within a certain time period, but it is the only recourse for a subcontractor to be protected on his claim. But placing a mechanics lien doesn’t entirely solve the problem; that lien penalizes the owner of the property (who has paid the full value of the contract), not the general contractor, who did not fully compensate the subs. In fact, a mechanics lien gives the owner a clouded title while the general contractor is able to walk away.
There may be recourse on the civil side for both the owner and the subcontractors against the general contractor. A lot of times, however, because of legal fees and various other costs, it isn’t feasible for owners and subcontractors to go after the general contractor. When owners and subcontractors do file civil suits, they usually are filed against the general contractor’s company, and unless the plaintiffs can pierce the corporate veil, their claims are limited by the company’s assets (rather than the general contractor’s assets). When these suits against the construction company do get filed, the general contractor can seek Chapter 7 bankruptcy protection for his company; once that happens, the various claims are listed as unsecured creditors.2 In bankruptcy law, an unsecured creditor will generally be last on the list to get paid, behind creditors whose claims are secured by collateral that the creditor can reclaim if the borrower defaults on payment (such as a car loan or mortgage). Many times owners and subcontractors get pennies on the dollar or nothing at all from winning a civil suit, especially if the general contractor files for bankruptcy protection.
The important thing to remember in this scenario is that although a subcontractor can try to become secure for his loss by taking a lien on the property, he’s taking the lien on the owner’s property, not on the general contractor’s property. And any claim against the general contractor will always be unsecured. The general contractor also has the benefit of an automatic stay when his company files for bankruptcy.3 An automatic stay prevents any further efforts to collect on a civil judgment after a debtor declares bankruptcy. The goal of the automatic stay is to preserve the status quo and protect the company’s remaining assets until the division of assets overseen by the bankruptcy court. The general contractor, by just filing for bankruptcy, gets this shield, and again, the owner and subcontractors are at least temporarily stopped from pursuing their claims against the general contractor.
There is of course no limit as to how many times a general contractor can create a new company and later file for bankruptcy for that, so a general contractor can create an endless cycle of stealing money from owners and subcontractors, then using the federal bankruptcy courts to wash his hands of liability.
Robbing Peter to pay Paul
General contractors might over-stretch themselves in paying for a specific job; however, instead of taking a loss on that specific job, they start shifting money from other jobs to compensate for their loss. One misstep after another slowly starts growing, and finally they find themselves in a hole that affects multiple jobs, rather than only the single, original mess-up. A typical defense strategy is simply to call this “bad business practices”—the general contractor went over-budget and intended to pay everyone, but he just had too much overhead. The defense might make this claim because all the money from various projects typically goes into a single bank account, so the defense argues there is no criminal intent by the general contractor not to pay the subcontractors; rather it’s simply a case of running out of money.
One way to dismiss this over-budget argument is to look for “change orders,” which are generally found on the last page of the pay application. Change orders are revisions to the original contract when (as the name suggests) the client makes a change or when costs end up higher than the general contractor originally estimated. If a construction job has a lot of change orders or something went wrong during the project—and the file has ended up on your desk—make sure to go over the numbers carefully. Many times a project requires more work from the subcontractors than originally thought and the general contractor just doesn’t have enough money to pay them. This happens all the time, but a reputable general contractor will include these overages on the last page of the pay application as one or more change orders, which the owner then has to pay. The final pay application will then show that the owner has paid the change orders.
What is important for a prosecutor when dealing with these types of cases is to understand the ramifications that “bad business practices” can have upon the owners of these properties. The only way a general contractor can shift money from one job to another is by making a false statement to the property owner that the money the contractor is receiving is going towards that owner’s particular project. An owner will not continue to pay the general contractor over the course of the contract if he knows the money is not going toward his project and that he will eventually have to pay even more at the end to subcontractors.
Taking the case to trial
This is plain and simple deception by the general contractor over a period of time. He might get away with it for a while because he is in a position of trust, not only with the property owner but also with the subcontractors. When trying Alexander for this crime, I told the panelists during voir dire that the best way to explain a false statement is in reference to the word trust. Because of the trust a contractor has with a client and the trust that client places in the terms of the signed document, the client will turn over property or credit to that contractor.
When it came to proving that different subcontractors were not paid the full amount of the contract price, we had to show the jury the connection between the pay applications submitted to the owner and the total amount still owed to the subcontractors. We called all the subcontractors during the guilt-innocence stage to testify about their individual contracts with the defendant, that those contracts didn’t change over time, and that the subcontractors weren’t paid the full amount they were owed. One by one, my co-counsel, Susan Linam, and I checked off the amount they were paid as well as the remaining balance. We created a large chart for the jury to see and follow along during each subcontractor’s testimony. Each sub’s work and payment was different, so it was important to make sure the jury was keeping up with all the information. Nine subcontractors were not paid the full amount, and seven mechanics liens were placed on the property representing almost a third of the original contract price between Ed Kent, the property owner, and the defendant, which totaled a little over $125,000.
The jury, after deliberating for a little under an hour, came back with a guilty verdict. In the punishment phase, we tracked Alexander’s pattern of behavior and showed the jury that this was not the only job where the defendant had scammed his subs. By getting Alexander’s “clear report,” we had a plethora of information on our defendant. A clear report compiles the results of a search of public records for anything pertaining to a particular suspect; it’s produced by Thomson Reuters.4 Investigators around the country use clear reports to get more information on a suspect (anyone who completes a certification class can have access to it). It tells us everything from corporations to which the suspect has been linked, to civil lawsuits to which the suspect has been a party. Alexander’s clear report showed that he had filed bankruptcy on two different construction companies after civil claims were brought against him for doing the exact same thing. We were also able to tell the jury that in 2013, the defendant again had a new construction company and was back to the same antics. We brought in witnesses who worked various other construction jobs with Alexander and testified that he had done the same thing with them, further adding to the total amount Alexander had stolen. We also introduced evidence that he had been forging various subcontractors’ signatures on joint checks from owners on other projects.
Knowing the complexity of construction fraud and that these cases rarely get indicted, let alone go to trial, I didn’t make a specific request for probation or penitentiary time. Rather I let the jurors decide what would be appropriate. After deliberation and understanding that the defendant had no prior felony convictions, the jury came back with a three-year penitentiary sentence. For us white-collar prosecutors, it is generally hard to get a jury to give pen time because defendants are often clean-cut and sympathetic with no prior criminal history. In this case I was ecstatic that the jury was able to the follow its complexities and give an appropriate sentence.
A lot times prosecutors forget to ask for restitution after a jury comes back with pen time, but the State can always ask for restitution for victims who are out money. It would be enforced after the defendant goes on parole and can be used as a factor to revoke parole if restitution is not paid. Of course, restitution is limited to the amount owed to the injured party listed on the indictment. In a False Statement case, the injured party is the one to whom the false statement is made, so that was Ed Kent of EZ Ed’s Auto. Although I wanted to ask for the full amount of restitution for all the subcontractors, I was limited to the amount Ed Kent was still owed, which was roughly $20,000. That amount was nowhere near what the subs were owed to get the liens off of Kent’s property, though. (One way to make sure the subcontractors can be paid through restitution would be to add separate counts of theft and list the subcontractors as injured parties, but I couldn’t do so in this case because the five-year statute of limitations on theft had already run by the time this case came across my desk. Because False Statement has a seven-year statute of limitations, I was lucky to ask for restitution for what Kent, the injured party, was owed.)
These cases can be very complicated in showing not only a loss to the subcontractors but also the relationship between an owner, general contractor, and subcontractors. I’m lucky to be in a large office that has the resources for a white-collar unit, where investigators are able to do most of the legwork and organize the case to track the different amounts passing between the entities.
However, prosecutors in smaller offices shouldn’t be afraid to try one of these cases. The key to prosecuting a False Statement to Obtain Property or Credit case is identifying where the false statement has occurred. If one of these cases does come across your desk, look for specific pay applications between the general contractor and the owner and then look at individual contracts between the subcontractor and the general contractor. If something doesn’t add up, you probably have a false statement on your hands, and you can start breaking down the case by each subcontractor. It starts with the last pay application submitted by the general contractor to the owner of the property. Look for language stating that previous pay applications have been paid and then find the actual amount of what has been paid. I would then go and talk to all the subcontractors and ask what they are still owed.
In the end, like all other white-collar cases, the most important thing to do as a prosecutor is show that the numbers don’t add up.
1 Tex. Penal Code §32.32.
2 11 U.S.C. §701.
3 11 U.S.C. §362 (a).
4 https://clear.thomsonreuters.com/clear_home/ index.jsp.