Bankruptcy by the Developer/Owner: Mechanics Lien Rights may still Prevail!

John W. Kim | Nossaman LLP | October 24, 2014

The rate of bankruptcies among construction industry participants is higher than some think.  The bankruptcy of a developer creates an “automatic stay” under federal law preventing almost all collection activities, including actions to perfect a lien.  However, there are unique exceptions to the automatic stay that will protect some parties in the construction industry, such as the right for a contractor to seek protections for payment of unpaid work on a residential or commercial project.   Upon a developer’s bankruptcy, two sets of laws that may conflict need to be harmonized: federal bankruptcy law and applicable state law relating to mechanics liens.  Since a violation of the bankruptcy automatic stay is a contempt of court, it is important to understand what can and cannot be done once a bankruptcy has been filed.

When any party files for bankruptcy, one of the first protections gained is the “automatic stay” under United States Bankruptcy Code section 362. The automatic stay broadly bars collection efforts and other creditor actions against the debtor and/or the debtor’s property. While numerous, some of the specifically prohibited actions include: “(4) any act to create, perfect, or enforce any lien against property of the estate; (5) any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under this title; …”  11 U.S.C. § 362(a).

Since a mechanics lien almost always qualifies as “a lien against property of the estate”, a cursory examination of the Bankruptcy Code leads to the conclusion that mechanics liens, and actions to record or otherwise perfect mechanics liens, are strictly prohibited after the filing of a bankruptcy case.  Claimants are concerned they may miss a deadline under state law to perfect a lien that would apply but for the bankruptcy.  However, mechanics lien claimants may be entitled to an “exception” from the automatic stay upon taking proper actions both inside and outside the bankruptcy case.  This exception permits significant relief for such a creditor:

“… to perfect, or to maintain or continue the perfection of, an interest in property to the extent that the trustee’s rights and powers are subject to such perfection under Section 546(b) [of the Bankruptcy Code] … ”.  11 U.S.C. §Section 362(b)(3).

Despite one of the most important safeguards created for debtors in bankruptcy — the automatic stay — claimants may continue to record and perfect a mechanics lien even after the bankruptcy has been filed notwithstanding the automatic stay.  This is true as long as the lien or work giving rise to the lien arose prior to the filing of the bankruptcy petition, which is the case in the vast majority of mechanics lien claims in a bankruptcy situation. While mechanics lien law varies significantly between states, mechanics liens generally arise either when labor and/or materials were supplied by the claimant, or when work on the project first commenced.  Both of these dates are generally well before the lien is perfected (filed). This means that, if the claimant, whether a general or subcontractor, provided work or supplied material prior to the bankruptcy filing, the lien is allowed to be perfected after the bankruptcy filing, even with the broad automatic stay.  Thus, the claimant’s rights will generally survive a bankruptcy case and will not be discharged.

It is important to note that the exception permitting a claimant to perfect the lien does not go so far as to allow actions to enforce the lien.  Nonetheless, the claimant’s rights can still be protected since the bankruptcy filing will normally toll any deadline to enforce a lien during the bankruptcy proceeding, so that the lien can be enforced after the bankruptcy discharges most of the other claims.  Many practitioners will simply seek a comfort order or a stipulation approved by the Bankruptcy Court permitting the claimant to proceed with its lien enforcement rights despite the bankruptcy.  Mechanics lien claimants therefore have the ability to both 1) be perfected after the automatic stay, and 2) emerge “whole” after the bankruptcy process concludes.  This exception places a mechanics lien claimant in a much better position to recover the money owed in (or after) a bankruptcy proceeding.   Nossaman lawyers can assist both debtors and creditors in this and other types of bankruptcy proceedings.

via Bankruptcy by the developer/owner: mechanics lien rights may still prevail! – Lexology.

Subcontractor Claims: What can you do once your General Contractor Files Bankruptcy?

Vicki R. Harding – Pepper Hamilton LLP – September 30, 2014

Branch Banking & Trust Co. v Construction Supervision Services, Inc. (In re Construction Supervision Services, Inc.), 753 F.3d 124 (4th Cir. 2014) –

After a general contractor filed bankruptcy, several of its subcontractors requested clarification from the court about whether they could file notices post-petition to perfect liens for construction materials and equipment supplied pre-petition. The bankruptcy court agreed that they could; the district court affirmed; and a lender appealed to the 4th Circuit.

Generally if a lien is unperfected on the date that a bankruptcy petition is filed, (1) the automatic stay prevents the creditor from perfecting post-petition, and (2) the unperfected lien can be avoided using the trustee’s “strong arm” powers.

However, Section 362(b)(3) of the Bankruptcy Code contains an exception from the automatic stay for “any act to perfect, or to maintain or continue the perfection of, an interest in property to the extent that the trustee’s rights and powers are subject to such perfection under section limits 546(b) …” (emphasis added). Section 546(b) limits a trustee’s powers when applicable laws permit perfection of “an interest in property to be effective against an entity that acquires rights in such property before the date of perfection” (emphasis added).

The court and the parties agreed that applicable law allowed retroactive perfection, so the appeal turned on whether the subcontractors had “an interest in property” on the bankruptcy petition date. Since “interest in property” is not defined in the Bankruptcy Code, the 4th Circuit looked to the “plain language” and quoted definitions from Black’s Law Dictionary, American Heritage Dictionary, and Oxford English Dictionary online. The court noted that it held in prior opinions that “interests” are broader than just “liens” and commented that other circuits have also drawn this distinction. In its view, this made sense because a lien is a mechanism for enforcement of pre-existing rights.

In the context of the construction liens, state law provided remedies to subcontractors who furnished services and materials in connection with an improvement of real property, including the right to obtain a lien on funds owed to the general contractor arising from the improvements. As provided in the statute, the “liens upon funds granted under this section shall secure amounts earned by the lien claimant as a result of having furnished labor, materials, or rental equipment at the site of the improvement under the contract to improve real property, … whether or not such amounts are due and whether or not performance or delivery is complete.”

Under the statute, the lien is granted by giving notice of the claim of lien and is effective upon receipt of the notice. However, a subcontractor is entitled to a lien upon delivery of the materials and equipment. As described in a state law treatise, the supplier has an inchoate lien that arises at the commencement of work that is preserved by providing notice. Upon perfection, the lien rights vest and relate back to the commencement of work.

There had been several previous bankruptcy court decisions that interpreted the state’s statute to mean that the notice of claim of lien both created the interest as well as perfecting the lien. This meant that subcontractors who had not given notice would not have an interest at the time the bankruptcy was filed, and thus would not have the benefit of Section 546(b) and the related exception from the automatic stay.

The statute was amended by the state legislature in response to these decisions to clarify that the intent was that rights arose upon the delivery of materials, as opposed to only later when the notice is sent. Although the amendment was not applicable to the claims under consideration by the 4thCircuit, it viewed this as relevant for interpreting the intended meaning of the statute.

In the end the 4th Circuit concluded that the subcontractors became entitled to a lien as soon as they furnished materials. Since the subcontractors delivered materials prior to the bankruptcy filing, they had an “interest in property” as of the petition date. Since the state statute provided that once the lien was perfected by giving notice it related back to the commencement of work, the subcontractor claims came within Section 946(b) and the automatic stay exception. The claims could not be avoided using the strong arm powers and the subcontractors could provide the required notice of claim of lien post-petition based on the exception from the automatic stay.

There are many state specific variations for construction liens. However, there is a common theme in many of the statutes that the priority of liens relates back to the commencement of work. Be aware that in these states all is not lost when the general contractor files bankruptcy, and subcontractors may be able to perfect their construction liens post-petition.

via Subcontractor claims: what can you do once your general contractor files bankruptcy? – Lexology.

Liens With Intentionally Incorrect Information May Still Be Enforceable

Adam L. Gill and Jeffrey L. Hamera – Duane Morris – September 8, 2014

Generally, lien waivers that contain fraudulent information are not enforceable. However, not all intentionally misleading statements are fraudulent. The crux of the issue is whether a lien waiver simply states that the subcontractor has been paid a specific amount or whether the subcontractor claims that the work completed is worth the amount stated in the waiver.

The Illinois Appellate Court addressed this issue briefly in Casablanca Lofts, LLC v. Blauvise (2014 Ill. App. Unpub. Lexis 1377 (1st Dist. June 26, 2014)).  In arbitration, prior to litigation, the developer/owner of a condominium project, Casablanca Loft, discovered that the electrical subcontractor had submitted three lien waivers totaling $135,000 and had been paid $135,000.  Id. at ¶6.  However, the electrical subcontractor had only provided material and labor with a value of $19,000.  Id.  Casablanca Lofts then filed a complaint against the electrical subcontractor alleging that it fraudulent misrepresented the amount owed for labor and materials.  Id. at ¶¶5, 7.  The trial court found that the electrical subcontractor and its owner did not make false statements in the lien waivers, because “the mechanics lien waivers don’t say anything about the amount of work done….”  Id.  at ¶12.  The Illinois Appellate Court affirmed the trial court’s ruling without comment on the issue.

This case provides a sobering reminder to owners and general contractors.  Obtaining lien waivers is not merely a clerical requirement.  Lien waivers are a critical element of the construction payment process.  The lien waivers provided by the Casablanca Lofts subcontractor did not provide a statement regarding the value of the work actually performed or provide a percentage of work completed.  Owners and general contractors should require that subcontractors provide lien waivers prior to disbursing funds.  Owners, or their agents, and general contractors should examine lien waivers to verify that the amount stated in the lien waivers conform to the work actually performed.  Finally, in order to avoid overpaying subcontractors, lien waivers should indicate the value or percentage of work actually performed.

via Liens With Intentionally Incorrect Information May Still Be Enforceable – Real Estate and Construction – United States.

News for Contractors and Construction Lenders in Arizona and Nevada – The Contractors’ Lien May Trump the Bank’s

Roy Bash, G. Edgar James and Scott C. Ryan – Polsinelli – July 10, 2014

In addition to an arid climate and plenty of sunshine, Arizona and Nevada have something more to offer contractors: a potentially advantageous position over lenders when a project goes bad.

When a project derails and everyone involved is looking to be made whole, banks typically have protected their first-place position even if the contractor commenced with construction prior to the bank making its loan. The bank achieves this by requiring the contractor to have executed a subordination agreement or by claiming its first-place position via the theory of equitable subrogation. Subordination agreements are typically enforceable, and equitable subrogation is the rule of law in much of the country. However in two separate rulings in Arizona (view here and here), the courts held that mechanic’s liens have priority of all other claims attaching after the commencement of construction. In Nevada, state law prohibits a bank’s jumping to the front of the line, going so far as to state that even if such an agreement to subordinate is made, it is “contrary to public policy and is void and unenforceable.”

Determining the order of repayment is an important consideration when entering into any construction deal. After a project derails this issue is complex, and typically involves a significant number of parties with none wanting to concede their position. Furthermore, as demonstrated above, some parts of the country operate under state laws that are counter to what is considered standard business practice elsewhere.

via Polsinelli.

Mechanic’s Liens: Does my Work Qualify?

Joshua A. Bennett – May 16, 2014

An unpaid contractor has many choices when the promised check doesn’t arrive. One of those choices is whether or not to file a mechanic’s lien. A mechanic’s lien is a statutory mortgage to secure payment of work performed or materials furnished in the erection, alteration, or repair of a building or structure upon privately-held real estate.

However, when deciding whether or not to file a mechanic’s lien, you may ask yourself whether your work qualifies. S.C. Code Ann. § 29-5-10 tells us that [a] person to whom a debt is due for labor performed or furnished or for materials furnished and actually used in the erection, alteration, or repair of a building or structure upon real estate . . . shall have a lien upon the building or structure . . . . But what qualifies as “labor” under the statute? It is easy to imagine that a framer would be entitled to a mechanic’s lien, but what about a site work contractor or an architect?

The mechanic’s lien statute provides some limited guidance on this issue. S.C. Code Ann. § 29-5-10 states the following:

 As used in this section, labor performed or furnished in the erection, alteration, or repair of any building or structure upon any real estate includes the preparation of plans, specifications, and design drawings and the work of making the real estate suitable as a site for the building or structure. The work is considered to include, but not be limited to, the grading, bulldozing, leveling, excavating, and filling of land (including the furnishing of fill soil), the grading and paving of curbs and sidewalks and all asphalt paving, the construction of ditches and other drainage facilities, and the laying of pipes and conduits for water, gas, electric, sewage, and drainage purposes, and the disposal of any construction and demolition debris, as defined in Section 44-96-40(6), including final disposal by a construction and demolition landfill. Any private security guard services provided by any person at the site of the building or structure during its erection, alteration, or repair is considered to be labor performed or furnished within the meaning of this section.

S.C. Code Ann. § 29-5-10.

As you can see, the statute sets forth specific scopes of work that would qualify as “labor” under the mechanic’s lien statute. However, it is apparent that this section of the statute merely provides examples and is not an exclusive list of work that qualifies as “labor performed or furnished in the erection, alteration, or repair of any building or structure upon any real estate.” Thus, although we don’t receive complete clarity on the issue, the statute is very helpful to some specific contractors.

via Mechanic’s liens: does my work qualify? – Lexology.