They Filed Chapter 11, You File a Lien: Surviving Owner Bankruptcy in Construction

You’re halfway through a job, and the owner goes belly-up. No payments, just a bankruptcy notice and a bunch of unpaid invoices. Hopefully, this doesn’t sound familiar to you. But with the ever-evolving trade war this year, it wouldn’t hurt to have a plan (no pun intended) for owner bankruptcy. In this week’s blog post, I cover steps contractors should consider in the event of owner bankruptcies, drawing lessons from the several construction bankruptcies I have worked on during my career. Next week, I will tackle contractor bankruptcies from an owner’s perspective.

Step 1: Chill Out — You’re Now in Bankruptcy Court

Once the owner files, the bankruptcy code’s automatic stay halts any legal action against the debtor (the owner) until the bankruptcy court lifts the stay. This means no lawsuits, no demands, no contract terminations, no walking off the job. Violating the stay can result in serious penalties. So slow down, take a deep breath, and get legal advice.

Step 2: Perfect Your Lien

The automatic stay does not stop you from filing a mechanic’s lien for pre-petition work (work performed before the owner filed for bankruptcy). Filing your lien elevates your claim from unsecured to secured, giving you more leverage in the bankruptcy proceedings—especially if the project property is being sold or reorganized as part of the bankruptcy estate. Mechanic’s lien deadlines do not stop and are not stayed or extended by bankruptcy filings. Do not wait to file your lien. But do not try to foreclose without a green light from the bankruptcy court.

Step 3: Administrative Priority and Reclamation Claims

If you delivered goods to the bankrupt owner, you may have the following avenues to recover the goods or get paid for them:

• 503(b)(9) Claims: Priority for Goods Delivered within 20 Days

  You can file a priority claim for the value of goods you delivered to the debtor in the 20 days before the bankruptcy filing. This claim is treated as an administrative expense, and gets priority over other kinds of creditors (and are often paid in full). The bankruptcy court will typically set the deadline to file a 503(b)(9) claim.

• 546(c) Reclamation Claims: Getting your Goods Back

  You may reclaim goods delivered to the debtor in the 45 days before the bankruptcy if they’re still in the debtor’s possession and have not been used. But you need to act fast—you have 45 days from the delivery date or 20 days after the bankruptcy filing to send a written demand for reclamation.

Step 4: Argue that You’re Essential

If you’re the general contractor or a major trade contractor or subcontractor, you may qualify as a “critical vendor.” If halting your work would seriously jeopardize the project or delay a valuable sale or refinancing, the bankruptcy court may approve payments to you ahead of other creditors. This is an opportunity to negotiate more favorable terms or obtain assurance of future payment—but only if you act quickly—and only if the Court approves a critical vendor program.

Step 5: Don’t Walk Off….Yet

If your contract is “executory” (i.e., both sides still have obligations to perform), the debtor must either assume or reject it. Until the debtor makes a decision, you may be stuck in a legal limbo—performing without getting paid (although work performed after the bankruptcy is filed is given administrative priority). If the debtor assumes your contract, they have to cure past defaults (e.g., get you paid) and continue performing (e.g., keep paying you). If the debtor rejects your contract, you can file a claim in the bankruptcy court. In any event, do not walk off the project before talking to your lawyer.

If you found this post helpful, check out my post on Contractor bankruptcies from the Owner’s perspective.