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Texas Construction Law Blog For Subcontractors & Suppliers

Weathering the Storm of an Owner or General Contractor Bankruptcy

Posted in Bankruptcy

Bankruptcy court is often the “court of bad news” for creditors.  In particular, subcontractors and suppliers face unique challenges when a customer files for bankruptcy.  But they also have unique rights that may elevate their claims.  Failing to act quickly and correctly on those rights can have significant consequences. 

 Do Not Violate The Automatic Stay

As soon as a debtor files bankruptcy, Chapter 7 or 11, the “automatic stay” immediately protects the debtor from its creditors.  The “automatic stay” is a court order that applies immediately after the debtor files for bankruptcy and prevents the debtor’s creditors from taking certain collection actions.  For example, the stay prohibits a subcontractor from commencing or continuing any activity to collect on debts that a general contractor or owner owed for labor or materials furnished before the general contractor or owner filed for bankruptcy.  The stay also suspends any lawsuit or collection action that was pending. 

Violating the stay is serious and can result in sanctions.  However, there are some activities that are allowed under certain circumstances that may bolster your position.      

Lien

The priority of your claim is vitally important in bankruptcy.  Creditors are not treated equally.  Unsecured creditors generally are the lowest priority and do not fare well in bankruptcy. 

Subs and suppliers should use their lien rights to avoid the fate of an unsecured creditor.  If the project owner has filed for bankruptcy, then perfecting a lien may provide the subcontractor or supplier with a secured claim in the bankruptcy.  If the general contractor files for bankruptcy, then the lien filed against the owner’s property may provide a means for recovery outside of the general contractor’s bankruptcy.

Suppliers and subcontractors should assess their mechanic’s lien rights while oil and gas field services providers should assess their mineral lien rights.  Perfecting such liens (e.g., recording a lien affidavit) should not violate the stay if the lien’s inception relates back, as it does in Texas, to the pre-petition period when the labor and/or materials were furnished. Each state is different on this point.  In some states the liens may not arise until a later date.  If the lien’s inception date is after the bankruptcy filing, then you will not be able to perfect your lien without leave of court.

A lien claimant should not, under any circumstances and regardless of the lien inception date, attempt to enforce a lien (e.g., filing or continuing to prosecute a lawsuit) without receiving leave from the bankruptcy court to do so.  Enforcement is not covered by the exception to the automatic stay that allows perfection (under certain circumstances) and may result in sanctions.

 Reclamation

Suppliers should also consider their “reclamation” claims if their customer files for bankruptcy.  When an unpaid seller of goods discovers that the buyer was insolvent at the time of delivery of the goods, the seller may reclaim the goods upon demand made within ten (10) days after the receipt by the buyer of the goods.  If the tenth day of this period is after the debtor filed for bankruptcy, then the bankruptcy code extends the reclamation period for twenty days after the buyer receives the goods. 

Assuming the demand is properly made and the buyer was insolvent when the goods were received, the seller may receive an administrative claim in bankruptcy for the reclamation amount. This administrative claim is not secured, but it has a higher priority than general unsecured claims.

The Bottom Line

Properly protecting your lien and reclamation rights in a customer’s bankruptcy can significantly reduce your loss.  Before undertaking these efforts, it would be wise to retain counsel to avoid running afoul of the automatic stay and to maximize your rights.