When Someone Files Bankruptcy

Securing Your Mechanics’ Lien Rights
Bankruptcy…the word no credit department wants to hear. Before you throw your customer’s account into the uncollectible pile, know that not all is lost when a customer, or even the project owner, files for bankruptcy. If you take the steps to preserve your mechanics’ lien rights, you may still be able to collect the balance owed on the account, despite the bankruptcy filing.

When Your Customer Files For Bankruptcy
When your customer files for bankruptcy the chance you will collect the full balance owed on their account from them is extremely limited. This is not helped by the fact that the moment your customer files for bankruptcy, the bankruptcy code applies an automatic stay on any and all collection activities. 11 U.S.C 362 prohibits you from taking any steps to try and collect the balance owed to you by your customer. However, this stay does not apply to your mechanics’ lien rights against the project where your labor and/or materials were provided. This assumes the owner of the project is not also your customer who is in bankruptcy. If you have preserved your mechanics’ lien rights your chances of collecting drastically increase. This is because your customer’s bankruptcy does not prevent you from recording and foreclosing on your mechanics’ lien even if your customer is in bankruptcy.

The mechanics’ lien is recorded against the property where the project is located, which is not part of the customer’s bankruptcy, and therefore not included in the automatic stay. Properly perfecting your mechanics lien rights when your customer ultimately files for bankruptcy may easily be the difference between getting paid in full, or not at all.

When The Owner Files For Bankruptcy
When the owner of the project files for bankruptcy the automatic stay under 11 U.S.C. 362 immediately goes into effect. The stay now applies to the property of the owner, including the property where the project is located. The good news is 11 U.S.C. 362(b)(3) provides a specific exception to the automatic stay rule that allows a mechanics lien claimant to record its mechanics’ lien against the property without violating the automatic stay. The mechanic’s lien claimant must then file a notice of lien in the bankruptcy proceedings in order to preserve its mechanics’ lien rights.

The automatic stay does preclude the mechanics’ lien claimant from filing its lawsuit to foreclose on the mechanics’ lien, which normally must be done within 90 days after the mechanics’ lien is recorded. To avoid a mechanics’ lien claimant’s time running and their mechanics lien becoming stale, the Courts have held that the period of time the automatic stay is in effect tolls the applicable statute of limitations period to foreclose on the mechanics’ lien. The recent case of Pioneer Const., Inc. v. Global Inv. Corp. (2011) 202 161 provides a perfect example.

On April 17, 2008, after not being paid, Pioneer recorded its mechanics’ lien. On June 13, 2008, the owner filed for bankruptcy. On January 29, 2009, Pioneer recorded a second mechanics lien and thereafter a notice perfecting its mechanics lien in the owner’s bankruptcy proceedings. On August 25, 2009, the property that the mechanics’ lien was recorded against was sold through a trustee’s sale. On November 12, 2009, Pioneer filed its lawsuit to foreclose on both its mechanics’ liens.

The owner argued Pioneer’s mechanics’ liens were unenforceable because more than 90 days had passed from when they were recorded to when Pioneer filed its lawsuit to foreclose. The Trial Court agreed and Pioneer appealed and the Court of Appeal. The Court of Appeal held the mechanics’ lien recorded by Pioneer on January 29, 2009, after the owner was in bankruptcy, was timely foreclosed on. This is because the 90 days to foreclose was tolled while the automatic stay was in effect. Since Pioneer’s mechanics’ lien was recorded while the owner was in bankruptcy, none of the 90 days Pioneer had to foreclose on its mechanics’ lien had run prior to the bankruptcy filing. Once the property was sold at the trustee’s sale on August 25, 2009, and thus no longer part of the bankruptcy and not subject to the automatic stay, the 90 days to foreclose began to run. Pioneer’s lawsuit to foreclose on its mechanics lien, filed on November 12, 2009, was within 90 days and therefore timely.

Although the Court does not address it, Pioneer’s original mechanics’ lien recorded April 17, 2008, is likely unenforceable. 56 days had passed between when it was recorded and June 13, 2008, the date the owner filed for bankruptcy. The automatic stay then took effect tolling the statute of limitations but leaving only 34 days to file the mechanics’ lien foreclosure lawsuit once the property was removed from the bankruptcy on August 25, 2009. Since Pioneer’s lawsuit was not filed within 34 days of August 25, 2009, the date the property was sold, April 17, 2008, mechanics’ lien was likely unenforceable.

While a bankruptcy filing by your customer or even the owner makes collecting the balance owed on the account more difficult, if you have preserved your mechanics lien rights, you have significantly increased your chances of collecting some, if not all, of the customer’s account.

– Michael Murray at [email protected]
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