Contractors and Bankruptcy: Getting the Piper Paid

For this week’s Guest Post Friday, Musings welcomes Jennifer Watt (@jenniferlwatt).  Jennifer is an Indiana litigator with experience litigating construction disputes, representing sureties and contractors following project defaults and advising on bankruptcy matters.  Jennifer, along with her colleague, Ryan Bowers, maintains Law under Construction, a blog built for Indiana construction professionals to monitor legal news and developments.  Jennifer is an attorney at Kroger, Gardis & Regas, LLP in Indianapolis, Indiana, a full service law firm founded in 1937.

First of all, I’d like to thank Chris for inviting me to be a guest blogger here at Construction Law Musings.  I’d also like to wish Musings a very happy 2^nd birthday!  Congratulations on two very successful years!

Like most, each day I review the headlines with my morning coffee.  Economic headlines usually catch my attention first…ok, unless there is some really juicy celebrity gossip.  Lately it appears that the economic news is encouraging.  But over the past two years, the construction industry has been particularly affected by the economic recession.  There have been numerous bankruptcy filings by contractors throughout the country in the past couple of years.  If you have not worked on a project affected by a bankruptcy filing of an owner, general contractor, subcontractor or supplier…count your blessings…but don’t hold your breath, because odds are one day you probably will.  If you have been affected you know that a lot of questions arise about if, when and how much you will be paid for work you performed or materials you supplied.  Any delay in getting paid in turn puts your company at risk.  So what do you do when someone on your project has filed for bankruptcy?

This post is primarily for contractors, subs and suppliers to use as a starting point when faced with non-payment from a bankrupt entity on a project.  It is meant to provide a general overview of basic strategies.  Every situation is different and the statutory laws governing these areas of law are complicated.  Therefore, please consult an attorney with experience in both construction and bankruptcy law to determine the best strategy to use for your situation.

They Filed Bankruptcy – What Just Happened?

If a company on your project has filed bankruptcy an automatic stay is imposed by the Bankruptcy Code.  Basically, the automatic stay stops all activity regarding a Debtor’s estate.  Before taking any action against the Debtor’s estate to collect debts or enforce contract rights or obligations, you must get permission from the Bankruptcy Court.

The Good News:  It’s An Executory Contract

Construction contracts are “executory” contracts.  The Bankruptcy Code allows a trustee or a debtor-in-possession (the term used when a company that has filed bankruptcy continues to operate its business under bankruptcy court supervision) to either assume or reject the contract.  The debtor-in-possession has until the confirmation of a plan of reorganization (the plan that explains how the debtor plans to reorganize and operate going forward) to assume or reject executory contracts.  However, this may be many months or years away.  Fortunately, the other party to the contract may request the court to make the debtor decide sooner.

The Really Good News:  If Assumed, All Defaults Must be Cured

If the debtor decides to assume the contract, it must cure all defaults.  This includes paying any past due payments owed to the subs and suppliers and to continue with its performance on the contract.  Therefore, you may be paid in full shortly after the contract is assumed and continue working and getting paid on the project.

The Bad News:  If Rejected, You Receive a General Unsecured Claim

If the debtor decides to reject the contract, the bankruptcy estate loses all of the benefits of the contract.  Any past due payment owed to your company become a general unsecured claim (provided you have not perfected your lien rights).  As a general unsecured claim, you will likely only get a percentage, if any at all, of the amount owed to you and only after the plan has been confirmed.

It’s Not All Bad News: Strategies

1.         Perfect Your Lien Rights. It is essential that lien rights are protected and perfected whether facing a bankruptcy situation or not.  In bankruptcy, failure to perfect your lien rights may allow the trustee or Debtor to avoid your unperfected lien and security interest and will reduce the priority of your claim to a general unsecured claim.  Every state grants lien rights to companies and individuals who contributed to the improvement of a project.  Sections 546(b)(1) – (2) of the Bankruptcy Code provide a means to perfect and maintain your lien rights after the filing of a bankruptcy petition if under your state law you could have perfected and maintained the mechanic’s lien.  However, because of the automatic stay you cannot take any post-petition action to enforce the lien rights, unless you first obtain permission from the court.  Every state’s lien requirements and time limitations vary so it is essential you hire an attorney to assist you with this process.

2.         File a Claim with the Surety. If there is a surety bond posted by the Debtor on the project you should file a claim with the surety.  Make sure to get a copy of the Bond and follow the process outlined in the Bond exactly to file a claim.  Claims against the surety are not subject to the automatic stay.  Therefore, assuming you have a legitimate and timely claim, your claim may be paid in full by the surety.  Additionally, if the project is assumed by the Debtor the surety will be in a position to monitor the project, possibly impose funds control and ensure that project funds, in the case of public projects, are used for the benefit of the subs and suppliers.

3.         File Your Claim With Bankruptcy Court. A deadline will be imposed for the filing of claims against the estate.  If you are owed money from the contractor you should file a claim with the estate detailing the amounts owed, for what and under what contract.

4.         Attend the Creditor’s Meeting. Shortly after the bankruptcy filing the court will set a date for the creditor’s meeting.  At this meeting a representative of the company will be placed under oath.  The trustee and creditors will then have an opportunity to ask the Debtor about the business, potential sources of assets, the extent of liabilities and the status of various projects.  This is an opportunity to get valuable information regarding your project and gauge the likelihood the contractor will continue working on the project.  As a creditor you will also have the opportunity to ask questions.  This is not a forum to air grievances, rather a time to gather information.

As always, Jennifer and I welcome your comments below.  Please subscribe to keep up with this and other Guest Post Fridays at Construction Law Musings.