Bankruptcy in Construction: An Overview

With what appears to be an upcoming downturn in the economy, I anticipate an increase in bankruptcy filings. Those likely will not materialize until sometime in 2023 or into 2024, but keep in mind many of those projects are getting ready to start now. So, protecting your rights now ensures when that day comes, you are prepared.

"The customer filed bankruptcy." These are words no credit professionals want to hear. Before you throw your customer's account into the trash, know that not all is lost. If you have anticipated the possibility of a bankruptcy and taken steps to preserve your mechanic's lien and payment bond rights, it is very likely you will still collect the full balance you are owed.

When your customer files bankruptcy, your chances to collect anything from your customer is extremely limited. The moment your customer files bankruptcy you are automatically prevented from taking any action to try and collect from your customer. This is known as the "automatic stay" and it applies the second your customer files for bankruptcy. If your customer has assets, the bankruptcy court may order them sold and the proceeds distributed to creditors. This too is somewhat rare and assets are usually extremely limited.

While the automatic stay applies to your customer, it does not apply to others, like the owner of the project (assuming the owner is not also your customer) or the payment bond surety. This is why you should always be serving preliminary notices. If you have preserved your mechanic's lien rights by serving your preliminary notice, you can still record your mechanic's lien and foreclose on your mechanic's lien without violating the automatic stay. This is because the mechanic's 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 mechanic's lien rights and filing your lawsuit to foreclose on your mechanic's lien in a timely manner when your customer is in bankruptcy will be the difference between getting paid in full, or not at all.

On public and federal projects, you also can pursue the Miller Act or Little Miller Act payment bond surety without violating the stay. This is because, like the mechanic's lien, the payment bond issued by the surety is not part of the bankruptcy and therefore not subject to the automatic stay. Like with your mechanic's lien, the key is to ensure you have preserved your rights by meeting your notice prerequisites and timely filing your claim.

While a bankruptcy filing by your customer makes collecting the balance owed on their account more difficult, if you have preserved your mechanic's lien and payment bond rights, you have significantly increased your chances of collecting most, if not all, of your customer's account.

-Michael Murray, Esq., associate attorney, Lanak & Hanna, P.C.