In the face of an unstable economy, it is essential that those in the construction industry understand the implications of an owner, general contractor, or subcontractor’s bankruptcy filing and take appropriate action to reduce risk. The first step in protecting your interests is to obtain general knowledge of creditors’ rights and remedies once a debtor files for bankruptcy.
Bankruptcy protection is governed by federal law. Generally, it is a structured process in which a debtor can obtain relief from hounding creditors and creditors can obtain a distribution of a debtor’s liquid assets. There are several chapters of the Bankruptcy Code in which a debtor may proceed; however, the most common within the construction industry are Chapter 7 liquidation and Chapter 11 reorganization.
Chapter 7 Bankruptcy
In a Chapter 7 bankruptcy, the debtor must deliver all property not protected by its state’s exemption statutes or the federal exemption statutes to the bankruptcy trustee. It is the trustee’s responsibility to liquidate all non-exempt property for the benefit of the creditors. Secured creditors are given top priority and general unsecured creditors are at the bottom of the hierarchy of the creditors. Chapter 7 bankruptcies are most often used by individuals.
Chapter 11 Bankruptcy
In a Chapter 11 bankruptcy, the debtor continues to operate a business under the supervision of a bankruptcy court and remains in possession of its assets and business. After the debtor files a bankruptcy petition, the debtor then files a plan of reorganization, which must be approved by the bankruptcy court. A committee of creditors will have an opportunity to object to the plan or file its own plan of reorganization. Ultimately, if a plan is not approved, the bankruptcy court has the authority to convert the case to Chapter 7 liquidation and proceed to liquidate the non-exempt assets and distribute the proceeds to the creditors. A creditor must file a proof a claim to participate in any distribution. However, if a plan is approved, it supersedes any previous contract between the debtor and its creditors.
The filing of a bankruptcy petition under any chapter imposes the automatic stay provisions of the Bankruptcy Code. Under the automatic stay, all collection efforts and foreclosure actions must stop and any action to satisfy a claim must follow the guidelines established by the Bankruptcy Code. Thus, if an owner or general contractor files for bankruptcy, the automatic stay protects the debtor from third parties actions against the bankruptcy estate. However, the Bankruptcy code does allow a creditor to “act to perfect, or to maintain or continue the perfection of, an interest in property.” This means a creditor is permitted to perfect their lien rights post-petition pursuant to Chapter 53 the Texas Property Code. However, the automatic stay still prevents a creditor from bringing suit to foreclose on its lien during the pendency of the bankruptcy. After termination of the stay, a lien claimant will have thirty days to file suit.
So, what should you do if an owner, general contractor, or subcontractor owes you money and files for bankruptcy? The answer is simple: stop collection efforts and consult with an experienced attorney immediately. Significant problems arise once a party to a construction contract files for bankruptcy and creditors risk losing their right to payment. In certain situations, the Bankruptcy Code allows a debtor to assume or reject a construction contract; conversely, a creditor must first obtain relief from the automatic stay before terminating a construction contract. Thus, for example, a contractor cannot simply walk off the job without obtaining approval from the bankruptcy court without the risk breaching the contract. It is also important to note that contract clauses that provide automatic termination in the event of a bankruptcy filing are generally unenforceable.
Bankruptcy within the construction context can pose unique challenges. Claims deadlines are strict and failure to meet them can jeopardize your rights as a creditor. For these reasons, when a party to an ongoing construction project becomes insolvent and you anticipate a bankruptcy filing, you should consult an attorney immediately.
If you have a related legal matter and would like to find out how The Cromeens Law Firm, PLLC, can assist you, contact us today.
This article is intended as a general educational overview of the subject matter and is not intended to be a comprehensive survey of recent jurisprudence, nor a substitute for legal advice for a specific legal matter. If you have a legal issue, please consult an attorney.