Unfortunately, bankruptcy is an all too common occurrence in today’s economy.  Companies which have been stalwarts of the construction industry are falling like dominos and entering into the protective waters of bankruptcy.  What effect does a bankruptcy filing have on your ability to file or perfect a lien?  A lot.

Until very recently, the general practice in North Carolina was that even if the general contractor was in bankruptcy, a subcontractor could still proceed with a lien on real property to the extent funds remained due and owing from the property owner.  It was common practice for subcontractors to serve a notice of claim of lien on funds and claim of lien on real property to the property owner even if the general contractor had filed bankruptcy, and no bankruptcy court approval was needed.

Recently, however, three cases in the Eastern District of North Carolina Bankruptcy Court (which extends from Raleigh to the Coast) have ended this practice and called into doubt whether any lien right can be preserved after the general contractor files bankruptcy.  The three cases are In re Shearin Family Investments, LLC, Case No. 08-07082080-JRL (Bankr. EDNC April 17, 2009); In re Harrelson Utilities, Inc., Case No. 09-025815-8-ATS (Bankr. EDNC July 30, 2009); and In re Mammoth Grading, Inc., Case No. 09-01286-8-ATS (Bankr. EDNC July 31, 2009).

In these cases, the Courts have held that no lien arises until it is perfected; therefore, if the notice of a lien on funds is not served prior to the bankruptcy filing, it is disallowed and the subcontractor (or supplier) will be treated as an unsecured creditor in the bankruptcy.  The Harrelson and Mammoth cases are on appeal, and the issue currently only concerns the Eastern District, although the Middle and Western Districts would likely treat those opinions with deference.

If these decisions stand, and become the new law of the land, then contractors and material suppliers must remain extra vigilant about account receivables and in pursuing lien rights if any sign of financial insecurity is suspected in the general contractor.

A detailed discussion of the facts of these three cases and each of their legal holdings can be found in article “To Assert or Not to Assert? Can Contractors Afford to Wait to assert Their Lien Rights”  (by Wayne Maiorano, Amos Priester, and Anna Osterhout), which first appeared in the October 2009 issue of the North Carolina Bar Association‘s  Construction Law Section newsletter, The Change Order.