Once a party files for bankruptcy protection, all of the creditors have the same question: Will I get paid? In order to determine the likelihood of a creditor receiving payment from a bankrupt debtor, one of the essential factors to consider is whether the debt is secured or unsecured.

Secured debts

Generally, unsecured debt is wiped out by a bankruptcy filing, but if an unsecured creditor is lucky enough to get any money at all through a Chapter 13 payment plan it is usually only pennies on the dollar.

Secured debts, however, generally remain intact through the bankruptcy if the debtor retains the property that serves as collateral for the extension of credit. Bankruptcy does not relieve a debtor of the obligation to pay secured debt if he wishes to retain the underlying property.

So, the question is whether a mechanics lien secures debt through bankruptcy. And this, finally, is a question with a relatively straightforward answer: Yes, a mechanics lien is secured debt. This is set forth by the Bankruptcy Code in 11 U.S.C. Sec. 506(a)(1), which states in part:

"An allowed claim of a creditor secured by a lien on property in which the estate has an interest, or that is subject to setoff under section 553 of this title, is a secured claim ..."

Since a secured claim survives the bankruptcy, a mechanics lien holder is a good position. However, since this is bankruptcy, and bankruptcy law is complicated, there is a unique wrinkle to the situation. A mechanics lien will remain enforceable after the bankruptcy adjudication — but the debt giving rise to the lien may be discharged.

If this seems impossible, or at least counterintuitive, remember that a mechanics lien is a right against property (which is why it is secured and survives the bankruptcy proceeding). So, the debtor's personal obligation to pay may be extinguished by his bankruptcy, but the property's obligation is not.

Unfortunately, though, this is not an iron-clad guarantee of payment. Generally, and absent specific rules providing differently, liens follow the "first-in-time, first-in-right" rule. So, if the property is mortgaged, the mechanics lien holder will usually only be paid after the mortgage is satisfied. If the property is overmortgaged (underwater), then, the mechanics lien holder may not be paid, despite the fact that he holds secured debt.

That being said, having a debt secured by a mechanics lien greatly increases the probability that a construction company will be paid in the event the property owner declares bankruptcy.

Mechanics liens and bankruptcy lien-stripping

A mechanics lien is a powerful tool even when confronted with a bankruptcy petition. This puts a mechanics lien holder in a generally enviable position when attempting to recover a debt from the bankrupt party.

However, a bankrupt debtor can avoid certain types of liens in a process known as "lien-stripping," even though these liens are "secured" by the debtor's property. This would be an unfortunate outcome for a creditor who thought that having a secured lien would guarantee payment.

Despite liens normally surviving bankruptcy unaffected by the debtor's discharge, some liens are "strip-able" and therefore avoidable by the debtor if the debtor takes specific affirmative action. So, what liens can be avoided, and should a mechanics lien holder be worried?

The liens generally avoidable are those attached to assets a debtor is entitled to claim as exempt, and to the extent that the lien impairs the value of the exemption. A lien impairs the value of the exemption if there is not enough equity in the liened asset to cover the non-avoidable liens, the exemption and the avoidable lien.

At first look, this appears to create a problem for a residential mechanics lien claimant, as the family home can be exempt from bankruptcy proceedings. Luckily for the lien claimant, though, a mechanics lien holder does not have to make the calculation of whether the lien impairs the value of an exemption.

The final requirement for a lien to be avoidable is that the lien must be either a judicial lien, or a nonpossessory nonpurchase money security interest. Mechanics liens are statutory liens, and as such are unavoidable in a bankruptcy proceeding and will survive the bankruptcy unaffected.

These are just a couple of the reasons that mechanics liens position construction companies well to recover, even in the face of another party's bankruptcy.