Unfortunately, the failure rate of businesses in the construction industry is high. This means that the bankruptcy or pending bankruptcy of a general contractor is a more common reason for payment problems than people may realize. Fortunately, for a financially troubled general contractor, mechanics liens may provide some protection.

Mechanics Liens & Bankruptcy’s 'Automatic Stay'

When a party files for bankruptcy, one of the first protections awarded to that party is the "automatic stay." This protection is triggered, and defined, by Bankruptcy Code Section 362(a), and bars collection efforts and other creditor actions against the debtor and/or his property. Some of these prohibited actions include:

(4) any act to create, perfect, or enforce any lien against property of the estate;

(5) any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under this title;

Since a mechanics lien is clearly "a lien against property of the estate," a quick glance would lead one to believe that mechanics liens, and actions associated with mechanics liens, are strictly prohibited by bankruptcy law. This, however, is not the whole story. Bankruptcy code section 362(b) provides exceptions to the automatic stay, and an exception outlined in 362(b)(3), allows a creditor

"… to perfect, or to maintain or continue the perfection of, an interest in property to the extent that the trustee’s rights and powers are subject to such perfection under Section 546(b) [of the Bankruptcy Code] … "

Provided that the requirements of 546(b) are satisfied, the bankruptcy code allows for the perfection of a mechanics lien after bankruptcy has been filed, and during the automatic stay, if the lien was established before the filing of the bankruptcy petition.

This is good news for mechanics lien claimants.

Mechanics lien law varies significantly between states, but mechanics liens generally arise either when labor and/or materials were supplied by the claimant, or when work on the project first commenced — both of which are generally well before the lien is perfected.

This means that if the claimant provided work or supplied material prior to filing for bankruptcy, the lien is allowed to be perfected (filed) after the filing and during the automatic stay.

Getting Paid During Bankruptcy or After the Bankruptcy Discharge

While this permission to file does not apply to any action to enforce, mechanics lien enforcement deadlines are tolled during the bankruptcy proceeding, so that the lien can be enforced against the property after the bankruptcy discharge.

Mechanics liens have the unique ability to be perfected after the automatic stay, emerging unscathed and in full effect after the bankruptcy process concludes. This means that holding a mechanics lien puts you in much better position to recover the money you are owed in, or after, a bankruptcy proceeding for several reasons, including:

  1. Mechanics liens secure debt. Generally, unsecured debt is not paid in bankruptcy proceedings because there is not enough money to go around. Secured debt gets the first crack at the money and is much more likely to get paid.
  2. Mechanics liens cannot be “stripped” by the bankrupt process or avoided by the bankrupt party, it emerges in full effect, and can be foreclosed upon.

Mechanics liens provide a great opportunity to be paid — even when a party files for bankruptcy. Making sure you protect your mechanics lien rights, and filing mechanics liens, puts you in the best possible position to be paid for your work in every circumstance.