In construction, owners, general contractors, subcontractors, and suppliers are all susceptible to bankruptcy. If any one of them chooses to declare themselves bankrupt, they not only leave the project vulnerable but the remaining parties are put at risk for not being paid, at all or in part.
Bottom line, any bankruptcy filing leaves the construction project irretrievably impacted and every party facing increased expenses in both time and money. In order to be paid, they’ve all got to work on two fronts now: the construction site and the bankruptcy courtroom.
Overview of the Bankruptcy Process – How It Begins
Declaring bankruptcy is a legal right guaranteed by the United States Constitution. Federal law and regulation defines and protects that right, and special federal courts have been created solely to deal with bankruptcy matters.
So much federal law has been created to control the bankruptcy process that it has been gathered together (codified) in a group of laws named the Bankruptcy Code. Within that code are several chapters, organizing various aspects of bankruptcy law by topic.
When an individual or a company involved in construction declares bankruptcy, they will most likely do so under one of three chapters:
•· Chapter 7 (“liquidation”), which essentially distributes the bankrupt venture’s assets (some assets are exempt from this process under the law) to the creditors and thereafter, the business dissolves;
•· Chapter 11 (“reorganization”), where the bankrupt business is reorganized or restructured, and continues in business in a new way; and
•· Chapter 13 (‘wage earners”), the most common choice overall, where unincorporated ventures (e.g., owners), keep their assets and pay creditors according to a court-approved plan usually for less than the full amount owed.
Immediately upon filing a petition for relief with the local bankruptcy court under one of these three chapters, the bankrupt will receive a case number as identification, and an assignment to a particular court and its presiding judge. Hearings will be held in the matter before that judge, and all correspondence to the court must contain the case number identifying the matter.
As soon as the bankruptcy case is created in the courts, the law stops everything with a procedure known as the “automatic stay.” This stay cuts off any actions by or against the debtor and forces everyone involved to participate in the judicial process overseen by the bankruptcy judge.
News of Bankruptcy — The First Response
It is wise to hire experienced legal counsel to deal with bankruptcy proceedings, and lawyers usually diversify their practices between debtors and creditors, large and small. Word of mouth is usually the best way to select good bankruptcy counsel.
An attorney can be very helpful in these situations. For example, if you want the general contractor to finish the job, your attorney can file the appropriate documents with the bankruptcy court to request that the automatic stay be lifted and the bankrupt company be allowed to finish the project. If the court grants your request, then the contract will continue as a “post-petition obligation,” with all the rights and duties contained within it.
An attorney can also advise you on the nuances of bankruptcy law and how it changes your previous arrangements. For example, the standard contractual provision that filing bankruptcy is an automatic default will not be respected under federal law: the contractual provisions defining default as being unable to properly man the job, or to pay subs and suppliers, must also exist in order to lift the stay and terminate the contract.
Your attorney can also file a proper “Proof of Claim” for you. This will be accepted by the court as valid unless the bankrupt disputes it in some way. If you do not file a proof of claim with the bankruptcy court, you cannot be paid. Always file a Proof of Claim.
In large bankruptcy cases, the court will segregate the creditors into secured and unsecured groups, and create committees for both with certain creditors serving on both committees as representatives of the whole. There are advantages and disadvantages to serving on a Committee, such as you may or may not be paid for your time, and it is best to discuss this option with your attorney before agreeing to serve.
There’s a Bankrupt on the Project: What Now?
When it’s a general contractor that files bankruptcy, the entire project comes to a sudden halt. The owner can rely upon his performance and payment bond surety – if the work has been bonded – to get things going again. If not, then the owner can ask the Bankruptcy Court for permission to try and find some assurance that the contractor will continue his work to completion.
When a subcontractor or supplier files bankruptcy, the project will not be completely stymied. Construction will work around the gap made by the bankrupt. Meanwhile, the general contractor will ask the Bankruptcy Court for permission to either terminate the bankrupt’s contract or to set up some type of assurance that they’ll get their commitments to the project met.
Regardless of who has filed, when they learn of any bankruptcy filing on a project, subcontractors and suppliers will usually file lien claims immediately in order to protect their rights to payment. This is a good strategy as long as the applicable state law defines their right as existing before the bankruptcy filing. Federal law allows perfection of pre-existing security interests.
No one should act based upon a contractual provision that attempts to deal with bankruptcy by stating such things as filing bankruptcy is an automatic default under the agreement. Every single action connected with the bankrupt must occur under the auspices of federal bankruptcy procedure, which means that you must appear before the court and obtain the judge’s approval before taking any action pursuant to the contract or otherwise. Act based upon the contract alone, and you will face the wrath of the bankruptcy judge.
Furthermore, everyone should check their payment records for any monies received from the bankrupt in the past ninety days. This is because federal law allows the bankruptcy court to order a return of payments received from a bankrupt for up to 90 days prior to the date the bankruptcy was filed. These are called “preference claims,” and while they were traditionally sought for only large amounts ($7500+), today preference claims for amounts as small as $250 are not uncommon.
Having an attorney is especially important if you want to fight a preference claim. There are legal defenses available to you, such as demonstration of a contemporaneous exchange of value, that can allow you to avoid a refund.
Depending upon the situation, the construction project may or may not proceed with a bankrupt debtor participating in the process. Regardless of whether or not they continue, or they are terminated, the project’s expense will increase for everyone in both time and money by the mere filing of the bankruptcy.
It goes without saying that the profit margin is shortened, if not erased, for many when a bankruptcy is filed. To minimize this cost, certain steps can be taken before starting any project:
1. Choose reputable parties to work with on each project you undertake. Established business ventures (5+ years) are less likely to fold.
2. Have legal counsel to review any construction contract before you sign it, with concerns not only for your legal rights and duties, but the ways you can protect yourself from the unfortunate circumstance of another party’s bankruptcy filing. Your construction law attorney should undertake the basics of bankruptcy law as i
t applies to the construction industry.
3. When you hear rumors of a project participant being in financial trouble, do not wait for notice of a bankruptcy filing. Check with your lawyer on what you can do proactively to protect your interests: he may suggest liens be filed, or various defenses to preference claims be established, as well as contingency plans including having alternatives at the ready (a new supplier if the current one goes belly up; an alternative electrical subcontractor if the project’s electricians go out of business).
4. Immediately seek the advice of counsel when you receive notice of a bankruptcy filing. There are set deadlines within which you must act or you will lose your right to any payment whatsoever for your work on the project.