Fourth Circuit Clarifies that Bankruptcy Proceedings Need Not Defeat Your Unperfected Mechanics Lien

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The statutory mechanics lien is a powerful tool for contractors and suppliers aggrieved by an owner or prime contractor who fails or refuses to pay. Before a mechanics lien may be enforced, the Code of Virginia mandates that it be “perfected” by, generally speaking, filing a memorandum of lien at the local courthouse and providing notice to the owner of the property. Perfection of a mechanics lien often occurs weeks or even months after the performance of work or furnishment of materials,[1] and thus there is typically a gap between the creation of a “potential lien” and perfection of that lien.

An owner’s failure to pay is often a consequence of financial distress, and many of these matters are ultimately resolved in bankruptcy court. The filing of a bankruptcy petition by the owner may occur during the pendency of the construction project, or before the expiration of the time provided for the perfection of a mechanics lien. When bankruptcy proceedings are initiated, virtually all litigation and collection efforts cease abruptly. This occurs because of Section 362 of the Bankruptcy Code, which mandates an “automatic stay” of all such proceedings. However, several exceptions exist, including an exception for perfection of a property interest that predates the bankruptcy petition.

The question arises: May a contractor or supplier take steps to perfect a mechanics lien even though the owner of the property has filed for bankruptcy, thereby invoking the “automatic stay” provision of the Bankruptcy Code? Probably, yes. As was recently clarified by the United States Court of Appeals for the Fourth Circuit in In re: Construction Supervision Services, Inc.,[2]the answer to this question turns on whether the lien of a contractor or supplier constitutes an “interest in property” after the performance of work but before perfection of the lien occurs. Applying North Carolina law, the court in In re: Construction Supervision Services, Inc. looked at North Carolina’s mechanics lien statute to determine whether an “interest in property” exists. Finding that the North Carolina statute provides that a lien arises as soon as work is performed or materials are delivered, the court held that the aggrieved subcontractors and suppliers could proceed with efforts to perfect their liens notwithstanding the issuance of the automatic stay.

The opinion in In re: Construction Supervision Services, Inc. suggests that contractors and suppliers in Virginia are likewise able to perfect a “potential lien” after the filing of bankruptcy. The court noted that under “most mechanics lien statutes” the supplier of labor or materials “enjoys an inchoate lien which arises at commencement of work on the project.” When steps are taken to perfect such a lien, “the claimant’s lien rights ‘vest’ and relate back to the commencement of work.” Virginia courts have similarly held that the commencement of work creates a “potential” or “inchoate” lien,[3] and it therefore seems likely that the result would be the same with respect to liens arising in the Commonwealth.

While this decision seemingly clarifies a significant right of lienholders in Virginia, it remains the case that the nuances of both the Bankruptcy Code and the Virginia mechanics lien statute are highly complex. Consequently, one should engage experienced counsel when evaluating and enforcing remedies for breach of a construction contract, including mechanics lien remedies.

[1] The time limits are strictly enforced and set by statute. Seek experienced counsel to ensure compliance with applicable statutory time limits.

[2] No. 13-1560 (4th Cir. May 22, 2014), available at http://www.ca4.uscourts.gov/Opinions/Published/131560.P.pdf.

[3] E.g., DeWitt v. Coffey, 150 Va. 365, 143 S.E. 710 (1928).

 

Topics:  Consumer Bankruptcy, Contractors, Liens, Mechanics Lien, Subcontractors

Published In: Bankruptcy Updates, Civil Procedure Updates, Construction Updates, Residential Real Estate Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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