Bankruptcy court is often the “court of bad news” for creditors. In particular, subcontractors and suppliers face unique challenges when a customer files for bankruptcy. But they also have unique rights that may elevate their claims. Failing to act quickly and correctly on those rights can have significant consequences.
Do Not Violate The Automatic Stay
As soon as a debtor files bankruptcy, Chapter 7 or 11, the “automatic stay” immediately protects the debtor from its creditors. The “automatic stay” is a court order that applies immediately after the debtor files for bankruptcy and prevents the debtor’s creditors from taking certain collection actions. For example, the stay prohibits a subcontractor from commencing or continuing any activity to collect on debts that a general contractor or owner owed for labor or materials furnished before the general contractor or owner filed for bankruptcy. The stay also suspends any lawsuit or collection action that was pending.
Violating the stay is serious and can result in sanctions. However, there are some activities that are allowed that may bolster your position.
File Your Lien
The priority of your claim is vitally important in bankruptcy. Creditors are not treated equally. Unsecured creditors generally are the lowest priority and do not fare well in bankruptcy.
Subs and suppliers should use their lien rights to avoid the fate of an unsecured creditor. If the project owner has filed for bankruptcy, then filing a lien may provide the subcontractor or supplier with a secured claim in the bankruptcy. If the general contractor files for bankruptcy, then the lien filed against the owner’s property may provide a means for recovery outside of the general contractor’s bankruptcy.
Suppliers and subcontractors should assess their mechanic’s lien rights while oil and gas field services providers should assess their mineral lien rights. Merely perfecting such liens (e.g., recording a lien affidavit) should not violate the stay (but enforcing them by filing a lawsuit will). Perfecting these liens is vital because they may provide a higher payout.
Suppliers should also consider their “reclamation” claims. When an unpaid seller of goods discovers that the buyer was insolvent at the time of delivery of the goods, the seller may reclaim the goods upon demand made within ten (10) days after the receipt by the buyer of the goods. If the tenth day of this period is after the debtor filed for bankruptcy, then the bankruptcy code extends the reclamation period for twenty days after the buyer receives the goods.
Assuming the demand is properly made and the buyer was insolvent when the goods were received, the seller may receive an administrative claim in bankruptcy for the reclamation amount. This administrative claim is not secured, but it has a higher priority than general unsecured claims.
The Bottom Line
Properly protecting your lien and reclamation rights in a customer’s bankruptcy can significantly reduce your loss.