Construction Liens Filed by Suppliers in New Jersey After Contractor’s Filing of Bankruptcy Petition Are Barred by the Automatic Stay Provision of the Bankruptcy Code

by Pepper Hamilton LLP
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In re: Linear Electric Co., Inc., No. 16-1477, 2017 U.S. App. Lexis 5527 (3d Cir., March 30, 2017)

This case concerns whether suppliers, Cooper Electrical Supply Co. and Samson Electrical Supply Co. (“Suppliers”), could file construction liens under New Jersey law, despite the fact that Linear Electric Inc. (“Contractor”), filed a petition for bankruptcy, which automatically stays any act to create or perfect any lien against the contractor’s property. Two weeks after Contractor filed for bankruptcy, the Suppliers filed construction liens against projects in New Jersey where the materials were incorporated.  Following a motion by the Contractor, the Bankruptcy Court held that the liens were in violation of the automatic stay provision of the Bankruptcy Code. The District Court affirmed the Bankruptcy Court’s holding that, under New Jersey law, the liens were claims against the Contractor’s accounts receivables, which receivables are part of the bankruptcy estate and protected by the automatic stay.  On appeal, the Third Circuit affirmed the ruling of the District Court.

Under New Jersey law, if a supplier sells materials on credit to a construction contractor and the contractor incorporates those materials into property owned by a third party without paying the supplier, the supplier can apply for a lien on the third-party property. The owner of the property subject to lien discharges a lien by paying into a lien fund, from which claimants recover what they are owed.  However, no lien fund exists if, at the time of service of the lien claim, the owner has fully paid the contractor for the work.  In addition, if there is money left over in the fund after the lien claims of subcontractors and suppliers are paid, the remainder is received by the contractor.  The Court relied on this allocation process to determine that, although the Suppliers’ liens were ostensibly against the property of third-party owners, they were also against the Contractor’s accounts receivable because the payments from the owners to the Contractor would be reduced by the lien claims of the Suppliers.  Thus, the Suppliers’ liens were against the Contractor’s property and violated the automatic stay created by the Contractor’s bankruptcy.

In addition, in coming to this conclusion, the Third Circuit distinguished New Jersey lien law from Pennsylvania lien law, where the lien of a supplier or subcontractor relates back to the date when work on the project first began. As a result of this, the Pennsylvania lien was considered to have been filed before the bankruptcy petition and therefore fell within an exception to the automatic stay. See In re Yobe Electric, Inc., 728 F.2d 207 (3rd. Cir. 1984).

To view the full text of the court’s decision, courtesy of Lexis®click here.

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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