Business Counselor September 17, 2012 Daniel R. Kubiak

Preserving Construction Lien Rights When the Owner Files for Bankruptcy

Most contractors, subcontractors, and suppliers are familiar with the requirements of Michigan’s Construction Lien Act. This article addresses the additional requirements imposed on a construction lienor when the owner files for bankruptcy.

Under the Michigan Construction Lien Act, a construction lien arises when the first actual physical improvements are made on the project, provided the construction lienor timely satisfies the other statutory requirements, including the recording of a claim of lien within 90 days of last furnishing labor or materials.

What if the owner files for bankruptcy before the contractor, subcontractor, or supplier has recorded a claim of lien? Must the construction lienor obtain bankruptcy court authority or approval to “lift the automatic stay” before recording its claim of lien? The shorter answer is no. In states such as Michigan, where the lien right “relates back” to the time of the first actual physical improvement, the bankruptcy courts have ruled that Section 362(b)(3) and Section 546(b)(1) of the Bankruptcy Code permit the construction lien claimant to record its claim of lien without obtaining a bankruptcy court order lifting the automatic stay.

Once the claim of lien is recorded, the lien claimant has one year from the date of recording to commence a foreclosure action. What impact does the owner’s bankruptcy have on this requirement?

The lien claimant may not commence a foreclosure lawsuit as long as the “automatic stay” remains in effect. If the “automatic stay” will remain in place until after the first anniversary of the recording of the claim of lien, special action in bankruptcy court taken prior to the first anniversary will be required in order to preserve the construction lien.

How long does the automatic stay remain in effect? Section 362(c) of the Code provides that any “act against property of the estate” is stayed until such property is “no longer property of the estate,” meaning until the case is fully administered and closed, or the asset sold, or the court enters an order “lifting” or “modifying” the automatic stay upon the request of the lien claimant.

Should the lien claimant find that it is bumping up against the one-year anniversary of the recording of its claim of lien, with the automatic stay still in effect, the lien claimant must file what is called a “Section 546(b)(2) Notice” with the bankruptcy court. The Section 546(b)(2) Notice should always be filed with the bankruptcy court prior to the first anniversary of the recording of the claim of lien.

If the automatic stay remains in effect as of the first anniversary date of recording of the claim of lien, and the lien claimant timely files the Section 546(b)(2) notice with the bankruptcy court, the Bankruptcy Code then extends the deadline for commencing the state court lien foreclosure proceeding. Section 108(c) of the Bankruptcy Code provides that, if a deadline for the commencement of an action, such as a construction lien foreclosure action, has not expired before the date of the filing of the petition, then the deadline does not expire until the later of (1) the end of such period; or (2) 30 days after notice of the termination or expiration of the automatic stay.

To avoid a “you filed too late” defense in a bankruptcy scenario involving an extended deadline for the commencement of a construction lien lawsuit, the construction lienor must monitor the bankruptcy court docket of the debtor carefully, to be assured that the state court action is, in fact, filed within 30 days after termination or expiration of the automatic stay. The lien claimant does not want to find itself in the position of filing the construction lien lawsuit more than 30 days after termination or expiration of the automatic stay and having to argue that it had no notice of such termination or expiration. This “30 days after notice” standard is a short time period that requires vigilance.

If you should have any questions with respect to preserving construction lien rights, whether in or outside of bankruptcy, please contact Dan Kubiak.

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