Construction after the Real Estate Boom
Protecting Yourself and
Finding Success in a Volatile Market
By Kevin S. Blanton and Joseph J. Devine
Second Part of a Two-Part Serie
This article is the second part of a two-part series that addresses how
to handle a project that has “gone broke.” Last month we discussed steps
to take prior to providing goods or services (see July 2010 USGlass, page
34). This part will address what to do when payments from the owner are
stopped or delayed and how to position your company for the best possible
result if a project goes into bankruptcy.
When a project is in trouble, often the owner will slow the timing of
payments and, as things get worse, eventually not make them at all. In
such an event, a glazing contractor needs to look to available remedies
within the terms of its contract with the owner as well as other legal
remedies that are available to maximize the chances of getting paid.
When entering into contracts or purchase agreements, contractors should
negotiate specific provisions that permit the termination of the contract
in the event of non-payment by the owner or when the project is stopped
for an extended period of time. By way of example, commonly used forms
provided by the American Institute of Architects (AIA) provide that a
contractor may terminate the agreement if the project is stopped for a
period in excess of 30 days or if the owner has not made payments within
the time frames stated in the agreement.
Although termination of the contract may mitigate any future losses suffered
by a glazing contractor or vendor, if one has to resort to such an extreme
measure, the owner and the project are likely already in financial crisis.
One way a glazing contractor may protect itself is to file a mechanic’s
lien to assist in recovering payments due. In addition, the contractor
may have rights under performance and payment bonds posted with respect
to the project and finally, if all else fails, a contractor has the right
to sue the owner for damages or invoke other legal
remedies, either inside or outside of an owner’s bankruptcy proceeding.
A mechanic’s lien is an encumbrance on real property for the benefit of
one who supplied labor or materials to improve real property. Mechanic’s
liens are available in most jurisdictions by statute. Each state is different
so before filing a mechanic’s lien one must ensure that the statutory
requirements are followed strictly as failure to do so may cause the lien
to be ineffective.
Generally, anyone supplying labor or materials incorporated into the construction
of a project may file a mechanic’s lien; however, some states require
that the entity filing the mechanic’s lien have a certain degree of contractual
privity with the owner so that sub-subcontractors may be prohibited from
filing. Mechanic’s liens may be filed on construction projects, renovation
projects, certain improvements to land and, in some instances, by those
providing specially fabricated materials that have little to no value
if not incorporated into a specific project. Mechanic’s liens are generally
not available for demolition projects and mechanic’s liens may not be
filed against government-owned properties.
The typical process involved in filing a mechanic’s lien consists of a
pre-lien notice, the filing of the lien itself and the subsequent foreclosure
of the lien. The effect of the lien on the owner is significant. A mechanic’s
lien becomes a cloud on the title to the real estate upon which it is
filed, similar to that of mortgage or tax lien. The act of filing the
lien may cause default under an owner’s financing documents and ultimately,
the foreclosure of the mechanic’s lien may result in the owner’s loss
of the project. Because of this, banks providing construction financing
often require an owner to pay off the lien or post a bond guaranteeing
payment within a relatively short period of time after a lien is filed
against a property. As a result, filing a mechanic’s lien will generally
get quick attention from the owner and force a resolution of the contractor’s
Before attempting to file a mechanic’s lien, it is important to check
that prospective lien waivers have not been filed or that the right to
file mechanic’s liens has not otherwise been waived by the contractor
or by the action of the parties.
Performance and Payment Bonds
Another method of recovery that may be available to a contractor is a
payment bond claim. A payment bond is essentially a guaranty by a third
party to the owner or lender that the contractor will pay its subcontractors
and vendors for labor and materials used in the project. Accordingly,
if a contractor does not pay a glazing contractor, they may have a claim
that may get paid by the surety under the bond. It is important on a bonded
project to follow the correct procedure regarding timing and notice to
the owner and, if required, to the surety, to assure that the ability
to have the claim paid by the surety is not compromised.
If none of the aforementioned options are available, the glazing contractor
may sue for non-payment. Prior to initiating suit, the applicable contract
provisions and relevant statutes should be reviewed to determine the forum
in which a claim should be filed (in many contracts it is custom to waive
jury trials or to require arbitration or mediation), the time limits in
which to file any notice and cure rights that must be provided prior to
filing such an action. The available claims to a party not receiving payment
may include breach of contract, unjust enrichment and third-party beneficiary
claims. In addition, if the owner of the project has filed for bankruptcy,
one may make claims inside the framework of the bankruptcy proceeding.
Regardless of how well a subcontractor attempts to mitigate risk and protect
itself from slow or non-paying owners, the one thing that cannot be avoided
is the bankruptcy of an owner or project. As a contractor or vendor there
are two main types of bankruptcy that you will face. The first, often
called a “liquidation,” is a proceeding under Chapter 7 of the bankruptcy
code. In a Chapter 7 bankruptcy, a trustee is appointed by the court to
accumulate and then liquidate the assets of the bankrupt company, called
the “debtor.” The proceeds of the liquidation are then used to pay administrative
expenses related to the bankruptcy and claims of those that are owed money
by the debtor (“creditors”). Claims are paid on a pro-rata basis based
on the priority status of the claim.
Often in a Chapter 7 proceeding creditors get little or no payment on
their outstanding obligations. The second type of bankruptcy that one
is likely to face is a Chapter 11 proceeding. In a Chapter 11 bankruptcy,
the debtor remains in business and enters into a plan to pay its creditors
over time and often at a discount.
If you find yourself in the position of having an owner file for bankruptcy
during the course of a project, the following are some of the most important
considerations that you will have. These considerations are generally
applicable to all bankruptcy.
Once a company files for bankruptcy, all activities to collect money from
the debtor must stop. Any claims that are pending must now be raised (even
if previously raised in another court) in bankruptcy court. This process,
called the “automatic stay,” is designed to give the debtor some breathing
room and give them a chance to have their situation reviewed by the bankruptcy
court. If collection efforts continue against the debtor after the creditor
is put on notice of the bankruptcy filing, the debtor may recover damages
and sanctions from the creditor in certain instances.
The bankruptcy code allows a debtor in a Chapter 11 case to assume or
reject executory contracts. For bankruptcy purposes, an executory contract
is a contract under which both parties have outstanding obligations at
the time the bankruptcy petition is filed. If you have an ongoing contract
and it is assumed by the debtor, the debtor must cure any existing defaults,
including payment defaults, and the contractual relationship will continue
throughout the bankruptcy case. On the other hand, if the debtor decides
to reject your executory contract, you will be left with an unsecured
claim against the debtor for the amount due and any damages you may suffer.
Because the claim is unsecured, your chances of recovering payment for
the full amount of the claim may decrease.
how well a subcontractor attempts to mitigate risk and protect itself
from slow or non-paying owners, the one thing that cannot be avoided is
the bankruptcy of an owner or project."
Section 503(b)(9) Administrative
Administrative expenses are expenses incurred after the filing of the
bankruptcy incurred in conducting the Debtor’s business or protecting
its property. Administrative expenses are entitled to priority over most
other types of claims and, as such, get paid prior to the typical unsecured
claims of contractors.
Section 503(b)(9) was added to the bankruptcy code in 2005 and grants
administrative claim priority for the value of any goods received by a
debtor in the ordinary course of a debtor’s business within 20 days before
the commencement of the bankruptcy case. This section was enacted so that
debtors could not avoid paying for goods they acquired at a time when
they knew they would be unable to pay because of their impending bankruptcy
and is a useful tool for those that supplied goods and services to a debtor
immediately prior to the bankruptcy filing for which they have not been
Once a bankruptcy case has commenced, a vendor may take back or reclaim
goods it sold to a debtor if the requirements of Section 546(c) of the
Bankruptcy Code are met. To reclaim the goods, a written demand for reclamation
must be made. The demand must be made no later than 45 days after receipt
of goods by the debtor, or no later than 20 days after the date of the
debtor’s petition for bankruptcy, if the 45-day period expires before
the commencement of the bankruptcy case. Where possible, vendors should
consider this option as it may allow them to place items back into inventory
to be sold at later time to a purchaser that is in a better position to
pay. This result is much better than wading through the bankruptcy process
in the hope of getting at least a partial payment and exposing oneself
to the risk of getting none.
In a Chapter 11 case, creditors often refuse to continue supplying the
debtor with critical services or materials unless all the creditor’s claims
that arose before the debtor filed bankruptcy are paid immediately, even
though such claims are not entitled to priority under the bankruptcy code.
There is nothing that requires a vendor to continue to supply goods to
a bankrupt company, so the threat of cutting off critical services or
materials is one that quickly gets the attention of a debtor struggling
to reorganize and keep its business alive.
Some bankruptcy courts have authorized the immediate payment of such “critical
vendors” when it becomes clear that a Chapter 11 debtor cannot continue
operating without the services or materials that a critical vendor supplies.
If you are fortunate enough to be in this position, your leverage can
be used to force back payments as well as ongoing payments during the
course of the bankruptcy proceeding without regard to how your claims
may have otherwise been classified or scheduled to be paid. When the bankruptcy
court permits such payments, it is usually within the debtor’s discretion
to determine which “critical vendors” will get paid.
Unsecured Proofs of Claim
Unless one is able to fit into one of the categories above, most glazing
contractors will find that their claims are designated as “unsecured.”
An unsecured claim is one of the last claims to be paid out in bankruptcy
and often unsecured creditors are forced to accept deep discounts. In
order to be paid on an unsecured claim in a Chapter 7 proceeding, a written
proof of claim must be filed with the bankruptcy court asserting your
right to be paid. An unsecured creditor however, is not required to file
a proof of claim in a Chapter 11 case if the claim was already disclosed
by the debtor in the schedules it filed with the bankruptcy court and
the claim is not listed as disputed, contingent or unliquidated.
In a Chapter 7 case, a proof of claim must be filed no later than 90 days
after the first date set for the meeting of creditors. In a Chapter 11
case, the deadline for filing a proof of claim is established by the bankruptcy
court. If a creditor does not timely file a proof of claim, the creditor
may lose its right to be paid.
In today’s challenging economy, it is almost inevitable that one of your
customers or project on which you are working will go broke. With careful
planning you can mitigate these risks. When signs of trouble, such as
slow or non-payment start to happen, you can attempt to cut your losses
and terminate the relationship and you will enhance your opportunity to
get paid by promptly enforcing your right under your contracts and provided
by law. If you are unable to recover or if bankruptcy filing prevents
you from exercising some of the more traditional remedies, such as enforcing
mechanics’ liens, bond claims or filing suit, by paying careful attention
to the considerations outlined above and seeking the advice of a professional
familiar with the bankruptcy process, you will be able to place yourself
in the best position to receive the largest possible available distribution
in the bankruptcy case.
Kevin S. Blanton and Joseph
J. Devine are partners with Schnader Harrison Segal & Lewis LLP.
Their opinions are solely their own and not necessarily those of this
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No reproduction of any type without expressed written permission.