How Bankruptcy Impacts a Construction Project

Join this free webinar to learn how contractors and suppliers can protect their interests in the event of a bankruptcy.

Construction attorneys Christopher K. LeMieux and Michael D. Lane will go in-depth on what happens when an owner, general contractor, subcontractor, or supplier declares bankruptcy during a project.

What we’ll cover:

• How ongoing construction projects are impacted by a bankruptcy filing
• Legal issues that contractors and suppliers should be aware of, including preservation of lien rights
• Asserting claims against the debtor’s estate
• Performance and payment bond issues

The presentation will be followed by a live Q&A!

Transcription

Kathryn Barona (00:04):

Good afternoon, or if you’re on the Pacific coast. Um, good morning, almost afternoon. Um, Katherine with Levelset and we’re presenting a webinar today with Riess Lemieux and Michael Lane, and Chris [inaudible] from their New Orleans office and they will present how bankruptcy impacts the construction project. And now I’ll let Chris and Michael get started and introduce themselves and go away with the presentation.

Chris LeMieux (00:35):

All right. Thank you, Catherine. We are live here from New Orleans on a very gloomy day. As Catherine said, I’m Chris LeMieux. This is my partner Mike Lane. We are with the law firm, uh, Riess Lemieux. We are predominantly a construction law firm. And so we handled these types of matters all across the Gulf, South some up on the East coast and a little bit on the, on the West coast. So today we’re going to be doing 30 minutes for you. It’s going to be how bankruptcy impacts the construction project. And obviously if this happens on one of your projects, it is a big problem in something you don’t want to deal with, but if it does happen, hopefully we can get you some tips and pointers on what to deal with. Uh, the first thing is when you’re dealing with a project and then regardless of whether it’s a bankruptcy, a lien, a claim, a default, whatever it is, it always starts in the same place for me.

Chris LeMieux (01:31):

And that that place where it starts is who are you? What is your role, how you fit into the process and who is around you, because in this case, when you’re dealing with bankruptcy, it really depends on who we’re dealing with. Are we dealing with an owner? Are we dealing with a lender, which we dealt with some of that in 2008, where lenders went over, um, are we dealing with a developer? Are we dealing with a general contractor or are we dealing with a saw, are we dealing with the supplier? So it, it really is critical to know who you are and know where you fit in the process. Because once you understand where you fit the process, then you can figure out what rights and remedies. If you’re a, if you’re a general contracting, you have certain rights, uh, vis-a-vis the lender. If you’re an owner, you have certain rights via assignments, um, and bonding company, surety bonds.

Chris LeMieux (02:24):

If you’re a sob, you have possible rights against upstream bonds. You have possible rights with the lender. You have possible rights with the owner. You have possible statutory rights. So really, although it’s incredibly basic, it really is very important from the very first and foremost, who are you? What are the contracts that you have in place? Where do all of the various parts and pieces to the puzzle fit together. And then once you really understand that you can move forward. And, and what we’re going to do today is we’re really going to talk about in a very short period of time and just scratched the surface. If you’re a project owner, if you’re a developer, what do you do? If you’re a general contractor, what do you do? If you’re a subcontractor supplier, what do you do? So that’s the outline. We’re going to follow. If you have any questions at all, certainly exactly. Then the Q and a, we have any time we’ll get to them at the end. If anything comes up after the fact that you have questions, you have our contact information, feel free to email us, call us text messages, whatever you want. I’m happy to respond to that.

Michael Lane (03:24):

And now we’re going to start with the basics of bankruptcy. This is not a bankruptcy webinar per se, but we wanted to hit on some of the high points that are relevant to contractors and subcontractors and suppliers. Because some of these terms we’ll discuss throughout this presentation. And the first thing we wanted to ask is what happens when a company files for bankruptcy, a number of things are common to all bankruptcies, regardless of the type of bankruptcy, the debtor, which is the party that files for bankruptcy has to list their assets and liabilities. When they filed their petition for bankruptcy. They also have to have to identify any creditors that they’re aware of who may have claims against their company or their estate once the bankruptcy is filed. And those creditors have to be notified at the, of the filing, uh, when the bankruptcy is, uh, started initiated, there’s an automatic stay of any actions by creditors that is put in place per the bankruptcy code.

Michael Lane (04:25):

And it, that becomes extremely important as we talk about lien rights and other attempts to recover from the bankrupt party. Execratory contracts is an important concept in bankruptcy as well. Uh, an executive wary contract is defined by the code as a contract that is not fully completed or performed. And we know that construction contracts during the course of a project are considered by the courts to be executive order in contracts. And the appointment of a trustee doesn’t happen in every bankruptcy, but it happens at all. A lot of them sometimes in a chapter 11, always in chapter seven. And so I wanted to quickly reference what types of there are different types of bankruptcies. There’s more than what’s on the screen here, but relevant for today is chapter seven liquidation. This is when a company is going to liquidate all of their assets to wipe out all of their debts.

Michael Lane (05:26):

Uh, the company will cease to exist once that a bankruptcy process plays out a chapter 11 is a reorganization, um, plan for a company that intends to survive the bankruptcy, come out after they’ve reorganized and dealt with a lot of their debt or financial difficulties. Uh, it’s interesting. A lot of contractors when they file for bankruptcy, chapter 11 is the route that they go. Um, and they can come out of that on the other side and reestablish themselves. And one of the things that we wanted to address here before we get into specifics of when an owner files for bankruptcy is in a chapter seven, the work on the project is going to stop completely. And the chapter 11, you work may continue on that project and be subject to what’s happening in the bankruptcy proceeding, but the project may be able to continue forward.

Chris LeMieux (06:23):

So if we look at the contractor options, if there is an owner that files bankruptcy, and again, we, we, we saw a lot of this back in 2008 when the world, as we knew it basically imploded when you’re a general contractor and you’re on a project, there are typically, unless it is a w and here we’re talking about obviously, uh, private owners, there are various agreements with the lenders. And so you’re going to need to get a copy of the lender agreements. Typically, when you sign up with a private project, there is typically an assignment of contract that is signed with the lender. There’s also other, uh, agreements that are signed with the lender. And what those agreements usually say is look, before you can default, or before you can place the owner in default. And before you can stop working on the project, you need to tell us the lender that our owner is in default.

Chris LeMieux (07:19):

And Michael talk a little bit later about the faults. One of it be in financial insolvency and, and, um, bankruptcy. But the, the, the immediate course of action is to go back and dig out those assignment documents that you signed with the lender, figure out who the lender contact is, and then have that direct communication with them, because you’re going to have to put it a notice to them in writing. You’re going to have to ask what they want to do. And then the is going to have the ability to come in. And in essence, takeover that project, if they want to, because obviously the lenders expended a significant amount of songs when you’re also wanting to want to do as a general contractor, is you have to be familiar with your state’s lien laws. And so that is going to be number one, as far as protecting your interest, you as the general contractors entrance, um, you’re going to want to preserve that claim because when you file a lien, you go ahead and attach a security interest to the property.

Chris LeMieux (08:18):

Various States have rankings. And, uh, just because a mortgage may be prime in certain States, Louisiana is one of them where even if there is a mortgage on the property, they may not necessarily rank higher than other people. The prime example, our labors labors will always rank higher than mortgage companies, assuming that they’ve timely, filed the lien. So you have to look at your state’s lien laws to properly preserve that. You also have to figure out if you’re going to have the ability to terminate the contract, you know, what is your ability to stop work? What is your ability to continue? What does the lender have to say about that? What is your ability to follow leads? What is your ability to try to secure a payment? And can you look at those rankings in various States, depending on where you are and file liens, to make sure you rank higher? Because if there is a bankruptcy in the mortgage holder as is currently prime, then obviously that’s going to impact your ability to get paid. But you, you just because an owner is going to declare bankruptcy doesn’t mean that the project’s over doesn’t mean that you’re not going to get paid. You have various avenues through the lender, through the lien statutes and through the contract to try to recover those songs.

Michael Lane (09:32):

Yeah. And Chris referenced termination of the contract. One thing that’s uniform across the country, uh, with respect to construction in bankruptcy is that you can’t terminate a contract solely because, uh, the other party in that contract, whether it’s the owner or the GC or a sub has filed for bankruptcy, or has insolvency issues. Now, there may be other grounds to be able to terminate if they’re not able to proceed with the work or meet other obligations that they have under that contract. But the federal courts are very clear that if a party files for bankruptcy, that is not sufficient grounds for termination of a construction contract, or frankly, most contracts, including leases, franchise agreements, and many other contracts that the courts.

Chris LeMieux (10:22):

But if, if to that same token though, that there’s also other provisions in the contract, we’ve got, you know, regarding proof of funding there provisions regarding payment, there’s a provisions regarding security for obligations. So Mike is a hundred percent correct that the bankruptcy in and of itself does not give grounds for termination, but what you also need to consider are, are there other grounds under the contract, because chances are, if there’s a bankruptcy, there’s going to be payment issues, there’s going to be security issues. There’s also going to be funding issues. So you have to go through that agreement to see, look, although the bankruptcy may not do it by itself. Are there any other basis that would allow me to go ahead and set up that termination again, if you’re the GC, you got to go back to the lender and you have to put them on notice immediately and figure out what the lender is going to do

Speaker 4 (11:10):

The process.

Chris LeMieux (11:13):

So we talked about this earlier, and this, this is an important case out of the fifth circuit, is that the bankruptcy filing by the owner, doesn’t invalidate a previously recorded lien, and that the lien is going to date back. At least in this case in Louisiana, it’s going to date back to the filing of the notice of contract. The filing of the notice of contractor starting to work is important because it comes back to the issue of who’s prod. Again, we’re looking at ranking issues a lot of times, and you, number one, obviously want to perfect your lien. You want to make sure that it’s proper, but you also want it to rank higher. And so the Tuscany reserve cases a phenomenal case in that case, they specifically tried to state that once the owner declared bankruptcy, that the lien that was filed by the GC on that project was invalid. And the bankruptcy court specifically came in and said that it’s not in this case, it was a little snafu by the mortgage company, uh, because in, in Tuscany reserve, the contractor actually filed its notice of contract prior to the mortgage company filing their mortgage. And what Tuscany reserves said is that because the lien related back to the filing of the notice of contract, and because the notice of contract was filed prior to the mortgage, the contractor’s lien had preference and priority and was valid, which is pretty significant.

Chris LeMieux (12:39):

So, you know, if we start looking at that, touched on the owner, what if there’s a general contractor that’s looking at bankruptcy? Well, number one, we talked about who are you in the process? Or are you an owner? Are you a lender? Are you a subcontractor or are you a supplier? And so depending on who you are in the process, again, it goes back to just because they declared bankruptcy. Doesn’t mean you may not have an Avenue of payment. If it’s a public job, it’s a federal job. Chances are the general contractor has performance and payment bonds. So even though you have a bankruptcy, you have security for those obligations. Um, if it’s a private job and you, they weren’t required to have performance or payment bonds, maybe you actually have, um, you have the ability to file a lien. So you have, uh, you have the ability to have a security interest.

Chris LeMieux (13:30):

And if we go back to the ranking of privileges, if you were paying people to do labors, uh, labor on the job, then those laborers on the job, outrank anybody. So looking at who’s got the ability to come in and file that lien. You need to look at those ranking scenarios because you want to make sure prior to filing that you give yourself and those funds the best ranking shot. Um, you obviously want to play someone notice. You obviously want to talk to the surety. You obviously want to talk to the owner because in a lot of cases, if the owner defaults and terminates for again, reasons other than bankruptcy, or for whatever, the reason, many of the subcontract provisions between the sub and the general have assignments. And so is the owner going to step in and take over the project? Is the lender going to step in and take over the project?

Chris LeMieux (14:20):

Is the surety going to step in and take over the project? And if they do that, part of that is your consent to an assignment of contract. And when you do that consent, obviously you’re going to have questions about payment. Am I going to be paid for these past two songs? What is the payment going to look like going forward? So just because the GC should file some type of bankruptcy doesn’t mean that you don’t have any tools in your tool chest as ad toolbox, um, as a sub or supplier, you have plenty, plenty of options.

Michael Lane (14:52):

And I would, uh, want to emphasize consult with bankruptcy counsel. It’s invaluable for, for anybody who is dealing with a bankruptcy on the outside as a creditor to work with an attorney who really understands how the bankruptcy process works, how, uh, privileges are ranked and how to best preserve or pursue your claim. Because one thing we haven’t yet really touched on is once the bankruptcy begins, there’s a proof of claim process where all creditors have to assert their claims against the estate of the debtor who’s filed for bankruptcy. So the court can sort out and figure out who is going to be able to recover and how much, uh, so, uh, starting a proof of claim in the bankruptcy is critical. In addition to, um, your link

Chris LeMieux (15:39):

And look, Mike, Mike makes an excellent point on that with, with contacting and associating, with competent bankruptcy counsel. The thing to remember is this is not a one size fits all approach. And this is not a one item approach when you’re dealing with a bankruptcy that obviously has significant ramifications. And typically our recommendations are, if we have an Avenue to get you paid, we’re going to pursue that Avenue. And we’re not going to put all of our eggs in just one basket. We’re going to process and proceed with all of the options available to you because one of the options, quite frankly, may not work. One of the options may not be valid, but if you pursue the lean, right, if you pursued the bankruptcy, um, process, if you pursue the assignment process, if you pursue the surety bond process, the more avenues you have to get paid, the more likely it is you’re going to get paid. If you put all of your eggs in one basket, you may be outranked and not get anything. So you really want to pursue everything

Michael Lane (16:39):

And keep in mind that even if you haven’t filed a lien and the bankruptcy occurs and you find out about it and you think you’re too late, that’s not the case. You can still perfect your main rights by filing your lien, pursuant to your state law. Even after the bankruptcy petition has been filed. And that’s critical because, uh, there have been cases out there discussing whether or not that violates the automatic stay, which goes into place. The minute the bankruptcy is filed, but there’s an important exception in the bankruptcy code that says mechanics, liens, laborers, liens, and those types of security interests can be filed after the bankruptcy petition initiates the bankruptcy. So once bankruptcy happens, you still have rights and you still have Avenue to go protect your right to recover. One of the examples of this, uh, down here in Louisiana at the Western district, uh, was a case where a drilling company filed for chapter seven liquidation.

Michael Lane (17:42):

And the question was whether liens could be filed within the 180 day window under the oil well lien that we have down here in Louisiana and the court addressed this head on and said, yes, the exception of the bankruptcy code concerning the interests of contractors, subs, laborers, et cetera, allows them to perfect their security interest in father liens. After the bankruptcy begins, execratory contracts. We touched on this a little bit before these are contracts that have not yet been fully performed if a general contractor or any party on a construction project files for bankruptcy. One of the important things that they have to do in the bankruptcy itself is to decide which contracts it’s going to accept or reject. If they accept it, that means that they’re going to move forward with that contract and continue to comply with their obligations under that contract. This is a situation where if the GC files for bankruptcy and accepts his contract with the owner and its subs, the work is going to continue on the project. But if, if there’s a rejection of that contract, for whatever reason, uh, that is considered a breach of a contract pre-petition, which is important, because what that does is it gives you a higher ranking in, in a higher priority in the bankruptcy. So if a GC rejects the subcontracts on a project, he, the GC gives rise to claims by the subs and suppliers, um, in the bankruptcy that are priority claims,

Chris LeMieux (19:20):

Proof of claim. Again, this is one of those things that isn’t a necessity as to what you need to do. If you reach the point where the GC is not paying again, in addition to the lean options, Michael mentioned, in addition to the surety options. And in addition to the notice options, keep in mind that a proof of claim is within 70 days after the filing of the petition date. Okay? So if you don’t do that, it may constitute a waiver, but the waiver is not a clickable. When you have recorded a lien again, that lien gives you a security interest in that property. And we can’t just stress that enough of how important that is to make your claim secure by virtue of actually attaching the lien. But again, it’s, it’s, this is a perfect example of a, another Avenue for you potentially to get paid.

Chris LeMieux (20:15):

So you want to make sure that you have that proof of claim is filed within 70 days, but that’s not it alone. You still have to go the lien. You still have to submit the claim and comply with the surety. And look, this is not a surety seminar today, but the, the, the surety, the surety, uh, payment bonds have very specific requirements of what you have to do, how you submit the claim, who you submit the claim to what information is required. Again, the lien as well, every state is different on what’s required, and it’s, it’s very technical and it’s very precise. And if you don’t comply with the statute, a hundred percent, your secure claim may become unsecured. So you really have to work with competent counsel to do all of them and do all of them correctly.

Michael Lane (21:04):

Exactly right, Chris, and one of the important things about a secured claim is that they are first in line to recover what is owed to them by the debtor. Uh, often you don’t want to be an unsecured claimant in a bankruptcy because you’re at the back of the line for a party that doesn’t have enough money or financial ability to pay off all their debts. So you have to get a secured claim if you can. And mechanics, liens and maternal insulins are automatically considered secure creditors, secured creditors, you know, mortgage companies, others who have security rights with respect to the debtor’s property, uh, come first ahead of everyone else. And right behind that are the priority unsecured creditors, which would include wages and benefits. And then all the way at the end of the unsecured creditors fighting for the scraps and general contractors fall into that category because they typically don’t have lien rights against a subcontractor. Uh, so you have to consult with counsel, uh, depending on your situation, to know where in the ranking of claims you’re playing would would fall. But again, we can’t stress enough. Securing your lien rights is more important, perhaps when a bankruptcy occurs, because it puts you at the front.

Chris LeMieux (22:23):

Yeah. And if we, if we look at this slide again, it talks about priority on secured creditors. So right after the secured is priority, and you have a claim for unpaid wages. The interesting part about that is if you follow your state’s lien process, you may take that priority. Unsecured creditor, make them a secure creditor and put them number one in the ranking because the bankruptcy court will go through the rankings of privileges. So knowing that statute, knowing that debt and knowing how to properly make it security can put you, you know, can take you from right in the middle. So to the top of the lawn, subcontractor, bankruptcy is obviously a problem if it happens. And so what you need to figure out once the self declares bankruptcy is who is under them, where do you have materials? Where do you have again, labor that has been on paid?

Chris LeMieux (23:22):

Who do they owe money to will a lot of times unpacking the information as to who they’ve purchased materials from who they have purchase orders with, who they have temporary labor, who they have on page, um, who they have on paid wages with is sounds a lot more calm. It sounds a lot easier than it normally is. It’s typically very complicated to figure out that mess of information. It’s something that you need to figure out. You also have to figure out where are they in the intellectual property phase of the project? Have they done their submittals? Have they done their shop drawings? What are they interacting with with other other trades? And again, the first step in any of these processes, it’s, you know, we don’t dive in and say, okay, now we’re going to the lien. We dive in to figure out who’s on first. What is the information? Who do they owe money to? What’s been paid? What has not been paid? What is owed? Do you have lien waivers? Um, do you have unpaid wages? How many unpaid wages do you have, how much is owed and that takes some time to unpack. So you, as the GC can start to figure out number one, what’s your exposure is number two. How do you correct it? And number three, how can you move forward while this bankruptcy is pending?

Michael Lane (24:37):

We touched on this a little bit before, about a termination for a filing of a bankruptcy. Again, the same rule applies to subcontracts and two purchase orders or any other agreements that are considered contracts under the law. But once again, any part of that, doesn’t comply with their other obligations, delivering materials to the site, performing their work would be grounds for termination, not solely because of the bankruptcy. And once again, we talked about if the subcon, if the debtor who files for bankruptcy assumes the contract, they may be able to continue to perform the work. This doesn’t always happen of course, but if they subcontractor on your job goes onto her files for bankruptcy. And if it’s a chapter 11 reorganization bankruptcy, they may be able to work with you to try to get, uh, the materials that they’ve previously purchased. And hadn’t been delivered yet delivered to the site, uh, coordinate with the replacement contractor, if they’re not able to perform the work themselves, despite the bankruptcy. Uh, so just be aware that there aren’t avenues to terminate and bring in a replacement supplier or subcontractor in, but not solely because of the bankruptcy.

Chris LeMieux (25:51):

We touched on it earlier, again, not necessarily a surety seminar today, but an Avenue to get the performance done. If there is a performance bond in place, you have to be careful because the performance bond has very specific requirements as to how you trigger the performance bond and their cases from all over the country that says, if you don’t comply with the obligations, and if you don’t do them properly, you won’t have a right of action against the bond. And then one of the requirements of the bond is putting the party in default preconditioned precedent. You’ve got to do that. Are you going to tender the subcontract balance or contract balance, um, to the surety? So you have very specific requirements of what to do. And if you trip up along the way and move along with somebody else without notification of the surety, without placing in default tendering contract balance, without complying with the very specific terms and conditions of the bond, you may take something that may turn out, not that bad and lose the rights and remedies you have under that bond.

Michael Lane (26:57):

Exactly. Right. In, in one of the recent cases we’ve seen come out, that was on point with, uh, what Chris was just saying is, is the notice required to the bonding company it’s absolutely critical, and it will be enforced by the courts if notice is not properly provided pursuant to the terms of the bond. Uh, this was not a bankruptcy case, but there are bankruptcy cases that, that hit on this point. But in this particular case that came out last year and you subcontractor terminated a sub subcontractor, but failed to put the shirt. Are you on notice for about eight months? And the claim was denied by the surety, of course. And then that was litigated all the way to the court. And the courts agreed with the surety because the subcontractor had not complied with the notice requirements, which sometimes are strict and, and have to be followed. Uh, the courts will side with the surety. They will enforce, uh, the limitations of that bond and preclude any claim against that bond.

Chris LeMieux (27:58):

And that really is snatching defeat from the jaws of victory. I mean, you’ve got the performance bond in place. You have the security in place for this very issue, and then you just air ball the requirements, and those can be catastrophic.

Michael Lane (28:15):

We touched on this a little bit, the proof of claim it’s, that’s a term of art in the bankruptcy proceeding. A proof of claim is typically a form supplied by the bankruptcy court. Uh, the amount of the claim is the nature of the claim. That is all part of that form that needs to be submitted to the bankruptcy court. And before we, you know, it looks like we’re running a little low on time. We wanted to touch on a few more things, um, as potential recovery options that we haven’t addressed here. Uh, one of the most important is subcontractor default insurance. We arbitrated the case just last year, where that was, uh, $7 million was paid to a general contractor who had this type of insurance when they subcontractor went out of business and they were able to recover some of that, uh, back from the subcontractor who gone out of business letters of credit and personal guarantees or other, other mechanisms that are in place that may allow for recovery, um, for the party that goes, um, that files for bankruptcy, leaving the project and not able to satisfy their obligations.

Chris LeMieux (29:23):

And, and those are front end risk mitigation procedures. You know, when, when the, when the party has declared bankruptcy is not the time to go as a party for a personal guarantee. Um, you know, w when the party has declared bankruptcy, it’s not the time to get that self default insurance in place. So again, a lot of this comes down to risk management on the front end. Mike gave you a couple options with that. Uh, we are out of time. We really appreciate the 30 minutes that we had to share with you today. If you have any questions, our email is up on the screen. You can find us@ourllaw.com. We thank you for your time, and we look forward to speaking with you in the near future. Thank you everybody. We appreciate it. Thank you.

Kathryn Barona (30:08):

All right. Thank you, Chris and Mike, um, I know everyone watching out there got a lot out of this today, so thanks so much for your time and, um, sharing that knowledge with us. Um, that’ll wrap it up now.

Chris LeMieux (30:28):

Good scene.