The current COVID-19 pandemic brings a level of uncertainty to industries throughout the United States. Business closures and quarantines have started a wave of employment losses. Though construction is an industry that has largely pushed on, builders should recognize the ripple effects that the halting of other businesses may have on their present and future work. One predictable result of these issues is an increase in bankruptcy filings. Some contractors assume that, if bankruptcy gets filed by someone in their chain of contracts, they are without options other than writing off the debt and moving on. While, at times, cutting your losses makes the most business sense, that is not always the case. There are steps your business can take to increase your chances of payment in case you need to collect from bankrupt owners or contractors.
In construction matters, liens are an important legal protection and their importance arises in a variety of ways. Contractors are granted liens by law which attach to properties for which they provide labor or materials. Though the rules granting those liens vary from state to state, the Bankruptcy Code will grant certain rights to valid lien holders from all states. In addition, other types of liens come up based on agreements to secure loans which finance construction projects or purchase of large equipment. Being a lien holder grants enhanced status in a bankruptcy case to be paid. For instance, in some bankruptcy payment plans, a debtor must satisfy all secured liens before paying any other creditors. Also, some bankruptcy debtors are forced to surrender the secured property to the lien holders unless they provide full payment to the liens. In other cases, liens can be reduced but creditors are entitled to payments with interest. If you have a lien on heavy equipment, your lien may be entitled to monthly payments known as “adequate protection” if the owner wants to continue using the equipment. In a bankruptcy case, these protections can mean much more collection for a lien claim than an unsecured debt like a regular credit card or utility bill. On the other hand, a potential lien that is not fully “perfected” when bankruptcy is filed can be removed and paid as an unsecured debt, which are routinely paid at 10% or less in bankruptcy cases. If you fear a bankruptcy may be filed by someone involved in one of your projects, make sure you have all liens perfected and documented.
Along those lines, if you are working under a contract with someone other than the owner, you may be required to provide some kind of notice to the owner or other contractors. Typically, it is advisable to send out these notices as a matter of routine at the beginning of every job if your state requires one to make sure your lien.
Various provisions of your contract can also improve your ability to collect in the event you’re involved in a bankruptcy case. Generally, having a well-written contract is valuable for many reasons. Often, taking a reasonable up-front deposit from your customer before starting work relieves some of the risk of non-payment. Similarly, having a clear, regular payment schedule incorporated into the contract should minimize loss if payment suddenly stops because a party in the chain of contracts filed for bankruptcy. Contracts which do not provide for payment until completion might make collection difficult if a bankruptcy is filed prior to completion. In addition, if you’ll be hiring subcontractors or material providers, having a well-written “pay when paid” clause, which limits your liability to pay downstream if you have not received payment, can provide some protection in the event that payments stop because the upstream party has filed a bankruptcy case.
One goal of the Bankruptcy Code is to ensure there is fair distribution of money to creditors. For this reason, it can be a good idea to participate in a bankruptcy case if you are pulled into one. Your ability to be paid after bankruptcy is filed depends on the specifics of the case, but the first step is to file a Proof of Claim. A Proof of Claim is a short form which advises the court of the amount and basis for the debt. Failure to file a Proof of Claim by the court’s deadline can mean a claim might be denied payment even if it otherwise might have received money. If you receive notice that a party who owes you money has filed for bankruptcy, it is typically a good idea to check the court documents, calendar the deadline, and file your Proof of Claim as soon as possible.
Keep in mind that filing a Proof of Claim does not guarantee payment but without filing one, your chances of payment are drastically reduced. The likelihood of your claim receiving money from a bankruptcy case is dependent on many factors such as whether or not your claim is secured by a lien, how many other claims are filed, and what money or property is available to pay the creditors. Reviewing those factors with an attorney is a good way to determine what payment you can expect.
As society takes more protective measures against COVID-19, business closures and layoffs may result in an increase in bankruptcy cases. Even in this climate, a bankruptcy filing by a customer or related contractor does not mean that all hope for payment is lost. Given current events, it is especially important for construction businesses to keep up with accounts and be ready for the possible bankruptcy wave.
Disclaimer: The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.