How Bankruptcy in Construction Impacts All Parties, Part 2 - September 2022

Fri, Sep 16, 2022 at 8:00AM

Trent Cotney, Partner, Adams and Reese, LLP

As discussed earlier in Part One of this article (FRM August 2022), bankruptcy filings in the construction industry can impact everyone involved in a project. From the property owner to the general contractor to the subcontractor, trades and beyond, all parties will likely worry about whether the project will continue and how everyone will be paid.

No matter what your role is in a construction project, it is critical that you know your rights and can protect yourself if another party enters bankruptcy. This article will describe what protections you have and what you can put in place.

Creditor Claims

Once a party files bankruptcy, creditors who request a payment distribution must file a proof of claim. The deadline for that claim is called the bar date. The creditor must complete the proof of claim form, sign it and attach all supporting documentation. If the bar date has passed, a creditor will face difficulty asserting a claim for debts. Claims are usually classified by four terms:

Secured: This type of claim is secured by collateral or a lien against specific personal or real property. A common example is the mortgage a person has on a home. In construction, a claim from a contractor, subcontractor or consultant can be secured by a perfected mechanics’ lien against real property.

Administrative: This type of claim is filed by a lawyer, accountant or another professional who provided services after bankruptcy was filed.

Priority: This is an unsecured claim for specific benefits or unpaid wages not to exceed $4,650 per claimant. It also applies to some taxes, consumer deposits and alimony.

General unsecured: This claim pertains to everything not considered secured or priority. One example is payment owed to a material supplier or vendor.

When a party files for Chapter 11 bankruptcy, it reorganizes and continues to operate its company. After filing, the debtor is then labeled a debtor-inpossession (DIP) since it still possesses its company and assets. A committee of its creditors is often formed to monitor the DIP’s business and negotiate a reorganization. After a plan is confirmed, the DIP and its creditors consider it a new contract, which supersedes all others. The DIP is then relabeled as a reorganized debtor. Usually, the plan stipulates payments to unsecured creditors over several years. It also includes provisions if the reorganized debtor does not make the agreed-upon payments.

If the DIP and the committee cannot agree on a reorganization plan, the issue may go before a court. In some cases, the bankruptcy judge may convert the case to a Chapter 7 filing. That means the debtor will have to liquidate.

After a Chapter 7 filing, the debtor’s assets are liquidated and the creditors are paid based on a specific hierarchy. First, secured creditors have legal rights to named assets, so they receive the items held as collateral or they receive funds from their sale. Next, administrative parties, such as attorneys, accountants and other professionals who provided post-bankruptcy services, receive payment. After that, payments are provided to unsecured creditors, such as pre-bankruptcy vendors and consultants and those with pre-bankruptcy wage claims. Read more.

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