WHAT TO DO WHEN A PARTY ON A CONSTRUCTION PROJECT GOES BANKRUPT

1. INTRODUCTION ........................................................1
2. SCOPE OF DISCUSSION .................................................1
3. THE BASICS ............................................................2
4. WHAT YOU CAN DO TO BECOME INFORMED ...........................2
1. Notice of Appearance ...............................................2
2. Meeting of Creditors ................................................3
3. SO, WHAT DO YOU DO WHEN A PARTY ON A CONSTRUCTION PROJECT GOES BANKRUPT? .....................................3
5. PROOF OF CLAIM .......................................................4
1. The Need to File a Claim ............................................4
2. The Time for Filing .................................................4
3. Filing a Claim is Consent to Jurisdiction ..............................5
4. SO, WHAT DO YOU DO WHEN A PARTY ON A CONSTRUCTION PROJECT GOES BANKRUPT? .....................................6
6. THE AUTOMATIC STAY .................................................6
1. The Bankruptcy Code Provisions .....................................6
2. When Does the Stay Apply? ..........................................7
3. To What Acts Does the Stay Apply? ..................................7
4. Violations of the Stay ...............................................8
5. The Co-Debtor Stay .................................................8
6. Motion Practice and Local Rules .....................................9
7. SO, WHAT DO YOU DO WHEN A PARTY ON A CONSTRUCTION PROJECT GOES BANKRUPT? .....................................9
7. DEALING WITH THE CONSTRUCTION CONTRACT .....................10
1. Exercise of Contract Rights Might Violate the Stay ....................10
2. The Executory Contract ............................................10
3. The Terminated Contract ..........................................11
4. Assumption of the Contract .........................................11
5. SO, WHAT DO YOU DO WHEN A PARTY ON A CONSTRUCTION PROJECT GOES BANKRUPT? ....................................11
8. CONTRACT PROCEEDS – ARE THEY OR AREN’T THEY PROPERTY OF THE ESTATE? ......................................................12
1. Property of the Estate ..............................................12
2. Trust Funds ......................................................12
3. Joint Checks ......................................................13
4. Favorable Contract Terms and Set-Off ...............................13
5. Recoupment ......................................................14
6. Options for Owners or General Contractors ..........................14
7. SO, WHAT DO YOU DO WHEN A PARTY ON A CONSTRUCTION PROJECT GOES BANKRUPT? ....................................15
9. MECHANIC’S LIEN - PERFECTION AND ENFORCEMENT ...............16
1. How it Appears ....................................................16
2. Relation Back and Perfection .......................................16
3. Enforcement of Liens is Stayed ......................................16
4. SO, WHAT DO YOU DO WHEN A PARTY ON A CONSTRUCTION PROJECT GOES BANKRUPT? ....................................17
10. SURETY’S RIGHTS AND OBLIGATIONS .................................17
1. Bankruptcy and Bonds .............................................17
2. The Equitable Lien ................................................18
3. Priority to Retainage and Perhaps Progress Payments .................18
4. Surety’s Options ...................................................18
5. SO, WHAT DO YOU DO WHEN A PARTY ON A CONSTRUCTION PROJECT GOES BANKRUPT? ....................................19
11. NONDISCHARGEABILITY UNDER SECTION 523 ........................19
1. No Discharge for Corporations ......................................19
2. Fraud Claims .....................................................19
3. Chapter 13 Discharges Fraud .......................................20
4. The Trust Fund and Fiduciary Capacity ..............................20
5. Fraud in the Pay Applications of Subs and Vendors ....................20
6. Evaluate the Cost Effectiveness ......................................20
7. SO, WHAT DO YOU DO WHEN A PARTY ON A CONSTRUCTION PROJECT GOES BANKRUPT? ....................................21
12. CONCLUSION ..........................................................21

Appendix "A" Notice of Appearance and Request for Notices.

Appendix "B" Proof of Claim (Chapter 7 and 11).

Appendix "C" Local Rule 4001 of Southern District of Texas.

Appendix "D" Cover Sheet for Motion for Relief from Stay in Souther District of Texas.

Appendix "E" Excerpt of contract language as discussed by the Fifth Circuit in United Parcel Service. 794 F.2d at 1008 (1986).

Appendix "F" An example of some contract terms helping establish that a debtor/contractor with unpaid claimants is not entitled to contract proceeds.

Abstract

The construction industry is known for its volatility. It is sensitive to even slight changes in the local and national economy. Even in times of economic stability construction contract defaults occur with some degree of frequency. Such defaults become far more frequent when a project is impacted by a weak local or national economy.

The typical construction project begins with a contractual relationship between a general contractor and the owner. Soon, numerous other parties are involved, with the owner making arrangements with one or more lenders, and the general contractor having one or more tiers of subcontractors, sub-subcontractors and respective suppliers under it. The claims or defaults of any one of these entities will present unique problems for the others, especially in the bankruptcy context. This is true because such claims or defaults typically implicate the rights and obligations of the other parties in the construction contract chain.

The financial interests of the contractors (at all tiers) and the suppliers are sometimes protected by state law, surety bonds and/or non-bankruptcy federal law. The non-bankruptcy rights and entitlements often are interpreted, litigated, and adjudicated in the bankruptcy case, thereby adding to the complexities that arise when a party in the construction contract chain files bankruptcy. A lawyer acting for one of the parties in the construction contract chain must know what to do when a party on a construction contract goes bankrupt.

There can be no doubt that the filing of bankruptcy by a party on a construction project will, in the best case, cause many complications, and in the worse case result in liability to some to make double payments, sanctions for conduct in violation of bankruptcy laws and a general nightmarish existence for the sureties and owner on the project. Fortunately most cases fall between these two extremes and are entirely manageable so long as the parties have some familiarity with bankruptcy laws and their implications and heed them. By becoming and remaining informed of events and developments in the bankruptcy proceeding and developing at least a basic understanding of the relative rights of the respective parties associated with the bankruptcy case – even if that understanding comes from consultation with bankruptcy specialists – a construction lawyer will be able to assist his client in determining what to do when a party on a construction project goes bankrupt.

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