Mechanics Lien Claim in Bankruptcy

Introduction

To a lawyer not practicing steadily in the construction area, the mechanics lien law presents pitfalls. Add the complexities of the Bankruptcy Code, and counsel can use guidance. The present article covers one point only: perfection of the mechanics lien in accordance with state law remains necessary and is permissible after owner files bankruptcy. This point is critical. Much is simplified if this point is understood.


Typical Fact Pattern

       We assume the following: (1) only one general contractor is involved; (2) the owner has recorded no "notice of cessation" under Civil Code §3092; and (3) the owner has recorded no "notice of completion" under Civil Code §3093. If either notice has been recorded, the contractor's time for recording a claim of lien would have begun to run upon recordation of that notice, and not upon "completion" of the job. ("Job" is common parlance for the "work of improvement" defined in Civil Code §3106.) "Completion" is defined in Civil Code §3086.

       General contractor completes the job, which starts the running of the 90-day period for perfection of the mechanics lien by the recording in the office of the county recorder of a document named "claim of lien."

       It is helpful to view the mechanics lien process as a three-step process. Step one is creation of the lien, which occurs upon contribution of labor or materials to the project. All mechanics liens have the same priority, based on the moment when the first contractor or supplier provides labor or materials for the job. Simons Brick Co v Hetzel, 72 Cal App 1, 236 P 357 (1925); see also Westfour Corp v California First Bank, 3 Cal App 4th 1554, 1563, 5 Cal Rptr 2d 394, 399 (1922). Upon delivery of a load of pipe or turning of a spade of earth, the "mechanic" obtains the right to be paid eventually, if necessary, out of the value of the real property benefitted. However, this right is an "inchoate" or unmatured, "unperfected" right.

       The second step is perfection. This is accomplished by recording a claim of lien in the county recorder's office. This gives notice to potential purchasers or encumbrancers that the claimant would be entitled to prior payment out of proceeds of liquidation of the property.

       The third step is enforcement of the lien by a lawsuit to foreclose the lien. No foreclosure is possible without perfection. If you have omitted step two, you can forget step three.

       Suppose that after completion of the job and during the 90-day period within which contractor must record a claim of lien, the property owner files a bankruptcy petition. Contractor has not yet recorded its claim of lien. Bankruptcy Code §362 (a) (4) provides that upon the filing of a bankruptcy petition, an automatic stay or freeze prohibits "any act to create, perfect, or enforce any lien against property of the [bankruptcy] estate." Assume that property of the estate includes the property to which contractor supplied value. The automatic stay or breathing spell is a major benefit to debtor under the Bankruptcy Code. Violation of the automatic stay can subject the contractor to a sanction by the Bankruptcy Court. The dilemma is how to observe the 90-day time limit under state law while respecting the automatic stay under the federal Bankruptcy Code.


Authorization of the Perfection after the Bankruptcy Filing

       Bankruptcy Code §362(b) (3) clears the roadblock. By reference to Bankruptcy Code §546(b), §362(b)(3) permits the contractor to record the claim of lien. Bankruptcy Code §546(b) says that any perfecting that would be regarded under state law as a pre-bankruptcy step, that is, a post-bankruptcy step that "relates back" in time to pre- bankruptcy, is permissible. Under California law, the recording of a claim of lien relates back in time to the first delivery of pipe, turning of earth, or other provision of labor or material. So Bankruptcy Code §546(b) permitsthe contractor to record a claim of lien even after the filing of the bankruptcy petition, which the petition otherwise freezes a whole ariay of actions by the creditor against the debtor in bankruptcy. The significance of the perfection cannot be overstated. It makes the difference between being a secured creditor and being an unsecured creditor in bankruptcy.


Time Limit on Filing the Claim of Lien

       The period for recording a lien under state law remains effective in bankruptcy. Suppose the job is completed on September 15th. The 90-day period for recording the claim of lien will expire on December 14th. Bankruptcy is filed on December 1st. Fourteen days remain in the period. While Bankruptcy Code §546(b) permits the contractor to record a claim of lien after December 1st, it does not say that the time to record it lasts forever. The time limit is established by Civil Code §3115. The contractor has only the same fourteen days.

       In re Paul Potts Builders, Inc, 608 F2d 1279 (9th Cir 1979) and Gayle Manufacturing Co v Federal Savings & Loan Insurance Corp, 910 F2d 574 (9th Cir 1990) hold that a contractor who fails to enforce on time has consolation. Those cases relate to a different 90-day period. In Potts and Gayle, contractor timely perfected its lien. After timely petfection, a second 90-day period begins to run under Civil Code §3144. The second 90-day period measures the time within which an enforcement action must be commenced.


Work or Materials Supplied Both Pre- and Post-Petition

       What happens if part of the contractor's work was performed before the date of filing, of the bankruptcy petition (pre-petition) and part was post-petition? For example, on January 1, work started. On March 1, the owner filed bankruptcy, and on March 15, the contractor recorded its claim of lien. Is the contractor limited to the pre-petition value in stating the lien amount in the claim of lien? No. Contractor may include the value of the post- petition work. The Bankruptcy Code permits it if work on the project was started pre-petition.

       If the mechanics lien is created pre-petition, it may be perfected post-petition. However, a mechanics lien may not be created post-petition. The §546(b) exception is only for perfection. The §362 (a) (3) prohibition on any act to create a lien retains its force despite §362 (13) (3) and §546 (b).


Work or Materials Provided Only Post-Petition

       Contractor providing only post-petition value may request that its debt be classified as an administrative expens of the bankruptcy estate. This would entitle contractor's claim to priority unsecured status, but not secured status, and the deadlines discussed above in connection with mechanics liens are not applicable. Contractor should file a motion in Bankruptcy Court making the administrative expense request as early as possible.

       The Bankruptcy Code establishes priorities for certain expenses and claims paid by the bankruptcy estate. 11 USC §507. Under §507, first priority is enjoyed by administrative expenses allowed under §503, including "the actual, necessary costs and expenses of preserving the estate." 11 USC §503(b) (1) (A) (emphasis added). Common examples of administrative expenses are rent and salaries paid by a Chapter 11 debtor as it attempts to reorganize. However, bankruptcy courts have broad discretion in determining whether to award administrative expense priority. In re Dant & Russell, Inc, 853 F2d 700, 707 (9th Cir 1988). Dant & Russell denied a lessor administrative expense priority for environmental cleanup costs because the debtor was a tenant, thus the benefitted property was not owned by the bankruptcy estate. The court said "NI uite a different result, however, is warranted when cleanup costs result from monies expended for the preservation of the bankruptcy estate." Id 709 (citing cases). In In re Blumer, 95 BR 143 (9th Cir BAP 1988), the Bankruptcy Appellate Panel affirmed the Bankruptcy Court's determination that an asphalt supplier was entitled to administrative expense status for its post-petition extension of credit to debtor, a road building contractor. See also In re Transamerican Natural Gas Corp, 978 F2d 1409 (5th Cir 1992) (Bankruptcy Court correctly held that post- petition supplier of well casings to debtor had met its burden of proving benefit of estate); In re Pioneer Acceptance Corp, 110 BR 314 (Bankr SD Ohio 1990) (granting administrative expense status to lumber supplier for framing packages delivered to three job sites post-petition, even though the materials were never incorporated into a structure).


Summary and Conclusion

       Bankruptcy can require contractor to harmonize provisions of state mechanics lien laws with provisions of the Bankruptcy Code. Contractor is permitted to record a claim of lien after the filing of the bankruptcy, but not after the 90-day period established by California Civil Code §3115.

This article originally appeared in
Mc Graw Hill Shepard's
California Construction Law Reporter
March 1994, Pages 29-30.