In a recent opinion, the Third Circuit Court of Appeals held that the automatic stay of claims against a bankrupt contractor barred the filing of an electrical supplier’s NJ construction lien against the project real estate. The decision points out how differences between state lien statutes can affect the rights of lien claimants where a bankruptcy has been filed.
In In Re Linear Electric Company, Inc., a prime electrical contractor filed a bankruptcy petition. After the petition had been filed, two electrical suppliers to the bankrupt contractor filed New Jersey Construction Liens against real estate which had been improved with the electrical material supplied by the two lien claimants. The bankrupt contractor moved to dismiss the liens as having been filed in violation of the automatic stay of claims imposed when a bankruptcy is filed, even though the lien claims were asserted against real property owned by the project owner, not directly against the bankrupt contractor.
The Court held that the liens violated the automatic stay. It reasoned that even though the liens were asserted against real estate owned by a non-bankrupt party, under the New Jersey Lien statute, the liens functioned as a claim against the accounts receivable of the bankrupt electrical contractor in that if the liens were paid, the project owner would not have to pay the bankrupt contractor. This would be to because, under the New Jersey Lien statute, construction liens are assessable only up to the amount of a “Lien Fund”, consisting of all unpaid contract balances at the time the lien is filed. Thus, under New Jersey law, payment of a lien by the project owner would be subtracted from the Lien Fund and therefore also from the account receivable of the bankrupt contractor, violating the bankruptcy automatic stay of claims against that company.
Had the project in this case been located in Pennsylvania, there would have been a different result, for several reasons. First, as the Court in In re Linear Electric noted, under the Pennsylvania lien statute, the priority of a mechanic’s lien relates back to the first visible commencement of work on the project (not the date of the lien filing) and therefore would not have violated the automatic stay of claims filed after the bankruptcy filing. Thus, if this project had been located in Pennsylvania, the priority of the liens filed would have related back to a time period before the bankruptcy had been filed. The Court noted that in at least one prior case (In re Yobe Electric, Inc.) the Third Circuit had allowed a Pennsylvania lien filed after a bankruptcy to proceed because it related back to a time period before the bankruptcy had been filed.
Second, unlike the New Jersey Lien Statute, there is no “Lien Fund” in the Pennsylvania lien payment allocation process. Amounts owed to lien claimants do not typically depend on the amount of unpaid contract balances. In other words, in Pennsylvania an owner of liened real estate can be required to pay a subcontractor lien claimant, even if it has already paid the general contractor. Thus, in Pennsylvania, a lien claim against an owner of real estate is not the equivalent of a claim against a prime contractor’s accounts receivable.
In re Linear Electric points out the importance to a second tier lien claimant of understanding how the mechanic’s lien process works in the state of filing when the project general contractor has previously filed for bankruptcy.
Andrew B. Cohn can be reached by email at firstname.lastname@example.org or via phone at 610-941-2549.