When a Project Goes Awry and You Want to Collect: Real World Advice for the Construction Industry

In the past 12 months, forecasts have suggested that an economic downturn may be coming based on the interplay of historic interest rates, inflation, volatility in the stock market, high corporate and consumer debt and tightening of bank lending, among others.

In response to these headwinds, we see a few trends in the construction industry:

• Owners and general contractors are slow to pay for projects.
• There is an increased focus on lien filings and collections.
• There is a potential increase in Chapter 11 bankruptcy filings.

What does this economic landscape mean for general contractors, subcontractors, sub-subcontractors and suppliers in a construction project?

They are turning to construction liens and payment bonds to get paid by the project’s owner. There are risks and benefits to these methods.

Keep in mind:

• A construction lien can only be placed on a property where the work has been done. If you are pursuing a construction lien, keep track of the specific address and/or legal property description of where the work was done.
• It is important to identify and verify the parties involved in the construction contract. Make sure the people who sign the contracts have the authority to bind the respective parties — to avoid invalid liens.
• As a contractor, double check that you are properly licensed to do the work and that your subcontractors are as well, or it could be impossible to recover payments under state law.
• In Alabama, if a contractor is not licensed, their contract can be void.
• In Florida, contracts entered into after Oct. 1, 1990, by an unlicensed contractor are not enforceable.

Notice, Notice, Notice

The three essentials of any claim are: notice, notice and notice. States differ on how to give notice to the project’s owner on potential construction liens.

In Florida:

• It is crucial to file a notice of commencement before doing any construction work because this can affect whether your lien takes priority over other security interests.
• Make sure your notice of commencement includes all the required information and attachments, including attaching any payment bond.
• Notice is required for bond and lien claims of subcontractors and suppliers no later than 45 days after beginning to furnish labor, materials or supplies, or 45 days after the date the lienor is served with a copy of the bond (if the bond is not attached to the notice of commencement).

In Alabama:

• Subcontractors must give their notice of intent to lien if there was no notice given in advance of furnishing goods.
• If a subcontractor or supplier fails to give notice before starting work, they can still file a lien as an unpaid balance lien holder. This limits their recovery to the amount that remains unpaid to the general contractor at the time the lien is filed.
• Sending these notices as a matter of course can be beneficial. They are common enough in the industry that they shouldn't be viewed as adversarial or litigious but rather as a standard business practice to protect your financial interests.

In Texas:

• For original contractors, there is generally no pre-filing notice requirement.
• Subcontractors must provide a pre-lien notice to the property owner and the original contractor.
• The timing of the notice depends on the claimant's role and the type of work done. In general, it must be sent by the 15th day of the third month following each month in which labor was performed or material was delivered.

Claim of Lien in Florida

Otherwise known as a construction lien, a claim of lien in Florida must be recorded within 90 days from the last day of providing labor, services, or materials. The lien must include:

• A description of the services or materials provided,
• The total amount due,
• The name of the person or company who contracted the services or materials, and
• A description of the property.

Don’t forget: The lien has a specific duration and must be enforced through legal action, typically within one year from the filing date – or it expires.

Construction Liens in Alabama

Alabama recognizes two kinds of construction liens:

• A full price lien allows the claimant to recover the full contract price of the goods and services provided. General contractors typically have the right to a full price lien.
• An unpaid balance lien limits the claimant’s recovery to the unpaid balance due to the general contractor at the time the lien is filed. Subcontractors and suppliers typically are entitled to this type of lien unless they provide notice to the owner before commencing work.

Deadlines vary for filing these liens. The original contractor has six months to file, while laborers have 30 days. Everyone else has four months. Remember, you have six months to file a lawsuit to enforce the lien.

Construction Liens in Texas

In Texas, a construction lien is often referred to as a mechanic's and materialman’s lien (M&M lien). It must be filed with the county clerk's office in the county where the property is located. The deadline for filing the lien affidavit is typically the 15th day of the fourth month after the month in which the work was completed, terminated or abandoned.  For subcontractors, the deadline is the 15th day of the fourth month after the month the subcontractor last provided labor or materials.

Once filed, the lien must be enforced through a foreclosure action in court within two years from the last day a claimant could file the lien affidavit or within one year from the completion of the work under the original contract, whichever is later.

What are the Benefits of Construction Liens in Texas?

You are able to trap funds with the owner, who must pay the general contractor with those funds. In addition, state law allows for retainage, where a portion of the contract price is withheld until the work is substantially complete to ensure that the contractor or subcontractor fully completes the work.

Also, you can file a lien against a landlord against the leasehold interest. The lien attaches to any interest in removables that the tenant contracted to add to the property.  (The landlord can defeat such a claim by terminating the lease prior to foreclosure.)  With respect to liens in general, general contractors can remove all removables supplied to job, but subcontractors can only remove what they supplied – a court order is needed.

Bond Claims in Texas

Bond claims arise when a payment bond covers a construction project. These bonds are typical in public projects and in some private projects to ensure that subcontractors and suppliers are paid if the general contractor defaults.

• Public work projects: Must perfect the claim against payment bond. Subcontractors must mail notice to the prime contractor and surety on or before the 15^thday of the third month after each month in which labor was performed and materials were supplied.
• Private projects: Perfect the claim by satisfying the requirements of a lien claim. Or perfect the claim against the payment bond by giving the surety the same notices that you are required to send to the owner in a lien claim.

What About Bankruptcy?

This is an option for the owners, general contractors, subcontractors and suppliers of a failing construction project.

Other groups involved in the project – who are creditors – need to be aware of how a bankruptcy will affect their ability to collect the money they’re owed.

A good rule of thumb is to pay attention to certain things happening with your project. Taken together, these signs could show a bankruptcy may be coming:

• Lien filings, subcontractor demands, project delays
• Payment bond claims
• Payments outside the ordinary course of business
• Contractors or subcontractors requesting meetings or change orders
• A shift in the primary business focus
• Employees discussing cash-crunch issues or failing to show up for work
• Unavailability of key equipment
• Frequent layoffs
• Other indicators from daily monitoring services such as DebtWire

The assets in dispute include:

• Bonded contracts
• Undisbursed contract funds
• Debtor’s subcontracts/purchase orders with subcontractors and suppliers
• Equipment and inventory to complete the project

Once an owner files a bankruptcy petition, an automatic stay is imposed. The stay halts all collection activities, including the enforcement of liens and ongoing construction contracts. It provides the debtors some breathing room — as well as time to reorganize and allow access to cash. The stay is designed to preserve the debtor’s estate and prevent the chaotic dismantling of the debtor’s assets by individual creditors. It doesn’t apply to parties that are jointly and severally liable with the debtor.

Meanwhile, the property owned by the debtor must be turned over on demand.  The larger issue is what constitutes property of the debtor versus an owner, GC or bond company right to assert its own ownership interest in the property.  This issue is highly litigated in bankruptcy.

Assumption and rejection of contracts in bankruptcy is a powerful tool.  Generally, the debtor has no deadline to assume or reject a contract prior to confirmation.  This creates significant delays in seeking to terminate or enforce defaults under the contract.  Contractors, subcontractors and other creditors can file a motion to compel the debtor to decide whether to assume or reject the construction contract. This action helps clarify the debtor's intentions and can speed up resolutions and reduce the period of uncertainty for contractors and subcontractors involved in the project.

Prior to the debtor deciding on assumption or rejection, both parties are required to perform in the ordinary course of business (absent some post petition default by the debtor).  If the debtor assumes an executory contract, they can force the other party to continue work. The flip side is the debtor must also continue work. And the debtor must also cure all amounts in default. If the debtor rejects the contract, it will be treated as a breach and an unsecured claim for damages.  Lastly, a debtor has the right to assume and assign executory contracts, which may prove beneficial to a general contractor or bonding company seeking to preserve existing purchase orders or other agreements that are required for project completion.

Be aware of preferences, where certain payments made to creditors shortly before the bankruptcy filing can be clawed back by the bankruptcy trustee. It is often shocking to learn you must pay money back when the debtor unquestionably owes you money.  Bonding companies must pay close attention to the concept of “indirect preferences” whereby the bonding company made payment to a supplier within 90 days of a contractor’s bankruptcy, and the debtor/trustee seeks repayment from the bonding company as being an avoidable transfer of the debtor (i.e. the supplier would have been just a creditor in the bankruptcy case).

Should You Continue to Work with the Debtor in Bankruptcy?

It depends. Think about these issues below before you come to a decision.

• Debtor’s cash position to pay admins.
• Will the debtor get a cash infusion through debtor-in-possession (DIP) financing?
• Does the DIP/cash collateral budget state there is money to pay ongoing operations?
• What are alternative sources of supply for current projects?
• What are the contract counter-performance issues?
• What do I do if the debtor fails to pay me post-petition in the ordinary course of business? File a motion for an administrative claim.

Please contact Winston R. Grow, Marcus R. Tucker, Rick M. Shelby or any member of the Phelps Bankruptcy and Reorganization and Construction/Design teams if you have questions or need advice or guidance.