Subcontractors dealing in New Jersey would be wise to pay close attention to a recent bankruptcy-related decision that will impact their ability to secure their accounts with construction liens. The United States District Court for the District of New Jersey affirmed a New Jersey Bankruptcy Court ruling that the filing of a construction lien postpetition, or after the filing of the bankruptcy case, pursuant to the New Jersey Construction Lien Law by a debtor's subcontractor against the real estate of a non-debtor, is a violation of the automatic stay imposed by section 362 of the Bankruptcy Code and is void. The Bankruptcy Court reasoned and the District Court agreed that although the real estate to which the lien attached is not the debtor's property, so-called property of the bankruptcy estate, the account receivable that the non-debtor property owner owed to the debtor for construction work is property of the estate and under the control and supervision of the Bankruptcy Court. Therefore, the courts determined that the act of filing the construction lien after the contractor filed for bankruptcy was an act to control property (the account receivable) of the estate because the amount of the construction lien is limited and determined by the amount owed by the property owner to the debtor.
The debtor, Linear Electric Company, Inc., is an electrical contractor that filed a voluntary petition for relief under the Bankruptcy Code on July 1, 2015. Cooper Electric Supply Co. and Samson Electric Supply Co., Inc. are suppliers that each supplied certain of their electrical materials to the debtor on account, which materials were subsequently incorporated into non-debtor third-party properties. As of the bankruptcy filing date, the subcontractors were owed more than $1.3 million in the aggregate for unpaid materials by the debtor.
Given that the imposition of the "automatic stay" prevented the claimants from seeking payment from the debtor for the materials after the bankruptcy filing, the claimants each filed construction liens totaling approximately $1.1 million in the aggregate against certain third-party properties, securing the claimants' ability to collect from the non-debtor third parties for a large majority of their unpaid materials as provided by N.J.S.A. 2A:44A-1, et seq. ("Construction Lien Law"). The claimants turned to the Construction Lien Law to secure payment for their materials because their construction liens "attach to the interest of the owner in the real property" where the materials were used. N.J.S.A. 2A:44A-3(a). The debtor filed a motion with the Bankruptcy Court seeking an order directing the claimants to discharge their construction liens, arguing the liens were a violation of the automatic stay provisions of 11 U.S.C. §362 and should be discharged. The debtor's motion to discharge was granted by an order in which the Court held the construction liens against the third-party properties were void and set aside as a violation of the automatic stay. Claimants appealed to the District Court for the District of New Jersey.
The District Court affirmed the Bankruptcy Court decision, first explaining that although Bankruptcy Code section 362 prevents actions to enforce liens against property of the debtor's estate, property of the debtor's estate is a broad concept that includes all legal or equitable interests of the debtor in property. Then the District Court pointed out that under construction lien law, the value of the claimants' liens on the third-party properties is determined solely by the amount the debtor owes to the claimants because the statute "limits the amount of the lienholders' claim, as well as the funds from which that claim may be paid, respectively, to the amount the debtor owes to the lienholder under their contract and to the accounts receivable the owners of the third-party properties owe to the debtor under their contract." Thus, the District Court held that the accounts receivable from which the third parties would pay the claimants' lien claims were technically property of the debtor's estate and protected from the imposition of construction liens under section 362.
The Linear Electric decision poses new risks for New Jersey construction creditors seeking to collect on claims for materials supplied to companies that file bankruptcy prior to paying for the materials. While most construction creditors could formerly seek solace in the exact argument advanced by the claimants in this case, the District Court's decision confirms that the concept of property of the estate is, indeed, a far-reaching one, with new implications providing the utmost deference to the estate. In light of this new ruling, New Jersey subcontractors should think twice before supplying materials to contractors on account.
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