Procrastinators Programs SM

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1 Procrastinators Programs SM The Relationship between Bankruptcy and Construction Law Frederick L. Bunol The Derbes Law Firm Melanie M. Mulcahy The Derbes Law Firm Course Number: Hour of CLE December 17, :10 am 11:10 am

2 New Orleans Bar Association 2014 Procrastinators CLE The Relationship between Bankruptcy and Construction Law By Melanie M. Mulcahy and Frederick L. Bunol December 17, :10 11:10 a.m. Biography for Frederick L. Bunol: Mr. Bunol is a member of The Derbes Law Firm, LLC where he has practiced for the past ten years. He obtained the degree of B.S. in Finance from Louisiana State University in 2000 and his J.D. from Louisiana State University in His practice areas include bankruptcy, construction, real estate, and commercial litigation. He has had the privilege of representing Chapter 7 Trustees, Chapter 11 Debtors, unsecured creditors committees, and unsecured creditors in the bankruptcy and construction law context. Biography for Melanie Mabile Mulcahy Melanie Mabile Mulcahy is a member of The Derbes Law Firm, L.L.C., where her main practice areas include commercial litigation and transactions, construction law, bankruptcy law, entity law, and employment law. She represents clients across the construction spectrum, including owners, contractors, subcontractors, and materialmen, in connection with construction, collection, bankruptcy, and other commercial matters. She received a BA degree in 1994 from Tulane University's Newcomb College and her JD degree in 1999 from Louisiana State University Paul M. Hebert Law Center. Ms. Mulcahy is a member of the Louisiana State Bar Association, American Bar Association, and Jefferson Bar Association. Ms. Mulcahy previously served in several capacities with the Louisiana State Bar Association, including as Chair of the Young Lawyers Section from , and with the American Bar Association.

3 New Orleans Bar Association 2014 Procrastinators CLE The Relationship between Bankruptcy and Construction Law By Melanie M. Mulcahy and Frederick L. Bunol December 17, :10 11:10 a.m. I. Identify the players in and navigate the bankruptcy process A. Chapter 7 Proceeding Liquidation for businesses and individuals. In a Chapter 7 proceeding, a panel Trustee is appointed by the US Trustee to administer the bankruptcy estate. The Debtor has little to no involvement in the process once the bankruptcy has been filed and the 341 meeting has been conducted. The person who has authority to make decisions concerning property of the bankruptcy estate is the Chapter 7 Trustee appointed to the case. The name of the Chapter 7 Trustee and his counsel can be located by reviewing the docket report of the case in PACER. Contact the Trustee or Trustee s counsel if you have questions about a Chapter 7 bankruptcy proceeding. The Chapter 7 Trustee has a duty to investigate all claims and collect all assets of the bankruptcy estate, including accounts receivable. If you or your client receives a letter from the Chapter 7 Trustee, please cooperate and provide the information that has been requested. If you fail to cooperate, the Chapter 7 Trustee can subpoena the information or set a deposition pursuant to Bankruptcy Rule B. Chapter 11 Proceeding Reorganization, generally for a business, but individuals may also file under Chapter 11. In the majority of Chapter 11 proceedings, the Debtor (Debtor in Possession) continues to manage the affairs of the Debtor and transact business, provided it is in the ordinary course of Page 1 of 7

4 business. The Debtor may need authority of the Court to perform certain functions, including those that are not within the ordinary course of business. Contact the Debtor or Debtor s counsel with any questions about a Chapter 11 proceeding. Before entering into a contract with a Chapter 11 Debtor, check to make sure Court approval is not required. If your client is a real estate agent, accountant, attorney, appraiser, auctioneer or other professional, make sure the Court has authorized the hiring of your client pursuant to section 327. If not, there is a risk that the Debtor will not have authority to pay your client. C. Chapter 13 Proceeding Reorganization for individuals. (Not likely to deal with this Chapter in the construction context.) The Debtor maintains control over property of the bankruptcy estate. II. Identify property of the bankruptcy estate and avoid pitfalls of the automatic stay A. Property of the Bankruptcy Estate (11 USC 541) The commencement of a bankruptcy under any title creates an estate. The estate is comprised of all the property, wherever located and by whomever held, and includes all legal and equitable interests of the debtor in property as of the commencement of the case. Property of the Estate is more fully set forth in 11 USC 541(a), but basically includes any and all assets owned by the debtor as of the date the bankruptcy is filed. Property of the Estate excludes property held by the debtor in trust for the benefit of another. 11 USC 541(b)(1),(d). Material and tools that are owned by the debtor are property of the bankruptcy estate and should be turned over to the Trustee/Debtor in Possession. The general contractor or owner cannot and should not prevent the Trustee or the Debtor in Possession from recovering the material and tools that are property of the estate. As soon as possible after the bankruptcy filing of any party on a construction site, it is advisable to conduct an analysis of which materials and tools are property of the bankruptcy estate and which ones are excluded as property held for another. Each party Page 2 of 7

5 must also give special consideration to the status and ownership of materials stored on or off the jobsite but not yet incorporated into the project. B. The Automatic Stay (11 USC 362) A bankruptcy filed under any chapter evokes the protection of the automatic stay. The automatic stay operates as a stay of the following: (1) the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title; (2) the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case under this title; (3) any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate; (4) any act to create, perfect, or enforce any lien against property of the estate; (5) any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under this title; (6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title; (7) the setoff of any debt owing to the debtor that arose before the commencement of the case under this title against any claim against the debtor; and (8) the commencement or continuation of a proceeding before the United States Tax Court concerning a tax liability of a debtor that is a corporation for a taxable period the bankruptcy court may determine or concerning the tax liability of a debtor who is an individual for a taxable period ending before the date of the order for relief under this title. In the construction context, the automatic stay will affect: i. How lien rights are preserved under the Private Works Act and the Public Works Act; ii. Enforcement of any contract against the debtor. (The automatic stay does not prevent the debtor from enforcing its contractual rights against another party other than the debtor.); Page 3 of 7

6 iii. iv. The ability to setoff amounts due to the debtor; and The ability to collect money from the debtor. III. Identify key issues relative to preserving claims and privileges under state law and in bankruptcy proceedings A. Privileges and Preservation of Privileges Pursuant to La. R.S. 9:4801 et seq., (the Private Works Act ), and La. R.S. 38:2242, (the Public Works Act ) a claimant must timely file a statement of claim, notice of lis pendens, and lawsuit to preserve its rights against the owner or surety. On its face, the automatic stay prohibits a claimant from filing the lien, notice of lis pendens, and lawsuit required to perfect a claim under the Private Works Act and Public Works Act. Fortunately, section 362(b)(3) and section 546(b) authorize a claimant to file a statement of claim to perfect its claim under the Private or Public Works Act without violating the automatic stay. In re Constr. Supervision Servs., Inc., 753 F.3d 124, 126 (4th Cir. 2014); Collier on Bankruptcy P [5]. Section 546(b)(2) facilitates postpetition perfection by providing for perfection, or continuation or maintenance thereof, by notice to the trustee in situations in which applicable law requires perfection, or continuation or maintenance thereof, to be accomplished by seizure of property or the commencement of an action, and the property has not been seized or an action has not been commenced prior to the filing of the bankruptcy petition. The interest holder must give the trustee notice within the time fixed by the applicable law for seizure or commencement of an action Collier on Bankruptcy P [3] (citations omitted). Notice is sufficient for purposes of section 546(b)(2) if it makes clear that the interest holder intends to enforce its interest in property. Some courts have held that the filing of a pleading, such as a notice of claim to collateral or motion for relief from stay, constitutes proper notice. However, other courts have held that "notice" requires a level of action beyond simply filing a Page 4 of 7

7 proof of claim. Generally, enforcement of a lien by filing a complaint has been held to violate the stay and, therefore, cannot be used as notice under section 546(b)(2) Collier on Bankruptcy P [3] (citations omitted). Although the notice requirement is effective in bankruptcy court, the idea of not filing suit raises concern for many practitioners because there is a multitude of events that could take place that would potentially jeopardize the privilege filed under the Private or Public Works Act, if a lawsuit is not filed timely. For example, what are the ramifications if the bankruptcy case is dismissed after the delays have run to file suit and file a Notice of Lis Pendens under the Private or Public Works Acts? This will put the claimant before a State Court Judge arguing that he properly perfected the lien by giving the Trustee notice under section 546(b)(2) of the bankruptcy code. The argument may not be convincing to a State Court Judge when the Louisiana Courts have held that lien statutes are construed stricti juris (strictly construed). State through Div. of Admin. v. McInnis Bros. Constr., (La.10/21/97), 701 So.2d 937. There is no right answer to this problem, and the answer will differ depending on who filed bankruptcy, but it is advisable to take all precautionary measures, which would include some or all of the following actions: 1. Filing the statement of claim in the manner set forth in the Private and Public Works Act, whichever is applicable; 2. Give Notice to the Trustee pursuant to section 546(b)(2) to perfect, continue or maintain the privilege; 3. File a Motion to Lift the Automatic Stay for the limited purpose of naming the debtor in a lawsuit and preserving lien rights or timely file an Adversary Proceeding; and Page 5 of 7

8 4. Timely file a Proof of Claim in the bankruptcy proceeding. B. The Defense of Setoff Setoff is a violation of the automatic stay and should not be done without first filing a Motion to Lift the Automatic Stay for that purpose. 11 USC 362(a)(7). Further, be aware that under section 553, both obligations must arise before commencement of the case for setoff to be applicable and there must be mutuality between the parties. IV. Identify effects of bankruptcy on contractual rights. A. In a Chapter 7, unless the Trustee assumes executory contracts and leases within 60 days of the bankruptcy being filed, all executory contracts and leases are deemed to have been rejected immediately prior to the bankruptcy filing. 11 U.S.C.A. 365(b),(d)(1) and (g). B. In a Chapter 11, the debtor has until the plan is confirmed to accept or reject executory contract and leases. Any executory contract or lease that is accepted must be cured. 11 U.S.C.A. 365(d)(2). C. Stop Work Rights: Will the debtor assume or reject the contract? In a Chapter 7, the executory contract will likely be rejected, while in a Chapter 11, it may need to be determined whether the debtor intends to assume or reject the executory contract. On the request of any party to such a contract, the Court may order the trustee/debtor to determine within a specified period of time whether to assume or reject such contract. 11 U.S.C.A. 365(d)(2). Therefore, out of an abundance of caution, it may be advisable to seek such an order from the bankruptcy Court prior to stopping work on the project. D. Pay If Paid/Pay When Paid Clause Considerations: Consider the effect of the bankruptcy proceedings on the ability to be timely paid and the result vis-à-vis lower tier contractors and materialmen. In pay-if-paid contracts, the bankruptcy or insolvency of the payor Page 6 of 7

9 party negates the payee party s right to payment. Consider the potentially devastating effects on the payee party if its subcontracts or terms with its materialmen do not include similar pay-if-paid provisions. Remember that payment in pay-when-paid contracts must still be made by the payor to the payee within a reasonable time, irrespective of whether the payor has been paid. Rather, the better reasoned view is that the provisions create terms for payment which at most retard the execution of the contractor's obligation for a reasonable time. See, for example, S. States Masonry, Inc. v. J.A. Jones Const. Co., 507 So. 2d 198 (La. 1987).Therefore, the bankruptcy or insolvency of the payor does not negate the payee s right to payment. V. Address demands by the bankruptcy trustee for return of preferential payments A. Preferences Under Section 547 If your client receives money from the Debtor within 90 days prior to the filing of bankruptcy, they may receive a letter from the Trustee requesting the money be returned to the Debtor. In the event you or your client receives a letter from the Chapter 7 Trustee, demanding return of a preferential payment, there are several defenses that may be available, including the new value defense, the contemporaneous exchange defense, and the ordinary course defense. The best course of action is to cooperate and provide the information that has been requested. If you fail to cooperate, the Chapter 7 Trustee may subpoena the information or set a deposition pursuant to Bankruptcy Rule Page 7 of 7