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The Relationship Between the New Jersey Construction Lien and Federal Bankruptcy Law

worried-30148__340-217x300In the case of In re Linear Electric Company, Inc., the Third Circuit was presented with whether construction liens filed by a supplier under New Jersey law were valid and enforceable against a contractor who filed a petition for Chapter 11 bankruptcy protection prior to when the construction liens were filed.

New Jersey’s Construction Lien Law, N.J.S.A. §2A:44A, et seq., provides contractors, subcontractors, and suppliers with the right of filing a lien for work, services, or materials provided pursuant to a written contract.   These protections are limited based on several factors including but not limited to whether the person or entity filing the construction lien is defined as a “claimant” under New Jersey’s Construction Lien law, what the unpaid portions of the contract price is, and compliance with strict time restrictions for filing the lien itself and a subsequent lawsuit based on the lien.

Under the Federal Bankruptcy Code, a debtor who files for bankruptcy is afforded the relief of an automatic stay that prevents most collection actions from continuing including acts to create, perfect, or enforce liens against property.  The protections of an automatic stay are broad and expansive but do include several expectations and limitations for certain debts.

These competing interests, rights, and protections were at stake in In re Linear Electric Company, Inc.  The Third Circuit ultimately held that construction liens under New Jersey Construction Lien law filed after the bankruptcy was filed violate the protections afforded by the automatic stay and are therefore unenforceable.  The Third Circuit reached its conclusion because the Court found that the contractor’s accounts receivable, which would have been used to pay the supplier pursuant to the construction lien, was part of the bankruptcy estate and protected by the automatic stay.  The Court was also persuaded by the fact that the other creditors of the contractor would suffer if the supplier’s construction lien was allowed to proceed.  Therefore, the supplier was limited to receive what it could as an unsecured creditor in the contractor’s bankruptcy.

The Court’s decision aligned with the purpose of bankruptcy’s automatic stay in a Chapter 11 or 13 bankruptcy, which is to give breathing room to the debtor for the development of a repayment plan.  It also allows for a fair and equitable repayment plan that does not discriminate or harm other creditors – which is required for the plan to be approved by a bankruptcy court.

The Third Circuit also noted that this decision may have been different if it involved a mechanic’s lien (similar to a construction lien under New Jersey law) filed under Pennsylvania law.  Mechanic’s liens filed under Pennsylvania law relate back to the commencement of work which gave rise to the mechanic’s lien as the date of filing.  Therefore, under Pennsylvania law, a lien that was filed after a bankruptcy may still be valid and an exception to the automatic stay if it related back prior to the bankruptcy being filed.

The takeaway from this case is clear.  Timing is everything when it comes to protecting you and your business, especially in cases involving construction lien claims and/or bankruptcy.  The New Jersey Construction Lien Law provides great protections to certain contractors and suppliers, but if these liens are not timely filed they can be unenforceable and leave contractors that do great work with little to no recourse, such as in In re Linear Electric Company, Inc..  Further, contractors that are considering bankruptcy must account for potential collection actions such as the potential of a subcontractor or supplier filing a construction lien in their determination of whether and when to file for bankruptcy.

Our attorneys specializing in bankruptcy or construction liens and bankruptcy law can help advise you and your business regarding decisions related to filing for a lien or bankruptcy.  To set up an appointment to speak with one of our attorneys, please call (973) 890-0004 or e-mail us.  We can help.