By Ryan C. Wood
Picture this: a homeowner wants to improve his or her property and hires contractors to do the work on the home. After the contractors complete the project, financial disaster strikes the homeowner and he or she is unable to pay the contractors or any of his or her other creditors. What happens if he or she files for bankruptcy and there is a mechanic’s lien on the property? How is the mechanic’s lien treated in bankruptcy?
Before we look at how the mechanic’s lien is treated in bankruptcy, we need to look at how mechanic’s liens work in general. If a contractor in California performs work or provides goods for the construction of a piece of property they can record a lien against the property if they are not paid timely. In California, a contractor has to serve a 20-day preliminary notice to a property owner in order to file a mechanic’s lien. Failure to provide a 20-day preliminary notice means the contractor may lose the rights to file a mechanic’s lien entirely. Once the project is completed the homeowner has to record a notice of completion within 10 days of the completion of the project. The homeowner has to serve the notice of completion to all the contractors that provided the homeowner with a 20-day notice within 10 days of the recording of the notice of completion. Once the notice of completion is served, a general contractor has 60 days to record a mechanic’s lien against the homeowner. The mechanic’s lien needs to be recorded in order to be considered “perfected.” A subcontractor or supplier has 30 days to record a mechanic’s lien. If the homeowner never recorded a notice of completion then a mechanic’s lien can be recorded against the homeowner within 90 days. Once a mechanic’s lien is recorded against the homeowner’s property the contractor has 90 days to either enforce the lien by filing a lawsuit or foreclosing on the property. Failure to do so will result in a mechanic’s lien being considered stale and unenforceable.
So let’s go back to the scenario in the beginning. If the homeowner files for bankruptcy before the contractor’s time is up to perfect the lien, is the contractor now out of luck due to the automatic stay that comes into play when a homeowner files for bankruptcy? The answer is no. 11 U.S.C. §362(b)(3) allows the contractor to perfect the lien even after the bankruptcy case is filed. This is because the perfecting of the lien relates back to a pre-bankruptcy event and this is permissible under 11 U.S.C. §546(b). Once the contractor perfects the lien, he still needs to enforce the lien. In order to enforce the lien, the contractor will need to file a motion to lift the automatic stay in bankruptcy court so the contractor can enforce the lien. The contractor may only enforce the lien once the judge grants the motion to lift the automatic stay. If the contractor misses this crucial step and just tries to enforce the lien without the bankruptcy court giving them permission to do so, the contractor will be in violation of the automatic stay and may be sanctioned by the bankruptcy court. If the contractor does not perfect the mechanic’s lien they will be considered a general unsecured non-priority creditor in the bankruptcy case and may be out of luck on receiving any payment if it is a no-asset Chapter 7 case.
The treatment of a mechanic’s lien is subject to state law so please refer to your particular state’s mechanic’s lien laws to determine what type of notice (if any) is required, when a mechanic’s lien can be recorded and what are the limitations of the liens.