Construction

The Construction Industry Advisor

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Contractor's toolbox

Show me the money

What happens when an owner goes bankrupt

Bankruptcy is an unpleasant fact of life in construction no matter how you look at it. Whether it's because of a complicated and expensive project or an owner's poor pre-existing financial situation, when the money runs out, the owner often can't continue to pay you.

An overview

Although there are several kinds of bankruptcies, the two most common involving owners and contractors are Chapter 11 reorganization and Chapter 7 liquidation. Owners who file Chapter 11 intend to keep operating. Filing gives them a little breathing room while they reorganize their financial affairs and return to profitability, which means you're more likely to get paid for your work.

Owners go into Chapter 7 when their circumstances are so dire that they don't intend to keep operating. Their assets are turned into cash, from which creditors are paid. Assets include real and personal property and contracts to which owners are a party. You may or may not get paid, regardless of how much work you did.

Reduce your risk

Ideally, you want to avoid owners who aren't financially stable. As amazing as it may sound, few contractors assure that funds are in place before they sign a contract. Most construction companies are just grateful to get the work and assume that jobs wouldn't be put out to bid or negotiated if the money weren't there. Making this assumption can prove costly.

Your best defense is to verify every owner's solvency before you sign on. Do business with only those who have the financial backing to see projects through to completion. You can identify potential problems by checking references, calling other contractors, asking your bank to verify with their bank the person's or organization's financial standing, and searching for lawsuits or judgments filed against the owner.

Protect your interests

If you've done your homework and an owner still files for bankruptcy, run -- don't walk -- to your attorney. The rules for dealing with such predicaments are complicated, and taking a wrong turn can add even more time and expense to an already difficult situation.

But, simply stated, when an owner goes belly up, federal bankruptcy laws forbid you from filing a lawsuit against the owner or canceling your contract. An automatic "stay" provision essentially stops all collection efforts against owners, with one exception -- mechanic's liens.

Also known as contractors' liens, these are claims made by contractors who have performed work at a job site but haven't been paid. Mechanic's liens will increase your chances of collecting at least a part of what you're owed.

You must file lien affidavits within 10 days of the owner's bankruptcy filing. After that, the automatic stay provision bars further liens. One caveat: Mechanic's lien laws are technical and vary from state to state. Learn your state's rules and deadlines as well as the differences in any states in which you operate. Consult with your attorney to make sure your rights are preserved.

The waiting game

It's difficult to be patient when you haven't been paid, but bankruptcies are typically long, drawn-out affairs. Realize that, if you're even able to collect from a bankrupt owner, it will probably take much longer than you anticipate. In any case, you'll be better positioned to maximize what you recover with a mechanic's lien and by relying on your attorney's expertise.