Lessons in Bankruptcy

Stop SignIt’s been a rough few years in the construction industry, not only for contractors, but for owners as well.  Not only have many contractors had to close their doors, many owners have lost their properties. In Pioneer Construction, Inc. v. Global Investments, Inc., 2011 WL 6382113 (December 21, 2011), the California Court of Appeals for the Second Appellate District provided an important reminder of how state mechanic lien laws are affected by federal bankruptcy laws.

In Pioneer, Pioneer Construction, Inc. (“Pioneer”) entered into a construction contract with Oakridge Homes LLC (“Oakridge”) to develop 19 lots in Stevenson Ranch in Los Angeles County, California.  Pioneer performed its obligations under the construction contract but Oakridge failed to pay Pioneer and later filed for bankruptcy.  After Oakridge filed for bankruptcy, Pioneer recorded a mechanic’s lien on the property for $2,669,832.06 on January 29, 2009 and filed a notice of perfection of security interest in the bankruptcy proceedings on April 15, 2009.

During Oakridge’s bankruptcy proceedings, mortgagors of the property obtained relief from the Bankruptcy Code’s “automatic stay” and sold the property at a trustee sale on August 25, 2009.  Thereafter, on November 12, 2009, Pioneer filed suit to foreclose on its mechanic’s lien.  The mortgagors and subsequent purchaser successfully challenged Pioneer’s complaint on the ground that Pioneer’s mechanic’s lien was recorded in violation of the automatic stay and that Pioneer filed suit to foreclose on its mechanic’s lien more than 90 days after it was recorded.  The Court of Appeals, however, reversed.

The Court explained that while the filing of a bankruptcy petition creates an “automatic stay” which, among other things, stays “any act to create, perfect, or enforce any lien against property of the estate” under 11 U.S.C. §362(a)(4), an exception is provided under 11 U.S.C. §362(b)(3), which permits a mechanic’s lien claimant to record a mechanic’s lien on a debtor’s property because it “relates back” to the time when labor and materials were furnished to the debtor prior to the debtor’s bankruptcy petition.  However, under 11 U.S.C. §546(b), in order to perfect a mechanic’s lien recorded after a debtor’s bankruptcy petition, a notice of perfection must be filed in the bankruptcy proceedings.  Thus, Pioneer was not precluded from recording its mechanic’s lien after Oakridge filed its bankruptcy petition.

Moreover, the Court explained, under 11 U.S.C. §108(c), the 90 day deadline to file suit to foreclose on a recorded mechanic’s lien is “tolled” while the debtor’s property is part of the bankruptcy estate.  Thus, the 90-day deadline for Pioneer to foreclose on its mechanic’s lien under California Civil Code section 3144 was tolled until the property was sold on August 25, 2009, and because Pioneer filed suit to foreclose on its mechanic’s on November 12, 2009, which was 79 days after the property was sold and was no longer a part of the bankruptcy estate, Pioneer had filed suit to foreclose on its mechanic’s lien within the 90-day deadline provided under state law.

Note: 11 U.S.C. §108(c) “tolls” the 90-day deadline it does not “reset” the 90-day deadline.  Thus, if Pioneer had recorded its mechanic’s lien, say 30 days before Oakridge filed its bankruptcy petition, once the property was sold on August 25, 2009, Pioneer would have had only 60 days to file suit to foreclose on its mechanic’s lien.

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