Trent Cotney, Partner, Adams and Reese, LLP
As you know, every construction project relies on multiple parties to complete the project. Owners are under contract with general contractors and general contractors have agreements with subcontractors and other trades. When any of these parties file for bankruptcy, that action can affect everyone. This article will explain the basics of bankruptcy and the parties involved. Part 2 will describe the various ways you can protect yourself when other parties face bankruptcy.
The Basics of Bankruptcy
Construction can be a risky and volatile business. You never know when an owner or a contractor will suddenly shutter its doors and disappear from the worksite. Another all-too-common occurrence is one of the parties having to file for bankruptcy. This action usually occurs when the company is losing money and cannot sustain itself.
The details of bankruptcy are managed by federal law. The law’s intent is to ensure all creditors are treated equally. Although there are many kinds of bankruptcy, there are a few common ones for owners and contractors:
■ Chapter 11: With this type of bankruptcy, the debtor seeks reorganization so it can stabilize its financials and become viable again.
■ Chapter 11, Subchapter 5: Subchapter 5 of Chapter 11 was enacted in 2019 and is designed for small businesses. There are many favorable provisions for businesses with less than approximately $2.7 million in debt that may allow them to restructure debt.
■ Chapter 7: With this type of bankruptcy, the debtor seeks to liquidate its assets and pay its creditors.
It may seem counterintuitive, but creditors often see better results when a debtor is in Chapter 11 because the debtor wants to stay in business and maintain a good relationship with its creditors. However, in many cases, debtors are unable to restore their stability and Chapter 11 bankruptcies devolve into Chapter 7.
In general, bankruptcy follows these steps: the debtor files a petition, creates lists of assets and liabilities, provides a financial statement and pays a filing fee. Next, an estate is created. It includes all the debtor’s assets, such as accounts receivable, property (both real and
intellectual), royalties, licenses, insurance policies, purchase options and pending construction contracts. Then, an automatic stay is imposed. This is an order of relief that prohibits creditors from trying to collect debts or taking any action that would prove detrimental to the estate. Such actions would include recording a mechanic’s lien or foreclosing on one.
On a construction project, many parties are interconnected, so if one files for bankruptcy, that action impacts all the others. For example, if an owner enters bankruptcy proceedings, contractors and subcontractors may fear never getting paid, so they may stop work immediately. That could effectively shut down the project (which is likely a breach of contract). In contrast, if a design professional, subcontractor or supplier files for bankruptcy, that can disrupt the project. The general contractor may have to scramble to find another subcontractor, design professional or supplier and get back on schedule. But if a general contractor enters bankruptcy, everyone is impacted. The owner will be concerned about salvaging the project, while suppliers, subcontractors and other trades will wonder if they will receive payment.
Whether the economy is on an upswing or a downswing, the construction industry can be unpredictable. Both large and small companies face bankruptcy every year. Those actions have a ripple effect on every project. Owners may see projects halted, while contractors
and suppliers will lose business and income. And filing claims can be daunting.
To learn more about filing claims and protecting yourself when another party files for bankruptcy, read part 2 of this article next month. In the meantime, if you have questions about how another party’s bankruptcy will impact you, do not hesitate to reach out to me at the contact information below.
The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation. Trent Cotney is a Partner and Construction Practice Group Leader at the law firm of Adams and Reese LLP and FRSA General Counsel. For more information on this subject, please contact the author at trent.cotney@arlaw.com.
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