With Hollister Construction’s recent filing of its Chapter 11 bankruptcy case in New Jersey, the United States Bankruptcy Court for the District of New Jersey is likely to address subcontractor liens at some point during the case.  Hollister is a large New Jersey construction management company that contracts with various subcontractors and suppliers, and in the construction industry, the subs are usually paid directly by the general contractor.  So what happens if the general contractor files for bankruptcy and cannot pay the subs?  Can the subs lien the property of a non-debtor project owner?  That issue was recently addressed by the Third Circuit Court of Appeals in In re Linear Electric Company, 852 F.3d 313 (3d Cir. 2017), and the Court ultimately ruled that in New Jersey, the answer is “no.”

In Linear Electric, two electric suppliers sold various materials to a general contractor who used the materials on several construction jobs.  Thereafter, the general contractor filed for Chapter 11 bankruptcy but had not fully paid the suppliers.  Two weeks after the Chapter 11 filing, the suppliers filed liens against the projects that utilized the materials sold by the suppliers.  Importantly, those properties that the liens were filed against were not owned by the debtor.  

The question the court addressed is whether the filing of the liens against a non-debtor owner violated the automatic stay.  The Court found that it did.  The Court began its analysis with the scope of the automatic stay.  For those not familiar with the term “automatic stay,” it essentially means that once a bankruptcy is filed, all actions or proceedings against the debtor (outside of the bankruptcy) must cease.

Weren’t the liens filed by the electric suppliers against non-debtor property owners and not the debtor?  While that is true, the Court examined the issue from a different angle.  The Court focused on the impact that the liens would have on the debtor’s accounts receivable.  Essentially, the Court found that if the electric suppliers were to receive full payment, the general contractor debtor would receive less as a result (because the project owner wouldn’t have to pay twice).  Thus, it found there would be less total money to be distributed to the creditor body as a whole, and as a result, the liens affected the debtor estate’s interest in the accounts receivable and violated the automatic stay.  (In practice, the payment of claims of the two suppliers would be treated pari passu with other general unsecured creditors.)

You may ask yourself what the ramifications are for violating the automatic stay.  First off, the subject liens will be voided.  Additionally, a court could theoretically penalize the party that placed the lien with monetary sanctions.

At the end of the day, subcontractors on New Jersey jobs should think twice before liening a property owned by a non-debtor, after the general contractor files for bankruptcy. Additionally, if a subcontractor believes the general contractor is headed for bankruptcy, it should file its lien as soon as possible – before the general contractor heads to the bankruptcy court.