Dealing With Mechanic's Liens When a Party Files for Bankruptcy

From time to time, we are called upon to assist clients with regards to mechanic's lien issues in a bankruptcy setting.

Any time a party files for bankruptcy protection, there is an automatic stay against commencement or prosecution of actions against the bankrupt and the assets of the bankrupt. This means that if you are a plaintiff, you cannot pursue a legal action against a party who has filed for bankruptcy. You must stop (stay) all proceedings against that person. Federal Bankruptcy Laws preclude you from pursuing an action against parties in bankruptcy without first obtaining court approval.

This creates a problem for the contractor, subcontractor, material supplier, etc., who has recorded a mechanic's lien because they have not been paid and they must file a lawsuit within 90 days, only to learn that the defendant has filed for bankruptcy protection. A mechanic's lien claimant is in a real bind. If the mechanic's lien claimant does not file a complaint to foreclose on a mechanic's lien within 90 days, the mechanic's lien becomes void. If you file a lawsuit, you are in violation of the Federal bankruptcy laws that prohibit you from pursuing legal actions against parties that are in bankruptcy.

What do you do?

A recent court of appeal decision dealt with this issue. Although the case dealt mainly with other matters, the underlying issue was based upon a mechanic's lien action.
Village Nurseries, a landscape contractor, entered into a subcontract agreement with Baldwin to provide services on a variety of properties located in Orange and San Diego counties. Baldwin filed for Chapter 11-bankruptcy protection, but continued to work its jobs as debtor in possession. Village Nurseries also continued to perform services for Baldwin and ultimately recorded several mechanic's liens for amounts that were owed to Village Nurseries.

With Baldwin filing a Chapter 11 bankruptcy, Village Nurseries was put in the position of having to file lawsuits to foreclose on the mechanic's lien, but, in turn, was dealing with a defendant (Baldwin) who had filed for Chapter 11 bankruptcy protection.

Village Nurseries learned about Bankruptcy Code Section 546(b). Entitled "Notices of Perfection of Security Interest." The code section has been interpreted to provide:
"where state law requires 'commencement of an action to accomplish ... perfection, or maintenance or continuation of perfection of an interest in property' and the action has not been commenced prepetition, 'perfection of such interest shall be maintained or continued, by giving notice within the time fixed by such law for ... such commencement.'"

Village Nurseries decided not to proceed with the filing of a 546(b) notice, but rather decided to file its actions in the conventional manner by filing its lawsuit to foreclose on the various mechanic's liens.

The trustee in the bankruptcy action filed several motions to free the properties from these liens. The bankruptcy judge who heard the motion stated that he had serious doubts as to whether the Village Nurseries liens on the property were properly perfected. The bankruptcy judge's rulings were appealed to a United States Bankruptcy Appellate Panel. This panel ruled that Village Nurseries mechanic's liens were invalid because its foreclosure complaints were void as violations of the automatic stay and Village Nurseries failed to satisfy the notice requirements of section 546(b).

As stated above, the real issue of the Village Nurseries case was not a mechanic's lien issue. This determination was not necessary for the ultimate court ruling.

Because of this, the comments of the court may be construed to be advisory opinions as opposed to a binding opinion. The point, however, is that a Bankruptcy Code Section 546(b) has a process setting out how to deal with mechanic's liens when you have a party that has filed for bankruptcy protection.

It would appear that under the circumstances above, where parties have filed mechanic's liens and seek to foreclose on that lien against the property of the party who filed for bankruptcy protection, you must consider United States Bankruptcy Code Section 546(b). More importantly seek the aid of competent bankruptcy counsel.

Abdulazis is an attorney with the No. Hollywood-based law firm of Abdulaziz and Grossbart.