With the continuing slump in the economy, we have seen an increasing number of contractors file for bankruptcy prior to completing construction projects. We have also increasingly seen situations where the contractor was paid by the owner prior to the filing of the bankruptcy. These situations could spell trouble for subcontractors and material suppliers attempting to obtain payment for such work or material already included in the owner’s payment to the contractor if they have not properly protected their interests by filing Claims for Liens under the Illinois Mechanics’ Lien Act (“Act”).
The Act provides contractors, subcontractors, and material suppliers with a method by which they may obtain a lien on real estate upon which they construct, or supply materials for the construction of, an improvement. If proper notice of the subcontractor’s or material supplier’s contract with the contractor is given to the owner at the beginning of the project, a subcontractor or material supplier can require the owner to pay the subcontractor or material supplier even if the owner has already paid the contractor. Thus, the Act serves to protect the interest of the subcontractor or material supplier as against the owner and contractor.
Conversely, the United States Bankruptcy Code (“Code”) prohibits creditors of the bankrupt debtor from taking any further action against the debtor once a bankruptcy petition is filed, except for the filing of a bankruptcy claim. Thus, a subcontractor or material supplier would be prohibited from taking action against a bankrupt contractor once a bankruptcy petition is filed. Although the Code allows for the filing of a Claim for Lien against a bankrupt owner, the Code does not address the filing of a Claim for Lien when a contractor, and not the owner, files bankruptcy. Accordingly, a subcontractor or material supplier must look to Illinois common law to determine its rights under the Act once the contractor files bankruptcy.
Since the foreclosure of a mechanics’ lien involves an asset of the owner of the real estate, and not an asset of the bankrupt contractor, it would follow that a subcontractor or material supplier could pursue its mechanics’ lien rights even though the contractor is in bankruptcy. The Code only prohibits proceeding against a bankrupt contractor’s assets. The Illinois case of Interstate Contracting & Supply Co. v. Belleville Savings Bank, however, holds that when a subcontractor fails to file a Claim for Lien prior to a contractor’s bankruptcy, the subcontractor loses the right to enforce its lien against the property and can only share with the creditors in bankruptcy estate if the owner paid the contractor prior to the filing of the bankruptcy. The court reasoned lien rights cannot be perfected once the contractor’s bankruptcy is filed because the subcontractor’s or material supplier’s recovery can only occur through the bankruptcy proceeding.
How do subcontractors and material suppliers protect themselves from a contractor bankruptcy? The Act provides that once the owner has received written notice subcontractors are providing work, or material suppliers are supplying material, the real estate is subject to a lien in the amount of the work performed or the material supplied. Moreover, the Act allows subcontractors and material suppliers to file Claims for Liens at the time they enter a contract with the contractor, which would allow them to avoid the result of the Interstate case.
Our firm represents contractors in many industries, and we are very familiar with mechanics’ lien statutes and cases in many states. Please telephone a member of the firm if you have a question about the Act or any mechanics’ lien issue.