Bankruptcy and Construction Projects: What You Need to Know

In today's challenging construction market, contractors and

developers must be prepared to handle bankruptcy law issues that

may arise during the course of their construction projects. Given

the recent increase in bankruptcy filings, any contractor or

developer involved in significant construction operations will

inevitably be required to deal with another project participant

seeking protection under the U.S. Bankruptcy Code, 11 U.S.C.

§§ 101-1532 (hereinafter, the Code). No doubt, the filing

of a petition for bankruptcy will have a negative impact on the

flow of work and the supply of materials on a construction

project.

Avoiding delays and additional costs are the primary concerns

when any party on a construction project files for bankruptcy

protection. The time to protect from, and minimize, the adverse

consequences associated with a bankruptcy filing is at the very

beginning when parties negotiate and draft their contract. Indeed,

the drafting of the contract is a critical stage in heading off

adverse consequences associated with a contractor and/or supplier

becoming insolvent during the course of a project. To properly

account for bankruptcy law issues that will ultimately arise from

the commencement of a bankruptcy case, one must have a basic

understanding of the Code and be familiar with the overall

framework over which the bankruptcy courts operate.

Basic Terms, Rights and General Overview

The bankruptcy case commences with the "debtor" filing

a petition seeking relief under the Code. Generally, a debtor will

either seek to liquidate all assets (governed by Chapter 7 of the

Code) or attempt to reorganize (governed by Chapter 11 of the

Code). There are significant distinctions between liquidation

proceedings under Chapter 7 and reorganization proceedings under

Chapter 11. In a liquidation proceeding, the debtor is terminating

all operations. In contrast, under a reorganization proceeding, the

debtor is attempting to restructure and continue operations.

Moreover, in a Chapter 7 liquidation case, a trustee is appointed

to oversee and administer the debtor's bankruptcy estate during

liquidation, the primary purpose of which is to generate cash to

pay the debtor's creditors. A trustee is not always appointed

in a reorganization proceeding under Chapter 11 unless there are

specific needs. Generally, in a Chapter 11 reorganization

proceeding, the debtor will be referred to as the "debtor in

possession," who serves as the trustee of the bankruptcy

estate during reorganization and reports to the bankruptcy court.

It is important to keep in mind that most bankruptcy filings start

as attempts to reorganize under Chapter 11, only to be later

converted to a liquidation proceeding under Chapter 7.

The Automatic Stay

Upon the filing of the petition, all collection efforts by

creditors against the debtor must stop pursuant to §362 of the

Code, which provides for an automatic stay. As the name indicates,

the "automatic stay" occurs immediately upon the filing

of the petition– without the need for an order

from the bankruptcy court– and halts all action against

the debtor and the property of the bankruptcy estate. The automatic

stay is extremely broad in scope and, aside from limited

exceptions, applies to almost all formal or informal action taken

against the debtor or the property of the estate by anyone. A

violation of the automatic stay may result in severe sanctions

against the offending party, including the award of damages, costs,

attorneys' fees and, in appropriate circumstances, punitive

damages to an injured party.

With the filing of the petition, the debtor is required to

provide a complete listing of all creditors, a schedule of assets

and liabilities, a schedule of current income and expenditures, and

a statement of the debtor's financial affairs. It is important

to review the schedule of assets and liabilities filed by the

debtor to determine whether the debtor has properly identified all

contracts and/or debts and the amounts due in relation thereto. A

creditor should confirm that the amounts listed on the debtor's

schedules comport with the creditor's financial records and

whether the debts reported are properly classified as secured or

non-secured. The amount of the reported debt and its classification

as secured versus nonsecured have significant implications with

regard to priority for payment allowed under the Code and whether

the filing of a claim against the bankruptcy estate is necessary.

For example, if a creditor discovers that the debtor has listed the

amount of the debt as being less than what is actually owed to the

creditor, the creditor should file a "proof of claim"

against the bankruptcy estate noting the correct amount of the

debt. Likewise, a priority creditor should file a proof of claim

and indicate the priority status of the claim if not properly

identified by the debtor. Regardless of the information contained

in the debtor's schedules, a creditor of the bankruptcy estate

should file a proof of claim to protect its interest and give

notice of its claim.

Secured Creditors

A secured creditor will have a secured claim with respect to the

collateral that serves to secure the debt owed. The collateral

securing the debt may consist of real property or inventory and/or

accounts receivable belonging to the debtor. Accordingly, if

certain property in the debtor's possession is subject to a

valid lien, security interest or mortgage, then the trustee in a

Chapter 7 case will typically abandon the property subject to a

valid lien, security interest and/or mortgage as not benefiting the

bankruptcy estate because the property cannot be sold to generate

any money to pay any claims other than the secured creditor's

claim. Typically, however, the trustee in...