Recent bankruptcies in the construction sector underline the importance of guaranteeing the right to payment
In just two construction company bankruptcy filings from January 2022, 80 separate contractors have failed to secure their right to payment in full, leaving millions of dollars in construction debt unsecured.
The construction industry is volatile: 97% of construction professionals surveyed said they experience stress due to cash flow and payment issues – and as a result bankruptcies are unfortunately commonplace.
With more than $3.3 million in debt to 51 separate contractors, Performance Paving Sealcoating & Maintenance of Florida filed for Chapter 7 bankruptcy late last month. Additionally, the recent collapse of solar company Midwest Wind and Solar, which put dozens of contractors at risk, provides another example of the significant challenges faced by construction companies.
But the bankruptcy filings of Performance Paving and Midwest Wind and Solar reveal disturbing similarities: In both cases, the companies’ assets were insufficient to service their debts, and all of the creditors’ debt was listed as not guaranteed.
Mechanical liens are a valuable tool entrepreneurs can use to secure debt. However, they were affected by entrepreneurs affected by this bankruptcy – and there is no simple answer as to why.
Levelset’s 2021 Construction Cash Flow and Payments Report found that only 71% of surveyed construction professionals said they filed a mechanic’s lien last year.
Although this statistic has improved from just 58% in 2020, there are still nearly a third of contractors who have not used a mechanic’s lien to claim their right to payment.
Matt Viator, construction lawyer and senior legal partner at Levelset, suggested the reasons for this may be varied.
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Why don’t contractors use the privileges of mechanics? Viator suggests it’s usually for one of the following reasons.
1. A complex and confusing process
“In many cases, contractors may simply be unfamiliar with the process of filing a mechanic’s lien,” Viator said. “Even if they are, they may avoid it for whatever reason – maybe they think it’s too complex, or they’re just a bit ‘old school’.”
To be fair to contractors, filing for a mechanic’s lien, while theoretically a straightforward process, can be difficult to pull off. The location and type of project can change the rules of the lien, and making a mistake can be extremely costly – even a small mistake can invalidate a contractor’s right to payment.
If contractors feel the risk or complexity of filing a mechanic’s lien is too great, they can just wait and hope for a natural resolution of payment issues.
2. Deadlines not respected
Unfortunately, waiting too long to secure the right to payment can put entrepreneurs in a difficult position. Taking a contractor’s word that payment will come can be risky, according to Viator.
“If a contractor is promised payment and suspended for too long, they may miss key deadlines to file a mechanic’s lien,” Viator said.
Contractors don’t always have to file a lien: Although deadlines vary by state, contractors generally have three months to a year after completion of the work to file.
3. Problems sending notifications
Many states require that a preliminary notice be submitted before filing a mechanic’s lien. These usually need to be submitted near the start of a project, and if a contractor fails to do so, they will likely lose their right to submit a mechanic’s lien later.
But in 2021, only half of contractors said they filed a notice for every job (compared to only 29% in 2020).
“If a contractor hasn’t filed a mechanic’s lien, it’s possible they were late to submit the required notices, or never sent them,” Viator said.
Preliminary notices are an effective tool to mitigate payment risk, but whether or not to submit a preliminary notice can be a difficult decision for contractors.
“Some contractors may think that filing a preliminary notice will upset other parties,” Viator said. “They can also choose not to send a notice unless there is actually a payment issue at hand.”
To make matters more problematic, notice laws vary by state and can be quite restrictive – in Florida, for example, a contractor only has 45 days from the start of a project to submit a preliminary notice.
4. No lien to start
“Some entrepreneurs may also believe they never had lien rights in the first place,” Viator said. “They may have misunderstood the rules or the contract, or thought there was a ‘no privilege’ clause applicable.”
Mechanical liens can help secure debt in bankruptcy
Whatever the ultimate reason for not filing a mechanic’s lien, contractors are doing themselves a big favor by factoring reviews and mechanic’s liens into their payment processes. Mechanical liens, which are mostly bankruptcy proof, allow contractors to secure their debt and protect their right to payment.
It’s unclear whether the dozens of creditors involved in the Performance Paving and Midwest Wind and Solar bankruptcies will be able to collect full payment or not.
In either case, the liquidated assets will not be enough to offset the liabilities. If the remaining unsecured debt is paid off, creditors may simply be out of luck.
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