A subcontractor's decision to serve a notice of claim of lien on funds shortly after its debtor's bankruptcy filing has landed it in hot water with a North Carolina Bankruptcy Court, which recently ruled that the move is a violation of the Bankruptcy Code's automatic stay rule. In In re Harrelson Utilities, Inc., held in the U.S. Bankruptcy Court for the eastern district of North Carolina, the court held that not only was the service of the notice a violation of the automatic stay, which prevents creditors from taking any action to collect money after a bankruptcy petition is filed, but that the action also voids the lien on funds itself, rendering the subcontractor's claim worthless.

Additionally, because under North Carolina law a subcontractor may only file a lien on real property upon the service of a valid notice of claim of lien on funds, the subcontractor's lien on real property was also voided by the court as well. The court in Harrelson noted that if, under state law, the subcontractor has an interest in the funds prior to the perfection of the lien, the action of serving a claim of lien post-petition is an exception to the automatic stay rule. However, if state law provides that the lien right is created by the service of a notice, there is no exception and the lien is then voided. In its decision, the court distinguished between liens on real property and liens of funds, stating that, statutorily, a lien on real property "relates back" to the time of first furnishing of labor or materials. As interpreted by the court, this means that a lien on property creates an interest in the property prior to the actual perfection of the lien. With liens on funds, however, the court ruled that the subcontractor interest is only created upon service and receipt of the notice.

The ruling is a victory for owners in the state, looking to avoid getting hit by liens, but the distinction between liens of real property and funds does no favors for North Carolina subcontractors. As mentioned earlier, since state law prevents the filing of a lien on real property without the service of a valid notice of claim of lien on funds, the court's ruling essentially means that a contractor's or debtor's bankruptcy cuts off the opportunity to perfect a lien on funds. If a contractor files for bankruptcy and a subcontractor serves the notice of claim of lien of funds, this violates the automatic stay, voids the claim and, by extension, eliminates the possibility of perfecting a lien on real property.

An appeal of the ruling has already been filed but, if sustained, subcontractors in the state would essentially be forced to serve liens on funds as soon as labor or materials are first supplied, which would have predictably negative effects on project cash flow. Other observers have noted that this statute could give subcontractors with knowledge of a contractor's financial trouble an unfair advantage over other creditors, as they could react to the news by serving liens on funds when they find out about the contractor's condition, much to the chagrin of other subcontractors not so informed.

This news was originally reported via NACM's Mechanic's Lien and Bond Service (MLBS). For up-to-date information on legal changes throughout the U.S. and tools to help optimize your construction credit department, click here today.

Jacob Barron, NACM staff writer. Follow us on Twitter at http://twitter.com/NACM_National.


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