Construction Liens and Bankrupt Owners

A construction lien is a lien on title to property in favor of someone who has supplied labor or materials that improve the property. In easier terms, if a plumber installs pipe, he may have a lien on the property for the price of the pipe and labor, so that if he is not paid, he can file a lawsuit asking a judge to order the sale of the property to pay the plumber out of the sale price. It is difficult enough for a contractor, such as our plumber, to follow the technical rules which must be observed under Florida law in order to be able to enforce the lien rights. Many contractors will give up on lien rights altogether if the owner of the property files bankruptcy. Representing contractors, subcontractors, and material suppliers, I encounter frustration and confusion in situations where a contractor has carefully protected its construction lien (or rights to record a claim of lien) and the owner files bankruptcy.

Except on federally funded projects where the Miller Act kicks in (a situation quite beyond the scope of this post), my experience is that most construction lien and bond litigation generally involves the application of state law. However, if an owner files bankruptcy (an unfortunately common occurrence in recent Florida history), a contractor or other construction lienor has to deal with the intersection of state law and the Federal Bankruptcy Code. Even though bankruptcy is a federal law, the bankruptcy courts must often apply state laws to determine the debtors rights and the rights of various creditors.

Ideally, the claim of lien was recorded prior to the filing of the bankruptcy. In this event, the lienor (e.g., our plumber) is a secured creditor in the bankruptcy, and the lien may be enforced if the bankruptcy is dismissed.

However, in many cases, a lienor is taken by surprise when the owner files bankruptcy, and while the lienor hasn't been paid yet, he hasn't recorded his claim of lien either. Most creditors are familiar with the idea that a bankruptcy filing immediately prevents any collection action. This is because of the "automatic stay" provision of the bankruptcy code (§ 362), which creates penalties from any person who attempts to collect from the debtor, sue the debtor, or create liens against the debtor. However, there is a limited exception which allows a lien to be perfected (to "perfect" a lien means to take steps, such as recording a claim of lien, to make the lien effective against third parties and the debtor) even after the bankruptcy filing if the lien would relate back to some time prior to the bankruptcy filing. A construction lien relates back to (in other words, is effective as of the time of) the notice of commencement. Therefore, in some situations, a lienor may record his claim of lien after the bankruptcy filing if there is a notice of commencement on the project recording prior to the bankruptcy filing.

Even so, a lienor in this situation should talk to his lawyer to be sure that the technical bankruptcy (and state law) rules are being carefully followed. Consequences for fraudulent liens and violations of the stay are severe. (Never ever rely on this blog to make legal decisions -- these posts are not legal advice).

A sophisticated reader of this post might think that I've missed the forest for the trees. Even if a lienor goes to the expense of recording the claim of lien, no action can be commenced to enforce the lien while the bankruptcy is pending, and the lien will expire after a year, even if the bankruptcy is still going. Nevertheless, the right to record a claim of lien will be lost if it is not done within 90 days of final furnishing (under Florida law), and it would be doubly annoying if the time for recording expired and the bankruptcy was abandoned by the debtor or dismissed by the court for some reason. Further, a perfected lien may put the lienor, such as our plumber, in a better position compared to other unsecured creditors in the bankruptcy. In some cases, the bankruptcy court could allow a lienor "relief from stay," and by doing so let a lienor enforce the lien in court despite a bankruptcy (this is admittedly in limited situations).

In sum, a construction lienor who faces the loss of substantial lien rights may wish to consider consulting an attorney about the possibility of recording a claim of lien even after the owner files bankruptcy.

Condo Association allowed to pursue construction bond

In an interesting split decision, the 1st District Court of Appeal has decided that, under Florida law, a condominium association may sue under a performance bond issued by a surety in favor of a developer and enforcable only by the 'owner and its ... successors'.

In a decision yet to be published (Marseilles Condominium Owners Ass'n, Inc. v. Travelers Cas. and Sur. Co. of America --- So.3d ----, 2009, App. 1 Dist., October 30, 2009), the majority held that the condo association is a "successor" to the owner (the developer) who may enforce the bond. This is interesting; as the dissent points out, the association does not typically step into the shoes of the developer except insofar as it ultimately manitains and controls the common elements of the condo -- the association is not a successor in ownership (it never owns the units or the common areas). Therefore, doesn't it seem like a stretch to deem an association which is not a successor in ownership to be a party able to enforce a bond which expressly limits its protection to the owner and its successors?

The Wall Street Journal reported today that 1 in 7 households with mortgages are either in the foreclosure process or delinquent in payment on their first mortgage. Based on data from the Mortgage Bankers Association, this report suggests that delinquencies are at a new highest rate since the beginning of the present 'crisis.' As existing home sales and the broader economy recover, a solution for homeowners without the ability to pay for their homes has yet to arrive.

Kelo, 4 years on

Goverment Attorneys and libertarians alike recall that four years ago, the Supreme Court upheld the condemnation of property for economic development in Kelo v. City of New London. The leaders of New London, CT, envisioned the replacement of a residential neighborhood with new condos and offices to enhance and support a nearby Pfizer facility. The court held that the city of New London was not prohibited from taking land from one private owner to turn it over to another in the name of this redevelopment project. This was a landmark eminent domain opinion which offended many Americans and touched off a wave of state-level legislation across the nation limiting the scope of condemnation powers. (In Florida, we amended the constitution to say that "private property taken by eminent domain ... after January 2, 2007, may not be conveyed to a natural person or private entity except as provided by general law passed by a three-fifths vote of the membership of each house of the Legislature.")

It was pointed out Wednesday, in a Wall Street Journal opinion piece (which called the Kelo decision "one of the worst in recent years"), that Pfizer has decided to shut down its R&D headquarters in New London, CT, and the condemned neighborhood stands bulldozed and vacant.

While it sparked outrage, the Court's opinion may very well have been constitutionally sound, and, ultimately, the political process worked; the Kelo story helped to raise awareness and spur the legislative shift toward restricting condemnation powers. But that doesn't help Ms. Kelo.

Proposed Change to Fla. RCP 1.110(b)

The Florida Supreme Court's Task Force on Residential Mortgage Foreclosure Cases made oral arguments to the Florida Supreme Court last week and requested, among other things, a change to the rules of procedure to require residential foreclosures to be instituted by a 'verified' complaint -- in other words, requiring the Plaintiff to swear to the contents of the initial pleading. The court seems to be perceiving that many high-volume foreclosure firms bring suits in a loose and disorganized manner, and the testimony pointed to the "lost note" count that is almost invariably included in foreclosure complaints despite the fact that the plaintiff is usually able to 'locate' the note at the last minute. As any attorney who practices in the foreclosure field knows, this perception is accurate in many cases, and some foreclosure matters are handled without the professionalism that should be expected from attorneys. Nevertheless, it is not clear why foreclosures ought to be subject to standards different from those imposed on the parties when commencing any civil matter. Don't the rules of professionalism, 57.105, and other standards already in place and applicable to ALL civil actions provide the necessary incentives to ensure accurate pleading?

FHA lending to more condo purchasers?

The FHA has decided to relax underwriting criteria for loans secured by residential condominiums, the Miami Herald reports. Every little bit helps... Perhaps traditional bank lenders will one day follow suit, even for loans that are not federally insured.

Changes to Construction Defects statute

Last week, changes to Chapter 558, Florida Statutes, became effective. Chapter 558 was enacted in 2003 to provide an alternative dispute resolution process to supposedly reduce the need for litigation by requiring a person who is making a damage claim for construction defects to follow certain procedures before initiating litigation. In short, before a property owner may sue a contractor, the property owner is required to notify the contractor of the defect and give the contractor an opportunity to examine the defect (including examination requiring destructive testing). If the contractor agrees that there is a defect, he is given an opportunity to repair it or offer to settle the matter. If the parties still disagree, the property owner may file his lawsuit. These procedures apparently applied to all construction contracts irrespective of the desire of the owner and contractor, though there was some ambiguity as to whether the legislature intended it that way. The recent bill changes Chapter 558 while preserving the basic concept.

The most important change, as far as my clients tend to be concerned, is that the notice that previously was mandated for all contracts for improvement is now optional if the parties agree in writing to opt out, and that in the event that the parties do opt out, the notice provisions do not apply to the contract. The bill also clarifies that Chapter 558 is generally inapplicable to projects prior to completion (C/O). Finally the bill prohibits Chapter 713 liens for persons who do destructive testing or for restoration work, raising interesting questions but having little practical significance. (I can think of instances where a contractor or materialman would be hired to do restorative work or furnish materials after destructive testing, unaware that the project is restorative in nature and provides no lien rights).

The changes to the law are an improvement insofar as ambiguity has been removed and the parties may contract around its provisions.