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In Construction Bankruptcy Case, Fourth Circuit Holds That Subcontractors Can Perfect Materialman and Mechanic’s Liens After General Contractor Filed For Bankruptcy

Branch Banking & Trust Company v. Construction Supervision Services, Inc. (In re: Construction Supervision Services, Inc.)
No. 13-1560 (United States Court of Appeals for the Fourth Circuit, May 22, 2014)
by Richard J. Medoff, Summer Associate
Semmes, Bowen & Semmes (www.semmes.com)

Available at http://www.ca4.uscourts.gov/Opinions/Published/131560.P.pdf

In Branch Banking & Trust Company v. Construction Supervision Services, Inc., the Fourth Circuit Court of Appeals held that subcontractors with unperfected state law materialman and mechanic’s liens could perfect their liens after the general contractor filed for bankruptcy under 11 U.S.C. §§ 362(b)(3) and 546(b). The Court rejected Defendant’s contention that the subcontractors lacked an “interest in property” under Sections 362(b)(3) and 546(b) because they had not yet served notice of, and thereby perfected, their liens when the bankruptcy petition was filed. The appellate court agreed with the district court’s affirmance of the bankruptcy court’s ruling that the subcontractors were not prohibited by the automatic stay imposed by 11 U.S.C. § 362(a)(4) to perfect their liens. Judge Wynn wrote the opinion, in which Judges King and Shedd joined.

By way of factual background, in January 2012, Construction Supervision Services (“CSS”), a full-service construction company, filed a Chapter 11 bankruptcy petition. CSS, acting as a general contractor, placed orders with several subcontractors for building materials and fuel. The subcontractors delivered the requested materials to CSS on an open account basis, later invoicing CSS for the amounts owed them. After CSS’s January 2012 bankruptcy filing, the subcontractors sought to serve notice of, and thereby perfect, their state law materialman and mechanic’s liens on funds others owed CSS. Branch Banking & Trust Company (“BB&T”), which had loaned CSS over one million dollars, secured by, among other things, CSS’s accounts and real property, objected to the subcontractors’ post bankruptcy petition notice and perfection of their liens.

Section 362(a)(4) of the federal bankruptcy code provides for an automatic stay of any attempts by creditors to collect their claims against a debtor who has filed a bankruptcy petition; however, exceptions exist. Section 362(b)(3) provides an exception for “any act to perfect, or to maintain or continue the perfection of, an interest in property to the extent that the trustee’s rights and powers are subject to such perfection under section 546(b)….” Section 546(b), in turn, subjects the bankruptcy trustee’s rights and powers to generally applicable laws that “permit perfection of an interest in property to be effective against an entity that acquires rights in such property before the date of perfection . . . .” In essence, Sections 362(b)(3) and 546(b) provide an exception for those with an interest in property that predates the bankruptcy petition but is not yet perfected at the time the debtor files for bankruptcy if, in the absence of the bankruptcy filing, the perfected interest would be effective under state law against a third party acquiring rights prior to that perfection.

BB&T argued that the subcontractors lacked an interest in property because they had not yet served notice of, and thereby perfected, their liens by the time CSS filed its bankruptcy petition. The subcontractors argued that the stay did not block them from noticing and perfection post-petition because doing so fell under the Section 362(b)(3) exception. The bankruptcy court ruled against BB&T, holding that the subcontractors had an interest in property upon delivery of the requested materials, i.e., before lien notice and perfection, and thus the subcontractors were not stayed from providing notice and perfecting their liens under Section 362(b)(3). BB&T appealed to the district court, which affirmed the order of the bankruptcy court. BB&T further appealed to the Fourth Circuit Court of Appeals.

On appeal, BB&T contended that because the subcontractors failed to notice their liens on funds before CSS filed for bankruptcy, the subcontractors lacked an “interest in property” at the time CSS filed its petition, and therefore the Section 362(b)(3) exception was not applicable. The appeal turned on the meaning of the phrase “an interest in property,” referred to in Sections 362(b)(3) and 546(b). If the subcontractors had an “interest in property” when CSS filed for bankruptcy, the parties agreed that it would then be permissible for the subcontractors to give notice and perfect their interests post-petition under Section 362(b)(3).

To the Court, it was clear that the Fourth Circuit precedent had established that the broad term “interest in property” encompassed more than just liens. The Court noted that while “interests” and “liens” are related, they are nonetheless logically distinct as a lien is a mechanism to secure an interest that already exists. The question left for the Court to answer was whether the subcontractors had an “interest in property” despite their not yet having served notice of, i.e., perfected, their liens under North Carolina law prior to CSS’s filing for bankruptcy. To answer that question, the Court looked to the pertinent North Carolina law. Under North Carolina General Statutes 44A-18, like the materialman or mechanic’s lien statutes of most states, the liens vested as soon as construction materials were delivered. There was no dispute that the subcontractors delivered materials and equipment to CSS for its building work before CSS filed for bankruptcy. Because the subcontractors were entitled to a lien securing the funds earned as a result of having delivered said materials and equipment to CSS, and that entitlement to a lien arose upon delivery, the Court concluded that the subcontractors had an “interest in property” when CSS filed its bankruptcy petition.

In reaching its conclusion, the Court rejected BB&T’s argument that any rights or interests that the subcontractors had were meaningless until noticed, and thereby perfected, because, without a perfected lien, the subject funds could be diluted or extinguished. The Court noted that just because a right or interest may be lost does not mean it therefore fails to exist. Thus, because the subcontractors had an interest in property at the time CSS filed its bankruptcy petition, and because the parties agreed all other conditions for Section 362(b)(3)’s bankruptcy stay exception were met, the bankruptcy court and district court correctly ruled that the Section 362(b)(3) exception to the automatic stay was applicable. The Court affirmed the district court’s affirmance of the bankruptcy court’s order.