In a recent decision,1 the United States Bankruptcy Appellate Panel of the 9th Circuit clarified an important step that construction lienholders must take to perfect their liens when the debtor has filed a bankruptcy petition before the lienholder files a foreclosure lawsuit.
In the case at issue, the debtor agreed to pay the contractor approximately $2 million for tenant improvement work on a shopping center owned by the debtor.2 When the debtor failed to pay, the contractor recorded a series of mechanic's liens on the shopping center, with the lien at issue recorded on December 19, 2019.3 Under California law, the contractor has 90 days to "perfect" its lien by filing a lien foreclosure lawsuit.4 However, before it did so, on January 10, 2020, the debtor filed a chapter 11 bankruptcy petition.5
The filing of the bankruptcy petition triggered the "automatic stay" under 11 U.S.C. § 362, which prevented the contractor from filing its foreclosure lawsuit.6 Although the contractor could not perfect its lien by filing a lawsuit, the court held that the contractor was still required to perfect its lien through the process set out in the bankruptcy code.7
According to the court, the contractor was required to give the debtor notice under 11 U.S.C. § 546(b) of its claim within the 90-day perfection period established under California law.8 Unfortunately for the contractor, it did not notify the debtor of its claim until over a month after the 90-day deadline had passed.9 Accordingly, the court held that the contractor's attempt to obtain payment on its lien through the bankruptcy proceeding had been properly dismissed and the contractor was left as an unsecured creditor.10
Contractors should note from this decision that if a debtor files a bankruptcy petition before the contractor has filed a lawsuit to foreclose its construction lien, the contractor is still required to provide notice of its claim through the bankruptcy process and must do so by the state statutory deadline to file the foreclosure action. Failing to do so will likely invalidate the contractor's lien and leave the contractor as an unsecured creditor.
1 In re 450 S. Western Ave., LLC, 633 B.R. 894 (9th Cir. BAP 2021). Note that the Bankruptcy Appellate Panel's decision was appealed to the Ninth Circuit Court of Appeals on December 10, 2021. As of this writing, that appeal is pending.
2 Id. at 895-96.
3 Id. at 896.
4 Id. at 898 (citing California Civil Code § 8460(a)).
5 Id. at 896.
6 Id. at 900.
9 Id. The court rejected an argument by the debtor that another provision of the Bankruptcy Code, 11 U.S.C. § 108(c), tolled its deadline to file its foreclosure action. Id. at 900-02.