Everybody has the same question when a debtor files for bankruptcy protection: Will I get paid? In order to determine the likelihood of a creditor receiving payment from a bankrupt debtor, one of the essential factors to consider is the nature of the debt. That is, is the debt secured, or unsecured?
Generally, unsecured debt is wiped out by filing bankruptcy, and if an unsecured creditor is lucky enough to get any money at all through a Chapter 13 payment plan it is usually only pennies on the dollar. Secured debts, however, generally remain through the bankruptcy if the debtor retains the property that serves as collateral for the loan. Bankruptcy does not relieve a debtor of the obligation to pay secured debt if he wishes to retain the underlying property.
So, the question for us is whether a mechanics’ lien secures debt through bankruptcy. And this, finally, is a question with a relatively straightforward answer. Yes, a mechanics’ lien is secured debt. This is set forth by the Bankruptcy Code in 11 U.S.C. Sec. 506(a)(1), which states in part:
An allowed claim of a creditor secured by a lien on property in which the estate has an interest, or that is subject to setoff under section 553 of this title, is a secured claim…
Since a secured claim survives the bankruptcy, a mechanics’ lien holder is a good position. However, since this is bankruptcy, there is a unique wrinkle in this situation. A mechanics’ lien will remain enforceable after the bankruptcy adjudication — but the debt giving rise to the lien is may be discharged. If this seems impossible, or at least counter-intuitive, remember that a mechanics lien is a right against property (that is why it is secured and survives the bankruptcy proceeding). So, the debtor’s personal obligation to pay may be extinguished by his bankruptcy, but the obligation on the property is not.
Unfortunately, though, this is not an iron-clad guarantee of payment. Generally, liens follow the “first-in-time, first-in-right” rule. So, if the property is mortgaged, the mechanics’ lien holder will usually only be paid after the mortgage is satisfied. If the property is over-mortgaged, then, the mechanics’ lien holder may not be paid, despite the fact that he holds secured debt.
That being said, having a debt secured by a mechanics’ lien greatly increases the probability that you will be paid in the event the property owner declares bankruptcy.
Learn more: The Three Main Types of Bankruptcy Chapters in Construction — and What They Mean