What happens to a lien if the property goes into bankruptcy?
I have filed a lien on a property in AZ and the house will be going into bankruptcy. What happens to my lien?
Mechanics liens typically fare pretty well during bankruptcy proceedings. A bankruptcy filing won’t wipe out a mechanics lien, which is good for claimants. Further, a lien claimant has finite steps they can take to best preserve their rights during that bankrupcty. But, there are still some other considerations to keep in mind – like how to enforce a mechanics lien during the automatic stay.
I’ll provide some detail below, but this resource should be really valuable: How to Protect Your Payments When Dealing with a Construction Bankruptcy.
Mechanics liens and bankruptcy
Once a mechanics lien is filed on the project property, that becomes what’s called a “secured debt” – meaning, the debt is tied to the project property. And, in bankruptcy proceedings, having a secured debt is a lot better than unsecured debt.
It’s common for unsecured debts to be completely or substantially wiped away during bankruptcy proceedings. But, when the debt is tied to the property itself, the creditor will have a better chance of recovering payment because the bankruptcy won’t wipe away the debt – the debt will remain tied to the property and will generally be paid (to some extent) according to its priority status. Priority is discussed in detail here: Lien Priority – What Happens When Everybody Is Trying to Grab a Piece from the Same Pie?
Enforcing a mechanics lien during bankruptcy
Having a mechanics lien filed prior to the bankruptcy will certainly alleviate some headaches. But, mechanics liens still have enforcement deadlines (in Arizona, the deadline is 6 months from the date when the lien was filed). With the automatic stay in place, though, enforcing a mechanics lien will be tricky.
In order to avoid the enforcement deadline’s passing, a lien claimant can generally file a lien preservation notice with the bankruptcy court as an indication of the intent to enforce the lien, if not for the automatic stay. This document is filed with the bankruptcy court and also served on the bankruptcy trustee or debtor in possession. And, to be sure, this must be done before the lien enforcement deadline passes.
Alternatively, a lienholder could try to petition the bankruptcy court for relief from the automatic stay (think of it as an excetpion) – but that might not be particularly successful.
When mechanics liens and bankruptcy cross paths, it’s probably time to get help
Finally, keep in mind that while the law can be favorable for lien claimants during bankruptcy, it’s a very good idea to seek out representation from a bankrupcty attorney to navigate bankruptcy requirements. They’ll have experience navigating the bankruptcy requirements – plus many of the required steps to preserve the lien will require an attorney’s help anyway.