Avoiding Traps for the Unwary: What Nevada Claimants Must Know about Mechanic’s Liens in Bankruptcy

By: Tracy M. O’Steen and James Patrick Shea

This article assumes that the debtor is the owner of the real property where the services and/or materials were provided. Different issues may arise if the debtor is not the owner, but rather the general contractor with respect to the construction project. This article does not address such issues.

Nevada state law provides a fairly straightforward process for perfecting mechanic’s liens. Under Chapter 108 of the Nevada Revised Statutes (“NRS”), there are specific steps to follow. In its most simplified version, in Nevada a claimant must (1) record its notice of lien[1], (2) properly serve the notice of lien[2], and (3) foreclose on the mechanic’s lien through court action[3]. However, when a bankruptcy comes into play, there are some traps that may befall the unwary. Understanding how the perfection and foreclosure of a mechanic’s lien is altered by the Bankruptcy Code requires a basic understanding of both Nevada construction law and bankruptcy law. Certain provisions of the Bankruptcy Code modify some of the basic concepts generally understood to be true in the area of mechanic’s lien law.

Perfecting a Mechanic’s Lien Post-Petition:

What happens when a claimant has provided goods and/ or services for a construction project, but before the claimant has either been paid or perfected its mechanic’s lien, the owner of the project files for protection under the Bankruptcy Code? Typically, once a bankruptcy petition has been filed, the “automatic stay” under 11 U.S.C. § 362(a)(4)[4] prohibits “any act to create, perfect or enforce a lien against the property of the estate.” This would seem to be a straightforward prohibition against taking any action to file and perfect a mechanic’s lien covering pre-petition goods and/or services. An unwary claimant may then stop all efforts to perfect and enforce its mechanic’s lien once a bankruptcy has been filed, and then lose those lien rights as a result. However, Bankruptcy Code Section 362(b)(3) specifically carves out an exception for perfecting a mechanic’s lien post-petition. This section states that the automatic stay does not apply to “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 perfection under § 546(b) of [the Bankruptcy Code].[5]

Section 546(b)(1), in turn, limits the Trustee’s powers to avoid liens by providing that those powers are subject to any “generally applicable law” that would 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 other words, most bankruptcy courts agree that state mechanic’s lien statutes that allow a supplier of labor and materials to assert a lien relating back to the time such labor or materials were first provided fall within the scope of § 546(b)(1). Under Nevada law, a mechanic’s lien may relate back to a pre-petition date if that date is when the labor and materials were originally supplied[6]; therefore, the act of recording and perfecting a mechanic’s lien under such circumstances is not subject to the automatic stay. That being said, the claimant may still want to seek a comfort order from the bankruptcy court prior to taking such an action and is encouraged to file a proof of claim regarding its lien as well.

Impact of the Automatic Stay on Actions to Foreclose a Mechanic’s Lien:

Even if a mechanic’s lien is perfected, whether that perfection occurred pre-bankruptcy or post-bankruptcy, the automatic stay will impact a claimant’s ability to either initiate or continue a suit to foreclose on the mechanic’s lien. The Bankruptcy Appellate Panel for the Ninth Circuit Court of Appeals has specifically concluded that the commencement of a foreclosure suit by the claimant post-petition violates the automatic stay.[7] This creates a major problem in Nevada since the procedure to enforce a properly perfected mechanic’s lien is the commencement of a foreclosure lawsuit within six months from the date the lien is recorded. Of course, a claimant may always seek relief from the automatic stay to commence or continue an action to enforce its lien. However, as an alternative, the Bankruptcy Code allows a claimant to preserve its rights by taking the substitute action of giving notice of its right to enforce the mechanic’s lien. It is recommended that this notice be filed in the bankruptcy case within the same time frame the claimant would be required to commence its action to foreclose the mechanic’s lien under Nevada state law. In Nevada, that time frame is six months from the date the Mechanic’s Lien is originally recorded.[8]

The Notice Required by § 546(b)(2):

Unfortunately, although the Bankruptcy Code requires the claimant to file a notice in the bankruptcy court to preserve its state law lien rights, the Bankruptcy Code fails to provide specific guidance as to what constitutes the requisite notice. The notice requirements under § 546(b)(2) differ from jurisdiction to jurisdiction, and unfortunately, there are no reported cases in Nevada dealing with the sufficiency of the § 546(b)(2) notice. However, the Ninth Circuit has concluded that the filing of a secured Proof of Claim is not sufficient to satisfy the § 546(b)(2) notice to maintain the mechanic’s lien nor is the recording of the lien itself.[9] Something more must be done to maintain the perfection of the mechanic’s lien or it will expire within the statutory six month period.[10] The guiding principle seems to be that the notice should inform the court and debtor that the creditor would have commenced the foreclosure action had bankruptcy not intervened. Despite some courts holding that oral notice or out-of-court action evidencing an intent to assert and enforce a lien can be sufficient, most courts conclude that § 546(b)(2) requires that something in writing be filed in the bankruptcy case.[11] A claimant should, at a minimum, file a pleading in the bankruptcy case that expressly provides that (1) the claimant has a right to assert a mechanic’s lien under applicable state law; (2) it intends to assert and enforce such a lien; and (3) it is authorized to do so under Bankruptcy Code provisions. The filing of this notice should preserve the claimant’s lien rights through the duration of the bankruptcy case.

Tolling of the Foreclosure Deadline:

Assuming the claimant has taken all the proper steps to preserve the lien, a majority of courts, including the Ninth Circuit Court of Appeals, agree that § 108(c) of the Bankruptcy Code tolls the deadline for commencing a foreclosure action to enforce a mechanic’s lien.[12] A claimant who timely records a mechanic’s lien under Nevada law and files the required notice under § 546(b)(2) in lieu of commencing a foreclosure action, has at least 30 days after the termination of the automatic stay (which may occur upon dismissal of the case or abandonment or surrender of property) to commence or continue its foreclosure action.[13] It is important to note that § 108(c) of the Bankruptcy Code only operates to toll the time period for commencing or continuing a civil action to foreclose the mechanic’s lien, and cannot be used to extend the time period for filing the original lien or the § 546(b)(2) notice discussed above.

Conclusion:

Claimants are cautioned to seek counsel if they have provided labor and materials with respect to a construction project and the property owner files for bankruptcy protection. In order to assert, perfect and maintain their lien during the bankruptcy case and avoid traps for the unwary, careful attention should be paid to the requirements of Nevada’s mechanic’s lien statute and the Bankruptcy Code. Otherwise, claimants risk waiving their mechanic’s lien rights.

Tracy O’Steen is an attorney in Armstrong Teasdale’s Financial and Real Estate Services practice group. She counsels clients on bankruptcy matters, distressed loans, commercial loan transactions, receiverships, landlord tenant disputes and other related commercial litigation. Mr. O’Steen can be reached by phone at 702.678.5070 or by email to tosteen@armstrongteasdale.com.

James Patrick Shea is a partner in Armstrong Teasdale’s Financial and Real Estate Services practice group and the immediate past president of the American Bankruptcy Institute. He has more than 30 years of experience advising financial institutions, landlords, vendors and other creditors in business bankruptcy proceedings. Currently, he serves as Special Counsel to the Chapter 7 Trustee in the Fountainebleau mechanic’s lien litigation. Mr. Shea can be reached by phone at 702.678.5070 or by email to jshea@armstrongteasdale.com.

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Footnotes:

1 NRS 108.226.
2 NRS 108.227.
3 NRS 108.223; NRS 108.239.
4 Unless otherwise stated, all section references in this article refer to sections of the United States Bankruptcy Code.
5 In re Orndorff Construction, Inc., 394 B.R. 372 (Bankr. Ct. M.D.N.C. 2008) (“An action to perfect a materialman’s lien is excepted from the automatic stay by Section 362(b)(3)”). See also In re Richardson Builders, Inc., 123 B.R. 736, 738 (Bankr. W.D. Va. 1990); In re Victoria Grain Co. of Minneapolis, 45 B.R. 2, 6 (Bankr. Minn. 1984).
6 NRS 108.222 (amount of lien); NRS 108.225 (a lien under this chapter is preferred to any lien recorded after the commencement of construction of a work of improvement).
7 In re Baldwin Builders, 232 B.R. 406 (9th Cir. B.A.P. 1999).
8 NRS 108.223.
9 In re Baldwin Builders, 232 B.R. at 413-14 (9th Cir. B.A.P. 1999).
10 NRS 108.223; In re In re Baldwin Builders, 232 B.R. at 413-14.
11 See In re Baldwin Builders, 232 B.R. at 413-14 (collecting cases).

 

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