Chapter X Bankruptcy and Mechanics Liens
Library | Turner on Illinois Mechanics Liens (2016 Ed.) |
A. Introduction
This chapter focuses on the intersection of bankruptcy and construction law and the rights that are impacted by the commencement of a bankruptcy case. The filing of a bankruptcy by any one of the players involved in a construction project presents unique problems. The rights, obligations, and liabilities of property owners, general contractors, and subcontractors in the context of a bankruptcy filing are always evolving.
B. Overview of a Bankruptcy Case
1. Jurisdiction, Commencement of an Action, and Property of the
Estate
The federal bankruptcy court is somewhat of an oddity in the pantheon of federal courts: it does not owe its existence to Article III of the United States Constitution (i.e., the article that provides for the establishment of the federal court system). Bankruptcy courts are created pursuant to the Bankruptcy Clause under Article I, § 8, cl.4 of the United States Constitution.1
Federal district courts have "original and exclusive jurisdiction" of all cases under title 11 of the United States Code (the "Bankruptcy Code").2 District courts can refer these cases to the bankruptcy judges for their districts under 28 U.S.C.A. § 157(a).3 By statute, a bankruptcy judge to whom a case has been referred may enter final orders and judgments on any "core proceedings" arising under the Bankruptcy Code or arising in a case under the Bankruptcy Code.4 Core proceedings include, among other things, "counterclaims by the estate against persons filing claims against the estate."5 Furthermore, a bankruptcy judge may enter final judgment in a non-core proceeding that is related to a bankruptcy case if the parties consent.6 A non-core proceeding is "related" to a bankruptcy case only when "it affects the amount of property available for distribution or the allocation of property among creditors."7
Until the decision by the United States Supreme Court in Stern v. Marshall, bankruptcy judges were authorized to enter final judgments of counterclaims against a claim of a creditor. After the Supreme Court's decision in Stern v. Marshall, a bankruptcy judge's authority to enter final judgments on state law counterclaims is limited. The Supreme Court held that a judgment by a bankruptcy judge on a counterclaim arising under non-bankruptcy law is not constitutionally permitted, even though it is under "core" authority, when the counterclaim is founded on "a state law action independent of the federal bankruptcy law," and is based upon private rather than public rights.8
The Supreme Court determined that Article III of the Constitution requires the "removal of certain counterclaims from core bankruptcy jurisdiction" so that such counterclaims are decided by a district court judge appointed under Article III of the Constitution, rather than a bankruptcy judge appointed under Article I. The Stern v. Marshall opinion did not hold that a bankruptcy judge can never decide a state law issue. Rather, the issue must "stem from the bankruptcy itself or would necessarily be resolved in the claims allowance process."9
Since Stern v. Marshall, the United States Supreme Court has rendered two additional pronouncements on a bankruptcy court's ability to exercise jurisdiction as an Article I court over certain types of claims that are to be heard by Article III courts, and to shed more guidance on the treatment of what are often referred to as "Stern" claims: Executive Benefits Ins. Agency v. Arkison, 573 U.S. ___ (2014) (holding that when, under the reasoning of Stern v. Marshall, the Constitution does not permit a bankruptcy court to enter final judgment on a bankruptcy-related or "Stern" claim, the relevant statute nevertheless permits a bankruptcy court to issue proposed findings of fact and conclusions of law to be reviewed de novo by the district court) and WellnessInt'l Network, Ltd., et al v. Sharif, 575 U.S. 134 S. Ct 2165 (2015) (holding that there is no violation of constitutionality mandated separation of powers by a bankruptcy court10 exercising jurisdiction over a "Stern" claim or one that should be decided by an Article III court when the parties to the litigation consent to the resolution of the claim by a bankruptcy court).
The powers of bankruptcy courts are circumscribed by a distinction between "core" and "non-core" proceedings.11 It is not likely that any action involving a mechanics lien would be non-core. Accordingly, the bankruptcy court would have power to dispose of the matter in its entirety if it retained jurisdiction in the face of a move by the mechanics lienholder to have the matter determined in another forum.
There are six chapters of the Bankruptcy Code,12 under which a bankruptcy case may be commenced. These chapters represent five different types of cases and methods of providing relief from financial distress for the debtor:
1. Chapter 7, liquidating the assets of a debtor;
2. Chapter 9, adjusting the debts of a municipality;
3. Chapter 11, reorganizing the financial affairs of a debtor;
4. Chapter 12, adjusting the debts of a family farmer with regular annual income;
5. Chapter 13, adjusting the debts of an individual with regular income; and
6. Chapter 15, cross-border insolvency.
The rights and duties of the holder of a mechanics lien are the same regardless of the chapter under which a case has been commenced. Even so, the treatment and the ultimate disposition of the lien can vary in each of those types of cases.
A bankruptcy case may be commenced at any time. Only cases under Chapters 7 and 11 may be commenced involuntarily against a debtor by its creditors. A debtor may commence a bankruptcy case voluntarily without regard to its solvency or insolvency. Immediately upon the commencement of a bankruptcy case, an injunction-like proscription arises called the "automatic stay." With certain exceptions, the automatic stay prohibits a creditor, during the pendency of the bankruptcy case, from initiating or continuing any action against the debtor or against its property on account of a pre-petition debt. Usually, this prohibition includes perfection and enforcement of mechanics liens.
If the case was commenced under Chapter 7, a private trustee from a panel will be appointed by the United States Trustee to take responsibility for liquidating the debtor's assets unless the creditors exercise their option to elect the trustee. In a Chapter 11 case, usually there is no trustee (the debtor becomes the "debtor-in-possession"), but a trustee may be appointed for cause upon request. There are no trustees in Chapters 9 and 12 cases, and the Chapter 13 trustee, a permanent feature of a Chapter 13 case, usually does nothing but administers the debtor's plan and relays payments to creditors.
The different kinds of administrative activities that occur in cases under Chapters 7 and 11 may cause mechanics lienholders to see very different processes at work (even though a debtor's assets can also be liquidated in a Chapter 11 case). Accordingly, the actions a mechanics lienholder may have to take to protect its interest may be different in each type of case.
One feature common to all bankruptcy cases without regard to the chapter under which a case may be filed is that, upon the commencement of the case, an estate is created composed of all the interests in property held by the debtor at that time.13 The significance of this fact for mechanics lienholders is twofold: both legal and equitable interests are included in property of the estate, but only to the extent of the interest held by the debtor. For example, the bankruptcy estate of a beneficiary of a land trust does not include the legal title.14 Funds held by an owner of a construction project on which the contractor-debtor performed services or furnished materials are considered property of the estate.
Not all entities that seek to commence bankruptcy cases are eligible to be debtors in bankruptcy. Due to the use of the term "person" in Bankruptcy Code §109 - which identifies the entities that may be debtors in bankruptcy and serves as the antecedent definition for "person" in Bankruptcy Code §101(41) -the case law consistently evidences that the land trust, which does nothing more than hold legal title, is not a person under the Bankruptcy Code and is not an entity that can be a debtor in bankruptcy.15
2. Trustees and Their Powers
Every judicial district of the United States (except those in North Carolina and Alabama) has a representative of the office of the United States Trustee. United States Trustees are responsible for the overall supervision of the administration of bankruptcy cases, but they usually do not become actively involved in a case (with exceptions not relevant here) because of the usual activity of parties in interest as trustee.
The trustees are private persons who have made application and been appointed to the panel of private trustees for the district. When the court authorizes appointment of a trustee to a case or a Chapter 7 case is filed, the Office of the United States Trustee selects, usually at random, a trustee from the panel to serve as trustee.
The Bankruptcy Code, under 11 U.S.C. §§ 704 and 1106, outlines the duties of a trustee in cases under Chapters 7 and 11, respectively. The trustee is the representative of the estate. In a Chapter 7 case, the trustee basically runs the case. The trustee convenes the first meeting of creditors, determines whether it is likely that assets will be distributed to creditors, and pursues actions to set aside transfers and transactions that may be avoidable under the avoiding powers given to the trustee in the Bankruptcy Code. The trustee in a Chapter 11 case is the substitute for the debtor-in-possession and possesses the powers of the debtor-in-possession. When no trustee has been appointed, the debtor-in-possession has all the powers of a trustee.
A most important determinant of how a trustee in bankruptcy will...
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