Protecting Your Company's Rights to Performance and Payment in the Bankruptcy Context

• Author: By David J. Theising, Marilyn Klinger, and Robert J. Berens
• Pages: 14-26

THE CONSTRUCTION LAWYER

14 Volume 42 Issue 3

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The Construction Lawyer

, Volume 42, Number 3. © 2023 American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not

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BANKRUPTCY AND PAYMENT RIGHTS

Protecting Your Company’s Rights

to Performance and Payment in the

Bankruptcy Context

By David J. Theising, Marilyn Klinger, and Robert J. Berens

This article provides the basic

concepts regarding bankruptcy

and obtaining performance and

payment on construction proj-

ects where bankruptcy is an issue.

Once understood on a basic level,

any party to a construction

project can direct its attention,

through competent counsel, to

achieving performance and pay-

ment notwithstanding that one

of the parties to the construction

project has gone into bankruptcy.

Key Concepts to

Understanding Rights and

Remedies When a Company

on a Construction Project Files

Bankruptcy

Those four key concepts regard-

ing the ling of bankruptcy are

(i) creation of a bankruptcy

estate, vested with certain rights

and powers; (ii) the automatic

stay; (iii) ratable distribution;

and (iv) discharge of debt. This

article addresses the rst two of

these concepts because it is at

those stages that the parties to a construction project must

set the stage to complete construction and receive payments,

notwithstanding the bankruptcy ling.

Creation of the Bankruptcy Estate—Property of the

Estate

A bankruptcy case begins when the debtor les a voluntary

petition for relief or when creditors le an involuntary peti-

tion against the debtor (although involuntary petitions are

relatively infrequent in the construction arena).1 The ling

of a bankruptcy petition creates an “estate” composed of

“all legal or equitable interests of the debtor in property

as of the commencement of the case.”2 The “bankruptcy

estate” is created by law to be administered under the pro-

tection and general supervision of the bankruptcy court.3

This estate is vested with special rights and powers, includ-

ing the right to (i) compel third parties to pay debts owed

to the debtor and return property of the estate in their

possession;4 (ii) avoid certain pre-petition transfers, includ-

ing preferential and fraudulent transfers,5 and recover the

property transferred or its value from the transferee;6 (iii)

sell, lease, or otherwise use property of the estate, even if

the property has valid pre-petition liens or encumbrances

or is subject to third-party adverse claims;7 and (iv) cure

defaults under, and reinstate the terms of, executory con-

tracts, notwithstanding defaults and provisions in those

agreements that otherwise would permit termination

because of the debtor’s bankruptcy or insolvency.8

By operation of law, an automatic stay becomes effective

immediately to protect the debtor, its estate, and the prop-

erty of the bankruptcy estate from virtually all forms of

litigation, debt collection, lien creation, and lien and judg-

ment enforcement.

9

This prohibition includes commencing

or continuing a lawsuit, entering or enforcing a judgment,

exercising a right of setoff, terminating a contract, or tak-

ing any other action to enforce a contractual obligation.

The ling date of a bankruptcy petition is signicant.

For example, the bankruptcy process treats all claims and

obligations that arose pre-petition—whether liquidated or

unliquidated, xed or contingent, disputed or undisputed—

as claims against the bankruptcy estate. Unsecured claims

will generally cease bearing interest. Secured claims that

might otherwise be entitled to interest can be “valued” by

determining the value of the collateral as of the petition

date. In other words, the claim will be secured to the extent

of the value of the collateral securing it. If that collateral

is worth less than the amount of the claim, the creditor

will only have a secured claim to the extent of the value

(and will not be entitled to interest on that secured claim)

and will have an unsecured claim for the deciency.10 If the

value of the collateral exceeds the amount of the debt, the

creditor will be entitled to interest, fees, and costs, to the

extent permitted by contract or applicable law up to the

value of the collateral.11

Claims that arise subsequent to the petition date are

often entitled to administrative expense status and have

a higher priority than general unsecured pre-petition

claims.12 One purpose of this higher priority is to encour-

age parties to do business with the debtor and facilitate its

reorganization.

The Different Chapters of the Bankruptcy Code—

Chapters 7, 13, 11, and New Subchapter V of Chapter 11

Depending on a particular debtor’s circumstances, a debtor

David J. Thei sing

Marilyn Klinger

Robert J. Berens

14 14 7/18/2023 1:52:06 PM7/18/2023 1:52:06 PM