August 25, 2009
A North Carolina Bankruptcy Court recently ruled that a subcontractor’s service of a notice of claim of lien on funds after the date the contractor had filed a petition in bankruptcy violates the automatic stay. Thus, held the court, the lien on funds was void. Further, because under North Carolina law a subcontractor may file a lien on real property only upon the service of a valid notice of claim of lien on funds, the subcontractor’s lien on real property was ruled void as well. This trial court opinion has been appealed.
In re: Harrelson Utilities, Inc., Case No. 09-02815-8-ATS, United States Bankruptcy Court, Eastern District of North Carolina, Raleigh Division July 30, 2009), recognized that whether a post-petition claim of lien in North Carolina falls within the exceptions to the automatic stay found in Bankruptcy Code § 362(b)(3) depends on a question of state law. In particular, if under state law the subcontractor has an interest in the funds prior to perfection (i.e. prior to service of notice of lien), the exception applies and the lien is valid. However, if under state law the lien right is created by the giving of the notice, the exception does not apply and the lien is void.
In reaching its decision, the court distinguished between North Carolina liens on real property and liens on funds, ruling that the statutory provision that a lien on real property “relates back” to the time of first furnishing of labor or materials, creates an interest in the realty prior to perfection, whereas a lien on funds, the court found, was afforded no such benefit. No subcontractor interest in the fund is created until service and receipt of notice. Curiously, the court did not find NCGS § 44A-22 provides the priority necessary to enforce a post-petition lien on funds. Section 44A-22 provides that a lien on funds enjoys priority over all other interests or claims “theretofore of thereafter created.”
While a boon to owners seeking to avoid all liens, this distinction between real property and fund liens provides no solace for North Carolina subcontractors. Under state law subcontractors may exercise only a subrogated right of the contractor to lien real property and, further, must serve a valid lien on funds as a precondition to perfecting that subrogated right. Here, where a contractor’s bankruptcy cuts off an opportunity to perfect a lien on funds, the subcontractor is additionally precluded from perfecting a lien on real property.
The In re: Harrelson ruling has generated spirited debate in the North Carolina construction industry and construction law bar. Industry advocates warn that the ruling, if sustained on appeal, will require subcontractors to serve liens on funds as soon as they first supply labor or materials, with predictable negative results on project cash flow. Others observe that some subcontractors may receive word that the contractor is experiencing financial trouble and, thus informed, proceed to serve liens on funds to the detriment of subcontractors who do not have that information or who do not receive it until alerted to a contractor bankruptcy. This result, observers argue, is inconsistent with the effect and intent of North Carolina lien law to require all subcontractors to share pro rata where a fund is inadequate to satisfy all claims. Further, some observers say liens on funds should not be afforded less dignity because actual receipt of a formal notice of lien on funds is far better notice than the first provision of labor or materials. Often an owner has no practical means of knowing who is supplying the subcontracted labor or materials to the contractor. Some express concern that this ruling could be logically extended to void liens on real property as well.
Steven D. Hedges, Esquire Contributing Author
Nexsen Pruet, PLLC
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