Written By: Byron L. Saintsing, Esq. and John M. Sperati, Esq.
Smith Debnam Narron Drake Saintsing & Myers, LLP
Raleigh, North Carolina
POPULATION BOOM LEADS TO CONSTRUCTION BOOM
North Carolinahas experienced unprecedented population growth in the last twenty years as a result of a multiple converging economic and social factors. This once sleepy agrarian state has become a powerhouse of finance,a global center for high-tech research and development and a retirement mecca. That population explosion has taxed the state’s infrastructure systems,local governments,public school systems and housing supply. These factors lead to a construction boom that is still going on today to some degree,even though most North Carolinians still feel the ongoing effects of the Great Recession. The booming construction industry lead to many out of state contractors,suppliers and subcontractors lining up to tap into the construction back log North Carolina based contractors and suppliers could not handle quickly enough to satisfy the state’s growing needs. Many of these early out of state companies got a quick and expensive lesson in whatNorth Carolinabased contractors and suppliers already knew,North Carolinahas some of the strongest and most complicated lien laws in the country.
The teeth of North Carolina Lien laws are found in the constitutional mandate contained in Article X Section 3 of the North Carolina Constitution. This provision specifically requires the General Assembly to make adequate provisions for a lien to protect the rights of those that provide labor and materials for the improvement of the lands of another. North Carolina’s early founders recognized that this state would be built on the backs of the everyday laborers who would be subjected to hardship if not protected from unscrupulous land owners,who wielded the power to withhold monies owed. Under Chapter 44A of the North Carolina General Statutes,many of these original protections are still in place and among them is the ability of a contractor or materialman to claim a lien on the improved real property that relates back in time to their first date of furnishing of labor or materials to the project. N.C. Gen. Stat. § 44A-10 Subcontractors and suppliers can also subrogate to the rights of the contractor having a direct contractual relationship with the owner of the real property they are improving with their provision of materials and/or labor through the notice of claim of lien on funds provisions contained within N.C.G.S. § 44A-19-23 (“the Relation-Back Doctrine”). The Relation Back Doctrine is a very powerful right becauseNorth Carolina is a “pure race” jurisdiction. That means the first to record their interest at the courthouse is the first in priority. A liening contractor, subcontractor or supplier may, under certain circumstances claim a lien superior to the owner of the real property and/or those of any financing institutions with a deed of trust recorded against the real property for the purposes of securing a loan, if the lien claimant’s first date of furnishing predates the filing date of the deed of trust. Therefore, the Relation Back Doctrine can be problematic for title insurance companies, owners and lenders.
RELATION BACK DOCTRINE TRANSLATES TO POWER IN NORTH CAROLINA’S BANKRUPTCY COURTS
Most North Carolina construction lawyers,contractors,subcontractors and suppliers operated under the belief that providing labor and/or materials for the improvement of the real property within the definition of Chapter 44A of the North Carolina General Statutes provided them with inchoate lien rights that arose upon the first date of furnishing of labor or materials. N.C. Gen. Stat. § 44A-10. These inchoate lien rights may be perfected post-petition as an exception to the automatic stay under 11 U.S.C. § 362(b)(3). See Equitable Life Assurance Soc. v. Basnight, 234 N.C. 347 (1951). These liens would be given “super priority” to all other interests in the funds N.C. Gen. Stat. § 44A-22. It was commonly accepted in the Bankruptcy Courts of North Carolina that a claimant’s lien rights could be exercised prior to or after the filing of bankruptcy, providing the lien right was exercised within the statutorily prescribed time limits of N.C. Gen. Stat. § 44A-12.
RULINGS IN THE EASTERN DISTRICT OF NORTH CAROLINA SEND TREMORS THROUGH THE NORTH CAROLINA CONSTRUCTION COMMUNITY
The troubles for North Carolina’s lien claimants began with the filing of the two now infamous cases,In re Harrelson Utilities, Inc. No. 09-028158 (E.D.N.C. Bankr. July 30, 2009), and In re Mammoth Grading, Inc., No. 09-01286-8 (E.D.N.C. Bankr. Aug. 24, 2009). Both companies were then seeking voluntary Chapter 11 bankruptcy protection.
Ferguson Enterprises Inc. ofVirginia(“Ferguson”) was an unpaid subcontractor on numerous real estate development projects throughoutNorth Carolinafor which Mammoth Grading, Inc. (“Mammoth”), and Harrelson Utilities, Inc. (“Harrelson”), were acting as general contractors or first tier subcontractors. After the filing of Mammoth’s and Harrelson’s bankruptcy petitions, Ferguson filed multiple notices of claims of lien on funds due Harrelson and Mammoth and multiple claims of lien by way of subrogation to Mammoth and Harrelson’s lien rights on the various construction projects.
THE ADVERSE RULING
In each case,the Bankruptcy Court for the Eastern District of North Carolina (“the Bankruptcy Court”) held that the post-petition filing and service of claims of liens and notices of claims of liens filed by Ferguson and various other subcontractors and suppliers to Mammoth and Harrelson violated the automatic stay imposed by 11 U.S.C. § 362. The Bankruptcy Court’s rulings in Mammoth and Harrelson Utilities held that a subcontractor’s lien rights do not constitute “an interest in property” within the meaning of Bankruptcy Code section 362(b) (3) which excepts from the automatic stay imposed by § 362 (a) (4) acts to perfect a “preexisting interest in property” and that post-petition claims of liens and notices of claims of liens are invalid and unenforceable. As you can imagine, these rulings were simultaneously celebrated and reviled by the various factions impacted by these rulings. Ferguson, along with four other subcontractors, appealed the Bankruptcy Court’s orders in both cases to the United States District Court. On August 26, 2010, the United States District Court consolidated the Harrelson and Mammoth appeals.
THE MAMMOTH AND HARRELSON UTILITIES APPEALS PROCESS
On July 29, 2011, Mammoth filed with the Bankruptcy Court a motion to abandon toFergusonthe bankruptcy estate’s claim to funds on deposit with the Clerk of Superior Court of Wake County, North Carolina for one particular project. As it turned out, this would serve to resolve the one remaining lien claim in both cases. On September 12, 2011, the United States District Court stayedFerguson’s appeal pending the Bankruptcy Court’s decision on Mammoth’s abandonment motion. The Bankruptcy Court allowed Mammoth’s motion to abandon and ordered that the funds held by the Wake County Clerk of Superior Court be abandoned to Ferguson and be credited against Ferguson’s claim in the bankruptcy estate. Mammoth then moved to dismissFerguson’s appeal. It it’s Motion to Dismiss, the Trustee for Mammoth argued that the abandonment of these funds on deposit with the Wake County Clerk of Court, which represented the remaining amount in controversy on appeal, rendered Ferguson’s appeal moot.
CRACKS IN THE ARMOUR
On February 23,2019,United States District Court Judge for the Eastern District of North Carolina Malcolm J. Howard (“Judge Howard”) issued an order granting Mammoth’s Motion to Dismiss Ferguson’s appeal. In the words of Judge Howard,the Bankruptcy Court’s rulings “have turned the construction industry’s standard operating procedure on its head.” Judge Howard’s order went on to analyze the Mammoth rulings and questioned if the Bankruptcy Court’s rulings prohibiting the filing of notices of claim of lien and claims of lien post-petition were in accordance with North Carolina statutory lien law and the further constitutional protections afforded laborers and materialmen by Article X Section 3 of the North Carolina Constitution. Judge Howard went on to express particular concern that the Bankruptcy Court may have erred in determining that a lien under Chapter 44A, Article 2 Part 2 of the North Carolina General Statutes does not arise until the filing of a notice of claim of lien by the subcontractor. However, Judge Howard was bound by law to dismissFerguson’s appeal as being moot. Before doing so, he cited several examples where the District Court could issue a ruling on the appealed issue, if the dismissal of the appeal would prevent an adverse ruling from being heard on the merits by a set of circumstances such as an appeal being rendered moot.
For the reasons cited above and to resolve the inadequacies of the Bankruptcy Court’s ruling in Mammoth, Judge Howard vacated the Mammoth rulings and remanded the case to the Bankruptcy Court for further proceedings. By vacating the Mammoth decision, Judge Howard essentially overturned it, which meant Mammoth was no longer binding precedent.
A SMALL VICTORY
Even with the rulings from Judge Howard in the Mammoth appeal, the rulings from Harrelson, holding that the filing of post-petition claim of lien or notice of claims of lien constituted a violation of the automatic stay remained the law of the land, at least for the Eastern District of North Carolina. The bright side of this small victory was that the Harrelson Utilities rulings had never been adopted by the Middle or Western Districts ofNorth Carolina and there was now a substantial crack in the reasoning behind the rulings in Harrelson and later Mammoth.
THE LATEST RULING: CONSTRUCTION SUPERVISION SERVICES, INC.
The most recent Bankruptcy Court ruling to impact the rights of lien claimants came from the Honorable Randy D. Doub presiding over In Re Construction Supervision Services, Inc., (E.D.N.C. Bankr. March 14, 2012) (“CSSI”). CSSI, like Mammoth and Harrelson, involved a general contractor/subcontractor seeking Chapter 11 bankruptcy protection from its creditors. Many of CSSI’s creditors were material suppliers and subcontractors that prior to the rulings in Mammoth and Harrelson would have been able to protect their rights to payment with the filing of post-petition claims of lien and claims of lien on funds under Chapter 44A of the North Carolina General Statutes. Several of these creditor suppliers filed emergency motions for relief from stay seeking the Bankruptcy Court’s permission to file and serve liens on funds in the hands of CSSI. The movants believed that CSSI was attempting to use money that would have normally been used to pay secured subcontractor/supplier priority lien claims to fund a portion of its reorganization plan.
Judge Doub ruled that based on the instructive guidance from the United States District Court in its order resolving the Mammoth appeal and his own detailed analysis ofNorth Carolina lien law and the Bankruptcy Code:
Many states have similar Relation Back Doctrines in their lien laws. Therefore the decisions in Mammoth, Harrelson and CSSI are instructive on the interplay the Bankruptcy Code and state law. Most states have quick deadlines within which to file a lien. A bankruptcy filing can cause lien claimants to sit on their rights and not file a lien for fear of violating the automatic stay. Doing so may cause them to lose their right to file a lien against the construction project, which may in turn cause the client to lose any chance at recovering the amounts that it is owed out of the bankruptcy case. The decisions discussed in this article set forth the various arguments as to why the automatic stay of the Bankruptcy Code would or would not apply to filing or perfecting a lien claim post-petition.