My last article examined strategies for construction managers facing an owner bankruptcy. Now, looking through the lens of the owner, let’s examine best practices when it is the contractor who has filed for bankruptcy.
Throughout New England and the United States the construction industry continues to thrive with several new projects underway and on the horizon. Last month, Dodge Data & Analytics projected that total U.S. construction will increase in 2017 by five percent. Lenders and sureties continue to aggressively underwrite contractors and subcontractors allowing businesses to grow quickly. But growing too quickly can lead to cash flow and labor allocation issues both of which are ingredients for a project bankruptcy.
Protecting the project from bankruptcy starts with your project delivery method and contract documents. The construction management agreement and subcontracts should have strong trust fund provisions, acknowledging that payments being made to the contractor are in trust for the benefit of the subcontractors and suppliers. Effective lien waivers should be required of all significant subcontractors and suppliers. Retainage should be withheld and segregated throughout construction and above all else the owner should do its best to ensure that the construction manager is not front loading its billings.
The most typical bankruptcy filings on construction projects are under Chapter 7 and Chapter 11. In a Chapter 7 proceeding the debtor’s assets are liquidated in an orderly fashion and the proceeds distributed to creditors based upon the priority of their claims. When a Chapter 11 proceeding is filed the debtor continues to operate and carry on its business; the strategy usually being to shed or restructure debt and avoid unfavorable contracts.
In either case, if the construction manager files a bankruptcy petition and breaches the contract, an Owner must immediately assess the status of its construction project and determine the percentage of work in place, the quality of the work, status of subcontractor payments and the cost to complete the project. The goal is to keep the project moving. Relief from the automatic stay will be required to take any adverse action against the construction manager, including the declaration of a default and termination of the construction management agreement. Notably, such approvals are not, however, required for the owner to proceed against any construction performance bond posted by the contractor (if such a bond exists); which if required would provide the Owner with ultimate protection in a bankruptcy context. Whether relief from the automatic stay will be granted depends upon several factors and the unique circumstances of each case. The court will weigh any prejudice to the debtor from lifting the stay with the hardship to the movant from continuing the stay and whether the movant has a reasonable probability of prevailing on the merits of its claim.
The construction manager generally has the ability to assume or reject any agreements which have not been fully performed by both parties. These are called executory contracts and include agreements governing half completed construction projects. In order to keep the project moving an owner will want to compel this decision as early as possible so that the project can proceed with or without the construction manager. The bankruptcy court rules provide the owner with the ability to file a motion to compel the construction manager or its trustee to assume or reject the construction management agreement. The agreement will be assumed if it has a net benefit to the estate. Otherwise, it will be rejected. If the construction manager assumes the contract and reaffirms its obligations owners can and should seek adequate assurances that the construction manager will be able to perform under the contract and complete the project.
The filing of a bankruptcy petition isn’t something that project participants anticipate. However, if such a proceeding is filed owners are well advised to be assertive and take strategic action quickly. Note that while this article sets out general observations, the actual circumstances encountered will dictate what actions or strategies should be employed and a construction manager or owner should always consult their attorney before taking any action.