In an opinion by Judge Roth issued on March 30, 2017, the Court of Appeals for the Third Circuit held that two suppliers who had sold electrical materials to a bankrupt contractor had violated the automatic stay by asserting a construction lien against the owner of the development where the contractor had installed the materials supplied.

Cooper Electrical Supply Co. and Samson Electrical Supply Co. (the “suppliers”) sold Linear Electric Co., Inc. various electrical materials, which Linear incorporated into several construction development projects. The development owners had not fully paid Linear for its work on these projects, and Linear had not fully paid the suppliers for their materials.  Linear filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code, and two weeks later the suppliers filed construction liens on the property owned by the developers.

Linear filed a motion with the Bankruptcy Court to discharge the liens as violating the automatic stay that arose upon the filing of its bankruptcy petition. The Bankruptcy Court granted the motion, holding that the construction liens were void ab initio for violation of the automatic stay.  The District Court affirmed, and the suppliers then appealed to the Court of Appeals for the Third Circuit.

After disposing of issues raised on appeal concerning alleged mootness and the scope of the bankruptcy court’s judicial power, the court turned to the merits of the stay issue. The court was faced with the question of whether a supplier can file a construction lien under New Jersey law when the contractor has filed a petition for bankruptcy, which automatically stays any act to create or perfect any lien against the contractor’s property. The court held that the filing of the liens did violate the automatic stay, because the liens were against Linear’s property, since the claim payment process allowed the suppliers to collect their recovery through reduction of the accounts receivable that were due to Linear from the property owner.  The court noted that where, “as here, a lien will be paid by transferring part or all of an asset from the bankruptcy estate to the lienholder, the lien is against the property of the bankruptcy estate,” and is not solely attached to the property interests of the development owners, as argued by the suppliers.  Interestingly, the court made no mention of whether Section 362(b)(3) of the Bankruptcy Code applies (providing an exception from the automatic stay for mechanics liens), and the district court explicitly stated that none of the stay exceptions were applicable in this case.  The inapplicability of the stay exception for mechanics lien may stem from the particular nature of the New Jersey law at issue and its focus on interdiction of monies otherwise payable to the debtor.

The court also noted that the “purpose of the automatic stay support[ed its] conclusion.” Specifically, the automatic stay is intended to give the debtor “breathing room for the development of…a plan” of repayment that repays creditors based on their classification. If the suppliers received full repayment, the court found, Linear “would receive less as a result,” “there would be less total money to go into the plan of repayment, and other creditors of Linear…would suffer.”  The court would not allow the suppliers to “effectively [circumvent] the bankruptcy case in order to unfairly advantage themselves at the expense of other creditors.”  This conforms to the general bankruptcy principle of treating all creditors fairly and only through the bankruptcy process.

This decision may have a significant impact on the construction industry, where payment arrangements such as that at issue in this case are common. The attorney for the suppliers described the decision as being “very detrimental…to the industry” and a “game changer” for some of his clients. Construction suppliers may suffer financially as a result of this decision, because without being able to pursue construction liens, suppliers will be forced to receive the same percentage of their claim as other unsecured creditors in bankruptcy.