The Bankruptcy and Construction Junction: Making Your Texas Mechanic’s Lien Function Better in Bankruptcy
In order to secure a real property owner’s payment obligation, contractors, mechanics, materialmen, and other workmen are often granted a lien referred to by a variety of names including, materialmen’s liens, workmen’s liens, and mechanic’s liens. While the parlance varies by jurisdiction, they are generally referred to as mechanic’s liens in Texas—even in the context of real property. Because a mechanic’s lien secures the real property owner’s obligation to the underlying real property, making sure that their mechanic’s lien is properly perfected should be in the forefront of all contractors’ minds. The protection afforded by a mechanic’s lien becomes increasingly important for contractors if they encounter issues obtaining payment from the real property owner or if the real property owner files bankruptcy.
Texas has two types of mechanic’s liens for real property: constitutional and statutory. Article XVI section 37 of the Texas Constitution expressly provides for a variety of mechanic’s liens, and states:
Mechanics, artisans and material men, of every class, shall have a lien upon the buildings and articles made or repaired by them for the value of their labor done thereon, or material furnished therefor; and the Legislature shall prove by law for the speedy and efficient enforcement of said liens.
Courts interpret this section of the Texas Constitution as providing for “self-executing” liens as between the lien claimant and the property owner; that is, these constitutional liens do not generally require a contractor to take any additional steps beyond furnishing materials or labor directly to the property owner in order to perfect their interest. The ease with which protection is afforded is generally great news for contractors because they receive increased rights just by virtue of their labor. There is also a second, and arguably superior, way to obtain a mechanic’s lien on real property.
The second way to create a mechanic’s lien on real property in Texas is by following the statutory procedures. More particularly described in chapter 53 of the Texas Property Code, the statute generally requires the completion of an affidavit containing certain statutorily specified information including, among other information, the amount of the claim, the contact information of the claimant, and a description of the encumbered property. The statute also requires recording the affidavit with the county clerk for the county in which the property is located within a statutory period, and then providing a copy of the notice to the property owner.
But why would anybody want to jump through all those additional hoops for a statutory lien when obtaining a constitutional lien is so easy? The answer is simple: the statutory lien is more powerful, and in certain situations, including if the real property owner files bankruptcy, may mean the difference between getting paid in full and getting pennies on the dollar. In the context of bankruptcy, the crucial difference between these statutory and constitutional liens is the type of notice each provides.
In Texas, a mechanic’s lien claimant must provide actual or constructive notice to third parties to be protected against the rights of those third parties. Because they are not recorded, constitutional liens rely on actual notice and constructive notice via the third party’s knowledge. On the other hand, properly perfected statutory liens provide constructive notice because they are recorded in the county’s real property records.
Section 544 of the Bankruptcy Code provides the so-called “strong arm powers” of the bankruptcy trustee, which may be used to avoid certain liens and interests in property of the bankruptcy estate. More particularly, Bankruptcy Code section 544(a) provides that
The trustee shall have as of the commencement of the case, and without regard to any knowledge of the trustee or of any creditors, the rights and powers of, or may avoid any transfer of property of the debtor or any obligation incurred by the debtor that is voidable by . . .
(3) a bona fide purchaser of real property, other than fixtures, from the debtor, against whom applicable law permits such transfer to be perfected, that obtains the status of a bona fide purchaser and has perfected such transfer at the time of the commencement of the case, whether or not such a purchaser exists.
Section 544 causes major problems for the contractors that only have a constitutional lien because it makes actual knowledge or notice irrelevant. Constitutional mechanic’s liens are not recorded and rely on actual notice or knowledge to be effective. Without actual notice and knowledge, constitutional liens are ineffective and can be avoided by the trustee’s strong arm powers. Absent another defense, section 544 leaves a contractor relying a constitutional mechanic’s lien no better off than another unsecured creditor.
The simple solution to the problems associated with constitutional liens in bankruptcy is for contractors to fulfill the requirements to obtain a statutory mechanic’s lien. The constructive notice provided by recording a statutory mechanic’s lien with the county clerk’s office is not rendered ineffective by section 544. As a result, contractors with properly perfected statutory mechanic’s liens generally cannot have their interest avoided by section 544. While constitutional mechanic’s liens are of value in some contexts, a properly perfected statutory mechanic’s lien provides greater protection in the event the real property owner files bankruptcy.
As the law continues to evolve on these matters, please note that this article is current as of date and time of publication and may not reflect subsequent developments. The content and interpretation of the issues addressed herein is subject to change. Cole Schotz P.C. disclaims any and all liability with respect to actions taken or not taken based on any or all of the contents of this publication to the fullest extent permitted by law. This is for general informational purposes and does not constitute legal advice or create an attorney-client relationship. Do not act or refrain from acting upon the information contained in this publication without obtaining legal, financial and tax advice. For further information, please do not hesitate to reach out to your firm contact or to any of the attorneys listed in this publication.