Lien Laws, Bankruptcy Preferences Laws

Preemption Under The Supremacy Clause of The U.S. Constitution

For contractors and materialmen doing business in the States of Colorado, Delaware, Illinois, Maryland, New Jersey, New York, Oklahoma, Texas or Wisconsin, payments under their state’s lien laws may constitute payments from a trust. As such, the payments are arguably trust property and not property of a debtor, should the debtor file bankruptcy and seek return of the transfers under federal bankruptcy laws. But are the states’ lien laws preempted by the Supremacy Clause of the U.S. Bankruptcy Code? This is the question faced by creditors who supplied services and equipment on construction projects in the Delaware bankruptcy case of In re IT Group, Inc.

In In re IT Group, two creditors, one a subcontractor and the other an equipment rental company, received transfers from the debtor-contractor within ninety days prior to the petition date. In response to the complaints filed against them, the creditors filed motions for summary judgment against the debtor asserting that the payments were from a statutory trust that the New York legislature had established for the benefit of parties providing labor, service and materials in connection with prime construction contracts. As such, the creditors asserted that the payments did not constitute an interest of the debtor in property, as required to constitute a preferential transfer.

In response, the debtor asserted tha the New York lien law conflicted with federal bankruptcy laws. The debtor argued that, as a result of the conflict, the New York lien law was preempted under the Supremacy Clause of the U.S. Constitution. The Supremacy Clause provides that to the extent federal and state laws conflict, the state laws are invalid.

In ruling on the defendants’ motions for summary judgment, the court concluded that defendants were entitled to judgment in their favor because New York lien law created a statutory trust, which required that the funds received by a general contractor for the improvement of real property be held in trust for the benefit of the subcontractors. Therefore, the funds were not property of the debtor’s estate. The court’s ruling gives creditors another weapon their arsenal against the war on preference recoveries.