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Release of Incohoate Lien

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By Bradley D. Blakeley Esq.
Reprinted by permission from Trade Vendor Quarterly Blakeley & Blakeley LLP

Construction Credit

As a construction contractor, you perform your services and are paid by the customer. After payment, you release your inchoate lien - a lien right that has not yet been perfected through the filing of a mechanic’s lien or action to foreclose. Thereafter, your customer files for bankruptcy and sues you for return of the payment. Trustees have successfully argued that once a lien is released, the creditor is not a secured creditor. As a result, the creditor received more than it would have in a chapter 7 liquidation and is forced to return the preferential payment. In the recent case of Golfview Development Center, Inc., the creditor defeated the debtor’s preference claim, demonstrating that an incohate lienholder is a secured creditor in the context of a preference claim.

In Golfview Development Center, the debtor contracted with a creditor to paint the interior of its leased building. The creditor completed the work and invoiced the debtor accordingly. The debtor submitted payment to the creditor, and the creditor forwarded a lien waiver to the debtor. Thereafter, the debtor filed the complaint to avoid and recover the transfer.

The parties disputed the fifth element of §547(b) - whether the creditor received more than it would have if the debtor had filed a liquidation case under chapter 7. The creditor contended that is was a secured creditor and thus the transfer did not enable it to receive more than under a chapter 7, thus there is no avoidable preference.

In a chapter 7 liquidation case, if a creditor is fully secured, it should receive the full value of its claim. In order to determine if a creditor is fully secured the court must determine if the value of assets secured as collateral equaled or exceeded the value of the creditor's secured claim. In order to determine the secured status and value of a creditor’s interest in the debtor’s property on the transfer date, the court must look to state law.

In Golfview Development Center, the court applied Illinois law. An Illinois mechanics lien is a statutory lien, and the lien extends to all interests that the owner has in the property improved by the lien claimant. The court found that the requirements of a valid inchoate mechanics lien had been met: (1) the debtor and creditor had a valid contract; (2) the landlord, pursuant to the lease with the debtor, knowingly permitted the debtor to make improvements on the property; (3) the creditor furnished lienable materials and labor; (4) the creditor did in fact perform under the contract.

The creditor was paid within two months of completion of the work, and thus had no need to give written notice or record a verified claim for lien, or file suit to enforce and foreclose its mechanics lien. The debtor argued that because the creditor did not perfect its lien rights, it released any secured status it had. The court disagreed with this argument finding that the creditor's claim was secured to the extent of its inchoate lien. Section 101(37) of the Bankruptcy Code defines lien as a charge against or interest in property to secure payments of a debtor or performance of an obligation. The legislative history of §101(37) makes clear that the term lien includes inchoate liens.

The court found that at the time of the transfer the creditor was a secured creditor by the full amount of the worth of work it had performed for and materials supplied to the debtor. Accordingly, the court found that the transfer was not a preference under section 547 of the bankruptcy code and was therefore not recoverable. The Golfview Development Center case may offer sanctuary to the construction creditor that releases its lien rights after payment, provided it is a fully secured creditor of the debtor.

Reprinted by permission from Trade Vendor Quarterly Blakeley & Blakeley LLP

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