Insurance coverage for ‘hidden’ mechanics and supplier lien claims in NC disappearing

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Guest Editorial by Lisa P. Sumner, Poyner Spruill, Attorneys at Law

​Even in good economic times, lien claims asserted by subcontractors and material suppliers abound and lead to costly disputes.  As in many states, North Carolina’s materialmen’s lien statutes create a system where “hidden” or non-recorded liens come into existence, but are not perfected by public filings until later, at which time the law provides materialmen’s liens retroactive priority status over certain intervening liens.  Two recent legal developments are further complicating the challenges faced by construction, real estate and lending interests in North Carolina.

The most recent development is the surprising announcement (click here) by Fidelity National Title Group, which includes Chicago Title, Commonwealth Land Title and Fidelity National Title.  They will stop selling materialmen’s lien coverage for North Carolina commercial and residential properties with recent construction or construction loans or both (i.e., properties for which potential lien claimants may have the ability to file timely lien claims, and  the proposed purchaser and/or lender cannot obtain legal priority of record over those potential liens not yet filed at time of closing).

Other title insurers are expected to follow suit in curtailing coverage.  If prompt legislative action is not taken, the unavailability of such insurance coverage may have the effect of severely squeezing North Carolina’s construction industry by limiting the availability of funds and raising the cost of doing business to offset the risks presented by uninsurable hidden liens.

The second development is taking place in the US Bankruptcy Courts located in North Carolina.  Reversing previous practice in this area, the Bankruptcy Court for the Eastern District of North Carolina recently issued an opinion concluding that subcontractors and suppliers can serve a notice of claim of lien upon funds post-petition without violating the automatic stay.  The Court ruled that North Carolina’s lien statute explicitly provides that a lien on funds is granted upon the furnishing of materials, labor or equipment.  Although the lien is not perfected at this time, the subcontractor still has the right to the benefit of the lien upon funds.  To perfect the lien, the subcontractor must give notice, but the giving of notice is merely the last step in perfecting the interest in property.   As such, the lien claimants were granted a lien on funds pre-petition, and could perfect the lien by serving the notice of claim post-petition without violating the automatic stay.  This development drastically changes the dynamics for all parties involved in a contractor’s chapter 11 bankruptcy case.  No longer is the debtor’s post-petition income protected from the lien claims of pre-petition subcontractors and material suppliers.  No longer is the primary secured lender’s interest in the debtor’s receivables insulated from the competing claims of materialmen’s liens perfected post-petition.  The resulting strain on the debtor’s cash flow jeopardizes the debtor’s ability to continue operations and pay post-petition operating expenses as incurred.

Ultimately, the debtor’s unsecured creditors may see their chances of any recovery dwindle as the debtor’s business contracts amid competing pressures.  If the pressures result in a collapse of the debtor’s business, even those with perfected materialmen’s liens stand to lose, if the debtor defaults before completing a project and the resulting damage claims result in setoff of funds payable to the debtor.  Read More

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