Investing in real estate properties and the inevitable construction projects that follow can be very lucrative. Regardless of how “real” reality TV is, popular house flipping and real estate investment shows demonstrate this fact. But what TV often doesn’t convey on these shows are the real risks that such projects entail–for instance, when construction bankruptcy happens.

Real estate investment is often a high risk/high reward endeavor—high reward because of the money that they generate, high risk because one false step and your project could be stalled for years or even indefinitely. One such misstep is when one of the businesses involved in the construction project goes bankrupt.

An Overview of Construction Bankruptcy Filings

Regardless of who in your collaborative construction effort files for construction bankruptcy, once the paperwork is filed, the entire project is put in jeopardy. It doesn’t matter if you’re a non-debtor in the case—the effects of the bankruptcy will reach you.

The process goes something like this. As someone not filing for bankruptcy but part of the construction project, you can expect a notice from the courts, usually within a week. The moment you receive this notice, you need to take action. Here’s why.

Even though part of the project is unable to fulfill its promises, you are still required to continue work. You read that right. You still have to fulfill your part of the deal because construction projects are executory contracts. In order to pull out from the project, you need to the approval of the bankruptcy court first.

So How Does Everyone Get Paid?

If you’re dealing with a Chapter 7 bankruptcy, the owner of the contract immediately turns over their assets. Payments to contractors and subcontractors thus come from whatever cash these assets produce, but it’s possible that these contractors and subcontractors won’t see a dime.

That’s because payments will be made to creditors according to a hierarchical scheme:

• Secured creditors—those with legal rights to a particular asset—receive collateral or the proceeds of its sale.
• Next, administrative expenses—these include money owed to court-approved lawyers, accountants, and other professionals who provided services in the bankruptcy.
• General unsecured creditors are paid last. These are the vendors, consultants, and other professionals who performed services prior to the bankruptcy but were not paid.

If any money remains, shareholders divide what’s left. This is rarely the case since the general unsecured creditors often aren’t even paid the full amount they’re owed.

Chapter 11 bankruptcies are different. In such cases, the debtor becomes a debtor-in-possession. Legally, they still possess their assets. From here, the courts and the debtor must come up with a plan. If they can’t come to an agreement, the judge will recommend that the Chapter 11 bankruptcy be converted to a Chapter 7 bankruptcy.

Mechanic’s Lien as a Solution

A mechanic’s lien acts as a safety blanket for anyone involved in the construction industry. A mechanic’s lien protects contractors from non-payment of goods or services due to bankruptcy. For large projects that require a significant amount of time and money, a mechanic’s lien can be a lifesaver—having one ensures payment even if the owner of the project files bankruptcy.

If you’re an investor that sees a current project heading for construction bankruptcy, or in any sort of financial trouble, contact us today for a consultation. We’ll make sure you’re as prepared as you can possibly be for any unforeseen setbacks.