Construction Subcontractor Claims: Is a Subcontractor Merely a Creditor of a Creditor Without Standing?

In re Alliance Consulting Group LLC, 588 B.R. 169 (Bankr. S.D. Miss. 2018) –

A subcontractor sought to reopen a bankruptcy case so that it could assert an administrative expense claim for work it did on a chapter 11 debtor’s facility. The bankruptcy court determined that the subcontractor did not have standing, and even if it did, the subcontractor did not establish cause to reopen the case.

The debtor (1) bought a mine, where it mined sand, and (2) built a drying facility for the sand on property owned by an affiliate that was funded by a loan of ~$30 million from lenders controlled by certain individuals (Moreno and Hess). The subcontractor’s claim related to the drying facility.

After the debtor developed financial problems, management of the properties was turned over to a company controlled by Moreno (“S3”). Subsequently the lenders foreclosed on the mine, bought it at the foreclosure sale with credit bid, and conveyed the property to another entity controlled by Moreno. Two days later Hess and other creditors filed an involuntary petition against the debtor. Ultimately a trustee was appointed.

S3 continued to manage the drying facility postpetition. It entered into an agreement with the trustee that authorized it to perform repairs and improvements to the facility, including installation of a sand screen. S3 owned the screen and entered into a contract with the subcontractor to install the screen and make other modifications. Work that was supposed to take three weeks in fact took three months, and the subcontractor billed S3 an amount far in excess of the original estimate.

In the meantime, the bankruptcy proceeded and the drying facility was sold “free and clear” to the lenders’ administrative agent for a $16.3 million credit bid. The right to buy the facility was assigned to another entity controlled by Moreno. The screen was not included in the drying facility sale because it belonged to S3, not the debtor, and consequently was acquired separately after the drying facility sale closed.

The court set the stage for its decision by noting the following:

  • The lenders made significant concessions in the plan of reorganization that was confirmed, including providing $2.2 million in exit financing and paying ~$1.6 million to unsecured creditors despite the $13.9 million deficiency still owed to the lenders after the credit bid for the drying facility.
  • In contrast, S3 paid the subcontractor ~$775,000 for work that was estimated to cost less than $500,000, and the subcontractor now claimed it was owed almost $1 million more.
  • The bankruptcy estate had been fully administered and closed almost a year before the motion to reopen was filed.
  • The lenders and Moreno received virtually nothing. After administrative expenses were paid, the trustee anticipated that the estate would have ~$65,000 left to repay the exit financing.
  • The new owner of the drying facility was expanding operations with a $60 million financing from an unaffiliated third-party that had first priority liens on the drying facility.

The court started by examining the threshold issue of standing. Under the bankruptcy rules a case may be reopened by the debtor or other “party in interest.” In the context of a motion to reopen “the only ‘designated players’ with ‘a particular and direct stake in reopening cognizable under the Bankruptcy Code’ are debtor, creditor, and in some cases, trustee.”

In this case the court held that the subcontractor was not a creditor because (1) the debtor was not liable for any debt to the subcontractor, (2) the estate did not contract with the subcontractor, and (3) the estate did not own the equipment installed by the subcontractor. Rather the estate contracted with S3, and S3 contracted with the subcontractor, so that the subcontractor was the creditor of a creditor with no standing.

The subcontractor attempted to argue it had sufficient interest based on its special construction lien rights under state law. However, the court concluded that this interest related solely to its status as a creditor of a creditor, and thus it still did not have standing. The court reiterated that bankruptcy is a forum where creditors and debtors can resolve disputes with each other, and there is no place for any party asserting rights that are purely derivative of another party’s rights.

The court went on to hold that even if the subcontractor had standing, cause did not exist to reopen the case.

  • First, the motion was “without any foundation in the realities of the case,” and in any event it would be an abuse of discretion to reopen the case when it would be futile (as indicated by the facts outlined above).
  • Further, the subcontractor could seek relief in other courts so that reopening the case was not necessary.
  • And if that were not enough, postconfirmation a bankruptcy court cannot adjudicate contract disputes between non-debtors that have nothing to do with the plan.
  • Last but not least, the Bankruptcy Code favors finality. This mitigated against reopening the case almost a year after it was closed and nearly 3 years after the plan of reorganization became effective.

Surprise, surprise: the court denied the motion to reopen the case.

It is typically the case that construction subcontractors are given special lien rights under state law so that, notwithstanding the fact that they do not have privity with the owner, they can protect their interests by liening the project that they improved. Assuming a subcontractor has exercised its lien rights, normally one would expect that it will have standing based on its claim against property of the estate. Although not entirely clear, it appears the subcontractor in this case ran into problems on the matter of standing due to a combination of factors: it did not perfect its construction lien rights, the drying facility was sold “free and clear” so that the subcontractor missed the opportunity to assert a claim against property of the estate, and the screen was not owned by the debtor.

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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