Ninth Circuit To Consider Whether Mechanic’s Lien Is Enforceable In Bankruptcy Case

The Supreme Court has observed that “. . . Congress has generally left the determination of property rights in the assets of a bankrupt’s estate to state law.” Butner v. United States, 440 U.S. 48, 54 (1978). A creditor desiring to protect itself in bankruptcy must know what state law requires to set up and maintain a lien and also understand that, if its efforts run afoul of the automatic stay, such protection may not be available. The creditor might face the issue that what state law mandates to maintain a lien as perfected could violate the automatic stay if it qualifies as lien enforcement. The problem is that the act of perfecting a lien is supposed to be excepted from the automatic stay. That issue and others will be considered by the Ninth Circuit on November 15, 2022, when it will hear an appeal from the Bankruptcy Appellate Panel’s opinion in Philmont Management, Inc. v. 450 S. Western Ave., LLC (In re 450 S. Western Ave., LLC), 633 B.R. 894 (9th Cir. BAP 2021).

Factual Background

In Philmont, a general contractor recorded a mechanic’s lien against the debtor’s property in July 2018 after the debtor failed to pay invoices for the contractor’s improvements. The debtor then assured the contractor that it would be paid from the proceeds of a refinance of the debtor’s property. So as not to risk the refinance, the debtor requested that the contractor forbear from suit. The contractor complied. Rather than sue the debtor within 90 days of recording its lien, the contractor re-recorded its lien against the property, four times.

On December 19, 2019, the contractor recorded its last mechanic’s lien. On January 10, 2020, the debtor filed a voluntary petition under chapter 11 of the Bankruptcy Code. On April 29, 2020, the contractor filed in the bankruptcy case a notice of perfection of mechanic’s lien.

The property was sold to the winning bidder at an auction held in October 2020. While the sale proceeds were sufficient to pay the amount owed to the contractor on its lien, the debtor proposed a plan of liquidation by which it disputed the extent, validity, or priority of the lien.

The contractor commenced an action requesting a judgment that it held an enforceable mechanic’s lien in the sale proceeds of the debtor’s property. The debtor responded with a motion to dismiss for failure to state a claim upon which relief can be granted. The debtor argued that the contractor had failed to bring suit to enforce its lien within the period required by state law such that the lien had expired, that there was no basis in equity to extend such period, and that even if the last re-recording of the lien worked to reinstate the lien, the contractor’s notice of perfection was untimely because it was filed more than 90 days later. The bankruptcy court granted the debtor’s motion, and the adversary proceeding was dismissed with prejudice. The Bankruptcy Appellate Panel affirmed the bankruptcy court.

The Statutes Involved

California Civil Code § 8412 governs the recordation of a “claim of lien” by a “direct contractor,” as follows:

A direct contractor may not enforce a lien unless the contractor records a claim of lien after the contractor completes the direct contract, and before the earlier of the following times:

(a) Ninety days after completion of the work of improvement.

(b) Sixty days after the owner records a notice of completion or cessation.

Recording the lien merely makes a contractor eligible to enforce the lien. In that regard, California Civil Code section 8460(a) states in relevant part as follows:

The claimant shall commence an action to enforce a lien within 90 days after recordation of the claim of lien. If the claimant does not commence an action to enforce the lien within that time, the claim of lien expires and is unenforceable.

The creditor must sue within 90 days of recording the lien or risk losing the lien. The statute details what will be given up as a result of failing to timely sue: “. . . a lien attaches to the work of improvement and to the real property on which the work of improvement is situated . . . .” California Civil Code section 8440.

Again, state law requires certain conduct by the creditor to maintain the perfection of its lien, and maintaining the perfection of a lien is excepted from the automatic stay. However, the very conduct that is required to maintain the perfection of a lien – because it appears to involve enforcement – is also prohibited by the automatic stay. The provisions of Bankruptcy Code section 362 excepting certain acts from the automatic stay addresses this dilemma by referring to another section of the Bankruptcy Code, section 546(b). That section states as follows:

(1) The rights and powers of a trustee under sections 544, 545, and 549 of this title are subject to any generally applicable law that—

(A) permits perfection of an interest in property to be effective against an entity that acquires rights in such property before the date of perfection; or

(B) provides for the maintenance or continuation of perfection of an interest in property to be effective against an entity that acquires rights in such property before the date on which action is taken to effect such maintenance or continuation. (

2) If—
(A) a law described in paragraph
(1) requires seizure of such property or commencement of an action to accomplish such perfection, or maintenance or continuation of perfection of an interest in property; and
(B) such property has not been seized or such an action has not been commenced before the date of the filing of the petition; such interest in such property shall be perfected, or perfection of such interest shall be maintained or continued, by giving notice within the time fixed by such law for such seizure or such commencement.

11 U.S.C. § 546(b) (emphasis added). The debtor in Philmont had the rights and powers of a trustee, i.e., the debtor’s rights and powers in that case were subject to the possible perfection, and maintenance of perfection, of a mechanic’s lien by a creditor such as the contractor. Accordingly, if a creditor must sue to maintain the perfection of the creditor’s lien and the debtor’s bankruptcy case intervenes before an action can be commenced, then that creditor – instead of commencing an action – must give notice, but do so within the state law period for commencing the (now unnecessary) action.

BAP Analysis

1. Contractor Had to Give Notice During Period to Commence an Action

The contractor and the debtor in Philmont agreed that the first mechanic’s lien, recorded in July 2018, had been timely recorded. For “direct contractors,” a lien must be recorded within 90 days of completing work or 60 days after an owner records a notice of completion or cessation, whichever occurs first. Because the contractor failed to then commence an action within 90 days of recording the lien, any lien based upon the July 2018 recordation expired.

As the last mechanic’s lien, which was recorded in December 2019, fell well beyond the completion of work or the property owner’s giving of notice, it was incapable of being enforced. The contractor invoked equitable estoppel as a bar to the debtor’s claim that the December 2019 lien had been untimely, based upon the contractor’s forbearance at the debtor’s request pending the refinance of the property.

However, because the contractor did not file its notice of perfection of its lien until April 29, 2020, which was 132 days after the contractor had recorded its lien, the contractor failed to meet the time period set forth by state law to maintain or continue the perfection of its lien. Such period is 90 days. Thus, even if the contractor’s fifth recording of its mechanic’s lien in December 2019 were deemed to have been timely, the lien had expired by the date when the contractor filed its notice of perfection. Thus, the BAP ultimately did not need to discuss the contractor’s allegations of equitable estoppel.

Even though the debtor commenced a bankruptcy case during the 90-day period under state law for the contractor to commence an action to maintain the perfection of its lien, the bankruptcy case did not affect the running of those 90 days. Section 546(b) requires that the contractor “give notice” to maintain the perfection of its lien. “Giving notice” to maintain a perfected lien is an alternative in a bankruptcy case to commencing an action that would otherwise violate the automatic stay. However, that alternative must be exercised within the period that governs commencement of the action.

2. Contractor Was Not Entitled to Tolling under Bankruptcy Code § 108(c)

The contractor viewed California law as not requiring the commencement of an action to maintain its lien as perfected. Instead, the contractor contended that commencement of an action under the mechanic’s lien statute is merely an enforcement mechanism. Under that view of the applicable law, the exceptions to the automatic stay afforded by sections 362(b)(3) and 546(b) for maintaining perfection would not apply. Accordingly, the contractor insisted that it had been subject to the automatic stay. The contractor then asserted that its lien claim was entitled to the tolling provisions of the Bankruptcy Code governing “applicable nonbankruptcy law . . . [that] fixes a period for commencing . . . a civil action in a court other than a bankruptcy court on a claim against the debtor . . . [that] has not expired before the date of the filing of the petition.” 11 U.S.C. § 108(c). If so, then the running of the 90-day period for the contractor to commence an action on its lien would have been tolled.

The contractor argued that the Ninth Circuit’s decision in Miner Corp. v. Hunters Run Ltd. Partnership (In re Hunters Run Ltd. Partnership), 875 F.2d 1425 (9th Cir. 1989), supported its position. In Hunters Run, Sunny Day Cement had recorded its mechanic’s lien pre-petition, i.e., it was a perfected lien. However, Sunny Day had failed to commence an action pre-petition to maintain the lien as enforceable.

The Ninth Circuit ruled that the period for Sunny Day to commence an action to foreclose its lien was tolled by section 108(c). In the view of the Hunters Run panel, such an action constituted enforcement activity that the automatic stay prohibited, and Sunny Day was not able to provide notice under section 546(b) because the version of section 546(b) in effect at the time of Hunters Run only permitted the giving of notice to perfect a lien (something that Sunny Day had already accomplished pre-petition) and did not also permit giving notice to maintain or continue perfection of a lien. While Hunters Run did toll the period to commence an enforcement action on a mechanic’s lien, section 546 has since been amended and the Ninth Circuit’s discussion revealed that there would have been no tolling under section 108(c) if Sunny Day had been able to maintain the perfected status of its lien by giving notice instead of having to commence a stay-violating foreclosure action. Under amended section 546(b), giving notice is available both to perfect a lien and to maintain or continue a lien where “generally applicable law” would otherwise mandate bringing suit or seizing property to achieve those ends. The giving of notice in such circumstances is required. Congress also added “acts” to maintain or perfect an interest in property to the exceptions to the automatic stay set forth in section 362(b)(3). Bankruptcy Code sections 362(b)(3) and 546(b) should be considered together. The Hunters Run ruling therefore was of no avail to the contractor in Philmont.

The contractor also did not persuade the panel that the BAP’s opinion in Village Nurseries v. Gould (In re Baldwin Builders), 232 B.R. 406 (B.A.P. 9th Cir. 1999), had been wrongly decided. Village recorded a mechanic’s lien pre-petition after completing landscaping and irrigation improvements. As of the debtor’s filing of its bankruptcy case, Village had still not commenced an action to foreclose its lien. Post-petition, Village filed, but did not serve, two Superior Court foreclosure complaints, recorded a second lien, and filed a proof of claim asserting a secured claim. The bankruptcy court found that the complaints were void as violations of the automatic stay, and determined that the proof of claim was incapable of providing timely notice of the recorded liens. (The opinion includes a thorough discussion of notice, because the principals of the debtor also happened to be partners in Village and had been involved in Village’s strategy with respect to enforcing its mechanic’s liens.)

Like the contractor in Philmont: (1) Village had a perfected lien (the final lien recorded by the contractor in Philmont was treated as perfected even though the debtor disputed such status), (2) Village was subject to a statute requiring the commencement of a Superior Court action to maintain the lien as perfected, and (3) Village had failed to provide timely notice under the alternative to enforcement afforded by section 546(b). By the time Baldwin was decided, sections 362(b)(3) and 546(b) had been amended. Village therefore argued that commencing its foreclosure actions did not violate the automatic stay because such actions were required to maintain the perfected status of its lien, and the new exception to the automatic stay for “any act . . . to maintain or continue the perfection” rendered the foreclosure actions valid. The BAP rejected Village’s position. It acknowledged that a foreclosure suit is required under California law to maintain a mechanic’s lien, but that did not prevent the foreclosure suit from also constituting the type of enforcement activity that would violate the automatic stay in bankruptcy so as to be void. Mechanic’s lien creditors must be aware that commencement of an action on a lien is the device under California law by which the lien is both maintained and enforced. Because commencement of an action is needed to maintain a mechanic’s lien, section 546(b) requires that notice of the lien be given in place of doing so. The holding of Hunters Run that commencing an action to foreclose a lien would violate the automatic stay remains intact. What differs since sections 362(b)(3) and 546(b) have been amended is the addition to the Bankruptcy Code of the ability to give notice to maintain a lien as perfected. Such notice must be given within the time mandated by state law to commence the foreclosure action. Tolling under section 108(c) of the period under section 546(b) in which such notice must be given is not available pursuant to the BAP’s opinion in Philmont.

Conclusion

Practitioners seeking to protect the secured status of their client’s mechanic’s liens after a bankruptcy case has been commenced should beware. The very conduct that on its face constitutes “enforcement” that would violate the automatic stay and be void may also be the same conduct needed to maintain and continue a lien as a perfected lien. Practitioners should not assume that their clients are barred from protecting their secured status and/or that the running of the state law period to start enforcement in order to preserve a lien will be tolled by section 108(c). Rather, in such circumstances the Bankruptcy Code expressly permits the creditor to maintain the secured status of the lien without violating the automatic stay. The creditor does so, not by filing an action, but by giving notice – with the requirement that notice be given before the time to commence an action would otherwise expire. Whether the Ninth Circuit departs from this structure by applying equitable estoppel and permitting tolling will be considered on November 15.