When a general contractor, subcontractor, or supplier cannot pay its debts in the ordinary course of business and files for bankruptcy, there can be substantial ramifications to the construction project. The completion of the project itself can be jeopardized, and payment for the services or materials already received or contracted for is most certainly affected. A “liquidation” under Chapter 7 of the Bankruptcy Code calls for the debtor to reduce its assets to cash, pay out a pro rata share of the funds to the creditors, and cease doing business. In contrast, a “reorganization” under Chapter 11 will allow the debtor to remain in business as a “debtor-in-possession” and deal with its creditors under a plan of reorganization.
Once the debtor files its bankruptcy petition, it is protected in that the creditors are not only prohibited from filing a lawsuit on a pre-petition claim, but are also not able to terminate their contracts with the debtor. Additionally, construction contracts are normally classed as “executory” before substantial completion of the construction project. As such, even though a debtor files for bankruptcy, these executory contracts remain viable. In both the Chapter 7 setting and the Chapter 11 setting, the debtor can either affirm or reject executory contracts. The debtor’s decision to affirm or reject an executory construction contract (especially if the debtor is a general contractor) may decide whether the construction project moves forward to completion. While the bankruptcy of a subcontractor or supplier may cause inconvenience to the construction project, the bankruptcy of a general contractor and its rejection of the executory construction contract can be catastrophic. The rejection of a contract for a residential home development, for example, would have a trickle-down impact on all the subcontractors, suppliers, and design professionals who had contracted to provide goods or services to the project.
Property of the bankruptcy estate can include materials and equipment being used in the construction project, as well as funds being dispersed or used in the construction process. The bankruptcy trustee or debtor-in-possession can, in some instances, use the materials, equipment, and funds in the liquidation or reorganization of the debtor.
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