A bankruptcy court in Dallas, Texas has recently held that an inchoate mechanic’s lien right presents a defense to a trustee’s preference action (see copy of Memorandum Opinion here). A preference action is an action brought in bankruptcy to recover a payment that was made to a creditor claiming that creditor was preferred over other unsecured creditors. The elements of a preference action are as follows:

The payment was to or for the benefit of the creditor.
The payment was made on account of the antecedent debt.
The payment was made while the debtor was insolvent.
The payment was made within 90 days before the bankruptcy case was filed.
The payment enabled the creditor to receive a larger share of the bankruptcy estate than if the transfer had not been made.

In the Texas case, the contractor received a payment of $290,532 within in the 90-day preference period. The contractor had issued a final payment lien waiver. The trustee argued that the lien had been waived and that the contractor was no more than an unsecured creditor at the time it received payment. The bankruptcy court found that the final payment had not been made and the lien waiver was conditional and, therefore, not enforceable. Although no mechanic’s lien was actually filed, the time period for filing such a lien was still open at the time of payment. The contractor’s management testified that in cases of non-payment, the contractor routinely filed mechanic’s liens before the lien period expired. Based on this evidence, the bankruptcy court found that, had the contractor not been paid, the contractor would have likely filed its lien and the value of those inchoate lien rights protected the contractor from the trustee’s preference avoidance suit.

On a second issue, the trustee challenged the value of the inchoate lien claiming that the value of the unperfected lien right would have been less than the $290,532 payment. The court noted that the ultimate burden of determining whether the creditor received more than they would have in a liquidation scenario was the trustee’s and, since no evidence was presented supporting the value of the inchoate lien right, the trustee’s contention was dismissed.

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Legal Alert: Inchoate Mechanic's Lien Right Presents a Defense to Preference Claim