Harrelson Utilities, Inc.

UNITED STATES BANKRUPTCY COURT
EASTERN DISTRICT OF NORTH CAROLINA
RALEIGH DIVISION
IN RE:
HARRELSON UTILITIES, INC.
DEBTOR
CASE NO.
09-02815-8-ATS
ORDER DETERMINING THAT THE AUTOMATIC STAY WAS VIOLATED,
DENYING REQUEST FOR SANCTIONS, AND
DISMISSING MOTIONS FOR RELIEF FROM AUTOMATIC STAY
There are several related matters before the court, including (1) the motions filed by the
chapter 11 debtor in possession, Harrelson Utilities, Inc., for sanctions against Ferguson Enterprises,
Inc., and Smith Setzer & Sons, Inc. for violating the automatic stay by filing notices claiming
statutory labor and materialmen's liens; and, (2) the motions of Ferguson, Smith Setzer, S.T. Wooten
Corporation and Tindall Corporation for relief from the automatic stay to file notices of and to
enforce their statutory liens for labor and materials. A hearing was held on July 2, 2009, at which
the court considered these motions as well as similar motions for relief from the automatic stay
involving the same issues in the chapter 7 case of Mammoth Grading, Inc., Case. No.
09-01286-8-ATS.
The facts are not disputed. Harrelson is a utilities contractor that filed a petition for relief
under chapter 11 on April 6, 2009, and is operating as a debtor in possession. Ferguson, Smith
SO ORDERED.
SIGNED this 30 day of July, 2009.
________________________________________
A. Thomas Small
United States Bankruptcy Judge
____________________________________________________________
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1 Ferguson acted as a first or second tier subcontractor on five projects, and contends it is
owed $450,000. Ferguson served notices of claims of liens on funds due Harrelson and filed, by
subrogation to Harrelson's lien rights, claims of liens on real property on April 21, April 23, and
April 27, 2009. Ferguson seeks relief from the automatic stay to enforce the liens on real property
pursuant to North Carolina law. Smith Setzer acted as a first or second tier subcontractor on five
projects, and contends it is owed approximately $112,332.52. Smith Setzer served notices of claims
of liens on funds due Harrelson and filed, by subrogation to Harrelson's lien rights, claims of liens
on real property on May 19, 2009; it seeks relief from the automatic stay to enforce the liens on real
property. 	Tindall acted as a second tier subcontractor for the improvement of two parcels of
property, and contends it is owed $20,995.03. Tindall served a notice of claim of lien on funds due
Harrelson on May 19, 2009, and filed, by subrogation to Harrelson's lien rights, a claim of lien on
real property on May 26, 2009. It seeks relief from the automatic stay to enforce its lien on real
property. S.T. Wooten acted as a first or second tier subcontractor on five projects, and contends
it is owed $11,804.88. S.T. Wooten seeks relief from the automatic stay to serve notices of claim
of liens on funds due Harrelson and to file, by subrogation to Harrelson's lien rights, and enforce
claims of liens on real property.
2
Setzer, S.T. Wooten and Tindall are unpaid subcontractors that did work for Harrelson on various
projects. 	On most of the projects Harrelson was the contractor and the lien claimants were the
debtor's "first tier" subcontractors. At times, Harrelson was a first tier subcontractor and the lien
claimants were Harrelson's "second tier" subcontractors. 1
Harrelson contends that Ferguson and Smith Setzer violated the automatic stay provided by
§ 362(a)(4) by filing postpetition notices pursuant to North Carolina General Statutes § 44A-19,
claiming statutory labor and materialmen's liens under § 44A-18 against funds due to Harrelson, and
by filing notices pursuant to § 44A-12 claiming, by subrogation under § 44A-23(a) and (b),
Harrelson's labor and materialman's liens against real property on which Harrelson and the
subcontractors did work. The subcontractors maintain that they did not violate the automatic stay
because the notices they gave were permitted by § 362(b)(3), which provides an exception to §
362(a)(4). If the court determines that the stay does apply to the notices, Ferguson, Setzer Smith,
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S.T. Wooten, and Tindall ask for relief from the automatic stay to file the notices and to enforce their
liens.
The resolution of the important and complex issues raised by these motions requires an
analysis of both the rights given to laborers and materialmen under North Carolina law and the
protections provided by the Bankruptcy Code to the estates of debtors. Whether the § 362(b)(3)
exception to the automatic stay applies is a matter of federal bankruptcy law, but that determination
depends on a question of North Carolina state law that comes down to when the interests of
subcontractors are created in the funds owed to the contractor. If the lien right on funds owed to a
contractor of a subcontractor is created prior to the giving of the notice of lien, the exception
applies, but if the lien right is created by the giving of the notice, it does not.
Section 362(a)(4) of the Bankruptcy Code provides that a petition for relief operates as a stay
of "any act to create, perfect, or enforce any lien against property of the estate." Funds owed to the
debtor pursuant to a construction contract are property of the estate and are protected from "any act
to create, perfect, or enforce any lien against property of the estate," unless the act comes within the
exception afforded by § 362(b)(3). Section 362(b)(3) provides that a petition does not operate as
a stay "of any act to perfect, or to maintain or continue the perfection of, an interest in property to
the extent that the trustee's rights and powers are subject to such perfection under section 546(b) of
this title or to the extent that such act is accomplished within the period provided under section
547(e)(2)(A) of" title 11.
Section 546(b) provides
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
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(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.
11 U.S.C. § 546(b)(1).
Both § 362(b)(3) and § 546(b) refer to "an interest in property," a phrase that encompasses
more than a "lien." See Maryland Nat'l Bank v. Mayor of Baltimore (In re Maryland Glass Corp.),
723 F.2d 1138, 1141-42 (4th Cir. 1983) ("section 546(b) speaks of an 'interest in property' and does
not limit its scope to 'liens'"). In determining whether the exception of § 362(b)(3) applies, the court
must consider what interest the creditor had in property before the petition was filed and the effect
of that interest on a hypothetical purchaser who might have purchased the property before the
creditor's "interest was fully perfected and enforceable by virtue of a statutory lien." 723 F.3d at
1142. Whether the subcontractors had an "interest in property," the perfection of which could be
effective against an entity that acquired rights in the property prior to the date of perfection, is an
issue to be determined by state law. Butner v. United States, 440 U.S. 48, 55, 99 S. Ct. 914, 918
(1979).
The North Carolina Constitution, Article X, Section 3, provides that "[t]he General Assembly
shall provide by proper legislation for giving to mechanics and laborers an adequate lien on the
subject-matter of their labor," and Chapter 44A of the General Statutes provides protection for
contractors in the form of liens on the real property for which they provided labor or materials.
Protection is provided for subcontractors through the right to claim a lien upon funds owed to the
contractor and to assert, through subrogation, the contractor's right to file liens against real property.
Chapter 44A, Article 2, Part 1 sets forth the rights and remedies of general contractors. "Any
person who performs or furnishes labor . . . or furnishes materials . . . pursuant to a contract, either
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express or implied, with the owner of real property for the making of an improvement thereon shall,
upon complying with the provisions of this Article, have a right to file a claim of lien on the real
property to secure payment of all debts owing for labor done . . . or material furnished . . . pursuant
to the contract." N.C. Gen. Stat. § 44A-8. A claim of lien on real property is perfected upon the
filing of the lien within 120 days after the last furnishing of labor or materials, and is enforced by
the filing of an action within 180 days after the last furnishing of labor or materials. N.C. Gen. Stat.
§§ 44A-12; 44A-13. The claim of lien relates back to the time of the first furnishing of labor or
materials by the person claiming the lien. N.C. Gen. Stat. § 44A-10. A contractor's lien has priority
over any liens or encumbrances that arise after the date of the contractor's first furnishing of labor
or materials to the site. Frank H. Conner Co. v. Spanish Inns Charlotte, Ltd., 294 N.C. 661, 242
S.E.2d 785 (1978).
Chapter 44A, Article 2, Part 2 provides for two lien rights for subcontractors: (1) a claim
of lien upon funds owed to the contractor, and (2) the right to assert, by subrogation, the lien rights
of the contractor against the real property owned by the party for whom the contract is being
performed. A first tier subcontractor may claim a lien on the funds owed to the contractor and may
also, by subrogation, assert the contractor's lien against the real property. 	Section 44A-18(1)
provides:
Upon compliance with this Article:
(1) A first tier subcontractor who furnished labor, materials, or rental equipment at
the site of the improvement shall be entitled to a lien upon funds that are owed to the
contractor with whom the first tier subcontractor dealt and that arise out of the
improvement on which the first tier subcontractor worked or furnished materials.
Section 44A-23(a) provides, in relevant part, that a "first tier subcontractor, who gives notice of
claim of lien upon funds as provided in this Article, may, to the extent of this claim, enforce the
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2 Section 44A-18(6) provides in full:
(6) A lien upon funds granted under this section is perfected upon the giving of
notice
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claim of lien on real property of the contractor created by Part 1 of this Article." N.C. Gen. Stat. §
44A-23(a).
A second tier subcontractor may claim a lien on the funds owed to the first tier subcontractor
and may by subrogation assert the first tier contractor's lien on funds and its subrogation lien rights
against real property.
(2) A second tier contractor who furnished labor, materials, or rental equipment at
the site of the improvement shall be entitled to a lien upon funds that are owed to the
first tier subcontractor with whom the second tier subcontrator dealt and that arise
out
of the improvement on which the second tier subcontractor worked or furnished
materials. 	A 	second 	tier 	subcontractor, 	to 	the 	extent 	of 	the 	second 	tier
subcontractor's lien provided in this subdivision, shall also be entitled to be
subrogated to the lien of
the first tier subcontractor with whom the second tier contractor dealt provided for
in subdivision (1) of this section and shall be entitled to perfect it by notice of claim
of lien upon funds to the extent of the claim.
N.C. Gen. Stat. § 44A-18(2). 	Section 44A-23(b) provides, in relevant part, that a "second or third
tier contractor, who gives notice of claim of lien upon funds as provided in this Article, may, to the
extent of his claim, enforce the claim of lien on real property of the contractor created by Part 1 of
Article 2." N.C. Gen. Stat. § 44A-23(b).
Pursuant to § 44A-18(6), a subcontractor's lien on funds "is perfected upon the giving of
notice of claim of lien upon funds in writing to the obligor as provided in G.S. 44A-19 and shall be
effective upon the obligor's receipt of the notice." N.C. Gen. Stat. § 44A-18(6). The subcontractor's
subrogation liens are perfected in accordance with the requirements of § 44A-23. N.C. Gen. Stat.
§ 44A-18(6). 2 Pursuant to § 44A-19(d), "[n]otices of claims of lien upon funds under this section
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of claim of lien upon funds in writing to the obligor as provided in G.S. 44A-19 and
shall be effective upon the obligor's receipt of the notice. The subrogation rights of
a first, second, or third tier subcontractor to the claim of lien on real property of the
contractor created by Part 1 of Article 2 of this Chapter are perfected as provided in
G.S. 44A-23.
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shall be served upon the obligor by personal delivery or in any manner authorized by Rule 4 of the
North Carolina Rules of Civil Procedure. A copy of the notice of claim of lien upon funds shall be
attached to any claim of lien on real property filed pursuant to G.S. 44A-20(d) or G.S. 44A-23."
Unlike a lien on real property, which, based on the effective date provision of § 44A-10, has
priority over claims against the real estate filed after the date on which labor or materials were first
furnished, a subcontactor's lien on funds has priority ahead of all other interests whenever created.
Section 44A-22 provides that properly perfected liens upon funds
have priority over all other interests or claims theretofore or thereafter created or
suffered in the funds by the person against whose interest the lien upon funds is
asserted, including, but not limited to, liens arising from garnishment, attachment,
levy, judgment, assignments, security interests, and any other type of transfer,
whether voluntary or involuntary.
N.C. Gen. Stat. § 44A-22.
If insufficient funds are available to satisfy all subcontractors that have asserted claims
against the funds owed the contractor, the claimants, pursuant to § 44A-21, receive payment pro rata.
(a) Where the obligor is a contractor or subcontractor and the funds in the hands of
the obligor and the obligor's personal liability, if any, under G.S. 44A-20 are less
than the amount of valid liens upon funds that have been received by the obligor
under this Article, the parties entitled to liens upon funds shall share the funds on a
pro rata basis.
(b) Where the obligor is an owner and the funds in the hands of the obligor and the
obligor's personal liability, if any, under G.S. 44A-20 are less than the sum of the
amount of valid claims of liens upon funds that have been received by the obligor
under this Article and the amount of the valid claims of liens on the real property
upon the owner's property filed by the subcontractors with the clerk of superior court
under G.S. 44A-23, the parties entitled to liens upon funds and the parties entitled
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to subrogation claims of liens on real property upon the owner's property shall share
the funds on a pro rata basis.
N.C. Gen. Stat. § 44A-21.
North Carolina law gives a priority to subcontractors with properly perfected liens on funds,
but subcontractors are not given an "interest" in the funds prior to time they give notice of their liens
pursuant to §§ 44A-18(6) and 44A-19(d). 	The North Carolina Supreme Court addressed the
question of when the subcontractor's interest in funds arises in Contract Steel Sales, Inc. v. Freedom
Construction Co., 321 N.C. 215, 362 S.E.2d 547 (1987), and, interestingly, the debtor and all the
subcontractors maintain that this case supports their respective positions. In fact, all parties cite to
the same language:
The subcontractor must prove performance of his contract to enforce the lien, but he
need not show such performance in order to assert his entitlement to a lien. For this
entitlement, he need only show that the materials were delivered to the site of the
improvement. Having made such a showing here, [the subcontractor] is entitled to
its lien if it is properly perfected . . . .
Contract Steel, 321 N.C. at 220, 362 S.E.2d at 550-51. The subcontractors focus on the idea that
entitlement to a lien is created upon the delivery of the materials, and that the entitlement is the
interest that is allowed to be perfected pursuant to § 362(b)(3). The debtor, however, focuses on the
holding that a subcontractor is entitled to a lien if it is properly perfected.
"Entitlement" to a lien is not the same as an interest in property. The entitlement to claim
a lien on funds due a contractor has no value until the subcontractor gives notice of the claim of lien.
Until notice is given, the obligor may pay sums directly to the contractor, and if that is done, there
are no funds available to which a lien may attach. On any given day, there may or may not be any
funds owed to the contractor on which the subcontractor could claim a lien. The lien on funds is
empty, imprecise, indeterminate and illusive, and, in essence, it does not exist until notice is served
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on the obligor pursuant to § 44A-19(d). 	Until that time, the obligor is free to ignore a
subcontractor's "entitlement" to the funds.
Put another way, a subcontractor's lien on funds is much like a tax lien on personal property,
and like a tax lien on personal property, there is no prior interest in property established for a claim
of lien on funds to perfect. Maryland Glass, 723 F.2d at 1144 n.14 (discussing In re New England
Carpet Co., 26 B.R. 934 (Bankr. D. Vt. 1983), and Geiger v. City of Southfield (In re Continental
Credit Corp.), 1 B.R. 680 (Bankr. N.D. Ill. 1979), and distinguishing real property liens from
personal property liens). The postpetition creation of the statutory lien is not the "perfection" of a
pre-existing interest, but the creation of an interest for the first time, Maryland Glass, 723 F.2d at
1144 n.14 (discussing New England Carpet Co., 26 B.R. 934). Accordingly, filing postpetition
notices of liens on funds due to a contractor does not fall within the exception to the automatic stay
provided by § 362(b)(3). For that reason, the subcontractors who served claims of lien on funds
postpetition violated the automatic stay in doing so.
There undoubtedly are strong policy arguments on both sides of this issue. The
subcontractors are correct that the mechanic's lien, which is mentioned in North Carolina's
Constitution, "has long been recognized as a fundamental tenet of North Carolina law." Ferguson
Brief at 4. The subcontractors also predict that if this court concludes that giving a postpetition
notice of a claim of lien on funds violates the automatic stay, it will create havoc in the construction
industry. 	According to the subcontractors, their future efforts to avoid the consequences of a
contractor's bankruptcy will require them to give notices of liens upon delivery of materials, rather
than waiting to see if they get paid. The subcontractors warn that once liens are filed, the flow of
construction funds will stop. 	Further, the subcontractors maintain, any subcontractor who has
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advance notice that a contractor is having financial difficulties may be able to perfect its liens
prepetition and gain an unfair advantage over those subcontractors who did not have the benefit of
inside information, and did not file notice of their liens prior to the contractor's bankruptcy.
From the bankruptcy perspective, disallowing the postpetition liens furthers an important
guiding principle for all bankruptcy courts, which was recently emphasized by the United States
Supreme Court in Howard Delivery Serv., Inc. v. Zurich American Ins. Co., 547 U.S. 651, 126 S.
Ct. 2105 (2006). The Court stated that "the Bankruptcy Code aims, in the main, to secure equal
distribution among creditors," 126 S. Ct. at 2109, and "any doubt concerning the appropriate
characterization [of a claim] . . . is best resolved in accord with the Bankruptcy Code's equal
distribution aim." 126 S. Ct. at 2116.
In the final analysis, however, these persuasive policy arguments cannot alter the
construction of the relevant statutes.
Having determined that the exception to the automatic stay in § 362(b)(3) does not apply to
the giving of notice of the claim of a subcontractor's lien on funds owed to a contractor who is a
debtor in bankruptcy, the court must determine whether a subcontractor may nonetheless file,
pursuant to its subrogation rights, a lien on real property. Section 44A-23(a) provides, in relevant
part, that a "first tier subcontractor, who gives notice of claim of lien upon funds as provided in this
Article, may, to the extent of this claim, enforce the claim of lien on real property of the contractor
created by Part 1 of this Article." N.C. Gen. Stat. § 44A-23(a) (emphasis added). Section 44A-
23(b) provides, in relevant part, that a "second or third tier subcontractor, who gives notice of claim
of lien upon funds as provided in this Article, may, to the extent of his claim, enforce the claim of
lien on real property of the contractor created by Part 1 of Article 2" N.C. Gen. Stat. § 44A-23(b)
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(emphasis added). Pursuant to § 44A-19(d), "[a] copy of the notice of claim of lien upon funds shall
be attached to any claim of lien on real property filed pursuant to G.S. 44A-20(d) or G.S. 44A-23."
The language of the statute is clear that in order to enforce the contractor's lien rights on the real
property, the subcontractor must first have given notice of its claim of lien on funds. 	See also
Cameron & Barkley Co. v. American Ins. Co., 112 N.C. App. 36, 45, 434 S.E.2d 632, 637 (1993)
(trial court correctly held that it was necessary for subcontractor to give notice in accordance with
the form specified in § 44A-19 for a claim of lien affecting title to real estate); Mace v. Bryant
Constr. Co., 48 N.C. App. 297, 307, 269 S.E.2d 191, 196 (1980) ("the existence of a lien upon the
realty granted by G.S. 44A-20(d) is dependent upon the existence of a valid lien upon funds").
Claims of liens on funds served in violation of the automatic stay are void, and because the
subcontractors have not given valid notices of claims of lien on funds, they cannot file claims of lien
on real property. 	Accordingly, the postpetition claims of lien on real property filed by the
subcontractors are invalid and cannot be enforced. 	Because the liens on real property are
unenforceable, the subcontractors' requests to enforce these liens are DENIED.
The debtor maintains that these stay violations were willful and that sanctions should be
imposed pursuant to § 362(k). 	The court disagrees. 	The subcontractors were doing what
subcontractors in North Carolina have been doing for years. Their actions in filing postpetition liens
on funds owed to the debtor and asserting by subrogation Harrelson's lien rights in real property are
consistent with their reasonable understanding of the law. In fact, earlier in the case, the debtor and
the subcontractors, based on that understanding, were negotiating a consent order that would have
permitted a recognition of the subcontractors' liens.
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3The facts in Shearin are much different than those before the court in this case. Shearin was
the landowner/developer, not a contractor like Harrelson. 	It can be argued that, in that case, §
362(a)(4) did not stay the subcontractors from filing claims against funds owed to their contractor
because the contractor was not in bankruptcy and was not protected by the stay. The funds owed
to the contractor by Shearin were not property of the debtor's bankruptcy estate; rather, they were
an obligation of the estate. 	An argument could also be raised that the subcontractors were stayed
by § 362(a)(4) from filing lien notices against funds due to their contractor, because the notices were
merely part of their main objective, which was to file liens against the debtor’s real property. The
question of whether § 362(a)(4) precludes subcontractors from filing their lien notices against funds
was not raised in Shearin, and the suggested arguments were not made. In any event, that issue is
not present in this case because, clearly, the funds owed to Harrelson are property of the debtor’s
estate and subcontractors are stayed by § 362(a)(4) from asserting their liens against them.
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The issue of whether the postpetition claims of lien violated the automatic stay came to light
because of a decision in the case of In re Shearin Family Investments, LLC, Case No.
08-07082-8-JRL, 2009 WL 1076818 (Bankr. E.D.N.C. April 17, 2009). In that opinion the court
observed that the "text of the statute [§ 44A-18(1) and (6)] suggests that no lien [on funds] arises
until it is perfected by giving written notice and made effective by receipt." Shearin, at *2. The
court in Shearin held, as the court in this case now holds, that a subcontractor's interest or lien on
funds owed to the contractor is not effective and is therefore not created until the notice has been
given to the obligor, and that the exception to the automatic stay of § 362(b)(3) does not authorize
subcontractors to give notice of their liens on funds owed to the contractor after the contractor has
filed for bankruptcy relief.
The debtor argues that at a minimum those subcontractors who filed their liens after learning
of the opinion in Shearin should be sanctioned. Although the holding in Shearin is clear enough,
it is not directly applicable to the facts of this case. 3 Because the lien claimants had a reasonable
belief that they were not violating the automatic stay, sanctions will not be imposed. Accordingly,
the debtor's request for sanctions is DENIED. However, the claims of lien that appear on the public
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record must be withdrawn by the subcontractors. Furthermore, this opinion is without prejudice to
any claim the debtor may have based on the giving of notice with respect to the wrong property.
In conclusion, § 362(b)(3) does not except from the automatic stay of § 362(a)(4) the giving
of notice by subcontractors to perfect mechanics and materialmen’s liens on funds due to a debtor
who is their contractor. The subcontractors violated the automatic stay by giving lien notices on
funds owed to the debtor. Those lien notices are invalid and must be removed from the record. The
notices of lien by subrogation on real property are also invalid and shall be removed by the
subcontractors. Sanctions for violating the automatic stay will not be imposed, and the motions of
the subcontractors for relief from the automatic stay are DENIED.
SO ORDERED.
END OF DOCUMENT
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