13 Jul Remodeling Contractors – Bankruptcy Considerations Part 1
Over the past couple of years I have met with several dozen remodeling contractors to discuss bankruptcy. Like many places, the Atlanta area has experienced a downturn in home building and home renovations and building contractors of all sizes have suffered greatly.
Clients and potential clients in this profession range from the one man contractor who hires subs on a per job basis to the full time homebuilder who purchases multi-acre tracts of land to build subdivisions.
While each case is different, I have noticed some common problem areas. This blog post will focus on the issues common to remodeling contractors – builders who may develop a spec house or two, but whose main business involves creating room additions or repairing existing homes.
The main problem that drives independent contractors into bankruptcy arises from poor cash flow. Building contractors often take on more than one project at a time and fail to properly estimate their costs and profit margin.
I recently spoke to the owner of a web site that offers estimating training to building contractors and he confirmed my suspicions. According to Perry Reiter of AsktheEstimator.com, there are multiple estimating processes that contractors can use to calculate a bid or estimate the cost of subcontractors. Some of these processes require a contractor to enter detailed information into a dedicated computer program while other methods require no more than a spreadsheet like Excel. According to Mr. Reiter, the one or two person shop gets in trouble when they fail to recognize that the cost of materials can change rapidly, as can the labor market in a particular area. Basing an estimate on assumptions that were valid two years ago will create problems.
Many of the building contractors I see have fallen into this trap and they find themselves in debt to suppliers or subcontractors. Not surprisingly, the suppliers and subs will cut the supply of materials or labor at precisely the wrong time leaving my potential client with one or more half completed projects.
Even worse, many small contractors will use the draw from one job to complete an unrelated job. When the money and credit run out, the contractor is faced with an angry homeowner who wants an accounting as to where the money from his draw went.
The bankruptcy issues that arise from this scenario – when the contractor runs out of money – are as follows:
- materialman’s liens – under Georgia law, a contractor, subcontractor, mechanic, materialman, laborer, architect, land surveyor, forester or engineer supplying materials, tools, equipment, appliances, labor or other services to the improvement of the real estate may file a materialman’s lien. This type of lien will function as a cloud on the title of the real estate at issue. If the contractor has an ownership interest in the property subject to the lien, that lien could preclude reaffirmation in a Chapter 7 or the confirmation of a Chapter 13. The presence of a lien on someone else’s property could lead to discharge or dischargeability problems
- dischargeability complaints – using the draw from one project to pay for work on another may be considered fraudulent and give rise to a dischargeability complaint under Section 523 of the Bankruptcy Code. In my experience, an angry homeowner may file such a complaint not because he expects to receive any money but because he wants to punish a dilatory contractor. Angry dischargeability complaint plaintiffs with money to pursue litigation are a bad omen for a building contractor who hopes to use bankruptcy as a tool to start over.
- objections to discharge under Section 727 of the Bankruptcy Code – unlike a dischargeability complaint which seeks to have a particular debt declared non-dischargeability, a 727 complaint seeks to have the entire bankruptcy dismissed because of the debtor’s fraudulent activity. Unlike a Section 523 dischargeability complaint a 727 complaint may not be something that can be settled
- priority claims by contractors in the amount of $10,950 or less per Bankruptcy Code Section 507(a)(4)
- 941 tax liability
Forthcoming post – pre-bankruptcy planning for small building contractor
Jonathan Ginsberg, Esq.
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