Construction Law: Bankruptcy Claims
Prime Contractor Denied Subcontractor Indemnification
by Trent Cotney, partner, Adams & Reese, LLP
(Editor’s Note: Trent Cotney, partner at Adams & Reese, LLP, is dedicated to representing the roofing and construction industries. Cotney is General Counsel for the Western States Roofing Contractors Association and several other industry associations. For more information, contact the author at (866) 303-5868 or go to www.adamsandreese.com.)
With the economy changing, more roofing contractors have to be concerned about their customers or subcontractors going out of business. When a subcontractor files for bankruptcy, what protections does the prime contractor have? This question was recently raised in the United States Bankruptcy Court in the Middle District of Louisiana.
Details of the Case
In August 2020, WGM Development hired Ferrandino and Son, Inc., to build a dental clinic in Lafayette, Louisiana. Ferrandino then hired Sahene Construction LLC to cover the site work and construct the building envelope. By April 2021, Ferrandino claimed that Sahene had abandoned the project without finishing it and had failed to pay all its suppliers and subcontractors. Ferrandino stated it had to cover some of those costs. In February 2022, WMG made a claim against Ferrandino for damages related to delays and incomplete work. The arbitration for that claim was scheduled for late June 2023.
Meanwhile, on February 15, 2023, Sahene filed a voluntary petition for bankruptcy relief, hoping to achieve liquidation of its assets. Ferrandino then filed an adversary complaint against Sahene and WMG on April 3, 2023. The contractor sought to extend the automatic stay to the pending arbitration proceeding between it and WMG. Two weeks later, on April 17, the arbitration ruled on Ferrandino’s request to stay the arbitration, denying it until the bankruptcy court ruled on Ferrandino’s request to extend the protections of the automatic stay.
What Ferrandino Argued
According to Ferrandino’s claims, the problems at issue in the WMG arbitration all resulted from Sahene’s actions. The prime contractor asserted that the arbitration with WMG is actually about recovering property from its subcontractor, Sahene. Therefore, Ferrandino believes that any judgment against it is really a judgment against Sahene, in accordance with the terms of their contract’s indemnity clause. Ferrandino had filed a lawsuit against Sahene on February 8, 2023. However, that lawsuit was stayed because Sahene entered bankruptcy protection a week later.
What Ferrandino Had to Prove
In Ferrandino and Son, Inc. v. Sahene Constr., the court had to decide if the protections of an automatic stay, which applied to Sahene, also could be extended to Ferrandino, the general contractor and a non-debtor. Since Ferrandino made the motion for the preliminary injunction, it bore the burden of proving all four elements required for such an action.
These are 1) if the plaintiff will likely succeed on the merits, 2) if the plaintiff will suffer irreparable harm without the injunction, 3) if the balance of hardships and inequities is in the plaintiff’s favor, and 4) if the injunction serves the public’s interest.
What the Court Ruled
After reviewing all the evidence, the court determined that the prime contractor failed to show the first element of success on merits. Regarding the third element of hardship and inequities, the court ruled that delaying arbitration would do harm to WMG, so Ferrandino failed to meet that element. The court also determined that Ferrandino could not prove the fourth element regarding the public interest. In fact, liquidating Ferrandino’s claim against Sahene during arbitration would support the public need for the orderly and efficient administration of the issue. However, the court commented most on Ferrandino’s failure to prove the second element of irreparable harm. It offered the following explanation.
In this court’s view, this is where the case breaks down for Ferrandino. Ferrandino contends irreparable injury would be suffered by it, and presumably, the estate because “Ferrandino’s seeking of indemnification through Sahene’s bankruptcy threatens Sahene’s plan process,” and a judgment against Ferrandino will effectively be a judgment against Sahene. That explanation falls short of demonstrating irreparable injury. To the contrary, an adverse ruling against Ferrandino in the arbitration would simply give rise to a liquidated, unsecured claim against this estate, something that happens on a daily basis in bankruptcy court. Stated another way, liquidation of a creditor’s claim in another forum is hardly an unusual situation, giving rise to grounds to extend the automatic stay to a non-debtor.
In conclusion, on April 19, 2023, the court determined that the prime contractor, Ferrandino, failed to satisfy the elements of the preliminary injunction, so its request was denied. According to the court’s ruling, the bankruptcy process can proceed only if claims against it are liquidated efficiently and promptly. The preliminary injunction would only hinder the procedure.
Advice for Contractors
Given the indemnity clause in the contract, it would seem that Ferrandino would have been protected when Sahene failed to complete the work on the project. However, its position was compromised when Sahene filed for bankruptcy. Looking at the timeline, though, Ferrandino should have acted more quickly. According to Ferrandino, Sahene had abandoned the project by April 2021, but Ferrandino failed to file a claim until February 8, 2023, a full year after WMG, the owner, had taken steps toward arbitration.
If you find yourself in a similar failure-to-perform situation with a subcontractor, do not hesitate to take action quickly. On larger projects, also consider having your subcontractor post payment and performance bonds, which you may be able to look to in the event the subcontractor becomes insolvent.
