Contractors who contract for work with other contractors or owners who go bankrupt stand to lose in two ways. The first and most obvious loss results from nonpayment of the contract balance. If the unpaid contractor is grouped with other unsecured creditors, the prospect of recovering any part of that loss is minuscule because the bankrupt's remaining assets will first be distributed among secured creditors, such as lending banks. Generally little is left for unsecured creditors.
The second potential loss arises from bankruptcy law and is possibly even more devastating. Bankruptcy law regards payments made by a bankrupt to its creditors within 90 days of the bankruptcy as preferential payments; and empowers the trustee in bankruptcy to sue recipients and to recover all such payments for the bankruptcy estate. Thus a subcontractor who receives payments on a requisition of say $100,000 within 90 days of a general contractor's bankruptcy could be forced to pay $100,000 back to the bankrupt's estate, even though the subcontractor may have already distributed that money to his subs and suppliers.
Fortunately new developments in the law may moderate the first loss, and exceptions in the bankruptcy law as to what constitutes a preferential payment may permit a contractor to avoid the second loss altogether. Recently evolving case law provides support for the idea that unpaid contractors are not always to be lumped with other unsecured creditors. A case currently pending in federal bankruptcy court asserts a right by subcontractors on a building project to share the unexpended contract balance held by the owner ahead of all other creditors of the bankrupt general contractor, on the ground that money belongs to those whose labor and materials earned it. Success in that case will permit subcontractors on a particular project where there is an unexpended general contract balance to share that balance on a prorata basis without the participation of the trustee in bankruptcy or other creditors. The exception most pertinent to contractors resisting a trustee's attempt to recover preferential payments is "the ordinary course of business" exception. Bankruptcy law prevents a trustee recovering payments made by the bankrupt within 90 days, if the debt was incurred and paid in the ordinary course of the debtor's and creditor's business and was made according to ordinary business terms. This exception has been heavily litigated resulting in various views of what constitutes ordinary course of business and ordinary business terms. Nevertheless a payment made on a monthly requisition within the usual time period under a contract requiring periodic payments would almost certainly qualify for the exception. A payment inconsistent with prior payments secured by any form of pressure tactic probably would not qualify.
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