Subrogation
Page1
Dunn
& Black, P.S., Plaintiff v. The United States of America, and
Environmental Reclamation, Inc., an Idaho Corporation, and John Doe
Corporations 1 --10, Defendants. Fidelity and Deposit Company of
Maryland, a Maryland Corporation, and American Guaranty & Liability
Insurance Company, a New York Corporation, Intervenors.
U.S.
District Court, East.
Dist.
Wash.
; CV-04-0229-LRS,
February 25, 2005
.
[ Code
Sec. 6323]
Lien, validity and priority: Federal tax lien: Statutory setoff:
Attorney's lien: Equitable subrogation. --
A law firm
that had provided legal services to a construction company could not
recover on its attorney's lien on a judgment obtained for the company
against the government because its lien was inferior to the government's
statutory right to setoff. The government's setoff for unpaid taxes
exhausted the entire judgment fund. The government's statutory setoff
also deprived surety insurance companies of recovery on their claims
based on equitable subrogation and the relation back doctrine.
[ Code
Sec. 7402]
Jurisdiction: District court: Suit against
U.S.
: Illegally collected tax. --
A federal
district court had jurisdiction over a suit filed by a law firm for a
portion of a judgment fund to cover fees incurred in obtaining the
judgment against the government for a construction company. Federal
district courts have jurisdiction over suits against the government for
recovery of taxes alleged to have been illegally collected, as claimed
by the law firm.
ORDER
SUKO, District Judge: BEFORE THE COURT is Intervenors' Fidelity and
Deposit Company of Maryland and American Guaranty & Liability
Insurance Company's [Intervenors 1
] Motion for Declaratory Judgment, filed October 19, 2004 (Ct. Rec. 20);
Plaintiff Dunn and Black, P.S.'s [law firm] Motion for Summary Judgment
(Ct. Rec. 28), filed November 2, 2004; and Intervenors' Alternative
Motion For Stay of Plaintiff's Motion For Summary Judgment under Fed. R.
Civ. P. 56(f) (Ct. Rec. 40), filed
November 16, 2004
. These motions were heard with oral argument on
December 20, 2004
, at which time the court requested supplemental briefing on
jurisdiction and lien priority issues.
I. BACKGROUND FACTS AND SUMMARY OF THE PARTIES' ARGUMENTS
On June 20, 2004, plaintiff law firm, Dunn & Black, brought a
complaint in this court for declaratory judgment against the United
States and plaintiff's former client Environmental Reclamation, Inc.
[ERI] 2
, the non-participating defendant construction company. Plaintiff
requested this court to declare that its fees and costs of $361,037.20
are reasonable for the legal services rendered and that it was entitled
to assert an attorney's fee lien. First Amended Complaint, Prayer for
Relief. Further plaintiff requested that the court declare its
attorney's fee lien superior to all subsequent liens, claims, interest
in and to the judgment in the matter of Environmental Reclamation, Inc.
v. United States, case number 02-5C, before the U.S. Court of Federal
Claims [Court of Claims litigation]. Id. Alternatively, plaintiff
requested that this court declare that the
United States
' setoff constitutes unjust enrichment without fairly compensating Dunn
& Black for its services in creating the judgment fund, which
reasonable amount is $361,037.20. Id. Additionally, plaintiff requested
this court declare that the
United States
' setoff would be a violation of due process and plaintiff be paid
$361,037.20.
On
September 16, 2004
, the court allowed intervenors, judgment creditors of ERI, to
intervene. Ct. Rec. 19.
The matter before the court on cross motions for declaratory judgment
and summary judgment began as a contest of liens: an attorneys' lien for
services rendered in winning the disputed settlement/judgment fund 3
against the government versus liens by the intervenors versus IRS liens
on the judgment fund based on taxes owed by the law firm's former client
ERI. There are combinations of four distinct theories set forth by the
parties for this court to consider in its determination of the destiny
of the Judgment Fund: lien priority, equitable subrogation, equity, and
set-off.
On
July 24, 1997
, ERI executed an Indemnity Agreement agreeing to indemnify, save, and
hold harmless the intervenors as sureties for its execution or
procurement of bonds or undertakings on behalf of ERI as the principal.
Ferguson Aff., ¶4.
On
September 29, 1998
, ERI executed a second Indemnity Agreement agreeing to indemnify, save,
and hold harmless the intervenors as sureties for its execution or
procurement of bonds or undertakings on behalf of ERI as the principal.
Ferguson Aff., ¶5.
On
March 11, 1999
, ERI and Flying Eagle Corporation executed an Application for
Performance and Payment Bond and Indemnity Agreement with the
intervenors as the surety. Ferguson Aff., ¶8. Flying Eagle Corporation
(a dissolved corporation) and ERI jointly, severally, and
unconditionally agreed to indemnify and reimburse intervenors for said
Payment and Performance Bond and reimburse intervenors for and against
any loss in connection with said Bond.
Id.
On
July 8, 1999
, the Western Federal Lands Highway Division of the Federal Highway
Administration [FHWA] awarded a contract to ERI in the amount of
$3,499,464.50. Points Aff., Exh. D. The overall purpose of the contract
was to rebuild
Forest Development Road
#340 in the
Payette
National Forest
near
Warren
,
Idaho
.
Id.
The project involved rebuilding four bridges, pioneering a new alignment
for the road across a steep hillside, and other miscellaneous work.
Id.
ERI began work on
July 22, 1999
.
Id.
ERI's original completion date was
October 12, 2000
.
Id.
This date was later extended to
July 9, 2001
.
Id.
On
August 18, 1999
, ERI executed a third Indemnity Agreement agreeing to indemnify, save,
and hold harmless the intervenors as surety for its execution or
procurement of bonds or undertakings on behalf of ERI as the principal.
Ferguson Aff., ¶16.
In the year 2000, ERI retained the plaintiff law firm to advise it
regarding a road project called the Warren Profile Gap Road Project
[Warren Project] in South Central Idaho for FHWA. Plaintiffs' SOF 4
, ¶1. The government was refusing to grant extensions of time and
increases to ERI's contract amount.
Id.
At the time ERI engaged Dunn & Black to advise it on the Warren
Project, Dunn & Black had an ongoing client relationship with ERI
and was representing ERI on several other matters at an hourly rate.
Id.
, ¶2.
On
January 4, 2001
, the contracting officer for the government issued a termination for
default to ERI for the Warren Project. Points Aff., Exh. D. According to
Dunn & Black, the alleged wrongful termination of ERI by the
government caused tremendous financial stress on ERI, including ERI's
inability to pay taxes. Plaintiffs' SOF, ¶5.
On
January 3, 2002
, plaintiff filed an action in the United States Federal Court of Claims
on behalf of ERI to recover monetary damages for alleged wrongful
termination in the amount of $1,724,295.98 against the FHWA, a U.S.
Department of Transportation organization. [Court of Claims litigation].
Plaintiffs' SOF, ¶3, Aff. of M. Points, Exh. D. In the Court of Claims
litigation, ERI also requested that the termination for default be
converted into a termination for convenience.
Id.
The Court of Claims litigation presented complex issues involving
scheduling, accounting, rock geology and blasting. Plaintiffs' SOF, ¶3.
The
United States
asserted a claim for reprocurement costs in the amount of $948,168.82.
Id.
Dunn & Black engaged and paid experts to assist in proving ERI's
case and defending the government's claim.
Id.
On November 20, 2002, Dunn & Black amended its existing hourly fee
agreement it had with ERI, negotiated 5
and entered into a contingency fee agreement due to the high balance of
accounts receivable carried on the Warren Project and other matters.
Plaintiffs' SOF, ¶4. At this time, ERI was indebted to Dunn & Black
in the amount of $137,682.33 for past due legal services rendered on the
Warren
Project as well as on other matters.
Id.
The contingency fee agreement stated that Dunn & Black "shall
be entitled to the first $137,682.33 of any recovery from any claims
related to the project."
Id.
The agreement further stated that Dunn & Black shall be compensated
for its further services relating to the [
Warren
] Project in the amount of 50% of any remaining recovery and that ERI
was responsible for all litigation costs."
Id.
On November 14, 2003, Fidelity & Deposit Company of Maryland
[F&D], et al. (intervenors in this action) brought an action
against ERI in the United States District Court, District of Idaho, Civ.
No. 03-497-EJL, to recover for the amount paid out against the ERI bonds
and related collection expenses, including Bond # SUR-3596528 for the
Warren Project. F&D filed a motion for summary judgment for the
cumulative total of $931,860.84 claimed to be owed by ERI to F&D.
(Ct. Rec. 14, Civ. No. 03-497-EJL). ERI did not respond to the
dispositive motion. On
July 29, 2004
, Judge Edward Lodge entered judgment in favor of the surety companies
(intervenors in this action) against ERI for $931,860. (Ct. Rec. 22,
Civ. No. 03-497-EJL).
On
March 30, 2004
, a "Stipulation For Entry of Judgment" was entered in the
Court of Claims litigation. Points Aff., Exh. D. The stipulation was
entered to settle the claims asserted in ERI's complaint and to permit
entry of final judgment upon those claims without constituting an
admission of liability upon the part of the government.
Id.
ERI offered to settle all of its claims in exchange for payment by the
United States
of $450,000 (inclusive of interest, costs, expenses, and attorney fees)
and the government's agreement to convert the termination for default
into a termination for the convenience of the Government.
Id.
Subsequent to that stipulation, a $450,000 judgment was entered against
the United States on April 5, 2004 6
[hereinafter referred to as the judgment fund].
Id.
This $450,000 judgment fund lies at the vortex of this litigation.
According to Dunn & Black, ERI was required to pay the law firm
$361,037.20 from the judgment fund pursuant to the contingency fee
agreement. Plaintiff's SOF, ¶6.
The Internal Revenue Service [IRS], upon learning of the settlement,
asked the government to stop payment of the judgment so that the IRS
could offset certain federal tax liabilities of ERI against the
judgment.
On May 5, 2004, plaintiff was informed by a government attorney that the
IRS would be making claims to the settlement funds as an intended offset
of the entire amount of the judgment based on an unrelated federal tax
debt purportedly owed by ERI 7
. Plaintiffs' SOF, ¶7. In its answer to the plaintiff's complaint in
the instant action, the government (IRS) claims to be owed $987,839.84
as of
April 30, 2004
.
Answer, ¶20. 8
The Treasury Department is now withholding the judgment fund based on
the following tax liens that the IRS filed against ERI:
August 29, 2003
$3,969.36
November 19, $64,178.03
2003
March 29, 2004
$419,573.16
April 7, 2004
$412,148.54
$899,869.09
Points Affidavit, ¶4.
On
May 5, 2004
, plaintiff, after being informed that the IRS would be making claims,
served the government with a Notice of Attorney's Lien. Plaintiffs' SOF,
¶8. On
May 7, 2004
, ERI terminated its attorney-client relationship with plaintiff law
firm. ERI has not paid any of the amounts owing to plaintiff.
Id.
, ¶13.
On
June 3, 2004
, the government filed a civil action in the United States District
Court for the District of Idaho (Case No.
2:04
-cv-279-EJL) to reduce ERI's federal tax assessments to judgment. Ct.
Rec. 1, Case No. 2:04-cv-279-EJL. Originally the government demanded
$988,000 in unpaid tax assessments.
Id.
On
September 2, 2004
the government amended its complaint, demanding only $567,304.85 for
unpaid federal employment and unemployment tax liabilities plus interest
and other statutory additions. Ct. Rec. 6, Case No. 2:04-cv-279-EJL.
On
November 29, 2004
, the
Idaho
district court entered judgment in the amount of $609,079.96 (with
statutory additions and interest) upon the government's motion for
default judgment against ERI. Ct. Rec. 15, Case No. 2:04-cv-279-EJL;
Auchterlonie Decl., Exh. 1.
Intevenors state that ERI owes them $931,930.61 plus interest accruing
for all projects having the same principal (ERI) and the same
obligee/owner (the
United States
), and which amount has been reduced to a judgment rendered in civil
action, Civ. No. 03-497-EJL.
Bonds,
Bond Payments, Related Bond Expenses
ERI entered into the following bonds as principal in which the
intervenors are sureties:
SUR-2887088 Rio Pojaaque 11/20/98 $2,483,840.59
SUR-2887092 DEQ Worland 02/24/99 $1,779,219.53
SUR-2887095 DOR Worland
04/20/99
$71,168.78
SUR-3596528
Warren
Project
07/12/99
$1,272,785.80
SUR-3596532 Burgdorf Bridge
09/17/99
$29,150
SUR-3596536 Barrick Mine 06/01/00 $800,000 9 9 The
original amount of
this bond,
originally issued
January 25, 2000
was
$250,000, which was
ultimately changed
to $800,000 on June
1, 2000.
SUR-3631158 Barrick Goldstrike
06/27/00
$60,000
SUR-3631159 Goat Creek
07/13/00
$633,595
Ferguson Aff., ¶¶9-17 [hereinafter collectively referred to as
"Issued Bonds"].
Intervenors state they have made payments of $1,467,455.03 pursuant to
the terms of the Issued Bonds and have incurred expenses of not less
than $122,800 associated with the collection of all unpaid balances owed
to intervenors by ERI. Ferguson Aff., ¶¶18, 19.
Intervenors' payments of amounts owing to ERI's material suppliers and
subcontractors used and any expense payments made to legal and
engineering firms on various bond projects with ERI are as follows:
Bond Number Payee Date Paid Amount
SUR-2887088 J.R. Striping
2/21/01
$2,571.76
Valley Fence
2/15/01
$17,989
Montoya Constr.
6/22/01
$17,085.38
$37,646.31
SUR-2887092
SUR-2887095 Product Level
3/8/01
$95,534.55
Martin Constr.
4/10/01
$27,500
R.H. Grover
10/4/02
$212,079.74
Wyoming
State
11/6/02
$71,168.78
$406,283.07
Legal Expense various $71,374.69
Travel Expenses $2,045.68
$73,420.44
SUR-3596528 10 10
This bond is the
Warren Profile Gap
Project.
SUR-3596527 11 11 MSE-HKM, Inc.
2/15/01
$12,053.93
This bond was also
apparently issued in
connection with the
Warren Profile Gap
Project. However,
this bond was not
originally mentioned
in intervenors' Memo
in Support of
Declaratory Judgment
(Ct. Rec. 21, page
4).
Neff Rental
2/15/01
$57,611.55
Materials Testing
2/15/01
$26,687.00
Precision Sawdust
2/16/01
$1,100.00
Heavy Equipment
5/4/01
$12,826.13
Quattro Envir.
5/4/01
$5,616.62
ICM/Great Northern
5/15/01
$6,510.00
$122,405.23
Law Firm/Travel Various $97,876.08
SUR-3596532 Crane West
5/28/02
$10,125.00
SUR-3596536 Komatso Equip. ** $800,000
SUR-3631158 Familliam NW
2/9/01
$58,903.76
SUR-3631159 ICM/Great Northern
5/1/01
$21,420.00
SUR-3631157 12 12 ICM/Great Northern 5/1/01 $4,758.00
This bond, No. SUR
3631157, was
apparently issued
for ERI's Beartrack
Reclamation Project.
This bond was not
mentioned until the
Suppl. Ferguson
Affidavit was filed
in support of
intervenors'
Declaratory Judgment
motion. It is not
clear if this bond
was one of the
bonded multiple
projects with the
same obligee. It is
clear from the
supplemental
affidavit that ERI
is the principal.
SUR-3596534 13 13 Missouri Dept. Rev.
6/11/03
$3,835.79
See Footnote 12. It
is unclear if this
bond was one of the
bonded multiple
projects with the
same obligee. It is
clear from the
supplemental
affidavit that ERI
is the principal.
SUR-2887086 14 14 Star Rentals 9/3/03 $2,166.45
See Footnote 12.
Grand Total $1,638,840.06
As a result of the government's issuance of termination for default 15
on January 4, 2001 with respect to the Warren Project, from Feb 15, 2001
through May 15, 2001, intervenors incurred losses totaling $220,281.31
under bond numbers SUR-3596528 and SUR-3596527. (Suppl. Ferguson Aff.,
Exh. A.
As a result of ERI's financial difficulties encountered on the Warren
Project, ERI evidently defaulted in its contractual obligation to pay
its subcontractors and material suppliers on other projects as well.
Intervenors consequently received notices of claims against the payment
bonds. After investigating and verifying the validity of the claims,
intervenors satisfied the obligations of its payment bonds by paying the
claims of the subcontractors, laborers and material suppliers and
legal/engineering expenses between February 2, 2001 and April 21, 2004
in sums totaling $1,638,840.06 under its bond numbers set forth in the
Supplemental Ferguson Affidavit, Exh. A.
Intervenors further provide dates in which they perfected a security
interest in ERI's contract rights prior to the date that plaintiff's
attorney lien first arose, giving intervenors a priority right to the
Judgment fund:
07/24/97
ERI granted a security interest to intervenors in all rights under
the contracts mentioned in the Bonds. [July 1997 Security
Agreement]
03/02/01
A UCC-1 Financing Statement filed with Idaho Sec. Of State's
Office, perfecting intervenors security interest in the Collateral.
08/18/99
ERI granted a security interest to intervenors in the Collateral to
secure and hold harmless intervenors against any and all
liabilities [August 1999 Security Agreement]
03/06/01
A UCC-1 Financing Statement filed with Idaho Sec. Of State's
Office, perfecting intervenors security interest in the Collateral.
09/29/98
ERI granted a security interest to intervenors in the Collateral to
secure and hold harmless intervenors against any and all
liabilities [September 1998 Security Agreement]
03/02/01
A UCC-1 Financing Statement filed with Idaho Sec. Of State's
Office, perfecting intervenors security interest in the Collateral.
Intervenors state that ERI was obligated to indemnify and hold
intervenors harmless for any payments made by intervenors under the
terms of the Issued Bonds, which were issued as a means of satisfying
obligations owed by ERI to its creditors. Ferguson Aff., ¶¶20, 22.
Although intervenors have recovered the amount of $221,061.66 in
retained contract funds in the Wyoming Department of Environmental
Quality Worland Project (Bond No. SUR-2887092), intervenors state that
the amount currently due intervenors by ERI (as of October 10, 2004) is
$931,930.61, for all bond payments and expenses incurred by intervenors
in connection with all bonds issued to ERI. Ferguson Aff., ¶¶21, 22.
A.
Intervenors' Theory For Recovery of $450,000
Intervenors are surety insurance companies. As a surety, intervenors
issued several performance and payment bonds on behalf of its principal,
a construction company, ERI. Intervenors assert that because all issued
bonds were issued in favor of ERI by July of 2000 and ERI owes them more
than $450,000, intervenors' claim to the entire Judgment Fund has
priority over any claim of plaintiff or any claim of the
United States
under the law of equitable subrogation. Intervenors argue that the date
of priority of their claim is based on the dates the bonds were issued.
The bond for the Warren Project was issued on
July 12, 1999
. Further, relying on Transamerica Ins. Co. v U.S., 989 F.2d 1188
(Fed.Cir. 1993), intervenors argue that when a surety has bonded
multiple projects with the same principal and obligee, the surety may
use the default on one project to trigger its equitable subrogation
rights to undisbursed construction funds on other bonded projects.
Because ERI owes intervenors $931,930.61 plus interest for all ERI
bonded projects with the
United States
, the entire judgment amount of $450,000 should be awarded to
intervenors under the law of equitable subrogation based on their dates
of priority.
Intervenors further argue that they have a valid and prior perfected
security interest in the judgment fund over any and all lien claimants
or secured parties pursuant to Idaho Code §28-9-308; §28-9-322.
Because Dunn & Black did not commence this suit until
January 3, 2002
, intervenors' security interest was perfected prior to the commencement
and perfection of Dunn & Black's attorney fee lien.
In response to United States v. Munsey Trust Co. of Wash. D.C.,
332 U.S. 234, 67 S.Ct. 1599, 91 L.Ed. 2022 (1947) case, raised by both
plaintiff and the Unites States, intervenors reply that although the Munsey
Trust case does establish that the government has a right to set off
claims against creditors, "[t]he surety who undertakes to complete
the project is entitled to the funds in the hands of the government not
as a creditor and subject to setoff, but as a subrogee having the same
rights to the funds as the creditor." Trinity Universal Ins. Co.
v. United States [ 67-2
USTC ¶9645], 383 [382] F.2d 317 (5th Cir. 1967).
Intervenors also point out that Pearlman v. Reliance Ins. Co.,
371 U.S. 132 (1962), cited by Plaintiff, reaffirmed that sureties who
complete the performance of a contract or the sureties who pay laborers
and materialmen have an equitable right of subrogation to all those who
have a claim in the subject contract.
In conclusion, the intervenors' position that the entire judgment fund
should go to Intervenors is based on these arguments: 1) the plain and
unambiguous language of the indemnity agreements between ERI and
Intervenors; 2) priority dating back to the issuance of bonds and U.C.C.
filings; 3) the special treatment of sureties; and 4) the amount ERI
owes intervenors.
B.
Plaintiff Law Firm's Theory For Recovery of $361,037.20
Dunn & Black argues that it is entitled to an adjudication of its
fees and costs which should be granted as a matter of law over ERI in
the amount of $361,037.20. The breakdown of that amount is as follows:
$137,682.33 ERI's debt pre-dating the Contingent Fee Agreement
$156,158.84 Fee on Warren Project
$ 67,196.03 Cost on the Warren Project matter
$361,037.20
Plaintiff argues that at the moment it filed the lawsuit on ERI's behalf
in the Court of Claims litigation on
January 3, 2002
, a lien for attorney's fees attached to the cause of action. Also, when
that lawsuit was filed, the parties to the present lawsuit had notice of
plaintiff's lien, which qualifies as constructive notice sufficient to
impose an attorney's lien under
Idaho
law. At the time of the Court of Claims litigation, plaintiff states
there were no outstanding IRS tax liens filed against ERI, as all tax
liens were filed after January 2002. Therefore, plaintiff's lien for
attorney fees attached and was choate prior to any federal tax lien.
Plaintiff argues that choate state-created liens take priority over
later-filed federal tax liens. The United States, plaintiff asserts, is
not entitled to offset the entire amount of the judgment because Dunn
& Black has a vested property interest in the judgment, under Banaitis
v. IRS [ 2003-2
USTC ¶50,638], 340 F.3d 1074 (9th Cir. 2003). 16
Plaintiff further argues that the
United States
is precluded from offsetting plaintiff's fee because there is no
mutuality of debt. Mutuality requires that the judgment creditor be the
same person the party owes the debt to be collected, and the government
must be the same person to whom the debt is owed. Plaintiff argues the
United States
cannot set off ERI's tax obligations against the amount of attorney's
fees owed to plaintiff as no mutuality of debt exists between plaintiff
and the
United States
.
Plaintiff asserts that the intervenors' judgment lien did not attach
until
July 29, 2004
. Pursuant to the first in time rule, plaintiff's attorney's lien, which
attached at the time it commenced the action on behalf of ERI on
January 3, 2004
, has priority over the intervenors' judgment lien.
Plaintiff additionally argues that public policy favors giving
attorneys' contractual liens for legal services priority over judgment
creditors' liens. Plaintiff cites Pangborn v. Carruthers, 119
Cal.Rptr.2d 416 (2nd Dist. 2002) and other cases to support its argument
that the equities and public policy favor judgement to plaintiff law
firm.
Through its efforts, plaintiff points out that the
United States
or the intervenors will still receive $88,962.80 ($450,000 -
$361,037.20) if plaintiff receives the requested $361,037.20 that they
otherwise would have had to collect from ERI at its own expense. In
light of ERI's financial troubles caused by the
United States
' alleged breach of contract, Dunn & Black contends neither the
intervenors nor the
United States
would have collected anything at all from ERI without the efforts of
plaintiff. Therefore, equity demands that plaintiff be compensated for
its services, ahead of the
United States
and the intervenors, because it was through plaintiff's efforts that
such fund exists for anyone to vie for.
C.
United States
' Theory For Setoff of $450,000
The
United States
argues, at the outset, that this court does not have jurisdiction to
provide relief sought by intervenors in excess of $10,000. The
United States
asserts that the Federal Court of Claims has exclusive jurisdiction over
claims against the government exceeding $10,000, regardless of whether
the claimant is seeking declaratory judgment. The
United States
urges this court to dismiss the intervenors' claims.
In the event jurisdiction is proper before this court, the
United States
argues that as to intervenors, the doctrine of equitable subrogation
provides that a surety who pays the debt of another is entitled to all
the rights of the person it paid to enforce its right to be reimbursed.
Therefore, any subrogation right claimed here by intervenors is
dependent on who the intervenors paid and what rights that person(s)
had. The
United States
argues intervenors have not provided this information and without it,
the court cannot make any determination with respect to the validity or
priority of any equitable subrogation rights claimed by the intervenors.
17
The United States, citing United States v. Munsey Trust Co. of Wash.
D.C., 332 U.S. 234 (1947), next asserts that laborers and
materialmen for whom the intervenors claim subrogation rights, do not
have enforceable rights against the United States for compensation.
As to plaintiff, the government asserts that plaintiff's claim to
judgment proceeds is not superior to the
United States
' right of setoff for ERI's unpaid federal tax liabilities. The
government argues that federal law determines the relative priority of a
federal tax lien. Pursuant to 26 USC §6323(b)(8),
attorneys' liens enjoy a superpriority to the extent that the attorney's
efforts creating the fund of settlement or judgment, would be recognized
by local law, and the amount of the lien reflects the extent to which
the attorney's efforts reasonably contributed to the award.
Although the government does not dispute that plaintiff's efforts
created the judgment fund, it argues that the plaintiff has not shown it
has perfected its lien under
Idaho
law. Citing Frazee v. Frazee, 104 Idaho 463, 660 P.2d 928 (1983),
the government argues that as interpreted by Idaho courts and the
Bankruptcy court, an attorney must perfect hisor her lien by taking
affirmative steps to reduce the lien to a judgment or order of the
court.
The United States argues that plaintiff has not shown it has perfected
its lien and as a matter of law, even if it could show it perfected,
plaintiff cannot enjoy priority over the government's right of setoff
under 26 U.S.C. §6323(b)(8).
This statute reads:
Validity
and priority against certain persons
(b) Protection
for certain interests even though notice filed. --Even though notice of
a lien imposed by section
6321 has been filed, such lien shall not be valid --
(8) Attorneys'
liens. --With respect to a judgment or other amount in settlement of a
claim or of a cause of action, as against an attorney who, under local
law, holds a lien upon or a contract enforceable against such judgment
or amount, to the extent of his reasonable compensation for obtaining
such judgment or procuring such settlement, except that this
paragraph shall not apply to any judgment or amount in settlement of a
claim or of a cause of action against the United States to the extent
that the United States offsets such judgment or amount against any
liability of the taxpayer to the United States. [emphasis added]
The government argues that the judgment here at issue is against the
United States
and it intends to offset such judgment against ERI's federal tax
liability, therefore, plaintiff cannot under any set of circumstances
enjoy priority over the
United States
' claim of setoff. The government states the policy behind this rather
harsh result is protection of the fisc.
Next, the government points out that the $450,000 judgment entered in
favor of ERI indicated that the total amount was "inclusive of
interest, costs, expenses, and attorney fees" meaning that no
specific amount was entered for attorney's fees, and the judgment check
could be made out only in the name of ERI. As such, the government
argues, it owed this judgment to ERI and no none else, and it has the
right to offset ERI's unpaid federal tax liabilities against the amount
it owes to ERI pursuant to the judgment. Thus, plaintiff's claims
regarding mutuality of debts must fail. Even if such mutuality were
lacking, the government states it has no effect on the government's
right of setoff.
In its post-hearing briefing and presumably based on the conclusion of
its civil action to reduce ERI's tax assessments to judgment on November
24, 2004, the government's argument shifted, in part, from common law
right of setoff to that of a statutory setoff pursuant to 31 U.S.C. §3728.
The
United States
argues that 31 U.S.C. §3728(a),
(b), and (c) enable it to deduct ERI's tax liability from the
Claims Court
judgment.
Under 31 U.S.C. §3728, "The Secretary of the Treasury shall
withhold paying that part of a judgment against the United States ...
that is equal to a debt the plaintiff owes the Government." If the
judgment creditor denies the debt or does not agree to the setoff, the
Secretary of the Treasury is required to "withhold payment of an
additional amount [to] cover legal costs of bringing a civil action for
the debt." 31 U.S.C. §3728(b)(2)(A). If the government loses such
a civil action, the Secretary of the Treasury must pay the judgment
creditor the balance of the judgment plus interest of 6 percent for the
time the money is withheld. 31 U.S.C. §3728(c).
The government asserts that although its right of setoff exists absent
statutory authority, Congress has specifically provided by statute that
the government must set off any judgment it owes against debts
owed to it by its judgment creditor. The government argues that there is
no question that the assessments made against ERI, having been reduced
to judgment, classify as "debts" owed to the government within
the meaning of 31 U.S.C. §3728. Citing various non-Ninth Circuit case
law, the government concludes there is no basis in law for the court to
deny its setoff right under 31 U.S.C. §3728.
Finally, the government reiterates that the plaintiff did not have a
perfected, choate lien under Idaho state law at the time the federal tax
liens arose because the amount of the attorney's lien could not be
established until the judgment was entered in the Claim Court litigation
on April 15 [sic], 2004. As to intervenors, the government also argues
in its post-hearing brief that intervenors' interest in the judgment
fund was not choate until April 15 [sic], 2004.
The government, at the close of briefing, requests the court to deny the
pending motions and dismiss this case.
III. STANDARDS OF LAW
A.
Jurisdiction
Only the United States (IRS) argues that this court lacks jurisdiction
to provide relief sought by intervenors in excess of $10,000. The IRS
argues that the Federal Court of Claims has exclusive jurisdiction over
claims against the government exceeding $10,000, regardless of whether
the claimant is seeking declaratory judgment. IRS requests that
intervenors' claims be dismissed based on the contract between the
government (FHWA) and ERI with respect to the Warren Profile Gap Road
Project.
Intervenors respond that they have not filed a claim against the
government, nor are they asserting in this action that they have been
damaged by any act of the government under a theory of contract or tort.
Instead, intervenors are seeking a declaratory judgment establishing
their priority rights and claim to the Judgment Fund, which is being
held by the Treasury Department, a federal agency. Finally, intervenors
conclude that their claims are not barred by sovereign immunity and the
Tucker Act is inapplicable to the intervenors' claim as sureties.
The court necessarily must deal with jurisdiction at this juncture. The
United States
' initial position in this litigation was to assert "superior"
liens for ERI's unpaid taxes to the other parties' liens. The government
also argued a common law right to setoff as a counterclaim to
plaintiff's complaint. Then, the government shifted the focus of its
position to reliance on a federal statutory right of setoff under the
Federal Offset Statute, 31 U.S.C. §3728 to setoff ERI's federal tax
liabilities.
Under 28 U.S.C. §1346, district courts shall have original
jurisdiction, concurrent with the United States Court of Federal Claims,
for any civil action against the United States for the recovery of any
internal-revenue tax alleged to have been illegally collected. In the
present case, plaintiff, although not the taxpayer, has alleged that the
government has illegally withheld the judgment fund based on a setoff
for ERI's federal tax liabilities. Section §1346 reads:
§1346
United States
as defendant
(a) The
district courts shall have original jurisdiction, concurrent with the
United States Court of Federal Claims, of:
(1) Any civil
action against the United States for the recovery of any
internal-revenue tax alleged to have been erroneously or illegally
assessed or collected, or any penalty claimed to have been collected
without authority or any sum alleged to have been excessive or in any
manner wrongfully collected under the internal-revenue laws;
...
As a general rule, the priority of competing liens against a taxpayer's
property, including tax liens, is governed by federal law. See
Aquilino v. United States [ 60-2
USTC ¶9538], 363 U.S. 509, 80 S.Ct. 1277, 4 L.Ed.2d 1365 (1960).
Specifically, federal common law and the Federal Tax Lien Act of 1966,
26 U.S.C. §§6321-
6326
(1976) govern the resolution of priorities among competing claims. See
Rice Investment Co. v. United States [ 80-2
USTC ¶9654], 625 F.2d 565 (5 th Cir. 1980). When
priority of a federal tax lien is asserted against a state-created lien,
state law determines the existence and characteristics of the state
lien, but federal law sets the standards for priority. 18
Federal law determines whether the status of "judgment lien
creditor" within the meaning of §6323(a)
of the Internal Revenue Code was attained before the Notice of Tax Lien
was filed. In re Dulaney [ 83-1
USTC ¶9201], 29 B.R.79, 81 (1982) (citations omitted).
The question of the priority of the government's common law setoff
rights is a question of federal common law. "The right of set-off
is within the equitable power of a court to offset mutual debts running
between two parties." Capuano v. U.S. [ 92-1
USTC ¶50,163], 955 F.2d 1427, 1430 (11 th Cir. 1992).
In conclusion, the court is satisfied that jurisdiction is proper in
this district court 19
pursuant to 28 U.S.C. §1346 for this civil action against the United
States for a sum alleged to have been wrongfully collected under the
internal-revenue laws. Here plaintiff alleges that the
United States
' setoff of $450,000 for ERI's tax liabilities would be a violation of
due process and unjust enrichment. This statute, 28 U.S.C. §1346, does
not say that only the person against whom the tax is assessed may sue,
but instead, uses broad language such as "any civil action against
the United States;" "any sum alleged to have been
excessive;" and "in any manner wrongfully collected."
B.
Legal Standards Fox Summary and Declaratory Judgment
Summary judgement applies to actions for declaratory judgment and is
appropriate where "the pleadings ... together with the affidavits,
if any, show that there is no genuine issue as to any material fact and
that the moving party is entitled to judgment as a matter of law."
Anderson
v. Liberty Lobby, Inc., 477
U.S.
242, 247, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986). Summary judgment may be
entered "against a party who fails to make a showing sufficient to
establish the existence of an element essential to that party's case,
and on which that party will bear the burden of proof at trial." Celotex
Corp. v. Catrett, 477
U.S.
317, 322, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986). Once the moving party
properly supports its motion for summary judgment, the non-moving party
must establish a genuine issue of material fact in order to preclude a
grant of summary judgment. Matsushita Elec. Indus. Co. v. Zenith
Radio Corp., 475 U.S. 574, 586, 106 S.Ct. 1348, 89 L.Ed.2d 538
(1986). "[T]he mere existence of some alleged factual dispute
between the parties will not defeat an otherwise properly supported
motion for summary judgment." Anderson, 477
U.S.
at 247-48, 106 S.Ct. 2505. In addition, "a complete failure of
proof concerning an essential element of the non-moving party's case
necessarily renders all other facts immaterial." Celotex,
477
U.S.
at 323, 106 S.Ct. 2548.
C.
Government's Right of Setoff
Setoff differs from a lien, inasmuch as the former belongs exclusively
to the remedy, and is merely a right to insist, if the party thinks
proper to do so, when sued by his creditor, on a counter demand, which
can only be enforced through the medium of judicial proceedings; whilst
the latter is, in effect, a substitute for a suit. 1834, 2 Op.Atty.Gen.
663. See BLACK'S LAW DICTIONARY 1372 (6th ed. 1990) (defining
"set-off" as a "claim filed by a defendant against the
plaintiff when sued and in which he seeks to cancel the amount due from
him or to recover an amount in excess of the plaintiff's claim against
him.").
The government has both a common law and a statutory right of setoff.
The government's common law right of setoff --which is inherent in the
federal government --is broad 20
and "exists independent of any statutory grant of authority to the
executive branch."
United States
v. Tafoya, 803 F.2d 140, 141 (5th Cir. 1986). "The government has
the same right which belongs to every creditor, to apply the
unappropriated moneys of his debtor, in his hands, in extinguishment of
the debts due to him."
United States
v. Munsey Trust Co. of
Washington
,
D.C.
, 332
U.S.
234, 239, 67 S.Ct. 1599, 1602, 91 L.Ed. 2022 (1947) (internal quotations
omitted). This right of setoff belongs to every creditor, including the
United States, through common law, United States v. Munsey Trust Co.,
332 U.S. 234, 239, 67 S.Ct. 1599, 1601-02, 91 L.Ed. 2022 (1947), and
additionally to the
United States
by statute. 31 U.S.C. §3728.
The government's statutory right of setoff 21
, the Federal Offset Statute, 31 U.S.C. §3728 (1994 & Supp. II
1996) 22
, provides:
(a) The
Comptroller General shall withhold paying that part of a judgment
against the United States Government presented to the Comptroller
General that is equal to a debt the plaintiff owes the Government.
(b) The
Comptroller General shall --
(1) discharge
the debt if the plaintiff agrees to the setoff and discharges a part of
the judgment equal to the debt; or
(2)(A)
withhold payment of an additional amount the Comptroller General decides
will cover legal costs of bringing a civil action for the debt if the
plaintiff denies the debt or does not agree to the setoff; and (B) have
a civil action brought if one has not already been brought.
(c) If the
Government loses a civil action to recover a debt or recovers less than
the amount the Comptroller General withholds under this section, the
Comptroller General shall pay the plaintiff the balance and interest of
6 percent for the time the money is withheld.
This statute provides that when a plaintiff obtains a judgment against
the
United States
, but owes a debt to the government as well, and does not agree to the
setoff, the Comptroller General must perform a setoff, withholding
payment of a portion of the plaintiff's judgment and discharging an
equal amount of his liability. In addition to the Comptroller General's
authority under 31 U.S.C. §3728, the head of any executive or
legislative agency may perform an "
admin
istrative offset" of like effect. 31 U.S.C. §§3701(a)(1), 3716.
These statutes, though, have not displaced the
United States
' common-law right of setoff. See Cecile Industries, Inc. v. Cheney,
995 F.2d 1052 (Fed.Cir. 1993).
Like other creditors, the
United States
may assert right of setoff against parties who are claiming rights
derivatively from other parties against whom the setoff would be proper.
U.S. v. Cohen [ 68-1
USTC ¶9138], 389 F.2d 689 (5 th Cir. 1967). In Cohen,
the Fifth Circuit held that the right of a federal prisoner's attorneys
to recover fees, awarded by federal district court out of tort recovery
based on a fellow inmate's assault on a prisoner, was derivative of
prisoner's right in the recovery and, hence, subject to government's
right to setoff against the prisoner's prior tax assessments, which had
been reduced to judgments against the prisoner. In Transocean Air
Lines, the fees were awarded under a contingency fee contract that
provided that the attorneys would receive a one-third interest in the
recovery. United States v. Transocean Air Lines, 386 F.2d 79, 80
(5th Cir.), cert. denied, 389
U.S.
1047, 88 S.Ct. 784, 19 L.Ed.2d 839 (1967). Because the attorneys'
interest in the fees was derivative of the plaintiffs' interest in the
judgment, the court allowed the government to setoff its claim against
the judgement, including attorneys' fees awarded to the plaintiffs.
Id.
at 82.
The government's [statutory] right of setoff, although also purportedly
broad, is not unlimited. Marre v. U.S. [ 97-2
USTC ¶50,573], 117 F.3d 297, 303 (5 th Cir. 1997).
Section 3728 expressly applies only to offsets against any
"judgment" owed by the
United States
. Further, in order for the government to invoke its right of setoff,
there must be mutuality of debt between the parties. See United
States v. 717.42 Acres of Land [ 92-2
USTC ¶50,335], 955 F.2d 376, 381 (5th Cir. 1992) (reasoning that a
mutuality of debt must exist before the
United States
can set off). Mutuality requires that the judgment creditor be the same
person (in the view of the law) as the party who owes the debt to be
collected, and the government must be the same person to whom the debt
is owed. See Doe v. United States, 58 F.3d 494, 498 (9th Cir.
1995) ("all agencies of the
United States
, except those acting in some distinctive private capacity, are a single
governmental unit" for setoff against the
United States
).
Another limitation on the government's statutory right of setoff is
known as the equitable subordination doctrine. This doctrine is rooted
from the bankruptcy court's inherent equitable powers, Pepper v.
Litton, 308
U.S.
295, 303-11, 60 S.Ct. 238, 84 L.Ed. 281 (1939), a power also shared by
admiralty courts ( see e.g., Cantieri Navili Riuniti v. M/V
Skyptron, 621 F.Supp. 171, 187 (W.D. La.1985), aff'd and remanded,
802 F.2d 160 (5th Cir. 1986); Hornbeck Offshore Operators, Inc. v.
Ocean Line, 849 F.Supp. 434 (E.D. Va.1994).
Under this doctrine, a court can subordinate the government's right of
setoff in certain situations. Three conditions are necessary to justify
equitable subordination: (I) The setoff claimant must have engaged in
some type of inequitable conduct, such as fraud, illegality, or breach
of fiduciary duty; (ii) the misconduct must have resulted in injury to
the creditors of the bankrupt or conferred an unfair advantage on the
claimant; and (iii) equitable subordination of the claim must not be
inconsistent with federal statutes. See Custom Fuel Services v.
Lombas Industries, 805 F.2d 561, 566 (5th Cir. 1986) (citations
omitted).
A procedural limitation under §3728(a) requires the government to bring
suit in district court on its offsetting claim if it seeks an offset and
the judgment creditor denies the debt or does not agree to the setoff.
D.
Priority Statute
Where several liens have attached to one fund, the lien that is
"first in time" will generally have priority, that is, it must
be satisfied before recovery may occur under subsequent liens. Montavon
v. U.S. [ 94-2
USTC ¶50,559], 864 F.Supp. 519, 520 n.1 (E.D. Va.1994). There are
exceptions to this general rule as well as a number of rules which
govern the determination of when a federal tax lien arises and when a
state-created lien arises for purposes of the general rule. Rice
Investment, Co. v. U.S. [ 80-2
USTC ¶9654], 625 F.2d 565, 568-69 (5 th Cir. 1980).
Under the federal common law of choateness, a state-created lien is
deemed to be in existence for "first in time" purposes when it
is "perfected" or "choate"; that is, when the
"'identity of the lienor, the property subject to the lien, and the
amount of the lien are established.'"
U.S.
By and Through I.R.S. v. McDermott [ 93-1
USTC ¶50,164], 507 U.S. 447, 449, 113 S.Ct. 1526 (citations
omitted); see also United States v. Central Bank [ 88-1
USTC ¶9256], 843 F.2d 1300, 1307 (10th Cir. 1988). Choate liens
take priority over later filed federal tax liens, while inchoate liens
do not. Horton Dairy, Inc. v. United States [ 93-1
USTC ¶50,195], 986 F.2d 286, 291 (8th Cir. 1993) (citations
omitted). While the choateness doctrine is irrelevant when 26 U.S.C. §6323
accords a lien priority over a federal tax lien, the doctrine of
choateness nevertheless still applies when §6323
is silent regarding priority. See, e.g. Burrus v. Oklahoma Tax
Commission, 59 F.3d 147 (10th Cir. 1995) (giving state tax lien
priority under choateness doctrine).
Treasury Regs.
§301.6323(h)-1(g) provides the following definition of a judgment
lien creditor:
The term
'judgment lien creditor' means a person who has obtained a valid
judgment, in a court of record and of competent jurisdiction, for a
recovery of specifically designated property or for a certain sum of
money. In the case of a judgment for the recovery of a certain sum of
money, a judgment lien creditor is a person who has perfected a lien
under the property involved. A judgment is not perfected until the
identity of the lienor, the property subject to the lien, and the amount
of the lien are established. ...
This definition is in accordance with the Supreme Court's decision in
the United States v. City of New Britain [ 54-1
USTC ¶9191], 347 U.S. 81, 74 S.Ct. 367, 98 L.Ed. 520 (1954). For
the first time, the court in
New Britain
deemed a state-created lien choate and, therefore, worthy of priority
over subsequent federal tax liens on the basis of the "first in
time" principle.
New Britain
[ 54-1
USTC ¶9191], 347
U.S.
at 84-5.
New Britain
announced the seminal test for determining priority of state-created
liens: A state-created lien takes priority over a later federal tax lien
when "there is nothing more to be done to have a choate lien-when
the identity of the lienor, the property subject to the lien, and the
amount of the lien are established."
New Britain
[ 54-1
USTC ¶9191], 347
U.S.
at 84. The New Britain court provided justification for applying
the choateness 23
doctrine to protect federal liens. The court hypothesized that
"[o]therwise, a State could affect the standing of federal liens,
contrary to the established doctrine, simply by causing an inchoate lien
to attach at some arbitrary time even before the amount of tax,
assessment, etc. is determined.
Id.
at 86.
In other words, the various fictions by which a lien, when ultimately
perfected, "relates back" under state law to a time when some
preliminary step was taken to create or enforce the lien, are not
applicable in determining whether a lien was perfected or choate at the
time a federal tax lien arose.
Recognizing that the confusing new judicial concept of choateness was
undermining the financing methods fostered by the Uniform Commercial
Code, Congress enacted the Federal Tax Lien Act of 1966 [FTLA], which
was incorporated into the Internal Revenue Code as sections
6321 through 6323
and has since remained largely unchanged. 26 U.S.C. §§6321,
6322,
6323
(1988 & Supp. IV 1992). A major goal behind the FTLA was to conform
federal law to the commercial transactions governed by the U.C.C. 24
The FTLA expanded the superpriority provisions now codified in section
6323(b) 25
and provided, among other things, specific protection for attorney's
liens, and certain commercial transactions financing agreements.
Id.
The FTLA also codified the "first in time" principle and
reaffirmed the notice-filing provisions and the choateness doctrine as
it applied to judgment creditors.
Id.
E.
Superpriority-Attorney's Lien
Under 26 U.S.C. §6323(b),
certain liens enjoy "superpriority" over federal tax liens,
meaning they must be satisfied first, regardless of the "first in
time" principle. Air Power, Inc. v. United States [ 84-2
USTC ¶9732], 741 F.2d 53, 55 n. 1 (4th Cir. 1984).
Section
6323(b)(8) provides that if an attorney has a lien or a contract
enforceable under local law against the proceeds or settlement of a
claim, and the lien is for reasonable compensation in connection with
securing the judgment or the settlement of a claim or cause of action,
that lien takes priority over the federal tax lien. IRC
§6323(b)(8); Reg.
§301.6323(b)-1(h). See U.S. v. State Nat. Bank of CT
[ 70-1
USTC ¶9209], 421 F.2d 519 (2 nd Cir. 1970). Knowledge by
the attorney of the tax lien does not disqualify the attorney from
asserting superpriority status. Reg.
§301.6323(b)-1(h)(3).
Without such a provision, the federal tax lien would cover all of the
taxpayer's property, including causes of action and any amounts which
may be owed to an attorney for work in connection with securing
judgments or settlement of suits or other proceedings. S. Rep. No. 1708,
89 th Cong.,2d Sess. 6. This provision protects the attorney
to the extent of a reasonable fee, as long as it is protected by local
law, for efforts in obtaining and collecting the judgment or amount. See
U.S. v. Stonehill [ 83-1
USTC ¶9285], 702 F.2d 1288 (9 th Cir. 1983), cert.
denied 471
U.S.
1066 (1985); Spielvogel v. Harkins & Maeger Ltd., 639 F.Supp.
1397 (S.D. N.Y. 1986).
Reasonable compensation is defined as the amount customarily allowed
under local law for such attorney's services for litigating or settling
a similar case or
admin
istrative claim. §301.6323(b)-1(h).
This is determined by the circumstances in each case. It may be
established by multiplying the attorney's reasonable hourly rate by the
number of hours reasonably expended on the legal activity. In
appropriate cases, the courts may adjust the lodestar figure according
to the twelve (12) factors identified in the Kerr v. Screen Extras
Guild, Inc., 526 F.2d 67 (9 th Cir. 1975), cert.
denied 425 U.S. 951 (1976) case.
When a judgment or settlement is in respect to a claim against the
United States
, the
United States
has the right to offset any liability of the taxpayer to the
United States
against the judgment or settlement. The attorneys' lien superpriority,
therefore, does not apply with respect to judgments obtained for the
taxpayer against the government. Internal Revenue Code
§6323(b)(8); Reg.
§301.6323(b)-1(h); Montavon v. U.S. [ 94-2
USTC ¶50,559], 864 F.Supp. 519 (E.D. Va. 1994). Section
6323(b)(8) reads:
(8) Attorneys'
liens. --With respect to a judgment or other amount in settlement of a
claim or of a cause of action, as against an attorney who, under local
law, holds a lien upon or a contract enforceable against such judgment
or amount, to the extent of his reasonable compensation for obtaining
such judgment or procuring such settlement, except that this
paragraph shall not apply to any judgment or amount in settlement of a
claim or of a cause of action against the United States to the extent
that the United States offsets such judgment or amount against any
liability of the taxpayer to the United States. [Emphasis added].
The House Report explains that an attorney will not enjoy superpriority
"to the extent that the
United States
, under any legal or equitable right, offsets its liability under the
judgment or settlement against any liability of the taxpayer to the
United States
." H.R.Rep. No. 1884, 89th Cong., 2d Sess. at 39 (1966) (emphasis
added). The report then offers two examples of means by which the
government might offset a judgment, one from common law, and the other
from statute, indicating that the examples are not meant to be
exhaustive.
Id.
Debate on the House floor also indicated that the offset exception
contained no technical restriction as to how the government applies the
judgment against the debt. The bill's chief proponent explained that
"[t]he right of offset would exist between two private parties each
having claims against the other. We saw no reason for treating the
Government worse in this situation, than we would a private party having
a claim against the person involved." 112 Cong.Rec. 22,226 (1966)
(statement of Rep. Mills).
The House and Senate reports each summarize the effect of the offset
exception as follows:
However, under
the bill, in a proceeding against the Government, the Government retains
its right to set off against any recoveries from it any amounts due it
by the taxpayer on account of any tax or any other debt or claim. This
setoff means that the attorney's lien "superpriority" does not
apply with respect to judgments he obtains for the taxpayer against the
Government (citations omitted). The passage suggests that the key fact
is whether the judgment obtained runs against the government.
Montavan v. United States [ 94-2
USTC ¶50,559], 864 F.Supp. 519, 526 n.18 (E.D. Va.1994).
Where there is a judgment against the
United States
, but the notice of federal tax lien has not been filed, neither the
basic purpose of Section
6323(b)(8) nor the claim against the
United States
exception is invoked, and the general rule of "first in time, first
in right" applies. Capuano, 955 F.2d at 1433.
In Capuano, the government conceded that attorney Capuano
had a charging lien under
Florida
law and that the attorney's charging lien for $25,000 of the $100,000
settlement amount was choate as of
June 9, 1988
, the day the final judgment was entered.
Id.
at 1433. The government further conceded that because the IRS, having
made its tax assessment on
July 7, 1998
, almost one month after the final judgment was entered,
Capuano's charging lien was clearly first in time and first in right
over the federal tax lien.
Id.
Although Capuano's lien was in fact based on a judgment against the
United States
, it was choate under local law before the federal tax lien was filed.
Id.
Hence §6323(b)
did not come into play and the general rule of "first in time,
first in right" applied.
Attorney's
Lien Under Local Law-Idaho
The statute that authorizes an attorney's charging lien under Idaho law 26
is I.C. §3-205, which provides:
The measure
and mode of compensation of attorneys and counselors at law is left to
the agreement, express or implied, of the parties, which is not
restrained by law. From the commencement of an action, or the service of
an answer containing a counterclaim, the attorney who appears for a
party has a lien upon his client's cause of action or counterclaim,
which attaches to a verdict, report, decision or judgment in his
client's favor and the proceeds thereof in whosoever hands they may
come; and can not be affected by any settlement between the parties
before or after judgment.
Kenneth F. White, Chtd. v. St. Alphonsus Regional, 136
Idaho
238, 241, 31 P.3d 926 (
Idaho
App.2001).
Under
Idaho
law, an attorney is not required to institute an independent action to
file an attorney's lien, but can file a notice and a motion to foreclose
on that lien in connection with the principal case. Frazee v. Frazee,
104
Idaho
463, 464, 660 P.2d 928, 929 (1983). An attorney can seek to enforce an
attorney's lien for payment for services rendered by
"petition" in the underlying case. Skelton v. Spencer,
102
Idaho
69, 73, 625 P.2d 1072, 1076 (1981). Moreover, I.R.C.P. 7(b) requires
that an application to the court for an order be made by motion. Dragotoiu
v. Dragotoiu, 991 P.2d 369 (
Idaho
App.1998).
Further, to enforce an attorney's lien under
Idaho
case law, it is clear that counsel seeking to enforce an attorney's lien
must, in an adjudicative process, show the reasonableness of the fees. Cole
v. Kunzler, 768 P.2d 815 (
Idaho
App.1989).
An attorney's right to compensation pursuant to a contingency fee
agreement is a property right determined under applicable state law.
Under
Idaho
law, the reasonableness of a contingency fee agreement is based on a
balancing of the risk factor with the potential for overreaching. Clark
v. Sage, 102
Idaho
261, 265, 629 P.2d 657, 661 (1981) (setting forth additional factors to
consider in determining the reasonableness).
An attorney's right to compensation pursuant to a contingency fee
agreement is a property right determined under applicable state law. Barnhill
v. Johnson, 503
U.S.
393, 112 S.Ct. 1386, 1389, 118 L.Ed.2d 39 (1992); Butner v.
United States
, 440
U.S.
48, 54, 99 S.Ct. 914, 918, 59 L.Ed.2d 136 (1979).
It is also generally accepted that an attorney does not receive a legal
or equitable interest pursuant to a contingency fee contract until the
contingency actually occurs, i.e. a finalized judgment or
settlement. Missouri Pac. R.R. Co. v.
Austin
, 292 F.2d 415, 419 (5th Cir. 1961).
F.
Surety's Equitable Subrogation Rights
In general terms, subrogation is the substitution of one party in place
of another with reference to a lawful claim, demand or right. It is a
derivative right, acquired by satisfaction of the loss or claim that a
third party has against another. Subrogation places the party paying the
loss or claim (the "subrogee") in the shoes of the person who
suffered the loss ("the subrogor"). Thus, when the doctrine of
subrogation applies, the subrogee succeeds to the legal rights and
claims of the subrogor with respect to the loss or claim. See, e.g.,
Amer. Surety Co. of New York v. Bethlehem Nat. Bank, 314
U.S.
314, 317, 62 S.Ct. 226. 86 L.Ed. 241 (1941) (discussing equitable
doctrine of subrogation in surety context); Han v. United States
[ 91-2
USTC ¶50,486], 944 F.2d 526, 529 (9th Cir. 1991) (discussing
equitable subrogation generally).
In the construction industry, there are generally two types of surety
bonds: the performance bond and the payment bond. Under a performance
bond, the surety guarantees the obligee (the party to whom the surety
owes the duty of performing its obligations under the bond) that in the
event of a principal's default, the contract will be completed for the
original contract price.
See
,
United States
v. Munsey Trust Co., 332
U.S.
234, 244, 67 S.Ct. 1599, 1604, 91 L.Ed. 2022 (1947).
The performance bond generally gives the surety the option of completing
performance of the contract or of assuming liability for the cost of
completing the contract in excess of the contract price. See,
Morgenthau v. Fidelity & Deposit Co., 94 F.2d 632, 635 (D.C.
Cir., 1937) ("No difference between completion of the work by the
surety ... and the furnishing of money to the contractor after his
default ... to enable him to perform the contract").
On the other hand, a payment bond (also known as a "labor and
material bond") issued by a surety guarantees that subcontractors,
laborers and material suppliers will be paid in the event of the
principal's default. See, Morrison Assurance Co., Inc. v. United
States [ 83-2
USTC ¶9711], 3 Ct.Cl. 626 (Ct.Cl., 1983).
Underlying these two bonds is the premise that "[i]f the contractor
defaults, the surety performs the work, mitigates loss by its
performance, and pays the subcontractors and suppliers." First
Indemnity of
America
v. Modular Structures, Inc (In re Modular Structures, Inc.), 27 F.3d
72, 74 n. 1 (3rd Cir. 1994).
It has long been held that where a surety, which issued payment and/or
performance bonds, satisfies the obligation of its principal, it is
subrogated to the rights of the obligee, the principal or the third
party beneficiary. See, Pearlman v. Reliance Insurance Co., 371
U.S.
132, 136-137, 83 S.Ct. 232, 9 L.Ed. 2d 190 (1962).
The surety in cases like this undertakes duties which entitle it to step
into three sets of shoes. When, on default of the contractor, it pays
all the bills of the job to date and completes the job, it stands in the
shoes of the contractor insofar as there are receivables due it; in the
shoes of the laborers and materialmen who have been paid by the surety
--who may have had liens; and not least, in the shoes of the government
[owner] for whom the job was completed. National Shawmut Bank v. New
Amsterdam Casualty Co., 411 F.2d 843, 845 (1st Cir., 1969).
Claims of a surety, by way of subrogation, do have limits however. See
Munsey Trust, 332 U.S. 234, 67 S.Ct. 1599, 91 L.Ed.2022
(recognizing that the government's right to a setoff based on sums due
from the contractor on other jobs is superior to any claim of the surety
by way of subrogation); Active Fire Sprinkler v. United States,
811 F.2d 747, 756 (2d Cir. 1987) (recognizing that claims based on
subrogation do not trump those of unpaid subcontractors).
The rights of subrogation apply equally when the surety is called upon
to pay a labor or material claim as when the surety is required to
complete the performance of the contract. See, Pearlman, and Fireman's
Fund Insurance Co. v.
United States
, 421 F.2d 706, 190 Ct.Cl. 804 (Ct.Cl., 1970). Under the payment
bond scheme, if the surety pays labor and/or material claims, it is
subrogated to the rights of the laborer and/or supplier and the
contractor to the corresponding contract funds. See, National Surety
Corp. v. United States, 133 F. Supp. 381, 383-384 (Ct.Cl., 1955), cert
denied, sub. nom., First National Bank v.
United States
, 350
U.S.
902, 76 S.Ct. 181, 100 L.Ed. 793 (1955). In the instant case, the
intervenors do not request subrogation to contract funds but to a
settlement fund stemming from the settlement of claims between ERI and
the governmental agency FHWA.
Equitable subrogation is a state law doctrine and therefore whether
equitable subrogation applies in this case presents a question of
Idaho
law. In
Idaho
, the doctrine of subrogation is not
admin
istered as a legal right but the principle is applied to subserve the
ends of justice and to do equity. Hoopes v. Hoopes, 124
Idaho
518,520 861 P.2d 88, 90 (
Idaho
App.1993). It does not rest on contract and no general rule can be laid
down which will afford a test in all cases for its application, and
whether the doctrine is applicable to any particular case depends upon
the peculiar facts and circumstances of such case. Houghtelin v.
Diehl, 47
Idaho
636, 639-40, 277 P. 699, 700 (1929).
Under Idaho law, one who claims to be equitably subrogated to the rights
of a creditor must satisfy certain prerequisites: (1) payment must be
made pursuant to an obligation to do so, or in order to protect the
subrogee's own interest, i.e., the subrogee must not be making
the payment as a mere "volunteer." Williams v. Johnston,
92
Idaho
292, 298, 442 P.2d 178, 184 (1968); (2) the debt paid must be one for
which the subrogee was not primarily liable; and (3) the entire debt
must be paid. Houghtelin, 47
Idaho
at 640, 277 P. at 700, (1929); Cozzetto v. Wisman, 120
Idaho
721, 726, 819 P.2d 575, 760, (Ct.App.1991). Finally, (4) the subrogation
must not work any injustice to the rights of others. Houghtelin, supra.
See generally, Caito v. United California Bank, 20 Cal.3d 694,
144 Cal.Rptr. 751, 576 P.2d 466 (1978).
Because the surety's rights are based in equity, not contract, it is
important to note that the surety need not file a U.C.C. financing
statement to perfect its equitable claim. See, Amwest Surety
Insurance Company v.
United States
[ 94-2
USTC ¶50,558], 870 F.Supp. 432 (D. Conn., 1994). See also, In re
Alliance Properties, Inc., 104 B.R. 306, 311 (S.D. Cal., 1989)
(surety "not required to file a financing statement to perfect [its
equitable subrogation] lien since it exists as a matter of equity rather
than by contract.").
It is clear that in the context of undisbursed construction funds, the
surety's equitable lien attaches to those proceeds which remain
undisbursed as of the time of the contractor's default. However, it is
not necessary that there be a formal declaration of the contractor's
default. See Fidelity & Deposit Co. v.
United States
, 393 F.2d 834, 837, 183 Ct.Cl. 908 (Ct.Cl., 1968).
A surety on the performance and payment bonds of a contractor, who
performs the contract on the default of the contractor, acquires an
equitable lien upon any sum remaining in the hands of the one for whose
protection the bond was given, and the lien is choate and perfected
where the surety has fully performed, even though the beneficiary of the
bond has not ascertained the balance due the surety. American
Fidelity Co. v. Delaney [ 53-2
USTC ¶9620], 114 F.Supp. 702 (D.C.
Vt.
1953).
Relation
Back Doctrine
Courts have adopted the rule that a federal tax lien will have priority
to contract proceeds over a surety only if the lien is filed before the
execution of the surety bond. In United States v. Trigg [ 72-2
USTC ¶9642], 465 F.2d 1264, 1270 (8th Cir., 1972) cert. den.,
410 U.S. 909, 93 S.Ct. 963, 35 L.Ed.2d 270 (1973), the Eighth Circuit
held that if the surety bond is issued before the federal tax lien is
filed and the surety incurs losses by reason of the bonds, the surety
has priority to contract proceeds remaining on the bonded contracts over
the I.R.S. under its tax lien.
This doctrine of "relation back" ( i.e., referring back
to the date of the execution of the surety bond) has been upheld by
numerous courts. See e.g., National Surety Corp. and Fireman's
Fund Insurance Co., supra. In Fireman's Fund Insurance Co.,
the court noted that the surety's equitable subrogation right is only a
potential right which becomes an actuality when the surety satisfies the
debt of its principal. "However, the surety's rights of subrogation
relate back to the date of the execution of the surety bonds ..." Fireman's
Fund Insurance Co., 421 F.2d at 708.
IV. ANALYSIS
The court will resolve the priority of rights of setoff, or the merit of
the United States' claim for setoff first, for if the setoff proves
successful in the full amount ($450,000), any recovery by ERI will be
destroyed and there will be nothing to which the plaintiff's and
intervenors' liens could attach. It was the initiation of the setoff
process on
May 5, 2004
, when the Comptroller General withheld paying that part of a judgment
against the
United States
equal to a purported debt ERI (the judgment creditor) purportedly owed
the government, that set into motion this contest of liens.
The government possesses the same self-help right of recovery through
setoff as any other creditor. See United States v. Munsey Trust Co.,
332 U.S. 234, 239 (1947); Hilburn v. Butz, 463 F.2d 1207 (5th
Cir. 1972), cert. denied, 410 U.S. 942 (1973); Burlington
Northern Inc. v. United States, 462 F.2d 526 (Ct.Cl. 1972); Aetna
Ins. Co. v. United States [ 72-1
USTC ¶9313], 456 F.2d 773 (Ct.Cl. 1972); United States v. Cohen
[ 68-1
USTC ¶9138], 389 F.2d 689 (5th Cir. 1967). Thus, the
United States
can assert a right of setoff independent of a statutory grant of
authority. See, e.g., United States v. Tafoya, 803 F.2d 140, 141
(5th Cir. 1986).
The
United States
is one party for mutuality purposes and can setoff claims held by
different agencies. See, e.g., Cherry Cotton Mills v. United States
[ 46-1
USTC ¶9218], 327 U.S. 536 (1946); Bosarge v. U.S. Dept. of
Education [ 93-2
USTC ¶50,590], 5 F.3d 1414, 1419 (11th Cir. 1993), cert. denied,
114 S.Ct. 2720 (1994).
In addition to the government's inherent right to offset, statutes and
regulations sometimes provide for offset. See, e.g., 26 U.S.C. §6402(a)
(IRS may setoff taxpayer's overpayment of tax against tax liability for
prior years); 31 U.S.C. §3720A (federal agencies may refer past due
debt to Treasury for offset against tax overpayment pursuant to 26
U.S.C. §6402(d));
31 U.S.C. §3716(a) (
admin
istrative offset statute); 31 U.S.C. §3716(c) (Treasury disbursing
officer offset statute); 31 U.S.C. §3728 (United States can setoff
judgment against it to recover a debt plaintiff owes to the United
States); 7 C.F.R. §1951.103 (1995) (the Consolidated Farm Services
Agency can setoff debts to the United States against ongoing
Conservation Reserve Program payments); 13 C.F.R. §140.5 (1993) (SBA
offset); 41 C.F.R. §101-41.102(a)(3) (GSA can setoff amounts due to the
United States from ongoing payments to carriers); Federal Acquisition
Regulation, 48 C.F.R. §§32.611, 32.612 (1992) (United States can
setoff obligations between itself and parties contracting with the
United States). See 4 C.F.R. §102.3, as to the responsibility of
client agencies to effect collection by offset.
A federal statute or regulation, of course, may limit setoff rights of
the
United States
. See, e.g., 31 U.S.C. §3720A (federal agency referring debt to
Treasury for offset must first notify person of plan to refer the debt
and give debtor at least 60 days to present evidence that debt is not
past due or legally enforceable). Compare McCall Stock Farms, Inc. v.
United States
, 14 F.3d 1562, 1567 (Fed. Cir. 1993) ("Debt Collection Act was
intended to supplement, not displace, the government's pre-existing
offset rights under the common law"); Bosarge v. United States
[ 93-2
USTC ¶50,590], 5 F.3d 1414 (11th Cir. 1993) (Federal Debt
Collection Procedure Act, 28 U.S.C. §3001 et seq., expressly
exempts common law or statutory right to offset or recoupment, see
§3003(c), from its requirements); Cecile Indus., Inc v. Cheney,
995 F.2d 1052 (Fed. Cir. 1993) (offset of claims from different
contracts (setoff) not governed by Debt Collection Act, 31 U.S.C. §3701
et seq.); Allied Signal, Inc. v. United States, 941 F.2d
1194 (Fed. Cir. 1991) (offset of claims from the same contract
(recoupment) is not governed by the DCA); Cascade Pac. Int'l v.
United States
, 773 F.2d 287, 295-96 (Fed. Cir. 1985) (any procurement contract
subsequent to 1979 containing CDA "all-disputes" clause
reserved the common law right to offset money owed by defaulted
contractor); Amoco Prod.
Co.
v. Fry, 904 F.Supp. 3 (D. D.C. 1995) (DCA merely supplements common
law right to offset) with Allison v. Madigan, 951 F.2d 869 (8th
Cir. 1991) (
admin
istrative setoff must comply with DCA).
When a claimant obtains a final judgment against the United States and
presents it to the Treasury for payment, the Treasury may withhold such
payment to setoff a claim which the United States has against the
claimant, and such further amount as will cover the government's legal
charges and costs in pursuing the government's claim to judgment if the
claimant does not assent to a setoff. See 31 U.S.C. §3728. The
policy of the statute is that claims against the
United States
are always subject to setoff. See Ozanic v.
United States
, 188 F.2d 228, 231 (2d Cir. 1951).
Generally, courts have only disallowed otherwise valid setoff in two
categories of cases: (a) where the creditor committed an inequitable,
illegal, or fraudulent act, or the setoff is against public policy, see
In re Cascade Roads, Inc., 34 F.3d 756 (9th Cir. 1994) (IRS
setoff denied because Government's conduct was inequitable); In re
Blanton, 105 B.R. 321, 337 (Bankr. E.D. Va. 1989) and cases cited
therein, and (b) where the setoff would significantly harm or destroy
the debtor's ability to reorganize, see, e.g., In re
Lincoln
, 144 B.R. 498 (Bankr. D.
Mont.
1992) (setoff denied where payments necessary for chapter 12
reorganization); In re Cloverleaf Farmers Co-op, 114 B.R. 1010
(Bankr. D. S.D. 1990) (setoff denied because inconsistent with purpose
of chapter 12 and the rehabilitation of American farmers); In re IML
Freight, 65 B.R. 788, 792 (Bankr. D.
Utah
1986) (legislative history shows setoff only appropriately denied in
reorganization cases; not appropriate in liquidation cases); In re
Penn Cent. Transp., 315 F.Supp. 1281 (E.D. Pa. 1970) (setoff denied
because it would frustrate railroad reorganization process), aff'd,
453 F.2d 520 (3d Cir.), cert. denied, 408 U.S. 923 (1972).
In this case, mutuality requirements are met. The requirement that a
"judgment" be owed by the
United States
is met. Under 31 U.S.C. §3728(a), mandatory-like language directs that
the Comptroller General shall withhold paying that part of a
judgment against the United States Government presented to the
Comptroller General that is equal to a debt the plaintiff owes the
Government when the judgment creditor does not consent to the setoff.
Presumably the taxpayer, ERI, did not consent to the setoff in this case
and the Comptroller General withheld payment of the judgment pursuant to
31 U.S.C. §3728 until a judgment was obtained for the tax debt. The
government, in its effort to statutorily setoff under §3728, properly
sued ERI through a judicial proceeding in the District Court of Idaho on
June 3, 2004, 17 days prior to plaintiff's instant suit, to reduce ERI's
tax assessment to judgment. The judgment was entered in favor of the
government for $609,079.96 on
November 29, 2004
.
Nothing in the stipulation between ERI and the
United States
demonstrates an intent on the part of the
United States
to waive its right of offset. Moreover, plaintiff has not argued that
the
United States
has waived its rights by entering into the stipulated judgment with ERI.
Pursuant to established case law, the stipulation between ERI and the
United States
, and the contingency fee agreement between plaintiff and ERI,
plaintiff's fee interest was derivative of ERI's recovery in the Court
of Claims litigation, and therefore inferior to the government's right
of setoff. See Marre v. U.S. [ 97-2
USTC ¶50,573], 117 F.3d 297 (5 th Cir. 1997); Morgan
v.
United States
, 131 F.Supp.783 (S.D. N.Y. 1955); Brozan v. United States [ 54-2
USTC ¶9695], 128 F.Supp.895 (S.D. N.Y.1954) (cases establishing the
government's superior right to setoff).
The plaintiff and intervenors are entitled to recover nothing on the
judgment fund, for the government's setoff destroyed any recovery.
Therefore, there is nothing to which the attorneys' lien nor the
intervenors' liens could attach.
If the government had not raised statutory setoff, the intervenors
likely would have prevailed, as to a portion of the judgment fund, under
the federal priority statute. Based on equitable subrogation and the
relation back doctrine, Intervenors could recover an amount paid on
behalf of ERI 27
for the Warren Project.
Applying its equitable powers under these circumstances, the court could
have also considered the award of plaintiff law firm's reasonable fees
and costs for work on the
Warren
project, based on public policy grounds. As under the federal priority
statute, plaintiff's attorneys' lien simply was not a choate lien at the
time the federal tax liens arose.
More specifically, the amount of the attorneys' lien could not have been
established until the judgment was entered in the Court of Claims
litigation on
April 5, 2004
. Under the federal priority statute, plaintiff's lien was not superior
to the several tax liens filed on or before
March 29, 2004
. Under Idaho (local) law, it would appear that plaintiff's lien was shy
of being an enforceable lien, having not shown the reasonableness of the
fees in an adjudicative process prior to filing this lawsuit or reducing
its lien to a judgment or court order. As discussed above, the
choateness doctrine must be factored in to decide whether a right of
setoff arising based on equitable principles should be accorded priority
over a federal tax lien. Plaintiff's lien had not achieved the level of
choateness required.
Moreover, without exploration of the purpose or spirit of 26 U.S.C. §6323(b)(8),
it is the court's assessment that the exception contained within §6323(b)(8)
is applicable to the facts of this case. In other words, superpriority
does not apply with respect to judgments obtained for the taxpayer
against the government and would not appear to save plaintiff's inchoate
lien in this case.
In summary, plaintiff's rights are derived through ERI and are not
independent of that relationship. The common law and statutory right of
setoff enjoyed by the
United States
and case law does not support plaintiff's claim for payment of attorney
fees, either on a lien or quantum meruit basis. Even if the attorneys'
lien superpriority provision of federal law were applicable, plaintiff's
attorneys' lien is not choate under
Idaho
law because no final determination and judgment in plaintiff's favor had
been entered before the rights of the
United States
arose.
The court very reluctantly arrives at the conclusion stated herein and
readily acknowledges the harshness of the result. Moreover, if the
undersigned judge had discretion to apportion the judgment fund at issue
using equitable principles, he would not hesitate to do so. However,
without solid support in the statutes and case law, plaintiff's and
intervenors' claims cannot have priority.
Accordingly,
IT IS ORDERED that:
1. Intervenors' Motion for Declaratory Judgment, filed
October 19, 2004
( Ct. Rec. 20) is DENIED.
2. Plaintiff Dunn and Black, P.S.'s Motion for Summary Judgment ( Ct.
Rec. 28), filed
November 2, 2004
is DENIED.
3. Intervenors' Alternative Motion For Stay of Plaintiff's Motion For
Summary Judgment under Fed. R. Civ. P. 56(f) ( Ct. Rec. 40),
filed
November 16, 2004
is MOOT.
4. Defendant
United States
' claim of setoff in the amount of $450,000 is appropriate pursuant to
31 U.S.C. §3728.
The District Court Executive is directed to file this ORDER and provide
copies to counsel.
1
Zurich American Insurance Company "Zurich" is the sole
shareholder of American Guarantee & Liability Corporation
"AGLIC" and Fidelity & Deposit Company of Maryland
"F&D," and are collectively called intervenors.
2
ERI has been out of business for several years and did not participate
in the proceedings before the court. Apparently ERI is judgment proof
and insolvent, although no bankruptcy has been filed. Aff. of R.
Campbell, ¶13.
3
The judgment fund of $450,000 is being held by the Department of
Treasury presently.
4
SOF designates "Statement of Uncontroverted Facts."
5
The terms of the contingency fee agreement were negotiated between Dunn
& Black and the ERI president at that time, Donald Tulloch.
Id.
In an affidavit filed by Mr. Tulloch on December 28, 2004 (Ct. Rec. 54),
apparently on his own behalf, he states that he was forced to resign in
early January of 2003 and questions the reasonableness of the settlement
between ERI and the government in the Court of Claims litigation and the
authority Dunn and Black had to settle.
6
In what appears to be merely a typographical error, the
United States
incorrectly refers to the $450,000 judgment date throughout its briefing
being entered on
April 15, 2004
, rather than
April 5, 2004
. Ct. Rec. 33, page 2.
7
According to Dunn & Black, at the time the Court of Claims
litigation was filed, there were no outstanding tax liens. Plaintiffs'
SOF, ¶10. At the time of the written contingency fee agreement between
Dunn & Black and ERI (
November 20, 2002
), the taxes owed by ERI were $40,683.93, based on a tax lien assessed
on
September 2, 2002
. Id., ¶10.
8
Dunn & Black disagrees with this amount, stating that tax records
from the state of
Idaho
show a total of $480,295.93 outstanding, which includes the $40,683.93
assessed on
September 2, 2002
.
Id.
, ¶11. intervenors, however, are in agreement with the
United States
tax lien figures. Ct. Rec. 21, page 4. The court attempted to verify
these assessment dates from the Auchterlonie Decl., Ct. Rec. 57, filed
after the hearing on January 3, 2005, but was unable to do so based on
copy quality, dates cut off of the right margin and unfamiliarity with
the forms.
15
It is unknown what the amount of undisbursed contract balance otherwise
payable to ERI, if any, was at the time of the government's termination
on January 4, 2001.
16
Banaitis examined the
Oregon
statute which governed attorney's fees. Plaintiff argues that the Idaho
statute is similar to Oregon's in that it provides generous protections
to attorneys in collecting their fees.
17
Intervenors have, during the interim, filed the Supplemental Affidavit
of Ferguson which contains itemization of claims and expense payments
made on the bonds subject of this litigation. However, the actual filing
with the court did not occur until after or on the same day the
pre-hearing reply briefs for the cross motions were filed. Ct. Rec. 46,
filed on November 24, 2004.
18
It would be contrary to the federal policy of uniformity in the federal
tax laws to permit the priority of federal tax liens to be determined by
the diverse rules of various states. In re Dulaney [ 83-1
USTC ¶9201], 29 B.R.79, 81 (1982) (citations omitted).
19
Although not raised by the parties, the United States District Court for
Idaho
would also appear to have continuing jurisdiction to protect and enforce
its judgments. Central of Georgia R.R. Co. v.
United States
, 410 F.Supp. 354, 357 (D. D.C.), aff'd, 429 U.S. 968, 97
S.Ct. 474, 50 L.Ed.2d 578 (1976); accord Sheldon v. Munford, Inc.,
128 F.R.D. 663, 665 (N.D.Ind.1989) (the district court retains
jurisdiction over any issues relating to the enforcement of the
judgment).
20
The Comptroller General has given limited effect to the government's
broad common law rights of offset and has, for instance, refrained from
offsetting "the current salary payments to officers and employees
still in the Federal service." 26 Comp.Gen. 907, 908.
21
See 24 C.F.R. §17.116 Procedures for
admin
istrative offset: offset of debtor's judgment against the
United States
. Collection by offset against a judgment obtained by a debtor against
the United States will be accomplished in accordance with 31 U.S.C.
3728.
22
The Federal Offset Statute has been revised twice since its original
enactment to reflect Congress' transfer of authority over the payment of
claims from the Secretary of the Treasury to the Comptroller General, see
Budget and Accounting Act, 42 Stat. 20 (1921), 31 U.S.C. §71 (1964) and
Act of March 3, 1933, ch. 212, §13, 47 Stat. 1516, 31 U.S.C. §227
(1964), and then, back to the Secretary of the Treasury, see
Pub.L. No. 104-53, §211, 31 U.S.C. §501 note (Supp. II 1996) and 31
U.S.C. §3728 (Supp. II 1996).
23
The requirement of choateness should not be confused with the concept of
perfection. While perfection usually requires that a private creditor's
lien be filed with an appropriate state authority in order for it to
have priority over another private creditor's lien, choateness usually
requires something more --it requires that there be no contingencies
standing in the way of execution of the lien. See Security
U.S.
v. Security Trust & Sav. Bank of San Diego [ 50-2
USTC ¶9492], 340 U.S. 47, 50, 71 S.Ct. 111 (1950). In Security
Trust, an attachment lien, even though filed, was contingent upon
the outcome of an underlying suit. Id.
24
When First In Time Is Not First In Right: The Supreme Court Frustrates
Judgment Creditors in United States v. McDermott, Loyola Univ. of
Chicago Law Journal, 25 Loy. U. Chi.L.J. 405,420 (1984). By Michael
D. McCullogh.
25
Superpriority --the priority granted to state interests over all federal
liens --was extended under the FTLA to eight new areas of interests
including attorney's liens and certain insurance contracts. Section
6323(b).
26
The parties do not dispute that Idaho law is the state law (local law)
to be applied in this case.
27
There is a serious question as to whether intervenors could use the
default on one project to trigger its equitable subrogation rights to
undisbursed construction funds on other bonded projects. There is also a
question whether payments made by intervenors in the amount of
$97,876.08 for legal and engineering firm expenses and travel expenses
are considered "unconnected" with the performance of the
Warren project contract and not recoverable. Carchia v.
U.S.
, Ct.Cl.622, 630 (1973).
Merchants
Bonding Co., Plaintiff v.
Utica
Community
Schools
,
West
Bloomfield
School District
, and
United States
Internal Revenue Service, Defendants.
U.S.
District Court, East.
Dist.
Mich.
; 01-60194,
May 2, 2003
.
[ Code
Sec. 6323]
Tax liens: Validity and priority against third parties: Constructive
trust. --
A third-party
subrogee was not entitled to summary judgment with respect to its claim
of priority interest over an IRS tax lien for funds held by its
subcontractor. The funds were property of the subcontractor and were not
held in trust pursuant to a public construction contract under state (
Michigan
) law. A constructive trust had not been created to hold the funds
because the subrogee failed to show that the parties intended to
designate the funds as trust property, even though the bond identified
the payment obligation to the subrogee under the construction contract.
Finally, at the time the IRS filed its notices of tax liens, the
subrogee's alleged equitable lien had not been perfected because the
amounts in question were not certain.
[ Code
Sec. 6323]
Tax liens: Validity and priority against third parties: Indemnity
agreement: Surety's interest. --
A third-party
subrogee was not entitled to summary judgment with respect to its claim
of priority interest over an IRS tax lien for funds held by its
subcontractor. The subrogee failed to show that an indemnity agreement
with the subcontractor predated the IRS tax lien and, as a result,
established its priority over the funds. The assignment of the contract
balances under the indemnity agreement would not occur until the
subrogee became obligated to perform under its surety agreement, the
date of which had not been determined. Moreover, a genuine issue of
material fact remained concerning whether the subrogee was required
under state (
Michigan
) law to perfect its interest by recording its lien.
[ Code
Sec. 6323]
Tax liens: Validity and priority against third parties: Security
interest: Obligatory disbursement agreement. --
A third-party
subrogee was not entitled to summary judgment with respect to its claim
of priority interest over an IRS tax lien for funds held by its
subcontractor. The court rejected the subrogee's argument that its
security interest qualified as an obligatory disbursement agreement
pursuant to Code
Sec. 6323(c)(1)(B). Even though the bonds issued for the contract
qualified as security interests, the subrogee failed to show that its
security interest was protected under local law. Also, a genuine issue
of material fact remained concerning when the subrogee's rights were
triggered under the bonds, and if that date predated the IRS's tax lien.
OPINION
AND ORDER OF THE COURT DENYING PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT
I. INTRODUCTION
BATTANI, Judge: Before the Court is Plaintiff Merchants Bonding Co.'s
Motion for Summary Judgment on its complaint against Defendants United
States Internal Revenue Service ("IRS"),
West
Bloomfield
School District
("WB") and Utica Community Schools. Plaintiff and the IRS both
assert claims to the outstanding balances of two construction contracts
("contract balances" or "funds") between Smelser
Roofing Co. ("Smelser"), a contractor, and Defendant school
districts. Plaintiff claims that it is entitled to the funds since it
made payments to various subcontractors and suppliers pursuant to the
terms of its surety agreement with Smelser, while the IRS asserts the
priority of its federal tax lien on Smelser's property.
As preliminary matter, Defendant WB has been dismissed as a party to
this lawsuit, and has interpleaded into Court the amount due on its
contract with Smelser, or $91,947.56, pursuant to Fed.R.Civ.P. 67, for
disbursal to the proper party when this matter is resolved. Defendant
Utica
has filed an answer and partial concurrence in Plaintiff's motion for
summary judgment, except to the extent to which Plaintiff's motion seeks
interests, costs, expenses and attorneys fees against
Utica
.
Utica
still has in its possession the amount due on its contract with Smelser.
In its Motion for Summary Judgment, Plaintiff first argues that the
contract balances are not Smelser's "property" subject to
federal tax liens, since they have been held in trust for the benefit of
the subcontractors and suppliers who performed work on the construction
contracts. In connection with that argument, Plaintiff also asserts that
its rights have been equitably subrogated to the rights of these
subcontractors and suppliers, and therefore, that it can assert any
claim to the trust corpus that they may have had. Second, Plaintiff
argues that it received a superior interest in the funds pursuant to the
Indemnity Agreement it entered into with Smelser, and that this interest
became effective prior to the IRS' tax lien. Finally, Plaintiff asserts
that 26 U.S.C. §6323(c)
grants Plaintiff a lien superior to several of the liens held by the
IRS.
In response, Defendant IRS argues that the Sixth Circuit's opinion in In
re Constr. Alternatives, Inc. [ 93-2
USTC ¶50,569], 2 F.3d 670 (6th Cir. 1993) controls the Court's
analysis here. In reliance upon this case, the IRS maintains that the
contract balances are "property" subject to the tax lien,
since Smelser completed the construction projects, and earned the right
to final payment from Defendant school districts. Second, Defendant
argues that no trust was created for the benefit of unpaid claimants
because the Indemnity Agreement and Payment Bonds do not reflect the
parties' intent to reserve a specific portion of the funds in trust for
the benefit of any ascertained beneficiaries, Third, Defendant contends
that Plaintiff's rights were not subrogated to the rights of the
subcontractors and suppliers because at the time the IRS filed its tax
liens, the amounts owed to those suppliers and subcontractors had not
been determined to any meaningful degree of certainty. Fourth, Defendant
contests Plaintiff's assertion that it had a "security
interest" in the funds, but argues, that even if it did, it did not
"perfect" that interest by filing a financing statement with
the Michigan Secretary of State. Therefore, because the IRS did
"perfect" its lien by filing notices of tax liens, its
interest takes priority over that of Plaintiff. For these same reasons,
Defendant maintains that Plaintiff's argument under §6323(c)
also fails.
II. STANDARD OF REVIEW
F.R.C.P. 56 states that summary judgment "shall be rendered
forthwith if the pleadings, [ etc.,] show that there is no
genuine issue as to any material fact and that the moving party is
entitled to a judgment as a matter of law." Fed.R.Civ.P. 56. There
is no genuine issue of material fact if there is no factual dispute that
could affect the legal outcome on the issue. Anderson v. Liberty
Lobby, Inc., 477
U.S.
242, 248-49 (1986). In other words, the movant must show that it would
prevail on the issue even if all factual disputes are conceded to the
non-movant. Additionally, for the purposes of deciding on a motion for
summary judgment, a court must draw all inferences from those facts in
the light most favorable to the non-movant. Matsushita Elec. Indus.
Co. v. Zenith Radio Corp., 475
U.S.
574, 587 (1986).
Accordingly, in the instant case, the Court evaluates this motion with
the rule that it should defer to Defendant's factual account whenever
that account clashes with Judgment, Plaintiff asserts three separate
grounds for its claim to the funds, and each will be discussed
accordingly.
1.
Equitable Subrogation and the Trust Theory
Plaintiff begins its argument by claiming its status as an equitable
subrogee. Equitable subrogation is a "legal fiction through which a
person who pays a debt for which another is primarily responsible is
substituted or subrogated to all the rights and remedies of the
other." Commercial Union Ins. Co. v. Med. Protective Co.,
426
Mich.
109, 117 (1986). Merchants, having paid the claim of its principal,
asserts that it is subrogated to the rights of the principal, the
claimant receiving the payment, and the owner's right to withhold
contract balances. The Court agrees that Plaintiff is, by a fiction of
law, subrogated to whatever rights the claimant, principal, or owner may
have in the contract balances, Pearlman v. Reliance Ins. Co., 371
U.S. 132 (1962).
Plainitff seeks here to enforce its claim to the contract balances owed
by WB and
Utica
as the subrogee of the Claimants. Those funds, according to Plaintiff,
were the trust corpus held for the benefit of the unpaid subcontractors
and suppliers --the Claimants. As trust fund money, Smelser did not have
a property interest in it. Therefore, the IRS could not attach its lien.
In response, Defendant IRS asserts two grounds for its argument that
Smelser had a property interest in the funds. First, the IRS argues
that, according to Construction Alternatives, once a contractor
completes work on a construction contract, as Smelser did here, it earns
the right to receive payment. It is that right to receive payment that
constitutes a property interest to which a tax lien may legally attach. Constr.
Alternatives [ 93-2
USTC ¶50,569], 2 F.3d at 674-65. Second, the IRS asserts that the
contract balances are not a separate trust fund, because the parties did
not create such a trust for the benefit of any subcontractors or
suppliers. In light of this, then, the IRS maintains that Plaintiff was
not a subrogee of the rights of the so-called "trustees."
Finally, the IRS argues that, in any event, a state law subrogation
claim does not become perfected until the amounts owed to the claimants
are determined with certainty. Here, the amounts owed to the claimants
were uncertain at the time the IRS filed its federal tax liens, and, so,
the claims were not perfected.
In determining whether or not Smelser had an interest in the funds, the
Court's analysis is twofold. Setting aside Plaintiff's "trust"
argument for the moment, the Court must first decide whether Smelser
acquired an interest in the funds when it completed its work on the WB
and
Utica
projects. The Court finds that it did. Construction Alternatives
holds that once a contractor completes work on a construction contract,
its "right to receive its final progress payment ..." is
deemed "property" under §6321,
and can be subject to a federal tax lien.
Id.
Here, then, since the parties agree that Smelser completed its work on
the WB and
Utica
construction projects, its right to receive final payment from the
school districts is property that can be subject to the IRS tax lien.
This does not end the Court's inquiry, however, for it must now decide
whether the contract balances were held in trust for the benefit of
unpaid subcontractors and suppliers, leaving Smelser with no property
interest in the funds. To prove that the funds at issue here were held
in trust, Plaintiff must show either that: "1) [state] law provides
that a portion of the progress payments were subject to a constructive
trust for the benefit of unpaid suppliers and subcontractors 1
; or, 2) the suretyship agreement created an express trust with the Fund
as the trust corpus." Constr. Alternatives [ 93-2
USTC ¶50,569], 2 F.3d at 677.
First, when a public construction contract is involved, as is the case
here, Michigan law does not provide that a portion of an owner's
payments are to be held in trust for the benefit of unpaid suppliers and
subcontractors. The
Michigan
Building
Contract Fund Act,
Mich.
Comp. L. 570.151 et. seq.,("MBCFA"), cited by Plaintiff,
applies only to private construction contracts, and provides
that, when such contracts are involved, balances paid to a contractor
are to be held in trust for the benefit of subcontractors and suppliers.
See In re Certified Question from U.S. Dist. Court for Eastern Dist.
of Michigan, 311 N.W.2d 731, 733 (
Mich.
1981) (holding "the [MBCFA] applies only to private construction
contracts.") Here, however, the contracts were public, not private;
therefore, the MBCFA does not apply.
Since the MBFCA does not apply to create a constructive trust, the Court
must look to the agreements. Plaintiff argues that Smelser, WB and
Utica
created a trust, with the contract balances serving as the trust corpus.
To determine whether a trust was created, the Court looks to state law. Constr.
Alternatives [ 93-2
USTC ¶50,569], 2 F.3d at 675. In
Michigan
, "it is a general principle of trust law that a trust is created
only if the settlor manifests an intention to create a trust, and it is
essential that there be an explicit declaration of trust accompanied by
a transfer of property to one for the benefit of another." Osius
v. Dingell, 134 N.W.2d 657, 660 (
Mich.
1965). Further, "[t]o create a trust, there must be an assignment
of designated property to a trustee with the intention of passing title
thereto, to hold for the benefit of others. There must be a separation
of the legal estate from the beneficial enjoyments..." In re
Americana Found., 387 N.W.2d 586, 588 (Mich. App. 1985) (quotation
omitted).
Here, Plaintiff argues that the language of the payment bonds issued for
the WB and
Utica
projects created an express trust for the benefit of subcontractors and
suppliers. Specifically, Plaintiff notes that paragraph 8 of the payment
bonds states as follows:
[a]mounts owed
by the owners to the contractor under the construction contract shall be
used for the performance of the construction contract and to satisfy
claims, in any, under any construction performance bond. By the
contractor furnishing and the owner accepting this bond, they agree
that all funds earned by the contractor in the performance of the
construction contract are dedicated to satisfy obligations of the
contractor and the surety under this bond ..." (emphasis added)
Clearly, the bond at issue here identified Smelser's payment obligations
with respect to the monies received from WB and
Utica
under the construction contracts. However, this language, by itself,
does not establish that Smelser, WB and
Utica
created a trust in favor of the subcontractors and suppliers.
Rather, as discussed above, to establish that a trust existed, Plaintiff
must show that the parties involved intended to create a trust, and that
they designated certain funds as trust property. Osius, 134
N.W.2d at 660; In re
Americana
Found., 387 N.W.2d at 588. The Court finds that this is not
established here.
To begin, it is arguable that the use of the word "dedicated"
in the payment bond signifies an intention or declaration on the part of
Smelser, WB and
Utica
to create a trust for the benefit of the subcontractors and suppliers.
Nevertheless, regardless of whether this language manifested such
intent, Plaintiff's argument fails because none of the parties involved
delivered any funds into trust in accordance with
Michigan
law. That is, the facts do not establish that the parties involved
intended to set aside a certain portion of the funds "in
trust" for the subcontractors or suppliers, and, in fact, at no
time did Smelser create a separate trust account for the contract
balances. The mere fact that Smelser earned the right to receive payment
for the school projects by completing its construction work does not, by
itself, make the money owed by WB and
Utica
trust property.
The Court's analysis is guided, in part, by Construction Alternatives,
where the Sixth Circuit held that the language of an Indemnity Agreement
between a surety and a contractor did not create a trust under Ohio Law.
There, the Indemnity Agreement stated that "all monies due .. are
trust funds, for the benefit of and for payment of all such obligations
in connection with any such contract ... for which the Surety would be
liable under any of the ... bonds..." Constr. Alternatives [
93-2
USTC ¶50,569], 2 F.3d at 676, n. 4. The
Ohio
law applied by the Sixth Circuit was very similar to
Michigan
law, and provided that "the manifested intention" of the
parties governed whether or not the parties had created a trust.
In deciding whether a trust had been created in Construction
Alternatives, the Sixth Circuit examined whether the parties
intended that the money be kept or used as a separate fund for the
benefit of third persons.
Id.
at 677 (quoting Guardian Trust Co. v. Kirby, 50 Ohio App. 539
(1935)). Ultimately, the Court concluded that despite the actual
"trust" language contained in the Indemnity Agreement, no
trust was created, because "no provision of [the indemnity
agreement] required [the contractor] to keep any portion of the progress
payments as a separate trust fund, and the record does not indicate that
[the contractor] kept the progress payments in a separate account."
Id.
at 677. Similarly, here, because the language of the payment bond did
not require Semlser to set aside a portion of the payments in a separate
trust fund, no trust was created.
In light of this, Plaintiff's subrogation claim to a trust fund fails.
This does not mean, however, that Plaintiff is not an equitable
subrogee, for, as noted above, in paying Smelser's claims, Plaintiff
became subrogated to whatever rights those claimants had in the contract
balances, Pearlman v. Reliance Ins. Co., 371 U.S. 132 (1962).
Consequently, as an equitable subrogee, Plaintiff must establish that
its right to the funds takes priority over the IRS's tax lien.
Federal liens do not "automatically have priority over all other
liens." Constr. Alternatives [ 93-2
USTC ¶50,569], 2 F.3d at 676 (quotations omitted). Rather, they are
subject to the "first in time, first in right" rule.
Id.
For purposes of this rule, a federal tax lien is perfected at the time
the notice of the lien is filed, Constr. Alternatives [ 93-2
USTC ¶50,569], 2 F.3d at 676 (citations omitted), while a state
lien is perfected only "when the identity of the lienor, the
property subject to the lien, and the amount of the lien are
established."
United States
v. Dishman Indep. Oil Co. [ 99-2
USTC ¶50,992], 46 F.3d 523, 526 (6th Cir. 1995) (quoting United
States v. McDermott [ 93-1
USTC ¶50,164], 507 U.S. 447, 449 (1993)). In the context of
equitable subrogation, the Sixth Circuit held in Construction
Alternatives that a surety's alleged equitable lien did not have
priority because "[t]he amounts owed to the unpaid persons on the
project were not yet certain" at the time the tax liens were filed.
Constr. Alternatives [ 93-2
USTC ¶50,569], 2 F.3d at 676.
Here, the IRS filed its notices of tax lien on
August 30, 2000
,
January 2, 2001
,
May 21, 2001
and
June 27, 2001
. Plaintiff, however, has not established that its alleged equitable
lien was perfected as of those dates, because it has not shown that the
amounts owed to the unpaid subcontractors and suppliers were certain at
that time. In fact, the record does not contain any evidence as to the
dates and amounts of Plaintiff's payments, or to whom those payments
were made. As such, the Court finds that as an equitable subrogee,
Plaintiff has not established the priority of its lien, because there is
a genuine issue of material fact with respect to the payments Plaintiff
made under its bond agreement with Smelser.
2.
Indemnity Agreement Theory
Plaintiff next argues that the Indemnity Agreement it entered into with
Smelser gave it a superior interest in the contract balances. In
particular, Plaintiff points to the language of the Agreement in which
Smelser agreed to assign and transfer its rights in the monies owed by
WB and
Utica
to Plaintiff as "collateral security" for performance of the
bond contract. According to Plaintiff, that assignment became effective
as of the date of execution of any bond, or
September 1, 1998
. And, since this preceded the dates upon which the IRS filed its notice
of tax lien, Plaintiff contends that it's interest takes priority over
the IRS lien.
In making this argument, Plaintiff acknowledges that, in most
circumstances, parties are required by Article 9 of Michigan's Uniform
Commercial Code to perfect their interests by filing financing
statements with the Michigan Secretary of State. However, in reliance
upon In Re V. Pangori Sons, Inc., 53 B.R. 711, 717 (Bankr. E.D.
Mich. 1985), Plaintiff asserts that, in
Michigan
, Article 9 does not apply to indemnity agreements. In particular,
Plaintiff relies on the language in Pangori that states that a
surety may assert "its rights deriving from the agreement of
indemnity because even though it did not take the steps necessary to
perfect an Article 9 security interest, it did not need to do so."
Id.
This is so because "the assignment does not create a security
interest" in the contract balances.
Id.
Therefore, Plaintiff maintains that it did not have to perfect its
interest with the Secretary of State.
In response, the IRS counters that Plaintiff's claim to the funds is not
superior to the IRS lien because Plaintiff was, in fact, required to
perfect its interest by filing with the Secretary of State. In so
arguing, Defendant asserts that Pangori, a 1985 bankruptcy case,
was called into doubt by the Sixth Circuit's 1993 holding in Construction
Alternatives, where an Ohio U.C.C. provision, identical to the
Michigan statute relied upon by the Pangori court, was
interpreted to require a bond company to perfect its interest by filing
a financing statement with the Secretary of State. The IRS now asks this
Court to extend the Sixth Circuit's holding to
Michigan
, and hold that, here, Plaintiff was required to file its Indemnity
Agreement with the Secretary of State.
Defendant's argument is quite compelling. For, as Defendant points out,
the relevant portion of the Michigan statute at issue in Pangori
is precisely the same as the Ohio statute analyzed in Construction
Alternatives. Both provisions provide that the UCC does not apply to
"a transfer of a right to payment under a contract to an assignee
who is also to do the performance under the contract...." Ohio Rev.
Code Ann. §1309.04;
Mich.
Comp. Laws §19.9104. Thus, one could reasonably argue, as the IRS does
here, that the Sixth Circuit's interpretation and application of the
Ohio
statute should carry over to
Michigan
to require Plaintiff to file its Indemnity Agreement with the Secretary
of State.
The Court, however, declines to apply the holding in Construction
Alternatives to
Michigan
. The Sixth Circuit did not have the opportunity to consider the issues
raised in Pangori, even though it may have been applying similar
law. It simply held in one cursory sentence that a financing statement
would have to be filed. Pangori, on the other hand, contained a
more detailed analysis of Article 9 and its relationship to indemnity
agreements. See Pangori, 53 B.R. at 717. Therefore, the
Court will not disturb the Pangori decision, and what may have
been the
Michigan
practice since 1985, unless it is clearly required to do so.
The Court's analysis does not end here, because it is still necessary to
determine when Plaintiff's interest in the funds became effective.
According to Plaintiff, the express language of the Indemnity Agreement
provided that Smelser's assignment of the contract balances became
immediately effective as of the date of any bond, or
September 1, 1998
, when the Fringe Benefit Bond was executed. In making this argument,
Plaintiff relies on two Michigan cases, Pangori, discussed above,
and Early Dubey & Sons v. Macomb Contracting, 97 Mich. App.
553 (1980). According to Plaintiff, the indemnity agreements at issue in
those cases granted the plaintiffs assignment rights in construction
funds. Unlike the Indemnity Agreement at issue here, however, those
agreements provided that the operative date upon which the plaintiffs'
assignment rights became effective was the date of the contractor's
default. Here, according to Plaintiff, the Indemnity Agreement provided
a different operative date, namely the date of the execution of any
bond. Therefore, Plaintiff concludes that because the IRS did not have a
lien on Smelser's property as of
September 1, 1998
, when the Fringe Benefit Bond was executed, the IRS does not have a
superior claim to the funds.
The Court duly notes Plaintiff's argument, but finds that neither Pangori
nor Dubey stand for the proposition advanced by Plaintiff that
the language of the Indemnity Agreement governs the date upon which a
surety's assignment rights become effective. First, in Pangori,
the indemnity agreement contained language similar to the Indemnity
Agreement here; in particular, it stated that the assignment was to
"be effective as of the date of [a] bond or bonds..."
Id.
at 716. However, unlike the Indemnity Agreement in this case, the Pangori
agreement contained additional language indicating that the surety's
assignment rights did not become effective until "the event of
default..."
Id.
Ultimately, the surety's claim was held to be inferior to the judgment
lien creditor's competing claim, and the court did hold, as Plaintiff
asserts, that the relevant date for analyzing the priority of the
surety's claim was the date of the contractor's default.
Contrary to Plaintiff's assertion, however, the Pangori court did
not seem to rest its decision on the language contained in the indemnity
agreement. Rather, the court looked to
Michigan
law, which essentially dictated that a surety's claim did not become
effective until the surety became obligated to pay under its bond
agreement with the contractor. Specifically, the Pangori court
held that:
Michigan
law holds that a lien of a judicial lien creditor which attaches before
a surety becomes obligated to perform under its bond is prior in right
to the surety's claim. Thus, the rights of subrogation and
indemnification are not permitted to relate back to the date of the
initial suretyship agreement when a judicial lien intervenes.
Accordingly, because [the surety's] claim to the proceeds by virtue of
its contractual indemnity agreement is inferior to the rights of the
[bankruptcy] trustee, it may thus be avoided.
Pangori, 53 B.R. at 721.
Similarly, in Dubey, the Michigan Court of Appeals found that the
operative date upon which the surety's assignment rights became
effective was the date of the contractor's default. Unlike Pangori,
however, the Dubey court relied more heavily upon the language of
the indemnity agreement, which also provided that the surety's
assignment rights would "be effective as of the date of any such
bond, but only in the event of a default..." Specifically, the Dubey
court noted that "it is ... clear from the contractual language
that default, requiring completion of the project at [the surety's]
expense, triggers [the surety's] right to claim, by assignment, [the
contractor's] rights to the [construction] funds..." Dubey,
97
Mich.
App. at 558. Thus, according to Dubey, the surety's assignment
rights were triggered as of the date of the contractor's default, and
those rights related back to the date of execution of any payment and
performance bonds.
Id.
at 559.
A careful review of the Dubey opinion reveals that, when
rendering its decision, the Michigan Court of Appeals did not rely
entirely on the language of the indemnity agreement, but rather, paid
considerable attention to the same
Michigan
law that governed the court in the Pangori decision. In
particular, the court noted that:
[a] number of
cases ... impel the conclusion that [defendant surety], as performance
bond surety, had no contractual rights to the funds ... because as of
the date of plaintiff's writ of garnishment, [the surety] was not
obligated to perform under its surety contract. [I]f in fact, [the
surety] had become so obligated, then either under the terms of its
indemnification agreement with [the contractor] or under equitable
subrogation principles its rights would be superior to plaintiffs'.
Of particular importance to the Michigan Court of Appeals was the
overarching principle that "[i]n order for a surety to prevail over
competing creditors it is necessary that the contractor be in default as
a matter of fact, and that the surety be obligated under its bond to
perform..."
Id.
at 559-60.
Therefore, what appears to have guided the courts in Dubey and Pangori
was not the language contained in the indemnity agreements itself, but
rather, the well-founded principle that a surety's assignment rights are
triggered upon the contractor's default. In fact, this is quite
understandable given that a surety does not need to enforce its
assignment rights unless and until it is obligated to perform under its
agreement with the contractor; i.e., when the contractor defaults
on its own payment responsibilities.
Here, the Indemnity Agreement stated that Smelser assigned the right to
the contract balances to Plaintiff "as of the date of execution of
any Bond..." The Court disagrees with Plaintiff's assertion that,
for purposes of assessing priority, its claim to those funds became
effective as of
September 1, 1998
, or the date it issued the Fringe Benefit Bond. Rather, in light of the
rule of law stated in both Dubey and Pangori, Plaintiff's
assignment rights were triggered when it became obligated to perform
under its surety agreement. This is so despite the fact that the
Indemnity Agreement did not contain any specific "default"
language. For, the Court notes while not explicitly stated, it was
implicit in the Indemnity Agreement that Smelser's assignment of the
contract balances would occur only when Smelser defaulted. Therefore,
the Court finds that Plaintiff's claim to the funds was not effective as
of the date Plaintiff executed the Fringe Benefit Bond, but rather, as
of date of Smelser's default. Since the facts are unclear as to when
this occurred, the Court finds that Summary Judgment in Plaintiff's
favor is inappropriate at this time.
3.
Statutory Theory
Lastly, Plaintiff argues that in the event that the Court finds that
Plaintiff is not entitled to all of the funds at issue here, it should
still receive a portion of the contract balances pursuant to 26 U.S.C. §6323(c).
This provision provides, in pertinent part, as follows:
(1) In
General. To the extent provided in this subsection, even though notice
of a lien imposed by §6321
has been filed, such lien shall not be valid with respect to a security
interest which came into existence after tax lien filing but which --
(A) Is in
qualified property covered by the terms of a written agreement entered
into before tax lien filing and constituting --
...
(iii) an
Obligatory Disbursement Agreement, and
(B) is
protected under local law against a judgment lien arising, as of the
time of tax lien filing, out of an unsecured obligation.
According to Plaintiff, the fringe benefit bond issued on
September 1, 1998
, and subsequent payment bonds issued in November and December, 2000,
qualified as security interests within the meaning of the statute in
that they were "obligatory disbursement agreements."
Furthermore, with respect to 26 U.S.C. §6323(c)(1)(B),
Plaintiff argues that "a surety's right of equitable subrogation
defeats a judgment lien, and therefore satisfies the second prong of the
... statute." Thus, according to Plaintiff, it should be
reimbursed, at the very least, for the amounts it paid on those bonds,
or approximately $177,000.
In response, Defendant argues that Plaintiff did not have a
"security interest" within the meaning of the statute, and
therefore, cannot assert priority based on §6323(c).
In particular, Defendant argues that the contract between Plaintiff and
Smelser was not an "obligatory disbursement agreement," and
more importantly, that Plaintiff's interest was not protected under
local law, since Plaintiff did not file its Indemnity Agreement with the
Secretary of State.
First, an "obligatory disbursement agreement" is "an
agreement (entered into by a person in the course of his trade or
business) to make disbursements, but such an agreement shall be treated
as coming within the term only to the extent of disbursements which are
required to be made by reason of the intervention of the rights of a
person other than the taxpayer." 26 U.S.C. §6323(c)(4)(A).
According to Amwest Sur. Ins. Co. v. United States [ 94-2
USTC ¶50,558], 870 F.Supp. 432, 434 (D. Conn. 1994), a surety bond
constitutes an obligatory disbursement agreement within the meaning of
the statute. Therefore, the Court agrees with Plaintiff that the bonds
issued for the construction contracts are covered by the first prong of §6323(c).
With respect to the second prong, the Court finds that Plaintiff has
failed to establish that its security interest was "protected under
local law" as required by §6323(c)(1)(B).
However, in so holding, the Court does not endorse Defendant's assertion
that, in order to protect its interest under local law, Plaintiff was
required to file its Indemnity Agreement with the Secretary of State.
For the reasons discussed above, Plaintiff was not subject to the filing
requirements of Article 9. Pangori, 53 B.R. at 717.
Plaintiff argues that it's interest was "protected under local
law" because it became equitably subrogated to the rights of
potential unpaid claimants on the dates it issued the bonds for the
school projects. In so arguing, Plaintiff relies on Amwest, which
provides that "[i]f the conditions of [ §6323(c)]
are met, a surety's interest in contract proceeds pursuant to a bond
executed before a tax lien is filed, will prevail over the lien even if
the surety payments are made after liens are filed." Amwest
[ 94-2
USTC ¶50,558], 870 F.Supp. at 434 (citations omitted). Accordingly,
Plaintiff argues that regardless of when it was actually called upon to
make surety payments on its bonds, its claim to the funds is superior to
Defendant's because it executed some of those bonds prior to the IRS
liens.
The Court agrees with Plaintiff that in Amwest the court held
that the surety's interest accrued on the date it executed the bond, not
the date upon which it paid the contractor's outstanding debts to the
unpaid subcontractors and suppliers. With that said, however, the Court
notes that the Amwest decision is based on
Connecticut
, not
Michigan
, law, and therefore, does not control this Court's analysis.
Notably, in Amwest, the court's decision was based on
Connecticut
's endorsement of the relation back doctrine, which dictates that a
surety's equitable subrogation rights relate back to the date of the
bond. Amwest [ 94-2
USTC ¶50,558], 870 F.Supp. at 435. 2
Michigan
, however, has not adopted the relation back doctrine as it relates to a
surety's equitable subrogation rights. Rather, in
Michigan
, "the right to subrogation accrues upon payment of the debt."
Dubey, 296 N.W.2d at 585. Therefore, "[i]n order for the surety to
prevail over competing creditors it is necessary that the contractor be
in default as a matter of fact, and that the surety be obligated under
its bond to perform..."
Id.
In Pangori, which Plaintiff relied on in the previous issue, the
Court, when analyzing the surety's equitable subrogation claim, applied
the Michigan Court of Appeals' holding in Dubey and found that
"[i]n Michigan, as long as the surety's liability is contingent and
has not become an actual obligation triggered by its principal's
default, its equitable rights may be subordinated to an intervening
judicial lien creditor." Pangori, 53 B.R. at 719. Therefore,
the Pangori court held, "[t]he court's conclusion in Dubey
may be summarized as stating that two elements were necessary for the
surety to prevail: first, it must show that there was an actual default
prior to garnishment; second, it must show that it actually became
obligated to pay."
Id.
at 719-20 (citing Dubey, 97
Mich.
App. at 559-60).
Clearly, then, Michigan law differs from that of Connecticut with
respect to a surety's right of equitable subrogation and the relation
back doctrine. In
Michigan
, the relation back doctrine does not apply in the context of equitable
subrogation to make the effective date of a surety's interest, for
priority purposes, the date upon which it issued its bond. Rather, an
equitable subrogee's rights are triggered when it actually becomes
obligated to pay on the bonds; i.e., when the principal defaults.
The opposite is true in
Connecticut
. Amwest [ 94-2
USTC ¶50,558], 870 F.Supp. at 435.
Here, as the Court is bound by
Michigan
law, it must follow the holdings set forth in Dubey and Pangori.
As such, the Court finds that Plaintiff's equitable subrogation rights
did not accrue until it was obligated to perform under its bond
agreement with Smelser. The Court cannot determine when this actually
occurred, however, since the details of Plaintiff's payments under the
bonds are unknown. Accordingly, since there is a genuine issue of
material fact with respect to these issues, the Court must deny
Plaintiff's Motion for Summary Judgment.
V. CONCLUSION
Therefore, for the reasons stated above, Plaintiff's Motion for Summary
Judgment is hereby DENIED.
IT IS SO ORDERED.
1
Construction Alternatives involved the application of
Ohio
law, which Plaintiff claims renders it inapplicable to the facts at
hand. The Court disagrees with Plaintiff, and finds that the Sixth
Circuit's analysis in Construction Alternatives is applicable so
long as appropriate allowances are made for Michigan law.
2
After the court issued its ruling in Amwest, the
United States
moved for reconsideration, [ 95-2
USTC ¶50,340], 1995 WL 452992, No. Civ. 3:92CV221 (D.Conn.
May 10, 1995
), arguing that the court improperly relied upon several cases that had
been repudiated by the Eighth Circuit's holding in Int'l Fid. Ins.
Co. v. U.S. [ 92-1
USTC ¶50,004], 949 F.2d 1042 (8th Cir. 1991). Notably, the Eight
Circuit in Int'l Fid. Ins. Co. rejected the relation back
doctrine, and held that a surety's equitable subrogation claim to a
contractor's progress payments did not accrue on the date the bonds were
issued.
Id.
at 1046. Upon reconsideration, however, the Amwest court adhered
to its original ruling, noting that Int'l Fid. Ins. Co. was based
on
Missouri
, not
Connecticut
, law.
Bednarowski
and Michaels Development, LLC, and Citizens Bank, Plaintiffs v. John C.
Wallace, et al, Defendants.
U.S.
District Court, East.
Dist.
Mich.
; 2002-60181,
June 16, 2003
.
[ Code
Secs. 6321 and 6323]
Validity and priority against third parties: Priority of tax liens:
Subrogation: Tax liens, property subject to: After-acquired property:
Property transferred to third party. --
An IRS tax
lien had priority over a purchase money mortgage by a third-party
corporation because subrogation was not available when the purchase of
the property was voluntary. The corporation purchased real property from
a married couple who had executed a mortgage on the property by
executing another mortgage to pay off the first. After the couple had
executed their mortgage, and before the corporation executed theirs, the
IRS made a tax assessment against the couple and a tax lien was recorded
on the property. The corporation's contention that it became subrogated
to the priority position of the first mortgage was rejected. Equitable
subrogation is only available when the parties paying off the
obligations are not doing so freely but, rather, pursuant to preexisting
agreements, such as insurance or guaranty contracts. Moreover, purchase
money mortgages only have priority when the mortgagor is the taxpayer
because the property is owned to a certain extent before the tax lien
attaches.
OPINION
AND ORDER OF THE COURT GRANTING DEFENDANT USA'S MOTION FOR SUMMARY
JUDGMENT AND DENYING PLAINTIFFS' MOTION FOR SUMMARY JUDGMENT
I. INTRODUCTION
BATTANI, District Judge: Before the Court are Plaintiffs' and Defendant
United States of
America
's Cross-Motions for Summary Judgment. Plaintiffs Bednarowski &
Michaels Development (hereinafter "Bednarowski") and Citizens
Bank seek to quiet title to a parcel of real property in
Shelby
Township
(hereinafter "the Property"), and argue in this motion that
they should be awarded that title as a matter of law. Specifically,
Plaintiffs assert that Bednarowski's title (in which Citizens Bank has a
mortgage interest) is unencumbered by the
USA
's tax lien on the Property because it gained the priority of a
preexisting mortgage on the Property. The
USA
responds in its cross-motion that Bednarowski's title is junior to the
government's tax lien, so that the
USA
has title to the Property. The Court agrees with the
USA
that Plaintiffs' interests in the Property is encumbered by the tax
lien. The Court also agrees with Defendant that the tax lien has
priority over Citizens Bank's mortgage despite the fact that Citizens
Bank's mortgage is a purchase money mortgage.
II. STANDARD OF REVIEW
F.R.C.P. 56 states that summary judgment "shall be rendered
forthwith if the pleadings, [ etc.,] show that there is no
genuine issue as to any material fact and that the moving party is
entitled to a judgment as a matter of law." Fed. R. Civ. P. 56.
There is no genuine issue of material fact if there is no factual
dispute that could affect the legal outcome on the issue. Anderson v.
Liberty Lobby, Inc., 477
U.S.
242, 248-49 (1986). In other words, the movant must show that it would
prevail on the issue even if all factual disputes are conceded to the
non-movant. Additionally, for the purposes of deciding on a motion for
summary judgment, a court must draw all inferences from those facts in
the light most favorable to the non-movant. Matsushita Elec. Indus.
Co. v. Zenith Radio Corp., 475
U.S.
574, 587 (1986).
III. BACKGROUND
In January 1995, Defendants John and Dawn Wallace purchased the Property
for $40,000. In 1999, the Wallaces executed a mortgage in favor of
Michigan National Bank to secure loans, including a $150,000 line of
credit. In January 2001, the IRS made a tax assessment against the
Wallaces, and a tax lien was recorded on the Wallaces' property on
April 12, 2001
. Meanwhile, the Wallaces decided to sell a portion of the Property to
Bednarowski, who, in turn, sought Citizens Bank's help in financing the
purchase. Citizens Bank agreed to receive a mortgage on the condition
that Bednarowski find a way to discharge the 1999 mortgage. These terms
were memorialized in a Purchase Agreement signed on
October 29, 2001
, and accepted on
October 31, 2001
. Accordingly, in November 2001, Bednarowski finalized the agreement
with Standard Federal Bank, the successor by merger to Michigan National
Bank, to pay off the 1999 mortgage with a $238,992.76 payment. Shortly
thereafter, the Wallaces sold about 2/3 of the Property to Bednarowski,
who executed a mortgage on the Property in favor of Citizens Bank for a
$288,000 loan. The
USA
claims title to the Property by virtue of its tax lien, which predated
the sale to Bednarowski. Plaintiffs contend that although they acquired
their interest in the Property after the
USA
had acquired its tax lien, they can assume the priority of the 1999
mortgage to gain precedence over the
USA
's title. The instant cross-motions ask the Court to quiet title with
respect to the claims made by Plaintiffs and the
USA
.
IV. DISCUSSION
A.
Plaintiffs do not have priority through equitable subrogation because
Bednarowski was a volunteer when it bought the Property
Plaintiffs acknowledge that their purchase of the Property post-dated
the federal tax lien, but argue that they are subrogated to rights of
Standard Federal Bank/Michigan National Bank, and that their interest is
therefore prior to the tax lien. Plaintiffs observe that under the
Internal Revenue Code, the Court must look to
Michigan
law to determine whether subrogation applies here. Plaintiffs contend
that, under
Michigan
law, they were subrogated to the first mortgage-holder's rights when
they paid off the first mortgage. Under the Internal Revenue Code, a
federal tax lien "shall not be valid as against any purchaser,
holder of a security interest, mechanic's lienor, or judgment lien
creditor until notice thereof ... has been filed by the Secretary."
26 U.S.C. §6323(a).
Thus, "priority of the federal tax lien provided by 26 U.S.C. §6321
as against liens created under state law is governed by the common-law
rule --the first in time is the first in right." United States
v. Pioneer Am. Ins. Co. [ 63-2
USTC ¶9532], 374 U.S. 84, 87 (1963).
There is an important qualification, however, to the first-in-time rule:
"Where, under local law, one person is subrogated to the rights of
another with respect to a lien or interest, such person shall be
subrogated to such rights for purposes of any lien imposed by section
6321." 26 U.S.C. §6323(i)(2).
The Court must therefore look to
Michigan
law to determine whether Plaintiffs' interests are subrogated to the
holder of the 1999 mortgage.
Equitable
subrogation is a legal fiction which permits a party who satisfies
another's obligation to recover from the party `primarily liable' for
the extinguished obligation... The doctrine rests on the equitable
principle that one who, in order to protect a security held by him, is
compelled to pay a debt for which another is primarily liable, is
entitled to be substituted in the place of and to be vested with the
rights of the person to whom such payment is made, without agreement to
that effect.
In re Air Crash Disaster, 86 F.3d 498, 549 (6th Cir. 1996)
(internal citations omitted).
The
USA
asserts that Plaintiffs cannot claim subrogation because they paid off
the mortgage voluntarily. A key requirement for equitable subrogation is
that the party seeking subrogation was "compelled" to pay the
debt in question; in other words, that the party was not a volunteer.
Id.
;
Hartford
Accident & Indem. Co. v. Used Car Factory, Inc., 461
Mich.
210, 215 (internal citations omitted). The
USA
insists that Plaintiffs paid off the 1999 mortgage voluntarily because
the purchase of the Property was a voluntary transaction, so subrogation
is not available to prioritize Plaintiffs' interest over the tax lien.
There is no dispute that Bednarowski paid off the Wallace's 1999
mortgage held by Standard Federal Bank/Michigan National Bank. The only
question, therefore, is whether Bednarowski was somehow
"compelled" to make the payment, or whether it was a volunteer
and therefore ineligible to claim subrogation. Bednarowski claims that
it was not a volunteer because paying off the 1999 mortgage was a
condition precedent to obtaining a new mortgage from Citizens Bank. This
argument, however, does not comport with the examples of entities that
have been "compelled to pay a debt" and were therefore
eligible for subrogation. Air Crash, 86 F.3d at 549. In Hartford
Accident, 461
Mich.
at 218, for example, an insurer was subrogated to the rights of its
insured's employee after discharging a contractual duty to pay the
employee's claim. See also Auto-Owners Ins. Co. v. Amoco Prod.
Co., 658 N.W.2d 460, 463 (
Mich.
2003) ("When an insurance provider pays expenses on behalf of its
insured, it is not doing so as a volunteer"). Similarly, in Harley
J.
Rob
inson Trust v. Ardmore Acres, Inc. [ 98-1
USTC ¶50,343], 6 F.Supp.2d 640 (E.D. Mich. 1998), to which
Plaintiffs cite, the court considered whether a guarantor for a loan
could be subrogated to the rights of the lender. In that case, Comerica
loaned $2.4 million to the defendant in return for a mortgage on certain
property, and the plaintiff agreed to serve as guarantor for the loan.
Id.
at 642. Two federal tax liens were recorded against the defendant, after
which the defendant defaulted on Comerica's loan. The plaintiff paid off
the loan pursuant to the guaranty agreement and received Comerica's
mortgage, and the court ruled that the plaintiff therefore became
equitably subrogated to Comerica's rights.
Id.
at 643, 645.
In these cases, the parties seeking subrogation were not volunteers
because they did not pay off the obligations freely, but rather paid
them off pursuant to preexisting agreements ( i.e., insurance or
guaranty contracts). In the case at bar, in contrast, Bednarowski paid
off the 1999 mortgage for the purpose of gaining the security interest;
Bednarowski had no relationship with the 1999 mortgage-holder until
payoff itself. A virtually identical position was presented in Lentz
v. Stoflet, 280
Mich.
446, 451 (1937). In Lentz, the plaintiff paid off the defendant's
1919 and 1923 mortgages in return for a mortgage of its own in 1930.
Id.
at 448. A competing mortgage had been placed on the property in 1929,
and the plaintiff sought to obtain the priority of the 1919 and 1923
mortgages through equitable subrogation. The Michigan Supreme Court
denied this request on the grounds that the plaintiff paid off the 1919
and 1923 mortgages as a volunteer, rather than pursuant to some
preexisting arrangement or interest.
Id.
at 451. In a more recent case, the Bankruptcy Court for the Western
District of Michigan held that a bank that obtained a mortgage by paying
off a prior mortgage could not equitably subrogate itself to the prior
mortgage because it was a volunteer. In re Lewis, 270 B.R.
215, 216-17 (Bankr. W.D. Mich. 2001). The Court finds this case is
analogous to Lentz and Lewis, and denies Plaintiffs'
request for equitable subrogation.
At oral argument, Plaintiffs implied that, although their actual
purchase came after the tax lien was recorded, the agreement that
contractually obligated Plaintiffs to pay off the mortgage predated
their access to knowledge of the lien. The Court is sympathetic to this
position, but it is of no consequence. The tax lien was filed in April
and the Purchase Agreement was not signed until October (although a
previous agreement was attempted in August). Plaintiffs have not
presented any evidence that the lien was not recorded, they only argue
that they did not learn of it. The Court further notes that the date of
the commitment for title insurance was July 2001, well before the
signing of the Purchase Agreement. No evidence was presented that any
subsequent title search was completed. The Court cannot merely assume
that the lien was somehow "in transit" for over four months,
and that Plaintiffs were therefore justifiably ignorant of it.
