Surety's
Interest Page1

American
States Insurance Co., Appellant v.
United States of America
, et al., Appellees.
U.S.
District Court, No. Dist.
Tex.
,
Dallas
Div.; Civ. 3:04-CV-0834-N, Civ. 3:04-CV-0837-N,
February 7, 2005
.
Vacating an unreported BC-DC Texas decision.
[ Code
Secs. 6323 and 6871]
Bankruptcy: Priorities: Equitable subrogation: Federal tax lien. --
A surety
company's claim to funds earned by a contractor, but retained pursuant
to an underlying subcontract, had priority over an IRS tax lien. The
surety company had issued performance and payment bonds on behalf of the
contractor and subsequently made payments on those bonds when the
contractor defaulted. Under the concept of equitable subrogation, the
surety, by paying off the contractor's obligations, was entitled to any
and all sums due or to become due the contractor. The District Court
overturned the Bankruptcy Court, which by denying motions filed by both
the surety company and the IRS, had ordered the withheld funds to be
turned over to the Trustee. The District Court ruled that the Bankruptcy
Court failed to give full effect to Pearlman v. Reliance Ins. Co.,
371 U.S. 132 (1962), and unduly limited a surety's equitable subrogation
right under Texas common law.
.
MEMORANDUM
OPINION AND ORDER
GODBEY, District Judge: Before the Court is Appellant American States
Insurance Co.'s ("ASIC") appeal from the Bankruptcy Court's
Orders of
January 13, 2004
and
March 8, 2004
. Because the Court determines that the Bankruptcy Court failed to give
full effect to Pearlman v. Reliance and unduly limited a surety's
equitable subrogation right under
Texas
common law, the Court vacates those orders and finds for ASIC.
I.
BACKGROUND
On
August 28, 2000
, Debtor SSEM Corp. ("SSEM") entered into a subcontract with
Manhattan Construction Co. ("
Manhattan
") as general contractor in connection with the City of
Dallas Convention Center Expansion
and Renovation (the "Project"). ASIC, as surety, issued both
performance and payment bonds for the Project on behalf of SSEM and for
the benefit of
Manhattan
. SSEM performed some work on the subcontract and then defaulted.
Pursuant to the subcontract, SSEM was to submit payment applications
monthly for work done. The subcontract further provided that
Manhattan
was not required to pay SSEM in the event of default, and could retain
5% of the amounts earned by SSEM. Apparently pursuant to those two
provisions,
Manhattan
withheld approximately $88,631.73 (the "Withheld Balances").
Following SSEM's default, ASIC as surety paid $430,806.66 to complete
SSEM's work on the Project.
On
April 11, 2003
, SSEM filed a voluntary petition for relief under Chapter 11 of the
Bankruptcy Code, which was converted to a Chapter 7 case. One of SSEM's
significant creditors was the Internal Revenue Service
("IRS"), which had filed a pre-petition lien against SSEM for
unpaid payroll taxes exceeding $500,000. On
August 7, 2003
, the
United States
, on behalf of the IRS, filed a motion for relief from automatic stay,
claiming that the Withheld Balances were property of the SSEM estate,
and that the IRS had a priority claim on the Withheld Balances due to
its pre-petition liens. ASIC disagreed with the IRS's motion and filed
its own motion for relief from automatic stay on August 12, 2003,
arguing that it was entitled to the Withheld Balances under its
equitable subrogation rights and that the Withheld Balances were never
earned by SSEM and thus never became part of the estate. The Trustee
opposed the IRS's motion on the basis that the IRS tax lien may be
subordinated to other claims under Section 724 of the Bankruptcy Code.
On January 13, 2004, the Bankruptcy Court entered its thoughtful and
scholarly order (the "Order") denying both motions for relief
from automatic stay, and ordering that the Withheld Balances be turned
over to the Trustee. ASIC timely moved for reconsideration. On
March 8, 2004
, the Bankruptcy Court issued an order denying the motion for
reconsideration, except that it vacated that part of the Order requiring
payment of the Withheld Balances to the Trustee. ASIC timely appealed
from both of those orders.
This Court has jurisdiction to "hear appeals from final judgments,
orders, and decrees from a bankruptcy court." 28 U.S.C. §158(a)(1).
On appeal, this Court applies the same standard of review as a court of
appeals would use reviewing a district court ruling.
Id.
§158(c). "[C]onclusions of law are reviewed de novo,
findings of fact are reviewed for clear error, and mixed questions of
fact and law are reviewed de novo." In re Nat'l Gypsum
Co., 208 F.3d 498, 504 (5th Cir. 2000) (citation omitted).
II.
THE NATURE OF SSEM'S INTEREST
Before considering ASIC's interests in the Withheld Balances, the Court
must briefly consider what basis SSEM had to claim an interest in those
balances. ASIC before this Court consistently refers to the balances as
unearned, but also indicates the funds were withheld by
Manhattan
under two contractual provisions. See ASIC Brief at 4, 6. Counsel
for the Trustee at oral argument below indicated that the Withheld
Balances were entirely retainage, and that the debtor had additional
claims for earned but unpaid balances not at issue in this appeal. R.
4:322. The Bankruptcy Court's Order stated: "The funds in question
were funds retained under the contract between the Debtor and Manhattan
Construction Company, the general contractor for the Project."
Order at 2 (R. 3:241). The nature of SSEM's interest in the Withheld
Balances may have been apparent to all parties and the Bankruptcy Court
below, and that may be why the Order does not address that subject in
greater detail. See R. 4:318 ("THE COURT: The facts are
undisputed ....") (also reflecting counsel indicating no facts in
dispute). Alas, the facts are not so evident to this Court sitting on
appeal given the limited appellate record, so the Court must undertake
some analysis of the subcontract.
The subcontract was for a face amount of $1,290,000. R. 3:199. SSEM was
to make applications for payment monthly for work performed during the
month. R. 3:219 (Art. 5.2.1). Subject to a variety of conditions, id.
(Art. 5.2.2-.7), SSEM would eventually receive payment for each
application. Payment for each approved application, however, was subject
to five percent (5%) retainage. 1
R. 3:199. Finally, the subcontract provides: "Notwithstanding any
provision of the Subcontract to the contrary, Manhattan is not obligated
to make any payment to [SSEM] under the Subcontract if any one or more
of the following conditions exists: (a) Subcontractor ... otherwise is
in default under the Subcontract or the Contract Documents." R.
3:219 (Art. 5.3.1(a)).
These two contractual provisions for withholding payment are the only
provisions cited to the Court by the parties permitting
Manhattan
to withhold payment from SSEM. The parties do not point the Court to any
factual basis in the record on appeal for SSEM's claim to the Withheld
Balances, such as evidence that SSEM performed work, submitted payment
applications that met the requirements of Article 5.2, and was due
payment. The Court will, therefore, assume that the Withheld Balances
comprise retainage and earned balances that were unpaid due to SSEM's
default, pursuant to Article 5.3.1(a). Because the Court's analysis is
the same for both of those categories, the Court will not dwell further
on the distinctions between the two. 2
Both retainage and earned but unpaid balances involve balances for work
actually done by SSEM but for which payment had not become due under the
subcontract at the time of SSEM's filing for protection. By having
actually performed the work, SSEM appears to have at least an equitable
claim to the balances. Moreover, under certain circumstances SSEM could
have a valid contractual claim to those balances. For example, if ASIC
could have stepped in and completed the subcontract for no more than the
unearned balance on the contract, and if SSEM had diligently paid its
downstream subcontractors and suppliers, it would have a valid contract
claim for the retainage and earned but unpaid balances. Property of the
estate includes "all legal or equitable interests of the debtor in
property as of the commencement of the case." 11 U.S.C. §541(a)(1).
Thus, it would appear that retainage and earned but unpaid balances
would become property of SSEM's estate absent any intervening factors. 3
III.
PEARLMAN SURVIVES THE BANKRUPTCY CODE
The Court now turns to Pearlman v. Reliance Ins. Co., 371 U.S.
132 (1962). That case, decided under the Bankruptcy Act, considered
whether a surety or trustee had the right to retainage held by the
United States
as owner, when the contractor failed to pay suppliers and subcontractors
and the surety had to make those payments. The Court initially noted:
Property
interests in a fund not owned by a bankrupt at the time of adjudication,
whether complete or partial, legal or equitable, mortgages, liens, or
simple priority of rights, are of course not a part of the bankrupt's
property and do not vest in the trustee. The Bankruptcy Act simply does
not authorize a trustee to distribute other people's property among a
bankrupt's creditors. So here if the surety at the time of adjudication
was, as it claimed, either the outright legal or equitable owner of this
fund, or had an equitable lien or prior right to it, this property
interest of the surety never became a part of the bankruptcy estate to
be
admin
istered, liquidated, and distributed to general creditors of the
bankrupt.
Id.
at 135-36 (footnote omitted). The Court then proceeded to analyze the
equitable subrogation rights of a surety under common law, and
concluded:
We therefore
hold in accord with the established legal principles stated above that
the Government [owner] had a right to use the retained fund to pay
laborers and materialmen; that the laborers and materialmen had a right
to be paid out of the fund; that the contractor, had he completed his
job and paid his laborers and materialmen, would have become entitled to
the fund; and that the surety, having paid the laborers and materialmen,
is entitled to the benefit of all these rights to the extent necessary
to reimburse it. Consequently, since the surety in this case has paid
out more than the amount of the existing fund, it has a right to all of
it.
Id.
at 141-42. Pearlman thus holds that a surety's equitable
subrogation rights can prevent retainage from becoming part of the
bankruptcy estate, at least under the Bankruptcy Act. The next two
questions are whether the Bankruptcy Code changes the result of Pearlman,
and whether the rights of a surety under
Texas
law are different from the common law rights that drove the result in Pearlman.
The Bankruptcy Court below attempted to create an intermediate position
on Pearlman, after noting that "[m]ost courts have held that
Pearlman survived the enactment of the Bankruptcy Code,"
Order at 3 (R. 3:242), but that "[s]ome courts have questioned the
continued vitality of Pearlman after the enactment of the Code
because the Code defines property of the estate more broadly than
pre-Code law."
Id.
(citations omitted). After considering sections 541(a)(1) and (d) of the
Code, the Bankruptcy Court concluded:
Certainly,
then, to the extent that a surety is the "equitable owner" of
funds under state law, those funds continue to be excluded from
"property of the estate" under the Code. But, property in
which a surety has an "equitable lien" or a "prior
right" vis-a-vis other creditors of its principal under state law
that the Court in Pearlman found to be excluded from the estate
under the Act would not be excluded from the bankruptcy estate under §541
of the Bankruptcy Code because a lien claim or priority claim under the
Bankruptcy Code is just that --a claim. This is where the Supreme
Court's pronouncement in Pearlman may have been superseded by the
new, expansive definition of "property of the estate" under
the Code. Thus, to the extent that a surety cannot claim equitable ownership
of the property under state law, but merely possesses an equitable lien
claim or a priority claim against the property, the property
becomes property of the bankruptcy estate. Likewise, if a surety has
ownership of the funds at issue, an IRS lien against the surety's
principal would not attach to those funds.
Thus, the
resolution of the issue before this Court turns on whether, under
Texas
law, ASIC actually has an ownership interest in the withheld funds or
merely a claim against the funds.
Order at 4 (R. 3:243) (emphasis in original).
This Court agrees with the Bankruptcy Court that the great weight of
authority holds that Pearlman survives enactment of the
Bankruptcy Code. See, e.g., First Indem. of Am. Ins. Co. v.
Modular Structs., Inc. (In re Modular Structs., Inc.), 27 F.3d 72,
77-80 (3d Cir. 1994); Caribbean Resort Constr. and Maint., Inc. v.
Coco Beach Util. Co. (In re
Caribbean
Resort Constr. and Maint., Inc.), 318 B.R. 241, 249-50 (Bankr. D.
P.R. 2003) (citing Modular Structures); Mendelsohn v.
Dormitory Auth. of State of N.Y. (In re QC Piping Inst., Inc.), 225
B.R. 553, 564-71 (Bankr.
E.D.
N.Y.
1998); J. Michael Frank & Michael E. Evans, A Defense of
Established Landmarks: Claims of Construction Sureties to Contract Funds
under Chapter 11, 25 TORT & INS. L.J. 28 (1989); 2 DANIAL R.
COWANS, COWANS BANKR. L. & PRAC. §12.30, at 587-88 (1989). But
see In re Nemko, 143 B.R. 980, 985-86 (Bankr.
E.D.
N.Y.
1992). 4
This Court concurs with the clear majority trend and holds that Pearlman
survives the enactment of the Bankruptcy Code in its entirety, rather
than in the limited form applied in the Order.
Under Pearlman, the label placed on the surety's equitable
subrogation interest was not important; the outcome did not turn on
whether that interest was characterized as a lien or an ownership
interest. See Pearlman, 371
U.S.
at 136 ("if the surety ... was ... either the outright legal or
equitable owner of this fund, or had an equitable lien or prior right
to it, this property interest of the surety never became a part of
the bankruptcy estate ....") (emphasis added). The point was that
under common law principles of equitable subrogation, the surety's
interest prevented the res from becoming property of the bankruptcy
estate. Application of that same principle here leads to the same
result: ASIC's interest in the Withheld Balances prevents those balances
from become part of SSEM's bankruptcy estate. Although this conclusion
is sufficient to resolve the appeal, the Court is cognizant that its
decision may be only a rest stop on the Order's journey from the
Bankruptcy Court to the Fifth Circuit. The Court will, therefore,
consider one further issue.
IV.
A SURETY'S EQUITABLE SUBROGATION RIGHT IS NOT A CLAIM
Finally, the Court will address the character of ASIC's interest in the
Withheld Balances. The Bankruptcy Court relied upon Section 53.151(b) of
the Texas Property Code to determine that ASIC's interest was a claim,
rather than an ownership interest. That portion of the Property Code,
however, applies only to statutory payment bonds issued in accordance
with Chapter 53, sometimes called Hardeman Act bonds, and not to
contractual performance or payment bonds generally. 5
A bond under chapter 53 must be: in a penal sum at least equal to the
total of the original contract amount; in favor of the owner; and
executed by the original contractor as principal. TEX. PROP. CODE §53.202.
See generally Laughlin Environ., Inc. v.
Premier
Towers
, L.P., 126 S.W.3d 668 (Tex. App. --Houston [14th Dist.] 2004, no pet.).
The bonds in this case did not meet those requirements. R. 3:210-11. Nor
did they evidence by their terms intent to comply with Chapter 53.
Id.
; see TEX. PROP. CODE §53.211(a)(2). Accordingly, Section 53.151(b) is
inapplicable to ASIC's bonds.
Because the statutory basis the Bankruptcy Court used to categorize
ASIC's subrogation rights is inapplicable, the Court turns to
Texas
common law.
Texas
case law regarding the nature of a surety's equitable subrogation
interest indicates that it is not simply a claim. In InterFirst
Bank Dallas, N.A. v.
United States
Fid. and Guar. Co., 774 S.W.2d 391 (Tex. App. --Dallas 1989, writ
den.), the court considered whether a surety's subrogation rights were
security interests under Article 9 of the UCC. The Court held they were
not a lien:
Although there
is some minor difference of opinion on this legal issue, the majority
rule clearly appears to be the one which was sanctioned by Justice
Rob
ert Braucher in his definitive analysis of the subject in Canter v.
Schlager, 358 Mass. 789, 267 N.E.2d 492 (1971). According to Justice
Braucher's analysis, a surety's subrogation rights are not security
interests within the purview of Article Nine.
Id.
at 494. This being the case, the promulgation of the UCC and the
enactment of its progeny (such as the Texas Business and Commerce Code)
do not adversely affect the pre-Code subrogation rights traditionally
afforded to sureties.
Id.
; see 2 WHITE & SUMMERS, UNIFORM COMMERCIAL CODE §23-6 (3d
ed. 1988) (surety's subrogation rights not a security interest); accord
National Shawmut Bank v. New Amsterdam Casualty Co., 411 F.2d 843,
847 (1st Cir. 1969). Further, it necessarily follows from Braucher's
analysis that a surety's right to equitable subrogation is not adversely
affected by the lack of perfection of lien claimants' rights if the
surety is obliged to satisfy all lienable claims of laborers and
materialmen, whether perfected or not.
The
overwhelming and essentially unanimous post-UCC decisions have held that
the interest of a surety, such as USF & G, continues to be superior
to the claim of a contract assignee, such as Bank. Transamerica Ins.
Co. v. Barnett Bank, 540 So.2d 113, 117 (
Fla.
1989); Mid-Continent Casualty Co. v. First Nat'l Bank & Trust Co.,
531 P.2d 1370, 1377 (Okl. 1975); accord National Shawmut Bank v. New
Amsterdam Casualty Co., 411 F.2d 843, 849 (1st Cir.1969); First
Alabama Bank v.
Hartford
Accident & Indem. Co., 430 F. Supp. 907, 911 (N.D. Ala. 1977); Fidelity
& Casualty Co. v. Central Bank, 409 So.2d 788, 790 (Ala. 1982); Alaska
State Bank v. General Ins. Co., 579 P.2d 1362, 1368 (Alaska 1978); Argonaut
Ins. Co. v. C & S Bank, 140 Ga. App. 807, 232 S.E.2d 135, 140
(1976); United States Fidelity & Guar. Co. v. First State Bank,
208 Kan. 738, 494 P.2d 1149, 1159 (1972); Finance Co. of America v.
United States Fidelity & Guar. Co., 277 Md. 177, 353 A.2d 249,
254 (1976); Canter v. Schlager, 358 Mass. 789, 267 N.E.2d 492,
497 (1971); Travelers Indem. Co. v. Clark, 254 So.2d 741, 745-46
(
Miss.
1971); Jacobs v. Northeastern Corp., 416
Pa.
417, 206 A.2d 49, 55 (1965); Third Nat'l Bank v. Highlands Ins. Co.,
603 S.W.2d 730, 734 (
Tenn.
1980).
Id.
at 398-99 (footnote omitted). By the same logic, a surety's equitable
subrogation interest is not a claim and takes precedence over mere claim
interests.
Other Texas cases have acknowledged that one purpose of retainage is
that "[i]t supplies a salvage fund for the contractor's surety in
the event it makes good on defaults for which it is bound." Corpus
Christi Bank and Trust v. Smith, 525 S.W.2d 501, 505 (
Tex.
1975). Accord Economy Forms Corp. v. Williams Bros. Constr. Co.,
754 S.W.2d 451, 457 (Tex. App. --Houston [14th Dist.] 1988, no writ)
("The fact that these funds were retained by the general contractor
rather than the property owner does not change the beneficiary or the
purpose. ... (3) the retainage provides salvage funds for its surety if
the surety makes good on defaults for which it is bound; ....").
Thus, under
Texas
law, if a surety's equitable subrogation right is not an ownership
right, it is at least closer to ownership than it is to a claim.
Accordingly, even if section 541(a)(1) modified the result in Pearlman
so that any earned portion of the Withheld Balances would enter SSEM's
estate if ASIC's interest were only a lien, as the Order held, under
Texas common law ASIC's equitable subrogation interest is greater than a
lien; ASIC has an equitable ownership interest in the "salvage
fund" to the extent of its completion costs. Thus, regardless
whether or not Pearlman alone is sufficient to keep the Withheld
Balances out of SSEM's estate, ASIC is still entitled to the Withheld
Balances. Because the Withheld Balances never enter SSEM's estate, the
IRS's priority is immaterial.
CONCLUSION
It is therefore ordered that the Bankruptcy Court's orders of January
14, 2004 and March 9, 2004 are vacated, that ASIC's motion for relief
from automatic stay is granted, and that the United States' motion for
relief from automatic stay is denied.
1
"Retainage" was not otherwise defined or addressed in the
subcontract. Black's defines retainage as "A percentage of what a
landowner pays a contractor, withheld until the construction has been
satisfactorily completed and all mechanic's liens are released or have
expired." BLACK'S LAW DICTIONARY 1341 (8th ed. 2004).
2
The Court can conceive of analytical frameworks that would treat
retainage differently than earned but unpaid balances. In such a case,
the Court would be required to remand for the Bankruptcy Court to give
more detailed consideration to the nature of SSEM's claim to the
Withheld Balances. Because the Court's analysis is the same for both
categories, that is unnecessary in this case.
3
As indicated above, ASIC characterizes the Withheld Balances as money
that "was never earned by SSEM, was not owed to SSEM under the
subcontract ...." See ASIC Brief at 6. The Court understands
ASIC's claim to mean simply that the balances were not due and payable
to SSEM under the terms of the subcontract, although SSEM had done the
work. Characterizing the balances as unearned, however, could be taken
as meaning they included that portion of the $1.3 million contract price
associated with work the SSEM did not perform before it defaulted, for
which SSEM did not submit a payment application, and that ASIC had to
complete. The Court does not understand that to be what ASIC is
contending. If the Withheld Balances included such truly unearned
contractual balances, SSEM would not have any legal or equitable
claim to such balances. Because that produces the same result the Court
reaches, it is not necessary to determine whether any of the Withheld
Balances were truly unearned in that sense.
4
The Bankruptcy Court in Mendelsohn v. DASNY distinguished In
re Nemko factually. 225 B.R. at 569.
5
"Subcontractors and suppliers are the 'beneficiaries' of a payment
bond. By contrast, a performance bond is only for the benefit of the
obligee/owner of the construction project. Subcontractors and suppliers
generally do not have the right to seek payment from the performance
bond surety if the principal defaults." Laughlin Environ., Inc.
v. Premier Towers, L.P., 126 S.W.3d 668, 671 n.3 (Tex. App.
--Houston [14th Dist.] 2004, no pet.).
[2000-2
USTC ¶50,562]
Wayne
County
Board
of
County
Commissioners
, Plaintiff v. Mendel, Inc., et al., Defendants
U.S.
District Court, No. Dist.
Ohio
, East. Div., 5:98 CV 1795, 5/30/2000
[Code Sec.
6321 ]
Lien for taxes: Validity and priority against third-parties: Property
subject to tax liens.--A construction company that entered into a
contract with a county board of commissioners to complete a bridge
project had an interest in a fund containing monies to pay for the
project that was held by the board after its completion. The contractor
was not in breach of contract and owed no amounts to the county that
would bar its claim to the funds. Therefore, it had an interest in the
fund to which a tax lien could attach.
[Code Sec.
6323 ]
Lien for taxes: Validity and priority against third-parties:
Equitable lien: Surety.--A claim by a surety, which made payments to
a construction company's subcontractors pursuant to a performance bond,
did not have priority over a federal tax lien to funds still owed to the
contractor because it was not "first in time." The surety's
purported equitable lien became choate when the subcontractors were
paid, which was after the tax lien was assessed.
[Code Sec.
6323 ]
Lien for taxes: Validity and priority against third-parties: Surety:
Security interest: Superpriority: Financing statement.--A surety,
which made payments to a construction company's subcontractors pursuant
to a performance bond, did not hold a security interest in funds still
owed to the contractor that took superpriority over an earlier federal
tax lien. The surety did not file a financing statement with the
appropriate office, which is required in order to perfect a security
interest.
ORDER
OLIVER, JR.,
District Judge:
On June 26,
1998, Plaintiff, Wayne County Board of County Commissioners ("Wayne
County"), brought an interpleader action against Defendants,
Mendel, Inc. ("Mendel"), the Internal Revenue Service
("IRS"), Ohio Farmers Insurance Co. ("Ohio Farmers")
and All Ohio Insurance Agency, Inc., in the Court of Common Pleas of
Wayne County to determine which of the Defendants is entitled to certain
proceeds of a construction contract between Mendel and Wayne County. 1
On August 6, 1998, the government removed this action to the United
States District Court for the Northern District of Ohio pursuant to 28
U.S.C. §1444. The government and Ohio Farmers both claim an interest in
the interpled funds. Presently before the court are the cross-motions
for summary judgment by Ohio Farmers and the government on their
respective claims to the interpled funds. For the reasons that follow,
the court finds that the government is entitled to the interpled funds
and therefore grants its motion for summary judgment (Doc. No. 36) and
denies Ohio Farmers' cross-motion for summary judgment (Doc. Nos. 26 and
31). 2
I.
FACTS
The facts are
generally undisputed. On
December 5, 1996
, the debtor-taxpayer, Mendel, entered into a contract with
Wayne
County
to improve a bridge in
Milton
Township
, located in
Wayne
County
("the bridge project"). To obtain the contract, Mendel secured
a surety bond from Ohio Farmers under which Ohio Farmers guaranteed
performance of the contract and also guaranteed payment to all persons
supplying labor and materials to the project.
Mendel
completed the project; it was therefore unnecessary for Ohio Farmers to
make any payments with respect to its performance bond. However, Mendel
did not pay all of its subcontractors. Pursuant to its obligation on the
payment bond, Ohio Farmers paid United Precast's claim of $7,677.00 on
December 1, 1997
, and Meredith Brothers' claim of $8,258.77 on
February 11, 1998
. Neither United Precast nor Meredith Brothers filed mechanic's liens
pursuant to Ohio Revised Code §1311.26.
Throughout its
performance on the bridge project, Mendel also failed to pay all of its
employees' share of federal income tax and social security withholding
on wages. These tax liabilities were assessed on
June 16, 1997
,
August 25, 1997
,
September 22, 1997
,
December 8, 1997
and
April 1, 1998
, and amounted to more than $100,000. Notices of federal tax lien with
respect to these liabilities were filed on
February 11, 1998
,
May 28, 1999
and
February 4, 1999
.
Wayne
County
made various payments to Mendel pursuant to the parties' contract.
However, under the terms of the contract,
Wayne
County
was authorized to retain and hold a percentage of estimated amounts due
monthly until final completion and acceptance of all work covered by the
contract. 3
Pursuant to this term,
Wayne
County
had in its possession $10,261.51 of undistributed contract funds at the
time the bridge project was complete. 4
On
February 24, 1998
, the Wayne County Auditor received a Notice of Levy from the IRS
regarding Mendel and providing for a lien on all monies in
Wayne
County
's possession which
Wayne
County
was obligated to pay to Mendel. On
June 1, 1998
,
Wayne
County
received a letter from Ohio Farmers directing
Wayne
County
to mail all remittances and checks to Ohio Farmers as surety for Mendel.
The letter indicated that Ohio Farmers had been forced to make payments
to subcontractors and suppliers furnishing labor or material on behalf
of Mendel in connection with the bridge project. Thereafter,
Wayne
County
filed the instant interpleader action, seeking to determine to whom the
remaining contract funds (the "Fund") belong.
II.
SUMMARY JUDGMENT STANDARD
Federal Rule
of Civil Procedure 56(c) governs summary judgment motions and provides:
The
judgment sought shall be rendered forthwith if the pleadings,
depositions, answers to interrogatories, and admissions on file,
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 a
judgment as a matter of law. . . .
Rule 56(e)
specifies the materials properly submitted in connection with a motion
for summary judgment:
Supporting and
opposing affidavits shall be made on personal knowledge, shall set forth
such facts as would be admissible in evidence, and shall show
affirmatively that the affiant is competent to testify to the matters
stated therein. . . . The court may permit affidavits to be supplemented
or opposed by depositions, answers to interrogatories, or further
affidavits. When a motion for summary judgment is made and supported as
provided in this rule, an adverse party may not rest upon the mere
allegations or denial of the adverse party's pleading, but the adverse
party's response, by affidavits or as otherwise provided in this rule,
must set forth specific facts showing that there is a genuine issue for
trial. If the adverse party does not so respond, summary judgment, if
appropriate, shall be entered against the adverse party.
However,
the movant is not required to file affidavits or other similar materials
negating a claim on which its opponent bears the burden of proof, so
long as the movant relies upon the absence of the essential element in
the pleadings, depositions, answers to interrogatories, and admissions
on file. Celotex Corp. v. Catrett, 477
U.S.
317, 106 S.Ct. 2548 (1986).
In reviewing
summary judgment motions, this court must view the evidence in a light
most favorable to the non-moving party to determine whether a genuine
issue of material fact exists. Adickes v. S.H. Kress & Co.,
398
U.S.
144, 90 S.Ct. 1598 (1970); White v. Turfway Park Racing Ass'n, Inc.,
909 F.2d 941, 943-44 (6th Cir. 1990). A fact is "material"
only if its resolution will affect the outcome of the lawsuit.
Anderson
v. Liberty Lobby, Inc., 477
U.S.
242, 248, 106 S.Ct. 2505, 2510 (1986). Determination of whether a
factual issue is "genuine" requires consideration of the
applicable evidentiary standards. Thus, in most civil cases the court
must decide "whether reasonable jurors could find by a
preponderance of the evidence that the [non-moving party] is entitled to
a verdict."
Id.
at 252, 106 S.Ct. at 2512.
Summary
judgment is appropriate whenever the non-moving party 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, 477
U.S.
at 322, 106 S.Ct. at 2552. Moreover, "the trial court no longer has
a duty to search the entire record to establish that it is bereft of
genuine issue of material fact." Street v. J.C. Bradford &
Co., 886 F.2d 1472, 1479-80 (6th Cir. 1989) (citing Frito-Lay,
Inc. v. Willoughby, 863 F.2d 1029, 1034 (D.C. Cir. 1988)). The
non-moving party is under an affirmative duty to point out specific
facts in the record as it has been established which create a genuine
issue of material fact. Fulson v. City of
Columbus
, 801 F.Supp. 1, 4 (S.D.
Ohio
1992). The non-movant must show more than a scintilla of evidence to
overcome summary judgment; it is not enough for the non-moving party to
show that there is some metaphysical doubt as to material facts.
Id.
III.
LAW AND ANALYSIS
Ohio Farmers
and the government have filed cross-motions for summary judgment on
their respective claims to the Fund. Ohio Farmers asserts its
entitlement to the Fund on the basis that Mendel has no interest in the
Fund to which a tax lien could attach. Ohio Farmers contends that this
is so because Mendel did not satisfy all of the requirements of its
contract with
Wayne
County
since Mendel did not pay all of its subcontractors. According to Ohio
Farmers, the money
Wayne
County
withheld pursuant to paragraph 25(a) of its contract with Mendel was
never earned by Mendel, and thus was not available for attachment by the
IRS lien.
Section 6321
of the Federal Tax Lien Act, 26 U.S.C. §§6321-6327, gives the
United States
a lien for unpaid taxes on "all property and rights to
property" of a taxpayer who neglects to pay his taxes after demand.
This lien reaches every interest in property that a taxpayer may have, U.S.
v. National Bank of Commerce [85-2 USTC ¶9482], 472 U.S. 713, 720,
105 S.Ct. 2919, 2924 (1985), arises on the date of assessment and
continues until the assessment is fully satisfied or becomes
unenforceable. 26 U.S.C. §6322. A tax lien can attach even if a
taxpayer's interest in property is less than full ownership or is one
among several claims of ownership. United States v. Safeco Ins. Co.
of Am. [89-1 USTC ¶9227], 870 F.2d 338, 341 (6th Cir. 1989). See
also In re Construction Alternatives [93-2 USTC ¶50,569], 2 F.3d
670 (6th Cir. 1993). "Unresolved questions concerning the ultimate
ownership of the property will not prevent provisional attachment of a
federal tax lien." Safeco [89-1 USTC ¶9227], 870 F.2d at
341.
In the instant
case, it is undisputed that the bridge project was completed by Mendel.
The fact that Ohio Farmers paid two of Mendel's subcontractors on the
project is immaterial for the purpose of determining completion of the
project. See In re Wm. Cargile Contractor, Inc., 203 B.R. 644,
646 (S.D.
Ohio
1996). Mendel owed nothing to
Wayne
County
; thus, no payments to the county were required or other expenses
incurred to perfect Mendel's claim to the retained funds. Moreover,
Wayne
County
has never declared Mendel in breach of its contract and disavows any
claim to the retained funds. See Menuez Declaration ¶5;
Complaint ¶7. Mendel thus earned the right to receive the retained
funds, and under the principles stated above, the government has a valid
tax lien on the Fund. See Construction Alternatives [93-2 USTC ¶50,569],
2 F.3d at 674 (finding that general contractor who had completed project
and owed no obligations to owner of the project but who had not paid
several subcontractors had earned right to receive its final progress
payment and therefore federal tax lien could attach to progress
payment).
Having
determined that Mendel had an interest in the Fund to which a tax lien
could attach, the next issue is whether Ohio Farmers also has a lien on
the Fund, and if so, whether that lien is superior to the government's
tax lien. Ohio Farmers contends that it has an equitable lien on the
Fund through subrogation to the rights of United Precast and Meredith
Brothers, the two subcontractors that it paid in Mendel's stead, and
also through subrogation to the rights of
Wayne
County
. It asserts that its equitable lien is superior to the government's tax
lien because it was perfected prior to the time the federal tax lien was
filed.
Even assuming
that Ohio Farmers has a valid equitable lien on the Fund through
subrogation, see Pearlman v. Reliance Ins. Co., 371 U.S. 132, 83
S.Ct. 232 (1962) (holding that surety who completed general contractor's
contract and paid contractor's laborers and materialmen held equitable
lien on retained contract funds through subrogation to rights of
government owner, to rights of laborers and materialmen and to rights
which contractor would have had he completed job), the court finds that
the government has priority to the Fund and is thus entitled to it. When
there is a competition between a federal tax lien and a state law lien,
priority is determined by the "first in time, first in right"
rule. Terwilliger's Catering Plus, Inc. v. Baverly [90-2 USTC ¶50,460],
911 F.2d 1168, 1176 (6th Cir. 1990) (quoting United States v. City of
New Britain, Conn. [54-1 USTC ¶9191], 347 U.S. 81, 85, 74 S.Ct.
367, 370 (1954)). If the competing state law lien falls into one of the
limited categories of liens enumerated in §6323(a), the federal tax
lien is only perfected once the notice of the federal tax lien is filed.
See United States, ex rel. IRS v. McDermott [93-1 USTC ¶50,164],
507 U.S. 447, 113 S.Ct. 1526, 1528 (1993). If the state law lien is not
among the enumerated categories in §6323(a), then the federal tax lien
need not be filed to gain priority over other interests; it is perfected
at the time the lien is assessed. Terwilliger's [90-2 USTC ¶50,460],
911 F.2d at 1176; IRC §6322.
Under §6323(a),
the tax lien is not effective against "any purchaser, holder of a
security interest, mechanic's lienor, or judgment creditor until notice
[of the lien] . . . has been filed by the Secretary." There is
nothing in the record to indicate that Ohio Farmers is subrogated to any
such rights. Thus, the tax lien has priority over any equitable lien
that Ohio Farmers can claim to the Fund as long as it was assessed prior
to Ohio Farmer's lien becoming choate. A state created lien interest is
usually held to be choate " 'when the identity of the lienor, the
property subject to the lien, and the amount of the lien are
established.' " Terwilliger's [90-2 USTC ¶50,460], 911 F.2d
at 1176 (quoting
New Britain
, 347 U.S at 84, 74 S.Ct. at 369). See also Construction Alternatives
[93-2 USTC ¶50,569], 2 F.3d at 676. Ohio Farmer's equitable lien, if it
exists, became choate on
December 1, 1997
with respect to United Precast's claim, and or
February 11, 1998
, with respect to Meredith Brother's claim. By
December 1, 1997
, the IRS had already assessed a tax lien in the amount of $58,789.52
against Mendel, well over the amount in the Fund. Thus, Ohio Farmer's
equitable lien would not have been perfected at the time the tax lien
was assessed and therefore, the tax lien takes priority.
However, Ohio
Farmers contends that under §6323(c), it has a security interest in the
Fund that has priority over the government's tax lien even though its
equitable lien may not have been perfected at the time of tax lien
filing. Under §6323(c), a surety's "security interest" has
priority over a tax lien even though the security interest came into
existence after the tax lien was filed, provided the following
circumstances are applicable: "1) the surety's security interest .
. . is an obligatory disbursement agreement such as a suretyship
agreement; 2) . . . the surety's interest is in "qualified
property" covered by the terms of a written agreement entered into
before the tax lien filing; and 3) the security interest would be
protected under local law against a judgment lien that arose at the same
time as the tax lien." Construction Alternatives [93-2 USTC
¶50,569], 2 F.3d at 677-678 (citing 26 U.S.C. §6323(c)).
A
"security interest" under §6323(c) exists if "the
property is in existence and the interest has been protected under local
law against a subsequent judgment lien creditor." 26 U.S.C. §6323(h).
Thus, before Ohio Farmer's alleged security interest in the Fund would
take priority over a subsequently-arising judgment lien under local law,
Ohio Farmers would have been required to perfect its security interest
by filing a financing statement in the appropriate office. Construction
Alternatives [93-2 USTC ¶50,569], 2 F.3d at 678 (citing Ohio Rev.
Code §§1309.21, 1309.23). For example, the court in Construction
Alternatives rejected the surety's argument that it was entitled to
priority over the government under §6323(c) on the basis that the
surety had not filed a financing statement.
Id.
Similarly, Ohio Farmers never filed a financing statement and thus does
not possess a security interest under §6323(c). Accordingly, Ohio
Farmers cannot come within the superpriority provisions of §6323(c) and
it remains true that the IRS has priority to the Fund.
IV.
CONCLUSION
For the
foregoing reasons, the court finds that the government has a valid tax
lien on the Fund and that such lien is superior to any equitable lien on
the Fund that Ohio Farmers may claim. Accordingly, the court holds that
the
United States
is entitled to the interpled funds and therefore grants its motion for
summary judgment on its claim to such funds (Doc. No. 36). Ohio Farmers'
motion for summary judgment on its claim to the interpled funds (Doc.
Nos. 26 and 31) is hereby denied.
IT IS SO
ORDERED.
JUDGMENT
ENTRY
Pursuant to a
separate order of this same date, judgment in this interpleader action
is hereby entered in favor of the
United States
in the amount of $10,261.51; Ohio Farmer's claim to this same amount is
hereby denied.
IT IS SO
ORDERED.
1
After indicating that it had no interest in the funds, Defendant All
Ohio Insurance Agency, Inc. was dismissed from this case on
November 24, 1998
.
2
On
May 23, 2000
, the court held a telephonic conference wherein the parties were
permitted to orally address several legal arguments discussed in their
briefs. However, for purposes of deciding the parties' cross-motions for
summary judgment, the court has relied on only factual information
addressed in the parties' memoranda.
3
Paragraph 25(a) of the contract provides:
Not later than
the 15th day of each calendar month the Owner shall make a progress
payment to the Contractor on the basis of a duly certified and approved
estimate of the work performed during the preceding calendar month under
this contract, but to insure the proper performance of this contract,
the Owner shall retain ten percent (10%) of the amount of each estimate
until final completion and acceptance of all work covered by this
contract . . . Provided . . . that the Owner at any time after
fifty percent (50%) of the work has been completed, if it finds that
satisfactory progress is being made, may make any of the remaining
progress payments in full. . . .
While it is
undisputed that Mendel completed the bridge project, it is not clear
from the record whether
Wayne
County
actually accepted the project. If it did, then, upon its acceptance,
Wayne
County
would have had no right to continue withholding the funds retained
pursuant to this provision. However, for purposes of the pending
cross-motions for summary judgment, the court will assume that
Wayne
County
did not accept the project and rightfully withheld the disputed funds.
4
Ohio Farmers asserts that
Wayne
County
was entitled to hold the undistributed contract funds pursuant to
paragraph 25(d) of the contract. This provision states in pertinent
part:
The Contractor
shall, at the Owner's request, furnish satisfactory evidence that all
obligations [owed to subcontractors, laborers, etc.] have been
paid, discharged, or waived. If the Contractor fails so to do then the
Owner may, after having served written notice on the said Contractor,
either pay unpaid bills, of which the Owner has written notice, direct,
or withhold from the Contractor's unpaid compensation a sum of money
deemed reasonably sufficient to pay any and all such lawful claims until
satisfactory evidence is furnished that all liabilities have been fully
discharged. . . .
There are
several prerequisites to
Wayne
County
being permitted to withhold money pursuant to this provision, including
that
Wayne
County
first request from Mendel evidence that subcontractors, laborers and the
like have been paid. In his declaration, Judson Menuez, President of
Mendel during the term of the bridge project, stated that
Wayne
County
never requested such evidence from Mendel, Menuez Declaration ¶4, and
Mendel has offered no evidence to the contrary. Accordingly,
Wayne
County
could not withhold any contract funds from Mendel pursuant to paragraph
25(d).
[98-2 USTC
¶50,609] Reliance Insurance Company, a
Pennsylvania
corporation, Plaintiff v.
United States of America
, acting by and through the Internal Revenue Service, Defendant
U.S.
District Court, Dist. Ore., Civ. 97-803-HA, 7/17/98
[Code
Secs. 3401 and 6323 ]
Liens and levies: Wrongful levy: Superior interest: Surety: Set-off:
FICA liability: Who is the employer.--The IRS was entitled to set
off contract funds to which an insurance company possessed a superior
interest against the company's unpaid Federal Insurance Contribution Act
(FICA) liability. Since the company controlled the payroll and disbursed
its own funds to pay the employees of a contractor that defaulted on a
bridge repair project, it qualified as an "employer" liable
for FICA taxes. The insurance company failed to contest the IRS's right
to set-off.
[Code Sec.
7426 ]
Liens and levies: Wrongful levy:
Superior
interest.--An insurance company's interest in contract funds was
superior to that of the IRS in connection with a contractor that
defaulted on a bridge repair project. The IRS conceded that the company,
which was the surety of the contractor, possessed a superior interest in
the funds with respect to its wrongful levy claim.
Jan D. Sokol,
Thomas A. Larkin, Stewart, Sokol & Gray, One S.W. Columbia St.,
Portland,
Ore.
97258-2097, for plaintiff. Kristine Olson, United States Attorney,
Portland, Ore. 97204, Sanford W. Stark, Department of Justice,
Washington, D.C. 20530, for defendant.
OPINION
AND ORDER
HAGGERTY,
District Judge:
Both parties
seek summary judgment regarding an Internal Revenue Service (IRS) levy
of funds from an Oregon Department of Transportation (ODOT) project
involving a contractor that defaulted. The contractor's surety
(plaintiff) argues that its interest in the project funds was superior
to the IRS's interest. The government does not dispute this, but
contends it is entitled to a set-off regarding employment tax funds for
which plaintiff remains responsible. For the reasons that follow, the
government is entitled to summary judgment, and plaintiff Reliance
Insurance Company's cross motion for summary judgment is denied.
BACKGROUND
In September
1995, a company called "Great Western Coatings, Inc.,"
("GWC") contracted with the ODOT to repair and install a
cathodic protection system on the approach spans to the
Yaquina
Bay
Bridge
in
Newport
,
Oregon
. Plain tiff Reliance Insurance Company was the surety for GWC,
guaranteeing GWC's performance on the project in the event GWC
defaulted. Reliance and GWC posted performance and payment bonds to ODOT
as obligee on
19 September 1995
totaling over $2,220,000.
Reliance was
notified on
1 October 1996
that GWC was suffering cash flow difficulty and was unable to make its
4 October 1996
payroll. Per an agreement with Reliance, GWC voluntarily defaulted on
7 October 1996
, well before the project was completed. Reliance agreed to finance
GWC's completion of the work, and directed ODOT to withhold further
payments to GWC. Reliance provided funding between October 1996 and
February 1997. Reliance made several payroll payments directly to GWC
employees, but claims that it never asserted control over employees
directly.
On
26 November 1996
, the IRS issued and served a tax levy on ODOT demanding payment of
$110,135.86 for past years' assessments against GWC. On
21 December 1996
, ODOT paid the IRS $34,121.57 from the project's contract funds.
Reliance received remaining payments from ODOT totaling approximately
$1,000,000, minus the payment ODOT made to the IRS. Reliance argues that
as financing surety, it had an interest in the contract funds paid to
the IRS that was superior and paramount to any interest of the IRS.
Accordingly, Reliance initiated this action for wrongful levy under 26
U.S.C. §7426, seeking to compel the
United States
to remit the levied funds to Reliance.
Reliance sues
to recover the $34,121.57 ODOT paid to the IRS, and seeks summary
judgment on this claim and against the IRS's counterclaim. In its
counterclaim, the IRS contends that the unpaid employer's share of
Federal Insurance Contribution Act (FICA) funds totals $28,287.82 for
the fourth quarter of 1996, and $17,521.91 for the first quarter of
1997, and that Reliance is responsible for these FICA payments. The IRS
seeks summary judgment against plaintiff's claim and in favor of its
counterclaim, on the theory that regardless of whether its levy was
wrongful, the IRS is entitled to a set-off for the FICA payments.
STANDARDS
Summary
judgment is proper under Fed. R. Civ. P. 56(c) "if the pleadings,
depositions, answers to interrogatories, and admissions on file,
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." Celotex Corp. v. Catrett, 477
U.S.
317, 322 (1986). The substantive law underlying the claims in issue
identifies which facts are material. Anderson v. Liberty Lobby, Inc.,
477
U.S.
242, 248 (1986). When assessing a motion for summary judgment, the court
must make all factual inferences in favor of the party opposing the
motion. Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio Corp.,
475 U.S. 574, 587 (1986).
The parties'
motions raise the following legal questions: (1) Whether the government
wrongfully levied contract funds to which Reliance maintained a superior
interest; and (2) Whether the government should nevertheless be entitled
to set off the levied funds against outstanding FICA liabilities that
Reliance is obligated to pay.
ANALYSIS
A.
Wrongful levy
Section 7426
of Title 26, United States Code, provides the exclusive remedy for an
innocent third party whose property is confiscated by the IRS to satisfy
another person's tax liability. Section 7426(a)(1) provides, in relevant
part:
If a levy has
been made on property or property has been sold pursuant to a levy, any
person (other than the person against whom is assessed the tax out of
which such levy arose) who claims an interest in or lien on such
property and that such property was wrongfully levied upon may bring a
civil action against the United States in a district court of the United
States.
26
U.S.C. §7426(a)(1).
If the court
finds that the property was wrongfully levied upon, §7426(b)(2)
provides that the court may:
(A) order the
return of specific property if the
United States
is in possession of such property;
(B) grant a
judgment for the amount of money levied upon; or
(C) if such
property was sold, grant a judgment for an amount not exceeding the
greater of--
(I)
the amount received by the
United States
from the sale of such property, or
(ii)
the fair market value of such property immediately before the levy.
26
U.S.C. §7426(b)(2).
In order to
state a cause of action under §7426, the plaintiff must show: (1) that
a levy has been filed against property in plaintiff's hands, (2) that
plaintiff has an interest in or a lien on the property which is senior
to the interest of the United States, and (3) that the levy was
wrongful. A levy is wrongful where the property levied upon "does
not, in whole or in part, belong to the taxpayer against whom the levy
originated." Arth v. United States [84-2 USTC ¶9601], 735
F.2d 1190, 1193 (9th Cir. 1984).
Reliance is
entitled to summary judgment on its wrongful levy claim, because it has
a paramount interest in the funds. Under 26 U.S.C. §6323(c), which
recognizes that certain security interests having priority over tax
liens, Congress provided:
(1) . . . To
the extent provided in this subsection, even though a notice of a lien .
. . 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.
The government
concedes that if the conditions of the statute 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. Furthermore, for the purposes
of this motion, the government does not dispute that under 26 U.S.C. §6323(c),
Reliance's interest in the levied funds is superior to the IRS's
interest.
Accordingly,
the court grants plaintiff's motion for summary judgment on its wrongful
levy claim. The government asserts no argument against there being a
"wrongful levy," but agrees that Reliance has a superior
interest.
B.
Government's right to set-off
The government
contends that Reliance qualified as the project workers'
"employer" for the fourth quarter of 1996 and the first
quarter of 1997 and is responsible for FICA payments. Therefore, the
government argues, it is entitled to a "set-off" of the FICA
amounts due. The government contends that it is not obligated to refund
the levied money, because the IRS may exercise its rights to a set-off,
and apply the levied funds to Reliance's outstanding FICA liabilities.
Courts
recognize the government's right to set-off. See United States v.
Munsey Trust Co., Receiver, 332 U.S. 234, 239 (1947) ("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"); Capuano v. United States [92-1
USTC ¶50,163], 955 F.2d 1427, 1430 (11th Cir. 1992); United Sand and
Gravel Contractors, Inc. v. United States [80-2 USTC ¶9626], 624
F.2d 733, 736 (5th Cir. 1980).
The government
properly filed a counterclaim to exercise its common law right of
set-off. To establish the right to set-off in a counterclaim, the
government bears the burden of showing that the plaintiff is indebted to
the government. See Cherry Cotton Mills v. United States [46-1
USTC ¶9218], 327 U.S. 536 (1946) (holding that illegally collected
taxes may be used to set off any indebtedness that the government
establishes is owed by the plaintiff to the government). Plaintiff
Reliance makes no argument against the government's set-off rights. The
only question presented by the government's counterclaim, therefore, is
whether the government has met its burden by establishing that Reliance
owes FICA taxes to the government.
The Internal
Revenue Code provides that an employer bears responsibility for
withholding FICA and FUTA taxes. 26 U.S.C. §§3101-02, 3111 & 3301.
The Internal Revenue Code addresses the taxes imposed on employees
regarding FICA under §3101(a),(b). Employers must withhold the
employees' shares and pay the shares to the IRS under §3102(a). Section
3111 of the Code addresses the employer's share of FICA taxes.
Employers are obligated to pay their own shares of FICA under this
section.
The government
argues that Reliance qualifies as the "employer" on the
project from 29 September 1996 through 15 February 1997, and has failed
to meet its obligation to pay the employer's share of FICA under §3111
for this time period. The term "employer" is defined in
section 3401(d) of the Internal Revenue Code as follows:
(d)
Employer.--For purposes of this chapter, the term "employer"
means the person for whom an individual performs or performed any
service, of whatever nature, as the employee of such person except
that--
(1)
if the person for whom the individual performs or performed the services
does not have control of the payment of the wages for such services
[then] the term "employer" . . . means the person having
control of the payment of such wages.
26
U.S.C. §3401(d)(1).
The Supreme
Court has held that this definition of "employer" is equally
applicable to FICA obligations. See Otte v. United States [74-2
USTC ¶9822], 419 U.S. 43, 51 (1974); Winstead v. United States
[97-1 USTC ¶50, 322], 109 F.3d 989, 991 (4th Cir. 1997).
In Otte
the question presented was whether a trustee in bankruptcy was required
to make appropriate withholdings when making payment of wage claims
representing wages earned before bankruptcy. Referring to §3401(d)(1),
the Court said the statute "obviously was in tended to place
responsibility for withholding at the point of control."
Id.
at 50.
The Ninth
Circuit has addressed FICA liability in In re Southwest Restaurant
Sys., Inc. [79-2 USTC ¶9578], 607 F.2d 1237 (9th Cir. 1979). The
court held that no one "other than the person who has control of
the payment of the wages is in a position to make the proper accounting
and payment to the
United States
. It matters little who hired the wage earner or what his duties were or
how responsible he may have been to his common law employer. Neither is
it important who fixed the rate of compensation. When it finally comes
to the point of deducting from the wages earned that part which belongs
to the
United States
and matching it with the employer's share of FICA taxes, the only person
who can do that is the person who is in 'control of the payment of such
wages.' "
Id.
at 1240 (quoting Otte).
The undisputed
evidence in this case is that Reliance controlled the payment of wages
to the project workers through the fourth quarter of 1996 and the first
half of the first quarter of 1997. Plaintiff alone financed every weekly
payroll during this period, beginning with the
11 October 1996
payroll (for work performed from
29 September 1996
through
5 October 1996
) until GWC was terminated from the contract in February 1997. Reliance
initially provided cashier's checks to GWC to distribute to workers. GWC
would provide payroll information to Reliance, and Reliance would draw
the appropriate amounts by purchasing cashier's checks from Sterling
Savings and Loan in
Federal Way
,
Washington
.
At the end of
November 1996, the parties established an account at the Bank of
America. This account was governed by an agreement prepared by Reliance
and dated
26 November 1996
. The agreement required two signatures for any check drawn on the
account, and one signature was required to be from a Reliance
representative. Reliance could refuse to countersign any check it
believed was improper. After opening this account, GWC would still
provide payroll information, and Reliance would review the information
for accuracy before countersigning checks and returning them to GWC.
Reliance alone funded the Bank of America account.
On
13 February 1997
Reliance terminated GWC's involvement with the ODOT project, effective
17 February 1997
. On that date a different contractor, Abhe & Svoboda, replaced GWC
and completed the project. The new contractor assumed responsibility for
processing payroll, and Reliance's last payroll payment was made on
21 February 1997
, for work completed during the week ending
15 February 1997
.
In essence,
Reliance acknowledges that it paid weekly payroll from
29 September 1996
through
15 February 1997
based upon invoices of labor GWC submitted to it. The evidence from
Reliance's documents establishes that Reliance controlled the payments
of wages to the workers for that time period. Since it controlled
payroll, and used its own funds to disburse pay, Reliance qualified as
the workers' "employer" under §3401(d)(1).
Reliance
disputes that 26 U.S.C. §3401(d)(1) is applicable. It argues that 26
U.S.C. §3505 is the statute that establishes tax responsibilities for
third parties paying wages. Enacted in 1966, §3505 pertains to third
parties (such as sureties) who make direct payments to employees. It
provides:
(a) direct
payments by third parties. For purposes of sections 3102, 3202, 3402,
and 3403, if a lender, surety, or other person, who is not an employer
under such sections with respect to an employee or group of employees,
pays wages directly to such an employee or group of employees, employed
by one or more employers, or to an agent on behalf of such employee or
employees, such lender, surety or other person shall be liable in his
own person and estate to the United States in a sum equal to the taxes
(together with interest) required to be deducted and withheld from such
wages by such employer.
Reliance
contends in its Reply brief that "Section 3505 is specifically
applicable to the situation in this action where Reliance and [GWC]
established a joint control trust account . . ." Reply at 3.
The court
concludes that §3505 concerns only subsections 3102, 3202, 3402, and
3403 of the Internal Revenue Code, and that these subsections relate to
the amount of taxes to be withheld from an employee's pay. Section
3505(a) pertains to the employee's share of employment taxes and
does not address a third party's liability for the employer's
share of FICA taxes that are at issue in this case. The taxes at issue
in this case arise pursuant to §3111. Reliance is properly construed as
the "employer" under §3401(d)(1), and the government is
entitled to a set-off of the unpaid employer's share of FICA.
CONCLUSION
For the
reasons stated herein, the court grants plaintiff's motion for summary
judgment (doc. #20-1) on its wrongful levy cla