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 claim on the undisputed
grounds that Reliance has a superior interest. The government, however,
is granted summary judgment on its motion (doc. #26-1) as well, because
Reliance qualified as the project workers' "employer" for the
fourth quarter of 1996 and the first quarter of 1997 and is respon sible
for FICA payments. The government is entitled to a set-off of the FICA
amounts due.
Counsel for
the government are ordered to file a proposed Judgment to opposing
counsel and this court by
7 August 1998
. Plaintiff shall file any objections by
14 August 1998
.
IT IS SO
ORDERED.
[98-1 USTC
¶50,168] Titan Indemnity Company, Plaintiff-Appellant v. The Triborough
Bridge and Tunnel Authority, Inc., Quadrozzi Equipment Leasing Corp.,
Quadrozzi Concrete Corp. and Helen Carr Corp., Defendants, Internal
Revenue Service and NYS Dept. of Labor, Defendants-Appellees
(CA-2),
U.S. Court of Appeals, 2nd Circuit, 96-6299, 1/26/98, 135 F3d 831,
Affirming an unreported District Court decision
[Code Sec.
6323 ]
Lien for taxes: State lien law: Funds held in trust: Priority: Claim
of surety.--A surety company's claim did not have priority, ahead of
several other parties including the IRS, with regard to funds withheld
from a contractor following its default on a public improvement
contract. The funds were held in trust under state (
New York
) lien law, which determined the order of priority. The IRS claim for
income and FICA taxes was entitled to first priority after deduction of
a state claim for back wages that had been withheld from the contractor
pursuant to notice before default occurred. The unsupported argument
that state lien law accorded first priority status only to state claims,
not federal tax claims, was rejected.
Neil B.
Connelly, Kroll & Tract,
520 Madison Ave.
,
New York
,
N.Y.
10022
, for plaintiff-appellant. Jeffrey S. Oestericher, United States
Attorney's Office, New York, N.Y. 10007, Patricia Smith, Department of
Labor, New York, N.Y. 10271, for defendants-appellees.
Before: KEARSE
and MCLAUGHLIN, Circuit Judges, and TRAGER, District Judge. *
MCLAUGHLIN,
Circuit Judge:
Titan
Indemnity Company appeals from a judgment of the United States District
Court for the Southern District of New York (McKenna, J.)
determining competing claims to the proceeds of a public improvement
contract. We reject all of Titan's arguments, and affirm the district
court.
BACKGROUND
On
October 26, 1990
, D.H. Farney Contractors, Inc. ("Farney") entered into a
contract with the
Triborough
Bridge
and Tunnel Authority ("TBTA") to repair both the
Triborough
Bridge
and the
Verrazano
Narrows
Bridge
("TBTA Project"). The contract required Farney to get
performance and payment bonds from a surety company. Accordingly, Titan
Indemnity Company ("Titan"), a
Texas
corporation licensed to write surety bonds in
New York
, issued the customary performance bond and a labor and material payment
bond on behalf of Farney. On or about
November 15, 1990
, Farney commenced work.
In the fall of
1991, Farney stopped working on the TBTA project; and sometime
thereafter Farney was declared in default of its contract obligations.
At this time, TBTA held a fund of $97,601.88 that it admittedly owed
Farney for its work ("Contract Fund").
The Contract
Fund lies at the vortex of this litigation. TBTA withheld $91,153.90
pursuant to liens, levies, and restraining orders, including $21,495.65
withheld pursuant to a "notice to withhold" from the New York
Department of Labor (NYDOL). The remaining $6,447.98 was withheld as
"contract retainage," that is, money withheld from each
contract payment as security for future performance.
After default,
TBTA demanded that Titan complete the project. Titan and TBTA entered
into a completion agreement, whereby Titan hired another company as a
completion contractor to finish the job. The repairs were then
completed, and on
June 8, 1994
, the TBTA issued its final certificate of completion.
All the while,
the TBTA continued to hold the $97,601.88 Contract Fund. Five creditors
made claim to this money--(1) the IRS demanded $16,721.39 for income and
FICA taxes that had been withheld on behalf of Farney employees who had
worked on the project; (2) the New York State Department of Labor
(NYDOL) had issued a notice to withhold $48,450, pursuant to §220-b of
New York Labor Law, which represented its estimate of Farney's
liability, including wages, interest, and penalties for failure to pay
two of its employees the prevailing wage rate under New York law; (3)
Quadrozzi Concrete Corp. and Quadrozzi Equipment Leasing Corp.
("Quadrozzi") sought $3,458.30 for concrete and other
materials provided to Farney for the TBTA project; (4) Helen Carr
Construction Corp. asserted a claim arising from an unrelated judgment
against Farney on another project; and (5) Titan, the surety, claimed
the lion's share including $90,350, the amount it had to pay to complete
the project, giving TBTA appropriate credit for the amounts TBTA had
already paid Titan.
The
Lawsuit
In March 1994,
Titan sued in the Supreme Court of the State of
New York
seeking a determination of the parties' rights in, and distribution of,
the Contract Fund. The TBTA filed an answer and an interpleader claim
admitting that it had the Contract Fund and seeking to deposit it with
the court pending adjudication of the parties' claims. As a
disinterested stakeholder, the TBTA made no claim to the Contract Fund.
The IRS
removed the action to the United States District Court for the Southern
District of New York (McKenna, J.) and all the parties moved for
summary judgment. Granting some of the motions and denying others, the
district court made the pivotal ruling that the Contract Fund was a
trust fund under section 70 of Article 3-A of the New York Lien Law
("3-A trust fund"). As such, said the court, the order of
priority for claims against the fund is set forth in Lien Law, Article
3-A, section 77. Accordingly, the court determined that the IRS' claim
for taxes arising from the TBTA project received first priority.
While no one
disputes that the Contract Fund is an Article 3-A trust fund, it is not
as simple as all that. As the district court noted,
New York
has introduced into the calculus the paradoxical notion of
"super-priority," which means that certain claims jump to the
head of the line and are deducted from the Fund before the
priority of the other liens is even evaluated. The district court
determined that under
New York
law some of NYDOL's claims earned "super-priority" status and,
consequently, were deducted from the $97,601.88 Contract Fund before the
other creditors even lined up.
NYDOL's claim
ultimately consisted of three parts: (1) $22,931.50 in back wages owed
because Farney failed to pay an employee the prevailing wage rate under
New York
law; (2) $9,174.22 in interest due on those back wages; and (3) a 25%
penalty assessed for Farney's failure to pay the prevailing wage rate.
The district court ruled that the wages owed and actually withheld by
TBTA pursuant to NYDOL's withholding notice "are properly deducted
from the funds retained by the [TBTA] before they form the corpus of
[the] 3-A trust." Those wage funds, the district court determined,
were entitled to a "super-priority" under section 220-b of the
New York Labor. Accordingly, because the money TBTA actually withheld
pursuant to NYDOL's withholding notice amounted to $21,495.65, the
district court granted NYDOL a "super-priority" for that sum.
The remainder
of NYDOL's claim--$10,610.67 in remaining back wages and interest, and
the 25% penalty--was determined not to enjoy this
"super-priority." Rather, the court determined that the
remaining back wages and interest constituted an Article 3-A trust claim
entitled to second priority after the IRS's tax claim. NYDOL's 25%
penalty claim was not considered an Article 3-A trust claim at all.
Quadrozzi's
claim for payment for materials was treated as an Article 3-A trust
claim and awarded third priority. All the remaining funds were awarded
to Titan as surety.
The claims of
Helen Carr Corp. and the penalty portion of the NYDOL's claim were
granted nothing, the court concluding that those claims did not
constitute trust beneficiary claims under Article 3-A of the New York
Lien Law. The district court determined that NYDOL, insofar as its claim
for the penalty, and Helen Carr would have to pursue their claims
against Farney independently of this action.
The following,
therefore was the ultimate priority and distribution fixed by the
district court:
A. $21,495.65 NYDOL super-priority (money withheld pursuant to
notice)
* * * * *
1. $16,721.39 IRS
2. $10,610.07 NYDOL (remainder of back wages and interest claim
not
covered by money withheld)
3. $ 3,458.30 Quadrozzi
4. $45,316.47 Titan (remainder after above claims satisfied)
----------
Total: $97,601.88
Titan appeals,
arguing that the district court erred: (1) by according priority to the
trust fund beneficiaries over Titan's suretyship claim; (2) by according
NYDOL's claim priority over Titan's claim; (3) by finding that New York
Lien Law, rather than the parties' agreement, established the priority
of claims; and (4) by applying state rather than federal law in
determining the IRS's rights.
DISCUSSION
A.
Titan's Claim v. Article 3-A Trust Fund Beneficiaries
Titan
maintains that the district court erred when it determined that Titan's
claim as a completing surety was inferior to Article 3-A trust claims.
Titan argues that its claim to the Contract Fund is superior to 3-A
trust claims, a priority it earned when it became equitably subrogated
to the rights of both Farney and TBTA in the Contract Fund.
Section 70(1)
of New York Lien Law states that funds "received by a contractor
under or in connection with a contract for . . . a public improvement in
this state, . . . and any right of action for any such funds due or
earned or to become due or earned, shall constitute assets of a
trust." N.Y. Lien Law §70(1). It is undisputed that the proceeds
of the contract at issue are trust funds under Section 70 of the New
York Lien Law.
That said, the
next inquiry is the order of priority. The priority of claimholders is
established by section 77 of the Lien Law. First priority is
given to claims for taxes and for unemployment insurance and other
contributions due by reason of employment. N.Y. Lien Law §77(8)(A).
Second
priority is given to trust claims of laborers for daily or weekly wages.
Id.
at (8)(B).
Third
priority is given to trust claims of laborers for benefits or wage
supplements.
Id.
at (8)(C).
Fourth
priority is given to certain claims to a laborer's wages made by third
parties.
Id.
at (8)(D).
Remaining
trust claims are distributed pro rata. §77(8).
Titan
misunderstands its rights under
New York
law. Generally in a public improvement contract, the contractor is
required to find a surety that will secure the performance of his
contract. Upon default by the contractor, the surety, pursuant to a
performance bond, completes the contract, at its own cost and expense.
It then becomes equitably subrogated to the rights of the contractor and
certain of the rights of the owner in the unpaid balance of the contract
price. See Tri-City Electric Co., Inc. v. New York, 96 A.D.2d
146, 149 (N.Y. App. Div. 1983); Scarsdale Nat'l Bank & Trust Co.
v. United States Fidelity & Guaranty Co., 190 N.E. 330 (N.Y.
1934). Under a performance bond, a completing surety becomes entitled to
the money still owed by the owner to the defaulting contractor, but only
after the claims of all 3-A trust fund beneficiaries are first
satisfied. Tri-City Electric Co., Inc., 96 A.D.2d at 149. It is
perfectly clear that the rights of a surety in the trust proceeds do not
trump those of the Article 3-A trust fund beneficiaries.
Id.
at 152.
Titan places
great faith in Scarsdale Nat'l Bank & Trust Co. v. United States
Fidelity & Guaranty Co., 190 N.E. 330 (N.Y. 1934), to
demonstrate that its claim should have taken priority over the claims of
the 3-A trust beneficiaries. Titan argues that, like the surety in
Scarsdale
, it was entitled to the entire amount of the Contract Fund. Titan's
faith is misplaced.
Scarsdale
dealt with a priority fight between an assignee of a defaulting
contractor and a completing surety. There were no trust beneficiaries.
Scarsdale
held that the assignee was entitled only to whatever rights the
assignor, the defaulting contractor, had. The surety, having completed
the duties the contractor owed to the property owner, became subrogated
to the rights of the owner as against the contractor; and because the
surety completed the project it had a claim to withheld money superior
to the defaulting contractor. A fortiori, the surety also had priority
over the claim of a mere assignee of the contractor.
Scarsdale
and its progeny stand for the unremarkable proposition that an assignee
stands in the shoes of his assignor when it comes to awarding
priorities. The district court's decision is in complete accord with
Scarsdale
. After the claims of all the designated Article 3-A trust
beneficiaries were paid, Titan was awarded the remainder (almost 50%) of
the Contract Fund over the claims of Farney's judgment creditor. It is
entitled to no more.
B.
Titan's Claim v. NYDOL's Claim
Titan
maintains that the district court erred by giving the New York
Department of Labor's claim under section 220-b of New York Labor Law
priority over its claim.
New York Labor
Law §220, known as the "prevailing wage law," requires that
all employees on public work projects be paid the prevailing rate of
wages and supplements for the locality in which the project is located.
N.Y. Labor Law §220. Whenever the Commissioner of Labor determines that
there are unpaid wages or supplements due under a contract that is
subject to the
New York
prevailing wage law, the Commissioner must notify the concerned public
agency to withhold from money due the contractor a sufficient sum to
satisfy the law. 220-b(2)(A).
In the fall of
1991, NYDOL determined that Farney had failed to pay prevailing wages
and supplements to two employees. Following §220-b, NYDOL issued a
notice to TBTA to withhold $48,450.00 from payments due Farney,
representing NYDOL's estimate of underpayments, interest and a possible
penalty. At the time of Farney's default, the TBTA had actually withheld
$21,495.65 from Farney pursuant to this notice.
Titan believes
that the $21,495.65 should not have been awarded to NYDOL because Farney
had already defaulted before NYDOL sent the notice to TBTA to withhold
payment to Farney. Titan argues that, once Farney had defaulted, Farney
was no longer owed any money; and therefore, no money could properly be
withheld pursuant to section 220-b. This argument will not detain us
long, because we do not agree that Farney was already in default when
TBTA received NYDOL's notice.
In August
1995, the Internal Revenue Service submitted a Rule 3(g) Statement
setting forth the facts as to which the IRS believed there was no
genuine issue. In paragraph 8 of the 3(g) Statement, the IRS asserted
that "[a]t the time of Farney's default, the TBTA was holding
$97,601.88 . . . which Farney had earned, but had not been paid under
the Contract." Titan took no exception to this assertion. Because
it is undisputed that the $21,495.65 withheld pursuant to NYDOL's notice
is part of the $97,601.88 TBTA already held at the time of Farney's
default, the IRS's statement obviously means that the $21,495.65 was
held by TBTA at the time of default. Because this money was withheld
pursuant to NYDOL's notice, the notice must have been received by TBTA
prior to Farney's default.
It is well
established that if a party fails to object or respond to the factual
assertions in an opposing party's 3(g) Statement, those factual
assertions will be deemed true. See Champion v. Artuz, 76 F.3d
483, 486 (2d Cir. 1996) (per curiam). This Court has recently cautioned
that it will not accept the "tactic of contending on appeal that
summary judgment was inappropriate on the ground that there were issues
of fact to be tried after [a party] had declined to dispute the
government's Rule 3(g) Statement."
United States
v. All Right, Title and Interest in Real Property and Appurtenances,
77 F.3d 648, 658 (2d Cir.), cert. denied, 117 S. Ct. 67 (1996).
Because Titan did not object to the IRS's implicit statement that Farney
was not yet in default when TBTA received NYDOL's notice to withhold, we
will not entertain an argument that now contradicts an undisputed 3(g)
statement.
Titan makes a
last ditch effort (in its reply brief) to call into question the
granting of "super-priority" to a claim under Labor Law §220-b,
noting that "super-priority" status has to date been granted
only to a perfected mechanic's lien. Titan contends that, because a
labor lien under §220-b is not the equivalent of a mechanic's lien, it
was inappropriate to grant NYDOL's labor lien "super-priority"
status. The core of Titan's argument is that giving any recognition at
all to NYDOL's claim under §220-b was improper because Farney was
already in default when Titan received NYDOL's notice. We have earlier
rejected this argument, supra. Because we find that no substantial issue
has been raised regarding the granting of "super-priority"
status to §220-b claims we will leave resolution of that unbriefed
issue to a more appropriate time.
C.
New York
Lien Law v. the Parties' Surety Agreement
Titan contends
that the district court erred when it determined that the priority of
claims was governed by New York Lien Law rather than by the parties'
surety agreement.
New York Lien
Law specifically establishes the priority of claims to funds received in
connection with a public improvement contract. N.Y. Lien Law §77(8).
Nowhere in Article 3-A of the New York Lien Law does it provide that the
priority of claims prescribed therein is to apply only when the parties
have not otherwise agreed. The purpose of Article 3-A is to safeguard
the rights of those working on construction projects by providing for
the payment of obligations incurred in performing the contract.
See
Atlas
Building
Sys., Inc. v. Rende, 635 N.Y.S.2d 694, 695-96 (2d
Dep't
1997
); Ingalls Iron Works Co. v. Fehlhaber Corp., 337 F. Supp. 1085
(S.D.N.Y. 1972). The statute would be disemboweled if the parties to a
construction contract could provide that one of them is to receive
contract funds ahead of other workers and creditors protected by the
legislature.
Titan concedes
that the trust beneficiaries' claims are valid under New York Lien Law,
but Titan claims it should have received the money first and then been
allowed to settle the trust beneficiaries' claims itself. Such an
arrangement would leave the trust beneficiaries at the mercy of Titan
and therefore, obviously defeat the salutary purpose of Article 3-A.
D.
Federal Law v. State Law
Lastly, Titan
maintains that the district court erred when it determined the priority
of the IRS's tax claim under New York Lien Law rather than federal law.
Section 70 of
the New York Lien Law provides for the creation and enforcement of
statutory trusts out of the funds earned by a contractor working on a
public improvement of real property. The purpose of the trust fund is to
provide for the payment of obligations incurred in performing the
contract, including tax obligations. See Flintkote Co. v. United
States [69-1 USTC ¶9242], 47 F.R.D. 322, 325 (S.D.N.Y. 1969), aff'd
[71-1 USTC ¶9184], 435 F.2d 556 (2d Cir. 1971).
Tax claims
arising from the performance of a public improvement contract are
expressly granted first priority. N.Y. Lien Law §77(8)(A); see also
Onondaga Commercial Dry Wall Corp. v. 150 Clinton Street, Inc., 25
N.Y.2d 106, 110 (1969). These tax claims have often included claims for
federal taxes as well as state and local taxes. See General
Fire-Proof Door Corp. v. Citibank, N.A., 544 F. Supp. 191 (S.D.N.Y.
1982); Marv Laxer Associates, Inc. v. Moredall Realty Corp., 533
F. Supp. 8 (S.D.N.Y. 1981).
Titan makes a
novel and unsupported argument that the provision of Article 3-A
granting tax claims first priority applies only to state and local
taxes, asserting that federal tax claims are governed solely by federal
law. Titan misunderstands the law governing the priority of federal tax
liens.
It is true
that, 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 (1960).
But in Aquilino, the Supreme Court held that it is state law that
determines the nature of the interest each claimant has in disputed
proceeds.
Id.
at 515. For example, it is state law that determines whether a claim is
recognized as an ordinary lien or accorded trust claim status.
Id.
It is
New York
that determines what interest competing claimants have in the proceeds
of a public improvement contract.
New York
has spoken clearly on this issue in Article 3-A, directing that the
proceeds of a public improvement contract constitute a trust for certain
claimants.
New York
has determined that the most important of those claimants, and those
receiving first priority are those asserting tax claims. There is
nothing in Article 3-A or elsewhere that indicates that
New York
chose to limit that priority to only certain types of tax claims. Absent
convincing proof to the contrary, we see no reason to narrow the plain
language of Article 3-A to deny the IRS its claim under New York Lien
Law.
We have
considered all of Titan's additional arguments and find them to be
without merit.
Accordingly,
the judgment of the district court is affirmed.
*
The Honorable David G. Trager of the United States District Court for
the Eastern District of New York, sitting by designation.
[94-2 USTC
¶50,558] Amwest Surety Insurance Company v.
United States of America
U.S.
District Court, Dist. Conn., Civ. 3:92CV00221 (PCD), 9/26/94, 870 FSupp
432
[Code Secs. 6323 and
7426 ]
Priorities: Equitable subrogation: Federal tax lien.--The claim
of a surety company that had issued a performance bond on behalf of a
contractor and that subsequently made payments on that bond when the
contractor defaulted had priority over an IRS tax lien in regards to
certain payments due the defaulting contractor pursuant to the insured
contracts. 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. This assignment was effective
as of the execution date of the bond, signed before the IRS perfected
its tax liens against the contractor. The surety was not required to
file a Uniform Commercial Code financing statement with the state to
perfect its interest in the proceeds of its principal's contract. The
IRS was, thus, ordered to remit to the surety monies the IRS had levied
from a debtor of the contractor.
RULING ON CROSS MOTION FOR SUMMARY JUDGMENT
DORSEY,
District Judge:
Cross motions
for summary judgment are pending in this case. Plaintiff, as surety for
SMP Developers, Inc., was obliged to perform on its bond when SMP
defaulted in the performance of its contract with Credo Housing
Development Corporation. Amwest has made payments of $87,199.89. The
Internal Revenue Service (IRS) assessed SMP for unpaid taxes and filed
liens therefor. It subsequently levied on Credo's payments due SMP.
Credo paid the IRS pursuant to the levy. Amwest claims a priority
interest over the IRS lien and claims a wrongful levy in the payment to
the IRS. I.R.C. §7426 .
Based on stipulated facts, the parties agree their priorities are to be
decided on the cross motions.
FACTS:
On
May 24, 1991
SMP contracted with Credo. Amwest then issued a performance bond naming
financiers, Credo and the State of
Connecticut
, as obligees. Exs. 1 and 2. SMP's failure to pay employees or
subcontractors constituted a default as to Credo. Ex. 1. Work began on
June 2, 1991
and on July 9, Credo paid SMP for work done in June. Through
August 10, 1991
, SMP defaulted on payments owed to employees, Exs. 6, 8, and for
materials, services and equipment used on the job. Checks issued on June
21 and July 14 were not covered by sufficient funds. Credo terminated
the contract by letter dated
August 16, 1991
, Exs. 10, 11, and invoked Amwest's bond obligations. Commencing
September 11, 1991
, Amwest paid $54,523.65 due suppliers and laborers and incurred
$6,471.55 in performance costs. SMP assigned to Amwest, on default, any
and all sums due or to become due pursuant to such contracts. Ex. 3, ¶3A.3.
The assignment was "effective as of the date of each [] bond, but
only in the event of Default . . ." id. A default occurred when SMP
failed "to pay for any labor or materials when such payment [was]
due . . .". Ex. 3, ¶3 C.
On
July 28, 1991
, SMP submitted to Credo its requisition for work performed in July in
the amount of $42,476.64. Ex. 5.
On five dates
in 1989, 1990 and 1991, most recently June 3, 1991, the IRS assessed SMP
taxes totalling $102,957.82. Despite notice and demand for payment, SMP
did not pay. Tax liens arose on the dates of the assessments in favor of
the IRS and against all of SMP's property. Notices of liens were filed
with the Secretary of the State of
Connecticut
on June 25, 1991, in the amount of $36,117.94, and on July 31, 1991, in
the amount of $30,147.55. On August 5, 1991, the IRS served Credo with
copies of the notices of liens and a Notice of Levy.
On August 15,
1991, Credo paid the IRS $42,476.64 requisitioned by SMP and
representing its work in July, 1991.
DISCUSSION:
The question
presented is whether Amwest's claim to a payment due SMP from Credo,
that was subsequently paid to the IRS, is superior to IRS's claim to
that same payment. Amwest began making payments under its bonds on
September 11, 1991. SMP had defaulted on payments for labor and
materials as of August 15, 1991, Additionally, by July 6 SMP had issued
21 checks which were not honored by SMP's bank for want of sufficient
funds. The surety obligation was invoked when Amwest was notified of the
claimed defaults by Credo's letter of
August 16, 1991
. Amwest met its obligations by paying SMP's established obligees and
the expense necessary to complete the project.
During July
1991, SMP performed its contract for which it submitted its invoice on
August 5, 1991
, then becoming entitled to payment therefor.
Plaintiff was
SMP's surety, not its insurer. As surety, Amwest seeks reimbursement for
payments made by receiving the contract payments owed to SMP. Its claim
is for equitable subrogation. Pearlman v. Reliance Insurance Co.,
371
U.S.
132, 136 (1962); Balboa Insurance Co. v. Bank of
Boston
Connecticut
, 702 F.2d 33, 36 (2d Cir. 1983). "When a surety performs its
obligations under a . . . bond, it stands in the shoes of the
contractor. Thus, if the contractor has the right to the retained funds,
the surety accedes to those rights when it meets its obligations
under the bonds."
Id.
at 37. (Emphasis added, citations omitted).
The question
presented is whether the surety's interest in the contract payments,
though not a fully ripened enforceable right when the government
perfected its lien, has nonetheless been endowed with a priority which
defeats the government's claim. Plaintiff's accrual of its interest in
the Credo payments is the date of its bond,
May 24, 1991
.
By that date,
the government on four occasions had assessed taxes on four occasions
totaling $74,934.40. See Stipulation ¶64. It is undisputed that
United States
tax liens arise on the assessment dates against all SMP property. See
Stipulation ¶67; I.R.C. §6322
. Tax liens reach after acquired property. Notices of liens were
filed on June 25 and
July 31, 1991
. Notice perfects liens. Miller v. United States [91-1
USTC ¶50,269 ], 763 F.Supp 1534 (N.D.Cal. 1991).
The
government's claim to the proceeds is based on statutorily created tax
liens, notices of which predated the plaintiff's payments. They also
claim plaintiff is entitled to no relation back of its interest in the
Credo payment.
In 1966
Congress added I.R.C. §6323(c)
which dated tax liens to the date of notice but prioritized certain
security interests over tax liens:
(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.
Id.
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 even if the surety payments
are made after liens are filed. It does not dispute plaintiff's bond as
an obligatory disbursement agreement. See I.R.C. §6323(c)(1)(B)
. What it does dispute is that plaintiff does not meet the
requirement that plaintiff's interest be protected under local law.
Id.
In effect the government argues that plaintiff's claim is not shielded
from a judgment lien which was valid and enforceable at the time of the
filing of the tax liens. Particularly it notes the absence of the filing
of a financing statement to perfect a security interest as required by
Conn.Gen. Stat. §42 -9-302.
It follows says the government that an unperfected security interest
gains no priority over a judgment lien creditor as a matter of state
law, citing Conn.Gen.Stat. §42
-9-301(1)(b). Only the statute is given as authority for the
proposition.
Plaintiff's
claim is premised on I.R.C. §6323
asserting that it should prevail against a theoretical judgment lien
perfected as of the filing of the tax liens. It does however, concede
the lack of any U.C.C. filing. In view of the parties' focus on this
provision, the plaintiff's payment after the lien filings is irrelevant.
The
government's claim is premised on the applicability of the cited U.C.C.
sections. There is no reference in the U.C.C. to sureties. There is no
explicit requirement that sureties file to ensure their claim. It has
been found by this court that the omission was intentional, Recommendation
of the Editorial Board for Changes in the Test and Comments of the
Uniform Commercial Code, U.C.C. §9-312, at 24-5 (Proposed Official
Draft, Text and Comments Edition, 1953), and thus no such filing is
required to perfect a surety's interest in the proceeds of its
principal's contract. Balboa Insurance Co. v. Bank of
Boston
Connecticut
, 702 F.2d 33, 36 (2d Cir. 1983); In re J.V. Gleason Inc.,
452 F.2d 1219, 1222 (8th Cir. 1971); National Shawmut Bank v. New
Amsterdam Casualty Co., 411 F.2d 843 (1st Cir. 1969). In addition,
the U.C.C. does not address a surety claim in its reference to security
interests in "personal property or fixtures." A surety claim
is derived from equity and not from a contract, nor the ordinary
financing contemplated by U.C.C. §9. Further, to create a contract
obligation to its principal, a surety would be obliged to expend funds
to only then to go unreimbursed if required to file to gain a priority
over an earlier filed competing claim. No unfairness to the competitor
results because sureties' involvement in contracts is generally known.
An inequity does result if sureties' later expenditures accrue to the
benefit of prior claims. If sureties were not reimbursed because they
stand in line with other creditors, bonds would not be issued. Finally,
uniformity, the purpose of the U.C.C., is achieved as opposed to
disparate results if states' laws control.
A tax lien has
a priority interest if filed before execution of a bond, but would not
prevail against an unrecorded equitable surety interest from a bond
executed before a noticed tax lien. United States v. Trigg [72-2
USTC ¶9642 ], 465 F.2d 1264 (8th Cir. 1972), cert. den. 410
U.S.
909 (1973);
Kansas City
v. Tri-City Construction Co., 666 F.Supp. 170 (W.D.MO. 1987): Housing
Authority v. General Ins. Co. [75-2
USTC ¶9631 ], 392 F.Supp. 65 (E.D.Mo. 1974). The government argues
that the relation back principle by which a surety's payments make
choate its inchoate claim does not apply. This argument flies in the
face of the Priority Statute of 1966 and the legislative history. See
S. Rep. No. 1708, 89th Cong. 2d Sess., reprinted in 1966 U.S. Code Cong.
& Adm. News 3722, 3730. No convincing authority is cited for the
argument. See The Employers Liability Assurance Corp. v. Crandall,
22
Conn
Supp. 404 (1961). The surety's right to the contract proceeds arises
from its undertaking to guaranty the performance of the contract. The
right to enforce the claim to the proceeds results from making
expenditures in performing the guaranty. This result insures the project
owner against liens otherwise imposable for costs of constructing the
project by having its contract payments apply to the of [sic] the costs
of construction.
Likewise the
government's waiver and estoppel arguments are not substantiated by the
record, by the statutes nor by convincing authority.
CONCLUSION:
As Amwest has
demonstrated that the proceeds payable by Credo were subject to its
equitable rights arising from its bond issued before the tax liens were
perfected by filing, plaintiff's motion (doc. # 12) is granted and
judgment shall enter for plaintiff in the amount of $42,476.54.
Plaintiff may substantiate its claim for interest by a further
submission in support therefor within 10 days hereof. The government's
motion (doc. # 10) is denied.
SO ORDERED.
[96-1 USTC
¶50,222] Capitol Indemnity Corporation, Plaintiff v.
United States of America
, Defendant/ /Third Party Plaintiff v.
Mt.
Vernon
Township
High
School District
201, Third Party Defendant
U.S.
District Court, So. Dist.
Ill.
, 92-CV-4141-JPG,
2/27/96
On remand from CA-7
94-2 USTC
¶50,618 .
[Code Secs. 6323 and
7426 ]
Lien: Priority: Surety's interest: Assignment of funds: Judgment
creditor: State law.--A perfected tax lien placed by the IRS on a
progress payment owed to a construction company had priority over the
claims of subcontractors and of the surety company that finished the
project after the construction company's default. The subcontractors did
not have any property rights to the payment because they failed to
perfect their liens, as required under state (
Illinois
) law. The surety company possessed only an unperfected security
interest in the payment until after the construction company defaulted
on the contract, and the IRS perfected its lien before the default
occurred. Thus, since the IRS was the first party to perfect a lien on
the payment, it was entitled to the funds.
David M.
Duree, Bernard A. Reiner, Joseph M. Krutzsch, Reinhart, Duree &
Crane, P.C., 812 N. Collins, Laclede's Landing, St. Louis, Mo. 63102,
for plaintiff.
Rob
ert L. Simpkins, Assistant United States Attorney, St. Clair County, 9
Executive Dr., Fairview Heights, Ill. 62208, Richard J. Gagnon, Jr.,
David S. Newman, Department of Justice, Washington, D.C. 20530, for
defendant.
MEMORANDUM
AND ORDER
GILBERT, Chief
Judge:
Pending before
this Court is a cause of action remanded from the Seventh Circuit Court
of Appeals for further proceedings consistent with that court's ruling.
[94-2 USTC
¶50,618 ], 41 F.3d 320 (7th Cir. 1994). Prior to the Seventh
Circuit's decision, this Court denied the motion of the
United States
for summary judgment, (Doc. #45), and granted motions for summary
judgment in favor of the plaintiff and the third party defendant. (Doc.
#45).
The facts of
that case are adeptly set forth by the Seventh Circuit, therefore, this
Court will set forth only those facts necessary to clarify this order. B
& H Construction entered a contract to perform asbestos removal
services for the Mount Vernon Township High School District 201
("the District"). The District was to pay for the services of
B & H in progress payments. When B & H failed to perform
properly Capitol Indemnity Corporation ("CIC"), B & H's
surety, stepped in and finished the contract. Prior to B & H's
default on the contract with the District, the Internal Revenue Service
placed a lien on the second progress payment. B & H applied for but
had not received this second payment. CIC brought suit against the
government, challenging the levy as unlawful and claiming that B & H
had no property interest in the $102,341.00 progress payment. CIC also
sought a declaration that it its rights were superior to those of the
United States
, and an injunction prohibiting the
United States
from enforcing the levy. This Court entered judgment in favor of CIC and
the District. Thus, the
United States
was denied recovery of the funds in controversy.
On appeal, Capitol
Indem. Corp. v. United States [94-2
USTC ¶50,618 ], 41 F.3d 320 (7th Cir. 1994), the Seventh Circuit
held that the subcontractors involved in the project had no property
rights in the second progress payment. The Seventh Circuit reasoned that
because the subcontractors failed to perfect their liens, as required
under
Illinois
law. 770 ILCS 60/23 (1994), these subcontractors did not have any
property rights to the payment.
Next, the
Seventh Circuit addressed the property rights that CIC had in the second
progress payment. The court held that CIC only possessed an
"unperfected security interest in the Contract proceeds until the
time B & H actually defaulted and CIC had to perform on the
bonds." Capitol Indem. Corp. v. United States [94-2
USTC ¶50,618 ], 41 F.3d 320, 325 (7th Cir. 1994). Thus, prior to
default by B & H, B & H held the only property interest in
monies already paid. Therefore, CIC had no property interest in any
monies until after B & H's default. The Seventh Circuit further
noted that the Internal Revenue Service placed and perfected the lien on
the progress payment before the District declared B & H in default
on the contract for asbestos removal. This lien "disposes of CIC's
direct rights as assignee as well as its right of equitable subrogation
in other valid claims."
Id.
at 326.
The court
pointed out that the first party to perfect a lien on monies is entitled
to those monies.
Id.
Therefore, the
United States
is entitled to the funds as the first party to perfect a lien on the
second progress payment. The court also dismissed any validity to CIC's
"super-priority" exception set forth in the Internal Revenue
Code.
Id.
at 327.
Accordingly,
Defendant's motion for summary judgment is GRANTED. (Doc. #26).
Capitol Indemnity Corporation's motion for summary judgment (Doc. #32)
is DENIED and Mt. Vernon Township High School District 201's
motion for summary judgment is DENIED. (Doc. #32). Judgment in
the amount of $102,341.00 plus statutory interest from
May 21, 1992
, is GRANTED to the
United States
against Capitol Indemnity Corporation and Mt. Vernon Township High
School District 201. The
United States
is further ORDERED to file a brief, with this Court, setting
forth its calculations as to the amount of interest owed. These
calculations shall be filed on or before
March 14, 1996
.
IT IS SO
ORDERED.
[94-2 USTC
¶50,618] Capitol Indemnity Corporation, Plaintiff-Appellee v.
United States of America
, Defendant- -Third-Party Plaintiff-Appellant v.
Mt.
Vernon
Township
High
School District
201, Third-Party Defendant-Appellee
(CA-7),
U.S. Court of Appeals, 7th Circuit, 93-3633, 11/30/94, Reversing and
remanding a District Court decision, 93-2
USTC ¶50,603
[Code Secs. 6323 and
6331 ]
Lien: Priority: Surety's interest: Assignment of funds: Judgment
creditor: State law.--A notice of levy against a progress payment
due to a construction company (who possessed the sole property interest
in such payment at the time of the tax lien) was valid, and the IRS tax
lien had priority over claims by subcontractors and a surety company
that completed the project. The subcontractors did not have a property
right in the progress payment because they forfeited their priority
interest by not following the procedural prerequisites of the state's (
Illinois
) mechanics lien act. Although a contract assigned the rights of the
contractor to the surety when the payment and performance bonds were
issued, the surety merely had an unperfected security interest until an
actual default by the contractor, which occurred after the IRS lien was
issued. The surety did not fit within the superpriority exception
regarding post-tax lien obligatory disbursement agreements because its
claim was unperfected and, therefore, unprotected under state law (
Illinois
) against a judgment lien.
Before
CUMMINGS, FERGUSON, *
and COFFEY, Circuit Judges.
CUMMINGS,
Circuit Judge.
This appeal
involves competing rights in a "progress payment" earned
during the course of an ill-fated construction contract. The payment was
designated for the general contractor, levied on by the Internal Revenue
Service, and claimed by the completing surety for itself and a host of
subcontractors. On cross-motions for summary judgment, the district
court found that the funds belonged in part to the subcontractors and in
part to the surety. The government has appealed this determination and
we reverse.
FACTS
In May 1991,
Mt. Vernon Township High School District No. 201 (the
"District") contracted (in the "Contract") with B
& H Construction Company ("B & H") for asbestos
removal and other work. B & H was to complete the project by
August 9, 1991
, in time for the new school year. The District agreed to a contract
price of $248,340, due in monthly progress payments upon certification
by the project architect that B & H had completed its work
satisfactorily and paid its subcontractors and suppliers. The monthly
payments would represent the work performed to date, less 10 percent
"retainage" to be withheld until completion of the project and
extinction of all liabilities to subcontractors, suppliers or other
creditors. B & H agreed to obtain performance bonds and payment
bonds for the protection of the subcontractors. The Contract further
provided that "[n]either the Owner nor the Architect shall have any
obligation to pay or to see to the payment of any moneys to any
Subcontractors except as may otherwise be required by law."
Contract article 9, section O.
B & H
procured the necessary payment and performance bonds on May 31, 1991,
from the surety, Capitol Indemnity Corporation ("CIC"), with
whom it had a general indemnity agreement dating back to May 1989 (the
"Agreement"). In the Agreement, B & H assigned all of its
rights under future contracts to CIC; this assignment was subject to
defeat if B & H did not default on its obligations. 1
Section 11 of
the Agreement also purported to create a trust in the contract funds,
"for the benefit of and for payment of all obligations for labor
and material furnished in connection with such contract * * * for which
the Surety would be liable under said bond or bonds" (Gov. Br. App.
39).
Work on the
project commenced on
June 4, 1991
, followed almost immediately by problems: B & H fell behind
schedule, and subcontractors began complaining about delayed or
inadequate payments. The subcontractors did not then or at any other
time file notices of liens pursuant to sec.
23 of Illinois' Mechanics Lien Act, 770 ILCS 60/0.01 et seq., which
governs liens against public funds. The District modified the contract
in an effort to ensure completion before school started but B & H
was unable to make up lost time, and the August 9 deadline came and went
with no end to the work in sight.
By early
September, B & H had completed $143,993 of the work and had
submitted its application for the second progress payment. Hovering over
that sum (which, minus previously paid sums and agreed-upon retainage,
totaled $102,341), however, was the long shadow of the Internal Revenue
Service ("IRS"). In late July 1991, the IRS informed B & H
of a federal tax obligation (unrelated to the District work) in the
amount of $124,448.51. B & H failed to pay this sum and on
September 12, 1991
, the IRS served a notice of levy on the District for all property owned
by B & H and in the District's possession. IRS officials instructed
the District not to pay B & H any money owed it, but instead to send
funds to the IRS.
The District's
architect had forwarded B & H's application for the contested
progress payment to his home office on September 9, 1991, with a
recommendation that it be paid. After hearing about the IRS lien,
however, District officials decided not to issue the funds to B & H.
Although the District's architect formally certified the pay application
on September 17, neither B & H nor the IRS was ever paid. On October
7 the District declared B & H in default, and on October 9 formally
demanded that CIC perform on its bonds and complete the project. 2
CIC finished the job, paid the subcontractors, and received the withheld
payment of $102,341 from the District in May 1992, along with the
remainder of the Contract funds.
CIC
subsequently filed suit against the government, challenging the levy as
unlawful and claiming that B & H had no property interest in the
$102,341 progress payment. CIC sought a declaration that its rights were
superior to those of the
United States
, and an injunction against the
United States
from enforcing the levy. The government responded by counterclaiming
that the progress payment was impressed with the lien, and also by
filing a third-party counterclaim against the District for its failure
to honor the levy.
The district
court granted summary judgment against the government on both claims.
The court held that the Illinois Mechanics Lien Act entitled the
subcontractors to the portion of the progress payment that represented
their work. Therefore, the court found that $85,921.70 was due the
subcontractors and properly paid over to CIC on their behalf. As to the
remaining $16,420, the district court held that the Agreement between
CIC and B & H had transferred any remaining property right in the
progress payment to the surety on the date that CIC issued the payment
and performance bonds. The court concluded that B & H had no
property right in the progress payment, and that the government thus had
nothing to levy against.
DISCUSSION
If B & H
possessed the sole property interest in the progress payment at the time
of the tax lien, the IRS was empowered to levy on those funds and would
prevail in the absence of a prior lien. See Avco Delta Corp. Canada
Ltd. v. United States [72-1 USTC ¶359], 484 F.2d 692 (7th Cir.
1973), certiorari denied, 415 U.S. 931; 26 U.S.C. sec.
6321 . State law governs the initial inquiry of whether the progress
payment constituted property of B & H; federal law determines
whether the state-created property right is one which a tax lien can
reach. Aquilino v. United States [60-2
USTC ¶9538 ], 363 U.S. 509, 512-514. If the progress payment was B
& H's property to which a tax lien could attach, the focus shifts to
examining lien priorities, which requires the application of federal
law.
Id.
at 514.
I.
Property Rights
It is to these
questions that we now turn, with the first step an examination of
whether B & H or some other entity--namely the subcontractors, the
District, or the surety--possessed a property interest in the progress
payment at the time of the IRS lien.
A.
The Subcontractors
We begin by
analyzing the subcontractors' interest. 3
CIC contends that Contract language stating that "Contractor shall
pay each Subcontractor, upon receipt of payment from the Owner, an
amount equal to the percentage of completion allowed to the Contractor
on account of such Subcontractor's work" (Gov. Br. App. 74-75 para.
J) created a trust for the benefit of the subcontractors in which B
& H functioned as a "conduit" with only legal title to the
funds. The above-quoted language manifests no intent to create a trust,
however, but merely indicates that payment of the subcontractors was B
& H's responsibility rather than the District's. The subcontractors'
claim is further diminished by the fact that the Contract does not
establish a discrete trust corpus. B & H was not required to pay the
subcontractors out of specific funds or to turn over portions of the
progress payment directly, but only to pay the subcontractors after the
District paid B & H. See LaThrop v.
Bell
Federal Sav. and Loan Ass'n, 68 Ill. 2d 375, 370 N.E.2d 188 (1977)
(lacking an "express provision in the contract indicating"
that segregation of funds was contemplated, the court found no trust had
been created), certiorari denied [93-2
USTC ¶50,569 ], 436 U.S. 925; see also In re Construction
Alternatives, 2 F.3d 670, 676-677 (6th Cir. 1993) (segregation of
funds critical to finding existence of trust). Section
11 of the Agreement, purporting to create a trust for the
subcontractors and the surety in the Contract proceeds, is mere
boilerplate, which
Illinois
courts generally view with suspicion. See, e.g., G.H. Miller &
Co. v. Hanes, 566 F. Supp. 305, 308 (N.D. Ill. 1983). While the
"boilerplate" characterization is not dispositive, as we will
see, section 11 conflicts
with limitations on rights implicit in the Illinois Mechanics Lien Act.
This fact also militates against imbuing the "trust" provision
with much significance. See In re Wm. Cargile Contractor, Inc.,
151 B.R. 854, 859-860 (Bankr. S.D. Ohio 1993) (finding trust would be
"contrary to requirements under the state mechanic's lien statutes,
since subcontractors would not need to concern themselves with filing
proper liens so long as the surety had executed a trust agreement
similar to the ones herein"); see also Construction Alternatives
[93-2 USTC
¶50,569 ], 2 F.3d at 676-677 (indemnity provision nearly identical
to section 11 did
not create express trust).
The Contract
itself spells out the subcontractors' rights--more precisely, their lack
of rights--in the progress payment. The relevant provision in the
Contract, at article 9 section O, states that "[n]either the Owner
nor the Architect shall have any obligation to pay or to see to the
payment of any moneys to any Subcontractors except as may otherwise be
required by law" (Gov. Br. 22). The first part of this directive
dispenses with CIC's argument that the Contract explicitly contemplates
giving rights in the progress payment to the subcontractors.
Thus CIC must
rely on section O's final clause, which brings into play any state law
that might offer the subcontractors additional recourse. See DC
Electronics, Inc. v. Employers Modern Life Co., 90 Ill. App.3d 342,
348, 413 N.E.2d 23 (1st Dist. 1980) (under Illinois law, "statutory
provisions applicable to a contract * * * are deemed to form a part of
the contract and must be construed in connection therewith"), cited
in Western Waterproofing Co., Inc. v. Springfield Housing Authority,
669 F. Supp. 901, 903 (C.D. Ill. 1987). Relevant here is the section of
the Illinois Mechanics Lien Act, 770 ILCS 60/23, regarding publicly
funded works. 4
The Act endows
"[a]ny person who shall furnish material, apparatus, fixtures,
machinery or labor to any contractor having a contract for public
improvement for any * * * school district * * * in this State" with
"a lien for the value thereof." 770 ILCS 60/23; see also Chicago
Bridge & Iron Co. v. Reliance Ins. Co., 105 Ill. App. 2d 91, 99,
245 N.E.2d 127 (1st Dist. 1969), reversed on other grounds, 46 Ill. 2d
522 (1970). However, sec.
23 requires the would-be lienor to provide written notice to school
officials and the general contractor in order to perfect the lien. 770
ILCS 60/23; Wilbur Waggoner Equipment Rental & Excavating Co. v.
Johnson, 33
Ill.
App. 3d 358, 362, 342 N.E.2d 266 (5th Dist. 1975). None of the
subcontractors in the instant action complied with this procedural
prerequisite; hence they forfeited their inchoate statutory lien. See Board
of Education of School Dist. No. 108 v. Collom, 77 Ill. App. 2d 479,
222 N.E.2d 804 (3rd Dist. 1966) (failure to perfect lien according to sec.
23 places subcontractor in same position as other general
creditors). For subcontractors performing work for public bodies, such
as the District, adherence to the procedural dictates of sec.
23 is a necessary prerequisite to the attainment of rights in a
progress payment.
CIC makes
additional arguments concerning the subcontractors' alleged property
rights in the progress payment, claiming that the subcontractors accrued
rights under an equitable lien theory, as third-party beneficiaries or
under an implied trust. All of these arguments are unavailing.
Illinois
case law recognizes subcontractors' equitable rights in construction
contracts under the above theories in the context of disputes over
retainage fees, which the Avco Delta court described as a sort of
"liquidated damages clause." 484 F.2d at 701. Funds intended
from the inception of a contract to settle potential claims differ
vastly from progress payments, which belong to the free flow of commerce
from the time they are properly paid over. See Northwest Water Comm'n
v. Carlo V. Santucci, Inc., 162
Ill.
App. 3d 877, 895, 516 N.E.2d 287 (1st Dist. 1987) (distinguishing
between retainage and amounts already paid over), appeal denied, 119
Ill.
2d 559, 522 N.E.2d 1247 (1988); see also International Fidelity Ins.
Co. v. United States [92-1
USTC ¶50,004 ], 949 F.2d 1042, 1046 (8th Cir. 1991). We are
therefore unpersuaded by the rationales advanced in the case law
presented by CIC. By failing to adhere to the Mechanics Lien Act, the
subcontractors in this case lost their priority interest in the progress
payment, and cannot be said to have any property right in that sum.
B.
The Surety
But what about
CIC? As the surety, CIC ostensibly succeeded to all of B & H's
rights under the Contract through the Agreement, which assigned these
rights when the payment and performance bonds were issued. If this
assignment were effective as written, then at the time of the IRS lien
the progress payment would have belonged to CIC, not B & H.
The
"assignment," however, simply granted CIC an unperfected
security interest in the Contract proceeds until the time B & H
actually defaulted and CIC had to perform on the bonds. See United
States v. R.F. Ball Construction Co. [58-1
USTC ¶9327 ], 355 U.S. 587 (similar assignment created
"inchoate and unperfected" security interest). In this case,
the Agreement itself was ambiguous in its attempt to create an effective
assignment of rights: as noted above, the boilerplate language in section
11 purported to create a trust in future contract earnings for the
benefit of the surety and the subcontractors. Had the
"assignment" in the Agreement been effective before default,
the "trust" provision would have made no sense. Section
11 's attempted trust is inconsistent with and thus renders
additionally implausible B & H's ostensible assignment of all of its
rights under the Contract to CIC, dating back to the time the bonds were
issued. Prior to default, then, B & H and not CIC had rights in all
monies already paid over. See Fidelity & Deposit Co. of Md. v.
Scott Bros. Const. Co., 461 F.2d 640, 643 (5th Cir. 1972) ("Any
payments made by the owner prior to default * * * are attributable to
the contractor's performance, not the surety's.").
For purposes
of analyzing CIC's direct interest, the question becomes one of timing:
did B & H default before or after the IRS invoked its tax lien? 5
Although the district court reserved judgment on this issue, the record
seems clear as a matter of law that only on
October 7, 1991
, did the District terminate B & H's ability to perform on the
Contract, and only on October 9 was CIC required to perform any of the
duties inherent in its role as surety. While CIC now contends that B
& H's concededly inadequate performance from day one constituted
default, both the surety and the District appear to have anticipated
that B & H would complete the project (albeit behind schedule) up
until the day the IRS notified school officials of the pending lien.
Indeed, the District made substantial efforts through September to
ensure that B & H stayed on the project, frequently modifying the
Contract through written change orders that reduced or altered work
specifications and amounts owed to B & H. The District's actions
served to waive their early opportunities to declare B & H in
default under the Contract, and by extension to postpone CIC's accrual
of rights.
As for the
surety, CIC could not, upon hearing of B & H's performance problems
or liquidity concerns, have forced the District to declare a default.
See
United States
v. Continental Cas.
Co.
, 346 F. Supp. 1239 (N.D. Ill. 1972) (federal government could waive
technical default of contractor despite warnings from surety; fact that
surety's subrogation rights were impaired was less important than
government's interest in completing the job efficiently). As Continental
Casualty makes clear, the District was entitled to exercise
discretion in deciding when to terminate B & H's performance; the
fact that in doing so it curtailed CIC's rights is immaterial.
The conclusion
that B & H did not default until after the IRS issued its lien
disposes of CIC's direct rights as assignee as well as its right of
equitable subrogation in other valid claims. As completing surety, CIC
was subrogated to the rights of several parties: the original
contractor, the subcontractors and suppliers, and the owner (here the
District) for whom the job was completed. See National Shawmut Bank
of
Boston
v.
New Amsterdam
Cas.
Co.
, 411 F.2d 843, 845 (1st Cir. 1969) (surety assumes rights of
numerous parties on contractor's default). The right of subrogation,
which entitled CIC to "step into the shoes" of any party whose
obligations it assumed, would not take effect until CIC actually assumed
these obligations. See American Cas. Co. of Reading, Pa. v. Line
Materials Industries, 332 F.2d 393 (10th Cir. 1964) (noting
"clear distinction" between right of subrogation, which exists
from date bond is executed, and actual subrogation, which occurs only
when payments are made on contractor's default), certiorari denied,
379
U.S.
960.
By the time
CIC could assert its right of subrogation, no claims remained for the
surety to be subrogated to: the subcontractors had lost their potential
interest by failing to file notices of lien, B & H had had its
property subjected to the IRS lien, and the District had neglected to
take the opportunity to declare B & H in default and to withhold the
progress payment on that basis. CIC's claim of subrogation rights, like
its claim to a direct interest in the progress payment, thus fails.
II.
Competing Lien Priorities
Having
rejected CIC's contention that B & H did not have a property
interest in the progress payment attachable by a federal lien, we must
now determine whether CIC has a superior claim as completing surety.
This answer is somewhat more straightforward: they do not. With respect
to lien priorities, the well-known rubric that "first in time is
the first in right" applies in this case.
United States
by and through I.R.S. v. McDermott [93-1
USTC ¶50,164 ], 113 S.
Ct.
1526, 1528, quoting United States v. City of New Britain [54-1
USTC ¶9191 ], 347 U.S. 81, 87. CIC could not prime its
state-created surety's lien until B & H defaulted and when there was
"nothing more to be done * * * --when the identity of the lienor,
the property subject to the lien, and the amount of the lien [were]
established." City of New Britain [54-1
USTC ¶9191 ], 347
U.S.
at 84. In this case, CIC did not step in and begin performing work and
making payments on the project--prerequisites to priming its surety's
lien--until
October 9, 1991
, well after the tax lien was in place.
CIC was also
not entitled to prevail under the "super-priority" exception
set forth in the Internal Revenue Code to give priority to certain
inchoate claims. 26 U.S.C. sec.
6323(c) . That statute provides in pertinent part that:
(1) * * * To
the extent provided in this section, even though notice of a lien
imposed by section
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.
Id.
Although CIC's inchoate lien met the
statutory definition of an "obligatory disbursement
agreement," the surety's claim was not perfected, and thus not
protected under local law against a judgment lien. See 810 ILCS 5/9-302
(
Illinois
law requires sureties to file financing statement in appropriate office
in order to perfect claim). Accordingly, with no protection against a
judgment creditor, CIC has none against the federal tax lien under the
super-priority structure. See Construction Alternatives [93-2
USTC ¶50,569 ], 2 F.3d at 678.
CONCLUSION
In attempting
to persuade this Court that the court below decided correctly, CIC
reserves its most impassioned rhetoric for arguments regarding the
rights of subcontractors to the fruits of their labor. Yet the
subcontractors had available the shelter of the Illinois Mechanics Lien
Act (which they forfeited) and the protection of the payment bond
supplied by CIC (which resulted in their full payment). The party with a
quantifiable monetary stake in this action was CIC, which is in the
business of taking risks and appears to have bet on the wrong horse.
Finding that CIC's claims are without merit and that B & H did in
fact possess a property right in the progress payment which the IRS
properly attached, we reverse the judgment of the district court and
remand for further proceedings consistent with this ruling.
*
The Honorable Warren J. Ferguson, United States Circuit Judge for the
Ninth Circuit, is sitting by designation.
1
The Agreement stated in pertinent part: [B & H does] hereby assign,
transfer and convey to the Surety, all of their right, title, interest
and estate in and to all of their property, real, personal or mixed,
wherever situated or of whatever nature, in which [they] have, or may
hereafter obtain, an interest including but not limited to [rights under
the construction contract], such assignment to be effective as of the
date hereof, subject to being defeated in the event there is no [breach]
of the obligations contained in or covered by [this bond].
2
B & H's owners filed for relief under Chapter 7 of the Bankruptcy
Code on
October 11, 1991
; the corporation itself filed for Chapter 7 relief on
October 30, 1991
.
3
Although the subcontractors press no claim in this action their rights
are nonetheless important: if they originally had a valid claim to the
progress payment, the IRS' attempted lien on the entire sum was
unlawful. Moreover, CIC as surety succeeded to any rights the
subcontractors had under the theory of equitable subrogation.
4
The district court relied exclusively on a 1953 Illinois appellate case,
Rob
ertson v. Huntley & Blazier Co., 351 Ill. App. 378, 115
N.E.2d 533 (4th Dist. 1953), for its conclusion that the subcontractors
had property rights in the progress payment under Illinois law. That
case involved private contracts and invoked a different section of the
Mechanics Lien Act.
Rob
ertson, therefore, is inapposite to the resolution of this case.
5
This question also affects any rights claimed by the District. Upon a
valid declaration of default, the District could legitimately have
withheld unpaid Contract funds in order to finish the project. See Gunther
v. O'Brien Bros. Const. Co., 369
Ill.
362, 364, 16 N.E.2d 890 (1938) (upon a contractor's default prior to the
completion of the work, a public body may use withheld funds to complete
the job), cited in Santucci, 162
Ill.
App. 3d at 894-895. By waiving its right to declare default until after
it had certified the progress payment, however, the District forfeited
its claim in the funds.
[93-2 USTC
¶50,569] In re Construction Alternatives, Inc., Debtor. Indiana
Lumbermens Mutual Ins. Co., Inc., Plaintiff-Appellant v. Construction
Alternatives, Inc., United States of America, Defendants-Appellees
(CA-6),
U.S.
Court of Appeals, 6th Circuit, 92-3961,
8/10/93
, 2 F3d 670. Affirming an unreported District Court decision
[Code Sec. 6323 ]
Priority of tax liens: Surety's interest: State law.--The IRS,
and not a surety, had a priority lien with regard to the proceeds of a
construction contract that were placed in a fund pursuant to the
bankruptcy of a construction company. The company earned the right to
receive the payment that comprised the fund because it had completed the
work on its project at the time that it petitioned for bankruptcy. The
surety's claim to the proceeds was rejected because no express trust had
been created in the suretyship agreement and no constructive trust arose
by operation of law or fact. There is no state (
Ohio
) law that creates a constructive trust in favor of unpaid suppliers or
contractors. Further, the General Agreement of Indemnity did not create
an express trust because it did not require the taxpayer to keep any
portion of its payments as a separate trust fund. Therefore, the
taxpayer was vested with both the legal and equitable interests in the
fund to which tax liens could attach. The tax liens took priority over
the equitable lien claimed by the surety because the equitable lien was
not perfected at the time the tax liens were filed. Affirming unreported
DC Ohio.
Before KEITH
and JONES, Circuit Judges; and BROWN, Senior Circuit Judge.
BROWN, Senior
Circuit Judge.
Appellant
Indiana Lumbermens Mutual Insurance Company ("Lumbermens")
appeals the judgment of the district court affirming the decision of the
bankruptcy court. Lumbermens contends that the bankruptcy court and
district court erred in concluding that the Internal Revenue Service
("IRS") had a lien and that this lien gave it priority to the
proceeds of a construction contract that the debtor-taxpayer,
Construction Alternatives, Inc. ("CA"), received from a
project on which Lumbermens paid as
C.A.
's surety. For the reasons stated below, we AFFIRM the district
court.
I
On
May 16, 1990
, the debtor, CA, an
Ohio
corporation, entered into a contract with the Forest Hills,
Ohio
School District
("
School District
") to remove asbestos from four of its schools. To obtain the
contract, CA was required, under
Ohio
law, to supply a surety bond to assure performance of its obligations
under the contract and to assure that it would pay the subcontractors,
suppliers, and laborers that provided material and labor to the project.
Lumbermens had issued a surety bond on
April 6, 1990
, and the bond was submitted to the
School District
along with CA's bid.
Pursuant to
tax assessments made against CA for unpaid taxes, the IRS filed a notice
of tax lien against CA on
May 14, 1990
in the amount of $13,146.61, and, on
August 20, 1990
, the IRS filed a second notice of tax lien against CA for the
additional amount of $30,194.90. 1
The next day,
August 21, 1990
, CA filed a petition for relief under Chapter 11 of the Bankruptcy
Code.
On August 21,
CA had completed all of its work on the asbestos removal project and was
due to receive its final progress payment; however, CA had not paid all
of its bills arising from the project. Pursuant to its obligation on the
surety bond, Lumbermens paid at least two of the unpaid subcontractors
or suppliers on the project, but the record does not reflect when or how
much it paid them. 2
At the time
that CA filed its bankruptcy petition, CA and the
School District
had not yet agreed on the final amount due on the contract, although, as
stated, the work was completed. On
September 4, 1990
, however, two weeks after CA filed its bankruptcy petition, CA and the
School District
agreed that $39,705 was the correct amount due. On
September 6, 1990
, CA filed a turnover complaint in bankruptcy court, seeking to have the
$39,705 turned over to CA as the debtor-in-possession, and to have the
validity and extent of any claims to the funds adjudicated. The
bankruptcy court entered a turnover order on
September 27, 1990
, and the
School District
paid over the $39,705 to a cash collateral account established for the
purpose of holding this final payment on the contract (referred to
hereinafter as the "Fund"). The order provided that any party
that wished to assert a claim to the Fund would be required to file an
answer or the claim would be lost. Lumbermens and the IRS then filed
answers.
Thereafter, CA
filed a motion for partial summary judgment, alleging that no claimant
to the Fund had a lien superior to the IRS' lien, that the amounts owed
to the IRS exceeded the balance of the Fund, and, therefore, the IRS was
entitled to the whole Fund. Lumbermens also filed a motion for partial
summary judgment, asserting that CA holds the Fund in trust for
Lumbermens' benefit; therefore, it argued, CA only has a legal interest
in the Fund while Lumbermens has the equitable interest; thus, it
contended, its equitable interest had never become part of the
bankruptcy estate and had never been subject to the federal tax liens.
Lumbermens also argued that it has an equitable lien on the Fund,
through subrogation to the rights of the
School District
and the suppliers and subcontractors that it paid, that is superior to
the IRS' lien. Last, Lumbermens contended that it has a lien superior to
any that the IRS might have pursuant to 26 U.S.C. §6323(c)
(1988).
On
September 30, 1991
, the bankruptcy court entered an order granting CA's motion for partial
summary judgment and denying Lumbermens' motion. The court rejected
Lumbermens' contention that CA held the Fund in trust for Lumbermens,
reasoning that no express trust had been created in the suretyship
agreement and that no constructive trust arose by operation of law or
fact; therefore, it held, the Fund was property of CA's bankruptcy
estate to which the tax lien had attached. It also held that Lumbermens
had no equitable lien or interest in the Fund. The district court
affirmed the bankruptcy court, and Lumbermens then appealed to this
court.
Before this
court, it is the position of the IRS that it has a lien on the Fund and
that Lumbermens has no interest in the Fund. It is the position of
Lumbermens that it has an equitable lien or beneficial interest in the
Fund and that the IRS has no lien. It is Lumbermens' alternative
position that, even if the IRS has a lien, Lumbermens' lien or interest
has priority over the lien of the IRS.
II
This court
reviews de novo the decision of the district court reviewing a
grant of summary judgment by the bankruptcy court. Stephens Indus.,
Inc. v. McClung, 789 F.2d 386, 391 (6th Cir. 1988).
III
Lumbermens
first contends on appeal that the bankruptcy court erred in granting
summary judgment to CA on the theory that the IRS has a valid lien
because, it contends, CA has no interest in the Fund to which a tax lien
could attach. This is so, Lumbermens contends, because CA had not, when
it filed its Chapter 11 petition, satisfied all of the requirements of
the contract inasmuch as it had not complied with certain provisions of
Ohio law governing contracts with the state and with certain provisions
in the contract between CA and the School District requiring CA to pay
its subcontractors and materials suppliers. It also contends that,
though CA had completed the work when it filed the Chapter 11 petition,
CA has no interest in the Fund because CA and the
School District
had not agreed on the final amount due on the contract at the time the
bankruptcy petition was filed. Thus, Lumbermens argues, since CA did not
have the right, at the time CA filed its bankruptcy petition, to receive
the final payment, CA has no property interest in the final payment to
which a tax lien could have attached.
The issue we
must initially decide, therefore, is whether CA has an interest in the
Fund to which a tax lien could attach. A tax lien arises "upon
assessment and attaches to 'all property and rights to property, whether
real or personal, belonging to [the taxpayer]' including property which
the taxpayer subsequently acquires." United States v. Safeco
Ins. Co. of Am. [89-1
USTC ¶9227 ], 870 F.2d 338, 340 (6th Cir. 1989) (quoting 26 U.S.C. §6321
(1988)) (alteration in original). State law determines what rights a
taxpayer possesses in property; however, federal law determines whether
those state-created rights are "property" or "rights to
property" under §6321
.
Id.
It is settled that a tax lien can attach to "a taxpayer's interest
in property regardless of whether that interest is less than full
ownership or is only one among several claims of ownership."
Id.
at 341. "Unresolved questions concerning the ultimate ownership of
the property will not prevent provisional attachment of a federal tax
lien."
Id.
In the case at
bar, it is undisputed that the work on the project was complete at the
time that CA petitioned for bankruptcy. There were several bookkeeping
and
admin
istrative matters, pursuant to state law and CA's contract with the
School District, to be completed and several subcontractors to be paid,
but CA owed nothing to the School District, 3
and therefore, no payments to the School District were required or other
expenses incurred to perfect CA's claim to the final progress payment.
Thus, we conclude that CA had earned the right to receive its final
progress payment, and, under the principles stated above, we hold that
the government has two valid tax liens on the Fund. See J.A. Wynne
Co. v. R.D. Phillips Constr. Co. [81-1
USTC ¶9305 ], 641 F.2d 205, 208-09 (5th Cir. 1981). The question to
which we now turn is whether Lumbermens also has a lien on the Fund, and
if so, whether that lien is superior to the tax liens.
IV
Lumbermens
contends that as a surety obligated to pay any unpaid contractors,
laborers, or suppliers on the project, it has an equitable lien on the
Fund, to the extent of its losses, through subrogation to the rights of
the suppliers, laborers, and contractors that it paid in CA's stead, and
also through subrogation to the rights of the
School District
. Citing Western Casualty & Surety Co. v Brooks, 362 F.2d 486
(4th Cir. 1966), a Fourth Circuit case applying
Ohio
law, it contends that its equitable lien relates back to the date the
surety bond was issued.
The nature of
the surety's interest is ascertained by reference to state law. Western
Casualty & Surety Co. v Brooks, 362 F.2d 486, 490 (4th Cir.
1966); see Safeco [89-1
USTC ¶9227 ], 870 F.2d at 341. All parties agree that
Ohio
law controls on state law issues. Under Ohio law, a surety that pays
amounts owed to a subcontractor, laborer, or supplier is subrogated to
the rights of those it has paid and to the rights of those persons whose
obligations the surety has discharged, i.e., the owner and the
contractor.
Ohio
ex rel. Star Supply v.
Greenfield
, 528 F. Supp. 955, 959 (S.D.
Ohio
1981). A surety's rights, however, are no greater than the rights of the
party to whom it is subrogated.
United States
v. Munsey Trust Co., 332
U.S.
234, 241-42 (1947); Miami Conservancy Dist. v. New Amsterdam Casualty
Co., 118 F.2d 604, 606 (6th Cir.), cert. denied, 314 U.S. 640
(1941); Western Casualty, 362 F.2d at 491 (applying
Ohio
law). Therefore, in the instant case, Lumbermens has no greater rights
to the Fund than does the
School District
, CA, or the unpaid subcontractors.
Lumbermens
first contends that it has an equitable lien on the Fund by subrogation
to the rights of the
School District
. It reasons that CA has not earned the right to receive the final
payment on its contract with the
School District
because it failed to complete the contract by failing to pay the
subcontractors. Thus, Lumbermens contends, the School District had a
right to recoup enough of the final payment to pay the subcontractors
and, therefore, Lumbermens has the same right to recoup from the Fund
through subrogation to the rights of the
School District
.
The contract
between CA and the School District required the School District to
disburse payments to CA under a "progress payments"
arrangement: every two weeks, CA could request another progress payment,
and the amount due would be determined by the value of the work that CA
had done during the two-week period. Further, the
School District
had no right, under its contract with CA, to retain any portion of the
progress payments to CA pending CA's payments of subcontractors and
suppliers. Once the work and bookkeeping details were completed, the
final payment was due and was made, and, as we have previously noted,
the
School District
had no right to retain the final progress payment. Thus, in short, the
School District has no claim to the Fund under the terms of its contract
with CA, and likewise, Lumbermens has no claim to the Fund through
subrogation to the rights of the
School District
. Western Casualty, 362 F.2d at 492.
Lumbermens
contends, however, that under the rule in Pearlman v. Reliance Ins.
Co., 371 U.S. 132 (1962), it has an equitable lien on the Fund that
is superior to the tax lien. We disagree. There, a contract between a
contractor and the government provided that a certain percentage of each
progress payment would be retained by the government to pay any unpaid
suppliers or subcontractors. The Supreme Court held that the surety had
an equitable lien on the retained funds through subrogation to the
rights of the government, the subcontractors that the surety had paid,
and the bankrupt contractor itself.
Id.
at 141. In the case at bar, however, the contract between CA and the
School District
, as heretofore pointed out, provided for no such retained fund. The
Fund is simply the final progress payment on the contract and the
School District
has no further rights in the payment because the contract was complete.
The
School District
was nothing more than a stakeholder. Western Casualty, 362 F.2d
at 492.
Lumbermens
also contends that it has a claim to the Fund through subrogation to the
rights of the unpaid subcontractors, the two unpaid contractors whom it
paid. Again, we disagree. Under
Ohio
law, when a subcontractor, laborer or supplier files a mechanics lien
against a state project and proper notice of the lien is given to the
state entity, such entity is then obligated to retain money from
payments to the general contractor in an escrow account in an amount
sufficient to satisfy the mechanics lien. Ohio Rev. Code Ann. §1311.28
(
Anderson
1958);
Ohio
ex rel. Star Supply v.
Greenfield
, 528 F. Supp. 955, 959 (S.D.
Ohio
1981). But, if the unpaid supplier or contractor does not file a
mechanics lien, the governmental entity is not obligated or permitted to
retain money from the contractor, and the unpaid suppliers and
subcontractors have no rights to the progress payment. In the instant
case, none of the unpaid suppliers or subcontractors filed a mechanics
lien, so the School District was not required or permitted to retain any
money from the progress payments to satisfy obligations to unpaid
suppliers and subcontractors; thus, the
School District
has no rights to the Fund to which Lumbermens can be subrogated.
Further, under
Greenfield
, subcontractors and suppliers that do not file a mechanics lien have no
rights in the Fund.
Id.
at 959. In this priority contest against the IRS, an unsecured creditor
loses, and therefore, Lumbermens, which is subrogated to the rights of
the
School District
or an unsecured supplier or subcontractor, must lose.
Even assuming
that Lumbermens does indeed have an equitable lien on the Fund through
subrogation, Lumbermens would still lose in a priority contest with the
IRS. As the Supreme Court has recently held, federal tax liens do not
"automatically have priority over all other liens"; rather,
they follow the "first in time, first in right rule"; however,
a state law lien is not first in time unless it is "perfected"
at the time the notice of the federal tax lien is filed. United
States ex rel. Internal Revenue Serv. v. McDermott [93-1
USTC ¶50,164 ], 113
S. Ct.
1526, 1528 (1993). "Perfected" for purposes of the federal tax
lien statute means that the identity of the lienholder, the property
subject to the lien, and the amount of the lien are certain.
Id.
; United States v. Pioneer Am. Ins. Co. [63-2
USTC ¶9532 ], 374 U.S. 84 (1963).
In the case at
bar, the amount of Lumbermens' alleged equitable lien was not certain at
the time that the tax liens were filed because the amounts owed to the
unpaid persons on the project were not yet certain. Thus, the equitable
lien, if indeed it exists, was not "perfected" when the tax
liens were filed and, therefore, the tax liens take priority.
V
Lumbermens
next contends that the tax liens did not attach to the Fund because, it
contends, CA holds the Fund as Lumbermens' trustee under the General
Agreement of Indemnity, which CA executed with Lumbermens as part of the
bonding undertaking; therefore, it contends, CA has no more than a legal
interest in the Fund, while Lumbermens holds the equitable interest. 4
Since CA has only a legal interest in the Fund, Lumbermens contends, the
tax lien only attached to the legal interest and the equitable interest
is not subject to the tax lien. Therefore, if the Fund were determined
to be subject to a trust, Lumbermens' equitable interest would not be
subject to the IRS' liens.
There are two
situations in which the Fund could be subject to a trust: 1) Ohio law
provided that a portion of the progress payments were subject to a
constructive trust for the benefit of unpaid suppliers and
subcontractors; or, 2) the suretyship agreement created an express trust
with the Fund as the trust corpus. There is no
Ohio
law that creates a constructive trust in favor of unpaid suppliers or
contractors. The only case that Lumbermens cites in its favor is a Third
Circuit case, Universal Bonding Ins. Co. v. Gittens & Sprinkle
Enters., Inc., 960 F.2d 366 (3rd Cir. 1992). There, the Third
Circuit held that funds paid by the state to a bankrupt general
contractor were held in trust pursuant to a
New Jersey
statute and were not part of the bankruptcy estate. Since, however,
Ohio
has no such statute, as the district court pointed out, Universal
Bonding does not apply to the facts of this case. We conclude that
no trust was created by operation of
Ohio
law.
Further,
contrary to Lumbermens' contention, we conclude that the General
Agreement of Indemnity does not create an express trust. To create an
express trust in
Ohio
, there must be a manifestation of intent to create a trust, there must
be created a trust corpus, and there must be a fiduciary relationship
between the trustee and the beneficiary. Brown v. Concerned Citizens
for Sickle Cell Anemia, Inc., 382 N.E.2d 1155, 1158 (
Ohio
1978). With respect to the creation of a trust, this court has stated,
applying
Ohio
law:
It is a
well-settled principle of law in this and other jurisdictions that if
one person pays money to another it depends upon the manifested
intention of the parties whether a trust or a debt is created. If the
intention is that the money shall be kept or used as a separate fund for
the benefit of the payor, or a third person, a trust is created. If the
intention is that the person receiving the money shall have the
unrestricted use thereof, being liable to pay a similar amount whether
with or without interest to the payor or to a third person, a debt is
created. The intention of the parties will be ascertained by a
consideration of their words and conduct in light of surrounding
circumstances.
Federal
Ins. Co. v. Fifth Third Bank, 867
F.2d 330, 333 (6th Cir. 1989) (quoting Guardian Trust Co. v. Kirby,
199 N.E. 81, 83 (1935)). In this case, no provision of the General
Agreement of Indemnity required CA to keep any portion of the progress
payments as a separate trust fund, and the record does not indicate that
CA kept the progress payments in a separate account. Thus, since there
was no trust corpus, no trust was created. Accordingly, we conclude that
CA was vested with both the legal and equitable interests in the Fund to
which the tax liens could attach, and that Lumbermens was not vested
with an equitable interest by the General Agreement of Indemnity.
VI
Lumbermens
next contends that under the federal tax lien statute, sureties' liens
are given priority over tax liens, even if they are not yet
"perfected" at the time of tax lien filing. Title 26 U.S.C. §6323(c)
does indeed give priority to certain liens and security interests
that are inchoate when the tax lien is filed. Section
6323(c) provides that a tax lien is primed by a surety's
"security interest," even though the surety's "security
interest" came into existence after the tax lien was filed, under
the following circumstances: (1) the surety's "security
interest," as here, is an obligatory disbursement agreement such as
a suretyship agreement; (2) as here, the surety's interest is in
"qualified property" 5
covered by the terms of a written agreement entered into before the tax
lien filing; 6
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.
26 U.S.C. §6323(c) (1988).
7
Lumbermens contends, relying on the General Agreement of Indemnity, that
under §6323(c) its
"security interest" is superior to IRS' tax liens.
We, however,
conclude that the General Agreement of Indemnity does not create a
security interest. Subsection 6323(h) states that a "security
interest" exists if "the property is in existence and the
interest has become protected under local law against a subsequent
judgment lien creditor." 26 U.S.C. §6323(h)
(1988). Before Lumbermens' alleged "security interest" in
the Fund would take priority over a subsequently-arising judgment lien
under local law, Lumbermens would have been required to perfect its
"security interest" by filing a financing statement in the
appropriate office. Ohio Rev. Code Ann. §§1309.21, 1309.23 (
Anderson
Supp. 1992). Lumbermens did not do so; thus, we conclude that Lumbermens
does not possess a "security interest" under §6323(c)
, and, therefore, the IRS has priority to the Fund.
VII
The judgment
of the district court is AFFIRMED.
1
The IRS also served a levy on the
School District
on
August 9, 1990
.
2
In its motion for summary judgment in bankruptcy court, Lumbermens
appended to the motion copies of two documents furnished by Central
Acoustical Supply House and Grayling Industries, releasing it from any
further obligation to them. The amount that Lumbermens paid them,
however, is not specified.
3
As will be seen, the
School District
had no right under its contract with CA to retain any portion of
progress payments to insure payment of unpaid suppliers and
subcontractors.
4
The portion of the General Agreement of Indemnity upon which Lumbermens
relies provides:
[I]t is
expressly understood and declared that all monies due and to become due
under any contract or contracts covered by the Bonds are trust funds,
whether in the possession of the Indemnitor or Indemnitors [CA] or
otherwise, for the benefit of and for payment of all such obligations in
connection with any such contract or contracts for which the Surety
[Lumbermens] would be liable under any of said Bonds, which said trust
also inures to the benefit of the Surety for any liability or loss it
may have to sustain under any said Bonds, and this Agreement and
declaration shall also constitute notice of such trust.
J.A. at 39.
5
"Qualified property" includes "the proceeds of the
contract the performance of which was ensured" by the surety bond.
26 U.S.C. §6323(c)(4)(C)(i)
(1988).
6
The General Agreement of Indemnity, which is part of the bonding
agreement between CA and the
School District
, provides:
[T]his
Agreement shall constitute a Security Agreement to the Surety and also a
Financing Statement, both in accordance with the provisions of the
Uniform Commercial Code of every jurisdiction wherein such Code is in
effect and may be so used by the Surety without in any way abrogating,
restricting or limiting the rights of the Surety under this Agreement or
under law, or in equity.
7
Section 6323(c) provides in relevant part:
To the extent
provided in this subsection, even though notice of a lien imposed by section
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.
[92-1 USTC
¶50,004] International Fidelity Insurance Company, Appellee v.
United States of America
, Appellant
(CA-8),
U.S.
Court of Appeals, 8th Circuit, 90-2974EM,
11/27/91
, 949 F2d 1042, 949 F2d 1042. Affirming and reversing an unreported
District Court decision
[Code Sec. 6323 ]
Federal tax lien: Priority: Surety's agreement: Progress payments.--A
competing surety's equitable lien on progress payments retained by the
owner or obligee arose under state law (
Missouri
) on the date the contractor defaulted; the surety's lien did not relate
back to the date the performance bond was executed. The IRS was entitled
to progress payments seized pursuant to one tax levy because it properly
perfected its lien and served the corresponding tax levy for the
contractor's unpaid payroll taxes before the contractor began the work
covered by the taxpayer's surety bond. The contractor could not have
been in default, and thus the surety could not have a lien, before work
began. However, the surety was entitled to a refund of the amount seized
pursuant to the second tax levy because the IRS filed notice of that
lien after the contractor defaulted and the surety had a lien.
Before ARNOLD,
Circuit Judge, HEANEY, Senior Circuit Judge, and GIBSON, Circuit Judge.
ARNOLD,
Circuit Judge:
This is a
dispute over who is entitled to two progress payments earned by a
contractor, Prudential Construction Systems, Inc., which defaulted on
its obligation to install drywall at a construction site. The
government, on behalf of the Internal Revenue Service, claims that it is
entitled to the funds because Prudential has an outstanding tax debt.
International Fidelity Insurance Company, which assumed Prudential's
obligations after it defaulted, claims that it is entitled to the
payments as Prudential's surety on the construction contract. Responding
to cross-motions for summary judgment, the District Court held for
International Fidelity. International Fidelity Ins. Co. v.
United States
, 745 F. Supp. 578 (E.D. Mo. 1990). On the government's appeal, we
affirm in part and reverse in part.
I.
The parties
stipulated to the following facts. On
November 13, 1987
, Prudential agreed to install drywall at a St. Louis Housing Authority
construction site. In order to guarantee completion of Prudential's work
on the job and the payment of any bills it incurred in connection with
the job, International Fidelity issued surety bonds on
November 19, 1987
, on behalf of Prudential as principal and the Housing Authority as
obligee.
Prudential
began its full-time work on the job on
June 13, 1988
. Despite Prudential's promise to complete its work by the end of July,
it did not do so. Although the general contractor threatened on August 9
to have Prudential's work completed for it if it did not complete its
work by August 12, Prudential's workers remained at the site through the
beginning of September. At that point, Prudential hired another
contractor to complete its work, but that contractor quit in mid-October
before completing the job because Prudential did not pay it.
On
September 22, 1988
, the Housing Authority warned Prudential in writing that it would
replace Prudential if it did not complete its work on that date. That
same day, the Housing Authority suspended further payments to
Prudential. International Fidelity learned of these problems from the
Housing Authority on October 7. On
October 18, 1988
, the Housing Authority terminated Prudential. The next day, the
Authority contacted International Fidelity and asked it to complete
Prudential's job as surety. By paying the contractor Prudential had not
paid and by hiring another contractor to complete the job, International
Fidelity honored its obligations. Thus far International has spent a
total of $48,388.50 pursuant to the bonds, with additional unpaid claims
of $16,699.52 for labor and materials.
Prudential's
inability to complete its contract with the Housing Authority was only
one of its problems. On
September 14, 1987
, and
November 3, 1987
, the IRS assessed against Prudential unpaid payroll taxes in the amount
of $38,616.23. The IRS filed a notice of tax lien for this deficiency on
March 22, 1988
. On June 7, 1988, the IRS served a tax levy on the Housing Authority
demanding that it pay any money it owed to Prudential to the IRS in
order to satisfy the tax deficiency. In response to the levy, the
Housing Authority paid $31,067.00--representing earned but unpaid
payments for work in progress--to the IRS on
August 8, 1988
.
The IRS served
the Housing Authority with a second tax levy for any money owed to
Prudential on
August 30, 1988
. This levy reflected three assessments for unpaid payroll taxes made
against Prudential: one on
March 25, 1985
, with a tax lien filed on
December 16, 1988
; a second on
June 27, 1988
, with a tax lien filed on
November 28, 1988
; and a third on a unknown date, without a tax lien's being filed. The
Housing Authority again complied with the IRS's request by paying the
IRS $16,562.28--this money was also earned for work in progress, but had
yet to be disbursed--on
September 28, 1988
. As of that date, the Housing Authority had not yet terminated its
contract with Prudential. Prudential's workers, however, were no longer
on the job site.
In February
1989, International Fidelity brought this wrongful-levy action against
the government under 26 U.S.C. §7426
to recover the funds the Housing Authority paid to the IRS. It
argued that as a completing surety, it had an equitable right of
subrogation to the progress payments which dated back to the execution
date of the surety bonds. Since International Fidelity issued the surety
bonds prior to both of the tax levies, it argued that its claim had
priority over the IRS's liens. The District Court adopted this reasoning
and entered judgment for International Fidelity. The government
appealed.
II.
In granting
summary judgment in favor of International Fidelity, the District Court
did not cite any provisions of the Internal Revenue Code. The parties
agree, however, that 26 U.S.C. §6323(c)
governs resolution of this case. We quote its relevant provisions:
Protection for
certain commercial transactions financing agreements, etc.
(1) In
general. To the extent provided in this subsection, even though notice
of [tax] 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--
(i) . . . ,
(ii) . . . ,
or
(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.
Section
6323(c) gives
certain claims which were not choate at the time of the tax-lien
filing--i.e., definite in amount--priority over the federal tax lien.
The dispute in this case, then, is over whether International Fidelity's
claim to the progress payments qualifies for priority under the statute.
The parties
agree that International Fidelity's interest in the progress payments
meets most of the requirements of §6323(c)
. There is no claim that International Fidelity's interest in the
progress payments was choate at the time the IRS served the tax levies.
The progress payments are "qualified property" covered by a
written surety agreement or "obligatory disbursement
agreement" entered into by International Fidelity in the ordinary
course of its business. See 26 U.S.C. §6323(c)(4)
(defining "qualified property" and "obligatory
disbursement agreement"). The parties also agree that the relevant
"local law" for purposes of §6323(c)(1)(B)
is the law of
Missouri
.
The source of
contention is whether International Fidelity's claim is "protected
under local law against a judgment lien arising, as of the time of tax
lien filing, out of an unsecured obligation." As a preliminary
matter, International Fidelity argues that this provision gives the
government only a judgment under
Missouri
law, not a lien. In order to establish a lien on Prudential's progress
payments, International argues, the government must execute upon the
judgment by providing "proper service of garnishment."
Appellee's Brief at 13. Since the government did not secure a lien in
accordance with
Missouri
law, International claims the government has no right to the funds. We
decline International Fidelity's invitation to read "lien" out
of the phrase "judgment lien." For purposes of the statute,
"judgment lien" means the government is assumed to have a lien
on the funds that has been perfected as a matter of local law. The focus
of the "local law" dispute is not whether the government has a
perfected lien, but whether International Fidelity's claim would
nevertheless take priority over it.
Only if
International Fidelity's claim has priority under
Missouri
law over a judgment lien obtained on the same date as the tax lien can
it prevail. International Fidelity argued below, and the District Court
agreed, that under
Missouri
law it had an equitable right of subrogation to the progress payments
which related back to the date it issued the bonds. Since the bonds
issued on
November 19, 1987
--long before the government's tax liens--International Fidelity's
equitable right to the funds preceded and therefore had priority over
the government's liens. Under this view, the actual date of Prudential's
default--which triggered the surety's obligation to perform under its
bonds--is irrelevant. We disagree with this interpretation of
Missouri
law.
The District
Court adopted the analysis used in Kansas City, Missouri v. Tri-City
Construction Co. [89-1
USTC ¶9148 ], 666 F.Supp. 170, 173 (W.D. Mo. 1987), that
"[s]uretyship law provides the surety an equitable lien to funds
owing to a principal upon the surety's performance of the principal's
obligation, which relates back to the time the contract of suretyship
was executed." Relying on this general principle, the
Tri-City Court
held that a completing surety's claim to undisbursed progress payments
had priority over a federal tax levy served after the date of execution
of the suretyship agreement. In our view, Tri-City was wrongly
decided in this respect.
Missouri
decisions do contain language to the effect that a surety's interest in
money retained by an obligee or owner relates back to the date of
execution of the suretyship agreement. See, e.g., United States
Fidelity & Guar. Co. v. Missouri Highway and Transp. Comm'n, 783
S.W.2d 516, 521 (Mo.App. 1990); Division of Employment Security v.
Trice Constr. Co., 555 S.W.2d 65, 67 (Mo. App. 1977). These cases,
however, involved retainages--percentages of progress payments withheld
by the owner or obligee until successful completion of the contract--not
undisbursed progress payments. The dispute here does not concern which
party is entitled to the contract retainage of $15,127.33 currently held
by the Housing Authority. Indeed, the government concedes that
International Fidelity has priority to these funds as the party which
successfully completed the contract. 1
While the
completing surety's equitable lien on the retainage relates back to the
date of the suretyship agreement, its lien on progress payments does
not. In National Surety Corp. v. Fisher, 317 S.W.2d 334 (Mo.
1958), the Missouri Supreme Court held that a surety's equitable lien on
progress payments made to a contractor prior to the contractor's default
did not relate back to the date of the suretyship agreement. The Court
noted the
Missouri
general rule "that when sums earned under the contract are paid
generally to the contractor, such funds are thereby freed of any equity
or right of subrogation in the surety."
Id.
at 345. The animating principle behind the general rule is the free flow
of commerce: parties which receive the progress-payment funds from the
contractor should not have to concern themselves with potential future
claims to the money.
It is true
that National Surety Corp. involved progress payments already
made to a contractor, instead of being held by the owner or obligee as
was the case here. The policy of not encumbering earned progress
payments with potential future liens applies equally, however, to those
payments not yet in the hands of the contractor. In First State Bank
v. Reorganized School District R-3, 495 S.W.2d 471 (Mo.App. 1973),
the Missouri Court of Appeals was presented with the issue of which of
two claimants had priority to a retainage and an undistributed progress
payment of a defaulting contractor held by an obligee: a surety which
completed the contract or a bank which had been assigned the contract's
proceeds after execution of the suretyship agreement.
Consistently
with the
Missouri
cases we have cited, the Court held that the surety had priority to the
retainage because its equitable lien related back to the execution of
the performance bond. The Court was not willing, however, for the
surety's interest in an undisbursed progress payment to relate back to
the same date. Rather, the Court held that the surety's interest in an
earned, but undisbursed, progress payment did not arise until the date
of the contractor's default. If the default occurred before the progress
payment was due, then the surety was entitled to the progress payment.
Since the lower court had not addressed the issue, the Court remanded
the case for a determination of the contractor's default date.
The rationale
of First State Bank governs here. 2
International Fidelity's claim of priority to Prudential's progress
payment depends upon the date of Prudential's default. If Prudential
defaulted before the IRS filed its notices of tax lien, then
International Fidelity has priority to the funds over the government. On
the other hand, if Prudential defaulted after the IRS filed the tax
liens, the IRS was free to seize the funds to satisfy Prudential's
outstanding tax debt. As we have noted earlier, the District Court
relied on the relation-back doctrine and therefore did not address the
issue of Prudential's default date.
Despite the
significance of Prudential's default date, we need not pinpoint it
exactly in order to decide which party has priority to the funds in this
case. The government is entitled to the funds it seized pursuant to the
first tax levy. The IRS filed its first notice of tax lien on
March 22, 1988
, and served the corresponding tax levy on the Housing Authority on
June 7, 1988
, for $38,616.23 in unpaid payroll taxes. Since Prudential began its
full-time work on the Housing Authority project on
June 13, 1988
, and originally promised to complete its work by the end of July, it
could not have been in default as of March 22. The IRS is therefore
entitled to the $31,067.00 seized pursuant to the first tax levy.
International
Fidelity, however, is entitled to the funds seized pursuant to the
second tax levy. Although the IRS served the second tax levy for three
assessments of deficiency on
August 30, 1988
, it never filed a tax lien with respect to one of the assessments, and
did not file tax liens for the other two until November 28 and
December 16, 1988
. The crucial date for deciding whether a claim is protected under local
law pursuant to §6323(c)
is "the time of tax lien filing[.]" For purposes of §6323
, "tax lien filing" means "the filing of notice . . .
of the lien imposed by [the assessment of taxes]." 26 U.S.C. §6323(h)(5)
. The government claims that its tax levy of
August 30, 1988
, is equivalent to a tax-lien filing under §6323
. Our response to the government's argument is the same response we
earlier gave to International Fidelity: we decline to ignore the plain
language of the statute. 3
The statute speaks of the date of tax-lien filing, not the date of a tax
levy. Even under the government's theory of the case, Prudential had
defaulted by
November 28, 1988
. Therefore, at the time of tax-lien filing, International Fidelity had
priority to the funds under local law.
III.
To summarize:
we reverse the judgment of the District Court with respect to the first
tax levy. Accordingly, judgment for the government shall be entered in
the amount of $31,067.00. We affirm the judgment of the District Court
with respect to the second tax levy. International Fidelity is entitled
to these funds as the completing surety. The cause is remanded to the
District Court with directions to enter judgment in accordance with this
opinion.
It is so
ordered.
1
Despite the presence of general language in support of its position, we
find International Fidelity's reliance on Housing Authority of
Mexico, Missouri v. General Insurance Co. of America [75-2
USTC ¶9631 ], 392 F.Supp. 65 (E.D. Mo. 1974), misplaced. General
Insurance involved priority to a retainage, not progress payments.
Moreover, the opinion did not cite any
Missouri
law on the issue.
2
It is true that in United States v. Trigg [72-2
USTC ¶9642 ], 465 F.2d 1264, 1271 (8th Cir. 1972), cert. denied,
410 U.S. 909 (1973), we indicated that a surety would be entitled under
26 U.S.C. §6323(c) to
a contractor's progress payments levied upon by the IRS prior to the
contractor's default date. This language from Trigg, however, is
dictum. In Trigg, the surety did not make any payments under its
agreement with the contractor. Three individuals who agreed to indemnify
the surety made the payments. The dispositive question was whether the
individuals agreed to indemnify the surety in the ordinary course of
their business as required by §6323
. The Court disposed of their claim when it answered no to this
question. Moreover, the local law applicable to the dispute in Trigg
was the law of
Arkansas
.
3
While it is true that the levy brings the funds within the constructive
possession of the government, this does not mean--contrary to the
government's assertion--that International Fidelity cannot later prove
it had a superior right to the funds at the time of the levy. If we were
to hold otherwise, we would eliminate the ability of claimants to bring
wrongful-levy actions against the government.