Surety's Interest Page1

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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.

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MEMORANDUM OPINION AND ORDER

GODBEY, District Judge: Before the Court is Appellant American States Insurance Co.'s ("ASIC") appeal from the Bankruptcy Court's Orders of January 13, 2004 and March 8, 2004 . Because the Court determines that the Bankruptcy Court failed to give full effect to Pearlman v. Reliance and unduly limited a surety's equitable subrogation right under Texas common law, the Court vacates those orders and finds for ASIC.

I. BACKGROUND

On August 28, 2000 , Debtor SSEM Corp. ("SSEM") entered into a subcontract with Manhattan Construction Co. (" Manhattan ") as general contractor in connection with the City of Dallas Convention Center Expansion and Renovation (the "Project"). ASIC, as surety, issued both performance and payment bonds for the Project on behalf of SSEM and for the benefit of Manhattan . SSEM performed some work on the subcontract and then defaulted.

Pursuant to the subcontract, SSEM was to submit payment applications monthly for work done. The subcontract further provided that Manhattan was not required to pay SSEM in the event of default, and could retain 5% of the amounts earned by SSEM. Apparently pursuant to those two provisions, Manhattan withheld approximately $88,631.73 (the "Withheld Balances"). Following SSEM's default, ASIC as surety paid $430,806.66 to complete SSEM's work on the Project.

On April 11, 2003 , SSEM filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code, which was converted to a Chapter 7 case. One of SSEM's significant creditors was the Internal Revenue Service ("IRS"), which had filed a pre-petition lien against SSEM for unpaid payroll taxes exceeding $500,000. On August 7, 2003 , the United States , on behalf of the IRS, filed a motion for relief from automatic stay, claiming that the Withheld Balances were property of the SSEM estate, and that the IRS had a priority claim on the Withheld Balances due to its pre-petition liens. ASIC disagreed with the IRS's motion and filed its own motion for relief from automatic stay on August 12, 2003, arguing that it was entitled to the Withheld Balances under its equitable subrogation rights and that the Withheld Balances were never earned by SSEM and thus never became part of the estate. The Trustee opposed the IRS's motion on the basis that the IRS tax lien may be subordinated to other claims under Section 724 of the Bankruptcy Code.

On January 13, 2004, the Bankruptcy Court entered its thoughtful and scholarly order (the "Order") denying both motions for relief from automatic stay, and ordering that the Withheld Balances be turned over to the Trustee. ASIC timely moved for reconsideration. On March 8, 2004 , the Bankruptcy Court issued an order denying the motion for reconsideration, except that it vacated that part of the Order requiring payment of the Withheld Balances to the Trustee. ASIC timely appealed from both of those orders.

This Court has jurisdiction to "hear appeals from final judgments, orders, and decrees from a bankruptcy court." 28 U.S.C. §158(a)(1). On appeal, this Court applies the same standard of review as a court of appeals would use reviewing a district court ruling. Id. §158(c). "[C]onclusions of law are reviewed de novo, findings of fact are reviewed for clear error, and mixed questions of fact and law are reviewed de novo." In re Nat'l Gypsum Co., 208 F.3d 498, 504 (5th Cir. 2000) (citation omitted).

II. THE NATURE OF SSEM'S INTEREST

Before considering ASIC's interests in the Withheld Balances, the Court must briefly consider what basis SSEM had to claim an interest in those balances. ASIC before this Court consistently refers to the balances as unearned, but also indicates the funds were withheld by Manhattan under two contractual provisions. See ASIC Brief at 4, 6. Counsel for the Trustee at oral argument below indicated that the Withheld Balances were entirely retainage, and that the debtor had additional claims for earned but unpaid balances not at issue in this appeal. R. 4:322. The Bankruptcy Court's Order stated: "The funds in question were funds retained under the contract between the Debtor and Manhattan Construction Company, the general contractor for the Project." Order at 2 (R. 3:241). The nature of SSEM's interest in the Withheld Balances may have been apparent to all parties and the Bankruptcy Court below, and that may be why the Order does not address that subject in greater detail. See R. 4:318 ("THE COURT: The facts are undisputed ....") (also reflecting counsel indicating no facts in dispute). Alas, the facts are not so evident to this Court sitting on appeal given the limited appellate record, so the Court must undertake some analysis of the subcontract.

The subcontract was for a face amount of $1,290,000. R. 3:199. SSEM was to make applications for payment monthly for work performed during the month. R. 3:219 (Art. 5.2.1). Subject to a variety of conditions, id. (Art. 5.2.2-.7), SSEM would eventually receive payment for each application. Payment for each approved application, however, was subject to five percent (5%) retainage. ¹ R. 3:199. Finally, the subcontract provides: "Notwithstanding any provision of the Subcontract to the contrary, Manhattan is not obligated to make any payment to [SSEM] under the Subcontract if any one or more of the following conditions exists: (a) Subcontractor ... otherwise is in default under the Subcontract or the Contract Documents." R. 3:219 (Art. 5.3.1(a)).

These two contractual provisions for withholding payment are the only provisions cited to the Court by the parties permitting Manhattan to withhold payment from SSEM. The parties do not point the Court to any factual basis in the record on appeal for SSEM's claim to the Withheld Balances, such as evidence that SSEM performed work, submitted payment applications that met the requirements of Article 5.2, and was due payment. The Court will, therefore, assume that the Withheld Balances comprise retainage and earned balances that were unpaid due to SSEM's default, pursuant to Article 5.3.1(a). Because the Court's analysis is the same for both of those categories, the Court will not dwell further on the distinctions between the two. ²

Both retainage and earned but unpaid balances involve balances for work actually done by SSEM but for which payment had not become due under the subcontract at the time of SSEM's filing for protection. By having actually performed the work, SSEM appears to have at least an equitable claim to the balances. Moreover, under certain circumstances SSEM could have a valid contractual claim to those balances. For example, if ASIC could have stepped in and completed the subcontract for no more than the unearned balance on the contract, and if SSEM had diligently paid its downstream subcontractors and suppliers, it would have a valid contract claim for the retainage and earned but unpaid balances. Property of the estate includes "all legal or equitable interests of the debtor in property as of the commencement of the case." 11 U.S.C. §541(a)(1). Thus, it would appear that retainage and earned but unpaid balances would become property of SSEM's estate absent any intervening factors. ³

III. PEARLMAN SURVIVES THE BANKRUPTCY CODE

The Court now turns to Pearlman v. Reliance Ins. Co., 371 U.S. 132 (1962). That case, decided under the Bankruptcy Act, considered whether a surety or trustee had the right to retainage held by the United States as owner, when the contractor failed to pay suppliers and subcontractors and the surety had to make those payments. The Court initially noted:

Property interests in a fund not owned by a bankrupt at the time of adjudication, whether complete or partial, legal or equitable, mortgages, liens, or simple priority of rights, are of course not a part of the bankrupt's property and do not vest in the trustee. The Bankruptcy Act simply does not authorize a trustee to distribute other people's property among a bankrupt's creditors. So here if the surety at the time of adjudication was, as it claimed, either the outright legal or equitable owner of this fund, or had an equitable lien or prior right to it, this property interest of the surety never became a part of the bankruptcy estate to be admin istered, liquidated, and distributed to general creditors of the bankrupt.

Id. at 135-36 (footnote omitted). The Court then proceeded to analyze the equitable subrogation rights of a surety under common law, and concluded:

We therefore hold in accord with the established legal principles stated above that the Government [owner] had a right to use the retained fund to pay laborers and materialmen; that the laborers and materialmen had a right to be paid out of the fund; that the contractor, had he completed his job and paid his laborers and materialmen, would have become entitled to the fund; and that the surety, having paid the laborers and materialmen, is entitled to the benefit of all these rights to the extent necessary to reimburse it. Consequently, since the surety in this case has paid out more than the amount of the existing fund, it has a right to all of it.

Id. at 141-42. Pearlman thus holds that a surety's equitable subrogation rights can prevent retainage from becoming part of the bankruptcy estate, at least under the Bankruptcy Act. The next two questions are whether the Bankruptcy Code changes the result of Pearlman, and whether the rights of a surety under Texas law are different from the common law rights that drove the result in Pearlman.

The Bankruptcy Court below attempted to create an intermediate position on Pearlman, after noting that "[m]ost courts have held that Pearlman survived the enactment of the Bankruptcy Code," Order at 3 (R. 3:242), but that "[s]ome courts have questioned the continued vitality of Pearlman after the enactment of the Code because the Code defines property of the estate more broadly than pre-Code law." Id. (citations omitted). After considering sections 541(a)(1) and (d) of the Code, the Bankruptcy Court concluded:

Certainly, then, to the extent that a surety is the "equitable owner" of funds under state law, those funds continue to be excluded from "property of the estate" under the Code. But, property in which a surety has an "equitable lien" or a "prior right" vis-a-vis other creditors of its principal under state law that the Court in Pearlman found to be excluded from the estate under the Act would not be excluded from the bankruptcy estate under §541 of the Bankruptcy Code because a lien claim or priority claim under the Bankruptcy Code is just that --a claim. This is where the Supreme Court's pronouncement in Pearlman may have been superseded by the new, expansive definition of "property of the estate" under the Code. Thus, to the extent that a surety cannot claim equitable ownership of the property under state law, but merely possesses an equitable lien claim or a priority claim against the property, the property becomes property of the bankruptcy estate. Likewise, if a surety has ownership of the funds at issue, an IRS lien against the surety's principal would not attach to those funds.

 

Thus, the resolution of the issue before this Court turns on whether, under Texas law, ASIC actually has an ownership interest in the withheld funds or merely a claim against the funds.

Order at 4 (R. 3:243) (emphasis in original).

This Court agrees with the Bankruptcy Court that the great weight of authority holds that Pearlman survives enactment of the Bankruptcy Code. See, e.g., First Indem. of Am. Ins. Co. v. Modular Structs., Inc. (In re Modular Structs., Inc.), 27 F.3d 72, 77-80 (3d Cir. 1994); Caribbean Resort Constr. and Maint., Inc. v. Coco Beach Util. Co. (In re Caribbean Resort Constr. and Maint., Inc.), 318 B.R. 241, 249-50 (Bankr. D. P.R. 2003) (citing Modular Structures); Mendelsohn v. Dormitory Auth. of State of N.Y. (In re QC Piping Inst., Inc.), 225 B.R. 553, 564-71 (Bankr. E.D. N.Y. 1998); J. Michael Frank & Michael E. Evans, A Defense of Established Landmarks: Claims of Construction Sureties to Contract Funds under Chapter 11, 25 TORT & INS. L.J. 28 (1989); 2 DANIAL R. COWANS, COWANS BANKR. L. & PRAC. §12.30, at 587-88 (1989). But see In re Nemko, 143 B.R. 980, 985-86 (Bankr. E.D. N.Y. 1992). ⁴ This Court concurs with the clear majority trend and holds that Pearlman survives the enactment of the Bankruptcy Code in its entirety, rather than in the limited form applied in the Order.

Under Pearlman, the label placed on the surety's equitable subrogation interest was not important; the outcome did not turn on whether that interest was characterized as a lien or an ownership interest. See Pearlman, 371 U.S. at 136 ("if the surety ... was ... either the outright legal or equitable owner of this fund, or had an equitable lien or prior right to it, this property interest of the surety never became a part of the bankruptcy estate ....") (emphasis added). The point was that under common law principles of equitable subrogation, the surety's interest prevented the res from becoming property of the bankruptcy estate. Application of that same principle here leads to the same result: ASIC's interest in the Withheld Balances prevents those balances from become part of SSEM's bankruptcy estate. Although this conclusion is sufficient to resolve the appeal, the Court is cognizant that its decision may be only a rest stop on the Order's journey from the Bankruptcy Court to the Fifth Circuit. The Court will, therefore, consider one further issue.

IV. A SURETY'S EQUITABLE SUBROGATION RIGHT IS NOT A CLAIM

Finally, the Court will address the character of ASIC's interest in the Withheld Balances. The Bankruptcy Court relied upon Section 53.151(b) of the Texas Property Code to determine that ASIC's interest was a claim, rather than an ownership interest. That portion of the Property Code, however, applies only to statutory payment bonds issued in accordance with Chapter 53, sometimes called Hardeman Act bonds, and not to contractual performance or payment bonds generally. ⁵ A bond under chapter 53 must be: in a penal sum at least equal to the total of the original contract amount; in favor of the owner; and executed by the original contractor as principal. TEX. PROP. CODE §53.202. See generally Laughlin Environ., Inc. v. Premier Towers , L.P., 126 S.W.3d 668 (Tex. App. --Houston [14th Dist.] 2004, no pet.). The bonds in this case did not meet those requirements. R. 3:210-11. Nor did they evidence by their terms intent to comply with Chapter 53. Id. ; see TEX. PROP. CODE §53.211(a)(2). Accordingly, Section 53.151(b) is inapplicable to ASIC's bonds.

Because the statutory basis the Bankruptcy Court used to categorize ASIC's subrogation rights is inapplicable, the Court turns to Texas common law. Texas case law regarding the nature of a surety's equitable subrogation interest indicates that it is not simply a claim. In InterFirst Bank Dallas, N.A. v. United States Fid. and Guar. Co., 774 S.W.2d 391 (Tex. App. --Dallas 1989, writ den.), the court considered whether a surety's subrogation rights were security interests under Article 9 of the UCC. The Court held they were not a lien:

Although there is some minor difference of opinion on this legal issue, the majority rule clearly appears to be the one which was sanctioned by Justice Rob ert Braucher in his definitive analysis of the subject in Canter v. Schlager, 358 Mass. 789, 267 N.E.2d 492 (1971). According to Justice Braucher's analysis, a surety's subrogation rights are not security interests within the purview of Article Nine. Id. at 494. This being the case, the promulgation of the UCC and the enactment of its progeny (such as the Texas Business and Commerce Code) do not adversely affect the pre-Code subrogation rights traditionally afforded to sureties. Id. ; see 2 WHITE & SUMMERS, UNIFORM COMMERCIAL CODE §23-6 (3d ed. 1988) (surety's subrogation rights not a security interest); accord National Shawmut Bank v. New Amsterdam Casualty Co., 411 F.2d 843, 847 (1st Cir. 1969). Further, it necessarily follows from Braucher's analysis that a surety's right to equitable subrogation is not adversely affected by the lack of perfection of lien claimants' rights if the surety is obliged to satisfy all lienable claims of laborers and materialmen, whether perfected or not.

 

The overwhelming and essentially unanimous post-UCC decisions have held that the interest of a surety, such as USF & G, continues to be superior to the claim of a contract assignee, such as Bank. Transamerica Ins. Co. v. Barnett Bank, 540 So.2d 113, 117 ( Fla. 1989); Mid-Continent Casualty Co. v. First Nat'l Bank & Trust Co., 531 P.2d 1370, 1377 (Okl. 1975); accord National Shawmut Bank v. New Amsterdam Casualty Co., 411 F.2d 843, 849 (1st Cir.1969); First Alabama Bank v. Hartford Accident & Indem. Co., 430 F. Supp. 907, 911 (N.D. Ala. 1977); Fidelity & Casualty Co. v. Central Bank, 409 So.2d 788, 790 (Ala. 1982); Alaska State Bank v. General Ins. Co., 579 P.2d 1362, 1368 (Alaska 1978); Argonaut Ins. Co. v. C & S Bank, 140 Ga. App. 807, 232 S.E.2d 135, 140 (1976); United States Fidelity & Guar. Co. v. First State Bank, 208 Kan. 738, 494 P.2d 1149, 1159 (1972); Finance Co. of America v. United States Fidelity & Guar. Co., 277 Md. 177, 353 A.2d 249, 254 (1976); Canter v. Schlager, 358 Mass. 789, 267 N.E.2d 492, 497 (1971); Travelers Indem. Co. v. Clark, 254 So.2d 741, 745-46 ( Miss. 1971); Jacobs v. Northeastern Corp., 416 Pa. 417, 206 A.2d 49, 55 (1965); Third Nat'l Bank v. Highlands Ins. Co., 603 S.W.2d 730, 734 ( Tenn. 1980).

Id. at 398-99 (footnote omitted). By the same logic, a surety's equitable subrogation interest is not a claim and takes precedence over mere claim interests.

Other Texas cases have acknowledged that one purpose of retainage is that "[i]t supplies a salvage fund for the contractor's surety in the event it makes good on defaults for which it is bound." Corpus Christi Bank and Trust v. Smith, 525 S.W.2d 501, 505 ( Tex. 1975). Accord Economy Forms Corp. v. Williams Bros. Constr. Co., 754 S.W.2d 451, 457 (Tex. App. --Houston [14th Dist.] 1988, no writ) ("The fact that these funds were retained by the general contractor rather than the property owner does not change the beneficiary or the purpose. ... (3) the retainage provides salvage funds for its surety if the surety makes good on defaults for which it is bound; ...."). Thus, under Texas law, if a surety's equitable subrogation right is not an ownership right, it is at least closer to ownership than it is to a claim.

Accordingly, even if section 541(a)(1) modified the result in Pearlman so that any earned portion of the Withheld Balances would enter SSEM's estate if ASIC's interest were only a lien, as the Order held, under Texas common law ASIC's equitable subrogation interest is greater than a lien; ASIC has an equitable ownership interest in the "salvage fund" to the extent of its completion costs. Thus, regardless whether or not Pearlman alone is sufficient to keep the Withheld Balances out of SSEM's estate, ASIC is still entitled to the Withheld Balances. Because the Withheld Balances never enter SSEM's estate, the IRS's priority is immaterial.

CONCLUSION

It is therefore ordered that the Bankruptcy Court's orders of January 14, 2004 and March 9, 2004 are vacated, that ASIC's motion for relief from automatic stay is granted, and that the United States' motion for relief from automatic stay is denied.

¹ "Retainage" was not otherwise defined or addressed in the subcontract. Black's defines retainage as "A percentage of what a landowner pays a contractor, withheld until the construction has been satisfactorily completed and all mechanic's liens are released or have expired." BLACK'S LAW DICTIONARY 1341 (8th ed. 2004).

² The Court can conceive of analytical frameworks that would treat retainage differently than earned but unpaid balances. In such a case, the Court would be required to remand for the Bankruptcy Court to give more detailed consideration to the nature of SSEM's claim to the Withheld Balances. Because the Court's analysis is the same for both categories, that is unnecessary in this case.

³ As indicated above, ASIC characterizes the Withheld Balances as money that "was never earned by SSEM, was not owed to SSEM under the subcontract ...." See ASIC Brief at 6. The Court understands ASIC's claim to mean simply that the balances were not due and payable to SSEM under the terms of the subcontract, although SSEM had done the work. Characterizing the balances as unearned, however, could be taken as meaning they included that portion of the $1.3 million contract price associated with work the SSEM did not perform before it defaulted, for which SSEM did not submit a payment application, and that ASIC had to complete. The Court does not understand that to be what ASIC is contending. If the Withheld Balances included such truly unearned contractual balances, SSEM would not have any legal or equitable claim to such balances. Because that produces the same result the Court reaches, it is not necessary to determine whether any of the Withheld Balances were truly unearned in that sense.

⁴ The Bankruptcy Court in Mendelsohn v. DASNY distinguished In re Nemko factually. 225 B.R. at 569.

⁵ "Subcontractors and suppliers are the 'beneficiaries' of a payment bond. By contrast, a performance bond is only for the benefit of the obligee/owner of the construction project. Subcontractors and suppliers generally do not have the right to seek payment from the performance bond surety if the principal defaults." Laughlin Environ., Inc. v. Premier Towers, L.P., 126 S.W.3d 668, 671 n.3 (Tex. App. --Houston [14th Dist.] 2004, no pet.).

 

[2000-2 USTC ¶50,562] Wayne County Board of County Commissioners , Plaintiff v. Mendel, Inc., et al., Defendants

U.S. District Court, No. Dist. Ohio , East. Div., 5:98 CV 1795, 5/30/2000

[Code Sec. 6321 ]

Lien for taxes: Validity and priority against third-parties: Property subject to tax liens.--A construction company that entered into a contract with a county board of commissioners to complete a bridge project had an interest in a fund containing monies to pay for the project that was held by the board after its completion. The contractor was not in breach of contract and owed no amounts to the county that would bar its claim to the funds. Therefore, it had an interest in the fund to which a tax lien could attach.

[Code Sec. 6323 ]

Lien for taxes: Validity and priority against third-parties: Equitable lien: Surety.--A claim by a surety, which made payments to a construction company's subcontractors pursuant to a performance bond, did not have priority over a federal tax lien to funds still owed to the contractor because it was not "first in time." The surety's purported equitable lien became choate when the subcontractors were paid, which was after the tax lien was assessed.

[Code Sec. 6323 ]

Lien for taxes: Validity and priority against third-parties: Surety: Security interest: Superpriority: Financing statement.--A surety, which made payments to a construction company's subcontractors pursuant to a performance bond, did not hold a security interest in funds still owed to the contractor that took superpriority over an earlier federal tax lien. The surety did not file a financing statement with the appropriate office, which is required in order to perfect a security interest.

ORDER

OLIVER, JR., District Judge:

On June 26, 1998, Plaintiff, Wayne County Board of County Commissioners ("Wayne County"), brought an interpleader action against Defendants, Mendel, Inc. ("Mendel"), the Internal Revenue Service ("IRS"), Ohio Farmers Insurance Co. ("Ohio Farmers") and All Ohio Insurance Agency, Inc., in the Court of Common Pleas of Wayne County to determine which of the Defendants is entitled to certain proceeds of a construction contract between Mendel and Wayne County. ¹ On August 6, 1998, the government removed this action to the United States District Court for the Northern District of Ohio pursuant to 28 U.S.C. §1444. The government and Ohio Farmers both claim an interest in the interpled funds. Presently before the court are the cross-motions for summary judgment by Ohio Farmers and the government on their respective claims to the interpled funds. For the reasons that follow, the court finds that the government is entitled to the interpled funds and therefore grants its motion for summary judgment (Doc. No. 36) and denies Ohio Farmers' cross-motion for summary judgment (Doc. Nos. 26 and 31). ²

I. FACTS

The facts are generally undisputed. On December 5, 1996 , the debtor-taxpayer, Mendel, entered into a contract with Wayne County to improve a bridge in Milton Township , located in Wayne County ("the bridge project"). To obtain the contract, Mendel secured a surety bond from Ohio Farmers under which Ohio Farmers guaranteed performance of the contract and also guaranteed payment to all persons supplying labor and materials to the project.

Mendel completed the project; it was therefore unnecessary for Ohio Farmers to make any payments with respect to its performance bond. However, Mendel did not pay all of its subcontractors. Pursuant to its obligation on the payment bond, Ohio Farmers paid United Precast's claim of $7,677.00 on December 1, 1997 , and Meredith Brothers' claim of $8,258.77 on February 11, 1998 . Neither United Precast nor Meredith Brothers filed mechanic's liens pursuant to Ohio Revised Code §1311.26.

Throughout its performance on the bridge project, Mendel also failed to pay all of its employees' share of federal income tax and social security withholding on wages. These tax liabilities were assessed on June 16, 1997 , August 25, 1997 , September 22, 1997 , December 8, 1997 and April 1, 1998 , and amounted to more than $100,000. Notices of federal tax lien with respect to these liabilities were filed on February 11, 1998 , May 28, 1999 and February 4, 1999 .

Wayne County made various payments to Mendel pursuant to the parties' contract. However, under the terms of the contract, Wayne County was authorized to retain and hold a percentage of estimated amounts due monthly until final completion and acceptance of all work covered by the contract. ³ Pursuant to this term, Wayne County had in its possession $10,261.51 of undistributed contract funds at the time the bridge project was complete. ⁴

On February 24, 1998 , the Wayne County Auditor received a Notice of Levy from the IRS regarding Mendel and providing for a lien on all monies in Wayne County 's possession which Wayne County was obligated to pay to Mendel. On June 1, 1998 , Wayne County received a letter from Ohio Farmers directing Wayne County to mail all remittances and checks to Ohio Farmers as surety for Mendel. The letter indicated that Ohio Farmers had been forced to make payments to subcontractors and suppliers furnishing labor or material on behalf of Mendel in connection with the bridge project. Thereafter, Wayne County filed the instant interpleader action, seeking to determine to whom the remaining contract funds (the "Fund") belong.

II. SUMMARY JUDGMENT STANDARD

Federal Rule of Civil Procedure 56(c) governs summary judgment motions and provides:

The judgment sought shall be rendered forthwith if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law. . . .

Rule 56(e) specifies the materials properly submitted in connection with a motion for summary judgment:

Supporting and opposing affidavits shall be made on personal knowledge, shall set forth such facts as would be admissible in evidence, and shall show affirmatively that the affiant is competent to testify to the matters stated therein. . . . The court may permit affidavits to be supplemented or opposed by depositions, answers to interrogatories, or further affidavits. When a motion for summary judgment is made and supported as provided in this rule, an adverse party may not rest upon the mere allegations or denial of the adverse party's pleading, but the adverse party's response, by affidavits or as otherwise provided in this rule, must set forth specific facts showing that there is a genuine issue for trial. If the adverse party does not so respond, summary judgment, if appropriate, shall be entered against the adverse party.

However, the movant is not required to file affidavits or other similar materials negating a claim on which its opponent bears the burden of proof, so long as the movant relies upon the absence of the essential element in the pleadings, depositions, answers to interrogatories, and admissions on file. Celotex Corp. v. Catrett, 477 U.S. 317, 106 S.Ct. 2548 (1986).

In reviewing summary judgment motions, this court must view the evidence in a light most favorable to the non-moving party to determine whether a genuine issue of material fact exists. Adickes v. S.H. Kress & Co., 398 U.S. 144, 90 S.Ct. 1598 (1970); White v. Turfway Park Racing Ass'n, Inc., 909 F.2d 941, 943-44 (6th Cir. 1990). A fact is "material" only if its resolution will affect the outcome of the lawsuit. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248, 106 S.Ct. 2505, 2510 (1986). Determination of whether a factual issue is "genuine" requires consideration of the applicable evidentiary standards. Thus, in most civil cases the court must decide "whether reasonable jurors could find by a preponderance of the evidence that the [non-moving party] is entitled to a verdict." Id. at 252, 106 S.Ct. at 2512.

Summary judgment is appropriate whenever the non-moving party fails to make a showing sufficient to establish the existence of an element essential to that party's case and on which that party will bear the burden of proof at trial. Celotex, 477 U.S. at 322, 106 S.Ct. at 2552. Moreover, "the trial court no longer has a duty to search the entire record to establish that it is bereft of genuine issue of material fact." Street v. J.C. Bradford & Co., 886 F.2d 1472, 1479-80 (6th Cir. 1989) (citing Frito-Lay, Inc. v. Willoughby, 863 F.2d 1029, 1034 (D.C. Cir. 1988)). The non-moving party is under an affirmative duty to point out specific facts in the record as it has been established which create a genuine issue of material fact. Fulson v. City of Columbus , 801 F.Supp. 1, 4 (S.D. Ohio 1992). The non-movant must show more than a scintilla of evidence to overcome summary judgment; it is not enough for the non-moving party to show that there is some metaphysical doubt as to material facts. Id.

III. LAW AND ANALYSIS

Ohio Farmers and the government have filed cross-motions for summary judgment on their respective claims to the Fund. Ohio Farmers asserts its entitlement to the Fund on the basis that Mendel has no interest in the Fund to which a tax lien could attach. Ohio Farmers contends that this is so because Mendel did not satisfy all of the requirements of its contract with Wayne County since Mendel did not pay all of its subcontractors. According to Ohio Farmers, the money Wayne County withheld pursuant to paragraph 25(a) of its contract with Mendel was never earned by Mendel, and thus was not available for attachment by the IRS lien.

Section 6321 of the Federal Tax Lien Act, 26 U.S.C. §§6321-6327, gives the United States a lien for unpaid taxes on "all property and rights to property" of a taxpayer who neglects to pay his taxes after demand. This lien reaches every interest in property that a taxpayer may have, U.S. v. National Bank of Commerce [85-2 USTC ¶9482], 472 U.S. 713, 720, 105 S.Ct. 2919, 2924 (1985), arises on the date of assessment and continues until the assessment is fully satisfied or becomes unenforceable. 26 U.S.C. §6322. A tax lien can attach even if a taxpayer's interest in property is less than full ownership or is one among several claims of ownership. United States v. Safeco Ins. Co. of Am. [89-1 USTC ¶9227], 870 F.2d 338, 341 (6th Cir. 1989). See also In re Construction Alternatives [93-2 USTC ¶50,569], 2 F.3d 670 (6th Cir. 1993). "Unresolved questions concerning the ultimate ownership of the property will not prevent provisional attachment of a federal tax lien." Safeco [89-1 USTC ¶9227], 870 F.2d at 341.

In the instant case, it is undisputed that the bridge project was completed by Mendel. The fact that Ohio Farmers paid two of Mendel's subcontractors on the project is immaterial for the purpose of determining completion of the project. See In re Wm. Cargile Contractor, Inc., 203 B.R. 644, 646 (S.D. Ohio 1996). Mendel owed nothing to Wayne County ; thus, no payments to the county were required or other expenses incurred to perfect Mendel's claim to the retained funds. Moreover, Wayne County has never declared Mendel in breach of its contract and disavows any claim to the retained funds. See Menuez Declaration ¶5; Complaint ¶7. Mendel thus earned the right to receive the retained funds, and under the principles stated above, the government has a valid tax lien on the Fund. See Construction Alternatives [93-2 USTC ¶50,569], 2 F.3d at 674 (finding that general contractor who had completed project and owed no obligations to owner of the project but who had not paid several subcontractors had earned right to receive its final progress payment and therefore federal tax lien could attach to progress payment).

Having determined that Mendel had an interest in the Fund to which a tax lien could attach, the next issue is whether Ohio Farmers also has a lien on the Fund, and if so, whether that lien is superior to the government's tax lien. Ohio Farmers contends that it has an equitable lien on the Fund through subrogation to the rights of United Precast and Meredith Brothers, the two subcontractors that it paid in Mendel's stead, and also through subrogation to the rights of Wayne County . It asserts that its equitable lien is superior to the government's tax lien because it was perfected prior to the time the federal tax lien was filed.

Even assuming that Ohio Farmers has a valid equitable lien on the Fund through subrogation, see Pearlman v. Reliance Ins. Co., 371 U.S. 132, 83 S.Ct. 232 (1962) (holding that surety who completed general contractor's contract and paid contractor's laborers and materialmen held equitable lien on retained contract funds through subrogation to rights of government owner, to rights of laborers and materialmen and to rights which contractor would have had he completed job), the court finds that the government has priority to the Fund and is thus entitled to it. When there is a competition between a federal tax lien and a state law lien, priority is determined by the "first in time, first in right" rule. Terwilliger's Catering Plus, Inc. v. Baverly [90-2 USTC ¶50,460], 911 F.2d 1168, 1176 (6th Cir. 1990) (quoting United States v. City of New Britain, Conn. [54-1 USTC ¶9191], 347 U.S. 81, 85, 74 S.Ct. 367, 370 (1954)). If the competing state law lien falls into one of the limited categories of liens enumerated in §6323(a), the federal tax lien is only perfected once the notice of the federal tax lien is filed. See United States, ex rel. IRS v. McDermott [93-1 USTC ¶50,164], 507 U.S. 447, 113 S.Ct. 1526, 1528 (1993). If the state law lien is not among the enumerated categories in §6323(a), then the federal tax lien need not be filed to gain priority over other interests; it is perfected at the time the lien is assessed. Terwilliger's [90-2 USTC ¶50,460], 911 F.2d at 1176; IRC §6322.

Under §6323(a), the tax lien is not effective against "any purchaser, holder of a security interest, mechanic's lienor, or judgment creditor until notice [of the lien] . . . has been filed by the Secretary." There is nothing in the record to indicate that Ohio Farmers is subrogated to any such rights. Thus, the tax lien has priority over any equitable lien that Ohio Farmers can claim to the Fund as long as it was assessed prior to Ohio Farmer's lien becoming choate. A state created lien interest is usually held to be choate " 'when the identity of the lienor, the property subject to the lien, and the amount of the lien are established.' " Terwilliger's [90-2 USTC ¶50,460], 911 F.2d at 1176 (quoting New Britain , 347 U.S at 84, 74 S.Ct. at 369). See also Construction Alternatives [93-2 USTC ¶50,569], 2 F.3d at 676. Ohio Farmer's equitable lien, if it exists, became choate on December 1, 1997 with respect to United Precast's claim, and or February 11, 1998 , with respect to Meredith Brother's claim. By December 1, 1997 , the IRS had already assessed a tax lien in the amount of $58,789.52 against Mendel, well over the amount in the Fund. Thus, Ohio Farmer's equitable lien would not have been perfected at the time the tax lien was assessed and therefore, the tax lien takes priority.

However, Ohio Farmers contends that under §6323(c), it has a security interest in the Fund that has priority over the government's tax lien even though its equitable lien may not have been perfected at the time of tax lien filing. Under §6323(c), a surety's "security interest" has priority over a tax lien even though the security interest came into existence after the tax lien was filed, provided the following circumstances are applicable: "1) the surety's security interest . . . is an obligatory disbursement agreement such as a suretyship agreement; 2) . . . the surety's interest is in "qualified property" covered by the terms of a written agreement entered into before the tax lien filing; and 3) the security interest would be protected under local law against a judgment lien that arose at the same time as the tax lien." Construction Alternatives [93-2 USTC ¶50,569], 2 F.3d at 677-678 (citing 26 U.S.C. §6323(c)).

A "security interest" under §6323(c) exists if "the property is in existence and the interest has been protected under local law against a subsequent judgment lien creditor." 26 U.S.C. §6323(h). Thus, before Ohio Farmer's alleged security interest in the Fund would take priority over a subsequently-arising judgment lien under local law, Ohio Farmers would have been required to perfect its security interest by filing a financing statement in the appropriate office. Construction Alternatives [93-2 USTC ¶50,569], 2 F.3d at 678 (citing Ohio Rev. Code §§1309.21, 1309.23). For example, the court in Construction Alternatives rejected the surety's argument that it was entitled to priority over the government under §6323(c) on the basis that the surety had not filed a financing statement. Id. Similarly, Ohio Farmers never filed a financing statement and thus does not possess a security interest under §6323(c). Accordingly, Ohio Farmers cannot come within the superpriority provisions of §6323(c) and it remains true that the IRS has priority to the Fund.

IV. CONCLUSION

For the foregoing reasons, the court finds that the government has a valid tax lien on the Fund and that such lien is superior to any equitable lien on the Fund that Ohio Farmers may claim. Accordingly, the court holds that the United States is entitled to the interpled funds and therefore grants its motion for summary judgment on its claim to such funds (Doc. No. 36). Ohio Farmers' motion for summary judgment on its claim to the interpled funds (Doc. Nos. 26 and 31) is hereby denied.

IT IS SO ORDERED.

JUDGMENT ENTRY

Pursuant to a separate order of this same date, judgment in this interpleader action is hereby entered in favor of the United States in the amount of $10,261.51; Ohio Farmer's claim to this same amount is hereby denied.

IT IS SO ORDERED.

¹ After indicating that it had no interest in the funds, Defendant All Ohio Insurance Agency, Inc. was dismissed from this case on November 24, 1998 .

² On May 23, 2000 , the court held a telephonic conference wherein the parties were permitted to orally address several legal arguments discussed in their briefs. However, for purposes of deciding the parties' cross-motions for summary judgment, the court has relied on only factual information addressed in the parties' memoranda.

³ Paragraph 25(a) of the contract provides:

Not later than the 15th day of each calendar month the Owner shall make a progress payment to the Contractor on the basis of a duly certified and approved estimate of the work performed during the preceding calendar month under this contract, but to insure the proper performance of this contract, the Owner shall retain ten percent (10%) of the amount of each estimate until final completion and acceptance of all work covered by this contract . . . Provided . . . that the Owner at any time after fifty percent (50%) of the work has been completed, if it finds that satisfactory progress is being made, may make any of the remaining progress payments in full. . . .

While it is undisputed that Mendel completed the bridge project, it is not clear from the record whether Wayne County actually accepted the project. If it did, then, upon its acceptance, Wayne County would have had no right to continue withholding the funds retained pursuant to this provision. However, for purposes of the pending cross-motions for summary judgment, the court will assume that Wayne County did not accept the project and rightfully withheld the disputed funds.

⁴ Ohio Farmers asserts that Wayne County was entitled to hold the undistributed contract funds pursuant to paragraph 25(d) of the contract. This provision states in pertinent part:

The Contractor shall, at the Owner's request, furnish satisfactory evidence that all obligations [owed to subcontractors, laborers, etc.] have been paid, discharged, or waived. If the Contractor fails so to do then the Owner may, after having served written notice on the said Contractor, either pay unpaid bills, of which the Owner has written notice, direct, or withhold from the Contractor's unpaid compensation a sum of money deemed reasonably sufficient to pay any and all such lawful claims until satisfactory evidence is furnished that all liabilities have been fully discharged. . . .

There are several prerequisites to Wayne County being permitted to withhold money pursuant to this provision, including that Wayne County first request from Mendel evidence that subcontractors, laborers and the like have been paid. In his declaration, Judson Menuez, President of Mendel during the term of the bridge project, stated that Wayne County never requested such evidence from Mendel, Menuez Declaration ¶4, and Mendel has offered no evidence to the contrary. Accordingly, Wayne County could not withhold any contract funds from Mendel pursuant to paragraph 25(d).

 

 

[98-2 USTC ¶50,609] Reliance Insurance Company, a Pennsylvania corporation, Plaintiff v. United States of America , acting by and through the Internal Revenue Service, Defendant

U.S. District Court, Dist. Ore., Civ. 97-803-HA, 7/17/98

[Code Secs. 3401 and 6323 ]

Liens and levies: Wrongful levy: Superior interest: Surety: Set-off: FICA liability: Who is the employer.--The IRS was entitled to set off contract funds to which an insurance company possessed a superior interest against the company's unpaid Federal Insurance Contribution Act (FICA) liability. Since the company controlled the payroll and disbursed its own funds to pay the employees of a contractor that defaulted on a bridge repair project, it qualified as an "employer" liable for FICA taxes. The insurance company failed to contest the IRS's right to set-off.

[Code Sec. 7426 ]

Liens and levies: Wrongful levy: Superior interest.--An insurance company's interest in contract funds was superior to that of the IRS in connection with a contractor that defaulted on a bridge repair project. The IRS conceded that the company, which was the surety of the contractor, possessed a superior interest in the funds with respect to its wrongful levy claim.

Jan D. Sokol, Thomas A. Larkin, Stewart, Sokol & Gray, One S.W. Columbia St., Portland, Ore. 97258-2097, for plaintiff. Kristine Olson, United States Attorney, Portland, Ore. 97204, Sanford W. Stark, Department of Justice, Washington, D.C. 20530, for defendant.

OPINION AND ORDER

HAGGERTY, District Judge:

Both parties seek summary judgment regarding an Internal Revenue Service (IRS) levy of funds from an Oregon Department of Transportation (ODOT) project involving a contractor that defaulted. The contractor's surety (plaintiff) argues that its interest in the project funds was superior to the IRS's interest. The government does not dispute this, but contends it is entitled to a set-off regarding employment tax funds for which plaintiff remains responsible. For the reasons that follow, the government is entitled to summary judgment, and plaintiff Reliance Insurance Company's cross motion for summary judgment is denied.

BACKGROUND

In September 1995, a company called "Great Western Coatings, Inc.," ("GWC") contracted with the ODOT to repair and install a cathodic protection system on the approach spans to the Yaquina Bay Bridge in Newport , Oregon . Plain tiff Reliance Insurance Company was the surety for GWC, guaranteeing GWC's performance on the project in the event GWC defaulted. Reliance and GWC posted performance and payment bonds to ODOT as obligee on 19 September 1995 totaling over $2,220,000.

Reliance was notified on 1 October 1996 that GWC was suffering cash flow difficulty and was unable to make its 4 October 1996 payroll. Per an agreement with Reliance, GWC voluntarily defaulted on 7 October 1996 , well before the project was completed. Reliance agreed to finance GWC's completion of the work, and directed ODOT to withhold further payments to GWC. Reliance provided funding between October 1996 and February 1997. Reliance made several payroll payments directly to GWC employees, but claims that it never asserted control over employees directly.

On 26 November 1996 , the IRS issued and served a tax levy on ODOT demanding payment of $110,135.86 for past years' assessments against GWC. On 21 December 1996 , ODOT paid the IRS $34,121.57 from the project's contract funds. Reliance received remaining payments from ODOT totaling approximately $1,000,000, minus the payment ODOT made to the IRS. Reliance argues that as financing surety, it had an interest in the contract funds paid to the IRS that was superior and paramount to any interest of the IRS. Accordingly, Reliance initiated this action for wrongful levy under 26 U.S.C. §7426, seeking to compel the United States to remit the levied funds to Reliance.

Reliance sues to recover the $34,121.57 ODOT paid to the IRS, and seeks summary judgment on this claim and against the IRS's counterclaim. In its counterclaim, the IRS contends that the unpaid employer's share of Federal Insurance Contribution Act (FICA) funds totals $28,287.82 for the fourth quarter of 1996, and $17,521.91 for the first quarter of 1997, and that Reliance is responsible for these FICA payments. The IRS seeks summary judgment against plaintiff's claim and in favor of its counterclaim, on the theory that regardless of whether its levy was wrongful, the IRS is entitled to a set-off for the FICA payments.

STANDARDS

Summary judgment is proper under Fed. R. Civ. P. 56(c) "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law." Celotex Corp. v. Catrett, 477 U.S. 317, 322 (1986). The substantive law underlying the claims in issue identifies which facts are material. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). When assessing a motion for summary judgment, the court must make all factual inferences in favor of the party opposing the motion. Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986).

The parties' motions raise the following legal questions: (1) Whether the government wrongfully levied contract funds to which Reliance maintained a superior interest; and (2) Whether the government should nevertheless be entitled to set off the levied funds against outstanding FICA liabilities that Reliance is obligated to pay.

ANALYSIS

A. Wrongful levy

Section 7426 of Title 26, United States Code, provides the exclusive remedy for an innocent third party whose property is confiscated by the IRS to satisfy another person's tax liability. Section 7426(a)(1) provides, in relevant part:

If a levy has been made on property or property has been sold pursuant to a levy, any person (other than the person against whom is assessed the tax out of which such levy arose) who claims an interest in or lien on such property and that such property was wrongfully levied upon may bring a civil action against the United States in a district court of the United States.

26 U.S.C. §7426(a)(1).

If the court finds that the property was wrongfully levied upon, §7426(b)(2) provides that the court may:

(A) order the return of specific property if the United States is in possession of such property;

(B) grant a judgment for the amount of money levied upon; or

(C) if such property was sold, grant a judgment for an amount not exceeding the greater of--

(I) the amount received by the United States from the sale of such property, or

(ii) the fair market value of such property immediately before the levy.

26 U.S.C. §7426(b)(2).

In order to state a cause of action under §7426, the plaintiff must show: (1) that a levy has been filed against property in plaintiff's hands, (2) that plaintiff has an interest in or a lien on the property which is senior to the interest of the United States, and (3) that the levy was wrongful. A levy is wrongful where the property levied upon "does not, in whole or in part, belong to the taxpayer against whom the levy originated." Arth v. United States [84-2 USTC ¶9601], 735 F.2d 1190, 1193 (9th Cir. 1984).

Reliance is entitled to summary judgment on its wrongful levy claim, because it has a paramount interest in the funds. Under 26 U.S.C. §6323(c), which recognizes that certain security interests having priority over tax liens, Congress provided:

(1) . . . To the extent provided in this subsection, even though a notice of a lien . . . has been filed, such lien shall not be valid with respect to a security interest which came into existence after tax lien filing but which

(A) is in qualified property covered by the terms of a written agreement entered into before tax lien filing and constituting--. . .

(iii) an obligatory disbursement agreement, and

(B) is protected under local law against a judgment lien arising, as of the time of tax lien filing, out of an unsecured obligation.

The government concedes that if the conditions of the statute are met, a surety's interest in contract proceeds pursuant to a bond executed before a tax lien is filed will prevail over the lien. Furthermore, for the purposes of this motion, the government does not dispute that under 26 U.S.C. §6323(c), Reliance's interest in the levied funds is superior to the IRS's interest.

Accordingly, the court grants plaintiff's motion for summary judgment on its wrongful levy claim. The government asserts no argument against there being a "wrongful levy," but agrees that Reliance has a superior interest.

B. Government's right to set-off

The government contends that Reliance qualified as the project workers' "employer" for the fourth quarter of 1996 and the first quarter of 1997 and is responsible for FICA payments. Therefore, the government argues, it is entitled to a "set-off" of the FICA amounts due. The government contends that it is not obligated to refund the levied money, because the IRS may exercise its rights to a set-off, and apply the levied funds to Reliance's outstanding FICA liabilities.

Courts recognize the government's right to set-off. See United States v. Munsey Trust Co., Receiver, 332 U.S. 234, 239 (1947) ("The government has the same right which belongs to every creditor, to apply the unappropriated moneys of his debtor, in his hands, in extinguishment of the debts due to him"); Capuano v. United States [92-1 USTC ¶50,163], 955 F.2d 1427, 1430 (11th Cir. 1992); United Sand and Gravel Contractors, Inc. v. United States [80-2 USTC ¶9626], 624 F.2d 733, 736 (5th Cir. 1980).

The government properly filed a counterclaim to exercise its common law right of set-off. To establish the right to set-off in a counterclaim, the government bears the burden of showing that the plaintiff is indebted to the government. See Cherry Cotton Mills v. United States [46-1 USTC ¶9218], 327 U.S. 536 (1946) (holding that illegally collected taxes may be used to set off any indebtedness that the government establishes is owed by the plaintiff to the government). Plaintiff Reliance makes no argument against the government's set-off rights. The only question presented by the government's counterclaim, therefore, is whether the government has met its burden by establishing that Reliance owes FICA taxes to the government.

The Internal Revenue Code provides that an employer bears responsibility for withholding FICA and FUTA taxes. 26 U.S.C. §§3101-02, 3111 & 3301. The Internal Revenue Code addresses the taxes imposed on employees regarding FICA under §3101(a),(b). Employers must withhold the employees' shares and pay the shares to the IRS under §3102(a). Section 3111 of the Code addresses the employer's share of FICA taxes. Employers are obligated to pay their own shares of FICA under this section.

The government argues that Reliance qualifies as the "employer" on the project from 29 September 1996 through 15 February 1997, and has failed to meet its obligation to pay the employer's share of FICA under §3111 for this time period. The term "employer" is defined in section 3401(d) of the Internal Revenue Code as follows:

(d) Employer.--For purposes of this chapter, the term "employer" means the person for whom an individual performs or performed any service, of whatever nature, as the employee of such person except that--

(1) if the person for whom the individual performs or performed the services does not have control of the payment of the wages for such services [then] the term "employer" . . . means the person having control of the payment of such wages.

26 U.S.C. §3401(d)(1).

The Supreme Court has held that this definition of "employer" is equally applicable to FICA obligations. See Otte v. United States [74-2 USTC ¶9822], 419 U.S. 43, 51 (1974); Winstead v. United States [97-1 USTC ¶50, 322], 109 F.3d 989, 991 (4th Cir. 1997).

In Otte the question presented was whether a trustee in bankruptcy was required to make appropriate withholdings when making payment of wage claims representing wages earned before bankruptcy. Referring to §3401(d)(1), the Court said the statute "obviously was in tended to place responsibility for withholding at the point of control." Id. at 50.

The Ninth Circuit has addressed FICA liability in In re Southwest Restaurant Sys., Inc. [79-2 USTC ¶9578], 607 F.2d 1237 (9th Cir. 1979). The court held that no one "other than the person who has control of the payment of the wages is in a position to make the proper accounting and payment to the United States . It matters little who hired the wage earner or what his duties were or how responsible he may have been to his common law employer. Neither is it important who fixed the rate of compensation. When it finally comes to the point of deducting from the wages earned that part which belongs to the United States and matching it with the employer's share of FICA taxes, the only person who can do that is the person who is in 'control of the payment of such wages.' " Id. at 1240 (quoting Otte).

The undisputed evidence in this case is that Reliance controlled the payment of wages to the project workers through the fourth quarter of 1996 and the first half of the first quarter of 1997. Plaintiff alone financed every weekly payroll during this period, beginning with the 11 October 1996 payroll (for work performed from 29 September 1996 through 5 October 1996 ) until GWC was terminated from the contract in February 1997. Reliance initially provided cashier's checks to GWC to distribute to workers. GWC would provide payroll information to Reliance, and Reliance would draw the appropriate amounts by purchasing cashier's checks from Sterling Savings and Loan in Federal Way , Washington .

At the end of November 1996, the parties established an account at the Bank of America. This account was governed by an agreement prepared by Reliance and dated 26 November 1996 . The agreement required two signatures for any check drawn on the account, and one signature was required to be from a Reliance representative. Reliance could refuse to countersign any check it believed was improper. After opening this account, GWC would still provide payroll information, and Reliance would review the information for accuracy before countersigning checks and returning them to GWC. Reliance alone funded the Bank of America account.

On 13 February 1997 Reliance terminated GWC's involvement with the ODOT project, effective 17 February 1997 . On that date a different contractor, Abhe & Svoboda, replaced GWC and completed the project. The new contractor assumed responsibility for processing payroll, and Reliance's last payroll payment was made on 21 February 1997 , for work completed during the week ending 15 February 1997 .

In essence, Reliance acknowledges that it paid weekly payroll from 29 September 1996 through 15 February 1997 based upon invoices of labor GWC submitted to it. The evidence from Reliance's documents establishes that Reliance controlled the payments of wages to the workers for that time period. Since it controlled payroll, and used its own funds to disburse pay, Reliance qualified as the workers' "employer" under §3401(d)(1).

Reliance disputes that 26 U.S.C. §3401(d)(1) is applicable. It argues that 26 U.S.C. §3505 is the statute that establishes tax responsibilities for third parties paying wages. Enacted in 1966, §3505 pertains to third parties (such as sureties) who make direct payments to employees. It provides:

(a) direct payments by third parties. For purposes of sections 3102, 3202, 3402, and 3403, if a lender, surety, or other person, who is not an employer under such sections with respect to an employee or group of employees, pays wages directly to such an employee or group of employees, employed by one or more employers, or to an agent on behalf of such employee or employees, such lender, surety or other person shall be liable in his own person and estate to the United States in a sum equal to the taxes (together with interest) required to be deducted and withheld from such wages by such employer.

Reliance contends in its Reply brief that "Section 3505 is specifically applicable to the situation in this action where Reliance and [GWC] established a joint control trust account . . ." Reply at 3.

The court concludes that §3505 concerns only subsections 3102, 3202, 3402, and 3403 of the Internal Revenue Code, and that these subsections relate to the amount of taxes to be withheld from an employee's pay. Section 3505(a) pertains to the employee's share of employment taxes and does not address a third party's liability for the employer's share of FICA taxes that are at issue in this case. The taxes at issue in this case arise pursuant to §3111. Reliance is properly construed as the "employer" under §3401(d)(1), and the government is entitled to a set-off of the unpaid employer's share of FICA.

CONCLUSION

For the reasons stated herein, the court grants plaintiff's motion for summary judgment (doc. #20-1) on its wrongful levy cla