Surety's Interest Page2

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[58-1 USTC ¶9516]Arthur L. Vermillion, Plaintiff v. Lynn Brodrick et al., Defendants

U. S. District Court, Dist. Kan. , Civil Action No. W-1007, 3/26/58

[1939 Code Sec. 3672--changed in 1954 Code Sec. 6323]

Priority of claims: Tax liens v. surety's chattel mortgage: Surety's completion of construction jobs after contractor's default: Assignment for benefit of creditors.--A contractor defaulted on two municipal construction jobs and the surety, as required by his surety contracts, assumed responsibility for completion of the jobs, thereby sustained a financial loss. Although the surety paid all federal taxes incident to the two jobs which accrued during the period of its control and supervision, the contractor was in default to the Government on FICA and withholding taxes on employees' earnings for periods before, during and after this period on these and/or other construction contracts. Prior to its completion of the two defaulted construction contracts the surety filed and had recorded a chattel mortgage upon the defaulting contractor's machinery and equipment. Subsequently, with the consent of the Government, the surety and all his other creditors, the insolvent contractor assigned his assets to a trustee for the benefit of creditors under an agreement providing that the proceeds of the trustee's sale of the mortgaged machinery and equipment would be substituted for these specific assets. Incident to the liquidation of the insolvent contractor's business the trustee sold the mortgaged assets, paid the net proceeds therefrom into Court and petitioned the Court to determine the relative priority of the Government and the surety as to these funds. The Court held that the Government's lien for taxes covering the period before the contractor's default became a general lien against their property on the date when the assessment list was received and, since it was received prior to the recording of the surety's chattel mortgage was entitled to first priority only as to such taxes. The surety had a superior claim to the balance of the funds.

Holmes, Mitchell & Holmes, Donald I. Mitchell, 623 Beacon Building , Wichita 2, Kan. , for plaintiff. William C. Farmer, United States Attorney, William F. Kolbe, Department of Justice, Washington, D. C., George Peabody, Beacon Building, Wichita 2, Kan., for United States. Foulston, Siefkin, Schoeppel, Bartlett & Powers, 608 Fourth National Bank Building, Wichita 2, Kan., for Employers Mutual Casualty Co., defendant.

Stipulation of Fact

SAVAGE, District Judge:

COME NOW the defendants, United States of America and Employers Mutual Casualty Company, a corporation, and make the following stipulation of fact for the sole purpose of submitting this controversy to the court for decision.

1. This is an action in the nature of an interpleader action and the court has jurisdiction of the parties and the funds.

2. The defendant, Employers Mutual Casualty Company, is a corporation organized and existing by virtue of the laws and the statutes of the state of Iowa , with its principal offices at Des Moines , Iowa , and is authorized to do business in the state of Kansas .

3. The intervention of the United States of America is sanctioned and directed by the Attorney General of the United States and is authorized and requested by the Commissioner of Internal Revenue by the United States. The United States of America is a corporation sovereign and body politic.

4. The claims of the United States of America and the Employers Mutual Casualty Company are superior and prior to the claims of all other parties defendant.

5. The registry of this court has in its possession the sum of Seven Thousand One Hundred Seventy-one and 63/100 Dollars ($7,171.63). The claim of the United States of America is in the sum of Seven Thousand Four Hundred Twenty-eight and 32/100 Dollars ($7,428.32), plus interest from the due date of the taxes assessed. The claim of Employers Mutual Casualty Company is in the sum of Seven Thousand and Forty and 18/100 Dollars ($7,040.18), with interest as provided by law from February 22, 1952 . Each of these parties contend their claim and right to the funds in the hands of the registry of this court is superior to the rights of the other.

6. On July 21, 1950 , N. W. Ricke and Edward J. Ricke, a partnership doing business under the firm name and style of Ricke Bros. Construction Co., entered into a contract with the City of Pratt , Kansas for the construction of certain street improvements and sewer improvements for the City of Pratt , Kansas . The Ricke Bros. Construction Co. was required to furnish a statutory bond in compliance with the General Statutes of Kansas . Pursuant to the contract, and in accordance with the Statutes, N. W. Ricke and Edward J. Ricke made application to the defendant, Employers Mutual Casualty Company, for such statutory bond, a copy of which application and bonds is attached hereto, made a part of this stipulation, and marked Exhibit "A" [not reproduced herein]. Pursuant to such application, the statutory bond was duly executed and was filed with the Clerk of the District Court of Pratt County, Kansas on July 28, 1950 .

7. On December 15, 1950 , the Ricke Bros. Construction Co. entered into a contract with the City of Anthony , Kansas to install certain curbing and guttering in that City. The Ricke Bros. Construction Co. was required to furnish a statutory bond in compliance with the General Statutes of Kansas . Pursuant to the contract, and in compliance with the statutes, N. W. Ricke, as a partner, made application to the defendant, Employers Mutual Casualty Company, for such statutory bond. The application, statutory bond, performance bond, proposal and contract are attached hereto, made a part of this stipulation, and marked Exhibit "B" [not reproduced herein]. Pursuant to such application, the statutory bond and performance bond were executed and duly filed with the Clerk of the District Court of Harper County, Kansas on April 2, 1951 .

8. On January 1, 1951 , the Ricke Bros. Construction Co. defaulted on the contracts with the City of Pratt and the City of Anthony , Kansas . Defendant Employers Mutual Casualty Company, under its bonds and applications, supervised the completion of the operation of Ricke Bros. Construction Co., met the payroll, and undertook to cause the contracts to be completed and performed, as required by the bonds and applications. Representatives of the Employers Mutual Casualty Company had actually appeared and inspected the jobs and made payments for work performed in December of 1950. Employers Mutual Casualty Company paid all federal taxes which accrued pertaining to the completion of the contracts while such completion was under its supervision and control.

9. The Employers Mutual Casualty Company continued to cause the contracts to be performed and to meet its obligations under the bonds and applications until final completion of the contracts and the determination of its loss on February 22, 1952 . The net amount of loss to the Employers Mutual Casualty Company under both contracts was Seven Thousand and Forty and 18/00 Dollars ($7,040.18).

10. The Employers Mutual Casualty Company notified the City of Anthony by letter of the default and its assignment under the application of bond on January 4, 1951 and caused such notification to be filed with the City Clerk on January 5, 1951 . A copy of such notification is attached hereto, made a part of this stipulation, and marked Exhibit "C". The City of Pratt, Kansas was notified on January 4, 1951 by a letter directed to the City Clerk, a copy of which is attached hereto, made a part of this stipulation, and marked Exhibit "D". Said letter was received by the Clerk of Pratt, Kansas , on or about January 5, 1951 .

11. The Commissioner of Internal Revenue assessed federal internal revenue taxes for the years 1950 and 1952, together with penalties and interest thereon as provided by law, against the defendant taxpayers Norbert W. Ricke, a/k/a N. W. Ricke, and Edward Ricke, doing business as Ricke Bros. Construction Co., Anthony, Kansas. The amounts assessed and the outstanding balance of the aforesaid taxes together with pertinent dates are as follows:

12. The Employers Mutual Casualty Company filed a document captioned a chattel mortgage on January 10, 1951 at 11:45 o'clock a. m., the same being recorded in Book "N", covering the principal machinery owned and operated by the Ricke Bros. Construction Co. A copy of this document is attached hereto, made a part of this stipulation, and marked Exhibit "E".

13. On May 13, 1953 , N. W. Ricke, of the Ricke Bros. Construction Co., executed an assignment for the benefit of creditors, Exhibit "A" attached to complaint, which is made a part of this stipulation by reference. Arthur L. Vermillion, complainant herein, was thereby appointed Trustee. The Ricke Bros. Construction Co. was insolvent at the time of the execution of such assignment for the benefit of creditors. The Trustee proceeded to and did liquidate the assets of the Ricke Bros. Construction Co., including the property listed in Exhibit "E", but did not include any payments made by City of Anthony or the City of Pratt after date of default. The Trustee made payments to the secured and preferred claims that had priority over all creditors. The Trustee was unable to determine whether the claim of the Employers Mutual Casualty Company or the claim of the United States of America for taxes was superior and filed this action to determine the priority to the funds. The court has allowed fees to the Trustee and his attorneys as reflected by the file.

14. The United States of America made demands for payment on account of the assessments set forth in paragraph 11 of this stipulation.

15. The assignment for benefit of creditors referred to in paragraph 13 was made with the knowledge and consent of the United States of America and the Employers Mutual Casualty Company and all other parties to the action with the understanding that the proceeds from the sale of said machinery and equipment should stand in the place and stead of such property.

16. Neither Employers Mutual Casualty Company or United States of America has attempted to enforce this claim against the property or funds by any other judicial proceeding.

Supplemental Stipulation of Fact

COMES NOW the United States of America and Employers Mutual Casualty Company and make the following additional stipulation:

1. The complainant, Arthur L. Vermillion, sold the machinery listed in the chattel mortgage (Exhibit "E") for the total sum of $8,600.68. He made a payment of $1,014.00 to satisfy the mortgage in favor of the Bank referred to in the chattel mortgage (Exhibit "E"). The said complainant paid to the Clerk of the District Court the sum of $9,458.23.

Journal Entry of Judgment

Now on this 21st day of March, 1958, the above entitled matter comes regularly on for trial before the court, the complainant appearing by his attorney, Donald I. Mitchell, the defendant United States of America appearing by and through its attorneys, William F. Kolbe and George Peabody, the defendant Employers Mutual Casualty Company appearing by and through its attorneys Foulston, Siefkin, Schoeppel, Bartlett & Powers. None of the other defendants appearing in person or by counsel.

THEREUPON, the court is advised that William Porter, Trustee in Bankruptcy, will not appear and that a ruling has previously been entered, although not journalized, against his intervening petition and claim.

THEREUPON, the court being duly advised and having examined the record finds that all parties have been duly notified of the setting of the cause for hearing. The court further finds, that all of the parties, except those appearing, are in default and have failed to present evidence in support of their claims and that judgment should be rendered against them.

THEREUPON, the court finds that the fee previously allowed the complainant and his counsel are just and proper and have been approved by the parties and should be approved by the court.

THEREUPON, the court receives into evidence and reads the stipulation of fact as submitted by the defendant United States of America and defendant Employers Mutual Casualty Company.

THEREUPON, the cause is duly argued to the court by counsel for the defendants United States of America and Employers Mutual Casualty Company.

THEREUPON, the court being duly and fully advised makes and enters his conclusions of law as follows:

1. The court has jurisdiction of the parties and subject matter of the action.

2. The claims of the United States of America and Employers Mutual Casualty Company to the funds now held by the Registry of the Court are prior, superior and paramount to the claims of all other parties.

3. The bond applications executed by Ricke Brothers Construction Company on July 21, 1950 and December 15, 1950 did not constitute a choate lien against the machinery, equipment and assets at the time of its execution.

4. The lien of the United States of America for WT and FICA Taxes covering the period 5/1/50 through 6/30/50 in the amount of $1223.46 became a general lien against the property of the Ricke Bros. Construction Company on September 29, 1950, the date the assessment list was received, and is superior to the claim of Employers Mutual Casualty Company under their bond applications.

5. The document attached to the stipulation of fact and marked Exhibit "E" is a valid chattel mortgage and was a mortgage lien against the property described in said mortgage from and after its execution on January 10, 1951 .

6. The claim of Employers Mutual Casualty Company to the money in the Registry of the Court representing the proceeds from the sale of the machinery described in the mortgage (Exhibit "E"), is superior and prior to the claims of the United States of America which became liens subsequent to January 10, 1951 .

7. The United States of America is not entitled to priority over the referred to chattel mortgage in the funds by virtue of the assignment for the benefit of creditors.

THEREUPON, the court requests the contesting parties to provide the court with additional evidence disclosing the amount of the proceeds realized from the sale of the machinery and equipment (Exhibit "E"), and the disbursement of funds.

THEREUPON, said cause is duly continued until March 26, 1958 at which time the parties appear as above.

THEREUPON, the contesting parties submit their supplementary stipulation of fact which is by the court received.

IT IS THEREFORE BY THE COURT CONSIDERED, ORDERED, ADJUDGED, AND DECREED that the claim of the intervenor, William Porter, Trustee in Bankruptcy, be and the same is hereby denied and disallowed.

IT IS FURTHER BY THE COURT CONSIDERED, ORDERED, ADJUDGED, AND DECREED that the claim of the Board of County Commissioners of Harper County, Kansas, the claim of the City of Anthony, Kansas, and the claim of the State of Kansas, Employment Security Division in and to the funds held by the Registry of the Court in this action are hereby denied and disallowed.

IT IS FURTHER BY THE COURT CONSIDERED, ORDERED, ADJUDGED, AND DECREED that the Clerk of the Court shall pay to the United States of America the sum of $1774.01 from the funds now held by the Registry of the Court in this action.

IT IS FURTHER BY THE COURT CONSIDERED, ORDERED, ADJUDGED, AND DECREED that the Clerk of the Court, after making the payment provided to the United States of America, and after deducting the costs of this action, shall pay the balance of all funds held by it in this action to the defendant Employers Mutual Casualty Company.

IT IS FURTHER BY THE COURT CONSIDERED, ORDERED, ADJUDGED, AND DECREED that judgment be entered in favor of the United States of America and against the defendants Norbert W. Ricke, a/k/a N. W. Ricke, d/b/a Ricke Bros. Construction Company, for the outstanding balance with interest from the date of assessment.

IT IS BY THE COURT SO ORDERED.

 

 

[54-2 USTC ¶9519]Alabama-Tennessee Natural Gas Company, Plaintiff v. Lehman-Hoge & Scott, et al., Defendants

In the District Court of the United States for the Northern District, Northwestern Division, of Alabama, Civil Action No. 827, 122 FSupp 314, April 23, 1954

Lien for taxes: Validity against surety.--After the contractor had defaulted, plaintiff completed the construction contract itself. On completion of the contract it paid into court the retained percentages due the contractor. It was held that the lien of the surety who had paid the contractor's creditors under a payment and performance bond was superior to the lien of the United States for withholding and FICA taxes which had not attached at the time of the assignment by the contractor to the surety of the monies payable under the construction contract.

H. A. Bradshaw, 1151/2 East Mobile Street, Florence, Ala., Marshall, Batman & Day, 710 Ohio Street, Terre, Haute, Ind., C. Eugene Fowler, 513 North 21st Street, Birmingham 3, Ala., for plaintiff, Alabama-Tennessee Natural Gas Company. J. Haran Lowe, Ramsey-McCormick Building, Birmingham, Ala., McDonald, McDonald & Kuhn, Memphis, Tenn., Calloway & Reid, Empire Bank Building, Dallas, Tex., for Dunn Brothers. Mitchell & Poellnitz, Florence, Ala., George W. Yancey, Comer Building, Birmingham, Ala., for Century Indemnity Company. Peach, Caddell & Shanks, Decatur, Ala., Harris & Harris, Decatur, Ala., for Crowe & Crowe Hardware Co. Russell A. Lynne, Decatur, Ala., for Clayton D. Blankenship. Clopper Almon, Sheffield , Ala. , for Louis S. Stein Bag Company. McBurney & Colebeck, 5 Bliss Building, Florence , Ala. , for Hawkinds Equipment Company. Frank M. Johnson, Jr., United States Attorney, Birmingham , Ala. , for United States .

Findings of Facts, Conclusions of Law, and Judgment

Statement of the Case

GROOMS, District Judge:

The plaintiff, Alabama-Tennessee Natural Gas Company, filed an action of Interpleader against Lehman-Hoge & Scott, The Century Indemnity Company, the United States , and, by amendment, J. L. Head, and a number of other creditors of Lehman-Hoge & Scott. It is alleged in the complaint that on, to wit, September 25, 1950 the plaintiff entered into a contract with Lehman-Hoge & Scott for the construction of a natural gas pipe line from a point near Decatur , Alabama , under and across the Tennessee River . The contractor defaulted, and Alabama-Tennessee was compelled to take over and complete the contract. After the contract was completed, Alabama-Tennessee admitted owing, under its contract, the sum of $30,598.35, which it paid to the register of this court.

The complaint alleges that each of the parties defendant claims that the contractors are indebted to them, and claims a right to or lien on said retained percentages so paid to the register of this court.

The United States intervened and asserted its claim to said funds so paid into court, and alleged that Lehman-Hoge & Scott had collected from employees income, withholding and FICA taxes in the amount of $50,552.21, and claimed that it had a prior lien and claim to said sum paid into court.

J. L. Head, doing business as J. L. Head Insurance Agency, intervened and claimed that Lehman-Hoge & Scott owed him the sum of $29,323.89, for premiums due and unpaid on insurance placed by him, as agent for Lehman-Hoge & Scott, and asserted that he had a prior lien and claim to said fund by virtue of an assignment or assignments of Lehman-Hoge & Scott to him.

The Century Indemnity Company, as Surety on the bond of Lehman-Hoge & Scott which covered the Tennessee River crossing pipe line contract, asserted its claim to the funds so paid into court, and claimed that it, as Surety, paid to creditors of the contractor, who had furnished materials to the contractor which were used in the performance of the Tennessee River crossing contract, a sum in excess of sixty thousand dollars, and that it had a prior claim to said funds so paid into court.

No other creditors of Lehman-Hoge & Scott appeared in this Intervenor action, and asserted a lien or claim to this fund.

[Issues]

On February 25, 1954 this court made and entered an order on pretrial stating the pleadings and the issues to be as follows:

1. Complaint and amendments; complaint in intervention of the United States; answer as amended of Century Indemnity Company and claim and answer to cross action of J. L. Head, doing business as J. L. Head Insurance Agency; and request for affirmative relief against J. L. Head; answer to complaint of intervention of the United States and request for affirmative relief as to the United States; answer of J. L. Head, doing business as J. L. Head Insurance Agency and claim based on an assignment, and request for affirmative relief.

2. It was agreed by all of the parties that the following are all of the issues in controversy in this cause:

Plaintiff, suing under Title 28, Section 1335, of U. S. C. A. in interpleader, claims that it had a contract with H. F. Lehman, V. V. Lehman, Phil Hoge and Pete Scott, doing business as Lehman-Hoge & Scott, hereinafter called the partners, for the construction of a certain pipe line known as the River Crossing Contract at Decatur, Alabama; that said partners defaulted on said contract and plaintiff was compelled to take over and complete same; upon the completion of which there was the sum of, to wit, $30,589.34 remaining in the hands of the plaintiff. The defendants, The Century Indemnity Company, J. L. Head, doing business as J. L. Head Insurance Agency (hereinafter referred to as J. L. Head), and intervenor, United States, have made claim to said balance which plaintiff had paid into the registry of this court, pending the granting of relief under its bill of interpleader. Plaintiff prays that the court determine the parties to whom the funds rightfully belong, and upon a final hearing that it be discharged with costs, together with an attorney's fee.

The defendant, J. L. Head, filed his answer to the complaint, and also a claim to the funds, asserting that by virtue of an assignment from the partners the plaintiff is indebted to him in the amount of $29,232.89, together with interest in the amount of $430.20, and that said claim is a prior claim and superior claim, and should be paid in preference to any claim of the United States and The Century Indemnity Company.

The intervenor, United States, answers the complaint and filed its claim in intervention, asserting that the partners were and are indebted to it in the amount of $53,663.38 for withholding, F. I. C. A. and F. U. T. A. taxes, and that said taxes constitute a lien against the partners and upon said fund, and that said lien is prior and superior to the claims of The Century Indemnity Company and J. L. Head.

Century Indemnity Company answered the complaint and intervention of the United States and claim of J. L. Head, and asserts that it is entitled to the funds which have been paid into court by virtue of the fact that it executed a payment and performance bond guaranteeing the payment of all materials and labor used in the execution of said contract and guaranteeing the faithful performance of said contract; that said contractor defaulted, and it was compelled to pay material and labor claims in the amount of $60,580.78. It claims that by virtue of its conventional assignment taken at the time it executed its said bond and by virtue of its equitable lien and its right of subrogation, it is entitled to all of said funds, and that its claim is superior to and prior to that of the United States and J. L. Head.

This cause coming on to be heard was, on the 15th day of April, 1954, at Florence, Alabama, tried to the court without the intervention of a jury, and in conformity with the pretrial order of February 25, 1954. The court having considered the evidence adduced upon the trial by the parties hereto, heard oral argument of counsel, now proceeds to make and enter the following finding of facts, conclusions of law and judgment.

Finding of Facts

(1) On, to wit, September 25, 1950 the Alabama-Tennessee Natural Gas Company entered into a contract with Lehman-Hoge & Scott, a partnership composed of H. F. Lehman, V. V. Lehman, Phil Hoge and Pete Scott, for the construction of a natural gas pipe line from a point near Decatur, Alabama, under and across the Tennessee River, referred to as the "River Crossing Contract". The River Crossing Contract provided that the contractor furnish the usual or customary performance and payment bond. The contractor applied to The Century Indemnity Company for the bond, and executed an application for the bond and agreement of indemnity. In the contract of indemnity, which was a part of the application for the bond, Lehman-Hoge & Scott agreed that should they fail or be unable to complete the contract in accordance with its terms, or abandon the work, or fail to comply with the terms or conditions of the contract, that as of date of the execution of the application for the bond, they assigned, transferred and conveyed to The Century all deferred payments and all retained percentages arising out of the contract, and any and all monies and property that may be due and payable to Lehman-Hoge & Scott and the balance of the contract price remaining unpaid to the contractor. The contractor failed to complete the River Crossing Contract, and Alabama-Tennessee Natural Gas Company took over the completion of the construction of the River Crossing Contract and completed same according to the terms and provisions of the contract. After the contract was completed, Alabama-Tennessee had on hand (as retained percentages) the sum of $30,589.34, which it had withheld as retained percentages, under and as provided for in the Alabama-Tennessee River Crossing Contract. This sum was paid to the register of this court, at the time of the filing by the Alabama-Tennessee Natural Gas Company of its complaint of intervention.

(2) The bond originally issued by The Century Indemnity Company to Alabama-Tennessee Natural Gas Company, covering the Tennessee River crossing, was a performance and lien bond and not a payment bond. In May of 1951 the Standard Oil Company, a creditor of Lehman-Hoge & Scott, on account of materials furnished to Lehman-Hoge & Scott on the Tennessee River Crossing Contract, for itself and for other creditors of Lehman-Hoge & Scott so situated, filed a civil action numbered 817 in this court, against The Century Indemnity Company and others, claiming that the bond issued by The Century Indemnity Company should have been both a performance and a payment bond, and asked the court to reform the bond so that it would be both a performance and a payment bond.

[Judgment Against Surety]

On May 9, 1952 the United States District Court for the Northern District of Alabama, Northwestern Division, entered an order and decree reforming the bond made by Lehman-Hoge & Scott as Principal, and The Century Indemnity Company, as Surety, to read as both a performance and payment bond, and ordered The Century to pay all valid claims for materials and supplies furnished Lehman-Hoge & Scott on the Tennessee River Crossing Contract, appointed a Special Master to hear and determine and pass upon the validity of the claims of such creditors of Lehman-Hoge & Scott, ordered the creditors to intervene in the action and file their claims with the clerk of this court, and for notice to be given to all creditors. The Special Master so designated, on November 10, 1952 , submitted his report, in writing, to this court, finding that The Century Indemnity Company, as Surety on the bond of Lehman-Hoge & Scott, owed to such creditors a sum of money in the aggregate largely in excess of sixty thousand dollars. The Master's report was confirmed by this court on, to wit, January 30, 1953 , with a few minor and unimportant exceptions.

It appearing to the Court, in Civil Action No. 817, that all of the creditors of Lehman-Hoge & Scott who furnished materials and supplies to Lehman-Hoge & Scott, which were used and consumed in the performance of the Tennessee River Crossing Contract, had agreed to accept 75% of the amounts found to be due by the court, in judgment rendered on the 30th day of January, 1953, with the exception of Howard Powell, who agreed to accept $20,000.00 in full settlement of his claim, the Court made and entered a judgment of date of July 13, 1953, and ordered and adjudged:

"(1) The said judgment rendered in this cause on January 30, 1953, in favor of various claimants, has been settled and discharged by Century Indemnity Company paying to the register of this court the sum of $60,580.78 on June 9, 1953.

"(2) That said parties shall, by accepting payment of said amounts, less the deduction therefrom on account of attorneys' fees hereinafter provided for, be deemed to have transferred and assigned to Century Indemnity Company their said claims, and it appearing to the Court that the judgments in favor of said parties were rendered against Century Indemnity Company by reason of the fact that Century Indemnity Company executed the bond reformed in this cause as surety for the defendants, H. F. Lehman, V. V. Lehman, Phil Hoge and P. J. Scott, who were the principals therein, doing business under the partnership name of Lehman, Hoge & Scott, said bond being dated September 25, 1950, and having been reformed by judgment of this court in this cause both as to the principals and as to the surety, and that said judgments were rendered on account of said parties having furnished labor and material to said principals as said terms were defined in the bond as reformed, it is adjudged that Century Indemnity Company is entitled to be and is hereby subrogated to all of the rights of the parties in whose favor judgments were rendered against it as against the principals in said bond, and said judgments are hereby assigned to and vested in Century Indemnity Company."

The Century Indemnity Company introduced in evidence checks of the register of this court, showing that the register had disbursed the funds thus paid into this court by The Century Indemnity Company in accordance with the decree of July 13, 1953, and that each and all of such creditors had accepted payment of the amount provided to be paid in said decree, by cashing the checks thus issued by the register of this court.

[Certificate of Assessment]

The sole evidence introduced by the United States in support of its claim was two transcripts of the accounts of the taxpayer, signed by Frank Scofield, Collector of Internal Revenue, bearing date of April 3, 1951, designated as certificate of assessments and payments of Lehman-Hoge & Scott, Phil Hoge, P. J. Scott, H. F. and V. V. Lehman of Harlington, Texas, certifying that the transcripts were true and correct. The transcripts showed that the taxes were due and unpaid by Lehman-Hoge & Scott to the United States for WT, F. I. C. A. and F. U. T. A. taxes for the second, third and fourth quarters of 1950, in the amount of $50,552.51. The Century objected to the certificates.

The Century, in its answer to the Claim of Intervention of the United States, did not admit that Lehman-Hoge & Scott, or the individual members of the partnership, owed the government the taxes claimed, or that the government had filed any lien or given any notice, or that the assessment was correct, and set out that it had no knowledge or notice of the correctness of the claim of the United States, as this information was peculiarly within the knowledge of Lehman-Hoge & Scott and the United States, and called for strict proof.

J. L. Head, doing business as J. L. Head Insurance Agency, offered no evidence in support of his claim, and relied, to prove his claim to the fund, on the exhibits to his complaint in intervention, consisting of a letter bearing date of January 15, 1951, addressed to Alabama-Tennessee Natural Gas Company, signed Lehman-Hoge & Scott by V. V. Lehman, advising that the partnership was indebted to J. L. Head in the sum of $29,323.89, and authorizing Alabama-Tennessee to pay over this sum to Head, and another letter, of January 20th, signed Lehman-Hoge & Scott by P. J. Scott, addressed to Alabama-Tennessee Natural Gas Company, authorizing and instructing Alabama-Tennessee to pay to J. L. Head the sum mentioned in the letter of January 15, 1951, also a telegram of January 16, to Mr. Prouty of the Alabama-Tennessee Natural Gas Company, again authorizing the payment to Head, and requesting acknowledgment of the telegram by a collect telegram; also a letter bearing date of January 20, 1951, addressed to Alabama-Tennessee Natural Gas Company, signed The Century Indemnity Company by J. L. Head, authorized agent, again authorizing the payment to Head of said sum; letter bearing date of January 27, 1951 to Alabama-Tennessee signed Lehman-Hoge & Scott, again requesting payment of said sum to Head, and advising that to avoid any uncertainty the partnership assigned said sum to Head. J. L. Head, in response to request by The Century, admitted, in writing:

"The letter of January 20, 1951, addressed to Alabama-Tennessee Natural Gas Company, to the attention of Mr. Prouty, and signed The Century Indemnity Company by J. L. Head, authorized agent, in which request was made for payment of $29,323.80, was not with specific authority from The Century Indemnity Company, nor any agent, servant or employee of The Century Indemnity Company. This admission was offered in evidence by The Century."

Alabama-Tennessee Natural Gas Company, in connection with its interpleader action, in securing bond required by court before entering an order enjoining creditors from further proceeding in the State court on their claims for materials furnished to Lehman-Hoge & Scott on the Tennessee River Crossing Contract, and expenses incurred by its attorneys and representatives in connection with the interpleader action, expended the amount of $1426.91. The attorneys of record for Alabama-Tennessee Natural Gas Company in the interpleader action are entitled to a reasonable attorneys' fee for preparing, filing and representing the Alabama-Tennessee Natural Gas Company in this interpleader action.

Conclusions of Law

The question for determination by the court is:

Which of the contestants, the United States, J. L. Head or The Century Indemnity Company has the superior right to the funds held by the register of this court?

The United States claims it has a prior lien to the fund for the Income, Withholding and F. I. C. A. taxes assessed against Lehman-Hoge & Scott. J. L. Head claims a superior right, arising from the letters and telegrams from Lehman-Hoge & Scott to Alabama-Tennessee Natural Gas Company. The Century Indemnity Company asserts that it has a prior lien and claim to the fund by virtue of the assignment to it by Lehman-Hoge & Scott in the application for the bond, at the time it executed by bond as Surety for Lehman-Hoge & Scott on the Tennessee River Crossing Contract. The Century contended that it has a superior lien over the other claimants under the basic law of suretyship, which gives a surety, who is called upon to make good under its contract of suretyship upon default of the principal, an equitable lien against any sum withheld as retained percentages in the hands of one for whose protection the bond was given. The Century also claimed that its right to said fund was superior to the rights of the United States and J. L. Head by virtue of its payments to creditors, and the decree of this court of July 13, 1953, subrogating it to the rights of creditors whose claims it had paid.

The taxes withheld by Lehman-Hoge & Scott from the wages of employees is a tax debt. Central Bank v. U. S. , 345 U. S. 639 [53-1 USTC ¶9408].

A surety who makes good under his contract of suretyship, upon default of the principal contractor, acquires an equitable lien upon the unpaid balance in the hands of the person in whose favor the bond runs, and such equitable lien, upon payment by the surety, relates back to the date of the contract of suretyship, although prior to the date of the payment by the surety. U. S. F. & G. Co. v. U. S., 201 Fed. (2d) 118 (10th) [53-1 USTC ¶9249]; Glenn v. American Surety Co., 160 Fed. (2d) 977 (6th) [47-1 USTC ¶9220]; New York Casualty Co. v. Zwerner, D. C., 58 Fed. Supp. 473 [45-1 USTC ¶9140]; General Casualty Company of America v. United States, 205 Fed. (2d) 753 (5th) [53-2 USTC ¶9483]; U. S. F. & G. Co. v. Triborough, 74 N. E. (2d) 226 [47-2 USTC ¶9327];American Fidelity Company v. Denis W. Delaney, Collector of Internal Revenue for the District of Massachusetts, et al., (U. S. District Court for the District of Vermont), 114 Fed. Supp. 702 [53-2 USTC ¶9620].

The assignment in the application for the bond by the principal to the surety has priority over the claim of the United States for taxes, which were not due the United States at the time of the assignment. Engleman v. Commodity Credit Corp., 107 Fed. Supp. 930.

[Assignment to Insurance Agency]

Lehman-Hoge & Scott, at the time of the attempted assignment to Head, had no right to have and receive any payment from Alabama-Tennessee Natural Gas Company as they had defaulted in the performance of the contract, had failed to pay for materials and supplies used up to the time of the default in the performance of the contract, hence had no right to assign any part of the balance under the contract to Head.Maryland Casualty Co. v. Dupree, 136 S. 811, 223 Ala. 420.

A road contractor's surety, completing work on contractor's default, with resultant expenditures of large sum, held entitled, by specific assignment, express terms of contract and general principles of law of subrogation, to amount payable on completion of work as against Bank which loaned money to contractor. Citizens Bank of Guntersville v. Pearson, 217 Ala. 391, 116 S. 350.

The surety's right to funds in the hands of the obligee, to the extent of the amount the surety was compelled to pay under the bond, was superior to the contractor's right to such funds, and superior to the right of the United States to such funds. The rights of the government could be no greater than those of the contractor. U. S. F. & G. Co. v. Triborough, 74 N. E. (2d) 226 [47-2 USTC ¶9327].

The assignment to The Century, contained in application for bond, and Century's equitable lien on retained percentages, and The Century's subrogation are not repugnant or inconsistent. There is nothing in the nature of an equitable lien which would prevent it from having its origin in such an assignment and subrogation. Exchange State Bank v. Federal Surety Co., 28 Fed. (2d) 485 (8th).

A surety does not assume the shoes of the debtor whose performance he assured--rather he takes the position of the creditor who has been satisfied by the surety. Lacy v. Maryland Casualty Co., (CCA 4th), 32 Fed. (2d) 48-51, 50 Am. Jur. Subrogation Section 110.

In view of the court's findings of facts and conclusions of law, the court rules that the lien and right of The Century Indemnity Company to the retained percentages so retained by Alabama-Tennessee Natural Gas Company under and in accordance with the terms and provisions of the contract with Lehman-Hoge & Scott, and paid into court by the obligee in the bond executed by The Century, as Surety, is prior to and superior to the claims and rights of the United States and J. L. Head, doing business as J. L. Head Insurance Agency.

The Century's claim to the fund is prior to and superior to the claims of the United States and of J. L. Head because of:

(1) Its equitable lien.

(2) The assignment of September 25, 1950 .

(3) By subrogation as ordered in decree of this court as of July 13, 1953 .

Judgment

It is, therefore, ordered, adjudged and decreed by the court:

(1) That the lien and claim of The Century Indemnity Company to the $30,589.34 paid to and held by the register of this court by the obligee in the bond executed by The Century Indemnity Company, as Surety, is prior to and superior to the claims and rights of the United States and of J. L. Head, doing business as J. L. Head Insurance Agency.

(2) The Alabama-Tennessee Natural Gas Company shall be paid out of said funds so held by the register of this court the sum of $1,426.91 to reimburse it for expenses incurred in this intervenor action.

(3) The attorneys of record for Alabama-Tennessee Natural Gas Company in the Intervenor Action are entitled to and shall be paid out of said funds so held by the register of this court the sum of $2,303.87, as attorneys' fees for representing Alabama-Tennessee Natural Gas Company in this action.

(4) The register shall deduct from said sum so held an amount equal to any unpaid court costs in this action and shall apply same to the payment of said costs.

(5) The Century Indemnity Company shall have and be paid the balance of said sum so held by the register of this court.

(6) The register of this court is directed to make distribution of said funds and make payments as herein provided.

 

 

[53-2 USTC ¶9620]American Fidelity Company v. Denis W. Delaney, Collector of Internal Revenue for the District of Massachusetts, John E. Burns, Deputy Collector In Charge, District of Massachusetts, et al.

In the United States District Court for the District of Vermont, 114 FSupp 702, September 8, 1953

Lien for taxes: Validity against mortgagees, etc.: Withholding and FICA taxes: Taxes withheld from employees.--Plaintiff, surety for a contractor who contracted to build a highway for the State of Vermont, paid the truckers, some bills for materials and the salary of the contractor's engineer. It was held that the surety's equitable lien was perfected prior to the filing of the tax liens by the United States and further that plaintiff was not liable, under the bonds given the State of Vermont, to the United States for contractor's failure to pay withholding and FICA (Federal Insurance Contributions Act) taxes, nor liable as an employer for taxes withheld from the employees of the contractor. As against Atlantic Corporation which made loans to the contractor, plaintiff was entitled to reimbursement for the salary paid to the contractor's engineer, the bill for gravel purchased by the contractor and a part of the attorney fees.

A. Luke Crispe, Brattleboro , Vt. , for plaintiff. Joseph A. McNamara, United States Attorney, Burlington , Vt. , for defendants Delaney and Burns. Joseph A. McNamara, United States Attorney, Frederick G. Rita, Assistant Attorney General, Washington, D. C., for the United States. Osmer C. Fitts, Brattleboro, Vt., Philip MacCausland, Essex Junction, Vt., for defendant Atlantic Corporation. Elliott Barber, Attorney General, Montpelier , Vt. , for the State of Vermont .

Statement of the Case

GIBSON, District Judge:

The American Fidelity Company, a Vermont corporation, filed a complaint against Denis W. Delaney, Collector of Internal Revenue for the District of Massachusetts, John E. Burns, Deputy Collector in Charge, District of Massachusetts, George E. Duteau, of Springfield , Massachusetts , and the Atlantic Corporation, a corporation organized and existing under the laws of the Commonwealth of Massachusetts .

Service was made on the United States by delivering the summons to the United States Attorney for the District of Vermont, and by sending copies by registered mail to the Attorney General of the United States and to the Commissioner of Internal Revenue, Washington, D. C. Service on the defendant George E. Duteau was made upon the authorized agent of said Duteau, and service on the Atlantic Corporation was made upon the Secretary of State of the State of Vermont, who was the duly authorized agent of the said Atlantic Corporation.

This complaint was answered by the Atlantic Corporation. Defendants Delaney and Burns each moved to dismiss for lack of jurisdiction. This motion was denied. The Plaintiff, shortly after the filing of its complaint, moved for leave to make the United States of America and the Department of Internal Revenue defendants in the action. This motion was granted. Shortly thereafter, the United States of America petitioned for leave to intervene, and upon leave being granted, filed its complaint in intervention. Both the plaintiff and Atlantic Corporation make answer to the intervener's complaint. With issue thus joined, the intervener moved for the dismissal of the original complaint as against Delaney, Burns and the Department of Internal Revenue. This motion was granted. The plaintiff then moved to join the State of Vermont and David V. Anderson, its Auditor of Accounts, as parties defendant. This motion was granted. Service of the motion and of the order granting the motion were accepted by the Attorney General of the State of Vermont , who also filed an answer to the complaint of the plaintiff. The Attorney General of the State of Vermont did not, however, appear at the trial and present any evidence.

Thus at the time of the hearing, the parties to this action were the American Fidelity Company as plaintiff, George E. Duteau and the Atlantic Corporation as defendants, the United States of America as an intervener, and the State of Vermont and David V. Anderson, its Auditor of Accounts, as defendants, these last two being in the nature of stakeholders. The defendant Duteau having filed no answer, the complaint as to him was taken as confessed. In effect, this action is brought by the plaintiff for judgment declaratory of the rights of the parties with respect to a certain fund held by the State of Vermont respecting the final payment upon a contract for road work between the defendant Duteau and the State of Vermont .

[Issues]

The basic issues here to be decided are:

1. Was the American Fidelity Company liable to the United States under its surety bonds for withholding and FICA taxes withheld by the defendant Duteau from the wages of his employees but not paid to the United States ?

2. Were the liens of the United States for the income, withholding and FICA taxes assessed against defendant Duteau entitled to priority over the American Fidelity Company and defendant Atlantic Corporation?

3. Was American Fidelity Company liable for taxes withheld from the employees of the defendant Duteau as an employer under Section 1621(d)(1) of the Internal Revenue Code?

4. If plaintiff is entitled to be reimbursed, how much is it entitled to and how much is the defendant Atlantic Corporation entitled to, if any?

Findings of Fact

A hearing was held in this matter at Brattleboro , Vermont , on the first day of June, 1953, and upon consideration of the pleadings, the stipulation as to agreed facts and evidence, I find the following facts:

1. The plaintiff was and is a corporation existing under the laws of the State of Vermont .

2. The former defendant, Denis W. Delaney, at the time of the filing of the complaint, was the United States Collector of Internal Revenue for the District of Massachusetts, and the former defendant John E. Burns was the Deputy Collector in charge of the United States Internal Revenue District of Massachusetts. Subsequent to the bringing of the complaint, the defendant Delaney ceased being the United States Collector of Internal Revenue for the District of Massachusetts, and since the United States has become an intervening party, the complaint as to Messrs. Delaney and Burns has been dismissed.

3. The defendant George E. Duteau is a resident of Springfield , Massachusetts , and was and is engaged in the general contracting business.

4. The defendant Atlantic Corporation was and is a corporation organized and existing under the laws of the Commonwealth of Massachusetts .

5. On June 10, 1949 , the defendant George E. Duteau contracted with the Vermont State Highway Department and the Vermont Highway Board, under the terms of which contract he was to construct a highway from Jamaica to Winhall , Vermont , for the sum of $310,625.78.

6. The laws of the State of Vermont (Vermont Statutes, Revision of 1947, Section 4909, subsections IV and V) and the regulations of the State Highway Department required said Duteau, as a contracting party, to furnish contract bonds to the State of Vermont and the Commissioner of Highways for the State of Vermont . Such bonds were filed, each in the amount of $155,312.89.

The condition of the first bond, commonly known as a Performance Bond, read as follows:

"NOW, THEREFORE, THE CONDITION OF THE ABOVE OBLIGATION IS SUCH that, if the above bounden principal and his subcontractors and his or their agents and servants shall well and truly keep, do and perform, each and every, all and singular the matters and things in said contract set forth and specified to be by the said Principal kept, done and performed at the time and in the manner in said contract specified and stall pay over, make good and reimburse the State of Vermont all loss or losses and damage or damages which the above named Obligee, the State of Vermont, may sustain by reason of failure or default on the part of the Principal or his subcontractors, or his or their agents and servants, to fully carry out the terms of said contract, then this obligation shall be void; otherwise, to be and remain in full force and effect."

The condition of the second bond, commonly known as a Wages and Material Bond, read as follows:

"NOW, THEREFORE, THE CONDITION OF THE ABOVE OBLIGATION IS SUCH that, if the above bounden Principal shall pay, settle, liquidate and discharge the claims of all creditors for material, merchandise, transportation, labor, rent, hire of vehicles, power shovels, rollers, concrete mixers, tools, and other appliances used or employed in carrying out the terms of said contract between said Principal and the State of Vermont, and shall pay all taxes, both State and municipal, and contributions to the Vermont Unemployment Compensation Commission accruing buring the term of performance of said contract, this agreement to make such payment being in compliance with the requirements of Section 4909 of the Vermont Statutes to furnish security thereunder, and being in fact such security, then this obligation shall be void; otherwise, to be and remain in full force and effect."

Accordingly, said defendant Duteau, on the 7th of June, 1949 , signed contract bonds with the plaintiff, as hereinbefore described, and filed them with proper officials of the State of Vermont .

[Agreement Between Contractor and Plaintiff]

7. In arranging for these contract bonds, defendant Duteau, in his application for the bonds and as a consideration for the plaintiff becoming his bondsman, agreed, amongst other things, as follows:

"That the said company, as surety on said bond, as of this date shall be subrogated to all rights, privileges and properties of the indemnator in said contract, and said indemnator do hereby assign, transfer, and convey to said company all the deferred payments and retained percentages arising out of this contract, and any and all monies and properties that may be due and payable to said indemnator, and the balance of the contract price remaining unpaid at the time of the happening of any of the occurrences mentioned in the first paragraph of the next preceding section or that may thereafter become due and payable to said indemnator on account of this contract or on account of extra work or materials supplied in connection therewith hereby agreeing that all such monies and the proceeds of such payments and properties shall be the sole property of the said company, and to be by it credited upon any loss, damage, charge, and expense (of whatever kind or nature, including premium charges) sustained or incurred by it under any bond of suretyship it was executed for the undersigned indemnator."

8. Notice of this assignment hereinbefore described was given by the plaintiff to defendant State of Vermont and its Highway Department on the 28th of June, 1949 .

9. Sometime in June, 1949, the defendant George E. Duteau commenced construction of the highway project running from Jamaica to Winhall. In early 1950 the plaintiff was notified by the Commissioner of Highways of the State of Vermont that defendant George Duteau was having financial difficulty; was having trouble with his truckers and certain materialmen; and had some threatened labor disputes and that this was impeding the proper construction of the highway which Duteau had contracted to build.

10. Thereafter, sometime towards the last of June, 1950, the plaintiff, through its agents, having investigated this complaint, agreed with the Highway Department and defendant Duteau that the plaintiff would pay certain truckers who were independent contractors, and some other bills for materials but it was to have nothing to do with the payrolls and it would not pay any of the employees of defendant Duteau who were working on the road. It did not maintain any control of any kind over the employees, nor did it control who would or would not be employees. It did not advance payroll money. In return for this agreement of the plaintiff to pay certain truckers for amounts due them by defendant Duteau and take care of future payments to certain truckers for work to be performed in the construction of this highway and to pay certain other miscellaneous bills, the Commissioner of Highways agreed to give all checks and state vouchers due said defendant Duteau to the plaintiff, that it might be reimbursed for moneys advanced by it, all as provided for in the assignment above recited, and this was subsequently done. However, the plaintiff advanced $18,523.94 more than it was reimbursed.

11. After this agreement was made in the latter part of June, 1950, work on the highway continued. However, the Commissioner of Highways, after investigation, objected to the manner of construction and so notified defendant Duteau. As a result of these objections, the Highway Commissioner notified defendant Duteau, in substance, that it was very doubtful if the road construction would be accepted by the State of Vermont unless the then man in charge of the construction, namely, George Duteau, Sr., father of defendant Duteau, was removed from his position as Construction Superintendent and a competent engineer put in. The Commissioner of Highways likewise so notified the plaintiff. As a result of this the plaintiff arranged to secure the services of one Kenneth Jones to be the Supervising Engineer on the job for the purpose of getting the job completed and accepted. Although engineer Jones was actually picked by the plaintiff as a competent Supervising Engineer and although he was paid by the plaintiff, he actually took over the work as Supervising Engineer of the project at the request of and with the full consent of the defendant Duteau. Defendant Duteau removed his own father, Mr. Duteau, Sr., from the post of Supervising Engineer and installed Mr. Jones in it. Mr. Jones, the engineer, was actually paid the sum of $1,200.00 by the plaintiff for his work as Supervising Engineer from the time he took over, early in November, 1950, until the project was completed and the highway accepted. The plaintiff has not been reimbursed for this amount by the defendant Duteau, although it seeks such reimbursement. However, from the first of November, 1950, when said engineer Jones was first employed as Superintendent, until the acceptance of the project by the State of Vermont, all payrolls, except the $1,200.00 item hereinbefore listed, were paid by defendant Duteau and said defendant Duteau had the same control and supervision over this project as he exercised when his father, George Duteau, Sr., was Superintendent. The job was finally completed and the work accepted on about December 12, 1950 . After its completion and acceptance, the Commissioner of Highways caused the job to be sectioned, as required by the rules and regulations of the Highway Department, and thereafter issued to defendant Duteau and to the plaintiff its final statement of work done and materials used under the constructions contract hereinbefore referred to. This final statement showed a balance due from the State of Vermont , through its Department of Highways, in the amount of $25,229.09.

12. After the receipt of the final statement, and before any tax lien was filed, the plaintiff made requests upon the Department of Highways for the payment to it of the $18,523.94, which it claimed was the amount necessary to reimburse the plaintiff for moneys which it had expended, itemized as follows:

Paid by plaintiff to material men and

truckers .....................................         $15,023.30

Paid by plaintiff to Kenneth Jones

for his services as Supervising Engineer .....           1,200.00

Paid by it to its attorney, A. Luke

Crispe, for services rendered by

him in negotiating the adjustment

of the truckers' claims against defendant

Duteau, and for various

negotiations with the 

Vermont
 
State

Highway Department which were

made necessary because of the

Highway Department's dissatisfaction

with the progress and type of

work on this highway .........................           1,930.38

For services and expenses of said

Attorney Crispe in defending defendant

Duteau at the request of

the plaintiff in the lawsuit brought

by one Janet Hoadley Jacques for

gravel .......................................             370.26

                                                       $18,523.94

 

13. On May 11, 1951, the State Highway Board, not disputing the fact that the plaintiff had advanced the sums demanded by it, refused to turn over this sum upon the ground that there existed a controversy between the Vermont Highway Department and defendant Duteau over the amount due from the State of Vermont to said defendant Duteau under the construction contract.

[Collector Intervened]

14. On the 14th of May, 1951, the intervener United States, through John E. Burns, then Deputy Collector in charge of the United States Internal Revenue for the District of Massachusetts, caused notice of a tax lien under the Internal Revenue laws to be filed, in which it now claims a balance due the United States from said defendant Duteau in the amount of $26,404.17. These taxes are broken down as follows:

15. After the filing of this tax notice, the plaintiff was notified by the Highway Department that no payments would be made to the plaintiff or any other person until a final disposition and adjudication had been made of the priority and validity of this tax lien.

16. The law of Vermont provides, as I have stated, that a prime contractor in a case such as this must file a surety bond for the benefit of labor and material men, as was done here. However, in order to obtain the benefit of such security, a claimant must file with the Commissioner of Highways a sworn statement of his claim after the claimant ceases to perform labor or furnish labor, materials, appliances and equipment as aforesaid, or within ninety days from the time such taxes or contributions to the Vermont Unemployment Compensation Commission are due and payable. At no time did the defendant United States of America or any of its representatives ever file any such sworn statement as to taxes alleged due to the United States from defendant Duteau arising out of this highway contract.

17. Of the taxes as assessed against defendant Duteau, the following are attributable to the highway contracts hereinbefore referred to:

Withheld Taxes

5/14/50-7/2/50 ....         $1,743.47

7/9/50-9/24/50 ....          2,488.76

9/30/50-12/3/50 ...            807.50

                            $5,039.73

F. I. C. A. Taxes

                               Employer          Employee

5/14/50-7/2/50 .......          $294.65          $ 294.65

7/9/50-9/24/50 .......           418.73            418.73

9/30/50-12/3/50 ......           100.05            100.05

                                $813.43          $ 813.43

Withheld taxes .......                          $5,039.73

F. I. C. A. taxes ....                           1,626.86

Total ................                          $6,666.59

[Assignment to Atlantic Corp.]

18. On or about July 14, 1950, the defendant Duteau executed and delivered to the defendant Atlantic Corporation an assignment of all moneys due and to become due under the contract for the construction of a highway between Jamaica and Winhall, less the amount of moneys advanced or paid or agreed upon for payment by the plaintiff under its Compliance Bond. This assignment reads as follows:

"For value received, I, George E. Duteau, of 1125 Page Boulevard, Springfield, Mass., hereby assign, transfer and set over unto Atlantic Corporation, 338 Park Square Building, Boston 16, Massachusetts, all monies now due or to become due to me, (less the amount of money advanced or paid or agreed upon for payment by the American Fidelity Co. to pay bills on the contracts bonded by them) from, or payable to me by, State of Vermont, under its contract dated June 7, 1949 in the amount of $310,625.75, for construction of highway in the Towns of Jamaica, Winhall, Vermont, as general collateral security for money advanced to me today by said Atlantic Corporation, together with interest and finance charges thereon, and also for all debts and liabilities whatsoever, past, present and future, of mine to said Atlantic Corporation, direct, indirect, contingent, joint or several; with full power and authority to sue for, collect, receive, adjust, and compromise any and all of the same.

"If said amount or any parts thereof shall be paid directly to me, then I shall hold all such payments and receipts in trust for said Atlantic Corporation and turn the same over to it promptly and in the same checks, drafts, orders or cash in which the same are received by me.

"Signed and Sealed, in triplicate, this 14th day of July, 1950.

s/ George E. Duteau

Witness:

s/ G. Rosenbaum

" July 14, 1950

Atlantic Corporation

Boston , Massachusetts

"We herewith accept and assent to the above referred to assignment and agree to turn over to you all monies received by us on the above contract less the amount of money advanced or paid or agreed upon for payment by us for bills on the contracts bonded by us; but any surplus of funds on the Jamaica-Winhall, Vermont contract over the monies advanced or paid or agreed upon for payment by us, will be turned over to you to the extent of fully reimbursing you for all monies loaned to George E. Duteau to cover payrolls on said Jamaica-Winhall, Vt. contract, providing such procedure is agreeable to the assignee, regardless of our obligations on other bonds for George E. Duteau. Any funds not necessary to reimburse you for said payrolls may be retained by us for our protection on such other obligations.

AMERICAN FIDELITY COMPANY

By: s/ Clark B. Bristol

Vice President"

[ Atlantic 's Loans to Contractor]

19. That thereafter the defendant Atlantic Corporation loaned to defendant Duteau $33,279.50 to pay net payrolls, or, in other words, the take-home pay of the employees of defendant Duteau who were working on the Jamaica-Winhall highway project. Defendant Duteau still owes the defendant Atlantic Corporation $33,279.50, which is the amount loaned to defendant Duteau by defendant Atlantic Corporation for the take-home pay of the employees on the Jamaica-Winhall highway project.

20. There is due from the State of Vermont the sum of $25,229.09 under the terms of the contract of June 10, 1949 , between defendant Duteau and the Vermont State Highway Department and the Vermont Highway Board. This sum is now due and has been due for some time, but the State of Vermont has refused to pay this sum to anyone until a final disposition or adjudication had been made regarding the priority and validity of the tax lien of the United States . The State of Vermont has further refused to issue any check or voucher to the plaintiff or anyone else.

21. The defendant Atlantic Corporation claims and agrees that $15,023.30 is due the plaintiff as claimed by the plaintiff, but disputes the following items of the plaintiff's $18,523.94 claim:

(a) $1,200.00 paid by it to Kenneth Jones as the Supervising Engineer to finish the highway job and secure its acceptance;

(b) $1,930.38 paid by it to its attorney, A. Luke Crispe, for services rendered by him in negotiating the adjustment of the truckers' claims against defendant Duteau, and for various negotiations with the Vermont State Highway Department which were made necessary because of the Highway Department's dissatisfaction with the progress and type of work on this highway.

(c) $370.26 for services and expenses of said Attorney Crispe in defending Duteau at the request of the plaintiff in the lawsuit brought by one Janet Hoadley Jacques for gravel.

Conclusion of Law

The first question presented is this: Were the liens of the defendant United States for the income, withholding and FICA taxes assessed against defendant Duteau entitled to priority over the American Fidelity Company and defendant Atlantic Corporation?

The question is--Which of the contestants possessed a superior right to the funds held by the State of Vermont ? The plaintiff asserts a lien in its favor which it claims originated on May 6, 1949 . The defendant United States claims that it has a priority lien over the plaintiff's lien because of its tax lien notice filed in May of 1951. The defendant Atlantic Corporation supports the plaintiff's contention since, if the plaintiff's lien has priority over the United States ' lien, its own lien, too, will have priority over the United States ' lien.

It is the contention of the United States that the plaintiff's lien was at best an inchoate right which hadn't been perfected; that if it did attach to anything, it attached to the funds which remained in the hands of the State of Vermont after the final "sectioning" or accounting by its Highway Department; that by the theory of subrogation, the plaintiff gained only such rights as defendant Duteau had.

These arguments seem clearly untenable. The contract of suretyship which contained the subrogation agreement was signed by Duteau on June 7, 1949 . On the 28th of June, 1949 , notice of this subrogation assignment was filed with the Highway Department of the State of Vermont . Starting in June of 1950, the plaintiff advanced moneys under its contract of suretyship. It continued to make such advances until the construction job was completed and approved by the State of Vermont in December of 1950. Some time after this approval, but before May 14, 1951 , the State of Vermont computed and ascertained the balance due and payable under the contract. And finally, on May 14, 1951 , the United States filed notice of its tax lien.

It seems basic to the law of suretyship that a surety who is called upon and makes good under its contract of suretyship upon default of its principal, or to prevent its principal being defaulted, acquires an equitable lien against any sum remaining in the hands of the one for whose protection the bond was given. Aetna Life Ins. Co. v. Middleport, 124 U. S. 534, 31 L. Ed. 537, 541. This lien relates back to the date of the contract and is superior to any lien arising thereafter. Prairie State National Bank v. United States, 164 U. S. 227, 41 L. Ed. 412, 419; New York Casualty Co. v. Zwerner, D. C., 58 Fed. Supp. 473, 476 [45-1 USTC ¶9140]. The question here involved is not one where the lien of the United States precedes the processes by which a surety's lien becomes choate, as the United States , in its brief, attempts to point out. Rather, every step of the normal routine of subrogation had been completed far in advance of the filing of the tax lien. In this case, the contract of suretyship had been signed. The surety had been called upon for performance. The surety had, in fact, performed. The surety had made its claim of subrogation by demanding the future payments the the withheld portions of the contract price. The state had acknowledged the rights of the plaintiff by making payments to it as surety for Duteau. The State accepted the completion of the contract the had determined the balance payable under that contract. All of these stages had been gone through before the United States filed its tax lien. Every requirement of a perfect subrogation had been completed by the plaintiff long before the filing of the tax lien. Any ruling which now gives priority to the lien of the United States would necessarily operate to alter and impair rights acquired by the surety under the original contract. Prairie State National Bank v. United States , supra.

What has been said above applies equally well to the claim of the United States, that the plaintiff acquired only such rights as Duteau had under this contract with the State of Vermont, and that until Duteau acquired a specific right to the final payment due under this contract, the rights to which the plaintiff was subrogated were merely inchoate--all this because the State of Vermont had not ascertained the balance due prior to the filing of the tax lien by the United States. As stated above, the filing of the tax lien was the very last step in these proceedings, and the lien of the plaintiff had become perfected well prior thereto. But this argument is further without merit in that it assumes that plaintiff succeeds only to the rights of Duteau, if any he had. It is elemental that a surety does not assume the shoes of the debtor whose performance he assured--rather, he takes the position of the creditor who has been satisfied by the surety. Lacy v. Maryland Casualty Co. (C. C. A. 4th) 32 Fed. (2d) 48, 51; 50 Am. Jur., Subrogation, Sec. 110. Thus, even if Duteau had no rights against the funds now in controversy, this would not affect the position of the plaintiff. Therefore, this Court rules that the lien of the plaintiff is prior and superior to that of the United States .

[Plaintiff Not Liable for Contractor's Taxes]

The second question for decision is this: Is the plaintiff liable to the United States for Duteau's failure to pay withholding and FICA taxes, under the bonds it provided to the Highway Department of the State of Vermont ?

The law of the State of Vermont which requires a prime contractor to furnish bonds for performance and for wages and materials has nothing in it to indicate that these bonds were in any way to cover such obligations as withholding and FICA taxes. Vermont Statutes, Revision of 1947, Sec. 4909. The purpose of the performance bond was to make the contractor liable for default by reason of his inability to keep the contract or by reason of failing to meet the requirements and specifications as to material. The wages and materials bond required by the State of Vermont is to insure the contractor's liability for claims of subcontractors, material men and laborers. The bonds alone govern any liability which the surety might have.

Clearly, the Vermont Legislature intended to protect the State, its subdivisions, employees and material men who need such protection, and not the United States . The Vermont statute is similar--at least in spirit--to the Miller Act. It is possible that the United States might have collected these taxes by filing a sworn statement with the Vermont Highway Department. Its failure to comply with this statutory requirement has barred it from any possible recovery under that statute. The statute creating such a right may impose conditions upon its exercise; these conditions are binding upon all, including the United States . General Casualty Company of America v. United States , C. C. A. 5th (No. 14355) June 30, 1953 [53-2 USTC ¶9483].

Since the United States did not avail itself of the only possible method by which it could have held plaintiff liable under the bonds given the Vermont Highway Department (and the availability of this method to the United States in such a case is not a question here), this Court concludes that the plaintiff was not liable under either its performance bond or the wages and materials bond to the United States for withholding and FICA taxes withheld by the defendant Duteau from wages of his employees but not paid to the United States.

The third question presented is this: Was the American Fidelity Co. liable for taxes withheld from the employees of the defendant Duteau as an employer under Section 1621(d)(1) of the Internal Revenue Code?

Defendant Duteau was at no time actually in default on his prime contract. At no time did the plaintiff (as Duteau's surety) have control of the payment of wages, or the hiring or firing of the help who worked on the highway project. It cannot be classified as an employer. By aiding the contractor in the completion of his contract and by collecting sums from the State of Vermont , the surety merely exercised its contract rights under the bond. It did not make itself liable for any default of the principal, since in this case there was no default of the principal. When an employer withholds the tax from an employee's wage and pays him the balance, the employee has been paid in full. The employer then has a tax liability, and he alone is liable to the United States for this. United States Fidelity & Guaranty Co. v. United States (C. C. A. 10th) 201 Fed. (2d) 118, 120 [53-1 USTC ¶9249]. Nor do the surety bonds furnished by the plaintiff to defendant Duteau furnish the United States any solace on this claim. They cannot be construed to include this claim of the United States . Such construction would require the plaintiff--or any such surety--to police the assured's accounting and payment system; it would increase the risk to the surety, increase the difficulty of the contractor in financing, and generally increase the cost of construction. This Court rules that the plaintiff was not liable for the taxes withheld from the employees of defendant Duteau, as an employer under Section 1621(d)(1) of the Internal Revenue Code.

Having ruled against the United States on its claims, the final question to be disposed of is: How much of the $25,229.09 now held by the State of Vermont , which represents the final payment due under the construction contract, goes to the plaintiff and how much to the defendant Atlantic Corporation?

The defendant Atlantic Corporation concedes that the plaintiff is entitled to $15,023.30 of that sum. It claims, however, that the plaintiff is not entitled to three additional items to which the plaintiff maintains it is entitled. These items are: First, $1,200.00 paid by the plaintiff to one Kenneth Jones for salary as the Supervising Engineer on the project for a short period of time prior to and at the completion of the project. It is true that Jones was selected by the plaintiff as a competent engineer to supervise the completion of the project. It is true that he was paid the sum of $1,200.00 for these services by the plaintiff. However, Jones could not have taken over the position of Supervising Engineer without the consent of defendant Duteau. Duteau was not in default on his contract. His was the sole right of hiring and firing. He did oust his own father as Supervising Engineer and at least consented to Jones taking over. Thus Duteau became the employer of Jones and was liable to Jones for the fair value of his services. This fair value is found by the Court to be $1,200.00, and the plaintiff, having paid that sum, is entitled to reimbursement.

The second item in dispute is one of $370.26. This was a legal bill incurred by counsel who defended defendant Duteau in a civil action brought in the State Courts of Vermont by the owner of the gravel bank. It was for gravel purchased by contractor Duteau for use on the work. In that suit, the plaintiff claimed the amount due to be $2,000.00 (although the plaintiff's specification prior to trial set the amount at $1,700.00). This figure was regarded as highly excessive by Duteau and trial was had before a jury. It does not appear from the record whether this case was actually decided by the jury or whether a settlement was reached. In any event, the amount paid to the plaintiff in that action was $857.00, substantially less than the ad damnum therein. For his efforts in effecting this reduction of the claim, Duteau's attorney was paid in the amount of $370.26 by the American Fidelity Co. The Court finds that such was a reasonable expense. The defendant Atlantic Corporation admits that the amount paid the defendant Duteau by the plaintiff for the gravel as fixed either by the jury or by settlement, is an amount fairly recoverable by the plaintiff in this action, and this Court can see no reason why the attorney that it paid to defend defendant Duteau, at Duteau's request, should not come under the same category.

The final item in dispute is a bill for services by an attorney hired by the plaintiff when it appeared that there was to be trouble between defendant Duteau and the Highway Department of the State of Vermont over this contract. This attorney rendered sundry services for the plaintiff in carrying on negotiations with the State Highway Department and the plaintiff and between Duteau and the plaintiff. The attorney's bill for services amounted to $1,903.38. While I find this bill to be a reasonable bill for the services rendered, I am unable to find that it is an item that is properly chargeable by the plaintiff to the defendant Duteau, or is an item that can in any way be included in the equitable lien held by the plaintiff on the funds still held by the State of Vermont.

It is therefore adjudged that there is now due and payable from the State of Vermont the sum of $25,229.09 as a result of the highway contract hereinbefore referred to. The State of Vermont is ordered to deposit this sum of money with this Court on or before September 21, 1953 , and upon doing so, its obligations under the contract hereinabove referred to shall be completed.

It is further adjudged that of the sum of $25,229.09, the plaintiff shall be paid $16,593.56 and the defendant Atlantic Corporation shall be paid $8,635.539

Let judgment be entered accordingly.

 

 

[56-2 USTC ¶9854]Colusa-Glenn Production Credit Association, a California Corporation, Plaintiff v. Phoenix Insurance Company of Hartford, Connecticut, a Connecticut Corporation; James C. Berlinger, et al., Defendants, United States of America, Plaintiff in Intervention

U. S. District Court, No. Dist. Calif. , So. Div., No. 33942, 145 FSupp 844, 8/2/56

[1939 Code Sec. 3672--changed in 1954 Code Sec. 6323]

Tax lien: Surety's completion of job after contractor's default: Inferior claim of Government to subsequent payments.--A contractor defaulted on a construction job after receiving all payments for work done and then abandoned the contract without payment of his taxes. The rights of the surety who completed the construction job as required by the surety bond were held superior to the rights of the Government to the payments thereafter made by the owner. The surety's rights to the funds was a question entirely apart from their susceptibility to federal tax liens.

Cushing, Cullinan, Duniway & Gorrill, 1 Montgomery , San Francisco , Calif. , for plaintiff. Laughlin, McKalson & Crable, 341 Broadway, Chico , Calif. , for Frank P. Ross. Hewitt & McBride, 540 Second Street , Yuba City , Calif. , for Frank P. Booth. Manwell & Manwell, 423 Fourth Street, Marysville, Calif., for Rice Bros. Arthur S. Powell, Nagler Building, Marysville, Calif., for Steel. Ira B. Langdon, 220 American Trust Building, Stockton , Calif. , for Gauthier. Archibald D. McDougall, 1831 I Street, Sacramento , Calif. , for Phoenix & Ross. United States Attorney, Post Office Building , San Francisco , Calif. , for United States .

Memorandum Order

MURPHY, District Judge:

This is an action under 28 U. S. C. 1335 by the holder of certain funds, amounting to $12,411.40 and now deposited in the registry of this Court, for a determination of the respective rights in that sum of the United States and a surety, the Phoenix Insurance Company of Hartford, Connecticut.

[The Facts]

The surety issued its bond to guarantee the performance of a building contract by one Berlinger, a contractor. The other party to the contract was the Colusa-Glenn Production Credit Association, hereinafter called owner. The bond was executed on November 21, 1953 , and the building contract on November 27, 1953 . The contract provided for the usual ten per cent withholding provision until completion of the entire job, and for progress payments upon architects' certificates only. The contract further provided that time was of the essence and that the building was to be completed by May 24, 1954 .

Pursuant to this contract, the owner paid to the contractor approximately $46,000 prior to June 1, 1954 . On that date, the contractor was in default in several respects, including the time provision in the contract. The government filed a notice of tax lien upon the owner on June 1, 1954 , and several days thereafter the contractor left the job altogether and did no further work. On June 1, 1954 , no amount of money was due and owing to the contractor under the contract, whether as withheld portions, or as portions of the contract price certified for payment by the architects.

The surety now stepped in and performed its obligations to the owner under its bond. It paid off certain liens and arranged for the completion of the job by another contractor, thereby incurring costs in excess of the withheld sum of $12,411.40. Upon completion of the job, the surety made demand upon the owner for the remainder of the contract price. In view of conflicting demands made by the United States , the owner filed this suit.

The United States bases its claim upon tax assessments becoming effective as liens upon any property of Berlinger on the following dates and in the following amounts: 11/18/53 , $6,952.32; 2/8/54 , $1,820.40; 6/3/54 , $657.95. These assessments were received in the office of the Collector on the dates and in the amounts indicated, and therefore became liens against "all property and rights to property . . . belonging to such person," here Berlinger. 26 U. S. C. 3670-3672. ^*

[Opinion]

The United States urges its claim as being prior to any liens not perfected in the manner provided by 26 U. S. C. 3672(a). Under recent Supreme Court decisions, there seems to be no doubt that a federal tax lien is superior to a surety's general claim arising out of the equitable doctrine of subrogation. See, for examples of liens inferior to federal tax liens because not sufficiently perfected, U. S. v. Acri, 348 U. S. 211 (1955) [55-1 USTC ¶9138]; U. S. v. Scovil, 348 U. S. 218 (1955) [55-1 USTC ¶9137]; U. S. v. The Liverpool & London & Globe Insurance Co., Ltd., 348 U. S. 215 (1955) [55-1 USTC ¶9136]; U. S. v. Security Trust and Savings Bank, 340 U. S. 47 (1950) [50-2 USTC ¶9492]; and Phoenix Indemnity Co. v. Earle, 218 Fed. (2d) 645 (9th Cir. 1955) [55-1 USTC ¶9179].

However, all of these cases determine the priority of federal tax liens where there is some property of the taxpayer, or rights to property, to which such liens may attach. In the Acri case, supra, the property was cash and bonds unquestionably belonging to the taxpayer. In the Scovil case, supra, the property was a fund resulting from sale of assets of the taxpayer corporation. In the Liverpool case, supra, the property was an insurance fund, again unquestionably the property of the taxpayer. In the Security Trust case, supra, the property was four parcels of real estate belonging to the taxpayer. In the Phoenix case, supra, the court specifically found that the taxpayer had not defaulted under the contract, 218 Fed. (2d) 645, at 647; the inference is plain that the rights to property to which the federal tax lien attached in that case were the sums owing to the contractor by reason of his substantial performance of the contract.

[Questions of Priority Only Distinguished]

Likewise, two recent cases cited by the government after oral argument, dealing with the priority of federal tax liens as against the surety's claim to funds withheld under a building contract, must be read as deciding questions of priority only, without resolving the issue of whether the contractor in circumstances such as those present here has any rights to property to which the government liens can attach. This Court finds itself in agreement with the opinion of Justice Hofstadter in Aetna Casualty and Surety Co. v. Horticultural Service, Inc., et al., 147 N. Y. S. 2d 422 (Supreme Court, Special Term, N. Y. County, Part IV, Jan. 3, 1956). In that case, no mention is made of the default of the contractor there involved, and it must be assumed that the property rights disputed were rights to money under a building contract substantially performed. The other case cited, Fidelity & Deposit Co. v. New York City Housing Authority, 140 Fed. Supp. 298 (S. D. N. Y. 1956) [56-2 USTC ¶9761], contains an express finding by Judge Dimock that the contractor completed the construction. See 140 Fed. Supp. 298, at 300. The sole default there was that the contractor had failed to pay all the laborers and material men, as he had contracted with the owner to do. The surety in that case contended that the contractor, not having paid his laborers and material men, despite the fact that he had finished the building, had no right to the withheld funds. To this, Judge, Dimock replied:

"The answer is a short one. The contractor's right to the withheld funds, even though conditioned upon acts which the contractor had not performed, was nevertheless an existing right albeit subject to the condition. The Government tax liens attached to it. If the surety is protected here it is not because the lien did not attach to the contractor's interest but because the contractor's interest was subordinate to that of the surety." Id. at 301.

The issue confronting us here is whether Berlinger, the contractor, had any rights to the sums withheld by the owner after June 1, 1954 . Unlike the contractor in the Fidelity Deposit case, supra, Berlinger here committed a breach which must be held to go to the essence of the contract. He was in default with respect to the element of time of completion, provided in the contract to be of the essence. He was in default with respect to payments to his sub-contractors and others. And if these violations of his duties under the contract leave any doubt as to whether they were such a breach of his contract as to dissolve the contract altogether and forfeit his conditional rights under the contract, the fact that he walked off the job completely and never finished the work resolves that doubt. Within a few days of June 1, 1954 , Berlinger effectively severed himself from any conditional rights he may have had under the contract up to that time. He could no longer have returned to the job and offered to perform, with the consequent power to hold the owner to the original contract. The owner could have refused such an offer in view of the previous breach by Berlinger. Therefore, there were no rights to property in the withheld funds left in Berlinger within the meaning of Judge Dimock's opinion in the Fidelity Deposit case, supra, and no government liens could attach to them.

[Apart from Priorities]

Substantially the same issue faced the court in Great American Indemnity Co. v. U. S., 120 Fed. Supp. 445 (D. Vermont 1954) [54-2 USTC ¶9469]. The Court there based its ruling on two alternate grounds. The first of these has been overruled by the Supreme Court cases discussed above. The second ground was expressed by the Court in the following language:

"But, there is another feature in this case that, in our opinion, is totally decisive. In the Supreme Court decisions herein cited and relied on by the government, we find one constant factor. In each of those cases, the liens (federal and others) attached to property belonging to the defendant debtor, property that was his all the time. Such is not the case here. The government's debtor here is the contractor, who did not get the money.

"It is not necessary to rely on the so-called 'equitable doctrine of relation back.' U. S. Fidelity & Guaranty Co. v. U. S. , 10 Cir., 1952, 201 Fed. (2d) 118, 121. It suffices to say that the rights of the Internal Revenue Collector can rise no higher than those of its debtor whose right to property is sought to be levied upon. Alexandria Insulation Company forfeited its rights to the fund prior to the filing of the tax lien. It had no right to the fund. Therefore, the government does not. New York Casualty Co. v. Zwerner, D. C., 58 Fed. Supp. 472 [45-1 USTC ¶9140]." Id. at 451.

And, again in what seems to be an alternate ground for decision although not specifically so denominated, the Court of Appeals for the 10th Circuit, in U. S. Fidelity & Guaranty Co. v. U. S., 201 Fed. (2d) 118 (10th Cir. 1952), a case similar to the one at bar, said (referring to the case of U. S. v. Security Trust & Savings Bank, 340 U. S. 47 (1950) [50-2 USTC ¶9492]):

"It is to be noted that both liens attached to property belonging to the defendant debtor, property that was his at all times. Such is not the case here. On the date of the execution of the subcontract the prime contractor had a specific right to ownership in any funds accruing to the subcontractor from the performance of his subcontract. The right to withhold these funds upon default was superior to any other claim against the fund as the property of the subcontractor. When the subcontractor defaulted and its surety, the appellant in this case performed it stepped into the shoes of the prime contractor and was subrogated to all rights that it held against the subcontractor. Those rights related back to the date of the subcontract and were effective from the date thereof. This was in point of time prior to the perfection of the Government's tax liens. Actually the defaulting subcontractor had no right to this fund. It owed the principal contractor more than was due to it from such principal contractor. As between the Government and appellant surety who stepped into the shoes of the principal contractor, the Government could acquire no greater right to this fund than the subcontractor had." 201 Fed. (2d) 118, at 121-122.

The surety's claim to the withheld funds is a question entirely apart from the issue of priorities, of course. It rests upon the doctrine of equitable subrogation that where a surety performs under a performance bond after the default of the contractor, it is entitled to an equitable lien on funds previously withheld by reason of the contractor's default, at least to the extent of the surety's expenses. See Lacy v. Maryland Casualty Co., 32 Fed. (2d) 48 (4th Cir. 1929) (see especially the discussion on pp. 51-53); Farmers' Bank v. Hayes, 58 Fed. (2d) 34 (6th Cir. 1932); American Fidelity Co. v. Delaney, 114 Fed. Supp. 702, at 711 (D. Vermont 1953) [53-2 USTC ¶9620]; U. S. Fidelity & Guaranty Co. v. U. S. , supra, at p. 122.

[Rights of Subrogation]

It is to be noted that this equitable doctrine is additional to and distinct from other rights of subrogation which the surety may have, be they derivative from the labor and material men it paid off, or derivative from the owner's rights against the contractor, if any. Some confusion was doubtlessly engendered by failure of counsel to distinguish among the several equitable doctrines of subrogation which may be involved in any complex fact situation. Also, counsel for the surety seems to have taken too optmistic a view of the effect of American Surety Co. v. Bethlehem National Bank, 314 U. S. 314 (1941), relating to the subrogation of the surety to the creditor's remedies on the money claim against the debtor, Id., at 317, on the rights of the surety in this case. In any case, the surety's right to the funds is a question entirely apart from the susceptibility of the funds to the federal tax liens. I have held that the funds are not so susceptible. No priority doctrine can make them otherwise, of course.

Let the sum of $12,411.40 now in the registry of this Court be paid to the surety.

^* "Sec. 3670. PROPERTY SUBJECT TO LIEN. 'If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, penalty, additional amount, or addition to such tax, together with any costs that may accrue in addition thereto) shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person.'

"Sec. 3671. PERIOD OF LIEN. 'Unless another date is specifically fixed by law, the lien shall arise at the time the assessment list was received by the collector and shall continue until the liability for such amount is satisfied or becomes unenforceable by reason of lapse of time.'

"Sec. 3672. VALIDITY AGAINST MORTGAGEES, PLEDGEES, PURCHASERS, AND JUDGMENT CREDITORS. '(a) INVALIDITY OF LIEN WITHOUT NOTICE. Such lien shall not be valid as against any mortgagee, pledgee, purchaser, or judgment creditor until notice thereof has been filed by the collector * * *'".

 

 

[57-1 USTC ¶9317]In the Matter of Buildice Company, Incorporated, Bankrupt

U. S. District Court, Chicago, Ill., No. 55 B 649, 146 FSupp 911, 12/11/56

[1939 Code Secs. 3670, 3671 and 3672--similar to 1954 Code Secs. 6321, 6322 and 6323]

Tax lien: Right of subrogation for surety guaranteeing payment of taxes: Tax debts in existence at time of surety's undertaking, and those arising thereafter.--Upon the execution of a bond by a surety, the government released a tax lien against a delinquent taxpayer for a certain amount. Payments reducing the amount covered by the bond were made by the taxpayer up until the time it went into bankruptcy. At the time the surety executed its bond, certain other unpaid taxes were owed by the taxpayer to the government. Additional sums accrued subsequent to the delivery of the bond by the surety to the United States . During the bankruptcy proceedings, the surety paid the balance of the tax due under the bond. It then claimed, that as a subrogee of the government to the extent of the amount it had paid under the bond, it was entitled to share proportionately and in preference with other tax claims due the United States . The Court held that, as to the tax due the government prior to the delivery of the bond and not covered by it, the government was entitled to priority. But as to those tax debts accruing after the delivery of the bond, the surety was entitled to be subrogated to the tax priority status enjoyed by the government as to the extent of the taxes discharged under its bond.

Harold J. Ross, 29 South LaSalle Street , Chicago 3, Ill. , for petitioner. R. Tieken, United States Attorney, Nicholas G. Manos, Assistant United States Attorney, 219 South Clark Street, Chicago 4, Illinois, for U. S. Wallace Streeter, Referee in Bankruptcy, 219 South Clark Street, James Overton Brooks , Attorney for Receiver, 33 South Clark Street , Chicago , Ill.

Memorandum

HOFFMAN, District Judge:

The United States Fidelity and Guaranty Company (hereafter referred to as the Surety) has filed its petition to review an order entered by the Referee in the matter of the bankruptcy of Buildice Company, Incorporated. The question raised by the petition is the relative priority of the United States of America (hereafter referred to as the United States ) and of the Surety, claiming as subrogee of the United States , in the general assets of the bankrupt.

The facts which produced the controversy can be briefly stated. On March 11, 1954, Buildice Company, Incorporated, was indebted to the United States for withholding and employment taxes falling due before 1953 in the assessed amount of $33,782.18, and the United States had filed a lien for that amount. To release this lien, Buildice Company, as principal, executed a bond for the payment of these taxes and the petitioner joined in the bond as surety. After the delivery of the bond, Buildice Company made payments which reduced the debt to approximately $13,000. In March, 1955, Buildice Company was adjudicated a bankrupt.

In the bankruptcy proceeding the United States filed a claim for the $13,000 remaining due under the bond and for additional withholding and employment taxes which had been assessed after the delivery of the bond. Some of the taxes claimed had fallen due before the bond was delivered; others had accrued subsequently. The claim totaled $46,699.02, and was made up of the following items:

(a) Taxes secured by the bond--

1. Withheld taxes, 
12/31/52
 ...................           $ 92.36

2. Withheld taxes, 
3/31/53
 ....................         12,220.33

(b) Other taxes due before delivery

of the bond--

3. Unemployment taxes, additional,

for 1952 ......................................            238.85

4. Unemployment taxes for 1953 ................            907.64

5. Withheld taxes, 
12/31/53
 ...................         13,750.80

(c) Taxes due after delivery of the

bond--

6. Withheld taxes, 
6/30/54
 ....................         14,277.34

7. Withheld taxes, 
12/31/54
 ...................          5,931.85

 

The basis of the claim in all respects was the priority of tax claims due the government; no claim based upon a lien for assessed taxes was made.

On November 2, 1955 , the Surety discharged its obligation under the bond by paying to the United States the amount remaining due upon the taxes secured by it. Thereafter the Surety filed its claim in the bankruptcy court, as subrogee to the United States , for the amount paid under the bond, and the United States amended its claim to eliminate those items paid by the Surety.

On April 26, 1956 , the Surety filed its petition for the allowance of its claim as a prior tax claim, payable proportionately and in equal preference with the tax claims due the United States . The Surety has sought review of the Referee's denial of this petition.

The question presented was certified with clarity by the Referee:

"Where a Surety Company issues its bond to the United States guaranteeing the payment of certain taxes due the United States, and where thereafter the principal on said bond makes certain payments to the United States in the reduction of the principal's liability; and where thereafter the United States filed its priority tax claims against the principal bankrupt's assets, including the unpaid balance of tax which was secured by said bond, and thereafter the United States made demand upon the Surety for the payment of the unpaid balance of the taxes, which payment was guaranteed, and the Surety complied with said request and paid said balance, is the Surety entitled to be subrogated to the priority of the United States on account of such payment, and, if so, is it entitled to have its claim paid before the claim of the United States on account of other taxes has been paid in full?"

There is no dispute concerning the Surety's right to be subrogated to the priority of the United States to the extent of preceding the claims of other creditors. The Referee decided that as to claims inferior to the tax claims of the United States the Surety should enjoy priority, and no one has contested that determination. The sole controversy remaining concerns the relation between the claims of the United States and the Surety. The Surety claims to be entitled to proportional participation with the United States . The United States claims, and the Referee found, that the Surety is not entitled to any payment until after all of the United States ' tax claim has been paid in full.

The Surety, in support of its claim to equal participation, relies upon two statutes. First, Section 3468 of the Revised Statutes (28 U. S. C. §193) provides:

"Whenever the principal in any bond given to the United States is insolvent, or whenever, such principal being deceased, his estate and effects which come to the hands of his executor, admin istrator, or assignee, are insufficient for the payment of his debts, and, in either of such cases, any surety on the bond, or the executor, admin istrator, or assignee of such surety pays to the United States the money due upon such bond, such surety, his executor, admin istrator, or assignee, shall have the like priority for the recovery and receipt of the moneys out of the estate and effects of such insolvent or deceased principal as is secured to the United States; and may bring and maintain a suit upon the bond, in law or equity, in his own name, for the recovery of all moneys paid thereon."

The second statute relied upon is Section 57(i) of the Bankruptcy Act (11 U. S. C. §93(i)), which provides:

"Whenever a creditor whose claim against a bankrupt estate is secured by the individual undertaking of any person fails to prove and file such claim, such person may do so in the creditor's name and, if he discharge such undertaking in whole or in part, he shall be subrogated to that extent to the rights of the creditor."

It has been suggested that the first of these statutes, Section 3468, Revised Statutes, is intended to control if the surety's payment is made before the petition in bankruptcy is filed, while the second, Section 57(i) of the Bankruptcy Act, controls if the surety's payment is made after the bankruptcy proceeding is begun. See 3 Collier on Bankruptcy, 290 (14th ed. 1941). But since both operate with the same effect upon the question at issue, it is unnecessary to decide which may govern.

Both of these statutes have been qualified in interpretation by the general principle of suretyship which forbids recovery by a surety upon a claim of subrogation until the full indebtedness secured by the bond has been satisfied. See Restatement of Security, §141 (1941); Stearns on Suretyship, §245, p. 430 (2d ed. 1915). In interpreting Section 3468 of the Revised Statutes, first quoted above, the Supreme Court has applied this general principle to deny equal participation with the government to a surety when the debt secured by the surety's bond has not been fully paid, despite the fact that the surety has paid the full sum for which it is liable under the bond. United States v. National Surety Company, 254 U. S. 73 (1920). Similarly, in interpreting Section 57(i) of the Bankruptcy Act, the Supreme Court has held that the surety may not share until the obligation secured by the bond is fully paid, even though the surety's liability is extinguished. American Surety Company v. Sampsell, 327 U. S. 269 (1946); American Surety Company v. Westinghouse Electric Mfg. Co., 296 U. S. 133 (1935). In the case last cited, this general principle was restated:

"A surety who has undertaken to pay the creditors of the principal, though not beyond a stated limit, may not share in the assets of the principal by reason of such payments until the debts thus partially protected have been satisfied in full." (296 U. S. , at 137).

Other applications of this principle may be found in United States Fidelity & Guaranty Co. v. Union Bank & Trust Co., 228 Fed. 448 (6 Cir. 1915); In re Hanson & Tyler Auto Co., 286 Fed. 161 (N. D. Ia. 1922); In re Manhattan Brush Mfg. Co., 209 Fed. 997 (S. D. N. Y. 1913); In re Heyman, 95 Fed. 800 (S. D. N. Y. 1899).

The Surety argues that the principle reflected in these decisions does not control the question here presented. In all of the cases cited the debt which the surety had guaranteed remained unsatisfied in part. Here the taxes secured by the Surety's bond have been paid in full, and it is the Surety's standing with respect to other debts due the creditor that is in issue. In this situation, the Surety submits, the principle has no application.

Underlying the principle which denies subrogation to the surety before full payment of the debt secured are the reasonable expectations of the creditor protected by the bond. When the creditor enjoys the guarantee of a surety bond as to a part of the debt, he may fairly rely upon the general assets of the debtor for the portion of the debt not secured. If the surety were permitted to share in these general assets to the prejudice of the creditor, and to reduce the creditor's recovery by participating equally in competition with the creditor, the full obligation of the surety would not be realized. The allowance of subrogation is governed by considerations of equity and good conscience. These considerations dictate that the creditor's claim should not be prejudiced or reduced by virtue of the bond obtained for a part. As stated in the case of In re Hanson & Tyler Auto Co., 286 Fed. 161 (N. D. Ia. 1922):

"* * * In the instant case petitioner, who was the original creditor guaranteed, was not paid his full claim, but only a part, and so far as appears from the record, were he permitted to receive the dividends upon the full amount of his original claim, there would still be a balance unpaid. In such circumstances to reduce petitioner's claim to the extent of the guaranty paid and permit the guarantor to prove for the amount so paid would deprive petitioner of a part of his security and impair the obligation of his contract with the guarantor." (286 Fed., at 162).

In view of this justification for the principle denying subrogation when the full debt has not been paid, there is no warrant for distinguishing between an unpaid and unsecured portion of the debt secured in part on the one hand and a distinct and different debt already accrued at the time of the surety's undertaking on the other. In either case the creditor may be expected to rely upon the general assets of the debtor to respond for so much of the total indebtedness as is not secured by the surety's bond. In either case, to permit subrogation before full payment of all indebtedness existing at the time of the surety's undertaking would impair the obligation of the surety by reducing the creditor's recovery from the general assets.

For these reasons the general principle denying subrogation has been applied, regardless of the fact that the full indebtedness secured has been discharged, where there remains unpaid some other indebtedness which existed at the time the surety entered into the guarantee. Thus where collateral has been pledged to secure two separate debts, and the surety has guaranteed only one of the debts, either in whole or in part, the surety is not entitled upon satisfaction of the debt he secured to a right in the collateral by way of subrogation; both debts must be paid before he may participate. National Bank of Commerce v. Rockefeller, 174 Fed. 22 (8 Cir. 1909); Hudson Trust Co. v. Cushman, 93 Conn. 119, 105 Atl. 344 (1918); Restatement of Security, §141 (1941).

It follows, under the general principles of suretyship which qualify the statutes relied upon by the Surety, that the Surety's right of subrogation must be postponed until the indebtedness to the United States due when the Surety's undertaking was made has been satisfied. The items included in the United States ' claim which represent taxes accrued and unpaid on March 12, 1954 , the date of the bond, must accordingly first be paid. These include the additional unemployment taxes for 1952, unemployment taxes for 1953, and withheld taxes due for the period ending December 31, 1953 , as set forth as items numbered 3, 4 and 5 in class (b) in the chart hereinbefore set out. To this extent the order of the Referee will be affirmed.

Different considerations are called into play by the taxes which accrued after the Surety's bond was delivered. The principles which deny subrogation before existing debts are paid stop short with the limits of their justification. The Surety's obligation to assume, as between creditor and surety, the risk of the debtor's insolvency does not extend to future indebtedness not within the contemplation of the parties, and there is no impairment of the Surety's undertaking when subsequent and junior claims are reduced by subrogation. In such a situation, there are no reasonable expectations of the creditor which are disrupted; it is rather the Surety who may reasonably expect that, once the existing indebtedness to the creditor is discharged, he will no longer be prejudiced by the undertaking to assure.

Authority upon the point seems to be limited to cases involving the surety's right to security, in the form of personal collateral or of a mortgage, given by the debtor to assure the same debt guaranteed by the surety, and pledged after the surety's undertaking to the same creditor for additional and subsequent obligations. In this situation, it is held that the surety need only discharge the obligations existing at the time of his undertaking in order to be subrogated to rights in the security; it is not a condition to the surety's rights that the subsequent and independent debts be paid. National Exchange Bank v. Silliman, 65 N. Y. 475 (1875); Schell City Bank v. Reed, 54 Mo. App. 94 (1893); Forbes v. Jackson, Law. Rep. 19 Ch. Div. 615, 21 Eng. Rul. Cas. 607 (1882); Stearns on Suretyship, §250, pp. 445-47 (2d ed. 1915). In Arant on Suretyship (1931), the author states the general rule that a surety has no right by subrogation to the creditor's security, when it also secures other debts of the principal, so long as any of the other debts remain unpaid, and follows with this qualification: "But, if the other secured debts are contracted after the surety's promise, the surety is not required to pay them before his right of subrogation arises."

Under this general principle of suretyship, the obligations which accrued after the Surety's undertaking raise no impediment to subrogation. It follows that after the payment of those taxes which had already accrued before the Surety delivered its bond, the Surety is entitled to be subrogated to the tax priority status enjoyed by the United States under Section 64 of the Bankruptcy Act, 11 U. S. C. §104. With these subsequent claims, the claim of the Surety is entitled to proportional participation in the dividends.

This result in no way undermines or abridges the priority given to government tax claims under either Section 64 of the Bankruptcy Act, 11 U. S. C. §104, or Section 3466 of the Revised Statutes, 31 U. S. C. §191. By paying the taxes due, the Surety becomes entitled to enforce the tax claim, but the nature of the claim is not changed. It remains a tax claim, entitled to priority as such, along with other tax claims remaining to the taxing authority. In re Ingersoll Co., 148 Fed. (2d) 282 (10 Cir. 1945). For purposes of determining the priority, the fact of subrogation is ignored. Thus if the United States claims as subrogee to a debt owed some private person, the nature of the claim is not affected, and the United States enjoys no higher priority than its subrogor. United States v. Marxen, 307 U. S. 200 (1939); In re Miller, 105 Fed. (2d) 926 (2 Cir. 1939).

The case of Standard Accident Ins. Co. v. United States, 97 Fed. Supp. 829 (Ct. Cl. 1951), relied upon by the United States , is not in point. There the controversy involved not the surety's right to participate in the estate of a bankrupt, or in any appropriated sum, but rather the surety's claim to enforce a debt owed by the government to the principal in disregard of offsetting debts owed by the principal to the government. The decision turned upon a matter of set-off, and has no application here.

An order will be entered modifying the order of the Referee and granting the petition of the Surety to participate proportionately with the United States after the full payment of all taxes due on March 12, 1954 .

Counsel are directed to confer, prepare a draft order in keeping with the views herein expressed and submit the same for the signature of the court on or before December 17, 1956 .

 

 

[89-1 USTC ¶9148] Kansas City , Missouri , Plaintiff v. Tri-City Construction Company and United States Fidelity & Guaranty Company and the Internal Revenue Service, Defendants

U.S. District Court, West Dist. Mo. , West. Div., 86-0570-CV-W-1, 8/11/87, 666 FSupp 170

[Code Sec. 6323 ]

Lien for taxes: Priority: Surety's interest.--The surety of a performance and maintenance bond was entitled to summary judgment because the principal possessed no right to a city's partial payment to which an IRS lien could attach. The principal's breach of contract severed its right to future partial payments and entitled the surety to all future payments under the contract. The United States did not obtain constructive possession of the progress payment due and owing to the principal through service of a notice of levy upon the city. Even if the principal possessed an interest or right in the partial payment, the surety's equitable lien to funds owing to the principal upon the surety's performance was superior to the IRS's lien.

Richard W. Ward, City Attorney, Thomas C. Clark, Assistant City Attorney, Kansas City, Mo. 64106, for plaintiff. Tri-City Construction Co., 3001 E. 83rd St., Kansas City, Mo. 64132, pro se. Rob ert A Babcock, Margolin & Kirwan, 928 Grand Ave., Kansas City, Mo. 64106, for defendant. Preston Dean, Assistant United States Attorney, Kansas City, Mo. 64106, William S. Rose, Jr., Rob ert D. Metcalfe III, Department of Justice, Washington, D.C. 20530, for I.R.S.

MEMORANDUM OPINION AND ORDERS

OLIVER, Senior District Judge:

The city of Kansas City , Missouri (City) filed the pending interpleader action to determine who is entitled to an earned and undisbursed contract partial payment of $27,703.28 under a contract the City entered into with Tri-City Construction Company (Tri-City) on June 26, 1985 . United States Fidelity & Guaranty Company (USF&G), at the request of Tri-City, provided a performance and maintenance bond for the contract amount of $1,705,166.75. Tri-City abandoned work on the project.

The factual circumstances are fully stipulated. The stipulation of the parties is attached as Appendix A and incorporated by this reference as our findings of fact. Neither the City nor Tri-City asserts any claim for the $27,703.28 partial payment. In paragraph 23 of the stipulation USF&G and the United States agree that this case may be determined as though cross-motions for summary judgment were filed by these parties and that neither party wishes to adduce any additional evidence.

The United States claims a superior right to the partial payment as the result of its service of a Notice of Levy on the City for Tri-City's unpaid federal withholding and Federal Insurance Contribution taxes. USF&G claims a superior right to the partial payment under the stipulated circumstances of this case. For the reasons stated below, USF&G's motion for summary judgment will be granted and the United States ' cross-motion for summary judgment will be denied.

I

It is undisputed that Tri-City failed to pay the claims of subcontractors, suppliers and materialmen furnishing labor and material during the performance of the work required by the contract. Stipulation of Facts (hereinafter Stip.) No. 9. Tri-City wrote the City on August 22, 1985 advising that all future payments under the contract should be issued to USF&G. ¹ Stip. No. 10 and Exhibit C. Tri-City abandoned the work project on March 28, 1986. Stip. No. 11. On April 16, 1986 , Tri-City advised its surety, USF&G, that it could not complete the project and requested that it continue to pay the claims against Tri-City for labor and materials. Stip. No. 12. USF&G thereafter secured the services of another contractor which completed the contract. Stip. No. 13. In total, USF&G has paid claims of suppliers and subcontractors under its bonds with Tri-City in the amount of $1,149,544.02. Stip. No. 14.

An assessment for unpaid federal withholding and FICA taxes for the tax period ending December 31, 1984 in the amount of $359,151.06, along with penalties and interest, was assessed against Tri-City on March 18, 1985 . Stip. No. 6. Notices of federal tax liens were subsequently filed against Tri-City with the Recorder of Deeds for Jackson County and Ray County, Missouri on February 26, 1986 and March 14, 1986 . Stip. No. 16. An Internal Revenue Service Notice of Levy reflecting the unpaid balance of the assessment was served on the paymaster of the City of Kansas City, Missouri on March 17, 1986 for all property rights and rights to property of Tri-City in the amount of $187,716.67. Stip. No. 15.

II

USF&G's initial argument for summary judgment is that the United States has no lien upon the partial payment which can be foreclosed since Tri-City's breach of contract divested Tri-City of its rights to the contract funds. We agree.

Section 6323 of 26 United States Code provides that "if any person liable to pay any tax neglects or refuses to pay the same after demand, the amount . . . shall be a lien in favor of the United States upon all property and rights to property belonging to such person." (Emphasis added). Thus, the threshold question in determining who is entitled to the partial payment is whether and to what extent Tri-City had "rights" to the partial payment to which the tax lien could attach. See e.g., Aquilino v. United States [60-2 USTC ¶9538 ], 363 U.S. 509, 513 (1960); Tony Thornton Auction Service v. United States [86-1 USTC ¶9434 ], 791 F.2d 635, 637 (8th Cir. 1986); United States v. Trigg [72-2 USTC ¶9642 ], 465 F.2d 1264, 1267 (8th Cir. 1972). State law determines this question and thus we must look to Missouri law to determine whether Tri-City possessed any rights to the payment.

See, e.g., Aquilino, 363 U.S. at 512-13.

Under Missouri law Tri-City never possessed a right to the partial payment to which the United States tax lien could attach. It is clear from the facts that as of August 22, 1985 , Tri-City was in default on its contract with the City of Kansas City, Missouri. First, shortly after commencing performance, Tri-City failed to pay the claims of subcontractors, suppliers and materialmen. Second, on August 22, 1985 , less than two months after the execution of the construction contract, Tri-City sent a letter to the City requesting that all future payments under the contract should be issued to the surety. This direction was irrevocable and subject to change only upon the written direction and consent of USF&G. Finally, as of August 22, 1985 , USF&G became obligated to pay under its contract a suretyship with Tri-City the obligations of its principal. In fact, by March 1986, USF&G had made payments to creditors of Tri-City totaling $755,409.92.

Under Missouri law all that is necessary for a surety's equitable right of subrogation and equitable lien upon retained funds to attach to the exclusion of the contractor is that "the contractor to be in default as a matter of fact, and that as a result of such default the surety become obligated to pay under its payment bond, and discharge the obligations of its principal." ² First State Bank v. Reorganized School District R-3, 495 S.W.2d 471, 481 (Mo. App. 1973). The contractor in this case was in default when it could not pay its subcontractors, laborers and materialmen. That default was fully recognized by all parties concerned when the contractor directed the City to make all future payments to the surety on August 22, 1985 .

It is thus clear that as of August 22, 1985 , Tri-City was in default under its contract with the City as a matter of fact and USF&G was obligated to pay under the terms of its bond. Tri-City's default severed any right of Tri-City to future partial payments and entitled USF&G to all future payments under the contract. We thus find and conclude that the United States ' tax lien and subsequent levy failed to attach to any interest or right in the partial payment at issue.

III

The United States , however, contends that through the Internal Revenue Service Notice of Levy served on the City on March 17, 1986 , the United States obtained constructive possession of the progress payment of $27,703.28 due and owing to Tri-City. This levy allegedly preceded the date USF&G's equitable lien or right of subrogation arose, which the government contends was on April 16, 1986 , the date of Tri-City's declared default. Thus, the United States argues since USF&G's equitable lien was not choate until after the United States tax levy, USF&G had no prior interest in the progress payment which would defeat the rights of the United States .

We reject this argument in light of our finding and conclusion stated above that Tri-City's default as a matter of fact as of August 22, 1985 divested Tri-City of any right to the partial payment to which the United States tax lien and subsequent levy could attach. Moreover, we agree with USF&G that even assuming, arguendo, Tri-City possessed rights to the partial payment to which the United States tax lien and subsequent levy could attach, USF&G's rights in the payment as surety for the defaulting contractor are superior.

The United States relies on Dependable Insurance Co. v. United States [78-2 USTC ¶9721 ], 42 A.F.T.R. 2d 78-5922 (D.Md. 1978), as authority for its priority argument. We find and conclude, however, that the court's analysis in Dependable is untenable.

In United States v. Trigg [72-2 USTC ¶9642 ), 465 F.2d 1264 (8th Cir. 1972), cert. denied, 410 U.S. 909 (1973), a case similar to Dependable, the Eighth Circuit recognized the surety's super priority rights in progress payments levied upon by the United States prior to the contractor's default as a matter of fact. The surety in Trigg executed a performance bond in August, 1968 for the contractor under construction contracts with two Arkansas municipalities. In March, 1969 the United States served notices of levy upon the two municipalities. The municipalities subsequently transferred progress payments to the United States . On April 13, 1967 the contractor defaulted on its contracts and the indemnitor of the surety paid the contractor's previously unpaid materialmen and laborers and secured another contractor to complete the two projects.

In determining the priority of competing claims to the progress payments levied upon by the United States prior to the default of the contractor, the court concluded that "the surety, Maryland Casualty Company, would clearly be entitled to priority against the progress payments if [the surety] had actually made disbursements under the suretyship agreement." Id. at 1271 (dicta). The court, in support of this conclusion, relied heavily on the language of 26 U.S.C. §6323 and the Senate Committee Report ³ explaining the priority of obligatory disbursement agreements (e.g., surety agreements). Id. Thus, the Eighth Circuit in Trigg, a case involving a tax levy prior to the contractor's default as a matter of fact, failed to adopt the analyses utilized by the Dependable court. See also Housing Authority v. General Insurance Co. [75-2 USTC ¶9631 ], 392 F.Supp. 65 (E.D. Mo. 1974) (relying on the surety's equitable rights, the court granted priority to the surety although United States ' tax levy was prior to contractor's default).

This Court does not dispute the United States ' contention that, assuming Tri-City had an interest in the partial payment, its levy in March, 1986 constituted a seizure of the payment. See Phelps v. United States [75-1 USTC ¶9467 ], 421 U.S. 330, 337 (1975). The United States , however, can only seize whatever rights the taxpayer had. United States v. Jenison [80-1 USTC ¶9195 ], 484 F.Supp. 747, 757 (D.R.I. 1980). Where the taxpayer's property is subject to preexisting liens so is that which the government takes by levy. Id.

Suretyship 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. See, e.g., Home Indemnity Co. v. United States , 313 F.Supp. 212, 213-14 (W.D. Mo. 1970). USF&G's payments to creditors of Tri-City and completion of the contract after Tri-City's default created an equitable lien in the partial payment which relates back to July 26, 1985 , the date the contract of suretyship was executed. Hence, the United States ' March 26, 1986 tax levy seized the partial payment subject to USF&G's equitable lien and is secondary to such lien.

IV

In summary, we find and conclude that Tri-City possessed no right to the partial payment to which the United States tax lien and subsequent tax levy could attach. Moreover, we find and conclude that assuming, arguendo, Tri-City possessed an interest or right in the partial payment, USF&G possessed superior rights to such payment.

Accordingly, it is

ORDERED (1) that the United States ' motion for summary should be and is hereby denied. It is further

ORDERED (2) that USF&G's motion for summary judgment should be and is hereby granted. It is further

ORDERED (3) that the sum of $27,703.28 now in the registry of this Court be paid to USF&G.

¹ From August 22, 1985 through February 19, 1986 payments to creditors of Tri-City were made on checks executed by both USF&G and Tri-City. Stip. No. 14. These payments totaled $755,409.22. Id. Although these payments were made through checks signed by both USF&G and Tri-City, the facts clearly indicate USF&G funds were being utilized. Id. From April 29, 1986 payments to creditors were made directly by USF&G. Id. These direct payments totaled $394,053.10. Id. In total, USF&G paid $1,149,544.02 to suppliers and subcontractors under its bond. Id.

² The United States incorrectly asserts that a formal notice of default must be given to the surety before a subrogee's rights ripen. The court in First State Bank expressly stated that default as a matter of fact is all that is needed to vest the interest in future contract payments in the surety to the exclusion of the taxpayer/contractor. See also Great American Insurance Co. v. United States, 481 F.2d 1298, 1308 (Ct. Cl. 1973) (" 'It is not necessary that there be a formal declaration of the contractor's default. All that is necessary for the surety to prevail is that the contractor be in default as a matter of fact' " [quoting Fidelity & Deposit Co. v. United States, 395 F.2d 834, 837 (Ct. Cl. 1968)]). The cases the United States utilizes to support its argument are not dispositive of this issue.

³ The legislative history of section 6323 provides in pertinent part:

In these cases [i.e., where a surety agrees to finance the completion of a contract entered into by the taxpayer] no limitation is placed on the time during which a disbursement may be made as long as the person is obligated to do so at the time of the tax lien filing by a written agreement. As a result, if an effort is made to foreclose on a federal tax lien before all of the potential obligations under an obligatory disbursement contract are met, these potential obligatory disbursements are given priority over the federal tax lien.

S. Rep. No. 1708, 89th Cong. 2d Sess., reprinted in 1966 U.S. Code Cong. & Admin. News 3730. (Emphasis added).

 

[59-2 USTC ¶9639]First National Bank in Yonkers , Plaintiff v. The City of New York, Liberty Mutual Insurance Company, William Casey & Sons, Inc., Maryland Casualty Company, United States of America, Charles M. Hanson, Charles W. Grant, James Martin, Rob ert M. Johnson, as Trustees of the New York City Carpenters' Welfare and Pension Fund, Defendants

U. S. District Court, So. Dist. N. Y., Civ. 134-228, 177 FSupp 175, 7/29/59

[1954 Code Secs. 6321, 6323 and 7501]

Lien for taxes: Priority of "completing" surety: Progress payments: Default before payments due: Surety's liability for taxes.--A completing surety had priority to all funds in the hands of New York City over tax liens of the Federal Government for withholding taxes due from a contractor where the latter had a sewer construction contract with the City under which progress payments became due only upon completion of prescribed payment steps, and such steps had not been completed when the surety was forced to come in and advance funds for payroll and material bills before and until the contractor was in legal default under the contract. Since the contractor had no property rights until formal completion of the steps for payment there was nothing against which the Government's tax liens could attach. Nor was the surety liable for the tax liens on the theory that taxes on wages which are withheld are to be considered trust funds since, even if the Government could trace the trust funds into the hands of third parties, it could not possibly find such funds in the hands of one who has suffered a loss on the transaction; in this case the surety lost close to three-quarters of a million dollars.

Samuel Gottesman, 100 William Street , New York , N. Y., for plaintiff. Charles H. Tenney, Corporation Counsel of The City of N. Y., Municipal Building, New York, N. Y., for defendant, the City of New York; Benjamin Rosen, Raymond Gitlin, 270 Madison Avenue, New York, N. Y., for defendant, Liberty Mutual Insurance Company; Nevius, Jarvis & File, 115 Broadway, New York, N. Y., for defendant, Maryland Casualty Company; S. Hazard Gillespie, Jr., United States Attorney, United States Courthouse, New York, N. Y., for defendant, United States of America; Raphael, Searles, Levin & Vischi, 18 East 41st Street, New York, N. Y., Attorneys for defendants, Charles N. Honson, Charles W. Grant, James Martin, Rob ert N. Johnson, as Trustees of the New York City Carpenters' Welfare and Pension Fund.

[Opinion]

CASHIN, District Judge:

On or about October 18, 1955 , defendant, The City of New York (City), acting through the Commissioner of Public Works, entered into Contract #179464 with defendant, William Casey and Sons, Inc. (Casey), whereby Casey was to construct certain sewers. In connection with the construction contract, performance and payment bonds were executed by Casey, as principal, and defendant Maryland Casualty Company ( Maryland ), as surety, on October 4, 1955 . On February 7, 1956 Casey gave an "all-moneys" assignment of moneys due or to become due under the contracts to plaintiff, First National Bank in Yonkers (Bank).

[Payments Under Contract]

Casey commenced work on the contract and for a time performed satisfactorily. In accordance with the terms of the contract, five partial or progress payments were made by the City, some to Casey and some to the Bank as per the assignment. Under the payment clause of the contract, a requisition for such payments could be made no oftener than once a month. After the requisition was submitted, the Engineer, if the requisition were satisfactory, would, within eight (8) days of the submission, certify a voucher for the payment which the Commissioner would approve. Thereupon the voucher would be delivered to the Comptroller for payment within fifteen (15) days from the filing of the voucher in his office. Not the entire amount of the requisition would be certified for payment, however. Rather five percent (5%) of the value of the work performed would be retained by the City pending final acceptance of the entire job. Payment Estimate #6 was so submitted, a voucher thereon certified and approved, which voucher was received in the Comptroller's office on either May 28 or May 29, 1956 . This voucher was in the amount of $47,133.90.

[Contractor in Default]

However, in the middle of May 1956 Casey experienced financial difficulties and notified the surety that it would need financial assistance in completing the contract. The surety thereupon set up a program whereby it advanced funds for payroll and material bills of the contractor with relation to the job. Despite the assistance of the surety, the City was not satisfied with Casey's performance and, on June 6, 1956 , notified Casey to appear before the Commissioner to explain why it should not be held in default. On June 13, 1956 , after Casey had been heard on both June 11 and June 13, a formal default of the contract was declared.

[Advances and Completion by Surety]

By the time Casey was declared in default, Maryland had advanced for payroll and material bills, the sum of $57,993.91. Maryland completed the contract at a net loss of $682,637.52. As of the same time the Bank had advanced $50,000.00 to Casey, which, for the purpose of these motions, will be assumed to have been expended in connection with the contract under question.

[Unpaid Insurance Premiums]

Defendant, Liberty Mutual Insurance Company ( Liberty ), furnished workmen's compensation and public liability insurance coverage to Casey for the project. Liberty claims it is due, for unpaid insurance premiums, the amount of $39,903.24.

[Welfare and Pension Fund Contributions]

Defendants, Charles M. Hanson, Charles W. Grant, James Martin and Rob ert M. Johnson, as Trustees of the New York City Carpenters' Welfare and Pension Fund (Trustee) obtained a judgment against Casey in the amount of $4,109.76 for welfare and pension fund contributions due for the years 1955 and 1956. A subpoena with injunction was served upon the City on August 28, 1956 .

[Amount Remaining Due Under Contract]

The action was originally instituted in the Supreme Court of the State of New York , County of New York , for the amount covered by Payment Estimate #6. However, subsequent pleadings by way of cross-claims have brought before the court the entire amount of the contract price remaining in the hands of the City. Apart from the payment covered by Estimate #6, there is due under the contract, or will become due upon final acceptance, an additional sum of $9,715.24 for work done by Casey subsequent to the date of submission of requisition #6 and prior to the date of formal default. There is, or will be, due also the amount of $77,789.43 representing retained percentages, $60,434.60 of which is allocable to the partial payments earned by Casey prior to formal default.

[Motions for Summary Judgment]

Presently before the court are motions for summary judgment brought on by the Government and by Maryland . Maryland demands the entire contract balance of $117,283.74. The Government demands so much of the sum as will compensate it for its unpaid taxes plus interest and penalties. The Bank opposes summary judgment on the ground that there are triable issues of fact and that, in any event, its rights are superior to the Government's and Maryland 's. Liberty supports Maryland in its argument that it is entitled to summary judgment as against the Government and the Bank. Liberty argues further, however, that its claims against Casey are within the terms of the Maryland 's payment bond and that, therefore, Maryland , as a condition to obtaining summary judgment, should be ordered to pay Liberty 's claim. The Trustee contends that its judgment is in the nature of wages and thus is entitled to priority.

[Government's Claim of Right]

The Government bases its right to priority over the competing claim of Maryland on the provisions of 26 U. S. C. §6321, which reads as follows:--

"Lien for taxes.

"If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty, together with any costs that may accrue in addition thereto) shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person."

It is not argued by the Government that the section quoted creates any rights to which a tax lien can attach. Rather, the existence of property rights to which a tax lien can attach is a question of state law. ¹ It is argued by the Government that if the law of the State of New York (obviously applicable here since the contract was made in New York, to be performed in New York, with payment to be made in New York) vested in Casey a "right to property" in any funds in the hands of the City at a time when the possibility of a tax lien under 26 U. S. C. §6321 existed, no subsequent condition such as a default on the part of the contractor giving rise to claims on the part of the City for excess costs, would act to divest the Government of its lien rights. ² This, the Government further argues, follows since the doctrine of relationship back has been complete rejected by the Supreme Court where such relationship back would act to defeat a tax lien. True it is that the doctrine of relationship back of state created liens has been rejected by the Supreme Court in some instances. ³ However, under the facts of the instant case, the problem of whether a similar treatment will be given to the rights of a surety arising after the attachment of tax liens is not presented.

[Date of Formal Declaration of Default]

Under the terms of the construction contracts, the City had the right to declare the contractor in default in the event of the happening of certain specified contingencies. It is undisputed that the formal declaration of default did not occur until June 13, 1956 , since it was on this date that the letter declaring Casey in default was dispatched, and on this date that Maryland was notified that the City would look to it for completion of the contract. It is equally true that prior to this declaration of default there was in the hands of the City a voucher based upon Estimate #6 certifying that the amount of $47,133.90 was due and payable to Casey or his assignee, the Bank. A blind adherence to mere form would compel the conclusion that the Government's lien, good at least as against Maryland , attached to the fund covering Estimate #6 at least on June 13, 1956 , i.e., fifteen days subsequent to the last possible date the voucher could have been filed in the office of the Comptroller. Slavish formalism need not, however, bind the court under the circumstances here present.

[Advances by Surety Before Formal Default]

In the middle of May 1956 Casey found himself in financial difficulties. Accordingly, a program was set up whereby the surety advanced funds to the contractor for the payment of labor and materials. As of the date of formal default, the amount so advanced was $57,993.91. Nor was the date of default, June 13, 1956 , the date when the City first became dissatisfied with the performance of Casey. Rather, on June 6, notification was sent to Casey to appear before the Commissioner of Public Works to explain why he should not be held in default. Casey did so appear on June 11 and June 13 but his explanation apparently was not availing since on the latter date the formal notification of default was dispatched. The very letter of notification speaks of a telegraphic explanation on June 4, 1956 by Casey of suspension of operations, which suspension presumably happened previously.

[Legal Default Date]

Under these circumstances, I find that the contractor was legally in default, at least as early as June 6, 1956 . I further find that as of that date there was no obligation presently payable from the City to Casey and thus nothing to which the Government tax lien could attach.

A case strikingly similar to the instant case has, in the comparative recent past been decided by the Court of Appeals for the Second Circuit. In that case ⁴ a contractor held two construction contracts from the United States, on each of which Massachusetts Bonding & Insurance Company was the payment and performance surety. During the performance of the work on both projects, the contractor found itself in financial difficulty and so notified the surety. The surety then set up a program whereby the surety advanced funds for use on the projects by depositing the funds in a joint bank account with the contractor. Certain mortgages of tangible property were given as security to the surety by the contractor and its principal stockholder and, as additional security, the attorney for the surety was authorized to receive checks of the Government for partial payments on one of the projects. In breach of its agreement with the surety, the principal obtained one payment check, part of the receipts of which were ultimately traced and recovered. Both the surety and the Government sought these funds, the surety by subrogation to the owner's rights and the Government for unsatified tax liens representing social security, withholding and unemployment taxes. The Court of Appeals noted that there was never any formal default but held that in legal contemplation a default occurred as soon as the surety stepped in even though its activities consisted merely of advancing funds, albeit, rather substantial sums. The unequivocal language of the Court of Appeals leaves no doubt as to the basis of its decision, for it said in Massachusetts Bonding & Insurance Company v. State of New York, supra, 259 Fed. (2d) 33 [58-2 USTC ¶9704], at p. 38:--

"The nub of the bankrupt's [contractor's] default was its inability to continue paying its bills. Whether the surety stepped in prior to or after the bankrupt failed to pay those bills is of little moment. The important fact is that the surety expended large sums of its own money to complete the contracts for which it has not been recompensed." ⁵

[Priority of Surety]

The Government argues strenuously that the cases supporting priority of the rights of a surety over a tax lien are distinguishable on the ground that in these cases ⁶ the contract provisions all gave the owner-obligee the right upon default to withhold from the contractor-obligor moneys both due and to become due. In the instant case, on the other hand, the contract provides only for the withholding of "such moneys as would have been payable to the contractor if he had completed the work". As shown above, however, the actual default of the contractor happened prior to the time the payment on Estimate #6 ever became due. Thus, the right of the contractor to withhold and the derivative rights of the surety preclude the attachment of the tax liens to any of the funds covered by Estimate #6.

[Retained Percentages]

Whatever has been said of the rights of the surety vis-a-vis the Government as to the funds covered by Estimate #6 applies, a fortiori, to the so-called earned moneys before default and to the retained percentages, since these funds were never payable to the contractor even if the date of formal default be considered the vital date for determining the rights of the parties.

[Rights of Completing Surety]

The Government also places great reliance on the case of United States v. R. F. Ball Construction Co., Inc. ⁷ However, that case is not apposite. The opinion of the District Court ⁸ makes it clear that the same company was the surety for the principal on two separate projects. In connection with the suretyship contract on the second of the projects, the principal assigned the retained percentages on the first project. The principal completed the first project but defaulted on the second, which the surety then completed at a loss. The surety and the Government competed for the funds due under the contract for the first project. Thus, it is clear that the surety was not seeking to avail itself of the rights of a completing surety which it obtained by way of subrogation to the contractee's rights against a defaulting contractor. Rather, it was seeking to enforce its rights as an assignee.

[Surety's Liability for Tax Liens]

In its supplemental brief submitted after the argument of the motion, the Government, for the first time, raised the argument that, in the event Maryland is entitled to any of the funds held by the City, Maryland should be held liable for the Government's tax liens. The Government seems to support this conclusion by two theories:--

1st. that Casey's bond required it to pay taxes on wages; and

2nd. that Casey's use of the withheld funds prior to default on other obligations reduced the surety's loss. The first argument is disposed of by uncontradicted authority. ⁹ The second argument would appear to be merely a restatement of the first argument. However, if the argument has any separate vitality because of the provisions of 26 U. S. C. §7501 to the effect that taxes on wages which are withheld are to be considered trust funds, it would appear that the Government, if it has any standing to trace the trust funds into the hands of third parties, cannot possibly find the funds in the hands of one who has suffered a loss on the transaction. ¹⁰

[Assignee-Bank's Rights]

Of course, the holding made above that there was never any debt due to Casey from the City disposes of the claim of the Bank since an assignee can have no greater right than his assignor. However, as between the surety and the Bank, the surety would seem to have priority even if the date of formal default be considered as the time as of which the competing rights arose. This follows because "* * * if the payment is still in the hands of the principal, its trustee in bankruptcy, or a stakeholder, the surety's rights are superior even to those of formal assignees of the proceeds of the contract, for its rights arise at the time of the making of the surety contract." ¹¹ The New York Court of Appeals also has set down the same rule. Thus, in Scarsdale Nat. Bank & Trust Co. v. U. S. Fidelity and Guaranty Co., ¹² the completing surety's rights were held superior to those of an assignee of the proceeds of the contract. While it is true that the decision, on the facts of the case, was supportable under the "no debt" theory, still the court adverted to the doctrine of relationship back of the rights of the surety to the time of the making of the suretyship contract. In addition, it stated that the same result would probably follow if the clause of the construction contract authorizing the retention of earned moneys by the owner in case of default had not been present. ¹³

[Derivative Rights for Unearned Premiums]

Since it has been decided that Mayland is entitled to the entire fund in the hands of the City as against the Government and the Bank, it becomes necessary to consider the derivative rights of Liberty . Apart from its contentions in the instant action, Liberty has brought suit against Casey and Maryland , among others, in this Court for the unpaid premiums which are the basis of its claims in the present action. Involved in this action is only a fund in the hands of the City. Liberty does not assert any lien on the funds. It does assert an in personam right against Maryland on the payment bond. Whether the in personam right exists is not before me. I will merely hold that there is no authority to condition the right of Maryland to receive the fund on its payment to a third party of a debt which is not clearly existing.

[Judgment Lien of Trustee of Welfare Fund]

The rights of the Trustee are on the same footing as the rights of Liberty . The judgment lien against funds arose subsequent to the time of the default and the expenditures by the surety. Thus the rights of the Trustee to the fund, if there are any at all, are inferior to the rights of the surety.

The City has requested that any order to be entered herein shall apply only to the funds covered by Estimate #6 since only that amount was due at the time of the argument of the motion. Accordingly, an order may be settled dismissing all of the claims except that of Maryland , granting Maryland summary judgment and ordering the payment to Maryland by the City of whatever funds are payable under the contract. If a further order is necessary at a subsequent time to cover funds later becoming due, such an order may be settled between City and Maryland only.

¹ Fidelity and Deposit Company of Maryland v. New York City Housing Authority (2 Cir. 1957) 241 Fed. (2d) 142 [57-1 USTC ¶9410].

² American Radiator Co. v. City of New York, 223 N. Y. 193; Schuessler v. Metropolitan Casualty Insurance Company of New York, 265 N. Y. 648, affirming 240 App. Div. 449, 270 N. Y. S. 287.

³ See e.g. United States v. Security Trust & Savings Bank, Executor (1950) 340 U. S. 47 [50-2 USTC ¶9492] (attachment lien); United States v. Scovil (1955) 348 U. S. 218 [55-1 USTC ¶9137] (landlord's distress lien).

⁴ Massachusetts Bonding & Insurance Company v. State of New York , 259 Fed. (2d) 33 [58-2 USTC ¶9704].

⁵ See also Wolverine Insurance Company v. Phillips (N. D. Iowa W. D. 1958) 165 Fed. Supp. 335 [58-2 USTC ¶9765].

⁶ See e.g. United States Fidelity and Guaranty Co. v. Triborough Bridge Authority, 297 N. Y. 31 (1947) [47-2 USTC ¶9327]; Fidelity and Deposit Company of Maryland v. New York City Housing Authority, 241 Fed. (2d) 142 (2 Cir. 1957) [57-1 USTC ¶9410]; and Aetna Casualty & Surety Company v. United States, 4 N. Y. (2d) 639 (1958) [58-2 USTC ¶9778].

⁷ 355 U. S. 587 (1958) [58-1 USTC ¶9327].

⁸ R. F. Ball Construction Co. v. Jacobs (W. D. Texas 1956) 140 Fed. Supp. 60 [56-1 USTC ¶9514].

⁹ United States v. Crosland Construction Company, 217 Fed. (2d) 275 (4 Cir. 1954) [55-1 USTC ¶9112]; Westover v. Wm. Simpson Construction Co., 209 Fed. (2d) 908 (9 Cir. 1954) [54-1 USTC ¶49,022]; General Casualty Co. of America v. United States, 205 Fed. (2d) 753 (5 Cir. 1953) [53-2 USTC ¶9483]; U. S. Fidelity and Guaranty Co. v. United States, 201 Fed. (2d) 118 (10 Cir. 1952) [53-1 USTC ¶9249].

¹⁰ It might also be noted that there has been absolutely no showing by the Government that any of the taxes for which it claims a lien arose out of the contract involved herein rather than out of the several other contracts which Casey performed during the same period.

¹¹ Massachusetts Bonding & Insurance Company v. State of New York , supra, 259 Fed. (2d) 33, 37 [58-2 USTC ¶9704].

¹² 264 N. Y. 159.

¹³ See also United States Fidelity and Guaranty Co. v. Triborough Bridge Authority, supra, 297 N. Y. 31 (1947) [47-2 USTC ¶9327].

 

 

[59-2 USTC ¶9568]General Insurance Company of America, a Washington Corporation, Plaintiff v. Ted Price Construction Company, a Corporation, et al., Defendants Intermountain Gas Company, a Corporation, Defendant and Counter-Claimant v. United States of America, Defendant

U. S. District Court, Dist. Ida., So. Div., No. 3396, 175 FSupp 261, 6/17/59

[1954 Code Sec. 6323]

Lien for taxes: Property right in taxpayer: Surety's priority.--Taxpayer had contracted to construct a natural gas distribution system for the Intermountain Gas Company, Inc. It completed the construction, but failed to pay material and labor claims, and the gas company withheld a part of the consideration under the terms of the contract. The surety under a performance bond paid the claims and brought this action to recover the withheld funds. The United States served a notice of levy on the gas company for taxes due from the contractor-taxpayer. It is held that though the construction company had some contingent rights in the withheld funds, at the time the federal tax lien attached to its property any such right had never matured into a choate interest to which the lien could attach. The surety company is entitled to the entire withheld sum.

Gigray & Boyd, M. H. King Building , Caldwell , Idaho , for plaintiff. Marcus & Evans, Given, O'Leary, Doane & Givens, Langroise & Sullivan, Box 1466, Paul B. Ennis, First Security Bank Building, Boise, Idaho, Alexanderson & Davis, F. W. Jarvis, Box 486, C. Rob ert Yost, Union Building, Dean Miller, Western Building, Smith & Ewing, Harmon Building, Caldwell, Idaho, for defendant, U. S. Attorney, Box 1776, Boise, Idaho, for U. S.

Memorandum Opinion

TAYLOR, District Judge:

The plaintiff, General Insurance Company of America, surety for Ted Price Construction Company, Inc., brought this action against the Ted Price Construction Company, Inc., Fish Service and Management Corporation, Intermountain Gas Company, Inc., and several other defendants who has labor and material claims arising out of the construction of a natural gas distribution system by Ted Price Construction Company under contract with Intermountain Gas Company, Inc.

By way of counterclaim the Intermountain Gas Company filed an interpleader action and deposited in Court the sum of $11,834.08 retained by Intermountain Gas Company under the provisions of Article III of the said contract.

The only remaining parties whose interests have not been settled or disposed of in the action are the plaintiff, General Insurance Company of America , and the defendant, United States of America , each of the parties claiming to be entitled to the funds which have been deposited in court.

The matter for decision is before the Court on the agreed statement of facts set out in the Amended Pre-trial Order, filed February 20, 1959 .

[Performance Bond]

It appears that on December 17, 1956, the Intermountain Gas Company, Inc., acting by the through its duly authorized agent, Fish Service and Management Corporation, entered into a contract with the defendant Ted Price Construction Company for the construction of a natural gas distribution system. Said defendant completed construction of the natural gas distribution system but failed to comply with the terms of Article III of the said contract by not paying the claims for labor and materials incurred in the construction of the gas distribution system. The plaintiff, General Insurance Company of America , has been compelled to pay these labor and material claims pursuant to the provisions of a performance bond, executed on December 16, 1956 , to guarantee performance and payment by the Ted Price Construction Company. The obligee of the said bond was and is Fish Service and Management Corporation.

[Lien for Taxes]

On July 19, 1957 , Fish Service and Management Corporation concluded that Ted Price Construction Company had breached the contract by failing to pay its creditors for labor and materials furnished and stopped further payments to Ted Price Construction Company, retaining the sum of $11,834.08. On January 23, 1957 , the Director of Internal Revenue Service, Dallas , Texas , assessed taxes against the Ted Price Construction Company in the amount of $58,327.81. On August 22, 1957 , the Internal Revenue Service, Treasury Department, served a Notice of Levy on the Intermountain Gas Company for unpaid taxes owing the Government by Ted Price Construction Company. On April 11, 1957 , the Notice of Federal Tax Lien under the Internal Revenue laws was filed in Wichita County , Texas , the county of the principal place of business of the Ted Price Construction Company.

No liability arose on the said performance bond until after April of 1957.

The parties seem to agree that the sole question to be decided is whether the Ted Price Construction Company had a property right in the amount retained by the Intermountain Gas Company pursuant to the provisions of Article III of the said construction contract. If Ted Price had a property right in the said funds to which the tax lien could have attached, then the United States is entitled to prevail.

[State Law]

The existence of a property or contractual right is a matter of state law. U. S. v. Bess, 357 U. S. 51, 78 S. Ct. 1054 [58-2 USTC ¶9595]; Fidelity & Deposit Co. v. New York City Housing Auth., 2 Cir., 241 Fed. (2d) 142 [57-1 USTC ¶9410]. It does not appear, however, that there is anything particularly unique about the Idaho law with which we are here concerned.

The contractual rights of the Ted Price Construction Company in question are those governed by the provisions of Article III of the said construction contract.

Under Article III of the construction contract, it is clear that the Intermountain Gas Company had the right to withhold the funds in question as long as there were labor and material claims outstanding against the construction work that had not been removed or remedied by the contractor, Ted Price Construction Company. Likewise, it is clear that the Intermountain Gas Company could remove or remedy any of the outstanding labor and material claims if the contractor did not do so within ten (10) days after written notice and deduct a like amount from the compensation payable to the contractor. Under the terms of Article III of the contract, Ted Price Construction Company had no legally enforceable right to these funds until it paid the outstanding labor and material claims. Accordingly, the Court is of the opinion that no debt ever became due and payable to Ted Price Construction Company that was or could be the object of the tax lien of the United States . Since Ted Price Construction Company had no right to the money, it follows that the United States could not acquire one by its lien.Fidelity & Deposit Co. v. New York City Housing Auth., 2 Cir., 241 Fed. (2d) 142 [57-1 USTC ¶9410]; Aetna Cas. & Sur. Co. v. U. S. A. (N. Y. Ct. of Apps., 1958) 152 N. E. (2d) 225; Wolverine Ins. Co. v. Phillips, 165 Fed. Supp. 335 [58-2 USTC ¶9765].

Even though it may be said that Ted Price Construction Company had some contingent right to acquire the funds in question at the time the Federal tax lien attached to property of the contractor, any such right never matured into a choate interest to which the Federal tax lien could attach.

The language in Article III of the contract relied on by the United States to distinguish the present case from the cases of Aetna Cas. & Sur. Co. v. Horticultural Service, Inc. (App. Div., 1956) 158 N. Y. S. (2d) 750--modified and affirmed.-- Aetna Cas. & Sur. Co. v. U. S. A. , supra; andFidelity & Deposit Co. v. New York City Housing Auth., supra, does not appear to create any right on the part of Ted Price Construction Company. This is made abundantly clear by the language used in the following paragraph of Article III where it is stated: "Any one or more payments otherwise due by Corporation to Contractor may be withheld in whole or in part by Corporation . . ." [italics added]. The Court believes the above cited cases are persuasive authority.

A number of cases have dealt with problems suimilar in nature to those presently before the Court and the decisions have consistently favored the surety's position. In addition to the cases heretofore cited see: Fidelity & Guaranty Company v. Triborough Bridge Auth., (N. Y., 1947) 74 N. E. (2d) 266; United States Fidelity & Guaranty Co. v. U. S., 10 Cir., 201 Fed. (2d) 118 [53-1 USTC ¶9249];Colusa-Glenn Production Credit Ass'n v. Phoenix Ins. Co., 145 Fed. Supp. 844 [56-2 USTC ¶9854]; U. S. v. Crosland Construction Co., 120 Fed. Supp. 792 [54-1USTC ¶9404]; aff. 217 Fed. (2d) 275 [55-1 USTC ¶9112]; Central Surety & Ins. Corp. v. Martin Infante Co., 164 Fed. Supp. 923 [58-2 USTC ¶9942].