Surety's Interest Page3

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Extended consideration and analysis has been given to cases similar to the one here in several of the cited cases and little purpose would be served by extensively reviewing said authorities. For a compilation of applicable authorities and legal theories see Wolverine Ins. Co. v. Phillips, supra.

The United States relies on the cases of Phoenix Indemnity Co. v. Earle, 9 Cir., 218 Fed. (2d) 645 [55-1USTC ¶9179]; and U. S. v. R. F. Ball Const. Co., 355 U. S. 587, 78 S. Ct. 442 [58-1 USTC ¶9327]. It appears that the result in the first cited case was controlled by the sovereign character of the United States and the provisions of the Bankruptcy Act, neither of which factors are material in this case. In the Ball case the fund in question was admittedly property of the delinquent taxpayer and the only question was whether the interest of the claimant was perfected as against the tax lien of the United States .

A number of cases involving the same questions as is presently before the Court have been decided since the decision in the Ball case and it did not control the results,Aetna Cas. & Sur. Co. v. U. S. A., supra; Wolverine Ins. Co. v. Phillips, supra; Central Sur. & Ins. Co. v. Martin Infante Co., supra.

In accordance herewith, the plaintiff, General Insurance Company of America , is entitled to the said sum heretofore deposited with the Clerk of the Court in the sum of $11,834.08.

Counsel for the plaintiff shall prepare Findings of Fact, Conclusions of Law, and a Proposed Judgment, serve copies of the same on counsel for the defendant and submit the originals to the Court.

 

 

[58-2 USTC ¶9778]Charles W. Berry Houses, Aetna Casualty & Surety Company, Respondent v. United States of America, Appellant, and Horticultural Service, Inc., et al., Defendants, and another action (Lester W. Patterson Houses)

State of New York Court of Appeals, No. 75, 4 NY2d 639, 4/30/58

[1939 Code Sec. 3670--similar to 1954 Code Sec. 6321]

Tax lien: Fund withheld from contractor: Effect of state law.--Tax liens were asserted against funds withheld from a contractor who had not paid for labor and materials. Under New York law, a contractor who defaults in payment of laborers and materialmen has no right to and no property interest in the withheld funds. Since the contracts involved required payment of claims for labor and material as a condition precedent to the contractor's right to payment, there was not a substantial performance which would entitle the contractor to the funds. Consequently, the Federal tax liens did not attach to any of the withheld funds and the surety which performed under its bonds and completed the contracts was entitled to the funds. The Appellate Division erroneously awarded the Government $331 on the grounds that one tax assessment list had been received before the execution of one bond.

Paul W. Williams, United States Attorney, Foley Square, New York, N. Y., John S. Clark, for United States of America. M. Carl Levine, Morgulas & Foreman, 521 Fifth Avenue, New York, N. Y., Albert Foreman, for Aetna Casualty & Surety Co. Irving Wise, 299 Broadway, New York, N. Y., for New York City Housing Authority.

Opinion

CONWAY, Chief Judge:

In these two actions both the plaintiff Aetna Casualty & Surety Company and the defendant United States assert liens against two funds which the N. Y. City Housing Authority holds as the balance due under two contracts for the landscaping of two public housing projects. This case was tried on stipulated facts. Horticultural Service Inc. entered into two contracts with the Authority, one on October 28, 1949 to landscape the Charles W. Berry project, and the other on January 24, 1950 to landscape the Lester W. Patterson project. Under these contracts Horticultural was required to procure bonds to secure the performance of the contracts and the payment of laborers, materialmen etc. Aetna, as surety, issued these Performance and Payment Bonds, those for the Berry project being issued on November 29, 1949 , and those for the Patterson project on February 6, 1950 . Applications for Contract Bond and Agreement of Indemnity, executed on the same respective dates, made Aetna the subrogee and assignee of all of Horticultural's rights to any monies due or to become due from the Authority under the contracts, should Horticultural default in its performance of the contracts thereby requiring Aetna to perform under its bond. Horticultural entered into performance of the work but was unable to complete it because it lacked sufficient funds. Consequently, Aetna performed under its bonds and made large expenditures in payment of materialmen, subcontractors, and the wages of Horticultural's laborers. Aetna 's expenditures on the Patterson project, commencing on March 19, 1951, totalled $38,288.98. However, it received payments of $5,990, leaving a present loss to Aetna on the Patterson project of $32,298.98. Aetna's expenditures on the Berry project, commencing on April 12, 1951, totalled $28,469.18 which represents the present loss since no payments were received. It will immediately be seen that Aetna's losses exceed the total unpaid contract balance presently held by the Authority which amounts to $9,444.02 on the Berry project, and $1,860.75 on the Patterson project.

[Tax Liens]

Opposed to Aetna 's claims on these funds are the tax liens presently asserted by the federal government which arose out of Horticultural's failure to turn over to the government the Withholding and Employment taxes which it collected from its workers. All except one of the tax assessment lists were received by the Collector of Internal Revenue subsequent to Aetna 's issuance of its bonds. One, in the sum of $331.30, was received on December 12, 1949, subsequent to the execution of the Berry bonds, but prior to the Patterson bonds. It may be noted that it was this asserted tax lien only for which the Appellate Division rendered judgment for the United States . While all but one of the tax assessment lists were received by the Collector subsequent to Aetna's execution of its bonds, the amount of the assessment lists received prior to Aetna's performance under its bonds exceeded the sums presently held by the Authority. Tax liens, of course, arise upon the receipt by the Collector of the assessment list (26 U. S. C. §3671), but they attach only to "property and rights to property" belonging to the taxpayer (26 U. S. C. §3670).

[Issue]

The crucial issue in this case is whether Horticultural had any interest in the funds presently held by the Authority to which a tax lien could attach. As far as Horticultural's contractual rights to these funds are concerned, each contract provided that "[a]s a condition precedent to his right to any partial payment the Contractor must, as requested, submit to the Authority proof satisfactory to the Authority that the Contractor is meeting his obligations to the Subcontractors, Materialmen, and workmen promptly." [section 5(c)]. The Authority was authorized to retain 10% of each estimated partial payment, as "retained percentages", until final completion of the work. [section 5(e)]. Partial payments could be withheld or reduced at the Authority's option if it felt the work was not progressing satisfactorily [section 5(g)]. As a "condition precedent" to final payment, Horticultural was obligated to furnish proof of payment to all subcontractors, materialmen, laborers, etc., until which time it was provided "[t]he Final Payment payable to the contractor shall not become due." [section 6(a)]. It was provided also that "[b]efore Final Payment or any retained percentages shall become due and payable, the Contractor must also, if required, obtain and furnish written consent of his sureties to such payment." (Ibid.) If the work were not performed in accordance with the contract, or if Horticultural failed to pay its subcontractors, materialmen, laborers etc., the Authority was entitled under the contract to withhold out any payment, final or otherwise, such sums as it deemed ample to satisfy such claims [Section 7(a)]. The net effect of these provisions was to condition Horticultural's right to any payment, partial or final, upon the full and faithful performance of its contract obligations to do the work and pay its laborers, materialmen, subcontractors etc.

The federal tax lien is assertable only to the extent of Horticultural's interest, if any, in the funds retained by the Authority. The parties agree that the basic question presented here is whether Horticultural had any interest in the funds, presently held by the Authority, to which the federal tax liens could attach. The United States contends that this issue presents a question of federal law, and that under that law Horticultural did have an interest. Aetna, on the other hand, argues that this is a matter of state law, and that under the law of the State of New York Horticultural had no such interest.

In Fidelity & Deposit Co. v. N. Y. City Housing Authority, 241 Fed. (2d) 142 (1957) [57-1 USTC ¶9410], the Second Circuit Court of Appeals said: "Section 3670 imposes a tax lien on 'all property and rights to property' of a defaulting taxpayer. In adopting this legislation, the Congress did not create property interests on which a lien might be imposed; there is no suggestion that it authorized the federal courts to do so." ( Id. at 144). Accordingly, that court held that the existence of a property interest "is solely a question of state law." (Ibid.) Citing this case, the United States Supreme Court held, on June 9th, 1958, in United States v. Bess, 26 U. S. Law Week 4381: "Third. We must now decide whether Mr. Bess possessed in his lifetime, within the meaning of §3670, any 'property' or 'rights to property' in the insurance policies to which the perfected lien for the 1946 taxes might attach. Since §3670 creates no property rights but merely attaches consequences, federally defined, to rights created under state law, Fidelity & Deposit Co. v. New York City Housing Authority, 241 Fed. (2d) 142, 144 [57-1 USTC ¶9410], we must look first to Mr. Bess' right in the policies as defined ( Id. at 4382).

[State Law]

Thus, whether Horticultural had any interest in the funds held by the Authority is to be determined by New York law. The case of U. S. Fidelity & Guaranty Co. v. Triborough Bridge Authority, 297 N. Y. 31 [47-2 USTC ¶9327], is dispositive of this question. In that case we held that a surety who performs under its bond upon the contractor's default has an equitable lien upon the funds held by the owner, and that this lien arises upon execution of the bond although it does not become enforceable until the surety suffers a loss by making payments pursuant to its obligation under the bond. In so holding we went on to say: "In addition, it is, of course, settled that intervenor's rights to the moneys held by defendant Authority can be no greater than those which its taxpayer--the contractor--had. (Karno-Smith Co. v. Maloney, 112 Fed. (2d) 690, 692 [40-2 USTC ¶9533]; Internal Revenue Code, §3670; U. S. Code, tit. 26, §3670). Here the contractor's rights to the fund were clearly subordinate to the right of defendant Authority--and, by subrogation, of plaintiff--to withhold and apply those moneys to the payment of unsatisfied claims for labor and materials. So long as such claims were outstanding and unpaid and so long as defendant Authority had the right to withhold and apply, the contractor had no rights to the fund, and consequently, had no property interest therein upon which intervenor could place a lien." ( Id. at 37). (Italics added). The law of the Triborough case, followed in other cases, is well-settled law. (See Scarsdale Nat. Bank & Trust Co. v. United States Fidelity & Guaranty Co., 264 N. Y. 159, 163-164; U. S. Casualty Co. v. Met Contracting Corp., 158 N. Y. S. 2d 117; Lumbermans Mut. Cas. Co. of Ill. v. Great Atl. Constr. Corp., 158 N. Y. S. 2d 115; Fidelity & Deposit Co. of Md. v. N. Y. City Hous. Auth., supra at 144, 146; Vincent v. P. R. Matthews, 126 Fed. Supp. 102 [54-2 USTC ¶9658]; Alabama-Tennessee Nat. Gas Co. v. Lehman-Hoge & Scott, 122 Fed. Supp. 314 [54-2 USTC ¶9519]; Royal Indemnity Co. v. United States, 93 Fed. Supp. 891, 899; In Re Cummins Constr. Corp., 81 Fed. Supp. 193, 196-197). The net effect of these cases is that Horticultural had no interest in the funds presently held by the Authority to which the tax lien could attach. Consequently, inasmuch as Aetna's losses far exceed the funds held by the Authority, it was entitled to recover the full unpaid balance of the contract price--(1) $9,444.02 on the Berry project, and (2) $1,860.75 on the Patterson project. The United States is entitled to nothing out of these funds.

[Conclusion]

The award by the Appellate Division of $331.30 to the United States suggests the conclusion that that court felt Horticultural did have an interest in these funds, and therefore the tax assessment list received prior to the execution of the Patterson bond created a lien in favor of the United States for $331.30 upon the unpaid balance of the Patterson contract price. This, as explained above, was error. Consequently, the judgment in Action No. 1 should be affirmed, and the judgment in Action No. 2 should be modified so as to increase the judgment in favor of plaintiff Aetna Casualty & Surety Company by $331.30 and, as so modified, affirmed.

In Action No. 1:

Judgment affirmed, without costs. All concur.

In Action No. 2:

Judgment modified in accordance with the opinion herein and, as so modified, affirmed, with costs to the plaintiff Aetna . All concur.

 

 

[58-1 USTC ¶9350]Fidelity and Deposit Company of Maryland , Plaintiff v. New York City Housing Authority, Caruso-Sturcey Corporation, Arnold Lewis, as Assignee of Caruso-Sturcey Corporation, People of the State of New York and United States of America, Defendants

U. S. District Court, So. Dist. N. Y., Civ. 93-145, 157 FSupp 87, 12/4/57

[1939 Code Sec. 3670--substantially unchanged in 1954 Code Sec. 6321]

Tax liens: Fund withheld from contractor: Surety's lien: Effect of New York law.--State and Federal tax liens were asserted against a fund withheld from a contractor who had not paid for labor and materials. Reversing the District Court, the Appellate Court held in an earlier opinion that state law governed the nature of the contractor's interest. Under New York law, a contractor who defaults in payment of laborers and materialmen has no right to and no property interest in the withheld funds. On remand, the District Court held that the tax liens against the contractor did not attach to the withheld funds. It held that the surety which had paid the laborers and materialmen had an equitable lien upon the withheld funds.

Maurice, McNamee & Dart, 149 Broadway, New York 6, N. Y. (Stewart Maurice, of counsel), for plaintiff. Louis J. Lefkowitz, Attorney General, State of New York, 80 Centre Street, New York 13, N. Y. (Samuel Backlar, Assistant Attorney General, of counsel), for People of the State of New York. Paul W. Williams, United States Attorney, Southern District of New York, United States Court House, Foley Square, New York 7, N. Y. (John S. Clark, Assistant United States Attorney, of counsel), for United States of America.

Opinion

DIMOCK, District Judge:

Plaintiff moves for summary judgment.

[Facts]

The suit is one by Fidelity and Deposit Company of Maryland , surety on the bond of Caruso-Sturcey Corporation, a building contractor, to recover the sum of $46,392.51 from defendant New York City Housing Authority, hereinafter referred to as the owner. That sum is the amount equal to the unpaid balance of the contract price for heating and ventilating work that the contractor agreed to do for the owner. Plaintiff, as surety on the contract, paid laborers and materialmen whom the contractor in breach of its contract had failed to pay. The amount paid by the surety was in excess of the amount unpaid under the contract and plaintiff seeks to apply the unpaid amount in reduction of its claim. Taxes are due from the contractor both to the United States of America and the State of New York and both asserted liens upon the contractor's claim against the owner.

The case was tried before me and I held, 140 Fed. Supp. 298 [56-2 USTC ¶9761], that federal law applied, citing United States v. Kings County Iron Works, Inc., 2 Cir., 224 Fed. (2d) 232, 235 [55-2 USTC ¶9536]. Accordingly I applied United States v. Munsey Trust Co., 332 U. S. 234, as I interpreted it, and held that the Government had a paramount lien upon the contractor's claim. Judgment for the Government was entered.

On appeal the Court of Appeals reversed the judgment, 241 Fed. (2d) 142 [57-1 USTC ¶9410], holding that the nature of the interest of the contractor, as distinguished from the priority of the Government, was to be determined by the law of the State of New York . The Court, p. 145, said that the Kings County Iron Works case did no more than hold that state-law classification of a right as a trust did not preclude its classification as a lien upon federal inquiry into its nature. The court therefore applied New York law as expressed in U. S. Fidelity & Guaranty Co. v. Triborough Bridge Authority, 297 N. Y. 31 [47-2 USTC ¶9327], and held that the owner had no property right in the unpaid portion of the purchase price to which any lien of the Government could attach. The case was therefore remanded.

Plaintiff, instead of seeking a new trial, has moved for summary judgment. This procedure is quite proper since there is no dispute as to the facts.

The Government, though held by the Court of Appeals to be without right as lienor upon any property right of the contractor, is still in the field asserting a priority over the surety. I must therefore determine the respective rights of the parties and, to do that, I must determine what law governs.

The Court of Appeals in its opinion in this case said, p. 145:

"These cases make it perfectly clear that : (1) the classification of state created rights and (2) the weighing of relative priorities under Section 3670, are both matters of federal law. But here we are concerned with the question of whether or not a contractual right exists and that we hold is a matter of state law only."

From this I conclude that in determining whether a right exists I must look to state law if its creation would be within state competence and federal law if its creation would be within federal competence. Then, in classifying a state created right according to its true nature, for purposes of resolution of competing state and federal claims, I am not bound by the name that the state law applies to it but must apply federal law. Finally, I must apply federal law in determining the relative priority of a federally created right, on the one hand, and state created rights on the other.

[Surety's Lien]

Any right which the surety in this case may have to the withheld funds is state created. The New York State case of U. S. Fidelity & Guaranty Co. v. Triborough Bridge Authority, 297 N. Y. 31, supra, as an alternative ground undiscussed by our Court of Appeals in reversing, held that the surety, in a case such as this, obtains an equitable lien upon the withheld funds. I believe that United States v. Munsey Trust Co., 332 U. S. 234, supra, holds to the contrary, but, even so, it does not purport to declare the law of the State of New York . ^*

It is thus established that the surety has an equitable lien on the withheld funds. It is also established that the Government has no lien on any right of its debtor, the contractor, and no one has suggested any other avenue through which the Government could reach the withheld funds. Since the Government has no interest in the withheld funds, no question arises either as to the true nature of the surety's equitable lien thereon or as to the relative priority of interests of the surety and the Government therein.

The Government suggests that an appeal to the Court of Appeals of the State of New York is now pending from the judgment of the Appellate Division in Aetna Casualty & Surety Co. v. Horticultural Service, Inc., 2 A. D. 2d 963, a case which followed the ruling in the Triborough case, and that I ought to withhold decision until a final determination of that appeal. As a general proposition I am loath to dealy the enforcement of the rights of litigants in anticipation of a possible change in controlling law. In this case, moreover, it would serve no purpose, since substantially the same result can be obtained by the taking of an appeal from my present determination and keeping it pending until the determination of the Horticultural Service appeal by the State Court of Appeals.

[Judgment]

Judgment is awarded plaintiff against the New York City Housing Authority for $46,392.51, and the claims of all other parties are dismissed.

With respect to the time for appeal counsel will please note the provisions of Rule 58 F. R. Civ. P.

^* Evidently its effect must be limited to cases like it where government contracts are concerned and where consequently a general federal common law rather than the law of a specific state is applied. Priebe & Sons v. United States , 332 U. S. 407, 411.

 

 

[57-1 USTC ¶9410]Fidelity and Deposit Company of Maryland , Plaintiff-Appellant v. New York City Housing Authority, Caruso-Sturcey Corporation, Arnold Lewis, as assignee of Caruso-Sturcey Corporation, People of the State of New York, Defendants, and United States of America, Defendant-Appellee

(CA-2), U. S. Court of Appeals, 2nd Circuit, Docket No. 24196, 241 F2d 142, 2/8/57, Reversing and remanding the decision of the District Court, 56-2 USTC ¶9761, 140 F. Supp. 298

[1939 Code Sec. 3670--substantially unchanged in 1954 Code Sec. 6321]

Tax lien on fund withheld from contractor: Effect of state law.--A tax lien was asserted against a fund withheld from a contractor who had not paid for labor and materials. Under the applicable New York law, a contractor who defaults in payment of laborers and materialmen has no right to the withheld funds and no property interest. Such local law must be recognized for federal tax purposes. Under 1939 Code Sec. 3670, the courts have authority to determine whether state-created interests are choate or inchoate; the existence of the interests to be federally classified, however, is solely a question of state law. Since the contract required payment of claims for labor and material as a condition precedent to the contractor's right to payment, there was not a substantial performance which would entitle the contractor to the withheld fund. Payment of the claims by surety did not satisfy this condition.

Maurice, McNamee & Dart , New York City (Stewart Maurice, Rob ert F. Dart, New York City , of counsel), for plaintiff-appellant. Paul W. Williams, United States Attorney, New York City (Arthur B. Kramer, Miriam R. Goldman, Assistant United States Attorneys, New York City, of counsel), for defendant-appellee.

Before SWAN, MEDINA and WATERMAN, Circuit Judges.

MEDINA , Circuit Judge:

This case was tried below [56-2 USTC ¶9761, 140 Fed. Supp. 298] on an agreed statement of facts. Caruso-Sturcey Corporation contracted on June 21, 1949 with the New York City Housing Authority to install heating and ventilating facilities on a housing project. The contract required Caruso to give a performance bond, not involved in this litigation, and a payment bond for laborers and materialmen. This the contractor did when it executed the bonds on July 11, 1949 with Fidelity and Deposit Company of Maryland .

When the heating and ventilating facilities had been installed and accepted by the owner on March 1, 1952 , there was an unpaid balance on the contract, amounting to $46,392.31. The principal claimants to this fund are Fidelity, which had made payments for labor and materials aggregating $75,650.09, from December 11, 1950 through November 13, 1951, as required by its bond, on Caruso's failure to make such payments when due, and the United States by reason of tax liens, for withholding taxes retained by Caruso from the wages of its employees, but not remitted. The tax assessments run from April 11, 1950 through September 12, 1951; and the total of these is $47,639.68.

On September 14, 1951, Caruso made an assignment for the benefit of creditors, pursuant to the provisions of the New York Debtor and Creditor law, to defendant Arnold Lewis; and there is a subsidiary claim of the defendant State of New York arising out of certain corporation and franchise taxes owing by Caruso.

In form the suit is one by Fidelity in equity against the Housing Authority to recover the fund. Caruso's assignee filed an answer containing a counterclaim but failed to appear at the trial. The State of New York asserted its claim against the fund for taxes. The United States pleaded a claim to the fund under Section 3670 of the Internal Revenue Code of 1939, 26 U. S. C., Section 3670. ¹

The fund was awarded by the court below to the United States on the theory that the defaulting taxpayer Caruso, under its contract, had a conditional right to the fund, that this right was a "right to property" within the meaning of Section 3670, and that the United States thus had a valid tax lien on the entire fund. As the tax lien thus found to exist would take superiority over any claim by Fidelity, it became unnecessary for the court otherwise to pass upon the nature and sufficiency of Fidelity's claim. Nor was consideration given to the claim of the State of New York , for the same reason. As we have concluded that there were no rights of Caruso upon which the government tax lien could attach, there must be a new trial in which all the issues raised by the pleadings and not yet disposed of may be adjudicated, including the rights of the State of New York, although the appeal to this court is by Fidelity alone.

[Contractor's Right to Withheld Fund]

The first issue to be considered is whether the defaulting taxpayer under its contract had a conditional right to the withheld fund. The contract was made and performed in New York . The New York Court of Appeals has had occasion to consider a similar contract that also required as a condition precedent to payment proof that the contractor had satisfied claims of materialmen and laborers. "So long as such claims were outstanding and so long as [the owner] had the right to withhold and apply," it held, "the contractor had no rights to the fund and, consequently, no property interest therein upon which [the United States] could place a lien.' United States Fidelity & Guarantee Co. v. Triborough Bridge Authority, 297 N. Y. 31, 37 [47-2 USTC ¶9327]. And again: "A failure by the contractor to pay for labor and material was just as much a failure to perform and carry out the terms of the contract as an abandonment of the work would have been." Ibid. p. 36.

For the highest court of the State of New York , in short, a failure to pay laborers and materialmen is a breach of contract and a contractor who fails to make such payments has no right under the contract. This decision, if binding here, disposes of the holding below: without a finding that the defaulting taxpayer has some right that may be classified as a "right to property," there can be no federal tax lien. But is it binding here?

[Effect of State Law]

Section 3670 imposes a tax lien on "all property and rights to property" of a defaulting taxpayer. In adopting this legislation, the Congress did not create property interests on which a lien might be imposed; there is no suggestion that it authorized the federal courts to do so. On the contrary, it took for granted here, as it normally does in the tax law, the vital existence of state laws creating and maintaining various interests. The statute was fashioned to require the courts to determine for federal purposes whether those state-created interests are "property" or "rights to property." That classification of interests is a federal question; the existence of the interests to be federally classified, however, is solely a question of state law.

This distinction was formulated by the Supreme Court in Morgan v. Commissioner, 309 U. S. 78, 80 [40-1 USTC ¶9210], which also involved the tax law. "State law," the court explained, "creates legal interests and rights. The federal revenue acts designate what interests or rights, so created, shall be taxed. Our duty is to ascertain the meaning of the words used to specify the thing taxed. If it is found in a given case that an interest or right created by local law was the object to be taxed, the federal law must prevail no matter what name is given to the interest or right by state law."

This distinction has not been discarded in the Supreme Court decisions under Sections 3670 and 3671. In none of those cases was there any doubt that a federal tax lien had attached to "property or rights to property"; nor for that matter was there any question under state law as to whether the party against whom the federal government asserted a tax lien had some interest in the disputed property. The question was solely one of priorities between two existing claims.

Thus, in United States v. Security Trust and Savings Bank, 340 U. S. 47 [50-2 USTC ¶9492], the court held "inchoate" an attachment lien that had been thought by the state courts, applying the state doctrine of relating a judgment lien back to the time of the attachment lien, to have been perfected. In United States v. Acri, 348 U. S. 211 [55-1 USTC ¶9138], the court exercised a similarly independent judgment in disregarding for federal purposes a state holding that an attachment is "execution in advance." In these and in other cases cited in the footnote, ² the issue was one of priorities under a federal statute; in disposing of this issue, the Supreme Court held itself free to disregard for federal purposes the state determination as to whether the right the state had created was "choate."

Nor was this distinction discarded in our decision in United States v. Kings County Iron Works, 224 Fed. (2d) 232 [55-2 USTC ¶9536]. The facts in that case, as in the one before us, were not disputed. It was admitted that the taxpayer-contractor owed money to the United States for unpaid taxes, that he also owed money to his subcontractor for services performed, and that he was owed money (having performed his promises under a contract) by the owner. The issue was whether the New York Lien Law that classified a reserve fund for workers and materialmen as a "trust," precluded a federal inquiry into the nature of the right thus created. The court held for federal purposes that it did not, that the right admittedly created by state law was for the purposes of Section 3670 a "lien" rather than a "trust," that peculiar local conditions were responsible for the differences in vocabulary. The court did not inquire whether the state had created a right. It assumed that it did and was concerned with the "relative priority of a federal tax lien and a mechanic's lien under state law." United States v. Kings County Iron Works, supra, at 234.

These cases make it perfectly clear that: (1) the classification of state-created rights and (2) the weighing of relative priorities under Section 3670, are both matters of federal law. But here we are concerned with the question of whether or not a contractual right exists and that we hold is a matter of state law only. F. H. McGraw & Co. v. Sherman Plastering Co., 60 Fed. Supp. 504, 511-512 (per Hincks, D. J.). Under the authority of Triborough Bridge Authority, supra, we are constrained to rule that Caruso was left with no contractual right; and, accordingly, we have nothing to "classify."

[Government's Arguments]

The government, citing no New York cases, tries to spell out a right to the withheld fund in two ways. First, it claims that the contractor could have sued for the fund after satisfactorily installing the heating facilities on a theory of substantial performance, even though the contractor failed to satisfy the claims for labor and material. This argument is not persuasive. The contract carefully requires satisfaction of those claims as a condition precedent to partial payment no less than to final payment. Thus, Section 5(c) provides:

"As a condition precedent to his right to any partial payment, the Contractor must, as requested, submit to the Authority proof satisfactory to the Authority that the Contractor is meeting his obligations to the Subcontractors, Materialmen, and workmen promptly. The Contractor's monthly requisitions must be accompanied by his affidavit showing the amounts previously paid for Work executed by such Subcontractors or materials furnished by such Materialmen, and the amounts remaining unpaid and owing to any such persons, setting forth therein the names of the persons whose claims are unpaid and the amount due to each and, if required, must also be accompanied by affidavits from all Subcontractors and Materialmen, containing this information."

And Section 6 provides:

"The Contractor shall, as a condition precedent to final payment, furnish to the Authority a detailed sworn statement of all liens, claims and demands, just and unjust, of Subcontractors, Materialmen, laborers, other employees, and third persons, then outstanding or which he has reason to believe may thereafter be made on account of the Work or performance thereof. The Final Payment payable to the Contractor shall not become due, however, until the Contractor shall deliver to the Authority all releases required by the Authority from all such claims and demands arising out of any Work done pursuant to the Contract * * *."

We do not understand how the New York courts, or any courts for that matter, could find justification for holding, in the face of so carefully drawn a contract, that a failure to satisfy these condition is "insubstantial." Jacob & Youngs v. Kent, 230 N. Y. 239; Dauchey v. Drake, 85 N. Y. 407; Spence v. Ham, 163 N. Y. 220; Cassino v. Yacevich, 261 App. Div. 685; Gompert v. Healey, 149 App. Div. 198.

The second theory assumes, as it were, that the contractor might not be able to recover on a claim of substantial performance. "Caruso might agree to waive its claim to the fund unless it paid all laborers and materialmen," the argument goes, "but it could not waive the Government's interest; for purposes of federal taxation, Caruso continued to have an interest in the fund despite any agreement to give laborers and materialmen a preferred and divesting interest."

This statement begs the very question it is designed to answer. Of course, if the government has an interest in the funds, Caruso by agreement could not waive it. The problem, however, is whether Caruso has, without prior payment of laborers and materialmen, the enforceable interest in the fund to which a tax lien might attach. By the terms of the contract, he does not.

The government advances one other reason for holding that Caruso has a right to the withheld fund under the contract. The terms of the contract, it urges, do not specifically require that the contractor pay the laborers and materialmen; it requires only that they somehow be paid. Here, they were paid (by the surety) and the condition precedent to payment was thus satisfied.

While perhaps superficially plausible, this construction of the contract is not convincing. Section 3 of the contract requires the contractor to "furnish all labor and materials" needed to comply with the contract. Section 5(c) declares that "As a condition precedent to partial payment, the Contractor must, as requested, submit to the Authority proof * * * that the Contractor is meeting his obligations to the Subcontractors, Materialmen and workmen promptly." Section 20 declares that "The Contractor * * * shall promptly pay all amounts due for services rendered, work performed and materials and equipment supplied * * *." This terminology indicates that while the ultimate aim of the Authority may have been to secure prompt payment for laborers and materialmen, it required contractually as a condition precedent to payment that the contractor do so.

We are satisfied, then that under Triborough Bridge Authority, supra, recently cited as controlling authority by the New York Appellate Division in Aetna Casualty & Surety Co. v. Horticultural Service, Inc., -- N. Y. Supp. --, reported in N. Y. L. J., Dec. 12, 1956 (Nos. 10544-10545) [56-1 USTC ¶9548], the taxpayer-contractor had no right to the withheld fund. Of necessity, it follows that it had no "right to property" to which a federal tax lien might attach and the government's claim must fail.

Reversed and remanded.

¹ Section 3670. Property subject to lien.

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, whether real or personal, belonging to such person.

² On the "inchoate" character of the lien: United States v. White Bear Brewing Co., 350 U. S. 1010 (1956) [56-1 USTC ¶9440], petition for rehearing den., 351 U. S. 958 (Mechanic's Lien); United States v. Colotta, 350 U. S. 808 (1955) (Mechanic's Lien) [55-2 USTC ¶9680]; United States v. Scovil, 348 U. S. 208[218] (1955) (landlord's distress lien) [55-1 USTC ¶9137]; United States v. Liverpool & London Ins. Co., 348 U. S. 215 (1955) (garnishment) [55-1 USTC ¶9136]; United States v. City of New Britain, 347 U. S. 81 (1954) (city tax lien) [54-1 USTC ¶9191]. See also, United States v. Gilbert Associates, 345 U. S. 361 (1953) (ad valorem tax held "judgment" under state law, but not for federal purposes) [53-1 USTC ¶9291].

 

 

[60-1 USTC ¶9413]The Atlantic Refining Company v. Continental Casualty Company, Joseph M. Smith, and Greensburg Concrete Block Company, Defendants, and United States of America, Intervenor

U. S. District Court, West. Dist. Pa., Civil Action No. 15185, 183 FSupp 478, 4/8/60

[1954 Code Secs. 6321-6323]

Tax liens: Funds withheld under construction contract: Surety's rights.--A lien for taxes did not attach to funds withheld from the tax-delinquent contractor under a construction contract which provided that final payment would be made only after the contractor showed that there were no liens for unpaid claims for labor and material, which the contractor was unable to do. The surety on the contractor's bond was subrogated to the rights of the person for whom the work was being done, not to the rights of the contractor (which would be subject to the tax lien), and, under the terms of the contract and bond, was not liable to the United States for withholding and social security taxes attributable to the construction performed under the contract.

Rob ert A. Rundle, of Wright & Rundle, Frick Building , Pittsburgh 19, Pa. , for plaintiff. J. M. McCandless, 304 Ross Street , Pittsburgh 19, Pa. , for defendant.

Opinion and Order

Opinion

MARSH, District Judge:

The facts as disclosed by the pleadings and stipulated by the parties, except as hereinafter specified, are adopted by the court as if found pursuant to Rule 52, Fed. R. Civ. P.

Atlantic Refining Company, hereinafter called the Owner, on November 8, 1954 , and May 16, 1955 entered into two no-lien construction contracts with Joseph M. Smith, hereinafter referred to as Contractor, to furnish labor and materials for the construction of two service stations located, respectively, in Mt. Pleasant , Westmoreland County , Pennsylvania , and Connellsville, Fayette County , Pennsylvania . The contracts were filed of record in the respective counties before visible commencement of work was begun on the ground. A construction and payment bond furnished by Continental Casualty Company, hereinafter referred to as Surety, accompanied each contract.

The Contractor completed the construction of the service stations but failed to pay certain materialmen on each job. As of November, 1956, the balance withheld by the Owner on the contract price was $6,027.68 for the Mt. Pleasant station and $6,626.26 for the Connellsville station, or a total of $12,653.94.

[Claims to Withheld Funds]

Previously, the United States Internal Revenue Service served on Owner notice of levy and demand for certain taxes owned by the Contractor, assessed in July and December of 1955 and noticed and filed of record on October 28, 1955 and December 30, 1955 . The total amount of the assessments was $11,632.06, plus interest, of which sum $1,114.81 was incurred by the Contractor in erecting the two service stations aforementioned.

Greensburg Concrete Block Company, a judgment creditor of the Contractor, served a writ of attachment execution on the Owner, as garnishee, attaching the fund allegedly due to the Contractor to satisfy its judgment of $737.65, with interest and costs.

The Surety claimed the balances withheld on the contract prices by reason of its liability on the bonds to unpaid materialmen.

Faced with these conflicting claims, the Owner on November 15, 1956 filed a "Complaint for Interpleader and Declaratory Relief" against the United States , the Surety Company, Greensburg Concrete Block Company, and the Contractor, and thereupon paid $12,653.94 into the registry of this court.

A default judgment was entered against Contractor Smith and Greensburg Concrete Block Company for failure to appear, answer or plead, and the Owner was discharged from any claim that they might assert against the funds paid into court.

[Tax Liens]

The complaint was dismissed as to the United States , and the United States was permited to intervene as a party plaintiff. The government's complaint in intervention alleges that the Contractor is indebted to it for certain withholding and F. I. C. A. taxes in the sum of $11,632.06, plus interest, and claims by virtue of the 1955 assessments that it has a prior lien on the fund allegedly due to the Contractor from the Owner. Hence, it demands the funds paid into court by Owner.

By amendment to its complaint, the government also sues the Surety directly on the bonds for all withholding and F. I. C. A. taxes due it from the Contractor in the sum of $11,632.06, plus interest. This suit, however, is pressed only for the sum of $1,114.81, plus interest, that amount being the withholding and F. I. C. A. taxes incurred by the Contractor in the construction of the service stations at Mt. Pleasant and Connellsville (see government's brief, pp. 32-34).

[Surety's Claim]

After the fund was paid into court, the Surety paid claims of materialmen on the Mt. Pleasant station in the sum of $6,004.51, leaving a balance of $23.17 unclaimed except by the United States . The Surety paid claims of materialmen on the Connellsville station in the sum of $12,285.53. The Surety took assignments from the materialmen which it paid.

The Surety presses its claim on the following grounds:

(1) The Contractor had no property or property interest in the fund upon which the government liens might attach.

(2) The Surety is subrogated to the rights of the Owner and materialmen in the fund created by the contract between the Owner and the Contractor.

(3) The Surety is entitled to the fund under equitable assignments given by the Contratcor to the Surety at the time of the execution of the bonds. ¹

In my opinion the Surety is entitled to the fund on the first ground, and on the second ground, i.e., because it is subrogated to the rights of the Owner. It is, therefore, unnecessary to discuss the third ground, although I am of the opinion that the Surety's contentions with respect to the effect of its equitable assignments would not succeed against the federal liens. ²

The provisions of the contracts between the Owner and the Contractor are identical except for description of work and prices.

The pertinent provisions thereof are as follows:

(1) "Contractor shall, during the progress of the work, pay all valid charges of all his sub-contractors and other persons furnishing labor and/or materials in the performance or prosecution of the work . . . when and as such charges become payable and in their full amount."

(2) "When the contract has been completed, the Contractor shall deliver to the Owner a full Release of Liens signed by himself and all sub-contractors and other persons who have furnished any materials, labor, or both, in the performance of the contract or prosecution of the work. . . . Such release, with accompanying affidavits, shall be in such form as the Owner may require and its presentation to Owner shall constitute a representation by Contractor that all sub-contractors . . . have joined in the proper execution thereof as having been paid. . . . Until such releases and affidavits are delivered properly executed, the final schedule of payments may be withheld."

(3) "WAIVER OF LIENS AND CLAIMS: . . . In the event that notice is given of any claim . . . which is chargeable to the Contractor . . . the Owner shall have the right to retain out of any payment then due, or to become due, an amount sufficient to completely indemnify the Owner against such claim. . . . In the event of . . . [the Contractor's] failure to have such claims . . . paid . . . the Owner shall have the right to take such action as is necessary to have the same done, charging the cost thereof . . . to the Contractor."

(4) "The Owner shall retain ten percent (10%) pending completion of the job and full compliance with the contract. . . . The final payment shall be made within thirty (30) days after final test and acceptance of the work, provided the Contractor shall have submitted to the Owner a satisfactory Release of Liens showing that all claims and bills for labor and material have been met and paid as hereinbefore provided."

The surety bonds are identical in their material provisions. Each contract was incorporated by reference in the accompanying bond.

Each bond was conditioned upon faithful performance of the contract and upon prompt payment of all just charges for labor and material furnished by Contractor.

No release of liens was furnished the Owner by the Contractor with respect to either job as required by both contracts. The Owner withheld the balances due on the contract prices and interpleaded the claimants thereto.

The Contractor Does Not Have Any Property or Rights to Property in the Withheld Balances of the Contract Prices Upon Which the Liens for Federal Taxes Might Attach

The United States bases its claim to the fund on §§ 6321 and 6322 of the Internal Revenue Code of 1954. ³ As therein provided "if any person liable to pay any tax neglects or refuses to pay 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."

It was held in United States v. Bess, 357 U. S. 51, 55 (1958) [58-2 USTC ¶9595] that ". . . §3670 [now 26 U. S. C. §6321] creates no property rights but merely attaches consequences, federally defined, to rights created under state law", citing Fidelity & Deposit Co. v. New York City Housing Authority, 241 F. 2d 142, 144 (2nd Cir. 1957) [57-1 USTC ¶9410]. As stated in Morgan v. Commissioner, 309 U. S. 78, 80 (1940) [40-1 USTC ¶9210]: "State law creates legal interests and rights."

As of the dates the federal liens were assessed (1955), the Contractor was not entitled to received any money under the terms of the contract, for the Contractor owed materialmen on both jobs. On the Mt. Pleasant job the unpaid amount was practically equivalent to the amount withheld by the Owner, and on the Connellsville job the amount was substantially in excess of the amount withheld.

[Contractor's Rights Under State Law]

It must now be determined under the Pennsylvania law whether the Contractor had any "property" or "rights to property" in the balances withheld from the Owner and paid by it into court. Cf. Central Surety and Insurance Corp. v. Martin Infante Co., 272 F. 2d 231 (3rd Cir. 1959) [59-2 USTC ¶9736].

It is a general principle that a material failure of performance by one party to a contract not justified by the conduct of the other discharges the latter's duty to give the agreed exchange. Sections 274 and 275, Restatement, Contracts, with which Pennsylvania law is in accord; Wright v. Barber, 270 Pa. 186, 113 Atl. 200 (1921); City of Farrell v. H. Platt Co., 142 Pa. Super. 242, 15 A. 2d 718; vol. 8 P. L. E. §301; Sum. Pa. Jur. Contracts, §498; cf. vol. 4, Corbin on Contracts, §901. Also in accord are cases in other jurisdictions involving contracts providing for the payment of labor and materialmen as a prerequisite for payment of the contract price. Central Surety & Insurance Corp. v. Martin Infante Co., supra; Fidelity & Deposit Co. v. New York City Housing Auth., supra; United States Fidelity & Guaranty Co. v. United States, 201 F. 2d 118 (10th Cir. 1952) [53-1 USTC ¶9249]; Wolverine Insurance Co. v. Phillips, 165 F. Supp. 335 (N. D. Iowa W. D. 1958) [58-2 USTC ¶9765]; United States Fidelity and Guaranty Co. v. Miller, 143 F. Supp. 941 (W. D. N. C. 1956) [56-2 USTC ¶9930]; Scott v. Zion Evangelical Lutheran Church, 75 S. D. 559, 70 N. W. 2d 326 (1955) [55-2 USTC ¶9669]; United States Fidelity & Guaranty Co. v. Triborough Bridge Authority, 297 N. Y. 31, 36-37, 74 N. E. 2d 226, 228 (1947) [47-2 USTC ¶9327].

In the cited cases it was held that the tax liens of the United States did not attach to the withheld funds; and the sureties and, in one case, the materialmen, won the money. In at least four of the cases, it seems that the contractors had completed or substantially completed the work for the owners, ⁴ the contractual breach being their failure to pay materialmen.

Therefore, I am of the opinion that a failure by the Contractor here to pay for labor and materials is just as much a failure to perform and carry out the terms of the contract as an abandonment of the work would have been.

Since the Contractor failed to pay the materialmen in amounts almost equal to or in excess of the balances withheld on the contract prices, express promises of the Contractor to the Owner to pay materialmen were materially breached by these substantial failures. Consequently, except for $23.17, the Contractor had no right of property in the balances withheld by the Owner; he could "not get" the withheld balances, Lancaster County Nat. Bank's Appeal, 304 Pa. 437, 155 Atl. 859; he had "no rights whatever" to the said balances, Prairie State Bank v. United States, 164 U. S. 227 (1896).

In Lancaster County Nat. Bank's Appeal, supra, the construction contract, as here, required the contractor to pay the materialmen. Being a contract for public work, it was, as here, in effect, a no-lien contract. On page 861 (155 Atl.), it was stated:

"[A]s it [the assignee of the contractor] was claiming the right to receive a sum payable to the contractor under the terms of the contract, it was bound to take notice also of the fact that the contractor could not get the semifinal estimate, which is the one in controversy here, until and unless all 'claims for labor and materials [incurred in the performance of the contract] have been satisfactorily settled,' . . .." (Italics supplied.)

Likewise, in Prairie State Bank v. United States, supra, with which it has been declared the Pennsylvania law is "in harmoney", Sundheim v. School District, 311 Pa. 90, 166 Atl. 365 (1933), it was stated at page 232:

"A great deal of confusion has arisen in the case by treating . . . [the surety] as subrogated merely 'in the rights of . . . [the contractor]' in the fund, which, in effect, was saying that he was subrogated to no rights whatever." (Italics supplied.)

Thus when perfected in 1955, the lien of the government's taxes bound a contingent right of the Contractor to receive the balance of the contract prices if, but only if, he substantially performed his direct contractual obligations to the Owner to pay the materialmen. After his material breaches, the Contractor's contingent right never ripened into a "right to property" which he could enforce or on which the federal tax liens could attach.

It is ". . . well settled that the lien of federal taxes extends only to property in which the taxpayer has an interest." United States v. Burgo, 175 F. 2d 196, 198 (3rd Cir. 1949) [49-1 USTC ¶9307]. "Since the government's rights under Sections 6321 and 6322 can rise no higher than the rights of the taxpayer, there was nothing of Infante's [the contractor's] to be levied upon." Central Surety and Insurance Corp. v. Martin Infante Co., supra, at pages 234-235.

Adapting Mr. Justice Brennan's statement in United States v. Bess, supra, at pp. 55, 56, it would be anomalous to view as "property" subject to lien, money never within the Contractor's reach to enjoy.

In the instant case, I conclude that the Contractor had no "property" or "right to property" in the withheld balances which the Owner paid into court, and, therefore, there was nothing to which the government's lien could attach.

The Surety Is Subrogated to the Rights of the Owner in the Withheld Balances

Having determined that the United States does not have a lien on the withheld balances, it seems certain that the Surety is entitled to recover the fund paid into court.

However, the government strenuously argues that in no-lien contracts where the work is completed by the Contractor, the Surety cannot be subrogated to the rights of the materialmen or the Owner, but only to the rights of the Contractor, which rights, of course, are subject to the government's tax liens. I am of the opinion that under Pennsylvania law the Surety can be, and is, subrogated to the rights of the Owner, and is thus entitled to the fund in which the Contractor, as shown, has no property rights.

It is established in Pennsylvania that upon elementary principles a surety is entitled to assert the equitable doctrine of subrogation to funds in the hands of the owner where there is a direct contractual obligation to the owner, as a party to the contract, binding upon the contractor and the surety to pay materialmen when the contractor breaches the contract by failing to pay the materialmen. In such circumstances, the surety is entitled to be subrogated to the rights of the owner in the retained balances. Subrogation arises from the owner's right to have the original contract performed according to its terms. When the surety pays the materialmen, it stands in the position of a surety who not only has completed the contractual obligations of the defaulting contractor, but also has carried out the equitable obligations of the owner to see that the materialmen are paid. Sundheim v. School District, supra. (Compare with similar cases in other jurisdictions, see footnote 4.)

In Henningsen v. United States Fidelity & Guaranty Co., 208 U. S. 404, 411 (1907), where the contractor promised the owner to pay materialmen, it was held that the surety was "entitled to assert the equitable doctrine of subrogation", citing Prairie State Bank v. United States, supra. And in Lancaster County No. Bank's Appeal, supra, at page 861 (Atl.), "under precisely similar circumstances" to those in Hinningsen, the Pennsylvania Supreme Court said: "With this statement of the law we are in complete accord. . . ." (page 862 Atl.).

In Sundheim v. School District , supra, at pp. 367-368 (Atl.), the Supreme Court of Pennsylvania stated:

"Consequently, when the contractor fails to pay labor and materialmen, it is tantamount to a breach of its contract with the United States [the owner]. . . . When this occurs and the surety pays the labor and materialmen, it stands in the position of a surety completing a contractual obligation of a defaulting contractor and performing an equitable duty to the United States . It [the surety] is therefore entitled to subrogation to the rights of the United States in the fund. Subrogation does not arise through the contractor, but from the government's [the owner's] rights. Prairie State Nat. Bank v. U. S. , 164 U. S. 227, 17 S. Ct. 142, 41 L. Ed. 412; Henningsen v. U. S. Fid. & Guar. Co. of Baltimore, 208 U. S. 404, 28 S. Ct. 389, 52 L. Ed. 547; In re Scofield Co. (C. C. A.) 215 F. 45. In Pennsylvania, where our statutes and the facts coincide with the cases decided by the federal courts, we are in harmony with those decisions as illustrated by Lancaster County National Bank's Appeal, 304 Pa. 437, 155 A. 859, 861." (Italics supplied.)

In Prairie State Bank v. United States , supra, at pages 232-233, it was stated:

"Hitchcock's [the surety's] right of subrogation, when it became capable of enforcement, was a right to resort to the securities and remedies which the creditor (the United States) [the owner] was capable of asserting against its debtor Sundberg & Company [the contractors], had the security not satisfied the obligation of the contractors, and one of such remedies was the right based upon the original contract to appropriate the ten percent retained in its hands. . . . The right of Hitchcock to subrogation, therefore, would clearly entitle him when, as surety, he fulfilled the obligation of Sundberg & Company [the contractors], to the government [owner], to be substituted to the rights which the United States [owner], might have asserted against this fund." (Italics supplied.)

In Henningsen v. United States Fidelity & Guaranty Co., supra, at page 410, it was stated:

"It [the surety] paid the laborers and materialmen and thus released the contractor from his obligations to them, and to the same extent released the Government from all equitable obligations to see that the laborers and supply men were paid." (Italics supplied.)

That the owner-promissee has equitable obligations and rights in a donee beneficiary contract, as a promise to pay materialmen seems to be, ⁵ is pretty well established. Restatement, Contracts, §138; Burnet v. Wells, 289 U. S. 670, 679-680 [3 USTC ¶1108]; Cove IRR. Dist. v. American Surety Co. of New York , 42 F. 2d 957 (9th Cir. 1930); Williston on Contracts, rev. ed., §§ 358, 359; Corbin, Contracts, vol. 4, §812.

Thus, Henningsen v. United States, supra, and Prairie State Bank v. United States, supra, pointed to in the Pennsylvania cases (Lancaster and Sundheim) as exemplifying the federal law with which Pennsylvania is in accord, clearly hold that in no-lien construction contracts, ⁶ the owner has an equitable obligation to see that the materialmen are paid, and when the surety has paid them, the surety is subrogated to the rights of the owner in the withheld balances as of the date of the original contract.

The rationale of the foregoing principles is well expressed in Corbin on Contracts, vol. 4, §901, pp. 609, 610, from which the following extracts are taken:

"If the surety claims by subrogation, his claim is not a 'latent equity' for the reason that he is being put into the position of the obligated owner, none of whose defenses and counterclaims can be described as 'latent'.

"The owner, in such a case as the above, is both an obligor and an obligee. His duty to pay is accompanied by a right to the performance promised in exchange for his money; his duty to pay is conditional upon performance by the builder. . . . In so far as the building contractor has not performed his part of the agreed exchange, he has no right to payment by the owner; and his assignee [lien creditor] has none. In so far as the agreed exchange has been performed at the surety's expense, under the compulsion of the surety bond, it has seemed fair and just to give to him that part of the payment that is dedicated to the agreed exchange; and it has seemed unjust to let either the contractor or his assignee [lien creditor] profit by the performance rendered under compulsion by the surety. This is the doctrine of subrogation of the surety to the position of the creditor. For, again be it noted, although the owner is a debtor (obligor) as to the promised payment, he is a creditor (obligee) as to full performance by the building contractor, and deferred payments are retained by him as security for such performance. . . .

"So, when the surety performs any of the contractor's duties to the owner, he is subrogated to the owner's right and securities against the principal contractor; and among these are included the deferred payments and retained percentages in the owner's hands."

The contracts, sub judice, are explicit in providing that the final schedule of payments may be withheld from the Contractor (promisor) until proof satisfactory to the Owner (promisee) is delivered, in order to show the Owner that all claims of laborers and materialmen (beneficiaries) have been paid by the Contractor as promised. ⁷ Because no such proof was ever submitted and substantial amounts were due to materialmen, the Owner did withheld final payments. Thereupon the withheld balances became collateral security for the Owner and ultimately for the Surety when it performed its obligations under the bonds and paid the materialmen. Prairie State Bank v. United States , supra. I hold that the Surety is entitled to the fund.

Payment by the Owner of the Withheld Balances Into Court Does Not Constitute a Waiver of the Surety's Right of Subrogation

The government argues that when the Owner paid the withheld balances into court, it waived its right to withhold them and the Contractor's property rights to same were reinstated and hence the federal liens attach. I do not agree.

In Lancaster County Nat. Bank's Appeal, supra, at page 861 (Atl.), it is stated:

". . . [T]he surety had an equity to insist that the secretary of the department 'withhold the payment of any semifinal or final estimate' until these claims were paid, as by the contract itself he said he would do, and on the faith of which provision, inter alia, the surety executed the bond. Derby v. United States Fidelity & Guaranty Co., 87 Or. 34, 169 P. 500; Canton Exchange Bank v. Yazoo County , 144 Miss. 579, 109 So. 1."

Cf. Sum. Pa. Jur., Surety & Guarantor, §139.

The Owner, when it actually withheld the balances and paid them into court, waived any defenses it had aaginst the claimants, ⁸ but it could not waive any right that the Surety might have to the withheld balances which are the security for the Contractor's performance. Interpleader does not affect the rights of the claimants or the merits of their respective claims inter se. Moore 's Federal Practice, 2d ed., vol. 3, ¶22.07, pp. 3021-3022.

The Surety upon payment of the materialmen was entitled to insist that the withheld balances remain as its security, ⁹ and their payment into court by the Owner, the plaintiff in interpleader, did not divest the funds of their character as security. They did not ipso facto become the property of the Contractor.

The United States Cannot Recover From Surety Unpaid Taxes of the Contractor Incurred in the Performance of Work Under the Contracts at Bar

It remains to be determined whether or not the government is entitled to a judgment against Surety in the sum of $1,114.81, plus interest, being the withholding and social security taxes attributable to the construction of the Mt. Pleasant and Connellsville service stations which the Contractor failed to pay.

In may opinion the claim should be denied.

It seems to be established that withholding and social security taxes due to the government from the Contractor are owing as taxes and not as wages. United States v. Crosland Const. Co., 217 F. 2d 275 (4th Cir. 1954) [58-1 USTC ¶9112]; Westover v. William Simpson Const. Co., 209 F. 2d 908 (9th Cir. 1954) [54-1 USTC ¶49,022]; United States v. Zschach Const. Co., 209 F. 2d 347 (10th Cir. 1954) [54-2 USTC ¶9164].

The pertinent portion of both contracts is as follows:

"With respect to all persons at any time employed by or on the payroll of the Contractor or performing any work for or on behalf or in connection with or arising out of his business, the Contractor shall indemnify the Owner against, and hereby accepts full and exclusive liability for the payment of, any and all contributions or taxes for unemployment insurance or old age retirement benefits, pensions or annuities or wage or income taxes, now or hereafter imposed by the Government of the United States, any State or political sub-division thereof, whether measured by the wages, salaries or other remuneration paid to such persons or the number of such persons or otherwise."

The pertinent condition of the bonds is that the Contractor

"(1) shall faithfully observe, perform and keep the said contract on the Principal's part to be observed, performed and kept, according to all its terms, covenants and conditions. . . ."

[Interpretation of Contracts]

The problem is one of interpreting the foregoing contractual provisions in order to determine whether the parties intended to benefit the United States and other taxing bodies by creating securities and remedies additional to their right to tax liens and the ordinary statutory methods of collection.

With respect to interpreting construction contracts and bonds, the law of Pennsylvania is laid down as follows in Commonwealth v. Fidelity & Deposit Co., 355 Pa. 434, 50 A. 2d 211 (1947):

`A bond given pursuant to a contract incorporated in the bond, will be construed in the light of the terms of the contract and the attendant circumstances, but "the obligation of a bond cannot be extended beyond the plain import of the words used". [City of] Lancaster v. Frescoln, 192 Pa. 452, 457, 43 A. 961, 962; [City of] Erie v. Diefendorf, 278 Pa. 31, 122 A. 159.' Fleck-Atlantic Co. v. Indemnity Insurance Co. of North America, 326 Pa. 15, 19, 191 A. 51, 53. Obligations not imposed by the terms of the bond cannot be created by judicial construction or interpretation which extends the terms beyond their normal meaning."

In the foregoing case, very like the case at bar, the bonds were conditioned on the contractor performing "the terms and conditions of said contract and his . . . obligations thereunder." There the contract provided that workmen's compensation insurance should be furnished by the contractor, but it did not in express terms require that the contractor pay the premiums thereon. The claim against the surety by the third party to recover for the unpaid premiums was denied. See also, Dravo-Doyle Co. v. Royal Indemnity Co., 372 Pa. 64, 92 A. 2d 554 (1952); Fleck-Atlantic Co. v. Indemnity Insurance Co. of North America, 326 Pa. 15, 191 Atl. 51 (1937).

With the foregoing principles and cases in mind, it seems plain that the contracts under consideration do not in express terms require that the Contractor shall pay the specified contributions and taxes as they do expressly require that he shall pay laborers and materialmen. Instead, the contracts provide that the Contractor shall indemnity the Owner against contributions or taxes, for the payment of which the Contractor "accepts full and exclusive liability". Similar language used in a contract construed in United States Fidelity & Guaranty Co. v. United States, 201 F. 2d 118, 119 (10th Cir. 1952) [53-1 USTC ¶9249], was held to be "merely declaratory of [the contractor's] existing liability under the federal tax laws" and "did not create the liability on [the contractor's] part for the payment of these taxes."

There are no other parts of the contracts from which a promise by the Contractor to Owner to pay the former's taxes can be implied; indeed, the implications are to the contrary. Whereas the contracts are quite specific in providing that the Owner could withhold unpaid balances until Contractor furnished releases of liens, nothing is said about withholding said balances until proofs were furnished that the contributions or taxes mentioned were paid; and whereas the bonds are conditioned specifically upon the Contractor's paying for labor and material, they nowhere mention taxes. In addition, the Contractor's promise to pay laborers and materialmen is clearly for the benefit of such third parties, but neither in the stipulation of facts or in the contracts is there any indication that the parties intended to benefit the United States or any other taxing body. The only obvious purpose and intention of the Owner "both in spirit and letter" was to protect itself and provide for indemnity. ¹⁰ Exceedingly great care and caution were used to make it plain that the Contractor recognized his sole liability to pay contributions or taxes arising out of his business, including the withholding and social security taxes in suit, but he did not expressly agree to pay them.

Construing the contracts, as I do, as undertakings to indemnify the Owner against loss, there is, of course, no liability on the Surety unless actual loss is suffered by the Owner, and "ordinarily a third person has no right to sue upon an indemnity agreement. . . ." Burke v. North Huntingdon Twp. Municipal Authority, 390 Pa. 588, 136 A. 2d 310, 315 (1957); Williston on Contracts, rev. ed., vol. 2, §403, p. 1159. Even if a promise to pay taxes could be implied, the government in simply an incidental beneficiary, the contracts and bonds not having been made for its benefit, and it cannot recover. Burke v. North Huntingdon Twp. Municipal Authority, supra; Williston on Contracts, rev. ed., vol. 2, §402, p. 1157.

If the parties intended to include taxing bodies as entities to be benefited, a few additional words would have expressed the agreement, as was done in the sections of the contracts and bonds providing that the Contractor shall pay laborers and materialmen.

The government relies on United States v. Phoenix Indemnity Co., 231 F. 2d 573 (4th Cir. 1956) [56-2 USTC ¶9659], but in that case the contract specifically and clearly provided that the contractor should "pay . . . taxes legally collectible because of the work. . . ." Obviously, that contract was made for the benefit of the taxing bodies.

Since no express or implied promise to pay the mentioned taxes for the benefit of the government can be found, in the light of the terms of the contracts and attendant circumstances, the government is not a donee beneficiary entitled to recover the Contractor's withholding and social security taxes from the Surety. The obligation of the bonds cannot be extended beyond the plain import of the words used in the contract. Dravo-Doyle Co. v. Royal Indemnity Co., supra; Commonwealth v. Fidelity & Deposit Co., supra; Fleck-Atlantic Co. v. Indemnity Insurance Co. of North America, supra.

Order ofCourt

AND NOW, to-wit, this 7th day of April, 1960, IT IS ORDERED that counsel for the parties shall collaborate on, approve as to form and content, and submit to the court an appropriate order consistent with the foregoing opinion within fifteen (15) days from the date hereof.

¹ See assignments contained in applications for bonds.

² See: United States v. Ball Construction Co., 355 U. S. 587 (1958) [58-1 USTC ¶9327]; United States v. White Bear Brewing Co., 350 U. S. 1010 (1956) [56-1 USTC ¶9440]; United States v. Colotta, 350 U. S. 808 (1955) [55-2 USTC ¶9680]; United States v. Security Tr. & Sav. Bk., 340 U. S. 47 (1950) [50-2 USTC ¶9492].

³ Section 6321, 26 U. S. C. A., provides as follows:

"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."

Section 6322, 26 U. S. C. A., provides as follows:

"Unless another date is specifically fixed by law, the lien imposed by section 6321 shall arise at the time the assessment is made and shall continue until the liability for the amount so assessed is satisfied or becomes unenforceable by reason of lapse of time."

⁴ Fidelity & Deposit Co. v. New York City Authority, supra; United States Fidelity & Guaranty Co. v. United States, supra; United States Fidelity and Guaranty Co. v. Miller, supra; United States Fidelity & Guaranty Co. v. Triborough Bridge Authority, supra.

⁵ Williston on Contracts, rev. ed., vol. 2, §372, p. 1085.

⁶ In all the cited cases the materialmen did not have the right to file mechanics' liens against public buildings.

⁷ Although these contracts were "no-lien contracts", such provisions are consistent by affording the Owner extra protection against any possible liens that might be filed, as pointed out in Morris v. Ross, 184 Pa. St. 241, 38 Atl. 1084 (1898), and if just unpaid claims were demanded, the Owner certainly would be at least equitably obligated to pay them out of withheld funds if that became necessary. See contract provisions, designated as (3), quoted above.

⁸ Cyclopedia Fed. Proc., 3d ed., §22.16, p. 607; Carter v. Thornton , 93 F. 2d 529 (8th Cir. 1938).

⁹ In United States v. Munsey Trust Co., 332 U. S. 234 (1947), it appears that the surety's right of subrogation is subject to the owner's counterclaims and set-offs against the contractor, including those arising under other contracts. The owner in that case was the United States who was not a disinterested stakeholder interpleading the fund as in the instant case.

¹⁰ The quoted phrase is from City of Lancaster v. Frescoln, 203 Pa. 640, 53 Atl. 508 (1902).

 

 

[60-1 USTC ¶9372]The Aetna Casualty and Surety Company, Plaintiff v. The Port of New York Authority and the United States of America , Defendants

U. S. District Court, So. Dist. N. Y., Civ. 136-84, 182 FSupp 671, 3/24/60

[1954 Code Sec. 6323]

Completing surety's priority: Performance bond covering contract: "Retained percentages of payments for work done".--The completing surety of a defaulting contractor had priority over federal tax liens against a fund held by the Port of New York Authority, the other contracting party, on the grounds that it represented "retained percentages of payments for work done", where (1) the surety executed a performance bond covering the contract entered into on the same day, (2) the contractor, eight days thereafter, assigned to the surety all its right, title and interest to all the money due under the contract, and (3) the liens subsequently filed represented claims to employment taxes on wages paid for work done under the contract.

[1954 Code Sec. 6321]

Property subject to lien: Bonus for early completion of contract: Right to withhold for benefit of third persons.--A bonus for early completion of work by a defaulting contractor represented "retained percentages of payments for work done" and was lawfully withheld by the Port of New York Authority under a contract which authorized it to withhold amounts from any payment, final or otherwise, to assure just claims to third persons. Thus, it was not "property" unlawfully withheld from the contractor to which federal tax liens could attach and, as to this portion of the fund, the completing surety also had priority.

[1954 Code Sec. 6321]

Government's claim against surety: Obligation to pay wages v. obligation to pay taxes on wages.--A completing surety of a defaulting contractor was not obligated under its contract to pay the Government's claim for employment taxes due from the contractor on wages paid under the contract. The surety's obligation to pay the wages did not obligate it to pay the taxes which should have been remitted to the Government by the contractor, since a failure to pay taxes is not the same thing as a failure to pay wages.

M. Carl Levine, Morgulas & Foreman, 521 Fifth Avenue , New York 17, N. Y. (Albert Foreman, of counsel), for plaintiff. Sidney Goldstein, 111 Eighth Avenue , New York 11, N. Y., for the Port of New York Authority. S. Hazard Gillespie, Jr., United States Attorney for the Southern District of New York (William Scott Ellis, Assistant United States Attorney, of counsel), for United States .

MCGOHEY, District Judge:

This case involves the question whether Aetna's lien as completing surety of a defaulting contractor has priority over tax liens of the United States against a fund of $67,000 held by the Port of New York Authority . The latter asserts no claim to the money which consists in part of retained percentages of payments certified as earned by the contractor for work done; and in part of the unpaid portion of a bonus concededly due but not paid to the contractor, for early substantial completion of the work called for by the contract.

[Motions for Summary Judgment]

The action was commenced in the New York Supreme Court and removed here by the government. The Port Authority, in its answer, asks that it be directed to pay the $67,000 into this court and that thereupon the action against it be dismissed.

Both Aetna and the United States moved for either complete or partial summary judgment.

Aetna 's motion seeks judgment (a) directing the Authority to pay it the $67,000; (b) dismissing the government's tax lien and claim; or, in the alternative, for partial summary judgment in the sum of $57,381.03 and dismissing the government's tax lien and claim as to that amount.

The government's motion seeks judgment (a) adjudging the tax liens to be superior to the plaintiff's; (b) directing the Authority to pay the government the $67,000; (c) directing Aetna to pay the government the balance, if any, of taxes with respect to which the government has a prior lien, and dismissing the complaint.

The government also moved, alternatively, for the following relief: (a) summary judgment on its first counterclaim for the unpaid portion of the bonus, which amounts to $9,184; (b) summary judgment on each of its second and third counterclaims. These, respectively, seek $8,106.26 for unpaid withholding taxes and interest; and $1,512.71 for unpaid unemployment insurance taxes and interest.

[No Issue as to Material Facts]

The parties agree and I independently find there is no genuine issue as to any of the material facts which I find to be as follows.

In 1954, Ranes Construction Corp., the defaulting contractor, entered into a contract with the Port Authority to construct Hangar No. 11 at New York International Airport . On the same day, Ranes as principal and the plaintiff as surety executed a performance bond covering that contract. Eight days later Ranes assigned to the plaintiff all right, title and interest to all monies due under that contract.

[Default]

On July 7, 1955 , all but about $1,000 worth of work on the hangar was completed and, under the terms of the contract as amended in March, 1955, a bonus of $57,400 became due to Ranes. All but $9,184 of the bonus was paid to Ranes. The latter, however, was then unable to meet its financial obligations under the contract. The plaintiff, as surety, was obliged to and did complete the contract, and in doing so expended the sum of $276,910.83. It thereupon made demand on the Port Authority for all monies then due Ranes under the contract and unpaid. These amounted to $157,380.58. The Port Authority, which had received notices of tax liens, paid the plaintiff $90,380.58 on account and withheld $67,000 to cover the tax liens filed by the government during August, 1955 and at various times thereafter.

[Completing Surety v. Assignee]

The government conceded on oral argument that the plaintiff, as completing surety, would be entitled, under prior authorities, to priority as to the retained percentages of payments for work done. This concession did not extend to the unpaid portion of the bonus. The government contended, however, that the rule announced in the earlier cases ¹ has been overruled by R. F. Ball Contracting Co. v. Jacobs. ² That contention is rejected. ³ In the Ball case, the plaintiff did not sue as completing "surety" but as "assignee," a status which it contended, under applicable state law as to assignments and mortgages, constituted it a "mortgagee" under section 3672(a) of the Internal Revenue Code of 1939 and thus entitled to priority. The Supreme Court held the assignment to Ball did not constitute it a "mortgagee" within the meaning of the code provision. The Ball decision, however, left undisturbed the rule announced in the prior cases cited above. Accordingly, on the authority of those cases, I hold that the plaintiff's lien as completing surety has priority over the defendant's liens for taxes against the retained percentages of payments for work done.

[Unpaid Bonus]

The government's contention with respect to the withheld portion of the bonus is that, this "was earned by Ranes, and thus is in a category different from that of the retained percentages" because Article 8 of contract, entitled "Withholding Payments," "applies primarily to retained percentages." Accordingly, the argument proceeds, the unpaid bonus is "property" of Ranes unlawfully withheld, to which the tax liens attached, thus giving them priority over Aetna's lien under decisions such as those in American Radiator Co. v. City of New York ⁴ and Schuessler v. Metropolitan Casualty Insurance Co. ⁵ These contentions are rejected. The cases cited in their support are inapplicable to the facts here.

[Bonus Provision]

The bonus provision was added to the contract by amendment executed with the surety's consent on March 3, 1955 . The contract originally called for complete performance of all work under the contract by September 15, 1955 . The amendment provided for payment of a bonus of $2,296 "for each calendar day between July 5 and July 31, 1955 . . . on which Hangar No. 11 is completely available for occupancy and use . . .." The amendment further provided that the "Bonus for Early Completion" was to be paid by monthly advances in "an appropriate amount . . . to be determined by the Engineer, in his sole discretion, taking into account [certain specified expenses not here relevant] in connection with the early availability of Hangar No. 11 for Occupancy." Article 8 of the contract, which was not modified by the amendment, authorizes the Authority to "withhold out of any payment, final or otherwise, such sums as the Director may deem ample to . . . assure the payment of just claims of third persons . . .." (Italics supplied) I hold, therefore, that the unpaid portion of the bonus was not illegally withheld and, as to that also, the plaintiff's lien has priority.

[Claim Against Surety]

The government's motions for partial summary judgment on its second and third counterclaims will be considered together. Both rest on the contention that, the government has a "lawful claim" against the defaulting contractor which the surety is required to pay under the provisions of its bond which obligates it to "pay or cause to be paid . . . all lawful claims of third persons arising out of or in connection with the [constitution] contract and work performed thereunder . . .." (Italics supplied) The steps in the argument in support of this contention are these. Ranes was required by the construction contract to pay "wages"; "wages" means "gross earnings" rather than the mere "take home pay" which remained after deduction of withholding and unemployment taxes. Ranes' failure to remit to the government the amounts withheld for these taxes was a failure to pay "wages" in full. This constituted a breach by Ranes of the construction contract and gave rise to a "lawful claim" by the government against Ranes for the amounts withheld. Similar contentions and argument have been repeatedly rejected in other cases. ⁶ They are rejected here.

[Taxes as Wages]

The government's purported reliance on the decision of the Supreme Court in United States v. Carter ⁷ is misplaced. That decision does not, as the government seems to suppose, support the foregoing argument. The basic question in that case was, whether the defaulting contractor's failure to pay contributions to a union welfare fund pursuant to his agreement with the union, of which his employees were members, was a failure, in violation of section 2a of the Miller Act, ⁸ to pay his employees "in full." The parties had stipulated that the contributions "were part of the consideration [the contractor] had agreed to pay for the services of laborers on his construction jobs." The court held the failure to pay the contributions was a violation of the Act; and therefore the surety, whose liability is "at least coextensive with the obligations imposed by the Act," ⁹ was liable under its statutory bond, recovery on which is not limited to "wages," which concededly had been paid. ¹⁰ The trustees of the welfare fund were allowed to assert the claim because they "stand in the shoes of the employees and are entitled to enforce their rights."

The government here, does not of course, pretend to "stand in the shoes" of Ranes' employees. Moreover, even they have no claim to the amounts withheld for taxes. ¹¹

The government's several motions for summary judgment and partial summary judgment are severally denied.

The plaintiff's motion for summary judgment is granted.

The order to be entered will contain a provision dismissing the complaint as to the Port Authority upon its payment of the $67,000 into court.

Settle Order.

¹ Fidelity & Deposit Co. v. New York City Housing Authority, 2 Cir., 241 F. 2d 142 [57-1 USTC ¶9410]; Aetna Casualty & Surety Co. v. United States, 4 N. Y. 2d 639, 176 N. Y. S. 2d 961 [58-2 USTC ¶9778]; United States Fidelity & Guaranty Co. v. Triborough Bridge Authority, 297 N. Y. 31, 74 N. E. 2d 226 [47-2 USTC ¶9327]. See also Massachusetts Bonding & Insurance Co. v. State of New York, 2 Cir., 259 F. 2d 33, 38 [58-2 USTC ¶9704].

² 355 U. S. 587 [58-1 USTC ¶9327].

³ Judge Cashin recently rejected a similar contention advanced in First National Bank in Yonkers v. City of New York, 177 F. Supp. 175, 180 [59-2 USTC ¶9639].

⁴ 223 N. Y. 193.

⁵ 265 N. Y. 648.

⁶ United States v. Crossland Construction Co., 4 Cir., 217 F. 2d 275 [55-1 USTC ¶9112]; Westover v. William Simpson Construction Co., 9 Cir., 209 F. 2d 908 [54-1 USTC ¶49,022]; General Casualty Co. of America v. United States, 5 Cir., 205 F. 2d 753 [53-2 USTC ¶9483]; United States Fidelity Guaranty Co. v. United States, 10 Cir., 201 F. 2d 118 [53-1 USTC ¶9249]; First National Bank in Yonkers v. City of New York, supra.

⁷ 353 U. S. 210.

⁸ 40 U. S. C. 270b(a).

⁹ 353 U. S. 215.

¹⁰ See United States v. Embassy Restaurant, 359 U. S. 29, 35 [59-1 USTC ¶9297].

¹¹ Sec. 3403, Internal Revenue Code of 1954; §31.3401(a)-1(b)(5), Regulations, I. R. C. 1954.

 

 

[54-2 USTC ¶9469]Grant American Indemnity Company v. United States of America , et al.

In the United States District Court for the Western District of Louisiana, Alexandria Division, Civil Action No. 3841, 120 FSupp 445, April 7, 1954

Lien for taxes: Liability of surety for unpaid taxes.--Taxpayer failed to remit to the government taxes withheld on a construction job. The Commissioner claimed that the surety for the job was liable for these taxes. The District Court held that the surely was not secondarily liable to pay taxes due for one who failed to pay them.

Collection of taxes: Lien for taxes: Application of statute.--Taxpayer, a contractor, failed to remit taxew withheld on wages earned in the construction of a school. Several subcontractors filed mechanics' liens against the funds held by the school board owing to the taxpayer, and in 1952 these funds with additional funds from the surety were paid over in full satisfaction of the claims of the subcontractors by an order of the Court. The government did not appear at that proceeding as the Treasury Department was not served, even though the tax lien had been filed. In the present proceeding the Commissioner asks to be considered a creditor of the taxpayer and contends that he is entitled to a first lien on the surety's bond. The District Court held that even though the Commissioner any have a prior lien over other creditors, the Commissioner had no rights as respects the surety, the only other party served in this case, as the Commissioner's debtor had no enforceable right against the surety. The Commissioner's rights can not exceed those of the taxpayer debtor.

Stafford & Pitts, Guaranty Bank Building , Alexandria , La. , for plaintiff. Mason P. Gilfoil, Assistant United States Attorney, Post Office Box 33 , Shreveport , La. , for defendant.

HUNTER, District Judge:

This is a suit in the nature of a bill of interpleader brought under the terms of 49 Stat. 1096, U. S. C. Title 28, Sections 1335, 1339 and 2361, and under the terms of Rule 22 of the Federal Rules of Civil Procedure, and for a declaratory judgment under the provisions of 49 Stat. 1027, U. S. C., Title 28, Sections 2201 and 2202.

The amount in controversy exceeds $3,000, and there is a diversity of citizenship, not only between the plaintiff and all defendants, but also among the defendants themselves, as is required by the statutes mentioned above.

One of the defendants, Alexandria Insulation Company, entered into a written contract with the Grant Parish School Board, obligating itself to build the Georgetown School . The contract was recorded as required by the law of the State of Louisiana . The job was bonded, and plaintiff, Great American Indemnity Company of New York , a non-resident insurance company, became surety on the bond. The job was completed, was accepted and the written acceptance was recorded in the office of the Clerk of Court of Grant Parish, Louisiana.

Within the time allowed by Louisiana law, some twenty or more creditors, who had sold materials or who had performed services on the school, filed liens for various amounts, totalling something in excess of $22,000. This amount was considerably in excess of the amount still due to the contractor by the School Board. The latter amount was $14,540.07.

About the same time the creditors were filing their liens, the United States of America , through the Treasury Department, levied against the fund in the hands of the School Board, and filed a lien with the Clerk of Court of Grant Parish, claiming that the contractor owed it something in excess of $8,000. Plaintiff, in its complaint, challenged the validity of the lien and of the levy.

Plaintiff deposited in court $5,500 and asked for an order directing the Grant Parish School Board to deposit into the hands of the court the balance due to the contractor stating that the two sums taken together would be sufficient to pay all parties holding valid liens.

In the prayer of its complaint, the plaintiff asked for the following, and other, relief:

1. That it be permitted to deposit $5,500 with the Clerk of Court to be retained by him pending the further orders of court.

2. That the Grant Parish School Board be ordered and directed to deposit with the Clerk of Court the sum of $17,504.07, to be retained by him, pending the further orders of the court.

3. That the rights of the various parties, including the materialmen and laborers who had filed claims be litigated in concursus and be fixed; that the laborers and materialmen finally be decreed to be entitled to be paid out of the funds deposited in court by preference over all other persons and particularly by preference over the United States of America.

4. That the lien and the levy of the United States of America be decreed to be of no effect and that they be ordered cancelled.

5. That plaintiff's bond be decreed to run in favor of the School Board, and the laborers and materialmen, and no other persons; that the bond be cancelled upon laborers and the materialmen.

6. That an injunction issue prohibiting the further prosecution of the existing suit, as well as the filing of new ones.

The court signed an order accepting plaintiff's deposit of $5,500 and directing the Grant Parish School Board to deposit with the Clerk of Court the balance that it owed to the contractor, and ordering all creditors claiming liens, not including, however, the United States of America , to show cause why an injunction should not issue restraining the prosecution of suits. A hearing on the demand for an injunction was set for August 28, 1952 .

All parties, including the United States of America , were served with process, prior to the date fixed for the hearing.

When the case was called, on the date set in the order, that is, August 28, 1952 , the late Judge Porterie, granted plaintiff a preliminary injunction as prayed for. In addition, but not at plaintiff's request, Judge Porterie ordered the Clerk to distribute to the various creditors who had filed liens, and whose claims plaintiff did not dispute, the full amount due to them. The effect of this order was to exhaust the fund in the hands of the Clerk, which had been made up of plaintiff's voluntary deposit of $5,500, and the deposit made by the School Board under the prior order of court ($17,540.07).

Naturally, this order, not objected to by plaintiff, was pleasing to all creditors except the Treasury Department, which was not even served.

The United States of America , through its attorney, has filed a motion to vacate the court's judgment of August 28, 1952 , the idea being, we take it, to attempt to get the funds back into the hands of the court. This motion was served on no one but the plaintiff, Great American Indemnity Company, the only party who could not comply, because it received no part of the distribution. Coupled with the motion is an answer and a cross-claim, in which the government says that the contractor, Alexandria Insulation Company, deducted from the wages it paid to its employees, withholding and unemployment compensation taxes amounting to more than $8,500, but that it failed to pay this amount to the Collector of Internal Revenue as required by law. In the cross-claim, it asked that, as to the amounts so collected and withheld, but not paid, it be recognized as a creditor of the contractor, and as such, entitled to a first lien and privilege on the fund and under the bond given by the contractor for the faithful performance of the building contract. Finally the United States of America asks for a judgment against the surety on the policy for such amounts as may be due.

Plaintiff has filed a motion to dismiss the cross-claim for the reason that it fails to state facts which would entitle the United States of America to a judgment. It also filed a motion for a summary judgment granting it all of the relief originally prayed for as against the United States of America . The United States of America has countered with a motion for summary judgment in its favor.

There is apparently no dispute as to any material fact. The issues presented are purely legal.

Motion to Vacate

The motion to vacate will not be passed on by this court until such time as the motion is served on those persons who received the money under the August 28, 1952 order. The creditors, paid the amounts admittedly due them, are necessary parties, and in their absence no motion can be granted ordering them to restore.

The Issues

There are two questions presented here, the first of which is:

Is the surety liable under the terms of its bond to the government for sums withheld by the contractor from the wages of his employees for the payment of taxes?

The answer to this question must be in the negative. The arguments made on this issue have been made by the government and decided against the government in a series of cases. It is well settled that the surety on an ordinary performance bond is not secondarily liable to pay taxes due the United States by the contractor who failed to pay them. This holding is made necessary by numerous decisions ¹ from which this case (on this question) is not distinguishable in fact or in law.

The second and most disputed issue for the court's determination is:

Does the government's alleged lien on the money that the Grant Parish School Board deposited in court outrank the statutory Louisiana liens in favor of suppliers of material and labor?

We are here dealing with several statutory liens, some owned by the materialmen, etc., and some by the federal government. The federal liens, securing unpaid withholding and unemployment taxes and insurance contributions, were created by Sec. 3670 of the Internal Revenue Code ². Section 3672 of the Internal Revenue Code (26 U. S. C. A. No. 3672) reads in pertinent part as follows:

"Such lien shall not be valid as against any mortgagee, pledgee, purchaser, or judgment creditor until notice thereof has been filed by the Collector."

Were the liens filed under the Louisiana Statute entitled to the status of a judgment creditor or a mortgagee within the meaning of Sec. 3672? If they are found to be so entitled and if they gained this status prior to the filing of notice, then and in that case the liens filed under Louisiana Law are entitled to priority. The United States relies heavily on two recent decisions of the Supreme Court of the United States : (a) U. S. v. Security Trust and Savings Bank (340 U. S. 47, 71 S. Ct. 111, 95 L. Ed. 53 [50-2 USTC ¶9492]), and (b) U. S. v. Gilbert Associates (345 U. S. 361, 73 S. Ct. 701) [53-1 USTC ¶9291]. TheGilbert case is not controlling. There, the court was dealing with an insolvent taxpayer. The court said in that case:

"Where the lien of the Town and that of the Federal Government are both general, and the taxpayer is insolvent, #3466 clearly awards priority to the United States." ³

Plaintiff's counsel relies on the well settled jurisprudence of Louisiana to the effect that these liens and privileges, when recognized by judgment, relate back to the date of the filing. He also cites the case of Board of Supervisors of Louisiana State University v. Hart, 26 So. (2d) 361 [46-1 USTC ¶9245] wherein the Supreme Court of Louisiana decided that an attachment lien was superior to an income tax lien of the United States .

The state is free to give its own interpretation to the nature and effect of its statutes for the purpose of its own admin istration, but the meaning of a federal statute is a question for this court to decide (U. S. v. Security Trust and Savings Bank, supra; U. S. v. Gilbert Associates, supra; U. S. v. City of New Britain, Conn., 74 S. Ct. 367, decided Feb. 1, 1954) [54-1 USTC ¶9191]. In the Security Trust case, four suits over a parcel of land in California were involved. The state court awarded a judgment creditor priority over liens of the United States for taxes. The tax liens were filed after the attachment of a seizing creditor, but prior to the time the attaching creditor's claim was reduced to judgment. The California court held that the judgment related back or became effective as of the date of attachment. The State District Court of Appeals affirmed this decision. The State Supreme Court of California declined to hear the case and the Supreme Court of the United States granted certiorari. The Supreme Court examined the law of California to find if such a lien under California law was and is, of itself, a judgment within the meaning of Section 3672 of Title 26, U. S. C. The Supreme Court of the United States found that it was not a judgment or a mortgage within the meaning of Section 3672. Mr. Justice Jackson, in his concurring opinion, said:

"While we should accept the law of California as its court has declared it, the federal question remains whether it is in conflict with 26 U. S. C. 3670-3672 * * *. The history of this tax lien statute indicates that only a judgment creditor in the conventional sense is protected.

"My conclusion from this history is that the statute excludes from the provisions of this secret lien those types of interests which it specifically included in the statute and no others."

It has been suggested that Congress did not intend, by giving priority over federal tax liens, to supersede state laws making certain interests superior to mortgages and judgments. This argument would be applicable, if accepted, to Louisiana . (It is conceded that the statutory state liens here involved are in certain instances superior to mortgage and judgment under state law). The Supreme Court of Error in Connecticut agreed with this argument in the New Britain case. ⁴ The United States Supreme Court did not agree when it heard the case on certiorari. We quote from that decision:

"The United States is not interested in whether the state receives its taxes and water rents prior to mortgages and judgment creditors. That is a matter of state law. But as to any funds in excess of the amount necessary to pay the mortgages and judgment creditors, Congress intended to assert the federal lien. There is nothing in the language of Sec. 3672 to show that Congress intended antecedent federal tax liens to rank behind any but the specific categories set out therein, and the legislative history lends support to this impression." (Italics supplied) (74 S. Ct. 372)

Our opinion is that the Louisiana liens are not judgments or mortgages within the meaning of Sec. 3672 and are therefore not entitled on that basis to any priority over the federal tax lien. This holding is in conformity with the majority view in the three recent decisions of the United States Supreme Court (Security Trust, Gilbert Associates and New Britian, all cited herein).

Our holding on this point does not dispose of our problem. We have only found that all three of the recent decisions of the United States Supreme Court, cited hereinabove, do hold that liens are not judgments within Sec. 3672, and thus are not entitled to priority on that basis over federal tax liens. The next problem that we are faced with is, who is entitled to priority? The government's counsel is not asserting a claim under Sec. 3466, but squarely pegs the issue on Sec. 3672. Here, Congress has failed to expressly provide for federal priority.

In the Security Trust case, priority was given to the government lien even though recorded subsequent to the date of the attachment lien. In that case the court seemed to assume that Sec. 3672 and Sec. 3466 were entitled to the same interpretation in regard to priority. The Supreme Court, in the New Britain case, distinguished the two cases by saying that the Security Trust case involved an "inchoate" lien. They defined an "inchoate" lien as one "that may become certain as to the amount, identity of the lienor, or the property subject thereto only at some time subsequent to the date the federal liens attach." In the Security Trust case the Supreme Court defines an "inchoate" lien as one "where numerous contingencies might arise that would prevent the attachment lien from ever becoming perfected by a judgment awarded and recorded." The Louisiana lien seems to fit the definition of an inchoate lien in the Security Trust case. ⁵ But, the New Britain case definition also fits and is appropriate. There, city tax and water rent liens were held to have attached and became "choate" upon filing. The Louisiana liens here were "certain as to amount, identity of lienor and the property subject thereto," and under the definition of the New Britain case were "choate." In the Security Trust case it was held the attachment was really not a lien at all but merely a right to perfect a lien. The Louisiana lien is a perfect lien with a right to reduce to a perfect judgment. Because they are not judgments they gain no special standing by Section 3672--but because they are choate liens they would be entitled to priority if recorded prior to the federal tax liens. The record indicates that most of these state liens are therefore entitled to priority on the old rule (again set forth in the New Britain case,) "the first in time is first in right."

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 and Guaranty Co. v. U. S. , 10 C. C. A. (1952), 201 Fed. (2d) 118) [53-1 USTC ¶9249]. 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, 58 Fed. Supp. 473 [45-1 USTC ¶9140].)

We have read numerous decisions involving contractors' bonds and attempts of the United States to recover taxes out of the balance in the hands of the owner. (Note: not the debtor, as in Supreme Court cases cited by the government). In each of these cases, the claim of the United States was denied. ⁶ Thus, it must be here.

An order in conformity with this opinion will be signed upon presentation.

¹ U. S. Fidelity and Guaranty Company v. U. S. (10 C. C. A. (1952), 201 Fed. (2d) 118) [53-1 USTC ¶9249]; General Casualty Company of America v. U. S. (5 C. C. A. (1953), 205 Fed. (2d) 753 [53-2 USTC ¶9483]; Westover v. Simpson Construction Company (9 C. A. A. decided January 28, 1954 [54-1 USTC ¶49,022]).

² "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 the 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." I. R. C. Sec. 3670, 26 U. S. C. 1946 Ed.), Sec. 3670, 26 U. S. C. A. Sec. 3670.

³ R. S. Sec. 3466. "Whenever any person indebted to the United States is insolvent or whenever the estate of any deceased debtor, in the hands of the executors or admin istrators, is insufficient to pay all the debts due from the deceased, the debts due to the United States shall be first satisfied, * * *"

⁴ 139 Conn. 363; 94 A. (2d) 10 [53-1 USTC ¶9272].

⁵ If such liens are not paid or reduced to judgment within a certain period of time they are automatically lost. Then, too, there is always the question of proof.

⁶ District Court cases:

(1) In re Caswell Construction Co., Inc., 13 Fed. (2d) 667 [1 USTC ¶189]; (2) New York Casualty Co. v. Zwerner, 58 Fed. Supp. 473 [45-1 USTC ¶9140]; (3) American Fidelity Co. v. Delaney, 114 Fed. Supp. 702 [53-2 USTC ¶9620];

Circuit Court cases:

(4) Glenn v. American Surety Co., 160 Fed. (2d) 977 [47-1 USTC ¶9220]; (5) U. S. Fidelity & Guaranty Co. v. U. S., 201 Fed. (2d) 118 [53-1 USTC ¶9249]; (6) General Casualty Co. of America v. U. S., 205 Fed. (2d) 753 [53-2 USTC ¶9483].

 

 

[77-1 USTC ¶9268] United States of America , Plaintiff v. Capitol Indemnity Corporation, Defendant

U. S. District Court, East. Dist. Ill. , Civil No. 71-104, 1/27/77

[Code Secs. 6672 and 7402--result unchanged '76 Tax Reform Act. Also Judicial Code Secs. 1340 and 1345]

Employment taxes: Failure to pay over: Liability of guarantor: Government as third-party beneficiary.--The surety on a performance bond was liable to the United States, as a third-party beneficiary, for withholding taxes unpaid by the no longer extant principal on the bond. The government was granted summary judgment.

Memorandum and Order

JUERGENS, ^* Senior District Judge:

Plaintiff's motion for summary judgment is for consideration. Plaintiff has attached its brief in support of the motion and stipulation of facts heretofore entered into between the parties.

Defendant on November 26, 1975, after receiving notice of this case's being forwarded to the court on the motion for summary judgment, requested that the court defer disposition of the case pending disposition of a case in Springfield, Illinois, which was, according to the letter, settled on December 30, 1975, but that [sic] it would be some time later before the settlement would be closed. More than one year has elapsed since defendant's letter and [the defendant] has not seen fit to favor the court with any further correspondence or advice.

The court therefore considers plaintiff's motion for summary judgment on the motion, the brief in support, and the stipulation of facts.

According to the stipulation, James Green Construction Company, Inc., an Illinois corporation (hereafter construction company), entered into a contract on September 10, 1969, with the Jackson County, Illinois Housing Authority to construct certain buildings, commonly referred to as low-rent housing, for a consideration of $725,000.00. On September 20, 1969 , the construction company, as principal, entered into a performance and payment bond contract in the amount of $725,000.00, [with] Capitol Indemnity Corporation, the defendant, as surety. During the calendar quarter ended March 31, 1970 , and at a time when the performance and payment bond was in effect, the contractor collected, deducted or withheld from its employees wages for withholding and FICA taxes, which, insofar as the Jackson County, Illinois Housing Authority Project is concerned, totaled $5,409.49. A quarterly return was filed, but payment of the taxes was not made. As a result of filing the return, a delegate of the Secretary of the Treasury made an assessment against the corporation for the unpaid taxes together with penalties and interest.

The corporation has ceased doing business without payment of the taxes due to the plaintiff.

On July 22, 1970, the District Director of Internal Revenue at Springfield , Illinois , directed a letter to the defendant, Capitol Indemnity Corporation, notifying it of the construction company's failure to pay withholding and FICA taxes due for the calendar quarter ended March 31, 1970. The letter was delivered to defendant on July 24, 1970, by a revenue officer; however, defendant has made no payment relative to the withholding and FICA tax liabilities noted above.

Jurisdiction is bottomed on the provisions of Sections 1340 and 1345, Title 28 U. S. C., and Section 7402 of the Internal Revenue Code of 1954.

This action was filed on July 22, 1971, to collect from the defendant surety company the taxes for the first quarter of 1970 applicable to the Jackson County contract.

On January 13, 1972, plaintiff filed its amended complaint to assert a third-party beneficiary claim. It is this claim that now serves as a basis for this motion for summary judgment.

Plaintiff brings this action not on the original contract but as a third-party beneficiary of the surety bond issued by the defendant, the guarantor in the surety bond, guaranteeing performance of the original contract.

The performance and payment bond, executed by the construction company, as principal, and Capitol Indemnity Corporation, being its agent, as guarantor, provides that:

". . ., the condition of the obligation is such that if the Principal (namely, James Green Construction Company, Inc.) shall in all respects fully perform the Contract . . ., and if the Principal shall fully satisfy all claims arising out of the Prosecution of the work under the contract . . ., and if the Principal shall make full payment to all persons supplying labor, services, materials or equipment in the prosecution of the work under the Contract, in default of which such persons shall have a direct right of action hereupon, then this obligation shall be void, otherwise it shall remain in full force and effect."

The original contract incorporates therein the original instrument, the general conditions, special conditions, technical specifications, drawings and addenda.

The general conditions, designated as part of the contract by the contract and attached as Exhibit B to the stipulation of facts, and specifically paragraph 3, General Responsibilities of Contractor, provides in pertinent parts as follows:

3. GENERAL RESPONSIBILITIES OF CONTRACTOR

a. Except as otherwise specifically stated in the Contract, the Contractor shall provide and pay for all materials, labor, . . ., taxes legally collectible because of the work, . . .."

It cannot be disputed that the taxes pursuant to which this action is filed are taxes assessed against the construction company by virtue of work performed on the project and are, therefore, due and owing under the contract and are covered by the performance and payment bond.

In United States v. Phoenix Indemnity Co. [56-2 USTC ¶9659], 231 F. 2d 573 (4th Cir. 1956), the Court of Appeals had before it a case which was in practically all respects identical to the case presented to the court here. The Court there held that the parties were liable under the bond for federal unemployment taxes, FICA taxes and withholding taxes, and stated:

"Our conclusion is based upon the provisions of the bond under which the sureties guaranteed the performance of all covenants and agreements undertaken . . . in the contract, and these included the agreement to pay all the taxes collectible because of the work, a provision plainly broad enough to cover not only the taxes payable by the employer, such as unemployment taxes and the employer's portion of the Federal Insurance Contributions taxes, but also the withholding taxes which are credited on the income taxes due by the employees and the employees' portion of the Federal Insurance Contributions taxes. It is to be noted that the contract was referred to in the bond and hence the contract may properly be regarded as a part of the sureties' undertaking and may be considered in its interpretation. Massachusetts Bonding & Ins. Co. v. Feutz, 8 Cir., 182 F. 2d 752, 757: It is true that the United States was not a party to the contract or the bond, but the bond was made for the Government's protection and it is entitled to sue thereon as a third-party beneficiary. (Citing cases)."

In Home Indemnity Company v. F. H. Donovan Painting Co., 325 F. 2d 870, 8 Cir. 1963, the Court stated at 874:

". . . It is a fundamental rule of construction that where the contract which is the subject of the performance bond is referred to in the latter, that the contract is to be regarded as a party of the undertaking of the surety under the bond. (Citing cases). It is equally well settled that where, as here, there is a compensated surety, the performance bond and the contract upon which it is based are construed most strongly against the surety and in favor of indemnity. (Citing cases)."

The Court finds that plaintiff, the United States, is a third-party beneficiary of the performance bond and is, therefore, entitled to bring suit against the surety on the bond for the amount due to plaintiff under the contract, which in this case is the sum of $5,409.49, plus interest at the rate of six percent per annum from April 30, 1970, to the date of payment.

The Court finds that the defendant in this case is liable for the taxes assessed against it for which this suit has been instituted.

The Court finds that summary judgment should be entered in favor of the United States of America, plaintiff, and against Capitol Indemnity Corporation, defendant, in the amount of $5,409.49 plus interest at the rate of six percent per annum from April 30, 1970, to date of payment.

The above and foregoing shall be considered findings of fact and conclusions of law.

It is, therefore, the order of this Court that summary judgment be and the same is hereby entered in favor of the plaintiff, United States of America, and against the defendant, Capitol Indemnity Corporation, in the amount of Five Thousand, Four Hundred Nine and 49/100 ($5,409.49) plus interest at the rate of six percent (6%) per annum from April 30, 1970, to date of payment. Execution therefor to issue.

^* Senior United States District Judge William G. Juergens of the Eastern District of Illinois is sitting by designation.

 

 

[57-1 USTC ¶9488]Commercial Standard Insurance Company, Plaintiff v. Ellis Campbell, Jr., District Director of Internal Revenue; S. W. Taylor, Collection Officer; and First National Bank, Arlington, Texas, Defendants

U. S. District Court, No. Dist. Tex., Fort Worth Div., Civil, No. 3053, 146 FSupp 919, 12/7/56

[1954 Code Sec. 3401(d)--substantially unchanged from 1939 Code Sec. 1621(d); 1954 Code Sec. 6323(a)--similar to 1939 Code Sec. 3672(a)(3)]

Collection of taxes: Withheld taxes: Tax liens: Priority: Government v. surety: Surety as employer.--A surety for performance by a contractor building armories for the State of Texas took as collateral an assignment of any and all sums due by the State on account of the contract. It also deposited money in a special account opened in the name of the contractor. In addition to this money, the deposit in this account was made up of proceeds from the contract and money borrowed from a bank. This was a suit by the surety to enjoin the District Director from enforcing a levy on the bank account for the purpose of collecting employees' taxes withheld by the contractor but not paid over. The Court held for the Government on the grounds that (1) the lien for taxes attached to the bank account because it belonged to the taxpayer and was not the surety's property, (2) since the assignment attached only to funds to become due in the future, the surety had at best only an unperfected lien, (3) the surety's lien did not attach to the bank account because its assignment covered only the proceeds under the contract, and (4) the doctrine of subrogation was not applicable even though a mechanic's lien was filed because such a lien was against the surety and not against the proceeds of the contract. It was unnecessary to decide whether the surety was an employer, as claimed by the Government, in view of the Court's conclusion that the bank account was the contractor's property. By that same token, the surety could not deny that it was an employer for income tax withholding purposes and at the same time claim that the money in the bank account belonged to it.

Malone, Lipscomb & Seay, 502-7 Southland Life Building , Dallas , Tex. , for plaintiff. Cantey, Hanger, Johnson, Scarborough & Gooch, Sinclair Building , Fort Worth , Tex. , for defendants.

ESTES, District Judge:

Pursuant to the National Defense Facilities Act of 1950, Public Law No. 783, 81st Congress, Tit. 50 U. S. C. A. Secs. 881-887, and the Department of Defense Appropriations Act of 1952, Public Law No. 179, 82nd Congress, the United States of America and the State of Texas entered into a written agreement whereby certain armory units were to be constructed at various points in the State of Texas, the United States of America paying 75% of the costs and the State of Texas 25%.

[Facts]

On February 10, 1954 , the State of Texas entered into a written contract with one Cleo Webb Key, doing business as C. W. Key and Son, for the construction of an armory at Denton , Texas , that contract being described by No. DA-41-292-NG-167 for a total consideration of $58,600.

On February 10, 1954, C. W. Key, doing business as C. W. Key and Son, as principal, and Commercial Standard Insurance Company, plaintiff herein, as surety, executed a performance bond and a bills payment bond, each in the sum of $58,600, payable to the State of Texas, as obligee, to secure the performance and payment of bills on the armory construction contract. As a part of the application for said bond, the principal, as "collateral to secure the obligations herein and any other indebtedness and liabilities of the undersigned to the company, whether heretofore or hereafter incurred, such assignment to become effective as of the date of said contract bond but only in event of" (certain specified defaults on the part of the contractor), assigned to plaintiff "any and all percentages retained on account of said contract, and any and all sums that may be due under said contract at the time of such abandonment, forfeiture, or breach, or that thereafter may become due." Between the dates of February 10, 1954, and September 21, 1954, the State of Texas entered into eight other contracts for the building of additional armories at various locations in the State of Texas . It is stipulated by the parties that each of the contracts, bonds, and application for bonds are identical save as to amount.

Some of the contracts were between the State of Texas and C. W. Key, G. E. LaRue, and V. L. Clynch, but the parties have agreed that all will be treated the same since these parties constructed and completed said units under a joint venture.

The State of Texas in its contract with the builders agreed to advance money on monthly estimates less the required retained percentage of 10%, which was to be paid to contractors upon completion of each project, provided all bills for labor and material had been paid. None of the money involved in this action constitutes any part of the retained percentages.

The contractors entered upon the performance of their contract, attempting to finance the costs through local banks, and the proceeds of the contracts were assigned to said banks. The contractor executed notes to the various banks for monies advanced and when payment was received from the State or the Federal government these monies were deposited in the contractor's account less the amount of indebtedness owed by the contractor to the bank.

This procedure was used until in November 1954 when Acme Brick Company filed notice of an unpaid account for some $35,000 for material furnished. At that time the contractors were unable to further finance the projects and this information was given to their surety.

[Bank Account in Name of Contractor]

It was agreed between the contractors and their surety that a bank account would be opened in the First National Bank of Arlington , Texas , defendant herein, known as the C. W. Key and Son Construction Account. The deposit in this account was made up of proceeds from the contract, monies advanced by the surety to the contractors for which contractors executed their notes to surety, and money borrowed from the First National Bank of Arlington . On the notes for these sums contractors and surety appear either as co-makers or as maker and guarantor, the surety being the guarantor.

It was further agreed by the parties that one Koeneman, an employee of surety and one Ford, an independent accountant who kept contractor's books, would be authorized to sign checks on this account. The contractors had no checking privileges. This account later was changed to the armory construction account, and at the time of the government's levy contained sufficient monies to pay the tax account. All payrolls and material bills were paid out of this account.

[Levy to Collect Withholding Taxes]

At all times, both before and after November 19, 1954 , there was deducted from the account paid each laborer, the withholding tax and employee's portion of social security. These withheld taxes were not, however, paid to the government and the Director of Internal Revenue at Dallas assessed withholding and social security taxes against the contractors, and gave notice to, and served levy upon, the defendant bank. Prior to the assessment and levy the surety had advanced more money to the contractor than there was in the bank account.

[Suit to Enjoin Collection]

Plaintiff filed this suit to enjoin the District Director and S. W. Taylor from enforcing the levy, and the bank from honoring the levy. A temporary restraining order against these parties was issued and remained in force at the time of this trial. Subsequently, the United States of America was made party defendant and at the time this case went to trial, Ellis Campbell, Jr., District Director of Internal Revenue, S. W. Taylor, Collection Officer, the First National Bank of Arlington, Texas, and the United States of America were defendants.

[Surety Not the Owner of Funds]

It is the contention of plaintiff:

(a) The funds on deposit in the First National Bank, Arlington , Texas , in the Armories Construction Account is the property of plaintiff.

(b) That in the event the account is held to be the property of taxpayers the assignment which surety holds as a part of the application for performance and bills payment bonds is prior to the lien of the government for withholding, social security, and unemployment taxes, and

(c) The claims of Commercial Standard Insurance Company are prior to the government's claim for taxes by virtue of the equitable doctrine of subrogation.

The government claims that the bank account in question is owned by taxpayers; that the government's claim for withholding, social security, and unemployment taxes is superior to the assignment or any lien held by the surety company; that the monies in the account are not covered by the assignment between the taxpayers and surety company; and that Commercial Standard Insurance Company is liable for the withholding, social security, and unemployment taxes as an employer within the meaning of the Internal Revenue Code, Chapter 24.

Defendant First National Bank of Arlington , Texas , claims that it is merely a stakeholder and is entitled to attorney's fees in the sum of $500.00. This amount is stipulated by the parties to be reasonable, if due.

At the pre-trial conference it was determined that the contested issues of law are:

1. Whether the Armories Construction Account was the property of the taxpayer or of the surety.

2. Determination of priority as between Commercial Standard Insurance Company's assignment and the government liens.

3. Whether Commercial Standard Insurance Company is an employer within the meaning of the Internal Revenue Code of 1954, Section 3401(d)(1).

4. Whether the First National Bank of Arlington , Texas , defendant, is entitled to allowance of reasonable attorneys' fees.

[Government's Lien Superior ]

The Court is of the opinion that the bank account in question is the property of contractor as taxpayer; hence the Government's lien for unpaid taxes attached to it. Investment and Securities Co. v. United States , 140 Fed. (2d) 894 [44-1 USTC ¶9210], (which was cited in Glass City Bank v. United States, 326 U. S. 265, 269 [45-2 USTC ¶9449]); Citizens State Bank of Barstow, Texas v. Vidal Collector, 114 Fed. (2d) 380 [40-2 USTC ¶9603].

This leads to the consideration of the priority of the Government tax lien and the assignment to surety. That assignment having been made to become effective on the date of the application for bond, on the happening of a future contingency created merely a lien and did not establish the surety as a purchaser within the meaning of the Internal Revenue Code. Street v. Pacific Indemnity Co., 61 Fed. (2d) 106; and since it governed funds to become due in the future is equitable. Hess and Skinner Engineering Co. v. Turney Co., 110 Tex. 148, 216 S. W. 621. As such, the assignment was inchoate and unperfected (at the time the Government's lien arose) under the tests laid down in the following decisions: United States v. Waddill (1945) 323 U. S. 353 [45-1 USTC ¶9126]; United States v. Security Trust and Savings Bank (1950) 340 U. S. 47 [50-2 USTC ¶9492]; United States v. Acri (1955) 348 U. S. 211 [55-1 USTC ¶9138]; United States v. Liverpool and Globe Insurance Company (1955) 348 U. S. 215 [55-1 USTC ¶9136]; United States v. Colotta (1955) 350 U. S. 808 [55-2 USTC ¶9680], reversing 79 S. (2d) 474 [55-2 USTC ¶9584]; United States v. White Bear Brewing Company (1956) 350 U. S. 1010 [56-1 USTC ¶9440], reversing 227 Fed. (2d) 359 [55-2 USTC ¶9776].

Since only a choate and perfected lien can be given priority over a lien for unpaid federal taxes, it must necessarily be concluded that the question of priority should be resolved in favor of the Government.

Nor am I convinced that the surety's lien ever attached to the bank account. This lien attached merely to the proceeds of the contract and in no manner attached to borrowed money nor to a bank account. Funds were so intermingled in the accounts that it is impossible to say that the funds in the bank at the time the tax lien arose were proceeds of the contract.

[Subrogation]

The surety cannot prevail under the doctrine of subrogation. To do so, a surety is required to show that some laborer or materialman whose claim it has paid, had a lien superior to the Government's tax lien. This being a public works contract, such laborer or materialman must have perfected a lien under Article 5160 or 7345(a) of the Revised Civil Statutes of Texas. Surety, in its brief, states that a lien was filed under Article 5160. However, this Statute does not create a lien on the proceeds on the contract but merely gives the claimant the right to proceed against the surety. Republic National Bank and Trust Company v. Massachusetts Bank and Insurance Company (C. A. 5-1934) 68 Fed. (2d) 445.

This case is distinguishable from such case as Glenn v. American Surety Company cited by plaintiff in its brief. The Glenn case involved retained percentages to which the contractor had no right until all laborers and materialman claims had been paid.

[Surety as Employer]

Having determined that the bank account in question is the property of the contractor, it is unnecessary to decide the Government's contention that plaintiff surety is an employer within the meaning of the Internal Revenue Code of 1954, Section 3401(d)(1), Chapter 24. However, is furety's contention that this account is not contractor's (taxpayer) property be correct, then surety's contention that it was not an employer under the Internal Revenue Code is untenable, because surety could only become entitled to the contract proceeds and proceeds of contractor's notes in such account (certainly the portion withheld from contractor's employees' wages) in the right, stead and legal position of contractor who was an employer.

The defendant, First National Bank of Arlington , Texas , is a mere stakeholder and is entitled to be paid its attorney's fee in the sum of $500.00 out of the funds in this account. United States v. Ullman, 115 Fed. Supp. 211 [53-2 USTC ¶9648]; Mutual Life Ins. Co. of New York v. Bondurant, 27 Fed. (2d) 464, 278 U. S. 630, 49 S. Ct. 30, 73 L. Ed. 548; McNamara v. Provident Sav. Life Assur. Soc. of New York , 114 Fed. 910.

Counsel for the Government will submit a decree in accordance with this opinion, after having same approved as to form by counsel for the other parties.

 

 

[56-2 USTC ¶9659] United States of America , Appellant and Cross-Appellee v. Phoenix Indemnity Company and The Century Indemnity Company, Appellees and Cross-Appellants

(CA-4), U. S. Court of Appeals, 4th Circuit, No. 7134, 231 F2d 573, 4/9/56, Modifying District Court, 56-1 USTC ¶9237

[1939 Code Sec. 3672--similar to 1954 Code Sec. 6323]

Lien for taxes: Liability of surety for defaulting contractor.--Sureties on a performance and payment bond executed by taxpayer lumber company as principal are liable, not only for unemployment taxes and social security taxes due from the taxpayer as employer, but also for income tax withholding taxes and the withheld employees' portion of the FICA taxes.

S. Dee Hanson, Department of Justice (Charles K. Rice, Acting Assistant Attorney General, Lee A. Jackson, A. F. Prescott, Fred E. Youngman, Department of Justice, Edwin M. Stanley, United States Attorney, Rob ert L. Gavin, Assistant United States Attorney, on brief), for appellant and cross-appellee. Claude C. Pierce (Kenneth M. Brim, Brooks, McLendon, Brim & Holderness, on brief), for appellees and cross-appellants.

Before PARKER, Chief Judge, and SOPER and DOBIE, Circuit Judges.

[Proceeding Against Surety]

SOPER, Circuit Judge:

This suit was brought by the United States against Phoenix Indemnity Company and The Century Indemnity Company, co-sureties on a performance and payment bond of January 16, 1952 which was executed by Crystal Lumber Co., Inc. as principal, in connection with a construction contract of even date between it and the Housing Authority of the City of Fayetteville, North Carolina, for the construction of a low cost housing project. The purpose of the suit is to recover certain sums assessed against the Crystal Lumber Co. for unemployment taxes, withholding taxes and Social Security taxes which accrued during the progress of the work.

The Government claimed that the sureties are liable for the payment of these taxes by reason of provisions of the construction contract and of the performance and payment bond. The construction contract provided that Crystal Lumber Company, as contractor, should "provide and pay for all materials, labor, * * * taxes legally collectible because of the work and all other services and facilities of every nature whatsoever necessary to execute the work under the contract." * * * The condition of the performance and payment bond was that if the principal should "well and truly perform and fulfill all the undertakings, covenants, terms, conditions and agreements of the construction contract; * * *" and if the principal should "promptly make payment to all persons supplying labor and materials in the prosecution of the work, * * *", then the obligation should be void and of no effect, otherwise to remain in full force and virtue. The obligors in the bond were the Crystal Lumber Company, as principal, and the surety companies as surety, and the obligee in the bond was the Housing Authority of the City of Fayetteville, North Carolina. The penalty of the bond was $1,214,000.

[Sureties Were Liable]

On or about January 29, 1952 the Crystal Lumber Co. began the construction of the project and continued therein until March 11, 1953 when it executed a contract with the Housing Authority and the two sureties, acknowledging that it was in default, and the surety companies agreed to undertake the performance of the contract. During the intervening period the taxpayer was the employer of divers individuals on the work and as the result thereof the Commissioner of Internal Revenue made certain assessments against it representing taxes, penalty and interest due under certain federal taxing statutes. These assessments include the sum of $1,239.01 for federal unemployment taxes for the calendar year 1952; and $1,774.88 for the employer's portion of the Federal Insurance Contributions Act taxes for the last two quarters of 1952 and the first quarter of 1953. The judge found that the sureties were liable to the United States for the aggregate amount of these taxes in the sum of $3,013.89. In addition to these taxes the Commissioner assessed against the employer the aggregate sum of $14,287.51 for withholding taxes and the employees' portion of the Federal Insurance Contributions Act taxes for the same periods. The judge held that the surety companies were not liable for the taxes composing this assessment. Both parties have appealed. We are of opinion that the sureties were liable under the bond for all of the taxes mentioned and that the judgment of the District Court must accordingly be modified.

Our conclusion is based upon the provisions of the bond under which the sureties guaranteed the performance of all covenants and agreements undertaken by Crystal Lumber Co. in the contract, and these included the agreement to pay all the taxes collectible because of the work, a provision plainly broad enough to cover not only the taxes payable by the employer, such as unemployment taxes and the employer's portion of the Federal Insurance Contributions taxes, but also the withholding taxes which are credited on the income taxes due by the employees and the employees' portion of the Federal Insurance Contributions taxes. It is to be noted that the contract was referred to in the bond and hence the contract may properly be regarded as a part of the sureties' undertaking and may be considered in its interpretation. Mass. Bonding & Ins. Co. v. Feutz, 8 Cir., 182 Fed. (2d) 752, 757: It is true that the United States was not a party to the contract or the bond, but the bond was made for the Government's protection and it is entitled to sue thereon as a third party beneficiary. United States v. Scott, 8 Cir., 167 Fed. (2d) 301 [48-1 USTC ¶9193]; American Equitable Assurance Co. v. Helvering, 2 Cir., 68 Fed. (2d) 46 [1933 CCH ¶9613]; Voorhees v. Porter, 134 N. C. 591, 602.

This conclusion is not at variance with our decision in United States v. Crosland Construction Co., 4 Cir., 217 Fed. (2d) 275 [55-1 USTC ¶9112], and the line of cases therein discussed. In each of these cases suit was brought on a surety bond given by a contractor to ensure the performance of the contract work; and the condition of the bond related to the obligation of the contractor to make payment to persons supplying labor and material to the work and did not refer to the obligation of the contractor to pay taxes due the Government. It was held that if the employer-contractor withheld from the wages of his employees taxes due by them to the Government and paid the employees the balance of their wages, his contractual obligation so far as wages were concerned was discharged and that the sums withheld by him were not wages within the terms of the bond, but taxes due by the employer to the Government, and that the surety was not liable on the bond for the failure of the employer to pay the sums withheld to the United States. It is plain that these decisions are not controlling in the present instance, for the bond in this suit covered not only the obligation of the employer to pay the wages earned by his employees but also to pay the taxes collectible because of the work; and there can be no doubt that the sums of money sued for were either taxes payable directly by the employer to the United States, or monies withheld by him from the wages of his employees under the federal tax statutes which had become taxes due the Government in his hands under the cited cases.

The judgment of the District Court [56-1 USTC ¶9237] will be modified to conform to this opinion.

 

 

[58-1 USTC ¶9206]Tri-State Insurance Company, a corporation, Plaintiff v. Joint Independent School District No. 5, Delaware County, Oklahoma, W. W. Patrick and Max H. Smith, d.b.a. Patrick and Smith Construction Company, Broken Arrow, Oklahoma, Defendants. United States of America , Intervenor

U. S. District Court, No. Dist. Okla., No. 4106-C, 1/7/58

[1954 Code Sec. 6323--similar to 1939 Code Sec. 3672]

Lien for taxes: United States as intervenor: Surety's right of recovery.--Taxpayer, a construction company, entered into a contract with a school district to construct a grade school, executing a performance and payment bond with an insurance company. The taxpayer defaulted in the performance of its contract, and the insurance company completed the contract, paying bills for labor and materials in the amount of about $17,000, of which about $15,000 was paid after the United States has made its levy of about $11,000 in taxes. The school district retained approximately the amount of the tax pending determination by the court of the proper payee. In a suit by the insurance company against the school district and the taxpayer, in which the United States intervened, the court held that the entire amount retained by the school district school be paid to the insurance company, and that the funds should be released from the tax lien of the United States.

Looney, Watts, Looney, Hamill and Nichols, E. H. Matthews, First National Building, Oklahoma City 2, Okla., for plaintiff. B. Hayden Crawford, United States Attorney, Hubert Marlow, Assistant United States Attorney, Tulsa, Okla., Dean E. McCormick, Department of Justice, Washington, D. C., for defendants.

Findings of Fact and Conclusions of Law

SAVAGE, District Judge:

This cause having been tried to the Court on September 3, 1957 from the issues as between the plaintiff and the intervenor, United States of America; the parties appearing by their respective counsel of record; and the Court, having heard the evidence and argument of counsel, and having considered Briefs filed on behalf of the plaintiff and intervenor, on December 30, 1957, made Findings of Fact and Conclusions of Law as follows:

Findings of Fact

1) This action involves the right to funds held by the defendant, Joint Independent School District No. 5, Delaware County, Oklahoma, hereafter called "SCHOOL DISTRICT", and claimed by the intervenor, United States of America, under a tax lien; and also claimed that by the plaintiff under equity of subrogation and under Assignment, as hereafter set forth.

2) On August 15, 1955 , the defendant, SCHOOL DISTRICT , entered into a construction contract with the defendant, Patrick and Smith Construction Company, a copartnership, described as follows:

Construction and completion of Oaks Grade School , Oaks, Oklahoma Project No. Okla. 54-C-430-AA, Oaks Grade School in Delaware County , Oklahoma .

3) On August 17, 1955, the plaintiff, as surety for Patrick and Smith Construction Company, executed a Performance and Payment Bond conditioned that the principal would faithfully perform the above contract, and a Statutory Payment Bond, conditioned that the principal would pay all indebtedness for labor or material furnished in the construction of the above contract, which bonds were executed by plaintiff under and pursuant to a written Bond Application and Indemnity Agreement executed by the defendant, Patrick and Smith Construction Company, under the terms of which, Patrick and Smith Construction Company assigned to plaintiff all monies due or to become due from the SCHOOL DISTRICT at the time of any breach or default by the Patrick and Smith Construction Company, as security to plaintiff for liability, loss, cost, damage, expense or attorney's fees sustained by plaintiff in connection with the above-described Bond for Patrick and Smith Construction Company, which Assignment was duly filed for record by plaintiff with the County Clerk of Tulsa County, Oklahoma on February 1, 1956, in Book 2654, Page 127, and was served upon the defendant, SCHOOL DISTRICT.

4) On February 1, 1956, the defendant, Patrick and Smith Construction Company, defaulted in the performance of its contract with the SCHOOL DISTRICT; and, pursuant to demand by the SCHOOL DISTRICT, the plaintiff, as surety for Patrick and Smith Construction Company, proceeded to complete the above contract and -- bills for labor and materials, in a total sum of Seventeen Thousand, Four Hundred Fifty-Two Dollars and Sixty-six Cents ($17,452.66).

5) On February 1, 1956, the defendant, Patrick and Smith Construction Company, in recognition of its default under the terms of the above contract and Bonds, executed and delivered to plaintiff a further Assignment of all funds due, or to become due, from the SCHOOL DISTRICT under and pursuant to the above contract.

6) Under the contract between Patrick & Smith Construction Company and the SCHOOL DISTRICT, the contractor was required to pay all bills for labor and materials; and, in the event of failure of the contractor to do so, the SCHOOL DISTRICT had the right to declare the contractor in default and pay such bills out of the contract price as due under the contract at time of default.

7) All funds paid by the plaintiff, in completion of the above contract, and in payment of labor and material bills were paid under compulsion of the obligation of surety bonds signed by plaintiff, and pursuant to demands by the SCHOOL DISTRICT , as obligee upon such Bonds.

[Tax Lien]

8) On February 28, 1956, the intervenor, United States of America, served upon the defendant, SCHOOL DISTRICT, a levy for taxes incurred by the defendant, Patrick and Smith Construction Company, and due to the United States of America in the sum of Eleven Thousand, Six Hundred Twenty-Six Dollars and Forty-Two Cents ($11,626.42), under which, the United States of America claims a tax lien upon funds held by the SCHOOL DISTRICT.

9) The SCHOOL DISTRICT holds the sum of Eleven Thousand, Four Hundred Sixty-Five Dollars and Forty-Two Cents ($11,465.42), as the balance of the contract price under the above contract.

[Surety's Right to Retained Portion of Contract Price]

10) Prior to levy of the Government's tax lien, the plaintiff paid labor bills in the sum of Twenty-Eight Hundred Thirteen Dollars and Eighty-Six Cents ($2,813.86). After levy of the Government's tax lien, the plaintiff paid labor and material bills in a total sum of Fifteen Thousand, Thirty-One Dollars and Forty-Eight Cents ($15,031.48), and paid cost of completion of the defaulted contract in the sum of Fourteen Hundred Thirty-Two Dollars and Sixty-Five Cents ($1,432.65); and, by reason of such payments, all made under compulsion of its Bond, plaintiff claims the funds held by the SCHOOL DISTRICT.

Conclusions of Law

1) This action is within the jurisdiction of this Court, pursuant to 28 USCA 2401-2414.

2) The Complaint in Intervention of the United States of America , and the tax lien therein claimed should be denied; and the claim of plaintiff to the funds held by the defendant, SCHOOL DISTRICT , should be confirmed upon the following grounds:

(a) The Government's tax lien, as fixed upon the rights and interest of Patrick and Smith Construction Company, the taxpayer, are limited to the taxpayer's right of recovery against the SCHOOL DISTRICT; and, since the taxpayer had defaulted in performance of its contract, with the SCHOOL DISTRICT by failure to pay labor and material bills and complete the contract, in amounts exceeding the balance of the contract price, neither the taxpayer, nor the Government, claiming through the taxpayer, would have a right of recovery against the SCHOOL DISTRICT, after default of the taxpayer. The plaintiff, as surety for Patrick and Smith Construction Company, having performed the obligations of the principal upon its Bonds, pursuant to demand by the SCHOOL BOARD, as obligee upon the Bonds, became subrogated to the rights of the obligee to apply the balance of the contract price in payment of the cost of completion of the defaulted contract, and in payment of labor and materials bills incurred in performance of the contract prior to default, such unpaid bills being further default under the terms of the Statutory Payment Bond involved herein.

(b) By reason of plaintiff's Assignment, duly filed for record under the law of Oklahoma , and served upon the obligee, SCHOOL DISTRICT , prior to the effective date of the Government's tax lien, plaintiff is entitled to such Assignment to possession of the funds covered thereby, as against the subsequent tax claim of the Government.

3) Plaintiff is entitled to Judgment herein against the defendant, SCHOOL DISTRICT, in the sum of Eleven Thousand, Four Hundred Sixty-Five Dollars and Forty-Two Cents ($11,465.42), and further Judgment releasing such funds from the tax lien of the intervenor, United States of America .

 

 

[47-2 USTC ¶9327]United States Fidelity and Guaranty Company, Respondent, v. Triborough Bridge Authority et al., Respondents United States of America, Intervener, Appellant

New York Court of Appeals, 74 NE2d 226, Decided July 2, 1947

Appeal from a judgment of the Appellate Division of the Supreme Court in the first judicial department, entered April 23, 1946, affirming, by a divided court, a judgment of the Supreme Court in favor of plaintiff, entered in New York County upon a decision of the court on a trial at Special Term (KOCH, J.).

Lien for taxes: Validity against surety of taxpayer.--Lien of taxpayer's surety, which arose in 1940 upon execution of a surety bond conditioned upon taxpayer's payment of all bills for labor and materials (subsequently defaulted) is superior to the Government's lien for taxes, which arose in 1942. Affirming the decision of the Appellate Division of the Supreme Court of New York, which affirmed the decision of the Supreme Court of New York, 44-1 USTC ¶9283.

John F. X. McGohey, United States Attorney, Southern District of New York (John B. Creegan of counsel), for appellant. William B. Shelton and John J. O'Connor for plaintiff-respondent.

[Nature of the Action]

FULD, J.:

This suit involves a controversy between the surety, United States Fidelity and Guaranty Company, as plaintiff--which became responsible, under a bond, for defaults in the debts of a contractor--and the Government of the United States as intervener--which seeks taxes owed by the contractor.

[The Facts]

The facts are not disputed. On July 10, 1940, defendant Triborough Bridge Authority entered into a contract with Petracca & Banko, Inc., for the construction of grade separations on the Hutchinson River Parkway Extension, for a contract price of $687,694.50. The contract required the contractor to furnish a surety bond in a specified form and further provided, in effect, that, if the contractor failed to pay all bills for labor and materials furnished in the performance of the contract, defendant Authority should have the right to withhold out of any payments due the contractor such sums as might be necessary to insure satisfaction of such unpaid bills.

On the same day--July 10, 1940--the contractor, as principal, and plaintiff, as surety, executed a bond in the form required by the contract. This bond was conditioned upon faithful performance of the contract and upon payment of all claims for labor and materials furnished.

On December 6, 1941, the completed work was accepted by defendant Authority which then held $108,904, representing the final payment due under the contract. At that time, the contractor was in default as to debts totaling $55,611.61--due and owing to subcontractors for labor and materials furnished. The corresponding payment provision of the bond therefore became operative, and, accordingly, upon demand by the unpaid subcontractors, plaintiff satisfied those debts in full in July and August, 1942. In the meantime, however, in May of 1942, the United States Commissioner of Internal Revenue assessed income taxes against the contractor for the years 1939, 1940 and 1941, aggregating $174,946.67, and immediately thereafter demanded payment. No part of the tax having been paid, a notice of lien was filed in June, 1942.

Plaintiff sued to impress an equitable lien--to the extent of its payments to the subcontractors--upon the fund in the hands of defendant Authority. The United States intervened, asserting its tax lien against the entire fund and asking for judgment declaring its lien superior to plaintiff's and awarding it the entire fund. The trial court, however, decided in plaintiff's favor; it held the surety's lien superior, impressed an equitable lien upon the fund in its favor and directed payment to it in the sum to $55,611.60, plus interest. It declined, though, to dispose of the balance of the fund, upon the ground that all of the necessary parties were not before the court. The Appellate Division--one justice dissenting and opining that intervener should have been allowed the balance--affirmed.

[Opinion]

The conclusion of the courts below--that the surety's rights are prior to those of the intervener--is in accord with settled law. (See e.g., Scarsdale Nat. Bank & Trust Co. v. United States Fidelity & Guar. Co., 264 N. Y. 159; Prairie State Bank v. United States, 164 U. S. 227; American Surety Co. v. Sampsell, 327 U. S. 269.) Plaintiff succeeded--under principles of subrogation--to all rights which defendant Authority might have against the contractor, including that of withholding money due the contractor and of applying it to the payment of unsatisfied claims for labor and materials furnished. As this court (per CRANE, J.), clearly demonstrated in the Scarsdale case (supra) the equity in the surety's favor arose at the time it gave its bond, although the right became available and enforcible when it carried out the contract's provisions; it was there said (264 N. Y., at p. 164): "However, we are here dealing with the contract which contained the right to retain earned moneys and apply them on the cost of any completed work. To all rights under this contract the bonding company was subrogated. The equity in favor of the surety company arose at the time of the giving of its bond. The right became available when the surety company completed that work at a loss. (Prairie State Bank v. United States, 164 U. S. 227, at pp. 232, 237, 240.) The equitable lien arose at the time of the execution of the bond and was thus superior to the assignment. (Exchange State Bank v. Federal Surety Co., 28 Fed. Rep. [2d] 485, 488.) This is the reasoning the the rule adopted by the weight of authority. [Cases cited.]" (Italics in original.) In the present case--applying the rule thus announced--plaintiff's lien, created in July of 1940, when the bond was executed, was prior and superior to intervener's lien which did not come into being until 1942.

The Supreme Court's recent decision in United States v. Munsey Trust Co. (332 U. S. 234, 67 S. Ct. 1599, 15 U. S. Law Week 4698, decided June 23, 1947 ), neither reaches nor points a contrary result. There, the Government, itself in possession of the fund, asserted a claim of its own by way of setoff and, to the extent of that setoff, the find upon which the surety's lien could operate was necessarily reduced. Quite different is such a case from one like the present--as the Supreme Court observed--where "the owner [defendant Authority herein] was a mere stakeholder and had no rights of its own to assert." (United States v. Munsey Trust Co., supra.)

The attempt to distinguish between the bond in the Scarsdale case (supra) and in the Prairie State Bank case (supra)--a completion bond--and the one here involved--a bond to pay labor and material claims--is without basis. A failure by the contractor to pay for labor and material was just as much a failure to perform and carry out the terms of the contract as an abandonment of the work would have been. The Authority had the right to remedy that failure and to apply any moneys in its hands to that end before paying other claimants. In either case, the bond was given to assure performance of the contract, to assure against defaults of its provisions. Intervener's argument that plaintiff's bond ran, not to the Authority, but solely to the subcontractors, not only is counter to the language employed in the bond but has been expressly repudiated and rejected by this court. (Johnson Service Co. v. Monin, Inc., 253 N. Y. 417, 420-421; Fosmire v. National Surety Co., 229 N. Y. 44, 48-49; see, also, Municipal Housing Authority v. Hatfield Elec. Corp., 264 App. Div. 99; Century Cement Mfg. Co., Inc., v. Fiore, 264 App. Div. 475; Maryland Casualty Co. v. United States, 53 Fed. Supp. 436 [44-1 USTC ¶9133].)

In addition, it is, of course, settled that intervener's rights to the moneys held by defendant Authority can be no greater than those which its taxpayer--the contractor--had. (Karno-Smith Co. v. Maloney, 112 Fed. (2d) 690, 692 [40-2 USTC ¶9533]; Internal Revenue Code, §3670; U. S. Code, tit. 26, §3670.) Here the contractor's rights to the fund were clearly subordinate to the right of defendant Authority--and, by subrogation, of plaintiff--to withhold and apply those moneys to the payment of unsatisfied claims for labor and materials. So long as such claims were outstanding and unpaid and so long as defendant Authority had the right to withhold and apply, the contractor had no rights to the fund, and consequently, had no property interest therein upon which intervener could place a lien.

Intervener's contention that the judgment improperly allowed interest to plaintiff, is without merit. There was here no dispute as to the actual payments made by plaintiff; its loss being susceptible of exact computation, interest was properly allowed from the dates of those payments. (See Faber v. City of New York , 222 N. Y. 255, 262; Flamm v. Noble, 296 N. Y. 262.)

Since disposition of the money remaining--after payment to plaintiff--has not finally been determined by the courts below, that matter may not now be considered by us.

[Conclusion]

The judgment should be affirmed, with costs.

LOUGHRAN, Ch. J., LEWIS, CONWAY , DES MOND and DYE, JJ., concur; THACHER, J., taking no part.

Judgment affirmed.

 

 

[57-1 USTC ¶9264]The Steelcraft Manufacturing Co., Plaintiff v. Orville J. Hewkin, Jr., d.b.a. Hewkin Construction Company, et al., Defendants, and United States of America, Intervenor

U. S. District Court, East. Dist. Ill., Civ. Action No. 1355-D, 148 FSupp 872, 11/15/56

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

Tax lien: Priority of claims: Contract assignee and materialmen v. government tax lien.--A steel manufacturing company deposited a sum in an interpleader suit between the government, certain materialmen and a contract assignee of the delinquent taxpayer, and asked that it be relieved from further liability on its payment bond. It had contracted to erect steel bins for a party; subletting the actual construction to the taxpayer, who immediately assigned his rights under the second contract to a bank to induce it to advance him funds. Upon completion of the contract, the taxpayer filed bankruptcy. The Court held that as the assignment to the bank was executed prior to the assessment of the unpaid taxes, it was superior to the government's lien. Upon finding that the materialmen had complied with the provisions of the Miller Act, 40 U. S. C. A. 270b(b) as to notice and the period in which claims were to be filed, the Court held that their claims were also superior to that of the government in that, as the manufacturing company was primarily liable on its payment bond for the unpaid material bills, it had a definite ownership in the funds due the taxpayer until the completion of the contract. The materialmen were thus third-party beneficiaries of the funds in the hands of the manufacturing company due the taxpayer. Since the taxpayer was not entitled to receive payment until the completion of the contract, the government lien never attached to this fund in that its rights could not rise higher than those of the taxpayer. Under the Miller Act, it was not necessary for the materialmen to reduce their claims to judgment. Being an assignee of the taxpayer, the bank stood in his shoes, and its claim was subordinate to those of the materialmen.

Paxton & Seasongood, by R. J. Katz, 1616 Union Central Bldg., Cincinnati, Ohio, and Steely, Norwood & Hegeler, 908 First National Bank Bldg., Danville, Ill., for plaintiff. Joseph H. Hedge, 223 No. Neil St., Champaign, Ill., for Orville J. Hewkin, Jr. William F. Woods, Commercial Bank Bldg., Champaign, Ill., for Thomas A. Hagan, Jr. John W. Schriber, 110 So. Race St., Urbana, Ill., for Hunter Lumber Co. Mitchem & Hendrix, 206 West Elm St., Urbana, Ill., for Champaign County Bank & Trust Co. Roger D. Doten of Dent, Hampton & Doten, 209 So. LaSalle St. , Chicago , Ill. , for Fidelity & Deposit Co. of Maryland . Dwight H. Doss, Kaiser Bldg., Monticello , Ill. , for Jesse Whitehouse. W. C. Noel Law Offices, 105 West Main St. , Urbana , Ill. , for Joseph T. Clancy. Wise & Meyer, 1106 First National Bank Bldg., Danville, Ill., for Ellis Gravel Co. C. M. Raemer, United States Attorney, and Charles R. Young, Assistant United States Attorney, Post Office Bldg., Danville, Ill., for the United States.

Opinion

FLATT, District Judge:

Steelcraft Manufacturing Company, an Ohio Corporation, filed suit in the nature of an interpleader praying that it be discharged from further liability on its payment bond executed under a contract with the Commodity Credit Corporation for the erection of steel bins. It tendered the payment of $15,861.51 into court to be distributed as ordered by the court.

Steelcraft entered into this contract with Commodity Credit Corporation prior to August 10, 1954 and on this date subcontracted with Orville Hewkin for the erection of the bins. Hewkin was obligated to erect the bins, furnish all materials and supplies, except those furnished by Steelcraft and Commodity Credit Corporation. Also on August 10, 1954 , Hewkin "assigned all his right, title and interest" in his contract to the Champaign County Bank and Trust Company, of Urbana , Illinois , and directed Steelcraft to make all payments to him under said contract direct to the bank. The bank advanced at least $10,000, which is unpaid, to Hewkin on the security of the assignment. A copy of the assignment was served upon Steelcraft. Hewkin completed his contract and in April, 1955 was adjudged a bankrupt, Steelcraft withheld the $15,861.51, being the balance due under the contract with Hewkin upon being advised that in addition to the bank's assignment there were four unpaid materialmen, viz:

Joseph T. Clancy .........         $4,371.00

Ellis Gravel Company .....          1,616.75

Jessie Whitehouse ........          3,862.34

Hunter Lumber Company ....            140.46

The bank, the materialmen, the trustee in bankruptcy and the bankrupt, all citizens of Illinois , were made parties defendant. The materialmen have filed answer asserting priority over the bank's assignment. The United States of America intervened in the suit seeking to impress upon the sum withheld its tax liens for delinquent withholding taxes of Hewkin in the amount of $5,397.68 assessed December 2, 1954 for the third quarter of the year 1954, and $3,995.95 for the fourth quarter of the year 1954 assessed March 15, 1955. At the time of the assessments all of the materialmen involved here had delivered their materials, completed their work and presented their bills to Hewkin. Steelcraft kept an agent on the jobs at all times and was aware of the progress of the work and materials furnished.

Clancy and Ellis filed counterclaims against Steelcraft and third-party claims for relief against the Fireman's Fund and Indemnity Company, the surety on the payment bond executed by Steelcraft to the Commodity Credit Corporation. Whitehouse, in substance by his answer, also filed a counterclaim against Steelcraft. Only the counterclaim of Ellis was filed in the name of the United States of America in strict accordance with the Miller Act, 40 U. S. C. A. 270b(b). In substance all the materialmen's claims are based upon the Miller Act and at the trial of the cause were so construed and considered. Rule 15(b) F. R. C. P. See Glens Falls Indemnity Co. v. United States , 9 Cir., 229 Fed. (2d) 370.

The Miller Act is remedial and must be liberally construed to accomplish its purpose. Fleisher Co. v. United States , 311 U. S. 15. Ellis Gravel Company literally complied with the notice required under the Miller Act. Clancy gave notice to Steelcraft within 90 days through the Agricultural Stabilization and Conservation Division of the Department of Agriculture. Whitehouse delivered a copy of his unpaid bill to Orville Hewkin who in turn at his request delivered it to Steelcraft within the required 90 days of the date the material was furnished. Thus the latter two claimants stated accurately the amount claimed and to whom the material was furnished to Steelcraft. This court finds that all of the notices were intended to inform Steelcraft of the unpaid material claims of Hewkin and were sufficient notice to comply with the Miller Act. Fleisher Co. v. United States, supra; Houston Fire & Casualty Ins. Co. v. United States, 5 Cir., 217 Fed. (2d) 727.

All of the answers and claims of the materialmen were filed within one year of the final furnishing of materials which necessarily is within one year of the settlement between Steelcraft and Commodity Credit Corporation. The Hunter Lumber Company filed an answer but failed to appear and make proof of their claim at the trial, and their claim must be disallowed. Steelcraft deducted liquidated damages in accordance with the subcontract due to delayed completion by Hewkin which it paid to Commodity Credit Corporation, leaving a balance due on the contract in the amount of $15,861.51. Neither the government nor any of the defendants have questioned the amount of liquidated damages so paid by Steelcraft.

The government maintains that its tax liens are entitled to priority over the claims of the materialmen whose claims had not been reduced to judgment. A tax lien of the government was fully perfected at the time the assessments were made, 26 U. S. C. A. 6321 (formerly 3671). If the materialmen were opposing the tax liens on the basis of a statutory mechanic's or materialman's lien, the government would have priority. United States v. Kings County Iron Works, 2 Cir., 224 Fed. (2d) 232 [55-2 USTC ¶9536]. United States v. White Bear Brewing Co., 7 Cir., dissenting opinion, 227 Fed. (2d) 359 [55-2 USTC ¶9776], reversed 350 U. S. 1010 [56-1 USTC ¶9440]; Cf. United States v. Saidman, C. A. D. C., 231 Fed. (2d) 503 [56-1 USTC ¶9322]; United States v. Hawkins, 9 Cir., 228 Fed. (2d) 517 [56-1 USTC ¶9143].