Surety's Interest Page4

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The facts in the instant case present a different situation. Steelcraft was the principal on the payment bond executed to the Commodity Credit Corporation with Fireman's Fund Indemnity Company as surety, and is therefore liable for the unpaid material bills as principal upon this bond under the Miller Act. In United States Fidelity and Guaranty Co. v. United States , 10 Cir., 201 Fed. (2d) 118, 121 [53-1 USTC ¶9249], the court said:

"On the date of the execution of the subcontract, the prime contractor had a specific right of ownership in any funds accruing to the subcontractor from the performance of the subcontract. The right to withhold these funds upon default was superior to any other claim against the fund as the property of the subcontractor."

This specific right of ownership has even been held to extend to interest on the sums expended by a surety. Glenn v. American Surety Co., 6 Cir., 160 Fed. (2d) 977 [47-1 USTC ¶9220]. Steelcraft as the principal on the bond had a definite ownership in the amount due Hewkin for a specific amount at all times. Steelcraft retained the ownership of the funds to be paid to Hewkin until the contract was fully performed. This amount was determinable by deducting from the subcontract price the amount which Steelcraft had advanced to Hewkin from time to time as the work progressed. Since Steelcraft is liable under the Miller Act to the materialmen for their unpaid bills it was entitled to retain sufficient funds to reimburse itself, based upon its prior right of ownership which existed from the inception of the subcontract. United States Fidelity and Guaranty Co. v. United States, supra; Glenn v. American Surety Co., supra. See also General Casualty Co. of America v. United States, 5 Cir., 205 Fed. (2d) 753 [53-2 USTC ¶9483]; Karno-Smith Co. v. Maloney, 3 Cir., 112 Fed. (2d) 690 [40-2 USTC ¶9533]; In re Caswell Const. Co., Inc., N. D. N. Y., 13 Fed. (2d) 667 [1 USTC ¶189]; American Fidelity Co. v. Delaney, D. Vt., 114 Fed. Supp. 702 [53-2 USTC ¶9620]; Great American Indemnity Co. v. United States, W. D. La. , 120 Fed. Supp. 445 [54-2 USTC ¶9469]; New York Casualty Co. v. Zwerner, N. D. Ill., E. D., 58 Fed. Supp. 473 [45-1 USTC ¶9140].

The terms of the contract obligated Hewkin to "furnish all materials and supplies," thereby creating an implied condition of the subcontract that the materialmen would be paid. Houston Fire and Casualty Insurance Co. v. E. E. Cloer, 5 Cir., 217 Fed. (2d) 506; United States v. United States Fidelity and Guaranty Co., 2 Cir., 113 Fed. (2d) 888. The materialmen are thus third-party beneficiaries of Steelcraft's specific ownership in the amount due Hewkin derived by and from the date of the subcontract. The government's claim is based upon the failure of Hewkin to pay his taxes and he and his property alone are liable for their payment. See Central Bank v. United States, 345 U. S. 639 [53-1 USTC ¶9408]. Steelcraft is not liable for the payment of Hewkin's taxes to the government. United States v. Crosland Const. Co., 4 Cir., 217 Fed. (2d) 275 [55-1 USTC ¶9112]. See Great American Indemnity Co. v. United States , supra. Since Hewkin was not entitled to receive payment until be complied with his subcontract he had no right of ownership in the amount still due and the lien of the government never attached to this fund. The rights of the government rose no higher than those of the taxpayer whose right to the withheld sum never accrued. Great American Indemnity Co. v. United States, supra; F. H. McGraw & Co. v. Sherman Plastering Co., D. C. Conn., 60 Fed. Supp. 504, affirmed 2 Cir., F. H. McGraw & Co. v. Milcor Steel Co., 149 Fed. (2d) 301, cert. denied 326 U. S. 753. To hold otherwise would impose upon Steelcraft double liability, that is, to the government and the unpaid materialmen. This would be inequitable. See Karno-Smith Co. v. Maloney, 3 Cir., 112 Fed. (2d) 690 [40-2 USTC ¶9533].

The bank contends that its assignment is superior to the claim of the materialmen. Steelcraft acknowledged the assignment but it is obvious that Hewkin thereby intended to assign only his profit to be received under the subcontract. See Mueller v. Northwestern University, 195 Ill. 256. Furthermore, the bank could stand in no better position against Steelcraft than Hewkin, its assignee. Reeve v. Smith, 113 Ill. 47; Angelina County Lumber Co. v. Michigan Cent. R. Co., 252 Ill. App. 32.

The bank does have priority over the tax claim of the government. This is not disputed by the government. The assignment to the bank was executed long before the government's taxes were assessed. By virtue of 26 U. S. C. A. 6323 (formerly 3672) the bank is a purchaser to the extent of the amount it advanced to Hewkin as present consideration for the assignment. National Refining Co. v. United States , 8 Cir., 160 Fed. (2d) 951 [47-1 USTC ¶9221]. Cf. Scovil v. United States , 348 U. S. 218 [55-1 USTC ¶9137]; R. F. Ball Construction Co. v. Jacobs, W. D. Texas, 140 Fed. Supp. 60 [56-1 USTC ¶9514].

This court therefore concludes that Steelcraft is entitled to an order that it be discharged upon the payment of $15,361.51 into this court and the materialmen are entitled to be paid their claims. The balance remaining after the payment of these claims of the materialmen must be paid to the bank. Since this absorbs the entire fund withheld there is nothing to be paid to the government on withholding taxes.

Findings of fact, conclusions of law and final order may be submitted.

 

 

[55-1 USTC ¶9407]United States of America, for the use and benefit of F. J. Gregg and W. L. Budlong; R. Hugh Haynes, trading as Service Plumbing and Heating Company; W. A. Browne, trading as Cavalier Electric Company; R. Lee White, trading as Lee White Hardware Company, Plaintiff v. Seaboard Engineering Corporation and U. S. Casualty Company, a New York Corporation, Defendants

In the United States District Court for the Eastern District of Virginia, Newport News Division, Consolidated Civil No. 344, March 5, 1955

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

Collection of taxes: Liability of surety under Miller Act payment bond.--The government was not entitled to recover from the taxpayer, a surety under two payment bonds which it had executed pursuant to the so-called Miller Act and in connection with two federal construction contracts between its principal and the government, Federal income withholding taxes and Federal Insurance Contributions Act taxes which were unpaid and owing by its principal. Such taxes were not within the coverage of the Miller Act payment bonds since the bonds merely promised that taxpayer's principal would promptly pay all persons furnishing labor or materials for use in the performance of the construction contracts. The decision by CA-4 in U. S. v. Crosland Construction Co., Inc. et al., 217 Fed. (2d) 275, 55-1 USTC ¶9112, was followed. [Note: The District Court's prior memorandum opinion in this case (54-2 USTC ¶9605) reached a contrary decision, but since the same issue was on appeal to CA-4 in the Crosland case, the parties stipulated that entry of judgment should await the decision of CA-4 in Crosland and an order continuing the case was so entered. Accordingly, since the District Court entered judgment for the taxpayer in accordance with the Crosland case, its prior memorandum opinion is of no effect.]

John M. Hollis, Assistant United States Attorney, Norfolk , Va. , for United States . Richard Newman, Melson Building , Newport News , Va. , for plaintiff. Maurice B. Shapero, Bank of Commerce Building , Norfolk , Va. , and E. Sclater Montague , First National Bank Building , Newport News , Va. , for United States Casualty Corp. and Seaboard Engineering Corp.

Judgment Order

WILKIN, District Judge:

This cause was referred on February 10, 1953 , to Special Master Rob ert M. Saunders who, after taking testimony filed his report of April 1, 1954 .

It was found, among other things, by the Special Master that the United States Casualty Company (hereinafter sometimes called Casualty Company) was liable on two payment bonds that it had executed as surety in connection with two federal construction contracts between the Seaboard Engineering Corporation and the United States . These payment bonds were furnished in accordance with the Act of August 24, 1935 , c. 642, 49 Stat. 793, the so-called Miller Act, and the condition or promise of each bond was that Seaboard Engineering Corporation would promptly pay all persons furnishing labor or materials for use in the performance of these construction contracts.

In the proceedings before the Special Master the United States asserted claims against the Casualty Company on its two payment bonds for federal income withholding taxes and the employees' portion of Federal Insurance Contributions Act taxes assessed against and owed by Seaboard Engineering Corporation for the second quarter of 1952. These taxes arose out of the performance of the two federal construction contracts covered by the payment bonds.

The Special Master refused to allow the claims of the United States on the ground that these claims were not within the coverage of the payment bonds excepted by the Casualty Company. The United States filed an exception to this portion of the report of the Special Master. Oral argument was heard on this exception on July 21, 1954 , and briefs were thereafter submitted.

Thereafter, on September 3, 1954, the court rendered its Memo Opinion [54-2 USTC ¶9605] in which it expressed the view that the claims by the United States asserted in this proceeding were within the coverage of a Miller Act payment bond and in said memorandum of said date announced that in its opinion the United States was entitled to recover from the Casualty Company.

Inasmuch as similar issues to those asserted in this case were then in process of adjudication before the United States Circuit Court of Appeals, Fourth Circuit, in the matter of United States of America, Appellant v. Crosland Construction Company, Inc., Pacific Employers Insurance Company, and American Indemnity Company, Appellees, Case No. 6891 [55-1 USTC ¶9112], the following was stipulated by counsel for both the United States of America and counsel for Seaboard Engineering Corporation and U. S. Casualty Company, a New York corporation, and said stipulation was filed by Order of this Court among the papers in this cause in the following words and figures, to-wit:

"STIPULATION

"It is hereby agreed and stipulated by the undersigned attorneys for the United States and the United States Casualty Company that entry of judgment in the above-entitled cause shall not be made until after the decision of the Court of Appeals in United States v. Crosland Construction Company now pending on appeal. It is further stipulated that in event any judgment is entered for the United States it shall bear interest from September 3, 1954 ."

Simultaneously with the filing of the foregoing Stipulation, the Court entered an Order in the following words, to-wit:

"ORDER

"This day came the United States of America and U. S. Casualty Company, a New York Corporation, by counsel, and submitted at the bar of the court a STIPULATION IN WRITING, which is herewith ordered filed, and pursuant to said stipulation it is ORDERED that this proceeding be continued generally until the further Order of this Court."

Thereafter, on the 1st day of December, 1954, the United States Circuit Court of Appeals, Fourth Circuit, rendered its decision in United States of America, Appellant v. Crosland Construction Company, Inc., Pacific Employers Insurance Company, and American Indemnity Company, Appellees, 217 Fed. (2d) 275 [55-1 USTC ¶9112], holding: "Though measured by the amount of wages, the money due the United States was owing as taxes and not as wages. Such a claim is not covered by the bond in this case."

In accordance with the announced decisions of the Tenth Circuit, the Ninth Circuit, the Fifth Circuit and the Fourth Circuit, the Court reverses its memo opinion rendered on September 3, 1954 in this proceeding and concludes that the claims by the United States of America for federal income withholding taxes and the employees' portion of Federal Insurance Contributions Act taxes are not within the coverage of the Miller Act payment bond and, therefore, the United States is not entitled to recover in this proceeding.

Accordingly, it is further ORDERED that the report of the Special Master be approved and confirmed.

WHEREFORE, it is hereby ORDERED, ADJUDGED and DECREED that judgment be entered in favor of the defendant, U. S. Casualty Company, a New York corporation.

 

 

[54-1 USTC ¶9404] United States of America , Plaintiff v. Crosland Construction Company, Inc., Pacific Employers Insurance Company and American Indemnity Company, Defendants

In the United States District Court for the Eastern District of South Carolina, Columbia Division, C. A. 3580, 120 FSupp 792, April 30, 1954

Collection of taxes: Liens: Priority of surety's interest.--Sureties of taxpayer paid the sub-contractors whom taxpayer had not fully compensated. The court held that surety's liens thus arising on amounts due the taxpayer on the indemnified contract relate back to the date of the contract between the contractor and the hospital, as the surety has all the rights of his principal. Such lien was prior in time over the government's tax lien which was perfected after the contract had been performed.

Collection of taxes: Liens: Priority to assigned funds.--Sureties, holding an assignment from the taxpayer for amounts due to the taxpayer on a contract which sureties indemnified, have priority over the government's tax lien by reason of the assignment, which was delivered according to the provisions of the application for the contract bond.

Collection of taxes: Federal Priority Statute.--Taxpayer's sureties, who had paid off taxpayer's obligations to sub-contractors, are not subject to the Federal Priority Statute, R. S. 3466, as taxpayer must be in bankruptcy proceedings for that statute to apply. Here the taxpayer was insolvent but not in bankruptcy.

Collection of taxes: Liens: Liability of sureties.--Sureties were held not to have insured the collection of taxes owing by taxpayer, when they indemnified "wages" to be collected from taxpayer. Sums withheld from wages of employees of taxpayer do not constitute "wages" within the meaning of the surety contract.

N. Welch Morrisette, Jr. for plaintiff. Cooper, Gary , Whaley and McCutchen, Columbia , S. C., for defendants.

Opinion and Order

WYCHE, District Judge:

This action was instituted on February 24, 1953, by the United States of America for unpaid taxes due it by the defendant Crosland Construction Company, Inc. for income withholding taxes for the third and fourth quarter-year periods (periods ending September 30th and December 31st) of 1950, for all four quarter-year periods of 1951, for federal insurance contributions taxes for the third quarter-year period (period ending September 30th) of 1950, and for federal unemployment taxes for the years 1949, and 1950. The total amount of taxes claimed to be owing the Government by the taxpayer, including interest and penalties, is Thirty-Seven Thousand, Three Hundred Ninety and 41/100 ($37,390.41) Dollars. By its amended answer, the taxpayer denies any tax liability in excess of Thirty-Two Thousand, Three Hundred, Eighty-Two and 95/100 ($32.382.95) Dollars, including interest and penalties. The defendants Pacific Employers Insurance Company and American Indemnity Company are sureties on the taxpayer's performance bond issued pursuant to a construction contract between taxpayer and the Newberry County Memorial Hospital , Newberry , South Carolina . The construction contract was entered into June 10, 1949 , in the amount of Two Hundred, Twenty-Four Thousand, Seven Hundred One and no/100 ($224,701.00) Dollars. The taxpayer and the sureties entered into a performance bond bearing date of June 29, 1949 . The taxpayer's application for contract bond bears date of July 6, 1949 . Of the total taxes due the Government, only Two Thousand, Four Hundred Eighty-Four and 31/100 ($2,484.31) Dollars, arise from performance of the hospital contract; the remainder is from other construction contracts performed by the taxpayer during the same or at about the same time as the hospital contract.

It does not appear that the sureties were involved in any job other than the Newberry Hospital . The taxpayer answered the complaint and subsequently filed an amended answer which admits its liability for taxes in the amount of Thirty-Two Thousand, Three Hundred Eighty-Two and 95/100 ($32,382.95) Dollars, but denies liability for any amount in excess of that sum. Taxpayer further denies any liability on the part of the sureties for any taxpayer's unpaid taxes, on their performance bond or otherwise.

The sureties served notice of a motion for an order dismissing the complaint as to them on the ground that it failed to state a claim upon which relief could be granted. Subsequently, the Government moved for leave to amend its complaint, which motion was granted in an order of the court dated December 2, 1953 , with leave to the defendants to file amended answers, motions, or to otherwise plead to the complaint as amended. Thereafter the sureties amended their previous motion to dismiss by filing an amendment thereto.

The case is now before me upon the amended motion of the sureties to dismiss. Arguments were based on the pleadings and affidavits submitted by the parties. The affidavits having been made a part of the record and having been considered by the court, I stated that the motion to dismiss on behalf of the sureties would be treated as a motion for summary judgment under Rule 12(b); no objection was made thereto by any party and the motion will be so treated.

The Collector of Internal Revenue received the assessment lists for withholding taxes as follows:

                       Assessment             Notice

Period Ended           List Rec'd         and Demand

9-30-50
                  
12-14-50
           
12-27-50

12-31-50
                  
4-16-51
            
4-20-51

3-31-51
                   
5-17-51
             
6-6-51

6-30-51
                   
9-19-51
            
9-25-51

9-30-51
                    
1-3-52
             
1-3-52

12-31-51
                  
3-13-52
            
3-14-52

 

The Collector of Internal Revenue received the assessment list for federal insurance contributions taxes on December 14, 1950 , notice and demand for payment being made on December 27, 1950 .

The Collector of Internal Revenue received the assessment lists for federal unemployment taxes for 1949, on March 19, 1951 , and for 1950, on April 7 1952 .

The Government filed notices of tax liens for the unpaid taxes on July 20, 1951 (for $29,782.72) and January 9, 1952 , (for $8,501.65) in the offices of the Clerk of Court, Richland County , Columbia , South Carolina , and the Clerk of Court, United States District Court, Eastern District of South Carolina, Charleston , South Carolina .

On January 5, 1952, and long after construction on the hospital contract had been completed, the taxpayer executed a written assignment to the sureties of retained percentages or sums due taxpayer on the hospital contract, in consideration of the sureties' payment of certain outstanding claims of materialmen and sub-contractors against the taxpayer incurred in the performance of the hospital contract. These claims were paid by the sureties, which they were obligated to do under their bond, and they suffered losses thereby in excess of Three Thousand ($3,000.00) Dollars, over and above the amount of the retainage. All work had been completed on the Newberry Hospital before January 5, 1952 ; the sureties did not supervise any work or complete the same.

On January 10, 1952 , the Government served a levy on the Newberry County Memorial Hospital for payment of Forty Thousand, One Hundred Ninety-Eight and 63/100 ($40,198.63) Dollars, in taxes claimed due by taxpayer. The total amount then remaining unpaid under the construction contract was Twenty-Four Thousand, One Hundred, Eighty-Seven and 35/100 ($24,187.35) Dollars. This amount was paid to the sureties by the hospital on November 6, 1952 , by reason of the assignment of January 5, 1952 .

The Government claims it has a lien under Title 26 USCA Sections 3670, 3671, 3672 and related sections, on the Twenty-Four Thousand, One Hundred, Eighty-Seven and 35/100 ($24,187.35) Dollars, assigned to the sureties by taxpayer and paid to them by the hospital, superior to the written assignment or any lien or claim of the sureties to this sum. The Government also asserts that even without a prior and superior lien under the statutes, it is entitled to priority in payment over the sureties by reason of the so-called "priority" statute (Section 3466 R. S., 31 USCA Section 191). In addition, the Government claims the sureties are liable on their performance bond in the amount of Two Thousand, Four Hundred, Eighty-Four and 31/100 ($2,484.31) Dollars, for the taxes owed by taxpayer from performance of the hospital contract.

The Government has a lien on all property of the taxpayer by statute. 26 USCA 3670. The lien arose at the time the assessment lists were received by the Collector. 26 USCA 3671. The first assessment lists received by the Collector were those received on December 14, 1950 .

By paying the materialmen and sub-contractors on the hospital contract, upon the taxpayer's inability to pay, the sureties did what they were required to do under their performance bond. The assignment of January 5, 1952 , was executed and thereafter the sureties paid the materialmen and sub-contractors. But even without the assignment of January 5, 1952 , the sureties were required to satisfy the claims of these unpaid materialmen and sub-contractors under the terms of the performance bond.

Upon the sureties' performance under their bond obligation, they acquired an equitable lien against any sum remaining in the hands of the one for whose protection the bond was given. This lien relates back to the date of the contract and is superior to any lien arising thereafter. Prairie State Bank v. United States, 164 U. S. 227, 17 S. Ct. 142, 41 L. Ed. 412; Henningsen v. U. S. Fidelity & Guaranty Co., 208 U. S. 404, 28 S. Ct. 389, 52 L. Ed. 547; Town of River Junction v. Maryland Casualty Co., (C. A. 5) 110 Fed. (2d) 278, Cert. den. 60 S. Ct. 1077; Standard Acc. Ins. Co. v. Federal Nat. Bank, (C. A. 10) 112 Fed. (2d) 692, affirmed on rehearing, 115 Fed. (2d) 34; Exchange State Bank v. Federal Surety Co., (C. A. 8) 28 Fed. (2d) 485, 488; Claiborne Parish Sch. Bd. v. Fidelity & Deposit Co. of Maryland, (C. A. 5) 40 Fed. (2d) 577, 579; Maryland Casualty Co. v. Dulaney Lumber Co., (C. A. 5) 23 Fed. (2d) 378, 380; Fidelity & Deposit Co. v. Union State Bank, (D. C. Minn.) 21 Fed. (2d) 102, 104; In re Van Winkle, (D. C. Ky.) 49 Fed. Supp. 711; United States F. & Guaranty Co. v. John R. Alley & Co., (D. C. Okla.) 34 Fed. Supp. 604; Southern Surety Co. v. J. R. Holden Land & Lumber Co., (C. A. 8) 14 Fed. (2d) 411, 413; American Fidelity Co. v. Delaney, (D. C. Vt.) 114 Fed. Supp. 702. It is superior to the Government's lien for unpaid taxes. American Surety Co. v. City of Louisville M. H. Comn. (D. C. Ky. ) 63 Fed. Supp. 486, affirmed 160 Fed. (2d) 977 [47-1 USTC ¶9220]; Glenn v. American Surety Co., (C. A. 6) 160 Fed. (2d) 977 [47-1 USTC ¶9220]; United States Fidelity & Guaranty Co. v. United States, (C. A. 10) 201 Fed. (2d) 118 [53-1 USTC ¶9249]; New York Casualty Co. v. Zwerner, (D. C. Ill.) 58 Fed. Supp. 473 [45-1 USTC ¶9140]; American Fidelity Co. v. Delaney, (D. C. Vt.) 114 Fed. Supp. 702 [53-2 USTC ¶9620]. The performance bond was executed on June 29, 1949 ; therefore, the sureties' lien is superior to any lien arising thereafter, including the Government's lien for taxes which dates from December 14, 1950 .

In addition to an equitable lien, the sureties have a written assignment of any funds remaining in the possession of the hospital under the provisions of the application for contract bond. Such a provision is valid and enforceable. Lacy v. Maryland Casualty Co., (CA 4) 32 Fed. (2d) 48. Accordingly, the rights of the sureties to the funds remaining in the hands of the hospital were not determined solely by the assignment of January 5, 1952, but by bond and application therefor (in view of the sureties' performance under the bond) and by the sureties' equitable lien.

The Government's rights to the funds in the hands of the hospital are no greater than the rights of the taxpayer. F. H. McGraw & Co. v. Sherman Plastering Co., (D. C. Conn.) 60 Fed. Supp. 504, affirmed, 149 Fed. (2d) 301, cert. den. 326 U. S. 753, 66 S. Ct. 92, 90 L. Ed. 452; United States Fidelity & Guaranty Co. v. United States , (CA 10) 201 Fed. (2d) 118 [53-1 USTC ¶9249].

Upon performance under its bond, a surety is subrogated to the rights of the obligee to any funds remaining in possession of the latter which were retained under the contract with the principal. Farmer's Bank v. Hayes, (CA 6) 58 Fed. (2d) 34; Lacy v. Maryland Casualty Co., supra. See, Amer. Surety Co. v. Bethlehem Bank, 314 U. S. 314, 62 S. Ct. 226, 68 L. Ed. 214; In re Baltimore Pearl Hominy Co., (CA 4) 5 Fed. (2d) 553 [1 USTC ¶130].

The Government's claim of priority over the sureties to the funds retained by the hospital is based on Section 191, 31 USCA, which gives the United States priority in payment of funds of an insolvent under certain conditions. It is claimed that the taxpayer was without sufficient assets to meet its obligations and was therefore insolvent at the time of the assignment of January 5, 1952 . It is admitted by the taxpayer that it was without assets sufficient to meet its obligations sometime prior to this assignment. In that sense the taxpayer is and was insolvent. However, the taxpayer continued in business after this assignment and, in fact, still is in business. No claim is made that the taxpayer has been adjudged a bankrupt or that receivership or bankruptcy proceedings have been brought against it or that it has made a general assignment for the benefit of creditors.

The "priority" statute applies only to cases involving some type of insolvency court proceedings disposing of an insolvent's estate. Conard v. The Atlantic Insurance Co., 1 Pet. 386, 7 L. Ed. 189; United States v. Oklahoma, 261 U. S. 253, 43 S. Ct. 295, 67 L. Ed. 638; Bramwell v. U. S. Fidelity Co., 269 U. S. 483, 46 S. Ct. 176, 70 L. Ed. 368; Glenn v. American Surety Co., (C. A. 6) 160 Fed. (2d) 977 [47-1 USTC ¶9220]; Davis v. Pringle, (CA 4) 1 Fed. (2d) 860, affirmed 268 U. S. 315, 45 S. Ct. 549, 69 L. Ed. 974; Davis v. Miller-Link Lumber Co., (CA 5) 296 Fed. 649; United States v. The Pomare (D. C. Hawaii), 92 Fed. Supp. 185; American Surety Co. v. City of Louisville M. H. Comn., (D. C. Ky.) 63 Fed. Supp. 486, affirmed, 160 Fed. (2d) 977 [47-1 USTC ¶9220]; New York Casualty Co. v. Zwerner, (D. C. Ill.) 58 Fed. Supp. 473 [45-1 USTC ¶9140]; United States v. Woodside, (D. C. S. C.) 34 Fed. Supp. 281. See also, United States v. Hooe, 3 Cranch 73, 2 L. Ed. 375; Prince v. Bartlett, 8 Cranch (12 U. S.) 431, 434, 3 L. Ed. 614; Brent v. Bank of Washington, 10 Pet. 596, 611, 9 L. Ed. 547; Beaston v. The Farmers' Bank of Delaware , 12 Pet. 102, 132, 9 L. Ed. 1017; and In re Baltimore Pearl Hominy Co., (D. C. Md.) 294 Fed. 921 [1924 CCH ¶2861], reversed on other grounds, (CA 4) 5 Fed. (2d) 553 [1 USTC ¶130]. This is not a proceeding involving the disposition of an insolvent's estate; therefore, the "priority" statute has no application.

Whether the sureties are liable on their bond for the taxpayer's taxes resulting from performance of the hospital contract will now be determined. Taxes owed by the taxpayer are owed by virtue of law and not because of any contractual relationship. Central Bank v. United States, 345 U. S. 639, 73 S. Ct. 917, -- L. Ed. -- [53-1 USTC ¶9408]; United States Fidelity & Guaranty Co. v. United States, (CA 10) 201 Fed. (2d) 118 [53-1 USTC ¶9249]. See, American Fidelity Co. v. Delaney, (D. C. Vt.) 114 Fed. Supp. 702; New York Casualty Co. v. Zwerner, (D. C. Ill.) 58 Fed. Supp. 473 [45-1 USTC ¶9140]; Westover v. William Simpson Construction Co., (CA 9) 22 L. W. 2384 ( 1-28-54 ) [54-1 USTC ¶49,022].

Sums withheld by the taxpayer from the wages of its employees do not constitute "wages" within the terms of a surety's bond for wages. United States Fidelity & Guaranty Co. v. United States, supra; United States v. Zschach Const. Co., (D. C. Okla.) 110 Fed. Supp. 551 [53-2 USTC ¶9529] (holding that a surety's bond is to indemnify the owner and not the United States for taxes). The sums retained by the hospital and assigned by the taxpayer to the sureties were for payment of materialmen and sub-contractors and no part of this sum was used to pay wages of employees of the taxpayer. But even if the sureties had paid wages owing to the employees of the taxpayer, the sureties still would not be liable for the taxes in this case. See, United States Fidelity & Guaranty Co. v. United States , supra; American Fidelity Co. v. Delaney, supra; Westover v. William Simpson Construction Co., supra. It follows that the sureties are not liable on their bond for the taxpayer's unpaid taxes arising from the hospital contract.

Accordingly,

IT IS ORDERED, That the defendants Pacific Employers Insurance Company and American Indemnity Company, sureties, have judgment entered in their favor, and

IT IS SO ORDERED.

 

 

[56-2 USTC ¶10,076]Wayne C. Huddleston v. U. S. Air Conditioning Corporation et al. The United States of America for the use of R. F. Zimmerman & Co. v. The Travelers Indemnity Company et al.

U. S. District Court, So. Dist. Tex., Corpus Christi Div., C. A. 1271, 1312, 9/22/56

[1939 Code Secs. 3670, 3671--covered in 1954 Code Secs. 6321, 6322]

Assessment: Lien for taxes: Fund withheld by general contractor from subcontractor.--A general contractor withheld certain money due a subcontractor on an Air Force base construction job because the subcontractor had failed to pay materialmen. The money was deposited in the district court in connection with an interpleader action. The Government intervened, asserting tax liens against the deposited fund for taxes due by the subcontractor, and claimed that it had a prior specific and perfected lien against the fund since the lien related back to and attached on the dates the assessment lists were received by the District Director. The court refused to sustain the Government's position, pointing out that the statute provided for a lien against property belonging to the taxpayer. Here, the court found, the subcontractor had no property rights in the withheld money because, by agreement, the general contractor could not pay him until he had furnished proof of payment of materialmen. Specifically, the court held that at the time the assessment lists were received by the District Director, the subcontractor had no property or right to property in the hands of the general contractor, and no equity to which the tax lien could or did attach. The general contractor's right to apply the withheld funds toward the payment of materialmen was good even against the Government.

Gus Kowalski, Kingsville, Tex., Kleberg, Mobley, Lockett & Weil, Jones Building, Corpus Christi , Tex. , for plaintiff Huddleston. L. L. Gragg, Jones Building, Corpus Christi, Tex., for U. S. Air Conditioning Corporation. Carter, Stiernberg & Skaggs, Post Office Box 809, Harlingen, Tex., for R. F. Zimmerman & Co. Malcolm R. Wilkey, United States Attorney, Willard I. Boss, Assistant United States Attorney, Houston, Tex., for Intervenor, United States of America. Elmer H. Theis, Medical Professional Building, Corpus Christi, Tex., for East Texas Plumbing Supply Co. Lewright, Dyer, Sorrell & Redford, J. M. Burnett, Driscoll Building, Corpus Christi, Tex., for Travelers Indemnity Company. Ungerman, Hill & Ungerman, Wilson Building, Dallas, Tex., for Minneapolis-Honeywell Regulator Co. Lloyd & Lloyd, Alice, Tex., for Roger J. Seaman.

[Interpleader Action]

ALLRED, District Judge:

These consolidated actions primarily involve the rights of four claimants to $4,735 deposited in the registry of the court by Huddleston, in an interpleader action. The Government has intervened, asserting liens against the fund for taxes due by Leo Gist who was a subcontractor under Huddleston in the construction of a dental clinic building at Harlingen Air Force Base. As a result of pretrial hearings, detailed and difficult stipulations were worked out. The court is appreciative of the careful and painstaking efforts of all counsel in the case in entering into stipulations and avoiding a long and complicated trial.

Huddleston is the successor to Huddleston-Seaman Construction Company, which was the general contractor for construction of the building at Harlingen Air Force Base; as such, he is subject to all the liabilities and has all the rights of the original contractor. Therefore Huddleston's name will be used throughout this memorandum just as though he were the original contractor.

[Materialmen Not Paid by Subcontractor]

Gist, the subcontractor, completed his contract with Huddleston but did not pay for materials furnished by four suppliers as hereafter set out. Traveler's Indemnity was surety on Huddleston's bond given as provided in the Miller Act, 40 U. S. C. A. 270a et seq. The unpaid claims are as follows:

United States Air Conditioning Co. .....         $3,228.50

R. F. Zimmerman & Co. ..................          1,994.00

Minneapolis-Honeywell Regulator Co.

(balance) ..............................            190.00

East Texas Plumbing Co. ................            341.93

Total ..................................         $5,754.43

 

These unpaid claims total more than the amount tendered into court (4,735.00) to say nothing of the Government's tax claims totaling $9,916.96.

Huddleston completed the contract, the building was accepted and final settlement made May 3, 1954 . During the construction, the contractor received progress payments of 90%, as provided in the contract. Huddleston, in turn, made 90% payments to Gist from time to time. These payments totaled $20,908.65, the last payment ($4,441.34) being made February 28, 1954 . Prior to that time, Huddleston had learned from Gist's suppliers that he was not paying them promptly and had determined not to make further payments to him except upon proof that he had paid all of such suppliers. At the time of the last payment on February 28, 1954, after considerable discussion, it was agreed between Huddleston and Gist (1) that out of the $4,441.34 paid that day, Gist would pay Zimmerman's claim ($1,994.00); and (2) that no further payments would be made to Gist but the balance would be held by Huddleston till Gist furnished proof of payment of outstanding bills. Both of them understood that at the time that Huddleston would be liable under the Miller Act for supplies and labor owned by Gist and the agreement was made in order that Huddleston might protect himself against such claims.

[Prime Contractor Withheld Funds]

After the last payment on February 28, 1954 , a balance of $3,709.37 was due Gist under the contract. This amount was withheld by Huddleston. It would have been sufficient to pay all outstanding bills provided Gist paid the Zimmerman bill, as agreed, out of the $4,441.34 payment of February 28th. In March or April 1954, Huddleston learned that Gist had not paid Zimmerman. Therefore "Huddleston awarded to Gist contracts to do other work in Corpus Christi in an effort to give Gist opportunity to make a profit to be applied by Huddleston to reimbursement for the excess of (a) amounts paid and owed to Gist and his suppliers over (b) the contract price as to the dental clinic. Gist authorized such reimbursement at the time of the agreements to do such additional work."

As stated, Huddleston has paid $4,735 into the registry of the court. This represents the $3,709.37 withheld from Gist on the Harlingen contract and $1,025.63 withheld on the Corpus Christi job under the agreement.

Huddleston was in direct and daily supervision of the Harlingen job, familiar at all times with the labor and materials performed for and furnished to Gist by various suppliers, including those whose claims are involved here, and approved such labor and materials so provided in performance of Gist's subcontract, although he did not know until later of the exact contract or invoice prices. After the two agreements with Gist as to withholding moneys due on either job, Huddleston paid three Miller Act claimants (on the Harlingen job) as follows:

Minneapolis-Honeywell .......          $500.00 
Mar. 8, 1954

Gist and Hargis Electric

Co.
 .........................         $207.32 
Aug. 16, 1954

Gist and Southern Engine

& Pump Co. ..................         $524.00 
Aug. 16, 1954

 

Huddleston later (November 10, 1954) issued a check to East Texas Plumbing Company for its account $341.93. Their representatives were to meet for delivery of the check but failed, for some reason, to do so. Huddleston also issued checks later (November 13, 1954) to the other claimants (Zimmerman, U. S. Air Conditioning Co., Honeywell), with Gist, or his company, as joint payee. These checks were issued, although they totaled more than the $4,735 due Gist on both the Harlingen and Corpus Christi jobs, "because Huddleston was familiar with the Miller Act and knew he would be liable for unpaid labor and materials supplied to Gist." None of these checks have been paid because of failure to secure Gist's endorsement promptly and later demands made by the Collector of Internal Revenue (after notice of Levy, December 8, 1954 ), that payment be stopped. This was the first notice Huddleston or the claimants had of the tax claims against Gist.

[Government Intervenes]

The Government claims the fund in the registry by virtue of alleged tax liens, Internal Revenue Code (1939) 3670, 3671, asserting that the lien relates back to and attached on the dates the assessment lists were received by the District Director of Internal Revenue, the first being May 17, 1954 , for $2,466.88. ¹ The Government takes the position that it has a prior specific and perfected lien against the fund whereas the other claimants have only a right to garnish the fund. ²

[Statute Discussed]

Section 3670 of Title 26, in effect at the time, provided for a lien in favor of the Government for unpaid taxes, "upon all property and rights to property, whether real or personal, belonging to such person," ³ (the taxpayer). Section 3671 provided that, unless another date was specifically fixed by law, the lien should arise at the time the assessment list was received by the collector, etc. Section 3672 provided that the lien should not be valid as against any mortgagee, pledgee, purchaser, or judgment creditor until notice thereof had been filed by the collector in the manner therein prescribed. Before becoming lost in discussion of the many cases as to priority of liens, it would be well to remember the basic fact that the lien provided by Section 3670 is on property and rights to property BELONGING TO THE TAXPAYER. Here, Gist's right to the balance due on both contracts with Huddleston was burdened with the equitable and contractual right of Huddleston to refuse to pay him until Gist furnished proof of payment of all outstanding bills; and to Huddleston's right to pay such accounts for his own protection against such claimants; and to the agreement in March or April, 1954, authorizing Huddleston to reimburse himself for any excess of the amounts paid or owed Gist and his suppliers over the contract price as to the dental clinic. Any demand on Gist's part for payment of either balance would have been denied by any court because he had nothing coming until all claims were paid. Any garnishing creditor of Gist's, or even The Government on its tax claims, could stand in no better position than Gist as against Huddleston. ⁴ The Miller Act does not purport to give suppliers of materials, etc., a lien on funds due the subcontractor; rather it is a right of action on the bond required by the act, provided proper notice is given. But the requirement as to notice is to be, and has been, liberally construed, to the point that an oral notice by the supplier, later acknowledged in writing by the prime contractor, has been held sufficient. ⁵

[Question of Notice]

Here there can be no doubt that Zimmerman, Honeywell and East Texas Plumbing gave sufficient written notice to Huddleston, within 90 days after the last of the supplies, etc. were furnished; so that not even Huddleston may now urge, and he does not urge, lack of written notice. The situation is a bit different as to U. S. Air Conditioning Corporation. There is no showing that it gave notice, or that Huddleston acknowledged such claim in writing, within 90 days. It is clear, however, that Huddleston knew that the air conditioning equipment had been furnished, when it was furnished, the amount of the claim and that Gist had not paid it,--all within the 90 day period. It is equally clear that within the 90 day period Huddleston recognized such claim and held back money for the purpose of paying it, along with others, at the time of the agreement of February 28, 1954 . Huddleston says in his affidavit that Gist agreed to pay Zimmerman's account ($1,994.00) out of the $4,441.34 final payment of February 28th. Gist did not keep his agreement. If he had paid the Zimmerman account, there would have remained, so far as we are concerned here, only the claims of U. S. Air Conditioning Corporation, East Texas, and the balance due Honeywell, all three totaling $3,760.43. ⁶ This is so close to the $3,709.37 withheld by Huddleston that it shows he knew almost exactly what was due these three unpaid suppliers. So it appears that the reason for the supplemental agreement in March or April, 1954, whereby Huddleston was also to withhold Gist's profits on the Corpus Christi houses, was that Huddleston had been notified in writing, April 12, 1954 , that Zimmerman had not been paid. ⁷

The 90 days notice requirement is for the protection of the prime contractor and his surety in order that he may do exactly what Huddleston did here--hold back sufficient moneys to indemnify him or his surety. Since he knew of U. S. Air Conditioning's claim, held back enough to take care of it and later committed himself in writing to pay it, he hardly could be heard to plead in a Miller Act case that he did not get the written notice within 90 days. It is clear that Huddleston waived such requirement during the 90 day period and agreed to pay in writing after the 90 days, by, among other things, the issuance of checks for the amounts claimed. Huddleston wanted to be protected against such claims, perhaps against a lawsuit even though he might have the right to plead that there was not sufficient notice within 90 days; therefore he withheld from Gist sufficient moneys to pay all of them except Zimmerman. He took his chance as to Zimmerman by relying upon Gist to pay this claim out of the February 28th payment. The remaining claimants should not suffer when Huddleston held out sufficient moneys to pay them, and could have held back sufficient [moneys] to pay the Zimmerman claim but saw fit to rely on Gist to pay that account. As pointed out, Huddleston retrieved and bettered his position by $1,105.63 by holding back that amount on the profits on the Corpus Christi job. (He lacked $968.37, however, of getting enough to take care of the Zimmerman claim in full.)

[Tax Lien Did Not Attach]

I find it unnecessary to discuss all the propositions and authorities asserted by the parties. Suffice to say that, as to the Government's claim for liens, I hold that, at the time the assessment lists were received by the District Director, ⁸ Gist had no property or rights to property in the hands of Huddleston and no equity to which the lien could or did attach. Huddleston had a specific right of ownership to any funds due Gist, superior to any tax lien of the Government. ⁹ He had a right, under the agreements with Gist, made long before the Government's tax lien attached, to reimburse himself for any amounts due Gist and his suppliers. This really is not a case as to priority of liens between the claimants and the Government. Rather it is between the right of Huddleston on the one hand to see that the money withheld by him is applied to the payment of claims for which he was or might be liable and the Government on the other. Huddleston's right to so apply the funds was and is good against Gist. It was and is good against the Government.

This also disposes of the Government's contention that a fee cannot be allowed to Huddleston's attorneys who were compelled to institute the action because of demands of the Government. The suppliers' claims total more than the funds against which the Government asserts its tax liens.

Zimmerman timely filed his action under the Miller Act and is entitled to recover against Travelers as surety to the extent that it does not secure payment from Huddleston as principal. U. S. Air Conditioning, East Texas and Honeywell are entitled to recovery against Huddleston who may apply the funds in the registry to the payment, pro rata, of all the claims. A fee of $1,000 will be allowed Huddleston's attorneys out of such fund. The remainder will be prorated between Zimmerman , U. S. Air Conditioning, East Texas and Honeywell in proportion to their claims. In addition, Zimmerman will be given judgment against Huddleston's surety, Travelers, for the difference between the total of his share of the funds on deposit, and his share of the attorney's fees, and the $1,994.00.

The foregoing is adopted as findings of fact and conclusions of law.

The Clerk will notify counsel to submit an order accordingly.

¹ The dates the other assessment lists were received were as follows: June 22, 1954 , ($6,024.70); September 9, 1954 , ($1,425.32).

² As in Kings County Iron Works, 2 Cir., 224 Fed. (2d) 232 [55-2 USTC ¶9536] and United States v. White Bear Brewing Co., Inc., et al., 350 U. S. 1010 [56-1 USTC ¶9440], reversing 7 Cir., 227 Fed. (2d) 359 [55-2 USTC ¶9776].

³ Emphasis mine throughout unless otherwise indicated.

⁴ Cf. Great American Indemnity Co. v. United States , (D. C., La. ), 120 Fed. Supp. 445 [54-2 USTC ¶9469], United States v. Bank of Shelby, 5 Cir., 68 Fed. (2d) 538 [4 USTC ¶1226].

⁵ Houston Fire & Casualty Insurance Company v. United States , 5 Cir., 217 Fed. (2d) 727, in which, however, the written acknowledgment was within 90 days of the last delivery.

⁶ Of course, at the time of the agreement there also was due the amounts paid Gist and Hargis, Gist and Southern, and the $500 paid on Honeywell's account; but the amount due Gist on the Harlingen contract was sufficient to take care of these and U. S. Air Conditioning, East Texas and the Honeywell balance.

⁷ See Exhibit H. Pretrial Order.

⁸ May 17, June 22, September 9, 1954 .

⁹ United States Fidelity & Guaranty Co. v. United States , 10 Cir., 201 Fed. (2d) 118 [53-1 USTC ¶9249].

 

 

[62-1 USTC ¶9229]A. J. Bankhead doing business as Airtrol Engineering Company, Plaintiff v. Maryland Casualty Company, Irving Ward-Steinman, R. F. Zimmerman & Company, Inc., and United States of America, Defendants

U. S. District Court, East. Dist. La., Baton Rouge Div., Civil Action No. 2131, 197 FSupp 879, 9/26/61

[1954 Code Sec. 6321]

Priority of liens: Federal tax lien: Surety's subrogration claim.--The Federal tax lien on retained percentages was held to be prior to a surety's claim of subrogation for amounts paid to materialmen and laborers on behalf of a defaulting subcontractor. The latter claims were not perfected and lacked specificity as to any particular fund.

David W. Rob inson and Watson, Blanche, Wilson, Posner & Thibaut, 137 St. Ferdinard St., P. O. Box 36, Baton Rouge 2, La., for plaintiff. Elven E. Ponder and Major & Ponder, 5053 Government St., Baton Rouge, La., Paul M. Hebert, Dean of Law School, Louisiana State University, Baton Rouge, La., Victor A. Sachse, III, of Breazeale, Sachse, Wilson & Hebert, 701-719 Fidelity National Bank Bldg., Baton Rouge, La., M. Hepburn Many, United States Attorney, New Orleans, La., Prim B. Smith, Jr., Assistant United States Attorney, and Leonard Fuhrer of Gravel, Sheffield & Fuhrer, 611 Murray St., Alexandria, La., for defendants.

WRIGHT, District Judge:

This suit in interpleader involves the sum of $11,208.39 paid into the registry of the court by Airtrol Engineering Company, representing retained percentages on a subcontract between Airtrol and the Yerby Tin Shop. Upon default by Yerby, his surety, Maryland Casualty Company, was called upon to complete the subcontract and now claims the retained funds. The United States has assessed withholding taxes against Yerby and it likewise claims the fund. While the representative of Yerby's estate and a materialman are interpleaded, the dispute is essentially between Maryland and the United States .

On October 29, 1956 , Airtrol signed a contract with the Louisiana State Authority to provide air conditioning facilities for Louisiana State University at Baton Rouge . Airtrol subcontracted the sheet metal work for the air conditioning to Yerby on December 12, 1956 . Maryland executed a performance bond for Yerby's contract on November 1, 1956 . Pursuant to this bond Yerby assigned all payments due or to become due under the contract to Maryland in case of default. Payment terms for the Airtrol-L. S. U. contract and the Airtrol-Yerby contract both provided for thirty-day estimates of work completed and retention of percentages until completion and acceptance of the work.

With the work 95 per cent complete, Yerby encountered financial difficulties. On January 3, 1958 , Airtrol formally put Yerby in default and called upon Maryland to complete the work. On January 6, 1958 , Yerby also called upon Maryland to perform. On January 8, 1958 , the United States assessed withholding taxes against Yerby in the amount of $13,988.01. A later assessment on March 3, 1958 , will be disregarded since the January 8 assessment would exhaust the fund.

After Yerby's default Maryland expended $21,911.49 in completing the work and satisfying prior claims arising before Yerby's default. The job was accepted by the Louisiana State Authority on February 6, 1958 . On the same day R. T. Zimmerman filed a mechanic's lien pursuant to La. R. S. 9:4801 and La. R. S. 38:2241. ¹ A similar lien was filed by John T. Megison, a foreman, on March 2, 1958 . Both the Zimmerman and the Megison claims arose before default. Maryland satisfied these claims and asserts the lien rights arising thereunder by subrogation.

On default the retainage on the Yerby contract amounted to $11,208.29. Being faced with several claimants to this fund, Airtrol filed this interpleader.

Although Maryland 's claim rests on three grounds, its principal reliance is on the proposition that the retainage in suit never became the property of Yerby and consequently there was nothing to which the federal tax lien could attach. The United States claims that Yerby had a right to the retained percentages which was perfected on completion of the job, and, under applicable federal law, its claim is prior to all other liens or claims on the fund.

The contest between the federal tax collector and private claimants for various funds, while of relatively recent origin, has a complexity beyond its years. ² When the fund involved is retained percentages held by an owner in the presence of a defaulting contractor and an incomplete building, and contest is even more recent but of comparable complexity, involving, as it does, a host of decisions interpreting priorities, ³ relation back, ⁴ the "no debt" theory, ⁵ and, more recently, the application of state property law and federal priority law. ⁶ From the older cases, and now from recent Supreme Court decisions, certain general principles emerge.

Federal tax liens are not property rights; they are claims to property which require perfecting as do other claims. ⁷ Being statutory liens, ⁸ they take preference over open accounts and inchoate and unperfected liens. ⁹ Likewise, assignments, without more, although prior in time to federal tax assessments, are subordinate to the tax lien because of the greater dignity of the tax lien under federal law. ¹⁰

Private claimants may assume a variety of positions. They may be simple creditors, or holders of mechanic's liens, or assignees, or sureties, or subrogees to private liens, or subrogees to private rights. For a private lienor to take preference over a federal tax lien, its lien must be perfected by prior recordation, ¹¹ or other "perfecting" device cognizable by federal law. Its priority may be based on a theory of relation back to the date of creation of the original debt. ¹² For a private assignee to take preference over a federal tax lien, he apparently must reduce his assignment to judgment, although this is not altogether certain. ¹³ For a surety to assert subrogative rights to property of parties other than the taxpayer, the surety must show that the property does not belong to the taxpayer against whom the federal tax lien is asserted. ¹⁴

In balancing these various claims, it must first be determined whether the taxpayer owns the property against which the federal tax lien is asserted according to state law. ¹⁵ If it is determined that the fund in question is the property of the taxpayer, then the various claims to the fund must be ranked according to federal law. ¹⁶

In the present case, the fund involved is retained percentages withheld by the general contractor, Airtrol, from the subcontractor, Yerby, and claimed by the federal tax collector and the subcontractor's surety. The surety's principal claim, and the one upon which it must stand, is that the retained percentages are the property of Airtrol since the owner, or as in this case the general contractor, has the right, under Louisiana law, to apply retained percentages to the completion of the work. Thus, only the balance remaining after completion, if any, belongs to the subcontractor and is subject to the federal tax lien. The surety, if it completes the work, is subrogated to the owner's rights, and thus the portion of the retained percentages used in completion of the work belongs to the surety.

The respective rights among owners, contractors, contractors' creditors, and sureties to retained percentages when a job is incomplete have been spelled out by the Louisiana courts and legislature in rather specific terms. The statute creating the Louisiana counterpart to federal interpleader, the concursus proceeding, states in part:

"In the event that the owner has claims in concursus with the other claimants who have a privilege on his property under the provisions of this Sub-part, the cost of completing the building or other work by reason of the default of the original contractor, when established to the satisfaction of the court and when paid for by the owner, shall be reimbursed to him by preference out of any balance which might have been due under the contract if completed by the contractor; but the owner shall have no claim for the excess in the cost of completion if such cost exceeds the amount of the said balance, or for any other of his claims against the surety on the bond of the contractor until all other claimants have been paid in full." La. R. S. 9:4804.

An early case in Louisiana jurisprudence gave the owner in a concursus proceeding the right to offset the amounts needed to complete the job against retained percentages required to be paid into court. ¹⁷ The setoff was ordered since "[w]hatever was necessarily and reasonably expended for that purpose [completion] must be deducted from the stipulated instalment, and the balance only belongs to Wills [contractor], or his creditors." ¹⁸ The Supreme Court of Louisiana explained that the purpose of retained percentages was "to create a temporary fund to insure all the better the payment of claims against the work, and to enable better the owner, or the surety, in the event of necessity, to complete the undertaking." ¹⁹ In a similar concursus proceeding, the plaintiff failed to pay retained percentages into court as required by statute. In excusing this the Louisiana Supreme Court said:

"In the present case, plaintiff has not made a tender and deposit of the 'balance due under the contract' for the reason that the building has never been completed and it will require more than the amount in plaintiff's possession to complete it. If this be true, and we must accept the allegations of the petition as true for the purposes of the exception, plaintiff is entitled to exhaust the funds in its possession to complete the contract, and there is therefore no 'balance due' the contractor under the contract, to be tendered and deposited into court." ²⁰

If only to make the position more definite, the Court later explained the Natchitoches Sweet Potato Co. case in the following succinct language:

"All that we said in that case [Natchitoches Sweet Potato Co. v. Perfection Curing Co.] was (in effect) that there was nothing due the contractor by the owner under the contract when the contractor had defaulted, and it would require more than the unpaid balance of the contract price to complete the building. In other words, there was no balance due under the contract because the contractor had not earned it by completing the contract." ²¹

The conclusion that Louisiana law gives the owner, and the surety, a property right in the retained percentages when the job is incomplete at the date of default is supported by the rule that the equitable lien theory does not obtain in Louisiana . ²² Neither surety nor owner had a statutory lien on the retainage and the right does not arise out of specific terms in the contract. Since Louisiana does not give owner and surety a "claim" on the retainages but does give them a right prior to all "claims," the indication, along with the specific words of the statute and cases, is strong that this is a property right and not a claim on property.

Thus it is apparent that the law of Louisiana is quite similar to the law generally as stated in Prairie State Bank v. United States, 164 U. S. 227, ²³ and the Fifth Circuit's decision in General Casualty Co. v. Second Nat. Bank of Houston , 5 Cir., 178 F. 2d 679. ²⁴ While Louisiana law in the present case would probably be at variance with North Carolina law as found in U. S. v. Durham Lumber Co., supra, Durham supports the conclusion reached here that the United States may claim only that portion of the funds which belonged to the taxpayer.

However, simply expending money after the subcontractor's default does not automatically give the surety the right to reimbursement from the retained funds. The law is clear that the retainage is to insure completion of the building and not to make a carte blanche satisfaction of every claim arising during performance of the contract by the now defaulting subcontractor. ²⁵ That amount of the retained percentage which remains after completion of the sheet metal work belongs to the subcontractor. ²⁶ While the owner may not collusively pay that money to the subcontractor in derogation of the rights of subcontractor's creditors, ²⁷ the property right nevertheless vests in the subcontractor. Any other result would work a nullification of the hierarchy of priorities developed by federal statutory and decisional law. If "completion of the contract" amounted to satisfaction of every claim on open account against the subcontractor, these claims would take "priority" over a federal tax lien since these claims would be paid by the surety out of the retained percentages, even though the federal tax lien was perfected, choate, and prior in time. The principle of subrogation can work no such magic.

After completing the work, the balance of retained percentages, if any, ²⁸ being the property of Yerby, is subject to the claims of his general creditors, private lienors, and the federal tax lien, according to their preference under federal law. The only private claims presently in issue are: (1) surety's claim as equitable assignee of payments due and to become due the subcontractor; and (2) surety's claim as subrogee to the claims, supported by liens, of the materialmen and laborers which have been satisfied by the surety.

The equitable assignments are, in all material respects, identical to the assignments involved in U. S. v. Ball Construction Co., supra. In that case the Supreme Court reversed the lower court which had granted preference to an assignment of retained percentages to a surety over a federal tax lien, holding that the assignments were inchoate and unperfected. Whatever may be the procedure for perfecting assignments, no action other than formal assignments occurred here and the surety's claim based on the assignments must fail here as it did in Ball.

The liens to which the surety claims subrogation are in reality statutory claims granted under Louisiana law to materialmen and laborers against retained percentages withheld by an owner which is a state agency. ²⁹ Clearly, the nature of these statutory claims as liens or their priority are irrelevant here. The statute, by its terms, does not apply to the contractor for a governmental authority who hold retained percentages against a defaulting subcontractor. Thus, as to the retained percentages held by Airtrol, the claims of materialmen and laborers have the status of general creditors unsupported by liens. These claims lack specificity as to any particular fund and are in no wise perfected. Thus the federal tax lien is prior under the Code provisions ³⁰ and by operation of law. ³¹ Hence the balance of the retained percentages must be paid to the United States .

Judgment accordingly.

¹ La. R. S. 9:4801 provides for liens by materialmen and laborers on private buildings for unpaid claims on completion of the work. La. R. S. 38:2242 provides for sworn statements of amounts due on contracts to build public buildings which may be filed by materialmen and laborers and which require the governmental authority to hold retained percentages from the contractor until materialmen and laborers have been satisfied.

² See the thorough history of this phase of lien priority law in Wolverine Insurance Company v. Phillips, N. D. Iowa [58-2 USTC ¶9755], 165 F. Supp. 335.

³ United States v. Bess [58-2 USTC ¶9595], 357 U. S. 51: U. S. v. White Bear Brewing Co. [56-1 USTC ¶9440], 350 U. S. 1010.

⁴ United States v. Acri [55-1 USTC ¶9138], 348 U. S. 211; U. S. v. Security Trust & Savings Bank [50-2 USTC ¶9492], 340 U. S. 47; see also Great American Indemnity Co. v. United States, W. D. La. [54-2 USTC ¶9469], 120 F. Supp. 445, 451.

⁵ Aquilino v. United States [60-2 USTC ¶9538], 363 U. S. 509; U. S. v. Durham Lumber Co. [60-2 USTC ¶9539], 363 U. S. 522; Fidelity & Deposit Co. v. New York City Housing Auth., 2 Cir. [57-1 USTC ¶9410], 241 F. 2d 142.

⁶ Aquilino v. United States , supra; U. S. v. Durham Lumber Co., supra.

⁷ Aquilino v. United States , supra.

⁸ 26 U. S. C. §6321.

⁹ U. S. v. Security Trust & Savings Bank, supra.

¹⁰ U. S. v. Ball Construction Co. [58-1 USTC ¶9327], 355 U. S. 587.

¹¹ United States v. New Britain [54-1 USTC ¶9191], 347 U. S. 81; see 26 U. S. C. §6323.

¹² United States v. Acri, supra.

¹³ U. S. v. Ball Construction Co., supra.

¹⁴ U. S. v. Durham Lumber Co., supra.

¹⁵ "The threshhold question in this case, as in all cases where the Federal Government asserts its tax lien, is whether and to what extent the taxpayer had 'property' or 'rights to property' to which the tax lien could attach. In answering that question, both federal and state courts must look to state law * * *." Aquilino v. United States, supra, 512-513.

¹⁶ "However, once the tax lien has attached to the taxpayer's state-created interests, we enter the province of federal law, which we have consistently held determines the priority of competing liens asserted against the taxpayer's 'property' or 'rights to property.'" Aquilino v. United States, supra, 513-514. The combined effect of Ball Construction, Durham Lumber, Aquilino, and Commercial Standard Insurance Co. v. Campbell, 5 Cir. [58-1 USTC ¶9477], 254 F. 2d 432, is to make the question of whether the right involved is a claim on property or property itself of controlling importance.

¹⁷ Hale v. Wills, 3 La. Ann. 504.

¹⁸ Hale v. Wills, supra, 506.

¹⁹ Hanson v. Liberty Const. Co., 172 La. 298, 134 So. 98, 99.

²⁰ Natchitoches Sweet Potato Co. v. Perfection Curing Co., 153 La. 916, 96 So. 808, 811.

²¹ Fidelity Homestead Ass'n v. Kennedy & Anderson, 158 La. 1059, 105 So. 64, 69.

²² In re Liquidation of Canal Bank & Trust Co., 181 La. 856, 160 So. 609; In re Hagin, E. D. La. , 21 F. 2d 434, affirmed sub nom. Phoenix Bldg. & Homestead Ass'n v. E. A. Carrere's Sons, 5 Cir., 33 F. 2d 563, certiorari denied 281 U. S. 726.

²³ "If the United States had been compelled to complete the work, its right to forfeit the ten per cent [retained percentages] and apply the accumulations in reduction of the damage sustained remained. The right of Hitchcock to subrogation, therefore, would clearly entitle him when, as surety, he fulfilled the obligation of Sundberg & Company, to the government, to be substituted to the rights which the United States might have asserted against the fund. It would hardly be claimed that if the sureties had failed to avail themselves of the privilege of completing the work, they would not be entitled to a credit of the ten per cent reserved in reduction of the excess of the cost to the government in completing the work beyond the sum actually paid to the contractor, irrespective of the source from which the contractor had obtained the material and labor which went into the building." Prairie State Bank v. United States , supra, 232-233.

²⁴ "In these retained percentages, the contractor could give no one a right superior to that of the owner and the surety. This principle was established in Prairie State Bank of Chicago v. United States, 164 U. S. 227, 17 S. Ct. 142, 41 L. Ed. 412." General Casualty Co. v. Second Nat. Bank of Houston , supra, 680.

²⁵ Hale v. Wills, supra; La. R. S. 9:4804. Compare General Casualty Co. v. Second Nat. Bank of Houston , supra, 680, wherein the Fifth Circuit distinguished between progress payments (money actually earned but not paid) and retained percentages (money withheld to insure completion of the job). The assignee of the progress payments prior to default had a right to those funds since they actually belonged to the contractor. The surety had a right to demand that the retained percentages be used to complete the building, as in fact they were, but the surety could claim no right to the funds advanced to satisfy claims arising before default. While only retained percentages were involved in the present case, the same principle obtains that the surety can claim property rights in only so much of the withheld funds as are needed to complete the building.

²⁶ "Whatever was necessarily and reasonably expended for that purpose must be deducted from the stipulated instalment, and the balance only belongs to Wills, or his creditors." Hale v. Wills, supra, 506.

²⁷ La. C. C., art. 2772.

²⁸ It is not entirely clear from the record which expenditures by the surety after default were for settlement of claims arising before Yerby's default and which were for labor and materials needed subsequent to default to complete the sheet metal work. Only the items of expenditure concerning materialmen are uncertain. The record illustrates the pay periods for which the expenditures were made. Surety may submit evidence of its disbursements needed for completion of the sheet metal work. It is assumed this may be done by affidavit and document.

²⁹ See Note 1.

³⁰ 26 U. S. C. §6321.

³¹ United States v. New Britain , supra.

 

 

[55-1 USTC ¶9179]Phoenix Indemnity Company, a corporation, Appellant v. Hugh H. Earle, Collector of Internal Revenue, and Ross H. Coppock, Trustee in Bankruptcy of the Estate of Alan A. Siewert, Bankrupt, Appellee

(CA-9), In the United States Court of Appeals for the Ninth Circuit, No. 13,755, 218 F2d 645, January 14, 1955

Appeal from the United States District Court for the District of Oregon.

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

Lien for taxes: Priority over claims of surety.--A contractor contracted to do certain construction work for a government agency. Appellant furnished a performance bond and a payment bond, in consideration of which the contractor made a conditional assignment to appellant of the percentages retained and all other sums due under the contract. Before the completion of the work the Government filed tax liens against the contractor. Upon the contractor's being adjudicated a bankrupt, the Collector filed in the bankruptcy proceeding a proof of claim containing the items included in the tax liens. The government agency delivered to the trustee in bankruptcy the balance due to the contractor on his contract. Appellant then filed with the Referee a claim for the amount it had paid to the laborers and materialmen. The Referee held that the sum received from the government agency should be paid to the Director of Internal Revenue, which holding was approved by the lower court. The lower court in turn was affirmed by the Ninth Circuit on the ground that the Government was the holder of a valid, perfected lien and as such a claimant had a position in bankruptcy superior to priority claimants whose claims were unsupported by perfected liens.

George A. Rhoten, Rhoten, Rhoten & Speerstra, Salem , Ore. , for appellant. H. Brian Holland, Assistant Attorney General, Ellis N. Slack, A. F. Prescott, John J. Kelly, Jr., Special Assistants to Attorney General, Elmer Kelsey, Attorney, Department of Justice, Washington, D. C., C. E. Luckey, United States Attorney, Maurice V. Engelgau, Assistant United States Attorney (Bryan Goodenough, Salem, Ore.), Portland, Ore., for appellee.

Before HEALY and BONE, Circuit Judges and DRIVER, District Judge.

BONE, Circuit Judge:

Alan Siewert, a self-employed contractor, was adjudicated a bankrupt by the lower court on July 7, 1951 , and on the same day the proceeding was referred to a referee in bankruptcy. On August 4, 1951 , the Collector of Internal Revenue for the District of Oregon filed a claim of the United States asserting a tax against the bankrupt and his assets in the hands of the trustee with the Referee in Bankruptcy, this claim being for $12,770.28. Later, two supplemental claims for taxes due were filed with the Referee, one on January 17, 1952 and the other on June 21, 1952 . These two subsequent claims totaled $684.20.

Phoenix filed petitions with the Referee on April 18, 1952 , and on August 4, 1952 , asserting claims against the assets in the hands of the Referee. The allowance of all of these claims was opposed by the United States .

Upon hearing and under date of November 22, 1952, the Referee entered his findings, opinion and order holding that the sum of $11,838.61 received from the Bonneville Power Administration, herein Bonneville, came into the hands of the trustee impressed with certain tax liens (later noted) of the United States, and that this sum (less costs and expenses of admin istration as determined by the court) should be paid to the Director of Internal Revenue.

The order of the Referee was later reviewed by the lower court on petition therefor by appellant Phoenix , and the Referee's order was, without opinion, affirmed by the court for the reason set forth in the Referee's findings, opinion and order. This appeal followed. As we later note, the basic question here is whether, under the facts ¹ and the law, the Government's tax liens asserted against the funds in the hands of the trustee in bankruptcy are superior to the claim of appellant Phoenix.

The Facts

Since the basic facts are of controlling significance, the chronology of events becomes important. The order of the Referee was based on the records before him which established to his satisfaction facts set forth in his findings, opinion and order which we summarize below. We find no reason in the record to disagree with the Referee's appraisal of the facts.

Siewert entered into a contract with Bonneville, the Government agency here involved, to construct an entrance road and parking area at a Bonneville substation in Oregon . At the same time Phoenix executed and delivered a performance bond and a payment bond in favor of the United States as required of contractors by federal law in situations of the character before us. In Siewert's application to Phoenix for these bonds, he agreed to indemnify this surety against all loss sustained by reason of the execution of the bonds, and assigned to Phoenix, as collateral, to secure the obligations contained in the application and any other indebtedness or liability of his to the surety, ² such assignment to become effective as of the date of the contract bonds, but only in the event of (1) breach of the contract or of the bonds; or (2) any breach of the agreements contained in his application; or (3) of a default in discharging other indebtedness or liabilities when due; or (4) of any assignment for the benefit of creditors or of the appointment of a receiver or trustee for Siewert, any and all percentages retained (by Bonneville) on account of said contract, and any and all sums that may be due under said contract at the time of abandonment (of the contract work), forfeiture or breach, or that thereafter may become due.

In the spring of 1951, Siewert experienced some financial difficulties and for a time funds paid by Bonneville on the Siewert contract were deposited with a bank in a special account from which disbursements were made (by Siewert and Phoenix) only for labor and material employed in performance of the Bonnevile contract. The Referee found that Siewert did not default in performing his contract; that his work was completed on June 19, 1951 and it was forthwith inspected and accepted by Bonneville as satisfactory.

Subsequently, Phoenix , under its payment bond paid claims totalling $15,210.60 for labor and material furnished to Siewert in the performance of his contract.

[Tax Liens]

Prior to Siewert's bankruptcy and prior to any payments made by Phoenix in compliance with the requirements of its payment bond, three separate notices of tax liens were filed by the United States against Siewert in Marion County, Oregon, (his place of residence and of doing business). These lien notices were filed on June 29, 1951 , June 15, 1951 , and May 24, 1951 , and the three lien claims totalled $12,486.00. On July 29, 1951 , the Collector of Internal Revenue filed in the bankruptcy proceeding a proof of claim containing the items included in the above (three) liens; the total of the Collector's claim, with penalties and interest to August 1, 1951 , amounted to $12,770.28.

Later, and on January 17, 1952, and Collector filed a supplemental proof of claim covering withholding and employment taxes for the June, 1951 quarter in the sum of $323.15, and the brief of the Government in the Referee's court indicated that a notice of lien for this amount had been filed in said Marion County, Oregon on January 3, 1952.

The total amount paid to Siewert's creditors by Phoenix under the payment bond amounted to $15,210.60.

On or about January 18, 1952 Bonneville delivered to the trustee a check for $11,838.61 this amount being the balance due to Siewert on his contract, including the amount of retained percentages of progress payments made prior to completion date of the contract.

The Claims of the Parties

The claims of the parties, asserted here and before the Referee and lower court, are brief and appear to concern only questions of law arising out of the agreed facts.

Appellee contends that the above noted tax liens of the Government are superior to the claim of appellant.

Appellant poses the problem here in two questions: First, does Phoenix have subrogation rights under the circumstances surrounding its claim; and second, did the lower court err in sustaining the above noted contention of the Government.

In the posture of the case, as above outlined, the question here for decision boils down to appellant's challenge to the validity of the Referee's conclusion and holding that the sum of $11,836.61 received by the trustee from Bonneville should be paid over to the Director of Internal Revenue by reason of the Government's prior lien for the aforesaid taxes due it. Or, in other words, is this lien for unpaid taxes superior to and entitled to priority over the claim of Phoenix ?

Appellee contends that the decisions of the Supreme Court in Goggin v. California Labor Division, 336 U. S. 118 [49-1 USTC ¶9142]; United States v. Munsey Trust Co., 332 U. S. 234; and our decision in In Re Knox-Powell-Stockton Co., 100 Fed. (2d) 979 [39-1 USTC ¶9277], require an affirmative answer to the question just above noted.

Appellant makes the following assignment of errors:

"First: That the referee and the District Court erred in determining that the doctrine of subrogation does not apply in favor of Phoenix Indemnity Company under the circumstances surrounding its claim; and

"Second: The referee and the District Court erred in holding that the tax claim of the United States is superior to the right of Phoenix Indemnity Company."

[Subrogation]

In its brief the appellant based its right of subrogation upon its payments to labor and materialmen. In oral argument appellant expressly abandoned any claim of subrogation based upon materialmen's claims ³ and appears to have no further claim of subrogation other than a passing remark in oral argument, that although it abandoned its right to be subrogated to materialmen it did not give up any right to be subrogated to the rights of the Government. No prior nor further reference was made to such a right of subrogation to the Government's position, nor was any explanation or authority offered for such a claim during oral argument or in the brief.

Such an assertion would seem to have been laid to rest in United States v. Munsey Trust Co., supra, from which the Referee quoted extensively in his "Discussion of Law" in "Referee's Findings, Opinion and Order" which were adopted in their entirety by the district court. After Justice Jackson established in the Munsey case that the United States was a secured creditor he said at page 241:

"But the infirmity in respondent's case goes deeper. If the United States were obligated to pay laborers and materialmen unpaid by a contractor, the surety who discharged that obligation could claim subrogation. But nothing is more clear than that laborers and materialmen do not have enforceable rights against the United States for their compensation. [citations] They cannot acquire a lien on public buildings, [citations] and as a substitute for that more customary protection, the various statutes were passed which require that a surety guarantee their payment. Of these, the last and the one now in force is the Miller Act under which the bonds here were drawn."

As to appellant's claim of assignment by way of the bond application and its subrogation to the claims of labor and materialmen the Referee said in his "Discussion of Law":

"The assignment was made as collateral to secure the indemnity agreements of Siewert [bankrupt]. No attempt was made to comply with requirements of Title 31 U. S. C. A. Section 203 relating to assignments of claims against the United States . It was, therefore, void as to the United States * * *"

"It is conceded that Phoenix is subrogated to the rights of the creditors whose claims it paid. This right is fortified by the assignment of these claims by the creditors to the surety. But these creditors had no lien or other enforceable right against Bonneville or the funds owing to Siewert. Hence, their claims against the estate of the bankrupt are general and unsecured. In this case no funds will be available for general creditors after the payment of expenses of admin istration, tax liens and other priority tax claims."

In oral argument appellant based its claim upon an asserted "right to an equitable lien." There is no reference to an "equitable lien" in the record before us from the district court (which includes the claims and memorandums presented to the Referee); there is no assignment of error by appellant dealing with an "equitable lien," and an "equitable lien" is not mentioned in the briefs.

It may well be that no case remains for our consideration. Rule 18(2)(d) of the Rules of this Court says in part: "in all cases a specification of errors relied upon which shall be numbered and shall set out separately and particularly each error intended to be urged * * * In all cases, when findings are specified as error, the specification shall state as particularly as may be wherein the findings of fact and conclusions of law are alleged to be erroneous."

[Bankruptcy]

This is an appeal from an affirmation of the lower court of the findings and conclusions made by the Referee in Bankruptcy. But, appellant cites no cases and no authority dealing with bankruptcy other than merely providing us with the citation of one 1917 case, Derby v. United States Fidelity & Guarantee Co., 87 Or. 34, 169 Pac. 500 which was concerned with a dispute between a bank and an insurance company. Appellant provided this Court with only one sentence which was in any way concerned with the statutory provisions of the Bankruptcy Act:

"The bankruptcy act provides that taxes due the United States are entitled to the priority there expressed. U. S. C. A. Title 11, section 104."

This sentence appears to support appellee and not appellant.

Appellant's position in this bankruptcy proceeding would appear to be fixed and limited by Section 57(i) of the Act (11 U. S. C. A. 93(i)) which permits a surety to be subrogated to the rights of creditors to the extent that he pays the creditors. This section and its effect are the subject of a full discussion in Collier on Bankruptcy, Vol. 3 (14th ed.) commencing at page 284 and continuing to page 296. Beginning on page 287 it is stated:

"The surety normally has against the principal a claim, express or implied, absolute or contingent, to be indemnified or reimbursed. Without §57i there could be no doubt but that such a claim is provable by the surety in the same manner any other claim provable under §63a may be presented, namely as the surety's own claim against the bankrupt principal debtor. Section 57i flatly denies this right. It confines the secondary debtor to a proof of the creditor's claim, in the creditor's name. 'A creditor may indeed prove against both principal and surety, but that is because he has two separate claims, really he has security upon a single claim. But there can never be more than one claim against the principal.' It is this one claim, namely the creditor's claim, that the surety may prove prior to or after subrogation, and not his own claim upon an agreement, express or implied, of indemnity."

Under the Bankruptcy Act it appears that a surety is limited to a right of subrogation to the position of the creditors of the debtor to the extent that the surety pays the creditors. The best position of any of the creditors paid by Phoenix Indemnity Company to which it might be subrogated (although we understand this claim to be abandoned) was a right to priority by §64 of the Act. The government is the holder of valid, perfected tax liens. Such a lien claimant has a position in bankruptcy superior to priority claimants whose claims are unsupported by perfected liens.

Section 57(i) appears to clearly support the conclusions of the Referee which were sustained by the affirming order of the lower court.

Judgment is affirmed.

¹ In argument here, we were advised that there is no dispute as to the facts. The Referee's findings, opinion and order clearly and succinctly state the controlling facts on which his order was based and we resort to it for our summary of the facts.

² This assignment was sweeping in character. It covered and included, inter alia, all rights of the assignor in all subcontracts and in the main contract, materials purchased for or chargeable to the contract, causes of action, claims and demands accrued or accruing in favor of the assignor arising out of the contract, and the assignor's rights and interest in all of the machinery, tools, equipment, plant and materials about the site of the work.

³ From the rest of the discussion we gathered that appellant also intended to abandon its claim of subrogation to laborers' claims. But in any event, and as we later note, the rule seems to be that perfected "liens" take preference over a "priority" claim unsupported by a lien.

 

 

[75-2 USTC ¶9631]The Housing Authority of the City of Mexico, Missouri, Plaintiff v. General Insurance Company of America and The United States of America, Defendants

U. S. District Court, East. Dist. Mo. , East. Div., No. 73 C 419(3), 392 FSupp 65, 5/7/74

[Code Sec. 6323]

Lien for taxes: Priority: Surety's interest.--General, surety of a bankrupt contractor, was entitled to the interpleaded funds. The court concluded that General has superior rights over the government's tax liens. General had acquired an equitable lien against the unpaid funds which related back to the date of the contract while the tax liens concerned periods subsequent to that date.

Edward D. Hodge, Edwards, Seigfreid, Runge & Hodge, Inc., 123 E. Jackson , Mexico , Mo. , for plaintiff. Donald J. Stohr, United States Attorney, St. Louis, Mo., Francis L. Kenney, Jr., Kenney, Leritz & Reinert, 843 Boatmen's Bank Bldg., 314 N. Broadway, St. Louis, Mo., for defendants.

Memorandum and Order

WANGELIN, District Judge:

This matter is before the Court upon the cross motions of the defendants for summary judgment pursuant to Rule 56, Federal Rules of Civil Procedure.

This is an interpleader action which was removed from the Circuit Court of Audrian County, Missouri. The interpleaded fund in the amount of $8,222.95 is the balance resulting from a Contract between the plaintiff Housing Authority of the City of Mexico, Missouri, (herein Authority) and the Contractor, Plez Lewis & Son, Inc. (herein Plez). On August 6, 1962, the plaintiff entered into a contract agreement with Plez for the construction of seventy-four dwelling units, management and community buildings, and site development in connection with housing project MO-10-1, Phase II, sites I and II located in Mexico , Missouri . Said construction project was bonded by the defendant General Insurance Co. (herein General) by its Performance and Payment Bond No. 477257 in the penal sum of $851,342.00. Said bond was executed on August 6, 1962, and created the relationship of General as surety and Plez as principal. ¹ Prior to the completion of the aforesaid project, Plez defaulted and was declared a bankrupt. General, pursuant to its obligation as surety, made payments in 1965, 1966 and 1967 to various claimants who had performed labor or supplied material or services under the housing contract in the amount of $8,643.20. The plaintiff prior to the default of Plez had retained the sum of $8,222.95 of the contract balance which was to have been paid upon satisfactory completion of the construction under the contract agreement. Such sum is the interplead amount. On May 5th, 1965, a notice of levy was served upon the plaintiff by a delegate of the Secretary of the Treasury demanding payment of all sums of money or other obligation owing to Plez. Said levy was made pursuant to tax assessments charged against the taxpayer Plez, the first such assessment being made on January 29, 1965, for withholding and FICA taxes and interest in the amount of $15,351.14 as taxes and $456.85 as interest. The plaintiff has paid into the registry of this Court the sum of $8,222.95 and claims no interest in the amount but seeks a determination as to the party lawfully entitled to it.

General contends that with the payments to the various claimants pursuant to its obligation as surety it became subrogated to the rights to the monies due the defaulting contractor in the hands of the Authority. General further contends that it has an equitable lien on said monies which relates back to the date of the suretyship contract (August 6, 1962) and such claim is superior to a claim of the United States for unpaid taxes for periods subsequent to the aforesaid contract. In contravention, the Government argues that the tax lien takes priority and is attached to all property and rights to property of the taxpayer, Plez, including the amounts retained by Authority.

The issue as the Court views it is whether the rights of General gained through subrogation based on a contract of suretyship dated August 6, 1962, is superior to the tax lien of the United States which arose prior to the payments by the surety? This Court holds that the rights of General have priority over the claims of the United States . For support of this decision the language of Glenn v. American Surety Co. [47-1 USTC ¶9220], 160 F. 2d 977 (6th Cir., 1947) as cited in Home Indemnity Co. v. United States, 313 F. Supp. 212 (W. D. Mo., 1970) at 215-6 is appropriate:

. . . a surety who makes good under his contract of suretyship upon default of the principal contractor, acquires an equitable lien against the unpaid balance in the hands of the person in whose favor the bond runs, and that such equitable lien upon payment by the surety relates back to the date of the contract and is superior to a claim of the United States for unpaid taxes for periods subsequent to the date of the contract of suretyship although prior to the date of payment by the surety. 160 F. 2d at 982.

In accord see United States Fidelity & Guaranty Co. v. United States [53-1 USTC ¶9249], 201 F. 2d 118 (10th Cir., 1952): Farmer's Bank v. Hayes, 58 F. 2d 34 (6th Cir., 1932) ²; and New York Casualty Co. v. Zwerner [45-1 USTC ¶9140], 58 F. Supp. 473 (N. D. Ill., 1944).

Accordingly,

IT IS HEREBY ORDERED that the motion of the defendant General Insurance Company of America for summary judgment be and is GRANTED and that it shall take the fund minus attorney's fees and costs;

IT IS FURTHER ORDERED that the motion of the defendant United States for summary judgment be and is DENIED; and

IT IS FURTHER ORDERED that the plaintiff be and is awarded reasonable attorney's fees and costs.

¹ The record indicates that on February 17, 1959 , Plez executed an indemnity agreement in favor of the insurance company and assigned all rights of Plez in the contract between Plez and the Authority. However, such agreement is not essential to the determination of this action.

² Though the above cases deal with payment under the Miller Act, 40 U. S. C. §270(a), et sec., for purposes here no distinction between subrogation under said Act and herein is relevant.

 

 

[44-1 USTC ¶9133]Maryland Casualty Company, a Corporation v. The United States

In the Court of Claims of the United States, No. 45659, 100 CtCls 513, 53 FSupp 436, Decided January 3, 1944

Set-off for unpaid taxes on government contract: Surety's right of subrogation on "payment" bond.--Surety on contractor's bond, given to guarantee payments to materialmen and laborers on a United States construction contract, seeks to recover balance of contract price due to such contractor after he had defaulted in such payments, after the government had applied such balance to past due income and other taxes owing by the contractor. The surety bases its right to recover from the United States for amounts paid out under the bond on its claim of subrogation to the contract price owing to the contractor. The Court of Claims denies the government's priority for taxes under Sec. 3466 of the Revised Statutes as inapplicable except where debtor's insolvency is evidenced by bankruptcy, receivership or assignment of creditors. The Court allowed recovery to the contractor on the theory that it was not intended by the contracting parties that the contract price would be "paid," not in money but by a bookkeeping process of crediting these sums against taxes to the prejudice of the surety.

John J. Wilson for the plaintiff. Whiteford, Hart & Carmody, and H. Ellsworth Miller were on the briefs. J. H. Sheppard, with whom was Assistant Attorney General Samuel O. Clark, Jr., for the defendants. Rob ert N. Anderson and Fred K. Dyar were on the brief.

Conclusion of Law

Upon the * * * special findings of fact, which are made a part of the judgment herein, the court concludes, as a matter of law, that the plaintiff is entitled to recover $1,987.22.

It is therefore ordered and adjudged that the plaintiff recover of and from the United States the sum of one thousand nine hundred eighty-seven dollars and twenty-two cents ($1,987.22).

Opinion

MADDEN, Judge, delivered the opinion of the court:

[The Facts]

The plaintiff seeks to recover from the United States $1,987.22 which the plaintiff paid to materialmen and laborers whom the Columbia Foundation Company, Inc., failed to pay. Columbia had, about February 3, 1940 , made a contract with the United States for the installation of a condensing water supply connection at the National Gallery of Art. It was required by law to furnish two separate bonds, one guaranteeing its performance of the contract, and the other guaranteeing its payment of materialmen and laborers from whom it might obtain supplies or services in the performance of the contract. ¹ The plaintiff furnished the payment bond.

Columbia became financially unable to pay its bills and, when it completed the performance of the contract it left unpaid the materialmen and laborers who were later paid by the plaintiff. On January 7, 1941, which was after completion of performance but before the plaintiff, as surety, had paid Columbia's unpaid bills, the Comptroller General of the United States determined that there was a balance of $4,253.63 of the contract price, which the Government had not paid Columbia, but that Columbia was indebted to the United States in a larger amount than that, for income taxes and federal insurance contribution and unemployment taxes. The Comptroller General applied the balance against the taxes, and gave Columbia a receipt for the payment of that amount on its tax bill. When he did this, the Comptroller General did not know that Columbia had failed to pay its bills, or was unable to do so.

On January 22, 1941 , the plaintiff, upon becoming aware of what the Comptroller General had done, protested against the set-off and demanded payment instead of the set-off. Columbia at the same time made a similar protest and demand. The plaintiff then paid Columbia 's unpaid debts to materialmen and laborers in the amount of $1,984.75, and social security taxes on the wages paid by it, in the amount of $2.47, making the total amount here sued for $1,987.22. It made no attempt to obtain reimbursement from Columbia because it learned that Columbia had no assets. It sought to have the Comptroller General rescind the set-off, and pay it $1,987.22 out of the $4,253.63 which that official had determined was owing Columbia on its contract, but was used up as a credit on Columbia 's unpaid taxes. That official, however, adhered to his former decision and denied the request.

Our question is whether the Government has the right to settle the unpaid balance which it owes a contractor for the performance of a certain contract, by setting off that balance against a debt which the contractor owes the Government upon some unrelated account, when there is a surety who has been obliged under its bond to pay debts of the contractor for materials and labor used by the contractor in the performance of its contract. In this case the contractor's debt to the Government was for taxes, but the Government does not claim that it had properly perfected a tax lien, or that the tax debt was different, in any respect material here, from any other debt which the contractor might have owed the Government, as, for example, for supplies sold to him by the Government.

[Priority Denied]

One basis for the Government's asserted defense is that, because of Section 3466 of the Revised Statutes, 31 U. S. C. Sec. 191, the United States, as a creditor, had priority over other creditors of Columbia, and therefore its paying itself by set-off gave it no more than it would have been entitled to in any event. That section is as follows:

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; and the priority established shall extend as well to cases in which a debtor, not having sufficient property to pay all his debts, makes a voluntary assignment thereof, or in which the estate and effects of an absconding, concealed, or absent debtor are attached by process of law, as to cases in which an act of bankruptcy is committed.

The plaintiff urges that this statute is not applicable except where, in the case of a living debtor, his insolvency is a formal one evidenced by a bankruptcy, receivership, or assignment for the benefit of creditors.

We agree with the plaintiff as to the construction of R. S. 3466. A provision in similar language has been in the statutes since 1797 and has always been construed as plaintiff would have us construe it. See United States v. State of Oklahoma , 261 U. S. 253. We conclude, therefore, that the Government, as such, had no statutory preference which would give its claim priority over the plaintiff's claim.

[Claim of Subrogation]

We now reach the difficult legal question in the case. The plaintiff claims that as a surety which has paid the debt of its principal, it is entitled to be subrogated to the right which its principal had, under the contract, including the right to collect so much of the unpaid balance due its principal from the other contracting party as is necessary to make it whole for payments made by it under its bond. The Government, in response, says that there was nothing for the plaintiff to be subrogated to, because Columbia , its principal, had no rights against the United States , since it owed taxes in a larger amount. The Government cites Globe Indemnity Co. v. United States, 84 C. Cls. 587. In that case the surety sued for the unpaid balance due the contractor from the Government, the surety having there, as here, paid labor and material bills of the contractor. But the contractor's claim against the Government had been forfeited, under the statute, for attempted fraud in the prosecution of it. The court held that the surety could not recover, and said. "The party for whose benefit the doctrine of subrogation is exercised can acquire no greater rights than those of the party for whom he is substituted."

We think the Globe case was rightly decided. There the principal's claim became literally nonexistent as a result of the forfeiture under the statute, so of course neither the surety nor anyone else could enforce it. But most cases of subrogation, including the one now before us, involve only a question of priority, i. e. whether the surety or some other creditor of the principal has a better right to an admitted asset of the principal. In Prairie State Bank v. United States, 164 U. S. 227, for example, the question was whether the surety who had expended money to complete the contract upon his principal's default, or the bank which had loaned money to the principal to finance the contract, had the better right to the balance due the principal from the United States, when the contract was completed. In that case, if the bank had had an assignment of the unpaid balance, good as against the principal, the assignor, it and not the principal would have been entitled to collect the money from the United States . But that would have proved nothing as to whether or not still another person, the surety, had a still better right than the assignee to get the money. So the surety's right by subrogation may give him, as it did in the Prairie State Bank case, supra, a right to money which, if there had been no surety, the principal would not have been entitled to because he had assigned his right, or had subjected it to a set-off or other valid defense not involving forfeiture of the claim.

A surety is entitled, by subrogation, to priority in valuables pledged by the principal debtor to the other contracting party as additional security for the performance of the contract. Arant on Suretyship, pp. 354, 355. In the case of the "performance" bond required by the Government of contractors, the money retained by the Government until performance is completed is retained for the purpose of securing performance. By proper analogy the contractor's right to that money, upon completion, should belong to the surety, so far as it is necessary to make him whole, and his claim to it should have priority over the claims of other creditors of the contractor, including claims of the Government which are unrelated to the contract. United States Fidelity and Guaranty Co. v. United States 92 C. Cls. 144.

The bond involved in the instant case was not a "performance" bond, but a "payment" bond. It is not clear that moneys were withheld from the contractor in order to give the Government additional security that materialmen and laborers would be paid. So far as appears, the balance of the contract price would have been paid to Columbia , if it had not been credited on Columbia 's taxes, without any investigation as to whether Columbia had paid its materialmen and laborers. If so, that would indicate that the Government, which would have no more than a moral obligation to see these creditors paid, relies entirely on the payment bond with regard to such debts of the contractor. The analogy of subrogation to additional security may, therefore, not be properly applicable to the type of bond here involved.

[Contract Construed]

The answer to our question should, we think, be looked for in the contract itself and its necessary implications. What did the parties mean? What risks did they intend the surety to undertake? The risks undertaken by a surety, and for which it receives its compensation, if it is, as the plaintiff is, a commercial surety, include the risk that the contractor, the principal, may receive the payments from the other contracting party, here the Government, and may spend the money in speculation or in riotous living and fail to pay his materialmen and laborers. The surety will then have to pay them. The surety also takes the risk that, by reason of the contractor's bad management, or of a rise in the cost of labor and materials, the payments made to the contractor will not be sufficient to pay the materialmen and laborers. But we do not think that it intends, or is expected by the Government or the other contracting party to take the risk that any part, or perhaps the whole, of the contract price which by the contract the Government promises to pay upon performance, will be "paid," not in money but by a bookkeeping process of crediting these sums against taxes or other debts of the contractor not related to the contract, to the prejudice of the surety.

Suppose a contractor defaults, at some stage, early or late, in performance. The surety elects to omplete performance in order to reduce its liability. It secures another contractor and enters into a contract with him for completion of the work. The work is completed. Then the Government says that the original contractor owed it more on other accounts than the unpaid contract price, hence the surety will be paid nothing, though it did some or most of the work covered by the original contract. If, in the same situation, the surety had not elected to complete the work, and the Government had finished the job itself, the surety would have been obliged to pay only the difference between the actual cost of completion and the part of the contract price which had not been paid the original contractor before his default.

In the first situation suggested above, the surety would have paid the original contractor's taxes or other debts to the Government. In the second it would not. We think that in no case is it intended that the surety transaction should work out in such a way that the surety has paid the contractor's taxes or unrelated debts to the Government.

The effect of the contract and the bonds is that the contractor promises the Government that it will build the structure, and will pay the laborers and materialmen. The Government takes two separate bonds to secure the fulfillment of these promises, since its interest in the first is more physical and direct than in the second. But when the surety pays the laborers and materialmen, it is performing the contract as much as when it completes the building. We see no more reason why the parties should intend that, either under the guise of building a building, or of paying laborers and materialmen, both of which the surety has promised will be done, it should in reality, and because of the ease of bookkeeping, be paying the contractor's taxes or other debts, which it has not promised will be done.

[Conclusion]

We construe the bond and the transaction as a whole as implying a promise on the part of the Government to the surety that it will not so settle the accounts of the contractor as to leave the surety in the position of paying the contractor's taxes. When the Comptroller General was made aware that that was the effect of his accounting, he should have rescinded the set-off. The fact that he had made the set-off without knowledge of its effect upon the surety's interest had no final effect upon the plaintiff's right. The credit given to Columbia on its taxes could have been cancelled, without any prejudicial change in the Government's position. This should have been done when the plaintiff's right became known.

The plaintiff may recover $1,987.22.

It is so ordered.

WHITAKER, Judge; and LITTLETON , Judge, concur.

WHALEY, Chief Justice, concurs in the result.

JONES, Judge, took no part in the decision of this case.

¹ Act of August 24, 1935 , C. 642; 49 Stat. 793, 40 U. S. C. §270.

 

 

[61-1 USTC ¶9376]United States of America, for the use of The Home Indemnity Company, a corporation, Assignee, Plaintiff v. American Employers' Insurance Company, a corporation, and Oil Capital Construction Company, a corporation, Defendants, and United States of America, Interpleaded Defendant, and York Electric Construction Company, a corporation, Additional Indispensable Party Defendant

U. S. District Court, Dist. N. Dak., Northeast. Div., Civil No. 3618, 192 FSupp 873, 4/8/61

[1954 Code Sec. 6323]

Priority of liens: Unpaid payroll taxes: Surety: Defaulting subcontractor.--A subcontractor notified its surety and the prime contractor that it would not be able to perform the subcontract even before commencing work under it. To minimize its losses, the surety permitted the subcontractor to perform the contract, with the subcontract price being assigned directly to it. The subcontractor's net payroll expenses were paid directly by the surety, but no provision was made for payment of withholding taxes. Because of adverse claims to an amount still owing under the subcontract, the prime contractor paid the remaining $12,000 into court. It was claimed by the surety for completing the contract and by the Government for some $11,000 in payroll taxes owing by the subcontractor. The surety was held to be entitled to the fund, since its subrogation rights dated back to the time its performance bond was executed. However, the Government was entitled to judgment on its cross-claim against the surety for $2,300 in withholding taxes which were incurred in completing the subcontract in issue.

Harold D. Shaft of Shaft, Benson & Shaft, Grand Forks, N. Dak., and John Murphy of Tucker, Murphy, Wilson & Siddens, 831 Scarritt Building , Kansas City, Mo. , for The Home Indemnity Company. Rob ert Vaaler of Day, Stokes, Vaaler & Gillig, Grand Forks, N. Dak., for American Employers' Insurance Company and Oil Capital Construction Company. Rob ert L. Handros and John M. Burzio, Tax Division, Department of Justice, Washington 25, D. C., for the United States .

Memorandum and Order

DAVIES, District Judge:

Oil Capital Construction Company (hereinafter Oil Capital) was prime contractor under a contract with the United States for certain construction work on the Grand Forks, North Dakota, Air Force Base. American Employers' Insurance Company (hereinafter American Employers') issued performance and payment bonds thereon under provisions of the Miller Act, 40 U. S. C. A., Sections 270(a), 270(b).

On February 11, 1957 , Oil Capital made a subcontract with York Electric Construction Company (hereinafter York ) whereby York agreed to furnish certain materials and labor for construction of utilities required under the prime contract. A performance bond was executed and delivered on February 25, 1957, by The Home Indemnity Company (hereinafter Home Indemnity) conditioned upon the faithful performance of the subcontract by York. The performance bond among other things provided:

"Whenever Contractor (York) shall be, and declared by Owner (Oil Capital) to be in default under the CONTRACT, the Owner having performed Owner's obligations thereunder, the Surety may promptly remedy the default, or shall promptly

"(1) Complete the CONTRACT in accordance with its terms and conditions, or

"(2) Obtain a bid or bids for submission to Owner for completing the CONTRACT in accordance with its terms and conditions, and upon determination by Owner and Surety of the lowest responsible bidder, arrange for a contract between such bidder and Owner and make available as work progresses (even though there should be a default or a succession of defaults under the contract or contracts of completion arranged under this paragraph) sufficient funds to pay the cost of completion less the balance of the contract price, but not exceeding, including other costs and damages for which the Surety may be liable hereunder, the amount set forth in the first paragraph hereof. The term 'balance of the contract price', as used in this paragraph, shall mean the total amount payable by Owner to Contractor under the CONTRACT and any amendments thereto, less the amount properly paid by Owner to Contractor."

Prior to commencing work under the subcontract, York notified both Home Indemnity and Oil Capital that due to financial difficulties it would not be able to perform the subcontract. Oil Capital immediately called upon Home Indemnity as surety to make good the default of its principal, York. Under terms of the performance bond Home Indemnity was confronted with a choice either of completing or reletting the subcontract. Oil Capital expressed a desire that York be allowed to undertake performance if at all possible. York was in default on several other contracts upon which Home Indemnity was acting as surety, and therefore, Home Indemnity anticipated substantial suretyship losses. Desirous of keeping its anticipated losses to a minimum, Home Indemnity allowed York to proceed under certain conditions.

[Surety Allowed Subcontractor to Perform]

York executed an assignment of the subcontract price to Home Indemnity; a joint control account was set up in which deposit was to be made of the subcontract funds; and Oil Capital was authorized to pay certain of York's suppliers directly. Other material suppliers were to be paid from the joint control account after Home Indemnity's approval. Material costs in excess of the deposits in the control account were to be paid from funds advanced by Home Indemnity. Payroll expenses were supplied to York by Home Indemnity upon submission of payroll vouchers. Net payroll costs only were advanced, no provision being made for the payment of withholding taxes.

After making this agreement on April 12, 1957 , York was allowed to proceed with the work commencing the week of April 25, 1957 , and so far as York was concerned, finishing the week of September 25, 1957 . Certain odds and ends called the "punch list" remained, and Home Indemnity employed Jayhawk Electric Construction Company (Jayhawk) to complete the subcontract. This was done by November 28, 1957 , but as a dispute arose over the amount due Jayhawk, they were not paid by Home Indemnity until April 7, 1958 .

A total of $22,852.47 was deposited in the joint control account from payments made by Oil Capital on the subcontract. Of this amount $19,791.38 was paid out for material expenses, and the balance of $3,061.09 was withdrawn by Home Indemnity for its own use. In addition to amounts paid out of the joint control account, Home Indemnity made necessary labor and material payments and thereby suffered a suretyship loss of $21,794.81.

The United States Government made assessments for payroll withholding taxes against York on May 31, 1957 , November 15, 1957 , and March 7, 1958 , respectively, filing notices of tax liens on January 3 and on June 4, 1958 . Notice of levy and demand were served on Oil Capital for the unpaid taxes.

[Balance Due Paid into Court]

Upon completion of the subcontract there remained due and owing an unpaid portion of the subcontract price which Oil Capital refused to deliver. Home Indemnity, Use Plaintiff here, as York 's assignee, pursuant to Sections 270(a) and 270(b) of the Miller Act, supra, brought this action against Oil Capital and its surety, American Employers'. The Defendants answered jointly, admitting liability but pleading the Federal tax liens as an affirmative defense. A motion to interplead the United States was granted, whereupon the Government answered, asserting the tax liens and crossclaiming against the Use Plaintiff, Home Indemnity, for the sum of $2,345.25 plus interest for payroll taxes not paid by York on the Grand Forks Air Force Base project. The tax liens asserted include York 's tax liabilities incurred on the Grand Forks job, but the Government contends that Home Indemnity is liable on its bond for this sum independently of the tax liens.

The Government moved to add York as an Indispensable Party Defendant which motion was granted. York did not appear or answer, and judgment for $11,175.71, the full amount of the taxes plus interest, will be entered against York in favor of the United States of America .

On trial it was stipulated that the total tax liability of York was $11,175.71 plus interest, and the sum left due and owing under the subcontract was $12,000.00. Oil Capital and its surety, American Employers', admitting liability, have paid into this court the $12,000.00 now in dispute.

The Government bases its claim to the fund here in issue upon 26 U. S. C. A., Section 6321, which reads so far as is here relevant:

"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."

The section following provides that a lien for taxes "shall arise at the time assessment is made."

Section 6321 creates no property rights but merely attaches consequences, Federally defined, to rights created under state law, United States v. Bess [58-2 USTC ¶9595], 357 U. S. 51, 78 S. Ct. 1054, 2 L. Ed. 2d 1135; and the right to recover from the fund must be based upon the strength of a claimant's title and not on the weakness of the title of another claimant, United States v. Chapman [60-1 USTC ¶9667], 281 F. 2d 862.

The Government contends that York completed the subcontract, merely obtaining financial aid from its surety, Home Indemnity. To better understand the Government's argument, the following is quoted from the Government's brief, P. 8, 9:

"Counsel for Home Indemnity, in their brief, cite numerous cases to show that, if a taxpayer-contractor defaults on performance of his contract, according to applicable state law there is no sum due him under the contract, to which deferal tax liens can attach. All of this is, in general, good and settled law, with which the Government has no dispute. However, this law has nothing whatever to do with the case at bar. Rights to the fund in issue in the instant case do not arise under a contract governed by state law. They arise under a bond issued pursuant to the Miller Act, and rights under such a bond are governed by federal law, i. e., Sections 1 and 2 of the Act. Leibman v. United States for Use and Benefit of Cal. Elec. Supply Co., 153 F. 2d 350 (C. A. 9th); Continental Casualty Co. v. Schaefer, 173 F. 2d 5 (C. A. 9th), certiorari denied, 337 U. S. 940, rehearing denied, 338 U. S. 841."

The Government then argues that only York as supplier of labor or materials could recover from American Employers' under the Miller Act.

[Subcontractor Acted as Surety's Agent]

With this contention this Court does not agree, but finds that, in effect, York was a mere agent of Home Indemnity and was the vehicle utilized by the surety in completing the subcontract as required by the performance bond. Central Surety and Insurance Corp. v. Martin Infante Co., 272 F. 2d 231.

It is true that original jurisdiction in this action was predicated on the Miller Act which gives the Use Plaintiff the right to proceed directly against the prime contractor's surety. The Use Plaintiff's theory in the original complaint was that the subcontract had been performed by York and, as York 's assignee, the action could be instituted directly against both Oil Capital as principal, and American Employers' as surety, on the payment bond.

The complexion of the case changed, however, after the original Defendants answered jointly, admitted liability, interpleaded the Government and paid into the Court's registry account the disputed sum of $12,000.00. An amended complaint was filed by Home Indemnity wherein its rights to the fund were based upon two theories, the first as assignee of York Electric, and the second on its rights as completing surety (subrogation). It is on the second theory that Home Indemnity must prevail if at all. United States v. Bess, supra; United States v. Acri [55-1 USTC ¶9138], 348 U. S. 211, 75 S. Ct. 239, 99 L. Ed. 264; United States v. City of New Britain [54-1 USTC ¶9191], 347 U. S. 81, 74 S. Ct. 367, 98 L. Ed. 520; United States v. White Bear Brewing Company [56-1 USTC ¶9440], 350 U. S. 1010, 76 S. Ct. 646, 100 L. Ed. 871; United States v. Ball Construction Company [58-1 USTC ¶9327], 355 U. S. 587, 78 S. Ct. 442, 2 L. Ed. 2d 510; cases wherein it was held that under Federal law for a lien to be valid it must be choate, and in the case of a surety's lien growing out of assignment it was inchoate, and therefore, not on the same footing as the Federal tax liens.

The first issue to be determined here is set out in Aquilino v. United States [60-2 USTC ¶9538], 363 U. S. 509, 512; 80 S. Ct. 1277; 4 L. Ed. 2d 1365:

"The threshold question in this case, as in all cases where the Federal Government asserts its tax lien, is whether and to what extent the taxpayer had 'property' or 'rights to property' to which the tax lien could attach. In answering that question, both federal and state courts must look to state law, for its has long been the rule that 'in the application of a federal revenue act, state law controls in determining the nature of the legal interest which the taxpayer had in the property . . . sought to be reached by the state.' Morgan v. Commissioner [40-1 USTC ¶9210], 309 U. S. 78, 82. * * * However, once the tax lien has attached to the taxpayer's state-created interests, we enter the province of federal law, which we have consistently held determines the priority of competing liens asserted against the taxpayer's 'property' or 'rights to property.'"

The Home Indemnity rights arising by subrogation relate back to the date of the execution of the performance bond. Prairie State Nat. Bank of Chicago v. United States, 164 U. S. 227, 17 S. Ct. 142, 41 L. Ed. 412; Henningsen v. United States Fidelity and Guaranty Company, 208 U. S. 404, 28 S. Ct. 389, 52 L. Ed. 547; United States Fidelity and Guaranty Company v. Sweeney, 80 F. 2d 235; Gilbertson v. Northern Trust Company, 53 N. D. 503, 207 N. W. 42; and it is entitled to the benefit of every security for the performance of the principal obligation held by the creditor at the time of entering into the contract of suretyship. North Dakota Century Code, Section 22-03-12 .

[Subcontractor Had No Property Rights]

Under North Dakota law, York Electric had no "property" or "rights to property" in the subcontract price to which Federal tax liens could attach. North Dakota follows the general rule 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. North Dakota Century Code, Section 9-01-16 ; Kupfer v. McConville, 35 N. D. 622, 161 N. W. 283. Since the Government's rights can rise no higher than those of York Electric, there was nothing to which the liens could attach. Central Surety and Insurance Corp. v. Martin Infante Co., Supra; Atlantic Refining Co. v. Continental Casualty Co. [60-1 USTC ¶9413], 183 F. Supp. 478. It appears to this Court that United States v. R. F. Ball Construction Company, Supra, would control here, as the Government contends, only if Home Indemnity was basing its action as York 's assignee. As this Court understands it, the rationale of Ball suggests that an assignment made by a subcontractor to his performance-bond surety of all sums to become due for performance of the subcontract, as security for any indebtedness or liability thereafter incurred by the subcontractor to the surety, did not constitute the surety a mortgagee of those sums within the meaning of the Internal Revenue Code of 1939, Section 3672(a), as amended.

It does appear, however, that since Aquilino, supra, and United States v. Durham Lumber Company [60-2 USTC ¶9539], 363 U. S. 522, 80 S. Ct. 1285, 4 L. Ed. 2d 1371, the so-called "choateness" rule of Ball has been restricted and the priorities will be established by state law. This is high-lighted by the dissenting opinion of Mr. Justice Harlan in Aquilino, supra, P. 521, wherein he says:

"* * * If the federal standard of choateness is thought to be an undesirable restriction on the States' freedom to regulate property relationships, the cases establishing that standard should be expressly overruled and not emasculated by dubious distinctions."

It is evident then that Home Indemnity's subrogation rights take priority over the tax liens of the United States . In Massachusetts Bonding and Ins. Co. v. State of New York [58-2 USTC ¶9704], 259 F. 2d 33, 37, 38, the Court said:

"The questions here are whether the bankrupt defaulted so as to bring into operation the rights of the surety, and if so, whether these rights to payments from the owner take priority over tax claims of the State of New York and the United States . Both the State and the United States vehemently argue that the default contemplated in the contract between the bankrupt and the surety never occurred, and hence the assignment never matured; nor did the surety acquire a lien by way of subrogation. To some extent the arrangement created by the bankrupt and the surety whereby construction costs were paid out of the joint account into which they deposited progress payments supports this argument, for nominally the bankrupt continued its operations subject only to financial supervision by the surety. In this way construction activity never ceased and bills were paid without material delay. But to analyze these facts so as to deprive the surety of its claim based on subrogation when it actually provided over $136,000 of its own money to pay laborers and materialmen is too technical to warrant serious consideration. * * *"

It is felt that the foregoing quotation aptly describes the situation in the case at bar.

[Surety Itself Liable for Payroll Taxes]

The Government is entitled to judgment on its cross-claim against Home Indemnity for withholding taxes not paid but incurred in performance of the subcontract.

Where a surety issues a performance bond conditioned upon the faithful performance of a contract in which there is no requirement that all taxes be paid, the Government cannot recover on the bond for unpaid taxes incurred by a defaulting principal. United States v. Crosland Construction Company [55-1 USTC ¶9112], 217 F. 2d 275; Westower v. Wm. Simpson Construction Co. [54-1 USTC ¶49,022], 209 F. 2d 908; General Casualty Co. of America v. United States [53-2 USTC ¶9483], 205 F. 2d 753; United States Fidelity & Guaranty Co. v. United States [53-1 USTC ¶9249], 201 F. 2d 118; First National Bank in Yonkers v. City of New York [59-2 USTC ¶9639], 177 F. Supp. 175. An exception occurs, however, where the surety guarantees the faithful performance of all covenants and agreements in the contract, and these include an agreement to pay all the taxes payable because of the work. United States v. Phoenix Indemnity Company [56-2 USTC ¶9659], 231 F. 2d 573.

The contract upon which Home Indemnity issued its performance bond provided that:

"The Subcontractor (York) shall pay all taxes of whatever kind imposed by any governmental authority in connection with his work, including but not limited to sales taxes, unemployment compensation and social security taxes. * * *"

But here the performance bond specifically provides that:

"No right of action shall accrue on this bond to or for the use of any person or corporation other than the Owner herein or the heirs, executors, admin istrators or successors of Owner."

And the Government cannot recover as a third party beneficiary as it did in the Phoenix case. United States v. Island Constructors, Inc., 179 F. Supp. 133.

This Court would be inclined to follow the view taken in Island Constructors, supra, if it were not for the fact that York was merely the means utilized by Home Indemnity in completing the subcontract. By this the Court means only that where the taxes are incurred under the facts here present is the surety to be held liable.

The Court finds that the Interpleaded Defendant, United States of America, is entitled to judgment against The Home Indemnity Company upon the Government's cross-claim in the sum of $2,345.25 plus interest, that being the amount of the unpaid taxes arising out of the completion of the subcontract on the Grand Forks Air Base.

The Court further concludes that The Home Indemnity Company is entitled to judgment in the sum of $12,000.00 against American Employers' Insurance Company and Oil Capital Construction Company.

So far as the Use Plaintiff, The Home Indemnity Company, and the Interpleaded Defendant, the United States of America, are concerned, the ultimate result is that of the $12,000.00 in the Clerk's custody the United States is entitled to the unpaid taxes incurred in the prosecution of the work called for by the subcontract, in the sum of $2,345.25, together with interest thereon as provided by law, and The Home Indemnity Company is entitled to the balance remaining.

No costs will be allowed or assessed against any party to this litigation.

The attorneys for the Use Plaintiff, The Home Indemnity Company, a corporation, will prepare appropriate findings of fact, conclusions of law, order for judgment and judgment, in conformance herewith and transmit them through the Clerk of this court.

 

 

[53-1 USTC ¶9249]United States Fidelity and Guaranty Company, a corporation, Appellant v. United States of America, Appellee

(CA-10), In the United States Court of Appeals for the Tenth Circuit, No. 4497--November Term, 1952, 201 F2d 118, December 30, 1952

Appeal from the United States District Court for the District of New Mexico.

Collection of income tax at source on wages: Liability of surety in case of government contracts.--Appellant, surety on a subcontractor's payment bond pursuant to a subcontract entered into with a prime contractor for the construction of a public building, is not liable for withholding taxes which the principal withheld from the wages of its employees but did not pay to the Government, such delinquency not being a breach of the subcontractor's contractual obligation to pay all claims for wages and material. For the same reason the liability of the subcontractor for the withholding taxes was not a part of the liability of the contractor under its payment bond. Furthermore, the surety's claim to the funds accruing from performance of the subcontract is superior to the government's tax liens. When, after the subcontractor's default on the contract, surety performed, it was subrogated to all the rights that the prime contractor held against the subcontractor, and these rights were effective from the date of the subcontract, which was prior to the date when the Government's tax liens were perfected. One dissent.

Justin T. Reid and J. Harry Cross (A. K. Montgomery and Wm. R. Federici were with them on the brief), for appellant, Louise Foster (Charles S. Lyon, Acting Assistant Attorney General, Ellis N. Slack, A. F. Prescott, and Fred E. Youngman, Special Assistants to the Attorney General, and Maurice Sanchez, United States Attorney, were with her on the brief), for appellee.

Before HUXMAN, MURRAH and PICKETT, United States Circuit Judges.

HUXMAN, Circuit Judge:

The Construction Department of the United States Army entered into a contract with C. H. Leavell and Company for the construction of the Missile Building at White Sands Proving Grounds in New Mexico . Leavell entered into a subcontract with Kendrick Electric, Inc., for performance of part of this work. The United States Fidelity and Guaranty Company executed the payment bond for Kendrick required by the Miller Act. ¹ In the application for the bond Kendrick assigned to the surety company as collateral to secure its obligations under the bond all right, title and interest it had under the subcontract, including all retained percentages, deferred payments, earned money, etc. Kendrick defaulted in the discharge of its obligations under its subcontract. In addition to claims for materials, supplies and equipment due from Kendrick, it was also indebted to the United States for withholding taxes from its employees, withheld by it from their wages but not paid to the Government. Demand being made upon Kendrick's surety by Leavell, it paid all unpaid claims for materials, supplies and equipment due from Kendrick. At that time there was due Kendrick from Leavell on the subcontract the sum of $4,960.24. Conflicting claims were asserted to this fund. The Government claimed prior right thereto in satisfaction of its lien for federal income taxes and federal unemployment taxes assessed against Kendrick. The surety company claimed prior right thereto by virtue of the assignment of all funds in the application by Kendrick for the bond. The trial court decided the issue in favor of the Government. This appeal challenges the correctness of that conclusion.

In its conclusions of law the trial court held that Kendrick agreed to and accepted full and exclusive liability for the payment of these withholding taxes and that it was obligated to the United States for their payment and that under the surety company's bond for the performance of Kendrick's obligations it became liable for their payment.

It is true that in Paragraph 12 of the subcontract Kendrick assumed and accepted "full and exclusive liability for the payment of any and all contributions or taxes for Unemployment Insurance and/or Old Age Retirement Benefit, Pensions, or Annuities, * * *" imposed by the Government and measured by the wages paid to its employees. But this did not create the liability on Kendrick's part for the payment of these taxes. It was merely declaratory of Kendrick's existing liability under the federal tax laws.

26 U. S. C. A. §1401(a) and 26 U. S. C. A. §1622(a) deal with the imposition of withholding taxes. §1401(a) provides that the tax imposed by §1400 shall be collected by the employer by deducting the amount thereof from the employee's wage. §1622(a) provides that "every employer making payment of wages shall deduct and withhold upon such wages a tax equal to * * *." 26 U. S. C. A. §1623 provides that "The employer shall be liable for the payment of the tax required to be deducted and withheld under this subchapter [§1622], and shall not be liable to any person for the amount of any such payment." A similar provision is contained in 26 U. S. C. A. §1401(b). By Treasury Regulation 116 §405.301 and Regulation 128 §408.304 the employer's liability for the tax attaches whether or not he withholds it from the wages and the amount withheld from the wages of an employee shall be allowed to him as a credit on his income tax liability ² and the Government shall make a credit or refund to the employee "even though such tax has not been paid over to the Government by the employer." ³ It is thus clear that Kendrick's liability for the payment of these taxes arises by virtue of law and not because of any contractual acknowledgment of the existing legal liability.

The trial court's conclusion that Kendrick breached its construction contract with Leavell was not predicated on the ground that it had failed to discharge its tax liability for these withholding taxes to the Government. Rather the court seems to have concluded that the sums withheld constituted wages and failing to pay them over to the Government constituted a breach of the contract requiring it to pay all wages. ⁴ This is also one of the contentions made by the Government on appeal. In its brief the Government states: "The amounts covered by the liens of the United States represent amounts deducted and withheld from wages paid by Kendrick Electric, Inc., to its employees in the performance of its subcontract. They represent a part of the liability assumed by the prime contractor and its surety for the payment of labor and material and to the extent of such withholding the United States succeeded to the rights of the wage earners by operation of law." And that "Under the circumstances the United States succeeds by operation of law to the rights of the wage earners to the amounts deducted and withheld from wages as effectively as if it had taken a written assignment from the wage earners covering the withheld portion of their wages." However, from the statutes and regulations as set out it seems clear that when an employer withholds the tax from an employee's wage and pays him the balance the employee has been paid in full. He has received his full wage. Part of it has gone to pay his withholding tax and the balance he has. The employer has discharged his contractual obligation to pay the full wage. Thereafter there remains only his liability for the tax which he has collected. That is a tax liability for which he alone is liable to the Government as for any other taxes which he may owe. ⁵

The Government in its brief cites a line of cases in support of its contention that failure to pay taxes such as these imposes liability under similar payment bonds. A detailed analysis of each case would unduly extend this opinion. Typical of this line of cases are Standard Insurance Co. v. United States, 302 U. S. 442, and Illinois Surety Co. v. John Davis Co., 244 U. S. 376. In the Standard Insurance Company case the Supreme Court held that a common carrier's claim for freight charges for the transportation of materials used in the construction of a federal building was one for labor and materials within the meaning of the act requiring the bond, and in the Illinois Surety Company case the Supreme Court held that the rental for cars and the expense of loading the plant there involved and freight thereon used in fulfillment of the contract constituted labor and materials within the act requiring a bond from the contractor. The facts in the other cases relied upon also distinguish them and make them inapplicable to the question before us. These cases as well as the others all hold that the Miller Act and the acts preceding it should be liberally construed in determining what constituted furnishing labor, material or supplies, but no case to which our attention has been called goes so far as to hold that an employer's tax liability is within the provision of the bond merely because wages were used in paying the employee's tax liability and creating that of the employer.

[Payment Bond Does Not Cover Tax Obligations]

The Government further asserts that "The liability of the subcontractor to deduct and withhold a part of the wages of its employees, and to pay over to the Collector the portion of wages so withheld, was as much a part of the liability of the prime contractor under its Miller Act bond to pay for labor and material as was its liability to pay the net 'take-home' wages of such employees." The reasons that impel us to conclude that Kendrick's liability for these taxes was not a liability for the payment of wages and that failure to pay them to the Government was not a breach of its contractual obligation to pay all wages and material claims requires the same conclusions with respect to this contention. The debate on the floor of Congress indicates that the performance bond of the Miller Act was to make the contractor liable for default by reason of his inability to complete the contract or by reason of failing to meet the requirements and specifications as to material, and that the payment bond was to insure the contractor's liability for claims of subcontractors, material-men and laborers. ⁶ There is nothing in the legislative history of the Miller Act or the acts which it succeeded to indicate that the performance bond was to cover any obligations other than the requirement that the contractor complete his contract according to its specifications.

[Priority of Surety's Claim Over Tax Liens]

Finally it is contended that the Government's lien for these taxes is superior to the surety's claim to these funds. This contention has been decided against the Government in a series of cases. As pointed out in the application for the payment bond, Kendrick assigned to the surety company all its right, title and interest in and to any funds it was entitled to receive from the principal contractor, Leavell, to indemnify it against liability to which it might become subjected by virtue of Kendrick's breach of its construction subcontract. At the time the surety company became liable and discharged its liability by paying all material, supply and labor claims, the fund in question was due Kendrick from Leavell. When a surety is called upon and makes good under its contract of suretyship upon default of its principal, it acquires an equitable lien against any sum remaining in the hands of the one for whose protection the bond was written due to its principal upon discharge of his obligation under its bond. This equitable lien relates back to the date of the contract and is superior to a Government lien for unpaid taxes subsequent to the date of the contract of suretyship, although prior to the date of payment by the surety. ⁷

The case of the United States v. Security Tr. & Sv. Bank, 340 U. S. 47 [50-2 USTC ¶9492], upon which the Government relies is distinguishable upon the facts. There it was held that the equitable doctrine of relation back will not operate to defeat the specific and perfected tax lien of the United States . In that case the Federal Government had perfected its tax lien against real estate belonging to a defendant debtor in the state court in an action in which the plaintiff had caused an attachment lien to be filed against the debtor's property. Under California law the attachment gave him only an inchoate lien which became perfected upon the entry of judgment. The effect of the decision by the Supreme Court is that the judgment subsequent to the perfection of the Government's tax lien did not relate back to the date of the filing of the attachment so as to give the judgment creditor a lien superior to the tax lien of the Government. It is to be noted that both liens attached to property belonging to the defendant debtor, property that was his at all times. Such is not the case here. On the date of the execution of the subcontract the prime contractor had a specific right of ownership in any funds accruing to the subcontractor from the performance of his subcontract. The right to withhold these funds upon default was superior to any other claim against the fund as the property of the subcontractor. When the subcontractor defaulted and its surety, the appellant in this case, performed, it stepped into the shoes of the prime contractor and was subrogated to all rights that it held against the subcontractor. Those rights related back to the date of the subcontract and were effective from the date thereof. This was in point of time prior to the perfection of the Government's tax liens. Actually the defaulting subcontractor had no right to this fund. It owed the principal contractor more than was due to it from such principal contractor. As between the Government and appellant surety who stepped into the shoes of the principal contractor, the Government could acquire no greater right to this fund than the subcontractor had.

The judgment of the trial court is REVERSED and the cause is remanded to proceed in conformity with the views expressed herein.

¹ 40 U. S. C. A. 270a.

² 26 U. S. C. A. §35.

³ Treasury Regulation 116 §405-401.

⁴ In its conclusion of Law No. 2 the court stated that "Under the terms of the subcontract, Kendrick Electric, Inc., was and is obligated to pay all wages due labor used in performance of such sub-contract and that the withholding taxes for which the United States makes claim are part of the wages due said labor, having been previously deducted and withheld by the employer, and that under the surety bond, on default by said employer Kendrick Electric Inc., the surety, plaintiff herein, became liable for the payment of such withholding taxes."

⁵ United States v. New York , 315 U. S. 510.

⁶ Congressional Record, Volume 79, Page 13, 382.

⁷ Glenn v. American Surety Co., 160 Fed. (2d) 977 [47-1 USTC ¶9220]; New York Casualty Co. v. Zwerner, 58 Fed. Supp. 473 [45-1 USTC ¶9140]; Farmers' Bank v. Hayes, 58 Fed. (2d) 34; Prairie State Bank v. United States , 164 U. S. 227.

PICKETT, Circuit Judge, dissenting:

It seems to me that my colleagues take too narrow a view of the coverage intended by the terms of the performance and payment bond in this case. Under the statute and the provisions of the bond, the surety has the primary obligation to pay the wages of the laborers upon default of the contractor. This obligation extends to the full amount of the wages earned and not just a percentage or portion of them. I can see no reason why this obligation should be diminished because the law requires that a portion of the wages be diverted to the United States for the payment of income taxes and other benefits for the wage earners. By holding the surety responsible for the amounts withheld from the wages under the law, no more is required than what the surety agreed to do and for which it was paid a premium. To so hold does not injure or mislead the surety or extend its liability in any manner.

Where a wage earner has assigned his wages or a portion of them to a third party, the surety is responsible to the assignee if the employer defaults. U. S. Fidelity and Guaranty Co. v. Bartlett, 231 U. S. 237; Title Guaranty & Trust Co. v. Crane Co., 219 U. S. 24; Third National Bank of Miami v. Detroit Fidelity & Surety Co., 5 Cir., 65 Fed. (2d) 548, certiorari denied, 290 U. S. 667; United States v. Rundle, 9 Cir., 100 Fed. 400; National Market Co. v. Maryland Casualty Co., 100 Wash. 370, 170 Pac. 1009; Northwestern Nat. Bank v. Guardian Casualty & G. Co., 93 Wash. 635, 161 Pac. 473; 43 Am. Jur., Public Works and Contracts, Sec. 152; Anno. 77 A. L. R. 149. I see no essential difference in this case and the assignment cases. The liability remains exactly the same as though the full amount of the wage earned was due to the wage earner. Under such conditions, the surety should bear any loss in the total amount of the wages earned even though a portion of the wages bears the label of a tax. This type of case is easily distinguishable from those where it was sought to hold the surety liable for ordinary taxes of the employer.

In determining whether the amounts withheld are part of wages earned or strictly a tax, the provisions of the Miller Act and the bond should be given a liberal construction to require full coverage of the bond. Fleisher Engineering & Construction Co. v. United States, 311 U. S. 15; Massachusetts Bonding & Ins. Co. v. United States, 5 Cir., 88 Fed. (2d) 388. I would affirm the judgment.

 

 

[69-1 USTC ¶9148]Fireman's Fund Insurance Company, Appellant v. C. S. Leonard, Individually and Trading as Leonard Excavating Company, W. W. Wendell Company, Inc., a Pennsylvania Corporation and Agricultural Insurance Company, a New York Corporation

(CA-3), U. S. Court of Appeals, 3rd Circuit, No. 17170, 10/1/68, Aff'g an unreported District Court opinion

[Code Sec. 6323 prior to enactment of P. L. 89-719]

Lien for taxes: Notice: Surety's interest: Subrogation.--A surety's interest in certain materials subject to a federal lien for unpaid withholding taxes did not ripen until after the lien was filed. The surety had notice of the lien and could not, consequently, claim ownership by reason of subrogation.

Rob ert F. McCabe, Jr., 930 Grant Bldg., Pittsburgh , Pa. , for appellant. James C. Larrimer, Dougherty, Larrimer, Lee & Hickton, Grant Bldg., Pittsburgh , Pa. , for appellees.

Before BIGGS, FREEDMAN and VAN DUSEN, Circuit Judges.

Opinion of the Court

PER CURIAM:

Fireman's Fund Insurance Company, a California surety company doing business in Pennsylvania , appeals to this court from the denial of its motion for a new trial in the court below. The facts are as follows.

On December 26, 1963 , Stanton Construction Company entered into a written contract with the Lower Yoder Municipal Authority of Cambria County, Pennsylvania, for the construction of a sewage collection system. Pursuant to the contract Stanton gave bonds for the faithful performance of the contract and the payment for materials and labor furnished. Fireman's Fund was surety on the bonds. The United States made an assessment under Sections 3402-03 of Chapter 24 ("Collection of Income Tax at Source on Wages") of the Internal Revenue Code of 1954 (26 U. S. C. §§ 3402-03 (1958)), against Stanton for the fourth quarter of 1963 and for every quarter of 1964, the last assessment date being November 4, 1964. Notice of liens was filed in the offices of the Prothonotary and Recorder of Deeds for Allegheny County on November 9, 1964 . The United States then executed on Stanton 's assets. It is clear that all interested parties including Fireman's Fund had notice of the liens when filed.

On November 25, 1964 Stanton was declared in default by the Municipal Authority. At that time Stanton was in possession of pipe and other materials for which payment had not been made. Fireman's Fund paid the materialmen and by reason of these payments acceded to Stanton 's interest in the materials under the assignment provisions of the bonds. On May 27, 1965 the United States sold the pipe and other materials at public sale to Wendell and Leonard, the new contractors. The Internal Revenue Service thereupon issued a certificate of sale to Wendell and Leonard. Fireman's Fund objected to these proceedings claiming ownership of the pipe.

The suit at bar is to recover the value of the pipe, Fireman's Fund contending that the material in question belonged to it by reason of subrogation. The argument is without merit. The federal tax lien was good against all persons having notice of it. See 12A P. S. §9-401(a) and 26 U. S. C. §§ 6321-22. Fireman's Fund is merely a general creditor. Its rights as subrogee did not ripen until the declaration by the Municipal Authority of the default, by which time the federal tax liens had already been filed.

Accordingly, the judgment will be affirmed.

 

 

[47-1 USTC ¶9220]Seldon R. Glenn, Collector, Appellant, v. American Surety Company of New York and the New York Casualty Company, Appellees

(CA-6), United States Circuit Court of Appeals, Sixth Circuit, No. 10302, 160 F2d 977, Decided April 1, 1947

Appeal from the District Court of the United States for the Western District of Kentucky.

Procedure: Correction of appeal record.--The Collector filed notice of appeal from a District Court decision, but did not file a record. The United States filed a record, but not a notice of appeal. The Court, in the discretion granted it by Rule 73(g) of the Federal Rules of Civil Procedure, grants the motion of the United States to correct the caption of the record, instead of dismissing the appeal.

Prohibition of suits to restrain assessment or collection: Application to third parties.--The statutory prohibition against suits to restrain the assessment or collection of taxes (Code Sec. 3653) applies to such suits by taxpayers, not to a third party seeking to enjoin the Collector from taking his property to pay the taxes of another.

Lien for taxes: Validity against sureties of taxpayer: Prior liens.--Lien for taxes is invalid against a taxpayer's surety's claim for interest upon the amount expended by it in making good under its contract of suretyship upon default of its principal (taxpayer). (The right of the sureties to recover their expenditures in principal amount is not here challenged.) One dissent. Affirming the decision of the District Court in American Surety Company of New York et al. v. City of Louisville Municipal Housing Commission et al., 63 Fed. Supp. 486.

Irving I. Axelrad, Washington, D. C., Sewall Key, Louis Monarch and Norman S. Altman, Washington, D. C., David C. Walls and A. Roy Copeland, Louisville, Ky., with him on brief, for appellant. Rob ert L. Blackwell, Louisville, Ky., William Marshall Bullitt and R. Lee Blackwell, Louisville, Ky., with him on brief, and Bullitt & Middleton, of counsel, for appellees.

Before SIMONS, ALLEN and MARTIN, Circuit Judges.

[The Issue]

SIMONS, Circuit Judge.

The only substantive question that appears to be left of the controversy in the present posture of the appeal, is whether sureties for the faithful performance by a contractor after satisfying the debts of their principal, are entitled to interest upon the amounts expended, recoverable out of retained percentages as against the claim of the government for taxes asserted against the same funds. The right of the sureties to recover their expenditures in principal amount, though unsuccessfully contested below, is not here challenged. Before reaching that question, however, it becomes necessary to solve a procedural problem raised by the appellees' motion to dismiss the appeal, and a motion of the appellant to correct the caption of the record.

[The Facts]

The controversy arose out of the following circumstances. On October 3, 1941 , one W. J. Paul entered into a contract with the Louisville Municipal Housing Commission to perform certain public housing construction work. Paul, as principal, and the appellees as sureties, delivered to the Housing Commission a faithful performance bond in the penal sum of $540,214, guaranteeing the faithful performance of the construction work and the payment of all obligations incurred in connection with it. Paul completed the contract but defaulted in the payment of labor and material claims in amounts totaling $52,571.57. Pursuant to the terms of the contract the Housing Commission withheld from Paul $59,647.72. On August 12, 1943 , Glenn, Collector of Internal Revenue for Kentucky , served a notice of levy and a warrant for distraint upon the Housing Commission for delinquent internal revenue taxes owed by Paul, in the amount of $13,029.28. The Kentucky Unemployment Compensation Commission also filed a lien against the fund, but since it has not appealed its claim of lien disappears from the case. Upon being notified that the Housing Commission proposed to pay the federal tax out of the retained percentages, the sureties brought suit to restrain the Commission from paying any money to the Collector until their claims were satisfied, and for a declaration of right that their claims were prior liens against the retained fund. A temporary restraining order was followed by a temporary injunction and the sureties paid the claims against Paul in amounts totaling $52,571.57. The Collector was made a party defendant to the suit, the United States intervened and, upon motion for summary judgment, the sureties were adjudged to have an equitable lien upon the fund which had, in the meanwhile, been deposited in the registry of the court, in an amount covering their payment of the debts of Paul with interest from the date of payment, and the clerk of the court was directed to make payment to them out of the fund on deposit in the registry. The facts are not in dispute and are sufficiently recited in the memorandum of the district judge. American Surety Co. et al. v. Louisville Municipal Housing Commission et al., 63 Fed. Supp. 486.

On March 8, 1946 , and within the jurisdictional period, the Collector filed a notice of appeal. After several extensions a record was filed and the appeal docketed in the name of the United States on July 17, 1946 . Subsequently, a motion was filed to correct the notice of appeal by substituting the United States , intervenor, for the Collector, and on July 29 an order was entered correcting the notice of appeal pursuant to the motion. Thereafter, by stipulation, the order of July 29 was vacated, and on October 16 an order was entered denying the motion of July 17, but without prejudice to a consideration of the rights of the United States as they may appear at the hearing of the case upon its merits. In January, 1947, the sureties moved to docket and dismiss the appeal of Glenn because he had failed to file a record and to docket his appeal on or before the return date, as enlarged, and to dismiss the appeal of the United States because it had failed to file a notice of appeal within the required time. The United States thereupon moved that the caption of the record and docket entry be corrected by a nunc pro tunc decree substituting the Collector for the United States as the appellant.

[Correction of Caption of Record and Docket Entry]

We have, then, this situation. The Collector filed the notice of appeal but did not file a record. The United States filed a record but had failed to notice an appeal within the statutory period. The United States now seeks to correct the docket by substituting Glenn as the appellant, which the sureties oppose. The sureties seek a dismissal of the appeal because of the variance between the party filing the notice and the party perfecting the record. Rule 73(g) of the Federal Rules of Civil Procedure, requires a docketing of the appeal within 40 days from the date of notice, and Rule 73(a) provides that the failure of the appellant to take any further steps following his notice of appeal will not affect its validity, but is ground for such remedies as may seem appropriate to the appellate court, including dismissal of the appeal. That remedy the sureties would now have us apply. Our jurisdiction attaches at the time of filing the notice of appeal, and whether a dilatory appellant should be allowed to proceed is within our discretion. Ispass v. Pyramid Motor Freight Corp., 152 Fed. (2d) 619 (C. C. A. 2). This discretion could be exercised if we grant the motion of the United States to correct the caption of the record, which would make it Glenn's record filed out of time, and this we think ought to be done for it is apparent that the caption of the record was a clerical error made by the United States Attorney who represented both the Collector and the United States as intervenor. The courts, in general, have liberally construed the rule. Mosier v. Federal Reserve Bank, 132 Fed. (2d) 710 (C. C. A. 2); Ainsworth v. Gill Glass & Fixture Co., 104 Fed. (2d) 183 (C. C. A. 3); National Surety Co. v. Williams, 110 Fed. (2d) 873 (C. C. A. 8).

A more fundamental and less technical ground for permitting the extension and correction, however, appears. The Collector, in asserting the rights of the United States to the reserved fund for the payment of Paul's taxes, was acting not in his individual capacity but as the agent of the United States . Second Nat'l Bank of Saginaw v. Woodworth, 54 Fed. (2d) 672 (D. C., S. D. Mich.) [1932 CCH ¶9049], affirmed 66 Fed. (2d) 170 (C. C. A. 6) [1933 CCH ¶9429]. While he was the formal party defendant, the real party in interest was the United States , which, by its intervention in the suit, likewise became a formal party thereto. The interests of the Collector and the United States were, however, identical. The tax, if collected, would be remitted to the Treasury of the United States . The appeal could have been prosecuted either by Glenn or the government. While it has been held, Sage v. U. S., 250 U. S. 33 [1927 CCH ¶7184], that a suit against the Collector for the recovery of an illegally held tax is not a suit against the United States, in respect to the application of the doctrine of res judicata, yet it has also been held that a judgment for or against the United States is binding upon the Collector who is the agent or trustee for the government. Second Nat'l Bank of Saginaw v. Woodworth, supra. However, it has been with great clarity pointed out that a suit against a Collector is today "an anomalous relic of bygone modes of thought" when he is engaged merely in the fulfillment of a ministerial duty. Moore Ice Cream Co. v. Rose, 289 U. S. 373, 382 [3 USTC ¶1100]. There Mr. Justice Cardozo observed, "There may have been utility in such procedural devices in days when the Government was not suable as freely as now (citing cases). They have little utility today, at all events where the complaint against the officer shows upon its face that in the process of collecting he was acting in the line of duty, . . . In such circumstances his presence as a defendant is merely a remedial expedient for bringing the Government into court." Whether the present appeal could be by us entertained in the name of the United States, in view of this identity of interest between the government and the Collector, we need not now decide, but viewing the present situation realistically, we are not persuaded that the appeal should fail because the United States Attorney, through neglect, excusable or otherwise, failed to caption the record in the name of the Collector who had filed the notice of appeal. We held in Toledo Edison Co. v. McMaken, 103 Fed. (2d) 72 [39-1 USTC ¶9447], cert. den. 308 U. S. 569, that while a Collector could expressly or by indirection waive the statute of limitations in a suit against him, he could not impart to such waiver the obligation which the statute, Title 28 U. S. C. A., §842, imposes upon the government under certain circumstances to pay a judgment rendered against him individually. Similarly, we think, a neglect by the Collector to caption a record on appeal to conform to the notice of appeal, may not deprive the government of its hearing on appeal where the government is not only the real party in interest but is likewise a formal party, and now, by its motion, seeks to have the record conform to the notice. Wherefore, we conclude that the motion to dismiss the appeal must be denied and the motion to correct the caption of the record granted.

The contention of the sureties that if the Collector's name is substituted for that of the United States upon the record and docket entry, he cannot bring this appeal because of the provisions of Title 28 U. S. C. A., §732, which requires that all suits for recovery of taxes must be brought in the name of the United States, is, of course, without merit. The present suit was not brought by the Collector. He was made a party defendant at the suit of the sureties, and it would be novel doctrine, indeed, to hold a Collector, subjected to an adverse judgment, to be deprived, by reason of this statute, of the right to appeal. It was said in Moore Ice Cream Co. v. Rose, supra, "One who is brought before the court as a formal party only will not be heard to object that there has been a denial of due process in enlarging the liability to be borne by someone else." Similarly, it may be said that those who bring before the court one who is only a formal party will not be heard to challenge the right of such party to defend the suit or to review an adverse judgment.

[Suit to Restrain Assessment or Collection of Tax]

Coming to the substantive issue of law, the appellant is in the anomalous position of declining to assail the judgment for the amount paid by the sureties, yet contesting the award of interest thereon on the ground that it violates §3653 of the Internal Revenue Code which, with certain exceptions, forbids a suit to restrain the assessment or collection of a tax in any court. The short answer to the contention, if it is still in the case, is that given by the district judge in his preliminary memorandum of December 31, 1943, "The statute, however, applies to actions by taxpayers; it does not apply to a third party seeking to enjoin the Collector from taking his property to pay taxes of another. Tomlinson v. Smith, (C. C. A. 7th), 128 Fed. (2d) 808 [42-2 USTC ¶9540]; Rothensies v. Ullman, (C. C. A. 3rd) 110 Fed. (2d) 590 [40-1 USTC ¶9308]; Long v. Rasmussen, Collector, 281 Fed. 236. See Hubbard Investment Company v. Brast, Collector (C. C. A. 4th) 59 Fed. (2d) 709, 710 [1932 CCH ¶9366]." Neither the validity nor the timeliness of the tax nor the correctness of the amount sought, is here assailed, and the plaintiffs in the suit are under no obligation to pay the tax.

[Validity of Tax Lien]

There is left the contention that a surety is generally not entitled to interest upon its claim, and that the tax lien is superior to the interest charge because the latter is an unsecured claim against Paul which arose after the effective date of the tax lien. As to the first, the prevailing rule is that a surety has a right to be made whole when it fulfills its obligations under a contract of suretyship, and this includes interest upon the money expended by it in fulfilling its obligations until repaid. American Law Institute, Restatement of Security, §104; Memphis & Little Rock R. R. Co. v. Dow, 120 U. S. 287; American Surety Co. v. Carbon Timber Co., 263 Fed. 295 (C. C. A. 8). The rule that interest is not allowable on claims against a bankrupt or insolvent estate, as illustrated in Thomas v. Western Car Co., 149 U. S. 95, is not applicable here and rests upon a different principle. Where there is not enough money to pay all lienholders of the same rank entitled to share in the estate of a bankrupt or an insolvent, the disallowance of interest on all claims is but in pursuance of the rule of equitable treatment to all claimants. Nor is the rule which denied to a surety a profit on a building contract which it completes in default of its principal, available to the appellant. While interest may, in certain aspects, be considered as a profit to the lender or investor, it is not profit within the doctrine of authorities exemplified by Fidelity & Guaranty Co. v. Worthington & Co., 6 Fed. (2d) 502 (C. C. A. 5), cert. den. 269 U. S. 583; Lacy v. Maryland Casualty Co., 32 Fed. (2d) 48 (C. C. A. 4). Nor is it within the purview of those cases which deny to the surety the right to retain funds which accrue to it by reason of a favorable compounding of the debts of its principal as illustrated in Laber v. Gall, 110 Fed. (2d) 697 (C. A., D. C.); Martin v. Ellerbe's Adm'r, 70 Ala. 326; Coggeshall v. Ruggles, 62 Ill. 401. The principle applied in rendering the presently assailed judgment, is the right of the sureties to be made whole, and profit is not involved.

There remains the appellant's final contention that the claim for interest is unsecured in that it arose after the levy of the tax lien. We agree with the district judge that a surety who makes good under his contract of suretyship upon default of the principal contractor, acquires an equitable lien against the unpaid balance in the hands of the person in whose favor the bond runs, and that such equitable lien upon payment by the surety relates back to the date of the contract and is superior to a claim of the United States for unpaid taxes for periods subsequent to the date of the contract of suretyship, although prior to the date of payment by the surety. In re Zaepfel and Russell, 49 Fed. Sup. 709, aff. Farmers State Bank v. Janes, 135 Fed. (2d) 215 (C. C. A. 6); Farmers' Bank v. Hayes, 58 Fed. (2d) 34 (C. C. A. 6); Prairie State Bank v. U. S. , 164 U. S. 227. The cases relied upon by the appellant are not contra. New York v. Maclay, 288 U. S. 90, involved 31 U. S. C. A. §191, which provides that when a person indebted to the United States is insolvent and the estate insufficient to pay all debts of the deceased, those due the United States shall be first satisfied. No disposition of an insolvent's estate is here involved, and the statute has no present application. U. S. v. City of Greenville , 118 Fed. (2d) 963 (C. C. A. 4) [41-1 USTC ¶9381]. Michigan v. U. S., 317 U. S. 338 [43-1 USTC ¶9225], is further afield. It rejected the contention that a Michigan statute declaring state taxes to be a first lien upon real property on specified dates, could create a priority against an earlier lien for federal taxes under the Supremacy Clause of the United States Constitution, Art. 1, §8, "Hence it is not debatable that a tax lien imposed by a law of Congress, as we have held the present lien is imposed, cannot, without the consent of Congress, be displaced by later liens imposed by authority of any state law or judicial decision." Conceiving the liens of the sureties to have been created by the contract and effective as of its date, the doctrine in the Michigan case has no present application.

[Conclusion]

The motion to dismiss the appeal is denied, the motion to correct the docket and caption of the record by substituting Seldon R. Glenn, Collector, for United States of America , is granted, and the judgment below is

AFFIRMED.

[Dissenting Opinion]

MARTIN, Dissenting.

I would reverse the judgment and remand this cause to the district court, with direction that the sum of $7,076.15 be paid from the funds in the registry of the court to the United States Collector of Internal Revenue in partial payment of the tax lien of the United States for $13,029.28.

It may be conceded that, in ordinary circumstances, a surety who makes good under his contract of suretyship upon default of the principal contractor acquires an equitable lien against the unpaid balance in the hands of the obligee of the bond and that such equitable lien, upon payment by the surety, relates back to the date of the contract. But, to my thinking, it does not follow from this that such equitable lien is superior to the perfected lien of the United States for unpaid taxes of the defaulting contractor, for periods subsequent to the date of the contract of suretyship but prior to the date of payment by the surety, to the extent that interest must be allowed the surety on the principal sum paid by it when such allowance would completely exclude the Government tax lien, which attached to the funds involved before the surety expended money in performance of its obligation under the bond.

Nor do I think the authorities cited, but not discussed, in the opinion of the court support the conclusion reached. In re Zaepfel and Russell, 49 Fed. Supp. 709, aff. Farmers State Bank v. Jones, 135 Fed. (2d) 215 (C. C. A. 6); Farmer's Bank v. Hayes, 58 Fed. (2d) 34 (C. C. A. 6); Prairie State Bank v. United States , 164 U. S. 227. None of these cases dealt either with interest or with tax liens. The controversies in them were between surety companies and banks, and were decided upon principles of subrogation, by which priority was accorded to the claims of the sureties over the claims of banks advancing money to the contractors.

In this case, the obligee of the faithful performance bond who had in possession retained percentages was served by the Collector with a notice of levy and warrant for distraint on August 12, 1943 , followed by service of final notice and demand on August 16, 1943 . The Collector appropriately recorded his notice of tax lien on August 13, 1943 . The obligee notified the sureties that, on August 20, 1943 , the $13,029.28 internal revenue taxes claimed out of the $59,647.72 retained percentages in its hands would be paid to the Collector, in compliance with his demand, unless the obligee was restrained from doing so. On August 19, 1943 , payment to the Internal Revenue Collector was stayed, and ultimately enjoined, by the filing of this action by the sureties.

After the sureties paid off the material and labor claims, there were sufficient retained funds ($59,647,72) in the hands of the obligee to pay in full the amount expended by the sureties ($52,571.57) and leave a balance of $7,076.15 to be paid pro tanto on the tax lien of the United States, if this action had not been brought. To allow the surety companies to absorb this sum in interest, to the exclusion of the United States in the partial collection of its taxes, seems to me inequitable in the circumstances. Such allowance is certainly not supported by direct authority.

Moreover, my reasoning by analogy differs from that of the majority opinion. The question before us is new; but the facts here are not too far afield to enable us to receive guidance from the applicable rules in bankruptcy, receivership and reorganization proceedings. It should be remembered that while no insolvency proceedings were pending against the contractor, he was nonetheless insolvent at the time this action was brought. See Vanston Bondholders Protective Committee v. Green, -- U. S. --, decided December 9, 1946 , for discussion of the balancing of equities with respect to the allowance of interest in bankruptcy, receivership and reorganization matters. See New York v. Maclay, 288 U. S. 290, for discussion of the priority of United States tax claims over claims of a state for franchise taxes given precedence by state law over other intervening claims. Upon the principles derivable from these authorities and from Michigan v. United States, 317 U. S. 338, and upon logical reasoning, I think the equitable lien of the sureties is equitably satisfied by reimbursement to them of the principal sum expended in fulfilment of their obligation, without added allowance of interest on such amount.

A surety is limited to recovery of his actual loss, and no profit may be made by him at the expense of other creditors of his principal. While interest is not generally the equivalent of profit, it may become so when balanced against the equities of other creditors of the principal. Especially is this true when, as in the instant case, the United States is a tax-lien creditor protesting against the allowance of six percent interest on a related-back lien accruing from the insolvency of a defaulting principal, whose faithful contractual performance the surety had guaranteed. There are relatively few six percent investments in the portfolios of insurance companies.