Equitable Subrogation;

W r o n g f u l

Disbursement; Breach

of Stakeholder Duty.

In the United States Court of Federal Claims

No. 16-999C

(Filed: August 24, 2017)

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THE HANOVER INSURANCE COMPANY,

Plaintiff,

v.

UNITED STATES,

Defendant.

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Eric H. Loeffler, Boston, MA, for plaintiff.

Vito S. Solitro, United States Department of Justice, Civil Division,

Washington, DC, with whom were Claudia Burke, Assistant Director, Chad

A. Readler, Acting Assistant Attorney General, and Robert E. Kirschman,

Jr., Director, for defendant.

OPINION

Bruggink, Judge.

In its amended complaint, plaintiff, Hanover Insurance Company

(“Hanover”), seeks to recover $440,000 from the United States on a theory of

equitable subrogation. Hanover executed payment and performance bonds on

behalf of its principal, B&J Multi Service Corporation (“B&J”), in connection

with a contract between B&J and the Department of Veterans Affairs (“VA”)

to repair the steam system at a VA facility in West Haven, Connecticut. 

Plaintiff contends that it notified the VA of a default by B&J, triggering its

right to be equitably subrogated to B&J’s right to the contract balance. 

Defendant moved to dismiss pursuant to Rule 12(b)(6) of the Rules of the

United States Court of Federal Claims (“RCFC”), arguing that Hanover’s

complaint is deficient as a matter of law because it does not allege that plaintiff

put the VA on notice of B&J’s default until after the contract balance had been
paid to B&J. Oral argument was held on May 2, 2017. As part of the briefing

on defendant’s motion, both parties submitted materials outside of the

complaint. The court therefore converted defendant’s motion to dismiss to one

for summary judgment pursuant to RCFC 56 and afforded the parties an

opportunityto submit supplemental materialsto further support their positions. 

Supplemental briefing is now complete. Because defendant has not

established that Hanover failed to give notice of default, defendant’s motion

must be denied.

FACTUAL BACKGROUND

The following facts are undisputed. On August 4, 2009, B&J and the

VA entered into Contract No. VA241-C-1241 (“West Haven Contract”),

pursuant to which B&J was to provide tools, labor, materials and equipment

to repair the steam system at a VA facility in West Haven, Connecticut. As

required bythe West Haven Contract, B&J separatelycontracted with Hanover

on August 20, 2009, to provide performance and payment bonds in support of

B&J in the amount of $2,505,000.

Shortlythereafter, B&J commenced work but was suspended bythe VA

on February 17, 2010, for walking off the site, not paying subcontractors, and

incorrectly certifying that subcontractors were being paid. During the course

of the West Haven Contract, a number of B&J’s subcontractors and suppliers

made claims against Hanover’s payment bonds. 

On December 22, 2010, Hanover forwarded to the VA a fully executed

assignment and direction of the contract funds from B&J to Hanover, but with

respect to a contract not at issue here:

. . . B&J Multi Service Corp. . . . does hereby assign, transfer

and set over to Hanover Insurance Group . . . all of the

Principal’s right, title, and interest in and to any and all

payments . . . and retainage . . . any other money now due or

hereafter to become due, arising out of [the contract] . . . . 

Pl’s. Suppl. Br., Ex. A. That assignment was acknowledged by John Zizik of

the VA, who noted that, “I am in receipt of your Notice of Assignment. I’ll be

working this week on determining payment and change order requests.”

On February 2, 2011, Hanover informed the VA by email that it had

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been “writing large checks” to “ensure that the work for your project (West

Haven Contract) is being performed without disruption.” Pl’s. Resp. to Mot.

for Summ. J., Ex. A. In an email exchange on May 9, 2011, between Ms.

Ruggiero, a contracting officer for the VA, and Mr. McDevitt, counsel for

Hanover, Ms. Ruggiero stated that she had a “basis for termination for default”

of the West Haven Contract. Pl’s. Supp. Br., Ex. D. On August 3, 2011, Mr.

Zizik, another contracting officer for the VA, sent an email to a subcontractor

on the West Haven project, NG Environmental Contractors, directing it to

address payment issues with Hanover. On August 11, 2011, another

subcontractor, EnviroMed, emailed Hanover’s Mr. McDevitt to assert a claim

against the surety, on which Mr. Zizik was copied. On March 7, 2012, the VA

terminated the West Haven Contract for convenience. 

On February 23, 2013, the VA copied Hanover on an email containing

its response to B&J’s settlement proposal for termination for convenience

costs. Hanover responded on February 25, 2013, instructing the VA that “[n]o

monies are to be paid to B&J. If this matter is resolved, all payments will be

to Hanover.” Pl’s. Resp. to Mot. for Summ. J., Ex. B. On May 7, 2013, the

VA agreed with B&J to pay it $440,000 to settle all of B&J’s claims under the

West Haven Contract.

On June 4, 2013, Ms. Ruggiero emailed Hanover’s counsel, Eric

Loeffler, notifying Hanover of the settlement with B&J and inquiring whether

payment was to go directly to the surety. Mr. Loeffler replied to the email

saying that he is “doubtful of the authority of B&J to enter into such

agreement, given Hanover’s equitable and contractual rights as surety” and

again requested that funds not be released to B&J without Hanover’s written

consent. Pl’s. Resp. to Mot. for Summ. J., Ex. C. Ms. Ruggiero then emailed

B&J employees on June 6, 2013, stating that she still had “an issue to resolve

with the bonding company requesting payment directly to them.” Id. Ex. D. 

Several weeks later, after learning of further communications between B&J

and the VA, Hanover reminded the VA by letter, dated June 25, 2013, of its

subrogation claim. The relevant portion of the June 25 letter is set out below:

This firm represents Hanover Insurance Group which issued the

above referenced bond, as surety, on behalf of [B&J], principal

. . . . Hanover was recently contacted by B&J about the status

of the final negotiated payment due under the contract, and I

understand you may have been in communication with B&J

about the documents required to close-out the contract such that

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the final negotiated payment can be processed. For the reasons

set forth below, it is important that Hanover be involved in that

process. Please give me a call at your earliest convenience to

discuss.

Also, I wish to reiterate Hanover’s demand that no further

contract funds, either earned, unearned or retained, or settlement

proceeds, be released to B&J or any other person or entity

without the express written consent and direction of Hanover. 

Hanover has received claims and incurred losses against the . .

. bond, as well as other bonds issued by Hanover on behalf of

B&J. Pursuant to Hanover’s common law rights of equitable

subrogation,its perfected securityinterest, along with Hanover’s

express assignment and trust fund rights as set forth in a written

Agreement of Indemnity between Hanover and B&J, Hanover

owns and/or otherwise has a priority interest to the funds.

Am. Compl., Ex. 3. 

Despite Hanover’s communications with the VA, the agency paid B&J

$440,000 on September 10, 2013. Defs. Mot. for Summ. J., Ex. 1. On

September 17, 2013, counsel for Hanover sent a certified letter to the CO 

demanding payment of the $440,000, stating that “B&J is in default of the

Bonds.” Am. Compl., Ex. 4. Having already made the final payment on the

West Haven Contract, the VA refused. Hanover filed suit here on August 12,

2016, seeking to recover the amount of the contract close-out payment, which

it alleges was wrongfully paid to B&J in violation of plaintiff’s rights as an

equitably subrogated surety. 

DISCUSSION

Even in the absence of contractual privity between the United States

and a surety provider, a legally enforceable duty can arise between the

government and a surety if the surety notifies the government that its principal

is in default of the bond agreement. Balboa Ins. Co. v. United States, 775 F.2d

1158, 1164 (Fed. Cir. 1985). At that point, the government must take

“reasonable steps to determine for itself that the contractor had the capacity

and intention to complete the job.” Id. Defenant’s motion puts into question

whether Hanover’s pre-payment communications with the VA adequately

notified the government of B&J’s default, therebytriggering the government’s

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equitable subrogation duty to Hanover. As we explain below, we find that the

surety’s letter of June 25, 2013 adequately notified the government of the

contractor’s default. 

The theory of equitable subrogation “is based on the view that the

triggering of a surety’s bond obligation gives rise to an implied assignment of

rights by operation of law whereby the surety ‘is subrogated to the [principal

obligor’s] property rights in the contract balance.’” Lumbermens Mut. Cas.

Co. v. United States, 654 F.3d 1305, 1312 (Fed. Cir. 2011) (quoting Balboa

Ins. Co. v. United States, 775 F.2d 1158, 1164 (Fed. Cir. 1985)). Those rights

do not arise vis-a-vis the government, however, unless the surety notifies the

government of the default. The law in this regard is succinctly summarized by

the Federal Circuit’s decision in Fireman’s Fund Insurance Co. v. United

States:

[T]he government as obligee owes no equitable duty to a surety

like Fireman’s Fund unless the surety notifies the government

that the principal has defaulted under the bond. It is irrelevant

whether the surety claims a right to funds during performance of

the contract, or after it is completed when the government

functions as a ‘stakeholder’ of funds owed but not yet paid. In

either event, notice by the surety is essential before any

governmental duty exists.

909 F.2d 495, 498 (Fed. Cir. 1990). In Fireman’s Fund, although

subcontractors and suppliers informed the government that they had not been

paid by the contractor, that did not satisfy the surety’s requirement to give

notice and therefore it did not trigger the government’s equitable duty towards

Fireman’s Fund. Id. at 499.

Defendant’s argument here can be reduced to one point: Hanover did

not invoke the precise words “the principal is in default” prior to the VA’s

payment to B&J. Defendant principally cites Firemen’s Fund in support. 

Notice of a potential default can also be sufficient to trigger the

Government’s obligation to protect the interests of the surety in remaining

contract funds. Ins. Co. of W. v. United States, 83 Fed. Cl. 535, 541 (2008). 

In Hartford Fire Insurance Co. v. United States, the court stated that the

Government’s equitable subrogation duty can arise when “the surety notifies

the government that the contractor has defaulted or is in danger of defaulting

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under the bond.” 40 Fed.Cl. 520, 522–23 (1998) (emphasis added), aff’d, 185

F.3d 885 (Fed. Cir. 1999); see also Capitol Indem. Corp. v. United States 71

Fed. Cl. 98, 102–03 (2006) (stating that “a payment bond surety must notify

the government that the contractor is or is close to being in default,” and later

stating that “the surety must explicitly notify the government of the default or

threatened default”). Thus the notice requirement cannot be as explicit as

defendant would have it. 

Hanover’s June 25, 2013 letter was adequate to put the agencyon notice

of default. Hanover informed the VA that it had made payments under its

payment bond and that it was therefore exercising its equitable subrogation

rights. It is not too much to assume that the VA should have understood this

as tantamount to saying that the principal had defaulted. Under these

circumstances, Hanover’s invocation of its “rights of equitable subrogation”

could mean only one thing: the surety was invoking its legal right to payment

because it had incurred costs due to the principal’s default. 

Under the case law in this circuit, the language of the June 25 letter is

sufficient to put the government on notice that the principal has defaulted and

the surety has been called upon to perform under its bond obligations. In

Lumbermens Mutual, for example, the circuit court makes it clear that notice

similar to that furnished here would be sufficient: “The Claims Court

dismissed Lumbermens’‘equitable subrogation’ claimhere because, before the

payments were made, Lumbermens ‘did not notify the Government was

approaching default or that the Navy should withhold or divert progress

payments.’ We agree.” 654 F.3d at 1309 (internal citations omitted). The

implication is that notice to the government that it should not make progress

payments to the principal would be sufficient to trigger the surety’s rights as

an equitable subrogee and the government’s duties to it. 

Similarly, in American Fidelity Fire InsuranceCo. v.United States, 513

F.2d 1375 (Ct. Cl. 1975), the Court of Claims held that the government

became a stakeholder when the surety there notified it that, 

In reference to the above captioned matter and pursuant to that

General Agreement of Indemnity as between Fidelity Fire

Insurance Company and [contractor], a copy of which is

attached hereto, and further pursuant to California Code of Civil

Procedure, Section 2847, 2848, and 2849, please consider this

letter formal demand that any monies due under the above

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captioned contract be forthwith distributed to and placed with

American Fidelity Fire Insurance Company.

Id. at 1377 n.1. The word “default” was not present in that notice. The court

pointed out that the references to the California Code were only relevant if the

principal on the bond had failed to pay laborers and materialmen. “None of

the sections has any application unless there is a defaulting principal or one

who is about to default. Once there is a default by the principal, the sections

provide in surety’s favor suitable rights, including subrogation.” Id. at 1380. 

The court thus rejected the government’s argument that the notice from the

surety was insufficient to trigger its equitable subrogation rights. Id. at 1380-

81.

Hanover’s letter in this case was more pointed than the notices in either

American Fidelity or Lumbermens’ Mutual and certainlywould have satisfied

the test set out in Fireman’s Fund, where the circuit court faulted the surety for

not notifying the government of “Westech’s failure to pay its subcontractors

or suppliers or ask that payments to Westech be withheld until December 22,

1983, almost five months after the government had fully released the retainage

. . . .” 909 F.2d at 499. In Balboa, the court treated notice that the principal

“was in financial straits and would not be able to fulfill its payment and

performance obligations” as tantamount to asserting that the contractor

breached by defaulting under one of the bonds. 775 F.2d at 1160, 1164. In

light of this precedent, we hold the notice here to have been sufficient.

In sum, in view of the evidence indicating that the agency paid the

principal in the face of notice of the principal’s bond default, we cannot grant

summary judgment for the government against the surety.

CONCLUSION

The parties agree that the court has before it all the materials it needs

to resolve defendant’s converted motion for summary judgment. Because

defendant has not established that plaintiff failed to notify defendant of B&J’s

default, the motion is denied. The parties are directed to consult and propose

by September 8, 2017, in a status report, their recommendations for further

proceedings. 

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s/Eric G. Bruggink 

ERIC G. BRUGGINK

Senior Judge

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