Equitable Subrogation; W r o n g f u l Disbursem ent; Breach of Stakeholder Duty

. 

# In th e United States Court of Federal Cl aims

No. 16-999C (Filed: August 24, 2017)

* * * * * * * * * * * * * * * * * * * * * * * * * *

THE HANOVER INSURANCE COMPANY,

Plaintiff
,

v.

UNITED STATES,

Defendant.

* * * * * * * * * * * * * * * * * * * * * * * * * *

Eric H. Loeffler , Boston, MA, f o r plaintif f

.

Vito S. Solitro , United States Departm ent of Justice, Civil Division, W a shington, DC, with whom were Claudia Burke , Assistant Director, Chad A. Readler , Acting Assistant Attorney General, and Robert E. Kirschman, Jr. , Director, f

or def endant.

OPINION

Bruggink, Judge.

In it s a mended com

plaint, plaintif

f
, Hanover Insurance Com pany (“Hanover”), seeks to recover $440,000 f rom the U nited States on a t heory of equitable subrogation. Hanover executed pay m ent and perf

orm ance bonds on behalf of its p rincipal, B&J Multi Service Corporation (“B&J”), in connection with a contract b etween B &J and the Departm ent of V eterans Af f airs (“VA”)
to r e p a i r t he s team s y stem a t a VA f acility in W est Haven, Connecticut. Plain t i f f c o n t e n ds that it notif

ied the VA o f a d ef

ault by B&J, triggering its right to be e quitably subrogate d to B&J’s right to the contract balance. Def endant m oved t o dism iss pursuant to Rule 1 2(b)(6) of the Rules of the United States Court of F ederal C laim s ( “RCFC”), arguing that Hanover’s

com plaint is def

i cient as a m atter of law because it does not allege that plaintif f put the VA on notice o f B&J’s def ault until af

ter t he c ontract balance had beenpaid to B&J. Oral argum ent was held on May 2, 2017. As part of the brief ing

on def endant’s m otion, both parties subm itted m ater i a l s o u tside of the

com plaint. T he court theref

ore converted def

endant’s m otion t o dism i ss to one f or sum m a ry jud g me n t p u r suant to RCFC 56 and af f orded t he parties an opportunity to subm it supplem ental m a t e r i a l s t o f u rther support their positions. Supplem e ntal brief

ing is now com

p l e te. B ecause def

endant has not established that Hanover f a iled to give notice of def ault, def endant’s m otion

m ust be denied.

FACTUAL BACKGROUND

The f ollowing f

a cts are undisputed. On August 4, 2009, B&J and the VA e ntered into Contract No. VA241-C- 1 2 41 (“W est Haven Contract”), pursuant to which B&J was to provide tools, labor, m aterials and equipm ent to r epair the steam s y s t e m a t a VA f acility in W est Haven, Connecticut. A s

r e q u ired by the W est Haven Contract, B &J s eparately c ontracted with H anov e r

on August 20, 2009, t o provide perf o rm a nce and pay

m ent b onds in support of B&J in the am ount of

$2,505,000.

Shortly t h e r e a f ter, B&J com m enced work but was suspended by the VA

on February 1 7
, 2010, f

or w alking of

f the site, not pay ing subcontractors, and incorrectly certif

y ing that subcontractors were being paid. During the course of t he W est Haven Contract, a num ber of B&J’s s ubcontractors and suppliers

m ade claim s against Hanover’s pay m e nt bonds.

On Decem

ber 2 2
, 2010, Hanover f

orwarded to the VA a f

ully executed assignm ent and direction of the contract f unds f rom B&J to Hanover, but with respect to a contract not at issue here:

. . . B&J Multi Service Corp.

. . . does h ereby assign, transf er and set over to Hanover Insuran c e G r o u p

. . . all of the Principal’s right, title, and interest in a nd to an y and all
pay m ents

. . . and re t a inage

. . . any other m oney now due or hereaf ter to becom e due, arising out of [ the contract] . . . .

Pl’s. Suppl. B r., Ex. A. That assignm ent was acknowledged by John Zizik of the VA, w ho noted that, “I am in receipt of y our Notice o f Assignm ent. I ’ll be working this week on determ ining pay m ent and change order requests.”

On February 2, 2011, Hanover i n f o r me d the VA by em ail that i t had

2been “writing large checks” t o “ e n s u re that the work f o r y our project ( W e st Haven Contract) is being perf orm ed without disruption.” Pl’s. R esp. to Mot. f or Sum m

. J., Ex. A. In an em ail excha n ge on M ay 9, 2011, between Ms. Ruggiero, a cont r a c t i n g of f icer f or the VA, and Mr. McDevitt, counsel f or Hanover, Ms. Ruggiero stated that she h ad a “basis f or term ination f

or def ault” of the W est Haven Contract. Pl’s. Supp. Br., Ex. D. On A ugust 3
, 2011, Mr. Zizik, a nother contracting of f icer f or the VA, s ent an em a il to a subcontractor

on the W e st Haven project, NG Environm ental Contrac t o r s, directing it to address pay

m ent i ssues w ith H anover. On August 11, 2011, another subcontractor, EnviroMed, em ailed Hanover’s Mr. McDevitt to assert a claim against the surety , on which Mr. Z izik was copied. On March 7, 2012, the VA
term inated the W est Haven Contract f or convenience.

On February 23, 2013, the V A copied Hanover o n an em ail containing its response to B&J’s settlem ent prop o s al f or term i nation f

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

m onies are to be paid to B&J. If this m atter is resolved, all pay m ents will be
to Hanover.” P l’s. Resp. t o M o t

. f or Sum m

. J., Ex. B. O n May 7, 2013, the VA agreed with B&J to pay it $440,000 to settle all of B&J’s claim s under the W e st Haven Contract.

On June 4, 2013, Ms. Ruggiero em ailed Hanover’s counsel, Eric Loef f ler, notif y ing Hanover of the settlem ent with B&J and inquiring whether
pay m ent was to go directly to the s urety

. Mr. Loef f ler replied t o t h e em ail
say ing that he is “doubtf ul of the authority of B&J to e n ter i nto such
agreem ent, g iven Hanover’s equitable and contractual rights as sure t y ” and again requested that f

unds not be released to B &J without H anover’s written
consent. Pl’s. Resp. to Mot. f or Sum m

. J
., Ex. C. Ms. Ruggiero then em ailed B&J em ploy ees on June 6, 2013, stating that she still had “an issue t o r esolve with the bonding com

pany requesting pay

m ent directly to them

. ” I d

. Ex. D. Several weeks later, a f

ter learning o f f

u r t h e r c om m

u nications between B&J and the VA, Hanover r e mi n d e d t h e V A by l etter, dated June 25, 2013, of its subrogation claim

. The relevant portion o f the June 25 letter is s et out b elow:

This f irm represents Hanover Insurance Group which i ssued the above r ef erenced bond, as surety , on behalf of [ B &J], principal

. . . . Hanover was r e c e n t l y contacted by B&J about the status of the f inal negotiated pay

m ent due under the c o ntr a c t , a n d I understand y ou m a y h a ve been in com m unication with B&J about the docum ents required to close-out the contract such t hat

3the f inal negotiated pay

m ent can be processed. For the reasons set f orth below, it is im

portant that H anover be involved i n t hat
process. Please g ive m e a call at y our earliest convenience to discuss.

Also, I wish t o reiterate Hanover’s dema n d that no f urther
contract f unds, either earned, unearned or retained, or settlem ent proceeds, be re l e a s ed to B&J or any other person or entity without the express written c onsent a nd d irection of Hanover. Hanover has received claim s and i ncurred losses against the . .

. b ond, as w e l l a s other bonds issued by H anover on behalf of B&J. Pursuant to Hanover’s com m on law rights o f equitable subroga t i o n , i t s p e r fe c t e d s e curity interest, along with Hanover’s express assignm ent and trust f und r ights as set f

orth in a written Agreem ent o f Indem nity between H anover and B&J, Hanover owns and/or otherwise has a priority interest to the f

unds.

Am . Com pl., Ex. 3.

Despite Hanover’s com m unications with the V A, the agency paid B&J $440,000 on S ep t e m

ber 1 0, 2013. Def

s. Mot. f or S um m

. J
., Ex. 1. On Septem ber 17, 2013, counsel f

or Hanover sent a certif

ied l e t t er to the CO dem anding p ay

m ent of the $440,000, stat i ng that “B&J i s in d ef ault of the Bonds.” Am . Com

pl., Ex. 4. Having already m ade the f

inal pay m ent on the W e st Haven Contract, the V A ref used. Hanover f

iled suit here on August 12, 2016, s eeking to recover the am ount of t he contract close-out pay m e n t, which it alleges was wr o n g f

u l l y p aid to B&J in violation of plaintif f ’s rights as an equitably subrogated surety

.

DISCUSSION

Even in the absence of contractual p rivity between t he U nited States and a surety provid e r, a legally e n f orceable duty can arise between the
governm e nt and a surety if the surety n otif ies the governm ent that its principal is in def ault o f the bond agreem ent. Balboa Ins. Co. v. United States
, 775 F .2d 1158, 1164 ( F e d

. Cir. 1 985). At that point, the governm ent m ust take “reasonable s t eps to determ ine f or itself that th e c o n t r actor had t he capacity and intention to com

plete the job.” Id. Def

enant’s m otion puts into question whether Hanover’s p re-pay m ent com m

u n ications with the VA adequately notif ied the g overnm ent o f B&J’s def ault, thereby triggering the governm ent’s

4equitable subrogation duty to Hanover. A s we explain b elow, we f ind that the surety ’s letter of June 25, 2 0 1 3 a d e q u ately notif ied the governm ent o f the contractor’s def

ault.

The theory of equitable s ubrogation “is b ased o n the view that the triggering of a surety ’s bond obligation gives rise to an im plied a ssignm ent of rights by operation of law whereby the surety ‘is subrogated to the [ principal obligor’s] property righ t s i n the contract balance.’” Lumbermens Mut. C as. Co. v. United States
, 654 F .3d 1305, 1 3 1 2 ( F e d. Cir. 2011) ( quoting B alboa Ins. Co. v. United States
, 775 F.2d 1158, 1 164 ( Fed. Cir. 1985)). Those rights do not arise vis-a-vis the governm ent, however, unless the surety notif ies the
governm e nt of the def

ault. The law i n this regard is succinctly sum m arized by the Federal Circuit’s decision in Fireman’s Fund Insurance Co. v. U nited States :

[ T]he governm ent a s obligee owes no equitable duty to a s u rety like Firem an’s F und unless the surety notif ies t h e governm ent that the principal has def a ulted under the bond. I t is irrelevant whether the surety claim s a right to f unds during perf

orm ance of the contract, or a f

ter i t is com

pleted when the governm ent f unctions as a ‘stakeholder’ of f u nds owed but not y e t p a i d

. In either ev e n t , n o tice by the surety is essential bef ore any governm e ntal duty exists.

909 F.2d 495, 498 (Fed. Cir. 1990). In Fireman’s Fund
, although subcontractors and suppliers inf orm ed t he governm e nt that they had not been paid by the contractor, that did not satisf y the surety ’s requirem ent to g ive notice and theref

ore it did not trigger the governm e n t’s equitable duty towards Firem an’s Fund. Id. at 499.

Def endant’s argum ent h ere c an b e r educed to one point: Hanover did
not invoke the precise w o r d s “ t he principal is in def ault” prior to the VA’s pay m ent to B&J. Def

endant principally

cites F iremen’s Fund

in support.

Notice of a p otential def ault c an also be suf

f i cient t o tri g g e r the Governm e n t ’ s o bligation to protect the i nterests of the surety i n rem a ining
contract f unds. Ins. Co. of W

. v. United States
, 8 3 F ed. Cl. 535, 541 (2008). In Hartford Fire Insurance Co. v. United States
, t h e c o u r t stated that the Governm ent’s equitable s u brogation duty c an arise when “the s u rety notif i es the governm e nt that the contractor has def aulted or is i n danger o

f defaulting

5under the bond .” 40 Fed.Cl. 520, 522–23 (1998) ( em p hasis added), aff’d
, 1 85 F.3d 885 (Fed. Cir. 1999); see also Capitol Indem. Corp. v. United States 71 Fed. Cl. 98, 102–03 ( 2006) (stating that “a pay m ent bond su r e t y must notif y the governm ent that the contractor is or is close to being in def ault,” and later stating that “the s urety m

ust explicitly n otif

y the governm ent of the def ault or threatened def

ault”). Thus the notice requirem ent cannot b e as expl i c i t as def endant would have it.

Hanover’s June 25, 2013 letter was adequate to p ut the a g ency on notice of def a ult. Hanove r inf

o r m ed the V A that i t h ad m ade pay m ents u nder its
pay m ent bond and that it was ther e f o r e exercising i ts equitable subrogation rights. It is not too m

uch to assum e that the VA should have understood this

as tantam ount to say ing that the principal had def aulted. U nder these circum stances, Hanover’s invocation o f its “ rights of equitable subrogation” could m ean only one thing: the surety was invoking its legal right to pay m ent because it had incurred costs due to the principal’s def ault.

Under the case law in this circuit, the language of the June 25 letter is suf f icient t o put the governm ent on notice that t he principal has def aulted and the surety has been c alled upon to perf o r m u n d e r its bond obligations. In Lumbermens M

utual
, f or e xam ple, the circuit court m akes it clear that notice sim ilar t o th a t f

urnished here would be suf f icient: “The Claim s Court dism i ssed L u

m b e r m e n s ’ ‘ e q u i t a b l e s u b r o g a t i o n ’ c l a i m here because, bef ore the
p ay m ents were m a de, Lum

berm ens ‘did not n otif

y the Governm ent w a s approaching def

ault or that the N avy should withhold or divert progress pay m ents.’ W e a g r e e

. ” 654 F.3d at 1 309 (internal citations om itted). The im p lication i s that n otice to the governm ent that it should not m ake progress pay m ents to the principal would be suf f icient to trigger the surety ’s rights as an equitable subrogee and the governm ent’s duties to it.

Sim ilarly
, in American Fidelity Fire Insura n c e C o

. v

. U n i ted States, 5 13 F.2d 1375 (Ct. Cl. 1975), the Court of Cl a i ms h eld that the governm ent becam e a stakeholder when the surety there notif

ied it that,

In ref erence to the above captioned m atter and p ursuant to t hat G e n e r a l A greem ent of Indem nity as between Fidelity Fir e Insurance Com

p a ny and [ contractor], a copy of w hich is attached h e reto, and f

urther pursuant to Calif

ornia C ode of Civil Procedure, Section 2847, 2848, and 2849, please consider t his letter f o r ma l dem and that any m o nies due under the above

6captioned c ontract be f orthwith distributed t o and placed with Am erican Fidelity

Fire Insurance Com

pany

.

Id. at 1377 n.1. The word “ def ault” was not present in that notice. The court pointed out that the r ef

erences t o the Calif

ornia Code were only relevant i f the principal on the bond had f ailed to p ay laborers and m aterialm en. “ None of the sections h a s any applicatio n u n l e s s there is a def a ulting principal or one who is about to def

a ult. Once there is a d ef

a u lt b y the principal, the sections provide in surety ’s f

a vor suitable rights, including subrogation.” Id. a t 1380. The court thus re

j e c ted the governm e nt’s argum ent that the n otice f rom the surety w as insuf

f icient to trigger its equitable s ubrogation rights. Id. at 1380- 81.

Hanover’s letter in this case was m ore pointed t han the notices in either American Fidelity or L umbermens’ Mutual and certainly w ould have satisf ied the test set out in F

ireman’s Fund
, where t he c ircuit court f aulted the surety f

or not notif y ing the governm ent o f “W estech’s f ailure to pay its subcontractors

or suppliers or ask that pay m ents to W estech b e withheld until Decem b er 22, 1983, alm ost f

i ve m onths af

ter the governm ent had f

ully released the retainage

. . . .” 909 F.2d at 499. I n Balboa
, t he c ourt treated notice that the principal “was i n f inancial straits a nd would not b e able to f ulf ill its pay m ent and perf orm ance obligations” as tan t a m o unt to asserting that the contractor b r e a c hed by def

aulting under one of t he bonds. 775 F.2d at 1 160, 1 16 4

. I n light of this precedent, we hold the notice here to have been suf f icient.

In sum , in view of the evidence indicating that the a gency paid the principal in the f

ace of notice of the p rincipal’s bond def a ult, we c annot grant

sum m ary judgm ent f

or the governm ent against the surety

.

CONCLUSION

The parties agree that t h e c o u rt has bef o re it all the m aterials it needs
to resolve def

endant’s c onver t e d mo t ion f o r sum m ary j udgm e n t. Because def endant has not established that plaintif f f ailed t o n otif

y def endant o f B&J’s def ault, the m otion is denied. The parties are directed t o consult a nd propose by Septe m

b e r 8
, 2017, i n a status report, their recom m endations f or f urther proceedings.

7s/Eric G. Bruggink ERIC G. BRUGGINK Senior Judge

8