Source: https://supreme.justia.com/cases/federal/us/371/132/
Timestamp: 2019-04-19 18:57:55+00:00

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Justia › US Law › US Case Law › US Supreme Court › Volume 371 › Pealman v. Reliance Ins. Co.
Pealman v. Reliance Insurance Co.
When, by reason of the contractor's default, a surety on a payment bond given by a contractor under the Miller Act, 49 Stat. 793, has been compelled to pay debts of the contractor for labor and materials, the surety is entitled by subrogation to reimbursement from a fund otherwise due to the contractor but withheld by the Government pursuant to the terms of the contract -- even though the contractor has become bankrupt and the Government has turned the withheld fund over to the contractor's trustee in bankruptcy. Pp. 371 U. S. 133-142.
(a) This fund never became a part of the bankruptcy estate, and its disposition is not controlled by the Bankruptcy Act. Pp. 371 U. S. 135-136.
(b) Prairie State Bank v. United States, 164 U. S. 227, and Henningsen v. United States Fid. & Guar. Co., 208 U. S. 404, followed. Pp. 371 U. S. 137-139.
(c) The Miller Act, which requires separate performance and payment bonds on Government contracts, did not change the law as declared in the Prairie State Bank and Henningsen cases. Pp. 371 U. S. 139-140.
(d) The Prairie State Bank and Henningsen cases were not overruled by United States v. Munsey Trust Co., 332 U. S. 234. Pp. 371 U. S. 140-142.
This is a dispute between the trustee in bankruptcy of a government contractor and the contractor's payment bond surety over which has the superior right and title to a fund withheld by the Government out of earnings due the contractor.
people's property among a bankrupt's creditors. [Footnote 10] So here, if the surety at the time of adjudication was, as it claimed, either the outright legal or equitable owner of this fund, or had an equitable lien or prior right to it, this property interest of the surety never became a part of the bankruptcy estate to be administered, liquidated, and distributed to general creditors of the bankrupt. This Court has recently reaffirmed that such property rights existing before bankruptcy in persons other than the bankrupt must be recognized and respected in bankruptcy. [Footnote 11] Consequently, our question is not who was entitled to priority in distributions under § 64, but whether the surety had, as it claimed, ownership of, an equitable lien on, or a prior right to this fund before bankruptcy adjudication.
than that a surety who pays the debt of another is entitled to all the rights of the person he paid to enforce his right to be reimbursed. [Footnote 13] This rule, widely applied in this country [Footnote 14] and generally known as the right of subrogation, was relied on by the Court of Appeals in this case. It seems rather plain that at least two prior decisions of this Court have held that there is a security interest in a withheld fund like this to which the surety is subrogated, unless, as is argued, the rule laid down in those cases has been changed by passage of the Miller Act or by our holding in the Munsey case. Those two cases are Prairie State Bank v. United States, 164 U. S. 227 (1896), and Henningsen v. United States Fid. & Guar. Co., 208 U. S. 404 (1908).
"The law upon this subject seems to be, the reserved per cent. to be withheld until the completion of the work to be done is as much for the indemnity of him who may be a guarantor of the performance of the contract as for him for whom it is to be performed. And there is great justness in the rule adopted. Equitably, therefore, the sureties in such cases are entitled to have the sum agreed upon held as a fund out of which they may be indemnified, and, if the principal releases it without their consent, it discharges them from their undertaking."
164 U.S. at 164 U. S. 239, quoting from Finney v. Condon, 86 Ill. 78, 81 (1877).
The Prairie Bank case thus followed an already established doctrine that a surety who completes a contract has an "equitable right" to indemnification out of a retained fund such as the one claimed by the surety in the present case. The only difference in the two cases is that here, the surety incurred his losses by paying debts for the contractor, rather than by finishing the contract.
and in full all persons supplying labor and material in the prosecution of the work contracted for." [Footnote 15] Henningsen completed the buildings according to contract, but failed to pay his laborers and materialmen. The surety paid. This Court applied the equitable principles declared in the Prairie Bank case so as to entitle the surety to the same equitable claim to the retained fund that the surety in the Prairie Bank case was held to have. Thus the same equitable rules as to subrogation and property interests in a retained fund were held to exist whether a surety completes a contract or whether, though not called upon to complete the contract, it pays the laborers and materialmen. These two cases therefore, together with other cases that have followed them, [Footnote 16] establish the surety's right to subrogation in such a fund whether its bond be for performance or payment. Unless this rule has been changed, the surety here has a right to this retained fund.
The company was then known as Fire Association of Philadelphia.
"(a) Before any contract, exceeding $2,000 in amount, for the construction, alteration, or repair of any public building or public work of the United States is awarded to any person, such person shall furnish to the United States the following bonds, which shall become binding upon the award of the contract to such person, who is hereinafter designated as 'contractor':"
"(1) A performance bond with a surety or sureties satisfactory to the officer awarding such contract, and in such amount as he shall deem adequate, for the protection of the United States."
"(2) A payment bond with a surety or sureties satisfactory to such officer for the protection of all persons supplying labor and material in the prosecution of the work provided for in said contract for the use of each such person."
30 Stat. 565 (1898), 11 U.S.C. § 110.
The surety appears also to have claimed some general priority over all creditors for the entire $350,000 it had paid out for the contractor, based on "liens, subrogation and assignment," but here its petition for certiorari and briefs seem to limit its claim to the net amount of the retained fund turned over to the trustee by the Government.
In re Dutcher Constr. Corp., 197 F.Supp. 441 (D.C.W.D.N.Y.1961).
298 F.2d 655 (C.A.2d Cir. 1962).
See, e.g., American Sur. Co. v. Hinds, 260 F.2d 366 (C.A.10th Cir. 1958); Phoenix Indem. Co. v. Earle, 218 F.2d 645 (C.A.9th Cir. 1955).
See Justice Holmes' discussion in Sexton v. Kessler & Co., 225 U. S. 90, 225 U. S. 98-99 (1912). As to the difficulties inherent in phrases like "equitable lien," see Glenn, The "Equitable Pledge", Creditors' Rights, and the Chandler Act, 25 Va.L.Rev. 422, 423 (1939).
United States v. Durham Lumber Co., 363 U. S. 522 (1960). See also Security Mortgage Co. v. Powers, 278 U. S. 149 (1928), and cases collected in 6 Am.Jur., Bankruptcy, § 949 (rev. ed. 1950). Cf. Aquilino v. United States, 363 U. S. 509 (1960).
"The right of subrogation is not founded on contract. It is a creature of equity, is enforced solely for the purpose of accomplishing the ends of substantial justice, and is independent of any contractual relations between the parties."
Memphis & L. R.R. Co. v. Dow, 120 U. S. 287, 120 U. S. 301-302 (1887).
See, e.g., Hampton v. Phipps, 108 U. S. 260, 108 U. S. 263 (1883); Lidderdale's Executors v. Robinson's Executor, 12 Wheat. 594 (1827); Duncan, Fox, & Co. v. North and South Wales Bank, 6 App.Cas. 1 (H.L. 1880). See generally Sheldon, Subrogation, § 11 (1882).
See cases collected in 50 Am.Jur., Subrogation, § 49 (1944).
208 U.S. at 208 U. S. 410.
See, e.g., Martin v. National Sur. Co., 85 F.2d 135 (C.A.8th Cir. 1936), aff'd, 300 U. S. 588 (1937); In re Scofield Co., 215 F. 45 (C.A.2d Cir. 1914); National Sur. Corp. v. United States, 133 F.Supp. 381, 132 Ct.Cl. 724, cert. denied sub nom. First Nat. Bank v. United States, 350 U.S. 902 (1955).
28 Stat. 278 (1894), amended, 33 Stat. 811 (1905).
Among the problems which would be raised by a contrary result would be the unsettling of the usual view, grounded in commercial practice, that suretyship is not insurance. This distinction is discussed in Cushman, Surety Bonds on Public and Private Construction Projects, 46 A.B.A.J. 649, 652-653 (1960).
332 U.S. at 332 U. S. 240.
State courts likewise apply the rule that sureties on public contracts are entitled to the benefits of subrogation. See cases collected in 43 Am.Jur., Public Works and Contracts, § 197 (1942).
See the somewhat different but closely related discussion by which Mr. Justice Cardozo, speaking for this Court, reached a similar result in Martin v. National Sur. Co., 300 U. S. 588, 300 U. S. 597-598 (1937).
Our result has also been reached by the Court of Claims in cases substantially like ours. Continental Cas. Co. v. United States, 169 F.Supp. 945, 145 Ct.Cl. 99 (1959); National Sur. Corp. v. United States, 133 F.Supp. 381, 132 Ct.Cl. 724, cert. denied sub nom. First Nat. Bank v. United States, 350 U.S. 902 (1955); Royal Indem. Co. v. United States, 93 F.Supp. 891, 117 Ct.Cl. 736 (1950). See generally Speidel, "Stakeholder" Payments Under Federal Construction Contracts: Payment Bond Surety vs. Assignee, 47 Va.L.Rev. 640, 646-648 (1961); note, Reconsideration of Subrogative Rights of the Miller Act Payment Bond Surety, 71 Yale L.J. 1274 (1962); comment, 33 Cornell L.Q. 443 (1948).
MR. JUSTICE CLARK, with whom MR. JUSTICE DOUGLAS and MR. JUSTICE BRENNAN join, concurring in the result.
"But nothing is more clear than that laborers and materialmen do not have enforceable rights against the United States for their compensation. . . . They cannot acquire a lien on public buildings . . . , 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."
Id. at p. 332 U. S. 241. "[I]t is elementary that one cannot acquire by subrogation what another whose rights he claims did not have. . . ." Id. at p. 332 U. S. 242.
Since the laborers and materialmen have no right against the funds, it follows as clear as rain that the surety could have none. It appears to me that today's holding that laborers and materialmen had "rights" to funds in the Government's hands might jeopardize the rights of the United States and have serious consequences for its building operations. The Congress has not so provided, and I would not so hold.
However, this Court has held in two cases not necessary to the decision in Munsey that the surety who pays laborers' and materialmen's claims stands in the shoes of the United States, and is entitled to surplus funds remaining in its hands after the contract is completed. The first is Prairie State Bank v. United States, 164 U. S. 227 (1896), and the other Henningsen v. United States Fid. & Guar. Co., 208 U. S. 404 (1908). In neither of those cases, however, did the Court find that laborers and materialmen had any right against the United States, but only that the "Guaranty Company [was] entitled to subrogation to any right of the United States government arising through the building contract." Henningsen, supra, at p. 208 U. S. 410.
"In our view of the law, the equities in favor of materialmen growing out of that agreement [between the surety and the contractor] were impressed upon the fund in the possession of the court."
Id. at pp. 300 U. S. 593-594. It is well to note also that the Court of Appeals in Martin had based its decision on the theory announced by the Court today, but Mr. Justice Cardozo, for a unanimous Court, chose the "narrower" ground of the assignment in affirming the judgment for the surety. I agree with Martin as to the "narrower" ground, and believe the Court should keep the opinion today "within the necessities of the specific controversy," rather than enlarging upon the rules of Henningsen and Prairie State Bank. In so doing, the Court would but fulfill the prophecy made in Martin that "the grounds chosen . . . may be expected to be helpful as a guide in other cases." Id. at p. 300 U. S. 593.
I would affirm the judgment on this basis.
"all the deferred payments and retained percentages, and any and all moneys and properties that may be due and payable to the undersigned at the time of any breach or default in said contract, or . . . thereafter. . . ."
"Any and all percentages of the contract price retained on account of said contract, and any and all sums that may be due under said contract at the time of such . . . forfeiture or breach, or that thereafter may become due. . . ."

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