Opinion ID: 1191028
Heading Depth: 1
Heading Rank: 5

Heading: Colonial's State-Court Lawsuit

Text: On July 7, 2003, Interworks and two of its affiliates filed petitions for relief pursuant to Chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court for the Eastern District of New York. Because Interworks was unable to complete performance of its public improvement contracts, Colonial, pursuant to the surety agreement, made payments to sub-contractors and fulfilled Interworks' other obligations under the public improvement contracts. Between Interworks' debts to subcontractors, suppliers, and laborers, and Interworks' federal and state tax obligations for which Colonial, as surety, is potentially liable, Colonial allegedly incurred financial obligations of $1,750,076.90 and suffered claims against the bonds it had issued for Interworks in an amount thought to be in excess of $650,000. As a provider of surety bonds in connection with Interworks' public improvement contracts, Colonial is a beneficiary of the Article 3-A trust funds that arise from payments made pursuant to those contracts. If those funds are diverted, Colonial is entitled to recover the amount it is owed from whomever diverted the funds, provided that such person was on notice, at the time the funds were diverted, that the funds were trust assets. N.Y. Lien Law §§ 77.1, 77.3(6). In an effort to recoup its expenses and satisfy the liabilities it incurred as a result of Interworks' default on its public improvement contracts, Colonial brought suit against Merchant in New York State Supreme Court in May 2003. Colonial alleged that under Article 3-A, the funds Merchant received that had been paid to Interworks under the public improvement contracts were trust funds that Merchant, standing in Interworks' place as fiduciary to the trust, was required to pay to trust beneficiaries, and that instead of paying the beneficiaries of the trust created by the public improvement contracts, Merchant had in fact used the assets to satisfy Interworks' obligations to Merchant arising from their separate financing agreement. See Second Amended Compl. (filed Jan. 13, 2004) ¶¶ 28-74. Colonial, as a beneficiary of the trust, sought to be recognized as an authorized class representative of all beneficiaries of the Article 3-A trust. The court allowed Colonial to join another putative class representative, but held the motion in abeyance pending the outcome of a further hearing on class certification. For reasons that are not readily apparent from the record, the United States did not seek to intervene in this state court action in an attempt to collect the unpaid employment taxes that Merchant, standing in Interworks' place as a result of the financing agreement between the two parties, owed on work stemming from the public improvement contracts.