Opinion ID: 781023
Heading Depth: 2
Heading Rank: 1

Heading: Equitable Subrogation and Entitlement to Set-Off

Text: 19 The major issue raised in this appeal is National Fire's equitable subrogation rights under the two performance bonds and the two payment bonds. National Fire asserts that it possesses a superior right to the unpaid contract balances in light of a surety's recognized right to equitable subrogation. 12 The District Court agreed and ruled below that National Fire had superior equitable subrogation rights under both its payment and its performance bonds. However, Fortune argues that the liquidated delay damages, Davis-Bacon Act violations, and the electrical overage costs incurred by Arkin should be set off against any unpaid contract balances that National Fire is claiming through equitable subrogation. 20 Fortune relies primarily upon United States v. Munsey Trust Co., 332 U.S. 234, 236, 108 Ct.Cl. 765, 67 S.Ct. 1599, 1600, 91 L.Ed. 2022, 2023 (1947), in which the Supreme Court of the United States addressed the issue of whether percentages retained pursuant to contract by the United States may be subjected to its set-off claims despite the claims of a surety who has paid laborers and materialmen. In Munsey Trust, the Government had entered into six contracts with a contractor to paint and repair certain federal buildings. Each contract was subject to both a performance bond and a payment bond. Although the contractor completed the work on the contracts so that the surety did not have to perform under the performance bond, the surety did pay $13,065.93 on payment bond claims made by laborers and materialmen. Under the terms of the contracts, the Government had retained percentages of the progress payments due to the contractor, amounting to $12,445.03. Subsequently, the same contractor submitted a bid to the Government for another project, which the Government accepted. However, the contractor failed to enter into a contract for the work, and another contractor performed the job at a price considerably higher than the bid price accepted by the Government, which resulted in damages to the Government in the amount of $6,731.50. In paying over the contract amount that it had retained on the other six contracts to the surety, the Government set off the $6,731.50 it claimed. The surety protested the set-off and asserted its right to an additional $3,568.23. See id. at 332 U.S. 234, 237-39, 67 S.Ct. at 1600-01. 21 With respect to any claims that may have been asserted by the contractor against the Government, the Supreme Court recognized that [t]he government has the same right `which belongs to every creditor, to apply the unappropriated moneys of his debtor, in his hands, in extinguishment of the debts due to him.' Id. at 239, 67 S.Ct. at 1602 (quoting Gratiot v. United States, 15 Pet. 336, 40 U.S. 336, 370, 10 L.Ed. 759 (1841)). However, the surety argued that it had subrogation rights superior to both the laborers and materialmen to whom the surety had paid and to the Government, the bond obligee. In response to this argument, the Supreme Court observed that: 22 [O]ne whose own appropriation and payment of money is necessary to create a fund for general creditors is not a general creditor. He is not compelled to lessen his own chance of recovering what is due him by setting up a fund undiminished by his claim, so that others may share it with him. In fact, he is the best of secured creditors; his security is his own justified refusal to pay what he owes until he is paid what is due him. 23 Id. at 332 U.S. 234, 240, 67 S.Ct. at 1602 (emphasis added). Therefore, the Court held that the Government could set off the amount it claimed. See also United States ex rel. P.J. Keating Co. v. Warren Corp., 805 F.2d 449, 452 (1st Cir.1986) (recognizing that Government's set off right is superior to a claim by a Miller Act surety under its payment bond to the same contract earnings); Marriott Corp. v. Dasta Constr. Co., 26 F.3d 1057, 1070-71 (11th Cir.1994) (recognizing owner's right to setoff against unpaid contract balance). 24 National Fire relies on the subsequent Supreme Court decision in Pearlman v. Reliance Ins. Co., 371 U.S. 132, 83 S.Ct. 232, 9 L.Ed.2d 190 (1962), in which the Court addressed the issue of whether a government contractor's trustee in bankruptcy or the contractor's payment bond surety had the superior right to a fund withheld by the Government out of earnings due to the contractor. The Court recognized the clearly established right of subrogation, which provides 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, and held for the surety. Id., 371 U.S. at 137, 83 S.Ct. at 235. The Supreme Court also noted that the Munsey Trust decision had no effect upon its prior holdings in Prairie State Bank v. United States, 164 U.S. 227, 32 Ct.Cl. 614, 17 S.Ct. 142, 41 L.Ed. 412 (1896), and Henningsen v. United States Fid. & Guar. Co., 208 U.S. 404, 28 S.Ct. 389, 52 L.Ed. 547 (1908), that there is a security interest in a withheld fund ... to which the surety is subrogated. Pearlman, supra, 371 U.S. at 137, 83 S.Ct. at 235. The Supreme Court construed Munsey Trust as limited to the narrow proposition that the Government could exercise the well-established common-law right of debtors to offset claims of their own against their creditors. Id. at 140, 83 S.Ct. 232, 83 S.Ct. at 237. Otherwise, the equitable rights of a surety to subrogation were left undisturbed. See id. Therefore, the surety had a superior right, vis-a-vis the principal's trustee in bankruptcy, to funds held by the Government. Pearlman did not involve the priority of rights between a surety and the obligee. 25 We note that neither Munsey Trust nor Pearlman attempted to differentiate the surety's equitable subrogation rights on the basis of whether a payment or a performance bond obligation had been fulfilled. Under Florida law, which applies here, a performance and payment bond surety's rights to equitable subrogation depend upon the nature of the obligation fulfilled by the surety under the terms of the bonds. In Transamerica Ins. Co. v. Barnett Bank of Marion County, 540 So.2d 113, 115 (Fla.1989), the Supreme Court of Florida addressed the issue of whether a surety's equitable subrogation rights are limited to rights it obtains by standing in the shoes of the defaulting contractor. In considering this issue, the court observed: 26 [T]he surety in cases like this undertakes duties which entitle it to step into three sets of shoes. When, on default of the contractor, it pays all the bills of the job to date and completes the job, it stands in the shoes of the contractor insofar as there are receivables due it; in the shoes of laborers and material men who have been paid by the surety — who may have had liens; and, not least, in the shoes of the [obligee], for whom the job was completed. 27 Id. at 115-16 (quoting National Shawmut Bank v. New Amsterdam Cas. Co., 411 F.2d 843, 844-45 (1st Cir.1969)). Therefore, [a] surety who performs or pays on behalf of a [ sic ] obligee steps into the shoes of the obligee to the extent of performance or payment.  Id. at 116 (emphasis added). Thus, only a performance and payment bond surety who pays all of the bills of the job to date and completes the job is entitled to stand in the contractor-principal's shoes and demand payment of unpaid balances from the obligee. The surety's rights, as subrogee, are not inferior even to the rights of the obligee and may be asserted against the obligee. Id. The Transamerica opinion of the Supreme Court of Florida recognizes that a performing surety may assert a right to contract proceeds superior to the obligee because, by completing the project, the surety conferred a benefit on the obligee and, therefore, stepped into the shoes of the obligee. See id. at 115-16. Where a surety pays the claims of laborers and materialmen, the surety is only entitled to stand in the shoes of those laborers and materialmen who might have had liens, but for the surety's payment. Of course, in both cases, the surety's subrogation rights exist only to the extent of the surety's performance. The fact that the surety in this case, National Fire, did not complete performance distinguishes this case from Transamerica. 13 28 We conclude that National Fire's right to subrogation is controlled by the rationale of the former Fifth Circuit's decision in Trinity Universal Ins. Co. v. United States, 382 F.2d 317 (5th Cir.1967). 14 In Trinity Universal, the former Fifth Circuit addressed whether, when a Miller Act surety completes a defaulted contract pursuant to its performance bond, the government may set off taxes owed by the contractor against the surety's claim to the fund retained by the government to insure performance. Id. at 318. Finding that there was no right to set-off, the former Fifth Circuit recognized that, in Munsey Trust, the rights of the surety were limited to those of subrogee of the contractor because the surety had only performed under a payment bond. Id. at 319. Having made payments pursuant to its payment bond, the surety in Munsey Trust became a creditor of the Government with respect to the funds retained by the Government, and the Government could exercise the well-established common law right to setoff claims against its creditors. Id. at 319-20. 29 However, the former Fifth Circuit noted that, [a] different situation occurs when the surety completes the performance of a contract. The surety is not only a subrogee of the contractor, and therefore a creditor, but also a subrogee of the government and entitled to any rights the government has to the retained funds. Id. at 320. The distinction between a surety's rights when performing under a payment bond or a performance bond is important. When a surety completes the project itself or pays the excess completion costs pursuant to the performance bond, the surety confers a benefit upon the obligee, whether the obligee is the Government or a private entity. That benefit relieves the obligee of the burden of completing the construction. In such circumstances, an implicit agreement exists that the surety has a right to all retained funds and any remaining progress sums, and the obligee does not possess a right to setoff. 15 See id. at 320-21; see also Aetna Cas. & Surety Co. v. United States, 435 F.2d 1082, 1083-84 (5th Cir.1970) (finding that surety's payments made under performance bond were not subject to set-off). 30 Courts often fail to address the distinction between a surety's right to subrogation when the surety makes payments under a payment bond, as compared to the surety's rights when it performs its performance bond obligations. The payment bond surety, who stands in the shoes of laborers and materialmen, normally has priority with respect to remaining contract balances because those laborers and materialmen would have high priority liens against the property under state law. Under Florida law, construction liens of laborers and materialmen have priority over all subsequently recorded encumbrances on the owner's property. Fla. Stat. § 713.07(3) (1997). Of course, the payment bond surety's subrogation is limited to proper payments made to valid lien claimants. Likewise, the performance bond surety who actually performs stands in the principal's shoes and can demand payment of the remaining contract balances. Further, such a performance bond surety's rights to contract balances are superior to the obligee's and any claims the obligee may have against the principal. Where, as in this case, the surety makes payments under the payment bonds, but does not fulfill its performance bond obligations, this distinction is critical to an equitable prioritization of rights, particularly where it is the obligee who performs in the face of the surety's possible breach of the performance bond. 31 The rationale of Trinity Universal controls the respective rights of National Fire and Fortune to any retained contract balances in Fortune's possession. To further analyze the surety's subrogation rights, it is necessary to differentiate between what claims are covered by each of the respective bonds. Since National Fire did not complete construction under its performance bonds, it has acquired equitable subrogation rights only with respect to its payment bonds. The district court erred to the extent that it granted summary judgment for National Fire on its claim of equitable subrogation arising out of the performance bonds. Further, the extent of National Fire's subrogation under the payment bonds to Fortune is limited to the amount of the valid claims National Fire properly paid on a particular project after Fortune's reasonable costs to complete construction on the project are deducted from the remaining contract balances. 32 Our holding that National Fire is not entitled to equitable subrogation for any performance bond related claims is also based upon our conclusion that the district court erred in its partial summary judgment ruling that National Fire had no obligation under the performance bonds for either project to complete construction itself or to arrange for the completion of construction. 16 Such a ruling would have been correct if the bonds were indemnity-type, but it is undisputed in the record that the performance bonds in this case were not merely indemnity bonds. The touchstone of any right to subrogation under a performance bond is actual and full performance of the bond's obligations. RESTATEMENT (THIRD) OF SURETYSHIP & GUARANTY § 27 (1995). The language of the two performance bonds plainly contravenes the district court's ruling. The Winston Park performance bond provided that: 33 Whenever [Arkin] shall be, and declared by [Fortune] to be in default under the [Winston Park Subcontract], [Fortune] having performed [Fortune's] obligations thereunder, [National Fire] may promptly remedy the default, or shall promptly 34 1) Complete the [Winston Park Subcontract] in accordance with its terms and conditions, or 35 2) Obtain a bid or bids for completing the [Winston Park Subcontract] in accordance with its terms and conditions, and upon determination by [National Fire] of the lowest responsible bidder, or if [Fortune] elects, upon determination by [Fortune] and [National Fire] jointly of the lowest responsible bidder, arrange for a contract between such bidder and [Fortune], and make available as Work progresses ... 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 [National Fire] may be liable hereunder, the amount [of the bond]. 36 Under the terms of this bond, when Arkin was declared in default, National Fire had three options: (1) it could remedy the default; (2) it could complete construction itself; or (3) it could arrange for the completion of construction by selecting, either by itself or jointly with Fortune, a completion contractor and by making funds available to the completion contractor for completion costs in excess of the contract price. National Fire could not, as the district court held, merely ignore Fortune's demands that National Fire perform, force Fortune to complete construction, and then pay Fortune for reasonable costs in excess of the contract price. The express terms of the Winston Park performance bond placed the burden of performance on National Fire. Because National Fire did not perform, it is not entitled to subrogation with respect to the Winston Park performance bond. 37 The district court also erred in applying the same analysis to National Fire's West Brickell performance bond obligation as to the Winston Park performance bond obligation. Unlike the Winston Park performance bond, the West Brickell performance bond's terms potentially contemplated completion of construction by Fortune. The West Brickell performance bond stated: 38 Whenever [Arkin] shall be, and be declared by [Fortune] to be in default under the subcontract, [Fortune] having performed [Fortune's] obligations thereunder: 39 (1) [National Fire] may promptly remedy the default subject to the provisions of paragraph 3 herein; or 40 (2) [Fortune] after reasonable notice to [National Fire] may, or [National Fire] upon demand of [Fortune] may arrange for the performance of [Arkin's] obligation under the subcontract subject to the provisions of paragraph 3 herein; 41 (3) The balance of the subcontract price... shall be credited against the reasonable cost of completing performance of the subcontract. If completed by [Fortune], and the reasonable cost exceeds the balance of the subcontract price, [National Fire] shall pay to [Fortune] such excess, but in no event shall the aggregate liability of [National Fire] exceed the amount of this bond. 42 (Emphasis added). 43 Under this provision, National Fire also had three alternatives: (1) it could remedy the default; (2) if Fortune provided National Fire reasonable notice that Fortune wished to arrange for completion, it could allow Fortune to arrange for the completion of construction; or (3) if Fortune demanded that National Fire arrange for completion of construction, it could arrange for completion of construction itself. According to the evidence in the record (and construing the record in the light most favorable to Fortune since it appears to be a genuine factual dispute), Fortune did not wish to complete construction of the West Brickell project itself after Arkin defaulted. Instead, Fortune demanded that National Fire arrange for completion of construction of the West Brickell project, and National Fire refused to do so. Paragraph three of the West Brickell performance bond does contemplate the possibility that Fortune could have completed the subcontract itself. However, this contingency would only occur if, under the second alternative, Fortune sought to complete construction itself or, under the third alternative, National Fire arranged for Fortune to complete construction. In either of these cases, Fortune (not National Fire) could choose whether Fortune would voluntarily complete construction. Because it appears National Fire did not perform, it is not entitled to subrogation with respect to the West Brickell performance bond. 44 We also find that disputed issues of material fact exist in the record about whether National Fire's failure to perform amounted to a breach of its performance bond obligations, as described above. National Fire claims it appropriately tendered a completion contractor and that Fortune refused this tender. (Aff. of Raymond Lemming, R.27 at 4-5.) Fortune claims a completion contractor was never tendered despite its demands. (Aff. of Michael Getz, R.44 at 2.) This obvious factual conflict was presented to the district court in the parties' arguments on National Fire's motions for partial summary judgment. The only way the district court avoided confronting this conflict was by erroneously ruling that, as a matter of law and without reference to the language of the performance bonds, National Fire had no obligation to tender a completion contractor or to complete performance itself. Summary judgment on Fortune's breach of contract claim against National Fire was improper and we remand for further proceedings on this issue. 17