October 1, 1955
, the Government filed a notice of tax lien and levy with Redhill and
with Belbee for withholding taxes owed by the taxpayer to the Government
in the amount of $9,850.18. On that date, under their respective
construction contracts, Redhill owed the taxpayer sums in excess of
$1,707.38 and Belbee owed the taxpayer sums in excess of $4,680.97.
After service of the notice of lien and levy, however, both Redhill and
Belbee made payments of $1,707.38 and $4,680.97, respectively, to
materialmen and suppliers of the taxpayer. It is these sums that the
Government now claims were the property of the taxpayer and therefore
due from Redhill and Belbee to the Government by reason of the notice of
lien on account of the withholding taxes owed by the taxpayer.
claims that it is entitled to recovery under 26
C. A. §§ 6321 and 6322, providing for the imposition of liens upon
property and rights of the taxpayer. Redhill and Belbee do not dispute
the effectiveness of any liens properly imposed upon the property of the
taxpayer pursuant to these sections, but assert that the sums paid out
to the materialmen and suppliers in this case were not property of the
taxpayer to which any lien could attach. They rely (i) upon principles
of contract and (ii) upon Section 36-a of the Lien Law of the State of
New York, as it existed in 1955, under both of which they claim no debt
was owing to the taxpayer.
The real issue
in this case is whether there existed in the hands of Redhill and Belbee
any assets or property of the taxpayer at the time the Government served
its notice of lien upon them. Conceivably, under the terms of the
respective contracts between the taxpayer and the contractors (including
the execution of promissory notes by one contractor), the taxpayer was
not entitled to the funds in question at the time the Government served
its notice of tax lien upon the contractors because they had a right to
retain the monies and apply the same to the claims of the materialmen
and suppliers. While contracts between individuals may not prevail to
immunize the property or rights of a taxpayer from the provisions of the
Internal Revenue laws, United States v. Manufacturers Trust Co.,
2 Cir., 1952, [52-2 USTC ¶9417] 198 F. 2d 366, such contracts insofar
as they create prior rights in third parties under state law, must
nevertheless be honored as against the Government, United States
Fidelity & Guaranty Co. v. Triborough Bridge Authority, 1947,
[47-2 USTC ¶9327] 297 N. Y. 31, since a taxpayer in such event has no
property rights to which a Federal lien might attach. Fidelity and
Deposit Company of
v. New York City Housing Authority, 1957, [57-1 USTC ¶9410] 241 F.
rights of the respective parties under the contracts in question raised
certain troublesome issues of incorporation by reference and extent of
coverage which the Court does not believe it necessary to explore
inasmuch as it is satisfied that the provisions of Sections 36-a and
36-b of the New York Lien Law are sufficient to dispose of the issues.
The pertinent portion of Section 36-a reads as follows:
funds received by a contractor from an owner for the improvement of real
property are hereby declared to constitute trust funds in the hands of
such contractor to be applied first to the payment of claims of
subcontractors, * * * laborers and materialmen arising out of the
improvement, and to the payment of premiums on surety bond or bonds
filed and premiums on insurance accruing during the making of the
improvement and any contractor * * * who applies or consents to the
application of such funds for any other purpose and fails to pay the
claims hereinbefore mentioned is guilty of larceny * * *.
trust may be enforced by civil action maintained as provided in article
three-a of this chapter by any person entitled to share in the fund,
whether or not he shall have filed, or had the right to file, a notice
of lien or shall have recovered a judgment for a claim arising out of
the improvement. For the purpose of a civil action only, the trust
funds shall include the right of action upon an obligation for moneys
due or to become due to a contractor." (Italics supplied)
claim that under the above section funds in their hands at the time the
notice of lien was served were held in trust for the materialmen and
that they held no property to which the tax lien could attach. It is the
Government's contention that the above section did not authorize
payments to materialmen of the taxpayer because at the time the
Government filed its notice of lien the liens of the materialmen were
inchoate and not perfected and consequently were ineffective against the
Government's claim, citing United States v. Kings County Iron Works,
Inc., 2 Cir., 1955, [55-2 USTC ¶9536] 224 F. 2d 232, and Gramatan-Sullivan,
Inc. v. Koslow, 2 Cir., 1957, 240 F. 2d 523.
County Iron Works the court held that Section 36-a of the New York
Lien Law did not prevent the Government from obtaining a lien upon funds
held by a contractor superior to the claims of a subcontractor who had
not perfected his mechanic's lien by a timely civil action before the
Government had filed its notice of lien. In so doing, the court
indicated that the rights of the materialmen were similar to those of
the holder of an attachment or garnishment lien before the same had
matured to judgment and reasoned that whether the property held by the
contractor or subcontractor is the property of the taxpayer and whether
a prior lien is sufficiently perfected "are, in the final analysis,
matters of federal law, although state law will be considered where
relevant." (p. 235) Subsequently this rationale
disregarded by the same court when considering analogous questions
created by contract rather than by statute. Fidelity and Deposit
v. New York City Housing Authority, supra. Thereafter in a similar
situation the Supreme Court had occasion to construe the rights granted
under the New Jersey law to a beneficiary of a life insurance policy and
held that it was the state law which should determine whether the
taxpayer had a sufficient interest in the cash surrender value of the
policy to justify the attachment of a Federal tax lien, thus rejecting
the rationale of Kings County Iron Works. United States v. Bess,
1958, [58-2 USTC ¶9595] 357
seems to be little doubt that state law, and not federal law, must
control in determining whether or not any property right existed in the
taxpayer to which any Federal lien might attach. In Aquilino v.
United States, 1960, [60-2 USTC ¶9538] 363 U. S. 509, a writ of
certiorari was issued by the Supreme Court to the New York Court of
Appeals to review its decision, [57-1 USTC ¶9659] 3 N. Y. 2d 511, 1957,
holding that under Sections 3670 and 3671 of the Internal Revenue Code
of 1939, 26 U. S. C. A., the Government had obtained a valid lien for
taxes due from the general contractor upon funds held by him superior to
the rights of the subcontractors. The
decision, in effect, was a pronouncement that Sections 3670 and 3671
were paramount to Section 36-a of the New York Lien Law. The Supreme
Court was dissatisfied with this resolution of the question and held
that the provisions of the Internal Revenue Code created no property
rights but merely attached consequences to the rights created under the
state law, stating (pp. 512-513):
threshold question in this case, as in all cases where the Federal
Government asserts its tax lien, is whether and to what extent the
taxpayer had 'property' or 'rights to property' to which the tax lien
could attach. In answering that question, both federal and state
courts must look to state law, for it has long been the rule that
'in the application of a federal revenue act, state law controls in
determining the nature of the legal interest which the taxpayer had in
the property * * * sought to be reached by the statute.' Morgan v.
78, 82, 60
424, 426, 84 L. Ed. 585." (Italics supplied)
the same effect see United States v.
Lumber Co., 1960, [60-2 USTC ¶9539] 363
was then remanded to the New York Court of Appeals to "ascertain
the property interests of the taxpayer under state law". Upon
remand the New York Court of Appeals 1
disavowed the view of the lien espoused by Gramatan-Sullivan, Inc. v.
Koslow, supra, as well as its prior decision, remarking:
conclusion, then, is that, as a matter of New York law, a contractor
does not have a sufficient beneficial interest in the moneys, due or to
become due from the owner under the contract, to give him a property
right in them, except insofar as there is a balance remaining after all
subcontractors and other statutory beneficiaries have been paid. This
being so, it follows that the tax lien herein asserted by the Government
against the property of the contractor-taxpayer is ineffective to reach
such moneys and that the plaintiff subcontractors are entitled to the
court-deposited fund." (Id., p. 282)
County Iron Works and Gramatan-Sullivan, Inc. v. Koslow can
no longer be followed. But it should be observed that in Aquilino
a trust was imposed upon funds due from the property owner to a prime
contractor-taxpayer, whereas in the case at bar a trust is sought to be
imposed upon funds due from a prime contractor and a subcontractor to a
subcontractor-taxpayer. These differences however, do not change the
result since Section 36-b of the New York Lien Law (effective in 1955)
impresses a trust upon funds received by a subcontractor from an owner
or contractor or subcontractor for the payment of claims of his
subcontractors, laborers and materialmen arising out of the improvement
of real property. See Williamson & Adams, Inc. v.
McMahon-McEntegart, Inc., 1st Dept., 1939, 256 App. Div. 313, 10 N.
Y. S. 2d 37.
this Court concludes that under New York law no property right existed
in the taxpayer under Sections 36-a and 36-b of the Lien Law to which
any Federal tax lien could attach since the interests of the materialmen
and suppliers were not inchoate but, on the contrary, were perfected
interests of beneficiaries of a true trust.
embodies the Court's findings of fact and conclusions of law and
judgment is ordered for the defendants.
10 N. Y. 2d 271 (1961).
Paul R. Van Etten, Plaintiff v. New
York State Natural Gas Corporation, et al., Defendants and
United States of America
S. District Court, Middle Dist. Pa., Civil Action No. 5575, 192 FSupp
[1954 Code Secs. 6321-6323]
Liens for taxes: Priority of subcontractor's liens: Breach of
contract by general contractor.--Funds due the taxpayer upon
completion of services performed and for materials furnished as an
electrical subcontractor were not paid by the contractor. This
constituted breach of the latter's contract with the owner, who retained
progress payments due under the construction contract and paid them into
the registry of the court following an assessment for unpaid withholding
taxes against the contractor. Tax liens of the
did not attach to these funds since the general contractor had no
property or right to property in the withheld balances.
, N. Y., and Emory Rockwell,
, for plaintiff. Owlett, Cox, Wilcox & Owlett, Wellsboro, Pa., for
New York State Natural Gas Corp. Anne X. Alpern, Attorney General,
Pittsburgh, Pa., and Morley W. Baker, Special Deputy Attorney General,
Harrisburg, Pa., for Pennsylvania Unemployment Compensation Fund. Abbott
M. Sellers, Acting Assistant Attorney General, Richard M. Roberts, and
Paul T. O'Donoghue, Department of Justice, Washington 25, D. C., and
Daniel H. Jenkins, United States Attorney, and Daniel R. Minnick,
Assistant United States Attorney, Scranton, Pa., for United States.
The facts as
disclosed by the pleadings and stipulated by the parties, except as
hereinafter specified, are adopted by the Court as if found pursuant to
Rule 52, Federal Rules of Civil Procedure.
New York State
Natural Gas Corporation (hereinafter called the Owner) on May 31, 1951
entered into a no lien construction contract 1
with Harold B. Fink, d/b/a Fink Construction Company (hereinafter called
the Contractor), to furnish labor and material for the construction of
office building and shops at Sabinsville, Pennsylvania. This contract
was duly filed of record in the Office of the Prothonotary of Tioga
Etten, entered into a subcontract with the Contractor to furnish the
electrical work and materials pursuant to the contract between the Owner
and the Contractor and duly performed all of the work and supplied all
the materials required by said subcontract. The value of the work
performed and materials supplied by the plaintiff under his contract
with the Contractor and for which he has not been paid is $13,244.52. On
or about March 27, 1953, the plaintiff terminated work due to the
failure of the Contractor to make the payments required by the contract
between the plaintiff and the contractor. On that date the plaintiff had
not completed work or furnished materials of the value of $570.74.
During the months of May and June 1952, plaintiff completed the work and
extras to complete the contract and was paid the sum of $570.74 by Tioga
County Savings and Trust Company of
, pursuant to an agreement made between the plaintiff, the Owner, the
Contractor and the creditors of the Contractor.
to Withheld Funds]
Commissioner of Internal Revenue assessed against Harold B. Fink, d/b/a
Fink Construction Company, withholding taxes and Federal unemployment
taxes in the total sum of $13,446.69. These taxes covered the period
starting with the second quarter of 1951 through the second quarter of
1952. The first liens arose on
May 21, 1952
, and the last liens arose on
November 5, 1954
. The first notice of lien was filed on
May 23, 1952
, and the last notice of lien was filed
November 8, 1954
provisions of Article 4 of the contract between the Owner and the
Contractor, the Owner, New York State Natural Gas Corporation, retained
the sum of $13,186.79 which, pursuant to an Order of this Court, has
been deposited in the registry of the Court.
for Retained Funds]
brought this action to obtain judgment for the retained funds. The
District Collector of Internal Revenue was named a codefendant with the
Owner and Contractor aforesaid. The District Collector was later
dismissed as a defendant and the
intervened to enforce the Federal tax liens and to obtain judgment
against Contractor for outstanding tax assessments in the sum of
$13,446.59, plus interest as allowed by law.
did not and could not furnish a statement that all the subcontractors
and material men had been paid.
portions of the contract are as follows:
4. Progress Payments--The Owner shall make payments on account of the
Contract as provided therein, as follows: On or about the Tenth (10th)
day of each month Ninety (90) per cent of the value, based on the
Contract price, of labor and materials incorporated in the work and of
materials suitably stored at the site thereof up to the First (1st) day
of that month, as estimated by the Engineers, less the aggregate of
previous payments; and upon substantial completion of the entire work, a
sum sufficient to increase the total payments to Ninety-five (95) per
cent of the Contract price.
5. * * *
issuance of final certificate the Contractor shall submit evidence
satisfactory to the Engineers that all payrolls, material bills, and
other indebtedness connected with the work have been paid."
conditions of the contract:
to Pay Subcontractor Is Breach of Contract]
22. * * * If the Contractor * * * should fail to make prompt payment to
subcontractors or for material or labor, * * * then the Owner, upon the
certificate of the Engineers that sufficient cause exists to justify
such action, may, without prejudice to any other right or remedy and
after giving the Contractor seven days' written notice, terminate the
employment of the Contractor * * *. In such case the Contractor shall
not be entitled to receive any further payment until the work is
finished. If the unpaid balance of the contract price shall exceed the
expenses of finishing the work including compensation for additional
managerial and administrative services, such excess shall be paid to the
Contractor. If such expenses shall exceed such unpaid balance, the
Contractor shall pay the difference to the Owner. * * *
26. * * * The Engineers may withhold or, on account of subsequently
discovered evidence, nullify the whole or a part of any certificate to
such extent as may be necessary to protect the Owner from loss on
Claims filed or reasonable evidence indicating probable filing of
Failure of the Contractor to make payments properly to subcontractors or
for material or labor.
32 * * * Neither the final payment nor any part of the retained
percentage shall become due until the Contractor, if required, shall
deliver to the Owner a complete release of all liens arising out of this
Contract, or receipts in full in lieu thereof and, if required in either
case, an affidavit that so far as he has knowledge or information the
releases and receipts include all the labor and material for which a
lien could be filed; but the Contractor may, if any subcontractor
refuses to furnish a release or receipt in full, furnish a bond
satisfactory to the Owner, to indemnify him against any lien. If any
lien remain unsatisfied after all payments are made, the Contractor
shall refund to the Owner all moneys that the latter may be compelled to
pay in discharging such a lien, including all costs and a reasonable
37. * * *
To pay the Subcontractor, upon the payment of certificates, if issued
under the schedule of values described in Article 24 of the General
Conditions, the amount allowed to the Contractor on account of the
Subcontractor's work to the extent of the Subcontractor's interest
To pay the Subcontractor, upon the payment of certificates, if issued
otherwise than as in (e), so that at all times his total payments shall
be as large in proportion to the value of the work done by him.
To pay the Subcontractor to such extent as may be provided by the
Contract Documents or the subcontract, if either of these provides for
earlier or larger payments than the above.
To pay the Subcontractor on demand for his work or materials as far as
executed and fixed in place, less the retained percentage, at the time
the certificate should issue, even though the Engineers fail to issue it
for any cause not the fault of the Subcontractor."
v. United States, 1950  [60-2 USTC ¶9538], 363
509, 512, the Court posed the question here involved as follows:
threshold question in this case, as in all cases where the Federal
Government asserts its tax lien, is whether and to what extent the
taxpayer had 'property' or 'rights to property' to which the tax lien
could attach. In answering that question, both federal and state courts
must look to state law, for it has long been the rule that 'in the
application of a federal revenue act, state law controls in determining
the nature of the legal interest which the taxpayer had in the property
. . . sought to be reached by the statute.' Morgan v. Commissioner
[40-1 USTC ¶9210], 309
78, 82. Thus, as we held only two Terms ago, Section 3670 'creates no
property rights but merely attaches consequences, federally defined, to
rights created under state law . . ..' United States v. Bess
[58-2 USTC ¶9595], 357
51, 55. . . ."
Had No Right to Withheld Balance]
Refining Company v. Continental Casualty Company, D. C. W. D. Pa.,
1960, [60-1 USTC ¶9413] 183 F. Supp. 478, involved a case very similar
to the instant case. The only substantial variation being that in
Atlantic Refining a surety was involved although it was not in the
instant case. I do not think that that makes any difference in the net
result so far as the facts of this case are concerned. The scholarly
opinion of Judge Marsh so thoroughly and convincingly covers the entire
situation that there is little that I can add other than to say that I
am in complete accord with that opinion. Judge Marsh held, inter
is a general principle that a material failure of performance by one
party to a contract not justified by the conduct of the other discharges
the latter's duty to give the agreed exchange. Sections 274 and 275,
Restatement, Contracts, with which
law is in accord; (citing
cases) * * *.
the cited cases it was held that the tax liens of the
did not attach to the withheld funds; and the sureties and, in one case,
the materialmen, won the money. In at least four of the cases, it seems
that the contractors had completed or substantially completed the work
for the owners, the contractual breach being their failure to pay
I am of the opinion that a failure by the Contractor here to pay for
labor and materials is just as much a failure to perform and carry out
the terms of the contracts as an abandonment of the work would have
* * Consequently, except for $23.17, the Contractor had no right of
property in the balances withheld by the Owner; he could 'not get' the
withheld balances, Lancaster County Nat. Bank's Appeal, 304 Pa.
437, 155 A. 859; he had 'no rights whatever' to the said balances, Prairie
State National Bank of Chicago, v. United States, 1896, 164 U. S.
227, * * *.
when perfected in 1955, the lien of the government's taxes bound a
contingent right of the Contractor to receive the balance of the
contract prices if, but only if, he substantially preformed his direct
contractual obligations to the Owner to pay the materialmen. After his
material breaches, the Contractor's contingent right never ripened into
a 'right to property' which he could enforce or on which the federal tax
liens could attach."
that the Contractor has no "property" or "right to
property" in the withheld balances which the Owner paid into Court
and, therefore, there was nothing to which the Government's lien could
Let Order be
submitted in accordance herewith.
An unnumbered paragraph following Article 6 of the contract provides as
agreed between the parties of this Contract that neither the Contractor
nor any Subcontractor, material man or other person or company, will
file or permit to be filed a Mechanic's Lien against the property or the
structure to be erected on the property."
The Atlantic Refining Company v.
Continental Casualty Company, Joseph M. Smith, and Greensburg Concrete
Block Company, Defendants, and United States of America, Intervenor
S. District Court, West. Dist. Pa., Civil Action No. 15185, 183 FSupp
[1954 Code Secs. 6321-6323]
Tax liens: Funds withheld under construction contract: Surety's
rights.--A lien for taxes did not attach to funds withheld from the
tax-delinquent contractor under a construction contract which provided
that final payment would be made only after the contractor showed that
there were no liens for unpaid claims for labor and material, which the
contractor was unable to do. The surety on the contractor's bond was
subrogated to the rights of the person for whom the work was being done,
not to the rights of the contractor (which would be subject to the tax
lien), and, under the terms of the contract and bond, was not liable to
the United States for withholding and social security taxes attributable
to the construction performed under the contract.
Rundle, of Wright & Rundle,
, for plaintiff. J. M. McCandless,
304 Ross Street
, for defendant.
The facts as
disclosed by the pleadings and stipulated by the parties, except as
hereinafter specified, are adopted by the court as if found pursuant to
Rule 52, Fed. R. Civ. P.
Refining Company, hereinafter called the Owner, on
November 8, 1954
May 16, 1955
entered into two no-lien construction contracts with Joseph M. Smith,
hereinafter referred to as Contractor, to furnish labor and materials
for the construction of two service stations located, respectively, in
, and Connellsville,
. The contracts were filed of record in the respective counties before
visible commencement of work was begun on the ground. A construction and
payment bond furnished by Continental Casualty Company, hereinafter
referred to as Surety, accompanied each contract.
completed the construction of the service stations but failed to pay
certain materialmen on each job. As of November, 1956, the balance
withheld by the Owner on the contract price was $6,027.68 for the
station and $6,626.26 for the Connellsville station, or a total of
to Withheld Funds]
the United States Internal Revenue Service served on Owner notice of
levy and demand for certain taxes owned by the Contractor, assessed in
July and December of 1955 and noticed and filed of record on
October 28, 1955
December 30, 1955
. The total amount of the assessments was $11,632.06, plus interest, of
which sum $1,114.81 was incurred by the Contractor in erecting the two
service stations aforementioned.
Concrete Block Company, a judgment creditor of the Contractor, served a
writ of attachment execution on the Owner, as garnishee, attaching the
fund allegedly due to the Contractor to satisfy its judgment of $737.65,
with interest and costs.
claimed the balances withheld on the contract prices by reason of its
liability on the bonds to unpaid materialmen.
these conflicting claims, the Owner on
November 15, 1956
filed a "Complaint for Interpleader and Declaratory Relief"
, the Surety Company, Greensburg Concrete Block Company, and the
Contractor, and thereupon paid $12,653.94 into the registry of this
judgment was entered against Contractor Smith and Greensburg Concrete
Block Company for failure to appear, answer or plead, and the Owner was
discharged from any claim that they might assert against the funds paid
was dismissed as to the
, and the
was permited to intervene as a party plaintiff. The government's
complaint in intervention alleges that the Contractor is indebted to it
for certain withholding and F. I. C. A. taxes in the sum of $11,632.06,
plus interest, and claims by virtue of the 1955 assessments that it has
a prior lien on the fund allegedly due to the Contractor from the Owner.
Hence, it demands the funds paid into court by Owner.
to its complaint, the government also sues the Surety directly on the
bonds for all withholding and F. I. C. A. taxes due it from the
Contractor in the sum of $11,632.06, plus interest. This suit, however,
is pressed only for the sum of $1,114.81, plus interest, that amount
being the withholding and F. I. C. A. taxes incurred by the Contractor
in the construction of the service stations at
and Connellsville (see government's brief, pp. 32-34).
After the fund
was paid into court, the Surety paid claims of materialmen on the
station in the sum of $6,004.51, leaving a balance of $23.17 unclaimed
except by the
. The Surety paid claims of materialmen on the Connellsville station in
the sum of $12,285.53. The Surety took assignments from the materialmen
which it paid.
presses its claim on the following grounds:
The Contractor had no property or property interest in the fund upon
which the government liens might attach.
The Surety is subrogated to the rights of the Owner and materialmen in
the fund created by the contract between the Owner and the Contractor.
The Surety is entitled to the fund under equitable assignments given by
the Contratcor to the Surety at the time of the execution of the bonds. 1
In my opinion
the Surety is entitled to the fund on the first ground, and on the
second ground, i.e., because it is subrogated to the rights of the
Owner. It is, therefore, unnecessary to discuss the third ground,
although I am of the opinion that the Surety's contentions with respect
to the effect of its equitable assignments would not succeed against the
federal liens. 2
of the contracts between the Owner and the Contractor are identical
except for description of work and prices.
provisions thereof are as follows:
"Contractor shall, during the progress of the work, pay all valid
charges of all his sub-contractors and other persons furnishing labor
and/or materials in the performance or prosecution of the work . . .
when and as such charges become payable and in their full amount."
"When the contract has been completed, the Contractor shall deliver
to the Owner a full Release of Liens signed by himself and all
sub-contractors and other persons who have furnished any materials,
labor, or both, in the performance of the contract or prosecution of the
work. . . . Such release, with accompanying affidavits, shall be in such
form as the Owner may require and its presentation to Owner shall
constitute a representation by Contractor that all sub-contractors . . .
have joined in the proper execution thereof as having been paid. . . .
Until such releases and affidavits are delivered properly executed, the
final schedule of payments may be withheld."
"WAIVER OF LIENS AND CLAIMS: . . . In the event that notice
is given of any claim . . . which is chargeable to the Contractor . . .
the Owner shall have the right to retain out of any payment then due, or
to become due, an amount sufficient to completely indemnify the Owner
against such claim. . . . In the event of . . . [the Contractor's]
failure to have such claims . . . paid . . . the Owner shall have the
right to take such action as is necessary to have the same done,
charging the cost thereof . . . to the Contractor."
"The Owner shall retain ten percent (10%) pending completion of the
job and full compliance with the contract. . . . The final payment shall
be made within thirty (30) days after final test and acceptance of the
work, provided the Contractor shall have submitted to the Owner a
satisfactory Release of Liens showing that all claims and bills for
labor and material have been met and paid as hereinbefore
bonds are identical in their material provisions. Each contract was
incorporated by reference in the accompanying bond.
Each bond was
conditioned upon faithful performance of the contract and upon prompt
payment of all just charges for labor and material furnished by
No release of
liens was furnished the Owner by the Contractor with respect to either
job as required by both contracts. The Owner withheld the balances due
on the contract prices and interpleaded the claimants thereto.
Contractor Does Not Have Any Property or Rights to Property in the
Withheld Balances of the Contract Prices Upon Which the Liens for
Federal Taxes Might Attach
bases its claim to the fund on §§ 6321 and 6322 of the Internal
Revenue Code of 1954. 3
As therein provided "if any person liable to pay any tax neglects
or refuses to pay same after demand, the amount . . . shall be a lien in
favor of the
upon all property and rights to property . . . belonging to such
It was held in
United States v. Bess, 357 U. S. 51, 55 (1958) [58-2 USTC ¶9595]
that ". . . §3670 [now 26 U. S. C. §6321] creates no property
rights but merely attaches consequences, federally defined, to rights
created under state law", citing Fidelity & Deposit Co. v.
New York City Housing Authority, 241 F. 2d 142, 144 (2nd Cir. 1957)
[57-1 USTC ¶9410]. As stated in Morgan v. Commissioner, 309
78, 80 (1940) [40-1 USTC ¶9210]: "State law creates legal
interests and rights."
As of the
dates the federal liens were assessed (1955), the Contractor was not
entitled to received any money under the terms of the contract, for the
Contractor owed materialmen on both jobs. On the
job the unpaid amount was practically equivalent to the amount withheld
by the Owner, and on the Connellsville job the amount was substantially
in excess of the amount withheld.
Rights Under State Law]
It must now be
determined under the
law whether the Contractor had any "property" or "rights
to property" in the balances withheld from the Owner and paid by it
into court. Cf. Central Surety and Insurance Corp. v. Martin Infante
Co., 272 F. 2d 231 (3rd Cir. 1959) [59-2 USTC ¶9736].
It is a
general principle that a material failure of performance by one party to
a contract not justified by the conduct of the other discharges the
latter's duty to give the agreed exchange. Sections 274 and 275,
Restatement, Contracts, with which Pennsylvania law is in accord; Wright
v. Barber, 270 Pa. 186, 113 Atl. 200 (1921); City of Farrell v.
H. Platt Co., 142 Pa. Super. 242, 15 A. 2d 718; vol. 8 P. L. E. §301;
Jur. Contracts, §498; cf. vol. 4, Corbin on Contracts, §901. Also in
accord are cases in other jurisdictions involving contracts providing
for the payment of labor and materialmen as a prerequisite for payment
of the contract price. Central Surety & Insurance Corp. v. Martin
Infante Co., supra; Fidelity & Deposit Co. v. New York City Housing
Auth., supra; United States Fidelity & Guaranty Co. v. United
States, 201 F. 2d 118 (10th Cir. 1952) [53-1 USTC ¶9249]; Wolverine
Insurance Co. v. Phillips, 165 F. Supp. 335 (N. D. Iowa W. D. 1958)
[58-2 USTC ¶9765]; United States Fidelity and Guaranty Co. v.
Miller, 143 F. Supp. 941 (W. D. N. C. 1956) [56-2 USTC ¶9930]; Scott
v. Zion Evangelical Lutheran Church, 75 S. D. 559, 70 N. W. 2d 326
(1955) [55-2 USTC ¶9669]; United States Fidelity & Guaranty Co.
v. Triborough Bridge Authority, 297 N. Y. 31, 36-37, 74 N. E. 2d
226, 228 (1947) [47-2 USTC ¶9327].
In the cited
cases it was held that the tax liens of the
did not attach to the withheld funds; and the sureties and, in one case,
the materialmen, won the money. In at least four of the cases, it seems
that the contractors had completed or substantially completed the work
for the owners, 4
the contractual breach being their failure to pay materialmen.
am of the opinion that a failure by the Contractor here to pay for labor
and materials is just as much a failure to perform and carry out the
terms of the contract as an abandonment of the work would have been.
Contractor failed to pay the materialmen in amounts almost equal to or
in excess of the balances withheld on the contract prices, express
promises of the Contractor to the Owner to pay materialmen were
materially breached by these substantial failures. Consequently, except
for $23.17, the Contractor had no right of property in the balances
withheld by the Owner; he could "not get" the withheld
balances, Lancaster County Nat. Bank's Appeal, 304 Pa. 437, 155
Atl. 859; he had "no rights whatever" to the said balances, Prairie
State Bank v. United States, 164 U. S. 227 (1896).
County Nat. Bank's Appeal, supra, the construction contract, as
here, required the contractor to pay the materialmen. Being a contract
for public work, it was, as here, in effect, a no-lien contract. On page
861 (155 Atl.), it was stated:
it [the assignee of the contractor] was claiming the right to receive a
sum payable to the contractor under the terms of the contract, it was
bound to take notice also of the fact that the contractor could not
get the semifinal estimate, which is the one in controversy here,
until and unless all 'claims for labor and materials [incurred in the
performance of the contract] have been satisfactorily settled,' . .
.." (Italics supplied.)
Likewise, in Prairie
State Bank v. United States, supra, with which it has been declared
the Pennsylvania law is "in harmoney", Sundheim v. School
District, 311 Pa. 90, 166 Atl. 365 (1933), it was stated at page
great deal of confusion has arisen in the case by treating . . . [the
surety] as subrogated merely 'in the rights of . . . [the contractor]'
in the fund, which, in effect, was saying that he was subrogated to
no rights whatever." (Italics supplied.)
perfected in 1955, the lien of the government's taxes bound a contingent
right of the Contractor to receive the balance of the contract prices
if, but only if, he substantially performed his direct contractual
obligations to the Owner to pay the materialmen. After his material
breaches, the Contractor's contingent right never ripened into a
"right to property" which he could enforce or on which the
federal tax liens could attach.
It is ".
. . well settled that the lien of federal taxes extends only to property
in which the taxpayer has an interest." United States v. Burgo,
175 F. 2d 196, 198 (3rd Cir. 1949) [49-1 USTC ¶9307]. "Since the
government's rights under Sections 6321 and 6322 can rise no higher than
the rights of the taxpayer, there was nothing of Infante's [the
contractor's] to be levied upon." Central Surety and Insurance
Corp. v. Martin Infante Co., supra, at pages 234-235.
Justice Brennan's statement in
v. Bess, supra, at pp. 55, 56, it would be anomalous to view as
"property" subject to lien, money never within the
Contractor's reach to enjoy.
In the instant
case, I conclude that the Contractor had no "property" or
"right to property" in the withheld balances which the Owner
paid into court, and, therefore, there was nothing to which the
government's lien could attach.
Surety Is Subrogated to the Rights of the Owner in the Withheld Balances
determined that the
does not have a lien on the withheld balances, it seems certain that the
Surety is entitled to recover the fund paid into court.
government strenuously argues that in no-lien contracts where the work
is completed by the Contractor, the Surety cannot be subrogated to the
rights of the materialmen or the Owner, but only to the rights of the
Contractor, which rights, of course, are subject to the government's tax
liens. I am of the opinion that under
law the Surety can be, and is, subrogated to the rights of the Owner,
and is thus entitled to the fund in which the Contractor, as shown, has
no property rights.
established in Pennsylvania that upon elementary principles a surety is
entitled to assert the equitable doctrine of subrogation to funds in the
hands of the owner where there is a direct contractual obligation to
the owner, as a party to the contract, binding upon the contractor
and the surety to pay materialmen when the contractor breaches the
contract by failing to pay the materialmen. In such circumstances, the
surety is entitled to be subrogated to the rights of the owner in
the retained balances. Subrogation arises from the owner's right to have
the original contract performed according to its terms. When the surety
pays the materialmen, it stands in the position of a surety who not only
has completed the contractual obligations of the defaulting contractor,
but also has carried out the equitable obligations of the owner to see
that the materialmen are paid. Sundheim v. School District, supra.
(Compare with similar cases in other jurisdictions, see footnote 4.)
v. United States Fidelity & Guaranty Co., 208 U. S. 404, 411
(1907), where the contractor promised the owner to pay materialmen, it
was held that the surety was "entitled to assert the equitable
doctrine of subrogation", citing Prairie State Bank v. United
States, supra. And in
No. Bank's Appeal, supra, at page 861 (Atl.), "under
precisely similar circumstances" to those in Hinningsen, the
Pennsylvania Supreme Court said: "With this statement of the law we
are in complete accord. . . ." (page 862 Atl.).
, supra, at pp. 367-368 (Atl.), the Supreme Court of Pennsylvania
when the contractor fails to pay labor and materialmen, it is tantamount
to a breach of its contract with the
[the owner]. . . . When this occurs and the surety pays the labor and
materialmen, it stands in the position of a surety completing a
contractual obligation of a defaulting contractor and performing an
equitable duty to the
. It [the surety] is therefore entitled to subrogation to the rights of
in the fund. Subrogation does not arise through the contractor, but
from the government's [the owner's] rights. Prairie State Nat. Bank v.
227, 17 S. Ct. 142, 41 L. Ed. 412; Henningsen v.
Fid. & Guar. Co. of Baltimore, 208
389, 52 L. Ed. 547; In re Scofield Co. (C. C. A.) 215 F. 45. In
Pennsylvania, where our statutes and the facts coincide with the cases
decided by the federal courts, we are in harmony with those
decisions as illustrated by Lancaster County National Bank's Appeal,
304 Pa. 437, 155 A. 859, 861." (Italics supplied.)
State Bank v.
, supra, at pages 232-233, it was stated:
[the surety's] right of subrogation, when it became capable of
enforcement, was a right to resort to the securities and remedies which
the creditor (the United States) [the owner] was capable of asserting
against its debtor Sundberg & Company [the contractors], had the
security not satisfied the obligation of the contractors, and one of
such remedies was the right based upon the original contract to
appropriate the ten percent retained in its hands. . . . The right of
Hitchcock to subrogation, therefore, would clearly entitle him when, as
surety, he fulfilled the obligation of Sundberg & Company [the
contractors], to the government [owner], to be substituted to the
rights which the
[owner], might have asserted against this fund." (Italics
v. United States Fidelity & Guaranty Co., supra, at page 410, it
[the surety] paid the laborers and materialmen and thus released the
contractor from his obligations to them, and to the same extent released
the Government from all equitable obligations to see that the laborers
and supply men were paid." (Italics supplied.)
owner-promissee has equitable obligations and rights in a donee
beneficiary contract, as a promise to pay materialmen seems to be, 5
is pretty well established. Restatement, Contracts, §138; Burnet v.
670, 679-680 [3 USTC ¶1108]; Cove IRR. Dist. v. American Surety Co.
, 42 F. 2d 957 (9th Cir. 1930); Williston on Contracts, rev. ed.,
§§ 358, 359; Corbin, Contracts, vol. 4, §812.
v. United States, supra, and Prairie State Bank v. United States,
supra, pointed to in the Pennsylvania cases (Lancaster and Sundheim)
as exemplifying the federal law with which Pennsylvania is in accord,
clearly hold that in no-lien construction contracts, 6
the owner has an equitable obligation to see that the materialmen are
paid, and when the surety has paid them, the surety is subrogated to the
rights of the owner in the withheld balances as of the date of the
of the foregoing principles is well expressed in Corbin on Contracts,
vol. 4, §901, pp. 609, 610, from which the following extracts are
the surety claims by subrogation, his claim is not a 'latent equity' for
the reason that he is being put into the position of the obligated
owner, none of whose defenses and counterclaims can be described as
owner, in such a case as the above, is both an obligor and an obligee.
His duty to pay is accompanied by a right to the performance promised in
exchange for his money; his duty to pay is conditional upon performance
by the builder. . . . In so far as the building contractor has not
performed his part of the agreed exchange, he has no right to payment by
the owner; and his assignee [lien creditor] has none. In so far as the
agreed exchange has been performed at the surety's expense, under the
compulsion of the surety bond, it has seemed fair and just to give to
him that part of the payment that is dedicated to the agreed exchange;
and it has seemed unjust to let either the contractor or his assignee
[lien creditor] profit by the performance rendered under compulsion by
the surety. This is the doctrine of subrogation of the surety to the
position of the creditor. For, again be it noted, although the owner is
a debtor (obligor) as to the promised payment, he is a creditor
(obligee) as to full performance by the building contractor, and
deferred payments are retained by him as security for such performance.
. . .
when the surety performs any of the contractor's duties to the owner, he
is subrogated to the owner's right and securities against the principal
contractor; and among these are included the deferred payments and
retained percentages in the owner's hands."
sub judice, are explicit in providing that the final schedule of
payments may be withheld from the Contractor (promisor) until proof
satisfactory to the Owner (promisee) is delivered, in order to show the
Owner that all claims of laborers and materialmen (beneficiaries) have
been paid by the Contractor as promised. 7
Because no such proof was ever submitted and substantial amounts were
due to materialmen, the Owner did withheld final payments. Thereupon the
withheld balances became collateral security for the Owner and
ultimately for the Surety when it performed its obligations under the
bonds and paid the materialmen. Prairie State Bank v.
, supra. I hold that the Surety is entitled to the fund.
by the Owner of the Withheld Balances Into Court Does Not Constitute a
Waiver of the Surety's Right of Subrogation
argues that when the Owner paid the withheld balances into court, it
waived its right to withhold them and the Contractor's property rights
to same were reinstated and hence the federal liens attach. I do not
County Nat. Bank's Appeal, supra, at page 861 (Atl.), it is stated:
. . [T]he surety had an equity to insist that the secretary of the
department 'withhold the payment of any semifinal or final estimate'
until these claims were paid, as by the contract itself he said he would
do, and on the faith of which provision, inter alia, the surety executed
v. United States Fidelity & Guaranty Co., 87 Or. 34, 169 P.
500; Canton Exchange Bank v.
579, 109 So. 1."
Jur., Surety & Guarantor, §139.
when it actually withheld the balances and paid them into court, waived
any defenses it had aaginst the claimants, 8
but it could not waive any right that the Surety might have to the
withheld balances which are the security for the Contractor's
performance. Interpleader does not affect the rights of the claimants or
the merits of their respective claims inter se.
's Federal Practice, 2d ed., vol. 3, ¶22.07, pp. 3021-3022.
upon payment of the materialmen was entitled to insist that the withheld
balances remain as its security, 9
and their payment into court by the Owner, the plaintiff in
interpleader, did not divest the funds of their character as security.
They did not ipso facto become the property of the Contractor.
Cannot Recover From Surety Unpaid Taxes of the Contractor Incurred in
the Performance of Work Under the Contracts at Bar
It remains to
be determined whether or not the government is entitled to a judgment
against Surety in the sum of $1,114.81, plus interest, being the
withholding and social security taxes attributable to the construction
and Connellsville service stations which the Contractor failed to pay.
In may opinion
the claim should be denied.
It seems to be
established that withholding and social security taxes due to the
government from the Contractor are owing as taxes and not as wages. United
States v. Crosland Const. Co., 217 F. 2d 275 (4th Cir. 1954) [58-1
USTC ¶9112]; Westover v. William Simpson Const. Co., 209 F. 2d
908 (9th Cir. 1954) [54-1 USTC ¶49,022]; United States v. Zschach
Const. Co., 209 F. 2d 347 (10th Cir. 1954) [54-2 USTC ¶9164].
portion of both contracts is as follows:
respect to all persons at any time employed by or on the payroll of the
Contractor or performing any work for or on behalf or in connection with
or arising out of his business, the Contractor shall indemnify the Owner
against, and hereby accepts full and exclusive liability for the payment
of, any and all contributions or taxes for unemployment insurance or old
age retirement benefits, pensions or annuities or wage or income taxes,
now or hereafter imposed by the Government of the United States, any
State or political sub-division thereof, whether measured by the wages,
salaries or other remuneration paid to such persons or the number of
such persons or otherwise."
condition of the bonds is that the Contractor
shall faithfully observe, perform and keep the said contract on the
Principal's part to be observed, performed and kept, according to all
its terms, covenants and conditions. . . ."
The problem is
one of interpreting the foregoing contractual provisions in order to
determine whether the parties intended to benefit the
and other taxing bodies by creating securities and remedies additional
to their right to tax liens and the ordinary statutory methods of
to interpreting construction contracts and bonds, the law of
Pennsylvania is laid down as follows in Commonwealth v. Fidelity
& Deposit Co., 355 Pa. 434, 50 A. 2d 211 (1947):
bond given pursuant to a contract incorporated in the bond, will be
construed in the light of the terms of the contract and the attendant
circumstances, but "the obligation of a bond cannot be extended
beyond the plain import of the words used". [City of] Lancaster
v. Frescoln, 192
452, 457, 43 A. 961, 962; [City of]
v. Diefendorf, 278
31, 122 A. 159.' Fleck-Atlantic Co. v. Indemnity Insurance Co. of
North America, 326 Pa. 15, 19, 191 A. 51, 53. Obligations not
imposed by the terms of the bond cannot be created by judicial
construction or interpretation which extends the terms beyond their
foregoing case, very like the case at bar, the bonds were conditioned on
the contractor performing "the terms and conditions of said
contract and his . . . obligations thereunder." There the contract
provided that workmen's compensation insurance should be furnished by
the contractor, but it did not in express terms require that the
contractor pay the premiums thereon. The claim against the surety by the
third party to recover for the unpaid premiums was denied. See also, Dravo-Doyle
Co. v. Royal Indemnity Co., 372 Pa. 64, 92 A. 2d 554 (1952); Fleck-Atlantic
Co. v. Indemnity Insurance Co. of North America, 326 Pa. 15, 191
Atl. 51 (1937).
foregoing principles and cases in mind, it seems plain that the
contracts under consideration do not in express terms require that the
Contractor shall pay the specified contributions and taxes as they do
expressly require that he shall pay laborers and materialmen. Instead,
the contracts provide that the Contractor shall indemnity the Owner
against contributions or taxes, for the payment of which the Contractor
"accepts full and exclusive liability". Similar language used
in a contract construed in United States Fidelity & Guaranty Co.
v. United States, 201 F. 2d 118, 119 (10th Cir. 1952) [53-1 USTC ¶9249],
was held to be "merely declaratory of [the contractor's] existing
liability under the federal tax laws" and "did not create the
liability on [the contractor's] part for the payment of these
There are no
other parts of the contracts from which a promise by the Contractor to
Owner to pay the former's taxes can be implied; indeed, the implications
are to the contrary. Whereas the contracts are quite specific in
providing that the Owner could withhold unpaid balances until Contractor
furnished releases of liens, nothing is said about withholding said
balances until proofs were furnished that the contributions or taxes
mentioned were paid; and whereas the bonds are conditioned specifically
upon the Contractor's paying for labor and material, they nowhere
mention taxes. In addition, the Contractor's promise to pay laborers and
materialmen is clearly for the benefit of such third parties, but
neither in the stipulation of facts or in the contracts is there any
indication that the parties intended to benefit the
or any other taxing body. The only obvious purpose and intention of the
Owner "both in spirit and letter" was to protect itself and
provide for indemnity. 10
Exceedingly great care and caution were used to make it plain that the
Contractor recognized his sole liability to pay contributions or taxes
arising out of his business, including the withholding and social
security taxes in suit, but he did not expressly agree to pay them.
contracts, as I do, as undertakings to indemnify the Owner against loss,
there is, of course, no liability on the Surety unless actual loss is
suffered by the Owner, and "ordinarily a third person has no right
to sue upon an indemnity agreement. . . ." Burke v. North
Huntingdon Twp. Municipal Authority, 390
588, 136 A. 2d 310, 315 (1957); Williston on Contracts, rev. ed., vol.
2, §403, p. 1159. Even if a promise to pay taxes could be implied, the
government in simply an incidental beneficiary, the contracts and bonds
not having been made for its benefit, and it cannot recover. Burke v.
Twp. Municipal Authority, supra; Williston on Contracts, rev. ed.,
vol. 2, §402, p. 1157.
If the parties
intended to include taxing bodies as entities to be benefited, a few
additional words would have expressed the agreement, as was done in the
sections of the contracts and bonds providing that the Contractor shall
pay laborers and materialmen.
relies on United States v. Phoenix Indemnity Co., 231 F. 2d 573
(4th Cir. 1956) [56-2 USTC ¶9659], but in that case the contract
specifically and clearly provided that the contractor should "pay .
. . taxes legally collectible because of the work. . . ."
Obviously, that contract was made for the benefit of the taxing bodies.
express or implied promise to pay the mentioned taxes for the benefit of
the government can be found, in the light of the terms of the contracts
and attendant circumstances, the government is not a donee beneficiary
entitled to recover the Contractor's withholding and social security
taxes from the Surety. The obligation of the bonds cannot be extended
beyond the plain import of the words used in the contract. Dravo-Doyle
Co. v. Royal Indemnity Co., supra; Commonwealth v. Fidelity &
Deposit Co., supra; Fleck-Atlantic Co. v. Indemnity Insurance Co. of
North America, supra.
to-wit, this 7th day of April, 1960, IT IS ORDERED that counsel for the
parties shall collaborate on, approve as to form and content, and submit
to the court an appropriate order consistent with the foregoing opinion
within fifteen (15) days from the date hereof.
See assignments contained in applications for bonds.
See: United States v. Ball Construction Co., 355 U. S. 587 (1958)
[58-1 USTC ¶9327]; United States v. White Bear Brewing Co., 350
U. S. 1010 (1956) [56-1 USTC ¶9440]; United States v. Colotta,
350 U. S. 808 (1955) [55-2 USTC ¶9680]; United States v. Security
Tr. & Sav. Bk., 340
47 (1950) [50-2 USTC ¶9492].
Section 6321, 26
C. A., provides as follows:
person liable to pay any tax neglects or refuses to pay the same after
demand, the amount (including any interest, additional amount, addition
to tax, or assessable penalty, together with any costs that may accrue
in addition thereto) shall be a lien in favor of the United States upon
all property and rights to property, whether real or personal, belonging
to such person."
C. A., provides as follows:
another date is specifically fixed by law, the lien imposed by section
6321 shall arise at the time the assessment is made and shall continue
until the liability for the amount so assessed is satisfied or becomes
unenforceable by reason of lapse of time."
Fidelity & Deposit Co. v. New York City Authority, supra; United
States Fidelity & Guaranty Co. v. United States, supra; United
States Fidelity and Guaranty Co. v. Miller, supra; United States
Fidelity & Guaranty Co. v. Triborough Bridge Authority, supra.
Williston on Contracts, rev. ed., vol. 2, §372, p. 1085.
In all the cited cases the materialmen did not have the right to file
mechanics' liens against public buildings.
Although these contracts were "no-lien contracts", such
provisions are consistent by affording the Owner extra protection
against any possible liens that might be filed, as pointed out in Morris
v. Ross, 184 Pa. St. 241, 38 Atl. 1084 (1898), and if just unpaid
claims were demanded, the Owner certainly would be at least equitably
obligated to pay them out of withheld funds if that became necessary.
See contract provisions, designated as (3), quoted above.
Cyclopedia Fed. Proc., 3d ed., §22.16, p. 607; Carter v.
, 93 F. 2d 529 (8th Cir. 1938).
In United States v. Munsey Trust Co., 332 U. S. 234 (1947), it
appears that the surety's right of subrogation is subject to the owner's
counterclaims and set-offs against the contractor, including those
arising under other contracts. The owner in that case was the
who was not a disinterested stakeholder interpleading the fund as in the
The quoted phrase is from City of Lancaster v. Frescoln, 203
640, 53 Atl. 508 (1902).
Casualty and Surety Company, Plaintiff v. The
Authority and the
United States of America
S. District Court, So. Dist. N. Y., Civ. 136-84, 182 FSupp 671, 3/24/60
[1954 Code Sec. 6323]
Completing surety's priority: Performance bond covering contract:
"Retained percentages of payments for work done".--The
completing surety of a defaulting contractor had priority over federal
tax liens against a fund held by the Port of New York Authority, the
other contracting party, on the grounds that it represented
"retained percentages of payments for work done", where (1)
the surety executed a performance bond covering the contract entered
into on the same day, (2) the contractor, eight days thereafter,
assigned to the surety all its right, title and interest to all the
money due under the contract, and (3) the liens subsequently filed
represented claims to employment taxes on wages paid for work done under
[1954 Code Sec. 6321]
Property subject to lien: Bonus for early completion of contract:
Right to withhold for benefit of third persons.--A bonus for early
completion of work by a defaulting contractor represented "retained
percentages of payments for work done" and was lawfully withheld by
the Port of New York Authority under a contract which authorized it to
withhold amounts from any payment, final or otherwise, to assure just
claims to third persons. Thus, it was not "property"
unlawfully withheld from the contractor to which federal tax liens could
attach and, as to this portion of the fund, the completing surety also
[1954 Code Sec. 6321]
Government's claim against surety: Obligation to pay wages v.
obligation to pay taxes on wages.--A completing surety of a
defaulting contractor was not obligated under its contract to pay the
Government's claim for employment taxes due from the contractor on wages
paid under the contract. The surety's obligation to pay the wages did
not obligate it to pay the taxes which should have been remitted to the
Government by the contractor, since a failure to pay taxes is not the
same thing as a failure to pay wages.
Levine, Morgulas & Foreman,
521 Fifth Avenue
17, N. Y. (Albert Foreman, of counsel), for plaintiff. Sidney Goldstein,
111 Eighth Avenue
11, N. Y., for the
Authority. S. Hazard Gillespie, Jr., United States Attorney for the
Southern District of New York (William Scott Ellis, Assistant United
States Attorney, of counsel), for
involves the question whether Aetna's lien as completing surety of a
defaulting contractor has priority over tax liens of the
against a fund of $67,000 held by the
New York Authority
. The latter asserts no claim to the money which consists in part of
retained percentages of payments certified as earned by the contractor
for work done; and in part of the unpaid portion of a bonus concededly
due but not paid to the contractor, for early substantial completion of
the work called for by the contract.
for Summary Judgment]
The action was
commenced in the New York Supreme Court and removed here by the
government. The Port Authority, in its answer, asks that it be directed
to pay the $67,000 into this court and that thereupon the action against
it be dismissed.
Both Aetna and
moved for either complete or partial summary judgment.
's motion seeks judgment (a) directing the Authority to pay it the
$67,000; (b) dismissing the government's tax lien and claim; or, in the
alternative, for partial summary judgment in the sum of $57,381.03 and
dismissing the government's tax lien and claim as to that amount.
government's motion seeks judgment (a) adjudging the tax liens to be
superior to the plaintiff's; (b) directing the Authority to pay the
government the $67,000; (c) directing Aetna to pay the government the
balance, if any, of taxes with respect to which the government has a
prior lien, and dismissing the complaint.
also moved, alternatively, for the following relief: (a) summary
judgment on its first counterclaim for the unpaid portion of the bonus,
which amounts to $9,184; (b) summary judgment on each of its second and
third counterclaims. These, respectively, seek $8,106.26 for unpaid
withholding taxes and interest; and $1,512.71 for unpaid unemployment
insurance taxes and interest.
Issue as to Material Facts]
agree and I independently find there is no genuine issue as to any of
the material facts which I find to be as follows.
In 1954, Ranes
Construction Corp., the defaulting contractor, entered into a contract
with the Port Authority to construct Hangar No. 11 at
. On the same day, Ranes as principal and the plaintiff as surety
executed a performance bond covering that contract. Eight days later
Ranes assigned to the plaintiff all right, title and interest to all
monies due under that contract.
July 7, 1955
, all but about $1,000 worth of work on the hangar was completed and,
under the terms of the contract as amended in March, 1955, a bonus of
$57,400 became due to Ranes. All but $9,184 of the bonus was paid to
Ranes. The latter, however, was then unable to meet its financial
obligations under the contract. The plaintiff, as surety, was obliged to
and did complete the contract, and in doing so expended the sum of
$276,910.83. It thereupon made demand on the Port Authority for all
monies then due Ranes under the contract and unpaid. These amounted to
$157,380.58. The Port Authority, which had received notices of tax
liens, paid the plaintiff $90,380.58 on account and withheld $67,000 to
cover the tax liens filed by the government during August, 1955 and at
various times thereafter.
Surety v. Assignee]
conceded on oral argument that the plaintiff, as completing surety,
would be entitled, under prior authorities, to priority as to the
retained percentages of payments for work done. This concession did not
extend to the unpaid portion of the bonus. The government contended,
however, that the rule announced in the earlier cases 1
has been overruled by R. F. Ball Contracting Co. v. Jacobs. 2
That contention is rejected. 3
In the Ball case, the plaintiff did not sue as completing
"surety" but as "assignee," a status which it
contended, under applicable state law as to assignments and mortgages,
constituted it a "mortgagee" under section 3672(a) of the
Internal Revenue Code of 1939 and thus entitled to priority. The Supreme
Court held the assignment to Ball did not constitute it a
"mortgagee" within the meaning of the code provision. The Ball
decision, however, left undisturbed the rule announced in the prior
cases cited above. Accordingly, on the authority of those cases, I hold
that the plaintiff's lien as completing surety has priority over the
defendant's liens for taxes against the retained percentages of payments
for work done.
government's contention with respect to the withheld portion of the
bonus is that, this "was earned by Ranes, and thus is in a category
different from that of the retained percentages" because Article 8
of contract, entitled "Withholding Payments," "applies
primarily to retained percentages." Accordingly, the argument
proceeds, the unpaid bonus is "property" of Ranes unlawfully
withheld, to which the tax liens attached, thus giving them priority
over Aetna's lien under decisions such as those in American Radiator
Co. v. City of New York 4
and Schuessler v. Metropolitan Casualty Insurance Co. 5
These contentions are rejected. The cases cited in their support are
inapplicable to the facts here.
provision was added to the contract by amendment executed with the
surety's consent on March 3, 1955. The contract originally called for
complete performance of all work under the contract by September 15,
1955. The amendment provided for payment of a bonus of $2,296 "for
each calendar day between July 5 and July 31, 1955 . . . on which Hangar
No. 11 is completely available for occupancy and use . . .." The
amendment further provided that the "Bonus for Early
Completion" was to be paid by monthly advances in "an
appropriate amount . . . to be determined by the Engineer, in his sole
discretion, taking into account [certain specified expenses not here
relevant] in connection with the early availability of Hangar No. 11 for
Occupancy." Article 8 of the contract, which was not modified by
the amendment, authorizes the Authority to "withhold out of any
payment, final or otherwise, such sums as the Director may deem
ample to . . . assure the payment of just claims of third persons . .
.." (Italics supplied) I hold, therefore, that the unpaid portion
of the bonus was not illegally withheld and, as to that also, the
plaintiff's lien has priority.
government's motions for partial summary judgment on its second and
third counterclaims will be considered together. Both rest on the
contention that, the government has a "lawful claim" against
the defaulting contractor which the surety is required to pay under the
provisions of its bond which obligates it to "pay or cause to be
paid . . . all lawful claims of third persons arising out of or in
connection with the [constitution] contract and work
performed thereunder . . .." (Italics supplied) The steps in the
argument in support of this contention are these. Ranes was required by
the construction contract to pay "wages"; "wages"
means "gross earnings" rather than the mere "take home
pay" which remained after deduction of withholding and unemployment
taxes. Ranes' failure to remit to the government the amounts withheld
for these taxes was a failure to pay "wages" in full. This
constituted a breach by Ranes of the construction contract and gave rise
to a "lawful claim" by the government against Ranes for the
amounts withheld. Similar contentions and argument have been repeatedly
rejected in other cases. 6
They are rejected here.
government's purported reliance on the decision of the Supreme Court in United
States v. Carter 7
is misplaced. That decision does not, as the government seems to
suppose, support the foregoing argument. The basic question in that case
was, whether the defaulting contractor's failure to pay contributions to
a union welfare fund pursuant to his agreement with the union, of which
his employees were members, was a failure, in violation of section 2a of
the Miller Act, 8
to pay his employees "in full." The parties had stipulated
that the contributions "were part of the consideration [the
contractor] had agreed to pay for the services of laborers on his
construction jobs." The court held the failure to pay the
contributions was a violation of the Act; and therefore the surety,
whose liability is "at least coextensive with the obligations
imposed by the Act," 9
was liable under its statutory bond, recovery on which is not limited to
"wages," which concededly had been paid. 10
The trustees of the welfare fund were allowed to assert the claim
because they "stand in the shoes of the employees and are entitled
to enforce their rights."
here, does not of course, pretend to "stand in the shoes" of
Ranes' employees. Moreover, even they have no claim to the amounts
withheld for taxes. 11
government's several motions for summary judgment and partial summary
judgment are severally denied.
plaintiff's motion for summary judgment is granted.
The order to
be entered will contain a provision dismissing the complaint as to the
Port Authority upon its payment of the $67,000 into court.
Fidelity & Deposit Co. v. New York City Housing Authority, 2
Cir., 241 F. 2d 142 [57-1 USTC ¶9410]; Aetna Casualty & Surety
Co. v. United States, 4 N. Y. 2d 639, 176 N. Y. S. 2d 961 [58-2 USTC
¶9778]; United States Fidelity & Guaranty Co. v. Triborough
Bridge Authority, 297 N. Y. 31, 74 N. E. 2d 226 [47-2 USTC ¶9327].
See also Massachusetts Bonding & Insurance Co. v. State of New
York, 2 Cir., 259 F. 2d 33, 38 [58-2 USTC ¶9704].
587 [58-1 USTC ¶9327].
Judge Cashin recently rejected a similar contention advanced in First
National Bank in Yonkers v. City of New York, 177 F. Supp. 175, 180
[59-2 USTC ¶9639].
223 N. Y. 193.
265 N. Y. 648.
United States v. Crossland Construction Co., 4 Cir., 217 F. 2d
275 [55-1 USTC ¶9112]; Westover v. William Simpson Construction Co.,
9 Cir., 209 F. 2d 908 [54-1 USTC ¶49,022]; General Casualty Co. of
America v. United States, 5 Cir., 205 F. 2d 753 [53-2 USTC ¶9483]; United
States Fidelity Guaranty Co. v. United States, 10 Cir., 201 F. 2d
118 [53-1 USTC ¶9249]; First National Bank in Yonkers v. City of New
40 U. S. C. 270b(a).
See United States v. Embassy Restaurant, 359
29, 35 [59-1 USTC ¶9297].
Sec. 3403, Internal Revenue Code of 1954; §31.3401(a)-1(b)(5),
R. C. 1954.
Central Surety and Insurance
Corporation, Plaintiff v. Martin Infante Co., Inc., et al., Defendants
S. District Court, Dist. N. J., Civil Action File No. 407-57, 164 FSupp
[1954 Code Sec. 6321]
Tax liens: Priority: Defaulting contractor: Surety completing
contract.--Under the terms and conditions of a contract for the
construction of a school, the contractor was to be entitled to payments
including the final payment only on condition that it submit proof that
all its obligations for labor and material were fully paid or secured.
The contractor defaulted and the surety (plaintiff) paid all the claims
of subcontractors and materialmen and completed the contract with the
facilities of the defaulting contractor, but at the cost of the surety's
own advances and payments received by it from the school board. After
the original contractor defaulted and before final payment was made, the
District Director served a levy upon the school board for moneys in its
hands which he claimed had become subject to a lien for federal taxes
due from the original contractor. Held, since there was a material
breach of the contract by the subcontractor in its failure to pay
laborers and materialmen it had no property rights under the contract
which could be levied upon.
English, J. Ward Herbert, for plaintiff. Chester A. Weidenburner, United
States Attorney, Charles H. Hoens, Jr., Assistant United States
Attorney, for Government.
James, for claimant Liberty Mutual Insurance Company.
action was instituted by plaintiff in the Chancery Division of the
Superior Court of New Jersey. After the
(Government) was made a defendant as tax claimant, it thereupon removed
the action to this Court, in accordance with the provisions of 28
C. §1444. The only remaining parties who allege interests in the fund
which is the subject of this action are the plaintiff, the
as tax claimant, and Liberty Mutual Insurance Company in connection with
claims for unpaid but earned premiums on certain policies issued to the
initial primary defendant.
(Surety) became surety upon a performance and payment bond required by
N. J. R. S. 2A:44-143 and by the terms of a written contract between
Martin Infante Co., Inc. (Infante), as general contractor, and the Board
of Education of the Township of Millburn (Board), for the construction
of a senior public high school in the Township of Millburn, New Jersey.
Both contract and bond were dated
August 17, 1954
, and the contract was incorporated by reference in the bond.
Completed by Surety]
commenced performance of and received payments under the contract, but
was unable to complete his undertaking with his own resources. He
suffered the accrual of unpaid claims of subcontractors and materialmen,
and assigned his rights under the contract to Surety. Surety paid all
the claims of subcontractors and materialmen, took assignments of their
respective liens, and completed the contract with the facilities of
Infante, but at the cost of Surety's own advances and payments received
by it from the Board.
had defaulted upon its contract with the Board, the District Director of
Internal Revenue assessed and made demand for payment of Federal Taxes
due from Infante, and ultimately served a levy upon the Board for moneys
in its hands which the Director claimed had become subject to a lien
under the provisions of 26 U. S. C. §6321.
with the provisions of N. J. R. S. 2A:44-141, and of this Court's order
dated August 27, 1957, the Board (on October 28, 1957) paid into Court
the sum of $185,572.58, constituting the balance of the moneys payable
by the Board under the contract. This fund was subsequently reduced by
the payment to Surety of $86,455.39 pursuant to consent order of this
November 7, 1957
contentions advanced by Surety as a basis for its recovery of the funds
remaining in the registry of this Court is that relating to its status
as subrogee of the Board. National Surety Corp. v.
Div. 1952, 20 N. J. Super. 100, 109,
aff'd 1953, 11 N. J. 506; Board of Education of Linden v. Vail,
Ch. 1931, 108 N. J. Eq. 207, aff'd per curiam E. & A. 1933, 113 N.
J. Eq. 113; Camden Co. Welfare Bd. v. Federal Dep. Ins. Co., Ch.
Div. 1948, 1 N. J. Super. 532; United States Fidelity & Guaranty
Co. v. Triborough Bridge Authority, 1947, 297 N. Y. 31 [47-2 USTC ¶9327],
reargument denied 297 N. Y. 694. Having satisfied all other claimants
(except Liberty Mutual Insurance Company, of which more hereafter),
Surety now claims to be entitled to this entire balance, free of all
claims of the United States, for taxes, interest and penalties, against
Infante. The claim of Liberty Mutual Insurance Company is for unpaid
earned premiums on workmen's compensation, public liability and group
liability insurance policies issued to Infante in connection with
various jobs on which Infante was engaged, and rests upon an assignment,
dated August 7, 1956, by Infante to Liberty Mutual, of moneys then due
or to become due on all such jobs. However, by stipulation, Liberty
Mutual has conceded that its said claim is subject to the payment of all
necessary expenses for the completion of said jobs and valid debts
incurred therefor, to the date of the assignment, including claims of
Surety for advancements to effect such completion. In view of the
Court's determination set forth herein of the rights in the present
fund, we are not here concerned with the claim of Liberty Mutual.
of the Contract]
By the terms
and conditions of its contract with the Board, Infante became entitled
to receive payments thereunder only if (a) there were no outstanding
claims against Infante filed with the Board, and (b) receipted bills or
other satisfactory evidence had been submitted to the Board that all
obligations incurred by Infante and its subcontractors in carrying out
the project had been satisfied. 1
Concerning the sums available for payment of the competing claims of
Surety and of the United States, I find that Surety received, after the
default of Infante, the sum of $402,217.33 (which takes into account the
$86,455.69 withdrawn from the registry of this Court pursuant to the
aforesaid consent order) but expended, in fulfillment of its obligations
under the bond covering the Millburn contract, the sum of $548,061.69.
This leaves the Surety with an out-of-pocket loss of $145,844.36 unless
it is permitted to reach the $99,117.19 remaining in the registry of
this Court since the aforesaid withdrawal.
in which Infante found itself when it admitted default 2
and called upon Surety to take over is strikingly similar to that which
confronted the contractors in Fidelity and Deposit Co. v.
New York City
Housing Authority, 2 Cir. 1957, 241 Fed. (2d) 142 [57-1 USTC ¶9410];
United States Fidelity and Guaranty Co. v. Miller, D. C. W. D. N.
C. 1956, 143 Fed. Supp. 941 [56-2 USTC ¶9930]; and in Scott v. Zion
Evangelical Lutheran Church, Sup. Ct. S. D. 1955, 70 N. W. (2d) 326
[55-2 USTC ¶9669].
Breach of Contract]
In the Fidelity
case the contractor was to install heating and ventilating facilities in
a housing project, and when these facilities had been installed and
accepted there remained an unpaid balance on the contract. This balance
was claimed by both the
for taxes and by the surety which made payments for labor and materials
as required by its bond. The contract required the contractor to pay
such claims before he would be entitled to final payment, and the court
held, at p. 144:
"* * *
classification of interests is a federal question; the existence of
interests to be federally classified, however, is solely a question of
Court then construed the failure to pay the labor and materialmen as a
material breach of the contract and concluded that the contractor had no
rights thereunder, saying, at pp. 146-147:
not understand how the New York Courts, or any courts for that matter,
could find justification for holding, in the face of so carefully drawn
a contract, that a failure to satisfy these conditions is
'insubstantial' * * *
* * This terminology indicates that while the ultimate aim of the
Authority may have been to secure prompt payment for laborers and
materialmen, it requires contractually as a condition precedent to
payment that the contractor do so.
are satisfied * * * that * * * the taxpayer-contractor had no right to
the withheld fund. Of necessity, it follows that it had no 'right to
property' to which a federal tax lien might attach, * * *"
of the Contractor]
In the Miller
case, Judge Warlick, construing 26 U. S. C. §6321, 3
points out at p. 944, that "Under that section nothing could be
plainer than that a lien for Federal taxes extend (sic) only to property
and rights to property, real or personal, which belongs to the
taxpayer." The question presented was whether Miller, who had
completed his contract except for several minor items, but was in
default in the full performance of his contract for the construction of
a Federal Housing project by reason of his indebtedness to materialmen
and subcontractors, had any interest in moneys in the hands of his
surety which were later deposited in the registry of the court. Upon the
authority of numerous cited cases and the principle therein stated that
"* * * a contractor or a subcontractor or his surety on default
coming about, has no property rights in monies due under contracts for
construction until and after performance is complete and all labor and
materialmen have been paid in full", the court held that the
Government could not find property of the tax debtor to which its lien
case, many of the authorities cited by Judge Warlick in the Miller
case were also cited and to a similar conclusion, which is to be found
in the following language of Judge Roberts, speaking for the South
Dakota Supreme Court:
question in the instant case is not one of priority and perfection of
liens. The decisive question is what amount under the contract was due
to * * * (the defaulting contractor). The contractor had no property
right in so much of the fund in the hands of the church as was necessary
for the payment of claims of materialmen and the Government cannot claim
more than the tax debtor * * * (the contractor) was entitled to."
Our own Judge
Maris, of the Third Circuit Court of Appeals, has disposed of similar
questions in a similar manner. Karno-Smith Co. v. Maloney, 3 Cir.
1940, 112 Fed. (2d) 690 [40-2 USTC ¶9533]; United States v. Burgo,
3 Cir. 1949, 175 Fed. (2d) 196 [49-1 USTC ¶9307]. More recently, in United
States v. Bess, June 9, 1958, 26 U. S. L. W. 4381 [58-2 USTC ¶9595],
in determining whether a deceased had property rights in a life
insurance policy to which a lien could attach, Mr. Justice Brennan said,
for the United States Supreme Court, at p. 4382:
must now decide whether Mr. Bess possessed in his lifetime, within the
meaning of §3670 4,
any 'property' or 'rights to property' in the insurance policies to
which the perfected lien * * * might attach. Since §3670 creates no
property rights but merely attaches consequences, federally defined, to
rights created under state law, Fidelity & Deposit Co. v.
New York City
Housing Authority, 241 Fed. (2d) 142, 144 [57-1 USTC ¶9410], we
must look first to Mr. Bess' right in the policies as defined by state
law. * * *"
Old Colony Insurance Company v. Lampert, D. C. N. J. 1955, 129
Fed. Supp. 545 [55-2 USTC ¶9628], aff'd per curiam, 227 Fed. (2d) 520
[56-1 USTC ¶9121].
All of these cases recognize that (1) the rights of the Collector of
Internal Revenue can rise no higher than those of the taxpayer in
property sought to be subjected to a Federal tax lien; and (2) whether
the taxpayer had any property or rights in property to which a lien
could attach is a matter of State law. See also, Great American
Indemnity Co. v. United States,
D. C. W. D. La.
1954, 120 Fed. Supp. 445 [54-2 USTC ¶9469]; New York Casualty Co. v.
Zwerner, D. C. N. D. Ill. 1944, 58 Fed. Supp. 473 [45-1 USTC ¶9140];
and F. H. McGraw & Co. v. Sherman Plastering Co., D. C.
Conn., 1943, 60 Fed. Supp. 504, aff'd 149 Fed. (2d) 301, certiorari
753. In each of these cases the finding of no property rights in the
defaulting taxpayer contractor was predicated upon his failure to pay
laborers and materialmen. Such failure was treated as a total breach of
the taxpayer's contract with the owner, disentitling the contractor to
receive any further payments under the contract. The decision law of
recognizes that the foregoing principles are applicable here. National
Surety Corp. v. Barth, supra; Damato v. Leone Construction Co., App.
Div., 1956, 41 N. J. Super. 366 [56-2 USTC ¶9944]. In National
Surety, Judge Stanton, at p. 109, relied upon United States
Fidelity & Guaranty Co. v. Triborough Bridge Authority, supra,
as disposing "* * * of the principal part of the claim of the
United States." In the Damato case a building owner
deposited moneys due under a construction contract in court and
interpleaded the general contractor and the
. The latter claimed a lien for unpaid taxes due from the contractor.
The contractor had abandoned the contract before completion and had left
unpaid certain claims of subcontractors. In determining that there was
no property right in the contractor to the moneys deposited in court by
the owner to which the Federal tax lien could attach, the Court
concluded that there had been no substantial performance of the contract
without which no interest in the balance of the contract price could
subsist in the contractor. See, Fidelity & Deposit Co. v. New
York City Housing Authority, supra, at p. 146.
[No Lien Without Property Rights]
necessarily be the disposition of the case at bar. I conclude that on
February 15, 1956, when the Deputy Director first certified his
assessment against Infante, for payment of which demand was thereafter
made, Infante had no property rights in moneys in the hands of the Board
which had been appropriated to the contract between them. Therefore, no
lien could then or thereafter attach to any such moneys, and the
subsequent levies were ineffective to create or establish in the
any right to the funds presently on deposit in the registry of this
The cases from
which the Government seeks support for its assertion that property
rights existed in Infante when the alleged tax liens arose do not hold
as construed by the Government. United States v. Security Trust and
Savings Bank, 1950, 340 U. S. 47 [50-2 USTC ¶9492]; United
States v. White Bear Brewing Co., 1956, 350 U. S. 1010 [56-1 USTC ¶9440]
(reversing per curiam, 227 Fed. (2d) 359) [55-2 USTC ¶9776]; United
States v. Kings County Iron Works, Inc., 2 Cir. 1955, 224 Fed. (2d)
232 [55-2 USTC ¶9536], all turned upon the issue of priority between a
federal tax lien and a state-recognized (choate or inchoate) lien. Sic
etiam, United States v. Colotta, 1955, 350 U. S. 808 [55-2 USTC ¶9680]
(reversing per curiam, 79 So. 2d 474 [55-2 USTC ¶9584]); United
States v. Vorreiter, 1957, 355 U. S. 15 [57-2 USTC ¶9956]
(reversing per curiam, 134 Colo. 543 [57-1 USTC ¶9415]); and United
States v. R. F. Ball Construction Co., 1957, 355 U. S. 587 [58-1
USTC ¶9327] (reversing per curiam, 239 Fed. (2d) 384 [57-1 USTC ¶9269]).
Nor is United States v. Munsey Trust Co., 1947, 332
234 at variance with our conclusion here. Munsey Trust held
merely that percentages retained pursuant to contract by the
may be subjected to its set-off claims despite the claims of a surety
who has paid laborers and materialmen. The question here confronting us
(whether the taxpayer had a property interest to which a Government tax
lien could attach) was not involved in those cases. The Government's
brief suggests a conflict between United States v. Kings County Iron
Works Inc., supra, and Fidelity and Deposit Co. v. New York City
Housing Authority, supra. There is no conflict because in Housing
Authority, as in the case at bar, the non-existence of a property
right to support a tax lien precluded a recognition of any Government
By virtue of
the undertaking of Infante in its application to Surety for the contract
bond, together with the assignments to Surety by the various
subcontractors and materialmen of their lien claims and the advancements
made by the Surety for the benefit of Infante, the Surety, as such, and
as subrogee of the Board, has become entitled to the entire balance on
deposit in the registry of this Court, without prejudice to any rights
which the Surety may have against Infante by reason of Infante's default
and the consequent unreimbursed losses which the Surety was thereby
compelled to sustain. It is, therefore, unnecessary to discuss Surety's
contentions with respect to the effect of the two Infante assignments or
its status as a mortgagee or pledgee within the meaning of 26
shall be deemed to constitute the Court's findings of fact and
conclusions of law, and an order for judgment may be presented in
The contract was made expressly subject to the following conditions:
Contractor shall, from time to time, as required by the Owner, furnish
satisfactory evidence that all persons who have done work or furnished
materials under this Contract, or have suffered damage on account of the
Contractor's operations, have been fully paid or secured.
"* * * So
much money due to the Contractor under and by virtue of the contract as
shall be considered necessary by the Board may be retained by the Board
and held until such bids, actions, claims or amounts shall have been
settled and suitable evidence to that effect furnished to the
the opinion of the Architect, the Project or any part thereof has been
abandoned, is unnecessarily delayed, or cannot be completed by the
Contractor at the rate of progress or within the time specified, or the
Contractor is willfully violating any of the covenants of this Contract,
or is carrying it out in bad faith, the * * * Board may then call on
Surety to complete the Project or may complete it by other means, as
they may elect. * * * The Board shall recover the cost of finishing the
Project by deducting the amount thereof from any moneys due or which may
become due the Contractor under this Contract, and when such moneys are
insufficient to pay said cost, the amount of said cost in excess of such
moneys shall be paid by the Contractor or his Surety." (G-15)
"* * *
payments on account will be made not exceeding 90% of the value of such
work * * * provided that if claims have been filed with the Board
against the Contractor, sufficient money may be withheld to satisfy such
claims until they have been satisfied.
Project is completed and accepted by the Board a final certificate of
cost of the Project will be made by the Architect * * * and when this
final certificate is approved, the money due the Contractor for the
performance of the Project as determined by said final certificate * * *
will be paid the Contractor, provided, however, that before such final
payment is made the following requirements shall be satisfied. (a) There
shall be no outstanding claims against the Contractor filed with the
Board, (b) The Contractor shall have paid all due obligations and shall
have furnished, when directed by the Architect, receipted bills or other
satisfactory evidence that all obligations incurred by him and by his
subcontractors in carrying out the Project have been satisfied; * *
By letter of
February 3, 1956
to Board, Infante requested that all future payments due on the contract
be made to Surety to be deposited in a trust account to pay present and
future obligations on the contract.
§6321. "If any person liable to pay any tax neglects or refuses to
pay the same after demand, the amount * * * shall be a lien in favor of
upon all property, whether real or personal, belonging to such
person." (Italics supplied.)
Now 26 U. S. C. §6321. See, fn. 3 ante.
William H. Lebowitz and Frances
Lebowitz v. Joseph J. Abdella, et al.
S. District Court, Dist. Conn., Civil Action No. 6475, 168 FSupp 266,
[1954 Code Sec. 6323]
Lien for taxes: Priority of creditors: Lien on funds not due to
taxpayer.--Taxpayer, a contractor, failed to complete the
construction of a home and the owner paid to complete it. The furnishing
of waivers of liens by the contractor, subcontractors and materialmen
was required as a condition precedent to payment to taxpayer. As
taxpayer did not furnish all such waivers and did not complete the
construction, there were no funds due him from the owner to which the
government's tax lien could attach. Defendant subcontractors and
materialmen are entitled to share in the balance of the contract price
remaining unpaid to taxpayer, reduced by the owner's payments for
completion of the work and costs and attorney's fees of owner-plaintiff,
in proportion to the amounts due on their mechanics' liens.
286 Main Street
, for plaintiff. Jules J. Bielizna,
8 West Street
, for Joseph F. Chudy. Norman A. Buziaid,
302 Main Street
, for Angelo P. Scalzo. Joseph Schwarz, 30 West Street, Danbury, Conn.,
for Nathan Loshin, d.b.a. Federal Glass Co. Harry W. Hultgren, Jr.,
United States Attorney, Henry C. Stone, Assistant United States
Attorney, Federal Building, Hartford 1, Conn., for United States. Louis
8 West Street
, for Matz Lumber Co.
Conclusions of Law
William H. Lebowitz, owner of real property at
65 West Street
, contracted on
August 22, 1955
with Joseph J. Abdella for the construction of a one family house
thereon, at a contract price of $20,400.
provided for the payment of $2,000 down, $6,000 when the foundation
first floor joists and sheathing were in place, $6,000 when the roof was
completed, and the balance of $6,400 within 30 days after total
completion of the work. Furnishing of waivers of lien by the contractor
and all subcontractors and materialmen was made a condition precedent to
payment. On unreasonable neglect or suspension of work the owner was
empowered to terminate the contract, complete the work and deduct the
cost of completion from the contract price. Payments were made by
Lebowitz to Abdella as follows:
August 22, 1955
..... $ 2,000
November 2, 1955
December 1, 1955 .... 6,000
Total ............... $14,000
abandoned the work before completion and Lebowitz contracted directly
for materials and labor to complete the job and made the following
James E. Gallagher (painting) ............ $ 628.00
B. J. Dolan (cement) ..................... 176.65
Matz Lumber Co. (lumber) ................. 556.69
Danbury Plumbing Supply Co. (plumbing
supplies) ................................ 457.96
Acme Sheet Metal (gutters) ............... 160.00
On January 13,
1956, The United States of America filed a notice of levy of a tax lien
($13,527.23) against the property and property rights of Abdella with
defendants, Federal Glass Company, Scalzo, Chudy and Matz Lumber Co.
filed certificates of mechanics lien after timely notice in accordance
with Conn. Gen. Stat., Rev. 1949, Sec. 7218, and have timely commenced
suit to foreclose thereon.
Co. furnished material from December 1955 to January 11, 1956 in the
amount of $1,635.47 and filed lien February 29, 1956.
furnished materials and services from January 25, 1956 to February 8,
1956 in the amount of $574.95, and filed lien March 28, 1956.
furnished materials and services from December 30, 1955 to January 27,
1956, in the amount of $1,600.00 and filed lien February 9, 1956.
Co. furnished materials from November 19, 1955 to January 16, 1956 in
the amount of $1,476.00 and filed lien January 18, 1956.
filed suit for interpleader, in the Court of Common Pleas for
, which was removed to this court by the
. In the action plaintiffs deposited in the registry of the Court the
balance of the contract price $4,420.70 after deduction of the payments
made to complete the job.
to appear and was defaulted.
furnished waivers of mechanics liens executed by himself and by some
materialmen and subcontractors, but failed to obtain and furnish waivers
from the four claimant defendants Federal Glass, Scalzo, Chudy and Matz
incurred costs of $44.65 in this action.
attorney's fee for bringing the action, opposing a motion to dismiss,
opposing a motion for summary judgment, factual research on the validity
of the liens, legal research, attendance at pre-trial conference and
incidental services is $500.00.
1. The Court
has jurisdiction of the parties and subject matter of the action.
having failed to complete the job or provide waivers of lien by all
subcontractors and materialmen, nothing is due him under the contract.
3. There are
and were no funds due Abdella in the hands of plaintiffs to which the
notice of levy of tax lien could attach.
in interpleader are entitled to their costs of suit and reasonable
attorney's fees from the funds, a total of $544.65.
claimants Federal Glass, Scalzo, Chudy, and Matz Lumber are entitled to
share in the balance of the fund, $3,875.05 in proportion to the amounts
due on their liens on the realty, as found above.
claims a prior lien on the balance remaining unpaid on a building
contract with taxpayer, a general contractor. If relative priority
between mechanic's lienors and tax liens in a fund due a taxpayer were
solely involved, or if the owner were the taxpayer, the claim of the
might prevail. The Kings County Iron Co. case, 2 Cir., 224 Fed.
(2d) 232 [55-2 USTC ¶9536], relied upon by the
, rejects the lienor's claim in a "trust fund" state. While it
does hold that the private contractual arrangements--apparently for
direct payment of subcontractors--may not defeat the tax claim, it is
doubtful that the contract there, as here, made the furnishing of lien
waivers specifically a condition precedent to entitlement to payment on
the part of the general contractor. Plaintiffs set up the balance due
under the contract with Abdella as the original contract amount less the
amounts it had paid for completion. They have contended throughout,
however, that there is no obligation to pay this amount to Abdella until
the contract provision for waivers of lien has been complied with, a
provision beyond Abdella's present power to fulfill. Under the contract
in question here, furnishing by the contractor of waivers of all liens
was made a condition precedent to entitlement to payment from the owner.
Since Abdella never furnished the waivers, no fund became due to him to
which the tax levy could attach. The fund may therefore be utilized to
discharge pro tanto the obligations on the land to the lienors who
helped create the improvement thereon.
enter providing for the payment from the fund of $544.65 to plaintiffs
in care of counsel for attorney's fees and costs, and
to defendant Federal Glass
of .......................... 1635.47/5286.42 x 3876.05
to defendant Scalzo of .......... 574.95/5286.42 x 3876.05
to defendant Chudy of ........... 1600./5286.42 x 3876.05
and to defendant Matz Lumber
of .......................... 1476./5286.42 x 3876.05
and providing for discharge of the mechanics' liens and declaring that
no tax lien attached to any funds in plaintiff's hands because none were
owing to Abdella.
Wolverine Insurance Company, Toy
National Bank, and Loren Mahoney, Plaintiffs v. V. Lee Phillips,
District Director of Internal Revenue, and United States of America,
S. District Court, No. Dist.
, West. Div., Civil No. 1015, 165 FSupp 335, 8/12/58
[1939 Code Sec. 3670--similar to 1954 Code Sec. 6321]
Tax liens: Priority of liens: Surety on defaulting contractor's
bond.--The taxpayer, a contractor, engaged to erect a residence,
entered into a surety bond, in favor of the owner of the property.
Thereafter the terms of the surety bond were breached as the result of
the attachment and nonpayment of mechanics' liens in the amount of
$19,248.02, which amount was paid by the surety in accordance with the
conditions of the bond. Prior to such payment by the surety company the
owner and the contractor agreed in an agreement termed an "Account
Stated" that the balance of the contract price remaining unpaid was
$10,168.46 and that the owner would accept the residence as completed.
This was followed by an escrow agreement between the owner, the surety
company and the contractor, pursuant to which the agreed amount was
placed in escrow pending the determination of the priority of the right
of the surety to such amount as against the various liens for unpaid
income tax deficiencies assessed against the contractor and with respect
to which notices of levy had been served upon the owner prior to the
consummation of the above arrangements. Under these circumstances the
Government's tax liens and levies do not attach to the escrowed fund in
question for the reason that there was "no debt" owing by the
owner to the contractor at the time the Government's tax liens were
perfected. This was so as the damages to the owner arising from the
nonpayment of the mechanics' liens of $19,248.02 were greatly in excess
of the agreed final payment of $10,168.46.
Stilwill, Kenneth T. Wilson,
, for plaintiffs. F. E. Van Alstine, United States District Attorney,
Theodore G. Gilinsky, Assistant United States District Attorney, for
controversy in this case is between a surety on the bond of a defaulting
building contractor and the Government as the holder of tax liens
against such contractor as to the sum of $10,168.46 being held in
May 26th, 1955
, Mr. and Mrs. Loren H. Mahoney, hereinafter referred to as Owner,
entered into a contract with Ericksson and Kochen, hereinafter referred
to as the Contractor, relating to the construction of a residence in
. That contract contained, among other provisions, the following:
of the Work--The Contractor shall furnish all of the materials and
perform all of the work shown on the drawings and described in the
specifications entitled "SPECIFICATIONS OF MATERIALS AND LABOR
NECESSARY AND REQUIRED FOR THE ERECTION AND COMPLETION OF A RESIDENCE
FOR MR. AND MR. (sic) LOREN H. MAHONEY AT NUMBER 6 WEST 37th STREET
PLACE, SIOUX CITY, IOWA" prepared by the Owner; and shall do
everything required by this agreement the general conditions of the
contract, and specifications and the drawing.
of completion--The work to be performed under this contract shall be
commenced at once and shall be substantially completed
December 1, 1955
bond--Performance bond in the full amount of the contract is to be
furnished by the Contractor and paid for by the Owner.
contract sum--The Owner shall pay the Contractor for the performance
of the contract, subject to the additions and deductions provided
therein, as follows: $30,591.00.
5--The payments shall be made in accordance with the specifications.
and final payment--Final payment shall be due ten days after
substantial completion of the work provided, the work to be then fully
completed and the contract fully performed. The Contractor shall furnish
lien waivers on all labor and materials.
contract documents--The conditions of the contract, the
specifications and the drawings, together with this agreement, form the
contract, and they are as fully a part of the contract as if hereto
attached or herein repeated."
specifications, as noted, are made a part of the contract. One paragraph
of the specifications provides as follows:
shall make payments on account the contract as provided therein, as
follows: payment of one-third of the contract will be made upon
completion of the basement portion of the structure. Two-thirds of the
amount of the contract will be paid when the contractor is ready to
begin the interior finishing of the structure and the balance due on the
contract will be paid upon completion."
July 20th, 1955
, the Contractor made application to the Wolverine Insurance Company for
a bond. That Company will be hereinafter referred to as the Surety. In
certain provisions of the application the Contractor is referred to as
the Indemnitor and the Surety as the Company. Paragraph VIII of the
application provides, in part, as follows:
the Indemmitor * * * further agrees in the event of any breach or
default on his part in any of the provisions of the contract and/or bond
that the said Company shall be subrogated to all the rights and
properties of the Indemnitor in such contract, including deferred and
reserved payments, current and earned estimates and final payments, and
any and all moneys and securities that may be due and payable at the
time of such default * * * or that may thereafter become due and payable
on account of said contract * * *."
July 22d, 1955
, the following bond was issued:
ALL MEN BY THESE PRESENTS:
& Kochen Construction Company of Sioux City, Iowa (Here Insert The
Name And Address Or Legal Title Of The Contractor) as Principal,
hereinafter called Contractor, and Wolverine Insurance Company, a
Michigan Corporation, of Battle Creek, Michigan, authorized to do
business in the State of Michigan as Surety, hereinafter called Surety,
are held and firmly bound unto Mr. and Mrs. Loren H. Mahoney of Sioux
City, Iowa (Here Insert The Name And Address Or Legal Title Of The
Owner) as Obligee, hereinafter called Owner in the amount of Thirty
Thousand Five Hundred Ninety-one and - - - No/100 Dollars ($30,591.00)
for the payment whereof Contractor and Surety bind themselves, their
heirs, executors, administrators, successors and assigns, jointly and
severally, firmly by these presents
Contractor has by written agreement dated May 26, 1955 entered into a
contract with Owner for Constructing one family, brick construction
dwelling 6 West 37th Street Place, Sioux City, Iowa in accordance with
drawings and specifications prepared by Gene Bratt, Sioux City, Iowa
(Here Insert Full Name And Title) which contract is by reference made a
part hereof, and is hereinafter referred to as the CONTRACT.
THEREFORE, THE CONDITION OF THIS OBLIGATION is such that, if Contractor
shall promptly and faithfully perform said CONTRACT, then this
obligation shall be null and void; otherwise it shall remain in full
force and effect.
Contractor shall be, and declared by Owner to be in default under the
CONTRACT, the Owner having performed Owner's obligations thereunder, the
Surety may promptly remedy the default, or shall promptly
Complete the CONTRACT in accordance with its terms and conditions, or
Obtain a bid or bids for submission to Owner for completing the CONTRACT
in accordance with its terms and conditions, and upon determination by
Owner and Surety of the lowest responsible bidder, arrange for a
contract between such bidder and Owner and make available as work
progresses (even though there should be a default or a succession of
defaults under the contract or contracts of completion arranged under
this paragraph) 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 the Surety may be liable hereunder, the amount set
forth in the first paragraph hereof. The term 'balance of the contract
price,' as used in this paragraph, shall mean the total amount payable
by Owner to Contractor under the CONTRACT and any amendments thereto,
less the amount properly paid by Owner to Contractor.
suit under this bond must be instituted before the expiration of two (2)
years from the date on which final payment under the CONTRACT falls due.
right of action shall accrue on this bond to or for the use of any
person or corporation other than the Owner named herein or the heirs,
executors, administrators or successors of Owner.
and sealed this 22nd day of July A D 1955
commenced the construction of the residence in the summer of 1955. On
July 26th, 1955
, the Owner paid the Contractor the sum of $10,305.91 as a progress
payment and on
October 5th, 1955
, the Owner paid the Contractor the sum of $10,263.00 as a further
progress payment. Later a number of parties filed mechanics' liens
against the property. It does not appear that the progress payments were
paid to those parties, except that the sum of $1,000.00 was paid to one
November 15th, 1955
, the Government made an assessment against the Contractor for federal
taxes in the amount of $5,168.27. On
December 15th, 1955
, a Government tax lien for that amount was filed in
terms of the contract the residence was to be completed by
December 1st, 1955
. At that date the residence was still incomplete. The house was finally
completed and accepted by the Owner on
May 24th, 1956
. In February 1956, while the residence was still uncompleted, there
were a number of claims for materials and labor furnished for the
residence which were unpaid. Starting on
February 3d, 1956
, a large number of mechanics' liens were filed against the property.
The Owner made demand upon the Surety to perform under its bond in
connection with those liens. On
February 12th, 1956
, the Government made an assessment against the Contractor for federal
taxes in the amount of $2,950.64. On
February 13th, 1956
, a Government tax lien for that amount was filed in
February 20th, 1956
, the Government made an assessment against the Contractor for federal
taxes in the amount of $1,764.20. On
February 21st, 1956
, a Government tax lien for that amount was filed in
. Three notices of levy for parts of the the above taxes were duly
served upon the Owner on January 24th, April 23rd, and
May 3d, 1956
February 23d, 1956
, the Contractor executed the following assignment to the Surety:
and in consideration of the sum of One Dollar ($1.00) in hand paid by
Wolverine Insurance Company of Battle Creek, Michigan, receipt whereof
is hereby acknowledged, the undersigned, Frank H. Kochen and Conrad L.
Ericsson, doing business under the name and style of Ericsson &
Kochen Construction Co., hereby sell, assign, transfer and set over to
the said Wolverine Insurance Company all of their right, title and
interest in and to any balance now due them or to become due them from
Mr. and Mrs. Loren H. Mahoney, pursuant to a contract entered into
between the undersigned and the said Mr. and Mrs. Loren H. Mahoney for
the construction of a dwelling house at 6 West 37th Street Place, Sioux
City, Iowa, and the undersigned do hereby further authorize and direct
the said Mr. and Mrs. Loren H. Mahoney to pay to the said Wolverine
Insurance Company or its designee all monies due or to become due the
undersigned under and by virtue of the building and construction work so
performed by them.
this 23 day of February, 1956.
May 23d, 1956
, there were still some items of work remaining to be done on the
residence which the Contractor was unable to complete. The Contractor
had performed some additional work and the Owner had purchased certain
items which had gone into the residence. There were mechanics' liens on
file against the residence property approximating $23,000.00. The Owner
and the Contractor then executed an agreement designated as an
"Account Stated." In that agreement it is recited that there
was still work to be done before the residence was completed and
acceptable but that because the Contractor was unable to complete the
same a deduction would be made from the contract price therefor and the
residence accepted by the Owner. In that agreement an adjustment was
made for extras and for some items furnished by the Owner. It then
recited that the balance of the contract price remaining unpaid was the
sum of $10,168.46. The agreement contains this provision:
The purpose of this Account Stated is to make an accounting with regard
to the construction of said dwelling house only, and does not portend to
cover any matters other than a summation of the status of the work under
the contract and the exchange of credits to fix the contract amount
between the parties; and it is expressly agreed that this instrument
shall not be determinative of any of the rights or obligations of any
third parties nor to waive any obligations on the part of the contractor
to remove, eliminate or obtain waivers for all liens."
The Owner did
not pay the amount referred to of $10,168.46 to the Contractor.
June 26th, 1956
, the Owner, Contractor, and the Surety entered into an agreement
designated as an "Escrow Agreement" relating to the
$10,168.46. In it the Surety is referred to as the Company. The
agreement first recites the contract between the Owner and the
Contractor and the execution of the performance bond by the Company. It
further recites that mechanics' liens had been filed against the Owner's
property and that the Government had served notices of levy for taxes
due from the Contractor. It refers to the sum of $10,168.46 and provides
that that sum be placed in escrow with the Toy National Bank subject to
the determination of the rights of the Government to it and that if the
Government is not entitled to it that it shall be paid to the Company.
The agreement also contains the following provisions:
That this Agreement shall not alter or vary the obligation of the
Company or of the Contractor under the original bond and contract,
including guarantee provisions contained therein, but it shall be
construed to be supplementary thereto.
That Owner acknowledges full and complete performance of the contract by
the Contractor and Owner in accordance with the terms of contract made
and entered into by the Owner and Contractor under date of
May 26, 1955
, save the continuing obligation of the Contractor or the Company as to
liens or purported liens as hereinafter referred to."
That the Company will pay or otherwise dispose of any valid and legal
mechanics' liens now on file or which may hereafter be filed against the
property of the Owner upon which the improvement made the subject of the
contract was constructed and arising out of the contract and said
construction. That it will furnish said Agent with lien waivers,
receipts of payment or other sufficient evidence of final disposition of
said lien. The Company may pay or dispose of any mechanics' liens or
purported mechanics' liens now filed or which may hereafter be filed or
may, at its option, resist and defend the foreclosure of any mechanics'
liens or purported mechanics' liens now on file or which may hereafter
be filed, contesting the validity or legality of the same. It shall be
within the sole discretion of the Company as to whether any mechanics'
liens or purported mechanics' liens shall be so contested and if any are
so contested, all expense thereof shall be borne by the Company but
defense may be made in the name of the Owner. The Company will pay or
otherwise dispose of all such mechanics' liens, finally adjudicated to
be valid and legal and a lien upon the said property of the Owner and
furnish said Agent with lien waivers, receipts of payment or other
sufficient evidence of final disposition of said liens."
1956, the Surety paid upon the mechanics' liens against the residence
property the sum of $19,248.02. The liens paid were correct in amount
and timely filed under the
law and were for labor and material furnished in connection with the
residence which was the subject matter of the contract between the Owner
and the Contractor. Under Code of Iowa 1958 relating to Mechanics'
Liens, Chapter 572, Code of Iowa 1958, the holders of mechanics' liens
have the right to foreclose their liens against the property involved
and have the same sold on special execution to satisfy the same. At the
time the Surety paid the mechanics' lien foreclosure had not been
commenced on any of them or judgment rendered thereon. The details of
the Government's claim is as follows:
Date Lien Balance Due
Taxable Amount Date of Filed of Not Including
Period Ending Assessed Assessment Record Interest
.......... $5,168.27 11/15/55 12/15/55 $4,930.92
......... 2,950.64 3/12/56 3/13/56 2,817.34
......... 58.65 11/8/56 12/7/56 58.65
1955* ............ 1,764.20 3/20/56 3/21/56 676.33
* Last entry relates to federal unemployment tax; all other entries
above pertain to withholding & social security taxes.
January 7th, 1957
, the Director served notice of levy upon the escrow agent.
February 11th, 1957
, the Surety, the Escrow Agent Bank, and the Owner commenced the present
action. The relief asked is that it be determined that the rights of the
Surety to the funds held in escrow are superior to that of the
Government and that the levies made by the defendant District Director
defendants named in the complaint were Frank M. Halpin, the local
District Director of Internal Revenue and the
United States of America
. The parties subsequently stipulated that the current District Director
is V. Lee Phillips and that he should be substituted in place of the
original defendant Director Halpin.
October 10th, 1957
, the Government filed an answer and counterclaim. In its answer and
counterclaim it asserts that the Contractors are indebted to it for
federal taxes in the sum of $9,991.44 with interest thereon from
October 10th, 1957
. The sum of $9,991.44 includes principal of the taxes in the sum of
$8,483.24 with interest to
October 10th, 1957
. The claim of the Government with accrued interest now exceeds the
amount held in escrow.
It is the
claim of the Government that it is entitled to the escrow fund by virtue
of its tax liens for the taxes due from the Contractor. The Government
bases its claim to that fund under the tax lien statute. Section 6321,
Code (Section 3670 Internal Revenue Code of 1939). It does not base its
claim on the priority statute. Section 191, Title 31,
The parties in
their briefs and arguments have pretty well encompassed the larger part
of the field of law relating to federal tax liens.
At the outset
the Government challenges the right of the Surety to assert any claim
because of the mechanics' liens paid by it. It asserts the Surety made
such payments as a volunteer. In that connection the Government
discusses the difference between "performance bond" and a
"payment bond." The Government then asserts that the bond in
question was a "performance bond" and not a "payment
bond." It further asserts that since the house of the Owner was
accepted by him as completed the bond had fulfilled its function to the
Owner and that the Surety was under no obligation to make payment to the
unpaid mechanics' lienholders and that in making such payments the
Surety acted as a "mere volunteer." In connection with its
claim that in making payment to the unpaid materialmen the Surety acted
as a "mere volunteer" the Government cites and relies upon the
case Bourrett v. W. M. Bridge Construction Co. (1957), 248 Iowa
1080, 84 N. W. 2d 4. In that case it was held that an unpaid
subcontractor could not recover against the surety on a private building
bond given by the principal contractor. The Iowa Supreme Court in the
recent case Rowe v. Stufflebeam (
1958), 89 N. W. 2d 875, refers to the holding in the Bourrett
case as follows (p. 879):
merely that where a building bond runs only to a named owner and
undertakes no more than to indemnify him against breaches of the
contract no one else may recover on the bond, especially where it
contains an express provision limiting its benefits or right of action
thereon to the owner and he has sustained no loss, in the legal sense,
by the contractor's breach of the contract."
also Hopper Bros. Quarries v. Merchants Mutual Bonding Company
(8th Cir. 1958), 255 Fed. (2d) 147.
involved in the Bourrett case, like the contract in the present
case, contained a provision that the contractor should furnish all
materials and perform all labor. In the Bourrett case the Iowa
Supreme Court held that such provision "is not equivalent to a
promise by the contractor to pay for labor and materials." The bond
involved in the Bourrett case, like the bond in the present case,
expressly limits its provisions to the benefit of the obligee owner
only. However, the contract in the present case, unlike the contract
involved in the Bourrett case, contains a provision providing
that the Contractors are to furnish the Owner with waivers of mechanics'
liens for materials and labor. Such a provision or a similar provision
would not permit those furnishing materials or labor for a building to
sue on the bond. Section 166 of the Restatement of the Law of Security
is as follows:
a surety guarantees the performance of a contract by a contractor who
does not promise the owner to pay those furnishing labor or materials
but agrees to complete the work free of liens or to furnish labor and
materials, laborers and materialmen have no rights against the
the fact that materialmen or laborers cannot sue or recover on the bond
does not mean that the surety is not under obligation to the building
owner to pay materialmen and laborers. The materialmen and laborers may
nevertheless be "incidental beneficiaries" who will benefit by
the performance by the surety of its obligation to the building owner,
although without standing to sue the surety directly on the bond. See
Sections 133, 147, Restatement of Law of Contracts. Such would seem to
be the situation in the present case. In the building contract in the
present case it is provided "The Contractor shall furnish lien
waivers on all labor and materials." The bond in the present case
* * THE CONDITION OF THIS OBLIGATION is such that, if Contractor shall
promptly and faithfully perform said CONTRACT, then this obligation
shall be null and void; otherwise it shall remain in full force and
the Contractor allowed mechanics' liens to be filed against the Owner's
property, it would seem that it was not "promptly and
faithfully" performing the provision of the contract on its part to
be performed relating to the furnishing of lien waivers. The failure of
the Contractor to keep the property free from mechanics' liens
constituted a material breach of the contract, for if the liens were not
paid the lienholders could foreclose them and the property would be lost
to the Owner. If the liens were not paid the damages sustained by the
Owner by such failure would be the amount of the valid liens. The
Contractor and the Surety would be liable to the Owner for such damages.
The fact that the Owner's damages were made up of identifiable items
owing to specific parties and that the Surety upon the request of the
Owner paid those items direct to such parties would not change the legal
situation. That situation was that the lienholders were not paid because
of any rights they had under the bond but were paid because of the
Owner's rights under the bond. Under the provisions of the bond, upon
default of the Contractor, the Surety had the right to "remedy the
default." It remedied the default by paying the amount of the
liens, which amount also constituted the amount of Owner's damages for
urges that although the bond is denominated a "Performance
Bond," it is only "concerned with actual construction"
and does not obligate the Surety for any breaches of the construction
contract that do not relate to the actual construction. The theory of
the Government is that Contractors did actually construct the structure
in accordance with the plans and specifications therefor and that such
being the case the Surety was under no further obligation.
The case fo Closson
v. Billman (1904), 161 Ind. 610, 69 N. E. 449, was an action against
the surety on a residence building contract bond. The contract provided
that the contractor was to build, construct, and complete the residence.
In the present case the contract provided that the Contractor should
"furnish all of the materials and perform all work" for the
residence. In the
case referred to, the contractor completed the construction of the
residence specified in the contract but did not pay for some of the
materials, and mechanics' liens were filed against the owner's
residence. When sued upon the bond the Surety contended that there was
no liability on his part because the owner did receive a residence
constructed in accordance with the plans and specifications therefor.
The Supreme Court of Indiana rejected that contention, stating (p. 451
in the face of the bond and contract, that the construction and
completion of the building in accordance with the plans and
specifications was a compliance with the bond, although the owner would
be compelled to pay out large sums, in excess of the amount stipulated
in the contract, to discharge liens for the purchase price of materials,
would be to keep the word of promise to the ear but break it to the
also Saint Paul Mercury Indemnity Company v. Wright Contracting
Company (4th Cir. 1958), 250 Fed. (2d) 758.
with its contention on this phase of the case, the Government cites the
case of United States v. Munsey Trust Co. (1947), 332 U. S. 234,
67 S. Ct. 1599, 91 L. Ed. 2022. That case involved a controversy between
and a Surety on payment bonds given to secure the payment of materialmen
and laborers in connection with contracts for the painting and repairing
of certain federal buildings as to the percentages retained by the
prevailed. In the opinion it is stated that the
was only concerned as to completion of the work since it was not under
any liability to the materialmen and laborers and its buildings were not
subject to liens in favor of them. In the present case the property of
the Owner was subject to such liens and the Owner was subject to losing
his property because of them. In 72 C. J. S., p. 768, it is stated:
present liability on the part of a surety exists * * * may be paid off
and satisfied by him without waiting to be coerced by process, and such
payment will entitle him to reimbursement from his principal; a payment
by a surety cannot be voluntary as long as the obligation is
92 C. J. S., p. 1032, it is stated:
general sense a 'volunteer' is one who does or undertakes to do that
which he is not legally or morally bound to do, and which is not in
pursuance or protection of any interest; one who intrudes himself into
matters which do not concern him."
It is the
holding of the Court that the Surety in the present case was under a
legally enforceable liability in connection with the mechanics' lien.
Liens Must Be "Specific" and "Perfected"]
of the Internal Revenue Code of 1954 (Section 3670, Internal Revenue
Code of 1939) makes a federal tax lien a lien "upon all property
and rights to property, whether real or personal," belonging to the
taxpayer. It attaches to all property and rights to property which are
subject to ownership and which can be transferred and which can be
brought under the dominion of a court by its usual processes; it
attaches not only to land and tangible personal property but also to
claims, demands, and causes of action which the taxpayer can assert
against third persons, including bank deposits, claims for wages and
actions for breach of contract.
v. Barndollar & Crosbie (10th Cir. 1948), 166 Fed. (2d) 793
[48-1 USTC ¶9203]; Citizens State Bank v. Vidal (10th Cir.
1940), 114 Fed. (2d) 380, 382, 383 [40-2 USTC ¶9603]; Bank of Nevada
v. United States (9th Cir. 1958), 251 Fed. (2d) 820 [58-1 USTC ¶9228],
certiorari denied (1958), 356
938, 78 S. Ct. 779, 2 L. Ed. (2d) 812. See also cases cited in Beeghly
v. Wilson (D. C. 1957), 152 Fed. Supp. 726, 729, 730 [57-2 USTC ¶9808].
In the field
of personal injury there are what are sometimes referred to as the
"two wicked sisters"--contributory negligence and assumption
of risk. In the field of federal tax law, holders of non-federal liens
which compete with federal tax claims encounter what are to them two
"wicked sisters." Those two wicked sisters being
"specific" and "perfected."
In order that
a non-federal lien may be given priority over a federal tax claim, it
must in addition to being prior in time be specific and perfected. In
order to be specific it must be definite as to amount, the lienor and
the property subject thereto.
81, 86, 74 S. Ct. 367, 98 L. Ed. 520 [54-1 USTC ¶9191]. In addition to
being specific the non-federal lien must also be perfected.
, supra. If such lien meets the United States Supreme Court tests of
specificity and perfectedness, it will be deemed to be a choate lien and
will be given precedence as to federal tax claims in the order of time.
, supra. A non-federal lien which does not meet the United States
Supreme Court tests of specificity and perfectedness is an inchoate lien
and it will not be given priority over a federal tax lien even though
prior in time to the latter. Just what is required in order for a
specific lien to be a perfected lien under the more recent holdings of
the United States Supreme Court is not entirely clear. So far only a
portion of one competing non-federal lien has been held to meet the
tests of that Court in regard to being perfected. A portion of the
competing non-federal tax liens involved in the case of
v. New Britain, supra, was regarded as meeting that test. In the
recent case of United States v. Latrobe Construction Co. (1957),
246 Fed. (2d) 357, certiorari denied, 355 U. S. 890, 78 S. Ct. 262, 2 L.
Ed. 2d 189, the United States Court of Appeals for this Circuit held
that a federal lien will prevail over any competing lien which is not
specific and perfected. In that case the federal lien was a real estate
mortgage lien. In the cases of
and Clear Lake R. Co. v. Imperial Seed
(D. C. 1957), 152 Fed. Supp. 145 [57-2 USTC ¶9736], Beeghly v.
Wilson (D. C. 1957), 152 Fed. Supp. 726 [57-2 USTC ¶9808], and Noltze
Motor Co. v. Burrows-Moore Pontiac (1958), 157 Fed. Supp. 593 [58-1
USTC ¶9209], this Court discussed certain phases of federal tax claims.
In the first case this Court (pp. 152-154) referred to an article by
Harold L. Reeve entitled "The Relative Priority of Government and
Private Liens," 29 Rocky Mountain Law Review 167 (February 1957).
In that article it was stated that during the ten years preceding twelve
cases involving the priority of federal tax claims had come before the
United States Supreme Court and that the Government had won all twelve
cases. The Government's unbroken string of victories in such cases has
been extended to fifteen.
In the case of
United States v. Vorreiter (1957), 355 U. S. 15, 78 S. Ct. 19, 2
L. Ed. 2d 23 [57-2 USTC ¶9956], the Court reversed Per Curiam the
holding of the Colorado Supreme Court (1957), 134 Colo. 543, 307 P. 2d
475 [57-1 USTC ¶9415]. That case involved priority as between a
mechanics' lien valid under the state law and a subsequently arising
federal tax lien. The Colorado Supreme Court had given priority to the
mechanics' lien. The Per Curiam opinion of the United States Supreme
Court was as follows:
petition for writ of certiorari is granted. The judgment of the Supreme
Court of Colorado is reversed. United States v. Security Trust &
Savings Bank, 340
47 [50-2 USTC ¶9492]."
is of interest that the United States Supreme Court cited in support of
the reversal the case of United States v. Security Bank & Trust
which involved an attachment lien rather than the cases of United
States v. White Bear Brewing Co. (1956), 350 U. S. 1010, 76 S. Ct.
646, 100 L. Ed. 871 [56-1 USTC ¶9440], and United States v. Colotta
(1955), 350 U. S. 808, 76 S. Ct. 82, 100 L. Ed. 725 [55-2 USTC ¶9680],
reversing United States v. Colotta (1955), 224 Miss. 33, 79 So.
2d 474 [55-2 USTC ¶9584], which involved mechanics' liens. The
concurring opinion of the Chief Justice of the Colorado Supreme Court in
the Vorreiter case contains some rather fiery language as to the
treatment being afforded mechanics' liens by the United States Supreme
Court. On remand of the Colotta case to the Mississippi Supreme
Court, three of its members also used some very fiery language in regard
to the same matter. See
v. Colotta (1956), 224
33, 86 So. 2d 19, 21 [56-1 USTC ¶9383].
The next case
in which the Government was successful before the United States Supreme
Court is the case United States v. R. F. Ball Construction Co., Inc.
(1958), 355 U. S. 587, 78 S. Ct. 442, 2 L. Ed. 2d 510 [58-1 USTC ¶9327],
in which it was held that Government's tax lien was prior to the claim
of a surety on certain construction bonds. That case will be later
The next case
in which the Government was successful was in the case of United
States v. Bess (June 9th, 1958), 357
1054, -- L. Ed. -- [58-2 USTC ¶9595]. In that case the Government's tax
lien prevailed as to the surrender value of life insurance policies of a
deceased delinquent taxpayer.
It might seem
as though the Government's winning streak was broken by the decision in
the case of Commissioner v. Stern (June 9th, 1958), 357 U. S.,
39, 78 S. Ct. 1047, -- L. Ed. -- [58-2 USTC ¶9594], since the
Government in that case was unsuccessful in its attempt to impose
liability upon the surrender value and the other proceeds of life
insurance policies of a deceased delinquent taxpayer. However, it should
be noted that in that case the claim of the Government was based upon
the section of the Internal Revenue Code relating to the transferees.
Section 6901, Internal Revenue Code of 1954 (Section 311 of the Internal
Revenue Code of 1939). It did not involve either the tax lien statute or
the priority statute.
been a number of articles, notes, and comments on the subject of tax
claims of the
. Kennedy, The Relative Priority Of The Federal Government: The
Pernicious Career Of The Inchoate And General Lien, 63 Yale Law Journal
905 (May 1954); Plumb, Federal Tax Collection and Lien Problems, 13 Tax
Law Review 247 (March 1958) and 13 Tax Law Review 459 (May 1958);
Anderson, Federal Tax Liens--Their Nature and Priority, 41 California
Law Review 241 (Summer 1953); Reeve, The Relative Priority of Government
and Private Liens, 29 Rocky Mountain Law Review 167 (February 1957);
Kerrigan, The Surety As Competing Claimant To Contract Funds, 24
Insurance Counsel Journal 34 (January 1957); Cross, Federal Tax Claims:
The Contractor's Surety and Suppliers, 24 Insurance Counsel Journal 384
(October 1957); Witherspoon, Surety's Salvage and Subrogation, 25
Insurance Counsel Journal 168 (April 1958); Prather, Federal Liens As
They Affect Mortgage Lending, 13 The Business Lawyer 118 (November
1957); Anderson, Wages And Taxes--A Surety's Headache, 5 Hastings Law
Journal 144 (1954); Note, Priority As Between The Federal Tax Lien and
The Mechanic's Lien, 25 Fordham Law Review 100 (Spring 1956); Note,
Effect Of A Federal Tax Lien On A Bank Deposit, 42 Iowa Law Review 412
(1957); Comment, Priority Of A Subsequent Federal Tax Lien Over An
Antecedent Inchoate Lien, 54 Michigan Law Review 829 (1956); Comment, 41
Minnesota Law Review 833 (1957). See 1957 Proceedings of the Section of
Real Property Probate and Trust Law of the American Bar Association, pp.
It is well
settled that an unforeclosed mechanics' lien even though filed prior to
a Government tax lien will be denied priority because it is not a
perfected lien. United States v. White Bear Brewing Company, supra;
United States v. Vorreiter, supra. It is also well settled that a
tax lien which is filed subsequent to the date of an attachment lien but
prior to the date the attaching creditor obtains judgment is entitled to
v. Acri (1955), 348
211, 75 S. Ct. 239, 99 L. Ed. 264 [55-1 USTC ¶9138]; United States
v. Security Trust & Savings Bank, supra. The doctrine of cases
cited is that a non-federal lien which is not perfected at the time the
Government tax lien arises cannot obtain priority over such tax lien on
the theory of relation back.
of Sureties on Bonds of Defaulting Contractors]
involving a surety on a bond of a defaulting contractor, the legal
situation may be quite complex. The surety may have rights as a subrogee
of those supplying materials and labor for the project. It may have
rights as a subrogee of the contractor. It may have rights as a subrogee
of the owner. It may have rights as the holder of an equitable lien
either with or without relation back. It may have rights as an assignee.
It may have rights as a chattel mortgage holder. It may also have
contractual rights not encompassed within the foregoing categories.
Where the claim of the surety is in conflict with a federal tax lien
there is frequently involved questions as to nature and extent of such a
In the case of
Colusa-Glenn Production Cr. Ass'n v.
(D. C. 1956), 145 Fed. Supp. 844 [56-2 USTC ¶9854], which involved
the question of priority between a Government tax lien and a surety on a
construction, the Court pointed out (p. 848) that it was necessary to
distinguish between the various equitable doctrines that might be
involved in such a situation.
In the case of
United States v. Munsey Trust Co. (1947), 332 U. S. 234, 67 S.
Ct. 1599, 91 L. Ed. 2022, there was involved the claim of a surety on a
construction bond to certain retained percentages. The Court stated (p.
239 U. S.):
these cases, it is usual for the rights relied upon to be largely
derivative or subrogated ones. Decision will be attended with
unnecessary confusion and difficulty if it is not clear whose rights are
being asserted and who claims them."