Unperfected interests Page3

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Thereafter, on 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.

[Issue]

The Government claims that it is entitled to recovery under 26 U. S. 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 Maryland v. New York City Housing Authority, 1957, [57-1 USTC ¶9410] 241 F. 2d 142.

[Statute Involved]

However, the 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:

"The 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 * * *.

"Such 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)

[Contentions]

Defendants 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.

[Controlling Court Decisions]

In Kings 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 wis disregarded by the same court when considering analogous questions created by contract rather than by statute. Fidelity and Deposit Company of Maryland 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 U. S. 51.

Today there 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 New York 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):

"The 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, 309 U. S. 78, 82, 60 S. Ct. 424, 426, 84 L. Ed. 585." (Italics supplied)

To the same effect see United States v. Durham Lumber Co., 1960, [60-2 USTC ¶9539] 363 U. S. 522.

Aquilino 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:

"Our 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)

Obviously, Kings 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.

[Conclusion]

Consequently, 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.

The above embodies the Court's findings of fact and conclusions of law and judgment is ordered for the defendants.

¹ 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 , Intervenor

U. S. District Court, Middle Dist. Pa., Civil Action No. 5575, 192 FSupp 837, 3/27/61

[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 United States did not attach to these funds since the general contractor had no property or right to property in the withheld balances.

Harry Treinin, Corning , N. Y., and Emory Rockwell, Wellsboro , Pa. , 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.

Opinion

FOLLMER, District Judge:

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 County, Pennsylvania.

Plaintiff, Van 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 Wellsboro , Pennsylvania , pursuant to an agreement made between the plaintiff, the Owner, the Contractor and the creditors of the Contractor.

[Claims to Withheld Funds]

The 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 .

Under the 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.

[Action for Retained Funds]

Plaintiff 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 United States 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.

The Contractor did not and could not furnish a statement that all the subcontractors and material men had been paid.

[Contract Provisions]

The pertinent portions of the contract are as follows:

"Article 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.

"Article 5. * * *

"Before 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."

General conditions of the contract:

[Failure to Pay Subcontractor Is Breach of Contract]

"Art. 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. * * *

* * *

"Art. 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 account of:

* * *

"(b) Claims filed or reasonable evidence indicating probable filing of claims.

"(c) Failure of the Contractor to make payments properly to subcontractors or for material or labor.

* * *

"Art. 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 attorney's fee.

* * *

"Art. 37. * * *

"The Contractor agrees--

* * *

"(e) 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 therein.

"(f) 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.

"(g) 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.

"(h) 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."

In Aquilino v. United States, 1950 [1960] [60-2 USTC ¶9538], 363 U. S. 509, 512, the Court posed the question here involved as follows:

"The 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 U. S. 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 U. S. 51, 55. . . ."

[Contractor Had No Right to Withheld Balance]

Atlantic 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 alia:

"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; (citing Pennsylvania cases) * * *.

"In the cited cases it was held that the tax liens of the United States 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 materialmen.

"Therefore, 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 been.

"* * * 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, * * *.

* * *

"Thus 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."

I conclude 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 attach.

Let Order be submitted in accordance herewith.

¹ An unnumbered paragraph following Article 6 of the contract provides as follows:

"It is 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

U. S. District Court, West. Dist. Pa., Civil Action No. 15185, 183 FSupp 478, 4/8/60

[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.

Robert A. Rundle, of Wright & Rundle, Frick Building , Pittsburgh 19, Pa. , for plaintiff. J. M. McCandless, 304 Ross Street , Pittsburgh 19, Pa. , for defendant.

Opinion and Order

Opinion

MARSH, District Judge:

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.

Atlantic Refining Company, hereinafter called the Owner, on November 8, 1954 , and 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 Mt. Pleasant , Westmoreland County , Pennsylvania , and Connellsville, Fayette County , Pennsylvania . 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.

The Contractor 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 Mt. Pleasant station and $6,626.26 for the Connellsville station, or a total of $12,653.94.

[Claims to Withheld Funds]

Previously, 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 and 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.

Greensburg 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.

The Surety claimed the balances withheld on the contract prices by reason of its liability on the bonds to unpaid materialmen.

Faced with these conflicting claims, the Owner on November 15, 1956 filed a "Complaint for Interpleader and Declaratory Relief" against the United States , the Surety Company, Greensburg Concrete Block Company, and the Contractor, and thereupon paid $12,653.94 into the registry of this court.

A default 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 into court.

[Tax Liens]

The complaint was dismissed as to the United States , and the United States 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.

By amendment 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 Mt. Pleasant and Connellsville (see government's brief, pp. 32-34).

[Surety's Claim]

After the fund was paid into court, the Surety paid claims of materialmen on the Mt. Pleasant station in the sum of $6,004.51, leaving a balance of $23.17 unclaimed except by the United States . 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.

The Surety presses its claim on the following grounds:

(1) The Contractor had no property or property interest in the fund upon which the government liens might attach.

(2) 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.

(3) 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

The provisions of the contracts between the Owner and the Contractor are identical except for description of work and prices.

The pertinent provisions thereof are as follows:

(1) "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."

(2) "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."

(3) "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."

(4) "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 provided."

The surety 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 Contractor.

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.

The 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

The United States 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 United States upon all property and rights to property . . . belonging to such person."

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 U. S. 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 Mt. Pleasant 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.

[Contractor's Rights Under State Law]

It must now be determined under the Pennsylvania 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; Sum. Pa. 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 United States 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.

Therefore, 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 contract as an abandonment of the work would have been.

Since the 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).

In Lancaster 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:

"[A]s 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 232:

"A 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.)

Thus 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 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.

Adapting Mr. Justice Brennan's statement in United States 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.

The Surety Is Subrogated to the Rights of the Owner in the Withheld Balances

Having determined that the United States does not have a lien on the withheld balances, it seems certain that the Surety is entitled to recover the fund paid into court.

However, the 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 Pennsylvania 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.

It is 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.)

In Henningsen 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 Lancaster County 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.).

In Sundheim v. School District , supra, at pp. 367-368 (Atl.), the Supreme Court of Pennsylvania stated:

"Consequently, when the contractor fails to pay labor and materialmen, it is tantamount to a breach of its contract with the United States [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 United States . It [the surety] is therefore entitled to subrogation to the rights of the United States in the fund. Subrogation does not arise through the contractor, but from the government's [the owner's] rights. Prairie State Nat. Bank v. U. S. , 164 U. S. 227, 17 S. Ct. 142, 41 L. Ed. 412; Henningsen v. U. S. Fid. & Guar. Co. of Baltimore, 208 U. S. 404, 28 S. Ct. 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.)

In Prairie State Bank v. United States , supra, at pages 232-233, it was stated:

"Hitchcock's [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 United States [owner], might have asserted against this fund." (Italics supplied.)

In Henningsen v. United States Fidelity & Guaranty Co., supra, at page 410, it was stated:

"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.)

That the 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. Wells, 289 U. S. 670, 679-680 [3 USTC ¶1108]; Cove IRR. Dist. v. American Surety Co. of New York , 42 F. 2d 957 (9th Cir. 1930); Williston on Contracts, rev. ed., §§ 358, 359; Corbin, Contracts, vol. 4, §812.

Thus, Henningsen 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 original contract.

The rationale of the foregoing principles is well expressed in Corbin on Contracts, vol. 4, §901, pp. 609, 610, from which the following extracts are taken:

"If 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 'latent'.

"The 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. . . .

"So, 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."

The contracts, 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. United States , supra. I hold that the Surety is entitled to the fund.

Payment by the Owner of the Withheld Balances Into Court Does Not Constitute a Waiver of the Surety's Right of Subrogation

The government 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 agree.

In Lancaster 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 the bond. Derby v. United States Fidelity & Guaranty Co., 87 Or. 34, 169 P. 500; Canton Exchange Bank v. Yazoo County , 144 Miss. 579, 109 So. 1."

Cf. Sum. Pa. Jur., Surety & Guarantor, §139.

The Owner, 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. Moore 's Federal Practice, 2d ed., vol. 3, ¶22.07, pp. 3021-3022.

The Surety 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.

The United States 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 of the Mt. Pleasant 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].

The pertinent portion of both contracts is as follows:

"With 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."

The pertinent condition of the bonds is that the Contractor

"(1) 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. . . ."

[Interpretation of Contracts]

The problem is one of interpreting the foregoing contractual provisions in order to determine whether the parties intended to benefit the United States and other taxing bodies by creating securities and remedies additional to their right to tax liens and the ordinary statutory methods of collection.

With respect 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):

`A 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 Pa. 452, 457, 43 A. 961, 962; [City of] Erie v. Diefendorf, 278 Pa. 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 normal meaning."

In the 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).

With the 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 taxes."

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 United States 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.

Construing the 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 Pa. 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. North Huntingdon 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.

The government 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.

Since no 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.

Order ofCourt

AND NOW, 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.

¹ See assignments contained in applications for bonds.

² 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 U. S. 47 (1950) [50-2 USTC ¶9492].

³ Section 6321, 26 U. S. C. A., provides as follows:

"If any 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."

Section 6322, 26 U. S. C. A., provides as follows:

"Unless 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."

⁴ 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.

⁵ Williston on Contracts, rev. ed., vol. 2, §372, p. 1085.

⁶ In all the cited cases the materialmen did not have the right to file mechanics' liens against public buildings.

⁷ 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.

⁸ Cyclopedia Fed. Proc., 3d ed., §22.16, p. 607; Carter v. Thornton , 93 F. 2d 529 (8th Cir. 1938).

⁹ 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 United States who was not a disinterested stakeholder interpleading the fund as in the instant case.

¹⁰ The quoted phrase is from City of Lancaster v. Frescoln, 203 Pa. 640, 53 Atl. 508 (1902).

 

 

 

The Aetna Casualty and Surety Company, Plaintiff v. The Port of New York Authority and the United States of America , Defendants

U. 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 the contract.
[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 had priority.
[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.

M. Carl Levine, Morgulas & Foreman, 521 Fifth Avenue , New York 17, N. Y. (Albert Foreman, of counsel), for plaintiff. Sidney Goldstein, 111 Eighth Avenue , New York 11, N. Y., for the Port of New York 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 United States .

MCGOHEY, District Judge:

This case involves the question whether Aetna's lien as completing surety of a defaulting contractor has priority over tax liens of the United States against a fund of $67,000 held by the Port of 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.

[Motions 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 the United States moved for either complete or partial summary judgment.

Aetna '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.

The 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.

The government 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.

[No Issue as to Material Facts]

The parties 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 New York International Airport . 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.

[Default]

On 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.

[Completing Surety v. Assignee]

The government 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.

[Unpaid Bonus]

The 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.

[Bonus Provision]

The bonus 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.

[Claim Against Surety]

The 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.

[Taxes as Wages]

The 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."

The government 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

The government's several motions for summary judgment and partial summary judgment are severally denied.

The 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.

Settle Order.

¹ 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].

² 355 U. S. 587 [58-1 USTC ¶9327].

³ 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].

⁴ 223 N. Y. 193.

⁵ 265 N. Y. 648.

⁶ 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 York, supra.

⁷ 353 U. S. 210.

⁸ 40 U. S. C. 270b(a).

⁹ 353 U. S. 215.

¹⁰ See United States v. Embassy Restaurant, 359 U. S. 29, 35 [59-1 USTC ¶9297].

¹¹ Sec. 3403, Internal Revenue Code of 1954; §31.3401(a)-1(b)(5), Regulations, I. R. C. 1954.

 

 

 

Central Surety and Insurance Corporation, Plaintiff v. Martin Infante Co., Inc., et al., Defendants

U. S. District Court, Dist. N. J., Civil Action File No. 407-57, 164 FSupp 923, 7/8/58

[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.

McCarter & English, J. Ward Herbert, for plaintiff. Chester A. Weidenburner, United States Attorney, Charles H. Hoens, Jr., Assistant United States Attorney, for Government. W. Ludlow James, for claimant Liberty Mutual Insurance Company.

Opinion

WORTENDYKE, District Judge:

The present action was instituted by plaintiff in the Chancery Division of the Superior Court of New Jersey. After the United States (Government) was made a defendant as tax claimant, it thereupon removed the action to this Court, in accordance with the provisions of 28 U. S. C. §1444. The only remaining parties who allege interests in the fund which is the subject of this action are the plaintiff, the United States 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.

Plaintiff (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.

[Construction Completed by Surety]

Infante 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.

After Infante 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.

In accordance 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 Court dated November 7, 1957 .

Among the 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. Barth , Ch. 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.

[Conditions 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.

The situation 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].

[Material 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 United States 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 state law."

The 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:

"We do 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.

"We 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, * * *"

[Interest 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 could attach.

[Property Rights]

In the Zion Church 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:

"The 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:

"We 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. * * *"

See, 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 denied, 326 U. S. 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 New Jersey 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 United States . 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]

Such must 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 United States any right to the funds presently on deposit in the registry of this Court.

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 U. S. 234 at variance with our conclusion here. Munsey Trust held merely that percentages retained pursuant to contract by the United States may be subjected to its set-off claims despite the claims of a surety who has paid laborers and materialmen. 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 lien.

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 U. S. C. §6323(a).

This opinion shall be deemed to constitute the Court's findings of fact and conclusions of law, and an order for judgment may be presented in accordance therewith.

¹ The contract was made expressly subject to the following conditions:

"The 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 Board." (G-11)

"When in 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.

"When the 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; * * *." (G-35)

² 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.

³ §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 the United States upon all property, whether real or personal, belonging to such person." (Italics supplied.)

⁴ Now 26 U. S. C. §6321. See, fn. 3 ante.

 

 

 

William H. Lebowitz and Frances Lebowitz v. Joseph J. Abdella, et al.

U. S. District Court, Dist. Conn., Civil Action No. 6475, 168 FSupp 266, 10/29/58

[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.

Spiro & Levine, 286 Main Street , Danbury , Conn. , for plaintiff. Jules J. Bielizna, 8 West Street , Danbury , Conn. , for Joseph F. Chudy. Norman A. Buziaid, 302 Main Street , Danbury , Conn. , 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 Katz, 8 West Street , Danbury , Conn. , for Matz Lumber Co.

Findings of Fact

Conclusions of Law

Opinion

SMITH, District Judge:

Plaintiff, William H. Lebowitz, owner of real property at 65 West Street , Danbury , 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.

The contract 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
 ....           6,000

December 1, 1955 ....           6,000

Total ...............         $14,000

 

Abdella abandoned the work before completion and Lebowitz contracted directly for materials and labor to complete the job and made the following payments thereon:

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

                                                   $1,979.30

 

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 the plaintiffs.

Four 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.

Federal Glass Co. furnished material from December 1955 to January 11, 1956 in the amount of $1,635.47 and filed lien February 29, 1956.

Scalzo furnished materials and services from January 25, 1956 to February 8, 1956 in the amount of $574.95, and filed lien March 28, 1956.

Chudy 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.

Matz Lumber Co. furnished materials from November 19, 1955 to January 16, 1956 in the amount of $1,476.00 and filed lien January 18, 1956.

Plaintiffs filed suit for interpleader, in the Court of Common Pleas for Fairfield County , which was removed to this court by the United States . 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.

Abdella failed to appear and was defaulted.

Abdella had 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 Lumber.

Plaintiffs incurred costs of $44.65 in this action.

A reasonable 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.

Conclusions of Law

1. The Court has jurisdiction of the parties and subject matter of the action.

2. Abdella 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.

4. Plaintiffs in interpleader are entitled to their costs of suit and reasonable attorney's fees from the funds, a total of $544.65.

5. Defendant 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.

Discussion

The United States 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 United States might prevail. The Kings County Iron Co. case, 2 Cir., 224 Fed. (2d) 232 [55-2 USTC ¶9536], relied upon by the United States , 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.

Judgment may 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

Co.
 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

Co.
 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, Defendants

U. S. District Court, No. Dist. Ia. , 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.

Charles F. Stilwill, Kenneth T. Wilson, Sioux City , Ia. , for plaintiffs. F. E. Van Alstine, United States District Attorney, Theodore G. Gilinsky, Assistant United States District Attorney, for defendants.

Opinion

GRAVEN, District Judge:

The 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 escrow.

On 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 Sioux City , Iowa . That contract contained, among other provisions, the following:

"No. 1--Scope 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.

"No. 2--Time of completion--The work to be performed under this contract shall be commenced at once and shall be substantially completed December 1, 1955 .

"No. 3--Performance bond--Performance bond in the full amount of the contract is to be furnished by the Contractor and paid for by the Owner.

"No. 4--The 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.

"No. 5--The payments shall be made in accordance with the specifications.

"No. 6--Acceptance 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.

"No. 7--The 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."

The specifications, as noted, are made a part of the contract. One paragraph of the specifications provides as follows:

"PROGRESS PAYMENTS:

The owner 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."

On 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:

"That 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 * * *."

On July 22d, 1955 , the following bond was issued:

"PERFORMANCE BOND

"KNOW ALL MEN BY THESE PRESENTS:

That Ericcson & 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

"WHEREAS, 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.

"NOW, 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.

"Whenever 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

"(1) Complete the CONTRACT in accordance with its terms and conditions, or

"(2) 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.

"Any 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.

"No 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.

"Signed and sealed this 22nd day of July A D 1955

(Signatures)"

The Contractor 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 of them.

On 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 Woodbury County , Iowa .

Under the 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 Woodbury County , Iowa . On 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 Woodbury County , Iowa . 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 . On February 23d, 1956 , the Contractor executed the following assignment to the Surety:

"ASSIGNMENT

"FOR 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.

"DATED this 23 day of February, 1956.

(Signatures)"

On 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:

"3. 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.

On 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:

"1. 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.

"2. 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."

"4. 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."

In November, 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 Iowa 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

9/30/55
 ..........         $5,168.27           11/15/55          12/15/55             $4,930.92

12/31/55
 .........          2,950.64            3/12/56           3/13/56              2,817.34

12/31/55
 .........             58.65            11/8/56           12/7/56                 58.65

1955* ............          1,764.20            3/20/56           3/21/56                676.33

                                                                                      $8,483.24

* Last entry relates to federal unemployment tax; all other entries above pertain to withholding & social security taxes.

On January 7th, 1957 , the Director served notice of levy upon the escrow agent.

On 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 be quashed.

The original 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.

On 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, Title 26, United States Code (Section 3670 Internal Revenue Code of 1939). It does not base its claim on the priority statute. Section 191, Title 31, United States Code.

The parties in their briefs and arguments have pretty well encompassed the larger part of the field of law relating to federal tax liens.

[Government's Contentions]

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 ( Iowa 1958), 89 N. W. 2d 875, refers to the holding in the Bourrett case as follows (p. 879):

"It holds 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."

See also Hopper Bros. Quarries v. Merchants Mutual Bonding Company (8th Cir. 1958), 255 Fed. (2d) 147.

The contract 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:

"Where 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 surety."

However, 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 provides:

"* * * 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."

When 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 such default.

The Government 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 Indiana 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 N. E.):

"To hold, 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 hope."

See also Saint Paul Mercury Indemnity Company v. Wright Contracting Company (4th Cir. 1958), 250 Fed. (2d) 758.

In connection 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 the United States 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 United States . The United States prevailed. In the opinion it is stated that the United States 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:

"Whatever 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 enforceable."

In 92 C. J. S., p. 1032, it is stated:

"In a 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.

[Non-Federal Liens Must Be "Specific" and "Perfected"]

Section 6321 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. United States 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 U. S. 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. United States v. New Britain (1954), 347 U. S. 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. United States v. New Britain , 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. United States v. New Britain , 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 United States 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 Mason City and Clear Lake R. Co. v. Imperial Seed Co. (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:

"The 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 U. S. 47 [50-2 USTC ¶9492]."

It 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 United States v. Colotta (1956), 224 Miss. 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 referred to.

The next case in which the Government was successful was in the case of United States v. Bess (June 9th, 1958), 357 U. S. 51, 78 S. Ct. 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.

There have been a number of articles, notes, and comments on the subject of tax claims of the United States . 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. 89-96.

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 priority. United States v. Acri (1955), 348 U. S. 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.

[Rights of Sureties on Bonds of Defaulting Contractors]

In cases 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 lien.

In the case of Colusa-Glenn Production Cr. Ass'n v. Phoenix Ins. Co. (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.):

"In 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."