Melvin S. Hoffman, U.S. Bankruptcy Judge.
Kathleen P. Dwyer, the chapter 7 trustee of the estate of Pihl, Inc., the debtor in the main case, initiated this adversary proceeding by filing a six-count complaint against the Insurance Company of the State of Pennsylvania ("ICSP") and American International Companies ("AIC," and collectively with ICSP, the "Sureties") seeking to set aside and recover certain alleged preferential transfers (counts II-V) and for a turnover order and injunctive relief (counts I and IV) with respect to certain funds held by the third defendant, Middlesex Savings Bank ("Middlesex").
A bench trial in this adversary proceeding took place over two days. Based on the evidence introduced, arguments most ably delivered by counsel and matters of which I may take judicial notice, I present this memorandum of decision which includes my findings of fact and conclusions of law in accordance with Fed. R. Bankr. P. 7052.
This court has jurisdiction over this adversary proceeding pursuant to 28 U.S.C.
Judge William C. Hillman of this Court had occasion to discuss many of the factual and legal issues in this adversary proceeding in a memorandum of decision denying the parties' cross-motions for summary judgment. Dwyer v. The Insurance Company of the State of Pennsylvania (In re Pihl, Inc.), 529 B.R. 414 (Bankr. D. Mass. 2015) [hereinafter Pihl I]. While Judge Hillman's interlocutory findings and rulings in Pihl I are not preclusive with respect to my rulings here, they are, characteristically thoughtful and well-reasoned, and have informed many of my conclusions.
The debtor, Pihl, Inc., was the American subsidiary of E. Pihl & Son A.S, a Danish company. Pihl provided general contracting services on large public works projects, including several highway and bridge construction projects.
By contract dated April 27, 2010 (the "Nahant Contract"), Pihl undertook to perform the Nahant Beach Reservation Reconstruction in Nahant, Massachusetts (the "Nahant Project") for the awarding authority, the Massachusetts Department of Conservation and Recreation (the "DCR").
Each contract permitted the respective Project Owner to terminate the contract for cause. The Nahant Contract states in relevant part:
The Willimansett Contract incorporates the Standard Specifications for Highways and Bridges.
On September 12, 2013, Pihl informed ICSP that Pihl was letting all of its employees go on that day and would not continue to work on the Bonded Projects.
On September 18, 2013, ICSP commenced an action against Pihl in the United States District Court for the District of Massachusetts seeking damages pursuant to the Indemnity Agreement and an attachment of Pihl's bank accounts at Middlesex. On September 19th, the District Court approved the attachment of "all bank accounts, funds, monies, or other things" of Pihl up to $1,072,804.
On September 18, 2013, the DOT sent a notice to Pihl stating, among other things, that Pihl was in default of the Willimansett Contract, that work had apparently stopped as of September 13, 2013, and that under section 8.12 of the Contract, titled "Default Termination," Pihl had "five (5) days to re-start work at the site in accordance with the requirements of the contract."
The DCR did not send similar notices with respect to the Nahant Project but on November 6, 2013, ICSP entered into a written takeover agreement with the DCR to complete the Nahant Project.
By order dated October 23, 2013, this Court approved a stipulation pursuant to which the Bonded Contracts were deemed rejected as of October 22, 2013.
From time to time the Sureties received notices of various claims by third parties (mostly subcontractors) against Pihl on one or more of its bonded projects, including the Bonded Projects. No evidence introduced at trial established that these claims resulted in the Sureties' exercising their rights under the Indemnity Agreement or the Project Owners' calling defaults under the Project Contracts.
Prior to Mr. Fine's September 13, 2013 letter, the Sureties neither exercised their
The funds at issue in this adversary proceeding resulted from three payments made in September and October 2013. On September 4, 2013, the Commonwealth of Massachusetts made a payment of $250,654.14 by deposit into Pihl's Middlesex account for work performed by Pihl on the Willimansett Project prior to September 4, 2013 (the "First Payment").
Boiled down to its essence, this is a battle over who has superior rights to the First, Second and Third Payments. Ms. Dwyer in her complaint seeks to avoid the Sureties' UCC-1 filing and the attachment of Pihl's Middlesex bank accounts as preferences by which the Sureties attempted to turn their multi-million dollar unsecured claims against Pihl into secured claims. She also seeks an order requiring Middlesex to turn over to her all funds it is holding and granting injunctive relief essentially to prevent any interference with her unfettered use of those funds or the funds she obtained from Middlesex subsequent to filing the complaint.
The Sureties strenuously disagree with Ms. Dwyer's premise that they are and have always been mere general unsecured creditors of Pihl. The Sureties assert equitable and contractual rights in the funds representing the three payments, the former under the doctrine of equitable subrogation and the latter by virtue of the assignment provision of the Indemnity Agreement.
Whether the doctrine of equitable subrogation under state law is available in bankruptcy cases in light of the Bankruptcy Code's broad definition of property of the estate and its own detailed subrogation provisions under § 509 is a matter of disagreement among the courts. As I recently noted in an unrelated case:
In re Morrison, 555 B.R. 92, 95 (Bankr. D. Mass. 2016).
"Equitable subrogation occurs where one party, by virtue of its payment of another's obligation, steps into the shoes of the party who was owed the obligation for purposes of getting recompense for its payment." In re N. Am. Rubber Thread Co., 333 B.R. 164, 168 (Bankr. D. Mass. 2005). "When the surety then finances the contract to completion, it is subrogated to the contractor's property rights in the contract balance." Balboa Ins. Co. v. United States, 775 F.2d 1158, 1161 (Fed. Cir. 1985). The doctrine can be invoked in the absence of an express subrogation agreement. N. Am. Rubber Thread Co., 333 B.R. at 168. It does not require that a financing statement be filed. Nat'l Shawmut Bank v. New Amsterdam Cas. Co., 411 F.2d 843 (1st Cir.1969); Canter v. Schlager, 358 Mass. 789, 791, 267 N.E.2d 492 (1971).
A surety "may stand in the shoes of either (1) the contractor whose obligations are discharged, (2) the owners to whom it was bound, or (3) the subcontractors whom it paid." Canter, 358 Mass. at 794, 267 N.E.2d 492 (citing Pearlman, 371 U.S. at 141, 83 S.Ct. 232).
Under Massachusetts law courts look to the following factors to determine whether equitable subrogation applies:
East Boston Sav. Bank v. Ogan, 428 Mass. 327, 330, 701 N.E.2d 331 (1998). Not all factors need be present for equitable subrogation to apply. Id.
There is disagreement about when subrogation rights arise. Some courts require a surety to begin making payments before its subrogation rights are triggered; others recognize subrogation rights as
In arguing that equitable subrogation principles do not apply to any of the three payments at issue here, Ms. Dwyer focuses on the default and termination provisions of the Project Contracts. She claims default was the exclusive triggering event for termination of the Project Contracts and that the Sureties' subrogation rights would not have arisen until default and subsequent termination.
Ms. Dwyer's position that the Sureties have no subrogation rights in the three payments because of the timing of the declarations of default, conflates the rights of the DOT and DCR to terminate the Project Contracts with Pihl's obligations to perform under those Contracts and the Sureties' guaranteeing such performance to the DOT and DCR. The Project Owners' decision to terminate the Contracts has nothing to do with triggering the Sureties' obligations under the payment and performance bonds. It is the failure of Pihl to perform that was the triggering event. There is nothing in the payment or performance bonds for either the Willimansett or Nahant Projects that requires a declaration of default to issue as a precondition to ICSP's obligations to perform or its right to recoup its losses. Compare Fidelity & Deposit Co. of Maryland v. Casey Indust., Inc., 8:12CV70, 2014 WL 1096355 (D. Neb. March 19, 2014) (rejecting need for formal declaration of default despite similar language in bonds because bonded contract did not so require) with Elm Haven Constr. Ltd. v. Neri Const. LLC, 376 F.3d 96, 98 (2d Cir. 2004) (surety's obligation not triggered under performance bond expressly providing that "whenever Principal [contractor] shall be, and be declared by the Obligee [project owner] to be in default" when no default declared); Liberty Mut. Ins. Co. v. Constr. Mgmt. Servs., Inc., No. 99C6906, 2004 WL 2271811, at *3 (N.D. Ill. Oct. 6, 2004) (same). Indeed Ms. Dwyer had to look to the Project Contracts even to find the word "default."
I conclude that the Sureties' subrogation rights arose no later than September 13, 2013, when Pihl ceased performing work
As for the First Payment which was made prior to the inception of the Sureties' subrogation rights, the Sureties argue that once triggered, their subrogation rights relate back to capture funds previously received by Pihl under the Project Contracts and not yet spent. This argument misconstrues the concept of relation back. "[T]he surety's right is only a potential one which does not become an actuality until the surety satisfies a debt [or at least becomes liable for it] of its principal." Home Indem. Co. v. United States, 376 F.2d 890, 893 (Ct. Cl. 1967); In re Bay State York Co., Inc., 162 B.R. 922, 934 (Bankr. D. Mass. 1993) ("[T]he relation back principle employed by the Court in Canter relates to the legal effect of the surety's actions rather than the actions themselves."). Canter explained that a bankruptcy trustee's rights as a judgment lien creditor did nothing to enhance his claim to the funds at issue because the surety's rights related back to the date of the bond. Id. at 795, 267 N.E.2d 492.
"The theory of equitable subrogation is based on the view that the triggering of a surety's bond obligation gives rise to an implied assignment of rights by operation of law whereby the surety is subrogated to the [principal contractor's] property rights in the contract balance," Colonial Sur. Co. v. United States, 108 Fed.Cl. 622, 633 (2013). In addition to their rights as subrogees, the Sureties assert rights in the three payments by virtue of the assignment provision in the Indemnity Agreement. They rely on language in the assignment provision making the assignment "effective as of the date of the bond covering such contract," to assert rights as assignees in the First Payment even though the First Payment predated any of the six triggering events set forth in the assignment provision.
Ms. Dwyer disagrees with the Sureties' relation-back argument and then doubles down by throwing an even more challenging obstacle in the Sureties' path. She maintains that the assignment provision of the Indemnity Agreement is a grant of a security interest subject to the perfection requirements of the Uniform Commercial Code ("UCC"). The Sureties did not perfect their security interest until AIC filed a financing statement with the Massachusetts Secretary of State on September 16, 2013. That date being within 90 days of
Whether the Indemnity Agreement granted an assignment or a security interest in the project payments is a question of contract interpretation under New York law, the controlling law selected by the parties to the Indemnity Agreement. In Pihl I Judge Hillman presented a thorough analysis of New York law regarding assignments for security concluding that "the language of the assignment provision in the Indemnity Agreement at issue here is within the parameters of what New York courts have held is an effective assignment." Pihl I, at 428. I concur with Judge Hillman and find that the assignment provision of the Indemnity Agreement granted an assignment for security not dependent upon filing under the UCC for its validity.
But the question remains, was the assignment provision of the Indemnity Agreement effective to confer upon the Sureties rights as assignees retroactive to the inception of the payment and performance bonds? The answer is that the Sureties will be no more successful with respect to their contract rights than they were in asserting retroactive application of their equitable subrogation rights. This is because the Indemnity Agreement does not do for the Sureties what they would like it to do.
The assignment provision of the Indemnity Agreement is a jaw-breaking, 497 word run-on sentence. An excerpt appears above but it is necessary to quote the entire provision here:
Parsing this passage requires a high pain threshold, a law degree and preferably some familiarity with 19th century legal writing. It assigns to the Sureties six baskets of assets described in detail in subsections (a) through (e). It enumerates six events (set forth in subsections (1) through (6)), the occurrence of any one of which triggers the assignment to the Sureties of the listed assets.
Although the Sureties argue that the subcontractor and other third party claims filed under the Project Bonds prior to September 13, 2013, triggered their rights under the assignment provision, no evidence established that those claims resulted from or caused Pihl's failure to perform under the Bonded Project contracts. I find that the event which triggered the Sureties' assignment rights under the Indemnity Agreement was Pihl's ceasing work on the Bonded Projects on September 13, 2013 (see subsection (1) of the assignment provision). At that time the Sureties' assignment rights in the six enumerated baskets of assets sprang into existence and they became entitled to the Second and Third Payments which on September 12, 2013, were sums "due" or to "become due" on the Project Contracts (see subsection (e) of the assignment provision).
So far so good. But the Sureties point to some additional language in the assignment provision preceding the enumerated triggering events and the identification of the assets assigned which they claim extends their assignment right to the First Payment. This introductory phrase states, "the assignment in the case of each contract to become effective as of the date of the bond covering such contract." The payment and performance bonds for the Willimansett Project were issued on April 26, 2011, well before the date of the First
The Sureties appear to interpret the chronological preface of the assignment provision as governing all that follows. A careful review of the provision establishes, however, that the prefatory time-frame is entirely subservient to the subsequent terms. Interpreting the introductory relation-back language as governed by the subsequent terms of the assignment provision rather than as governing those terms results in the understanding that upon the occurrence of a triggering event and the Sureties' acquiring assignment rights in the enumerated assets, their assignment rights would apply to those assets retroactive to the date of the bonds. For example, on September 13, 2013, the date of the triggering event, the Sureties acquired assignments of any amounts then held by the Project Owners and due to Pihl, such as for project retainages or unpaid invoices, dating as far back as the issuance of the payment and performance bonds. But if the asset in question, like the First Payment, was not an asset included in any of the six baskets assigned to the Sureties, the introductory relation-back language in the assignment provision would never come into play. Cash is not one of the assets assigned to the Sureties in the Indemnity Agreement and once the First Payment was deposited into Pihl's Middlesex bank account on September 4, 2013, it became fungible cash no longer subject to any rights of the Sureties under the Indemnity Agreement.
The Sureties' lien rights in the First Payment would at best have arisen upon their obtaining the trustee process attachment against Middlesex or perhaps upon the filing of their UCC-1 financing statement. I find, however, that Ms. Dwyer has established that the bank account attachment and the UCC-I filing were preferences under Bankruptcy Code § 547 and therefore the Sureties have no lien claims in the First Payment.
The Sureties have both equitable subrogation and contractual assignment rights to the Second and Third Payments. The First Payment is property of the Pihl bankruptcy estate free of any claims of the Sureties. Middlesex shall turn over the First and Second Payments, with any interest actually accrued thereon, to Ms. Dwyer, who is already holding the Third Payment. Ms. Dwyer shall pay the amount of the Second and Third Payments to the Sureties. Judgment will enter on the complaint as follows:
4 Corbin, Contracts § 891, at 268-69 (Supp. 1992). See also Maloney v. John Hancock Mut. Life Ins. Co., 271 F.2d 609, 614 (2d Cir. 1959) ("[N]umerous decisions of this circuit recognize the validity of conditional assignments under New York law.").
