United States Court of Appeals
                            FOR THE EIGHTH CIRCUIT
           ___________

           No. 02-3600
           ___________

Pennsylvania National Mutual             *
Casualty Insurance Company, a            *
Pennsylvania Corporation,                *
                                         *
              Plaintiff/Appellant,       *
                                         *
Cannon Contracting, Inc.,                *
                                         *
              Intervenor Plaintiff,      *   Appeal from the United States
                                         *   District Court for the
      v.                                 *   Eastern District of Arkansas.
                                         *
City of Pine Bluff,                      *
                                         *
              Defendant/Appellee,        *
                                         *
David Mitchell Construction, Inc.;       *
David R. Mitchell; Theresa               *
Mitchell; Karl F. Dix, Jr.; Pine Bluff   *
National Bank; Nobel Insurance           *
Company,                                 *
                                         *
           Defendants.                   *
      ____________________               *
                                         *
Surety Association of America,           *
                                         *
              Amicus on Behalf of        *
              Appellant.                 *
           ___________

           No. 02-3646
           ___________

Pennsylvania National Mutual             *
Casualty Insurance Company, a            *
Pennsylvania Corporation,                *
                                         *
              Plaintiff,                 *
                                         *
Cannon Contracting, Inc.,                *
                                         *
              Intervenor Plaintiff/      *
              Appellant,                 *
                                         *
      v.                                 *
                                         *
City of Pine Bluff,                      *
                                         *
              Defendant/Appellee,        *
                                         *
David Mitchell Construction, Inc.;       *
David R. Mitchell; Theresa               *
Mitchell; Karl F. Dix, Jr.; Pine Bluff   *
National Bank; Nobel Insurance           *
Company,                                 *
                                         *
              Defendants.                *

           ___________

           No. 02-3735
           ___________

Pennsylvania National Mutual             *
Casualty Insurance Company, a            *

                                         -2-
Pennsylvania Corporation,                *
                                         *
             Plaintiff/Appellee,         *
                                         *
Cannon Contracting, Inc.,                *
                                         *
             Intervenor Plaintiff/       *
             Appellee,                   *
                                         *
      v.                                 *
                                         *
City of Pine Bluff,                      *
                                         *
             Defendant/Appellant,        *
                                         *
David Mitchell Construction, Inc.;       *
David R. Mitchell; Theresa               *
Mitchell; Karl F. Dix, Jr.; Pine Bluff   *
National Bank; Nobel Insurance           *
Company,                                 *
                                         *
             Defendants.                 *
      ____________________               *
                                         *
Surety Association of America,           *
                                         *
             Amicus on Behalf of         *
             Appellee.                   *
                                    ___________

                            Submitted: September 8, 2003

                                Filed: January 15, 2004
                                 ___________

Before WOLLMAN, BOWMAN, and RILEY, Circuit Judges.
                        ___________

                                      -3-
WOLLMAN, Circuit Judge.

      In this suretyship case, the City of Pine Bluff, Arkansas (City), and
Pennsylvania National Mutual Casualty Insurance Company (Penn National) cross-
appeal the district court’s findings regarding the contours of equitable subrogation,
suretyship, and municipal immunity in Arkansas. We conclude that the City must
reimburse Penn National for the losses it suffered after the City released funds to a
general contractor despite notice of the general contractor’s default and a request
from the surety to withhold funds pending investigation. We therefore reverse and
remand with directions to enter judgment for Penn National.

                                          I.

      After severe ice storms littered Pine Bluff with debris in December 2000, the
City applied for Federal Emergency Management Agency (FEMA) funds and hired
general contractor David Mitchell Construction (Mitchell) to clean up the aftermath.
The contract required that the City withhold ten percent of any progress payments to
Mitchell as retainage,1 and Mitchell agreed to pass on payment to subcontractors
working on the project within ten days of any progress payment from the City.
Acting as surety, Penn National underwrote a combined performance and payment
bond for the project in the penal sum of $3.5 million.2

      1
        Retainage is “[a] percentage of what a landowner pays a contractor, withheld
until the construction has been satisfactorily completed . . . .” Blacks Law Dictionary
1317 (7th Ed. 1999).
      2
        Often issued in conjunction, performance and payment bonds are usually
required in public works projects. See, e.g., 40 U.S.C. § 3131(b) (West 2003); cf. Ark.
Code Ann. § 22-9-401 (Michie 1996). A performance bond protects the owner, or
obligee, ensuring project completion if the general contractor defaults. In re Modular
Structures, Inc., 

, 74 n. 1 (3d Cir. 1994); Int’l Fidelity Ins. Co. v. United
States, 

, 708 n. 2 (1998). A payment bond ensures that laborers and
material suppliers will be paid if the general contractor defaults. Int’l Fidelity Ins.

                                         -4-
       As the work progressed, Mitchell and the City began arguing over pricing and
Mitchell’s hauling of debris allegedly ineligible for FEMA reimbursement. On
March 26, 2001, the City terminated its contract with Mitchell and arranged for City
employees to complete the work – actions Penn National did not discover until
approximately June 5, 2001. On that date, the City returned to Penn National a
completed status inquiry form indicating that the contract had been terminated and
that the final contract price was “disputed.” The form also contained a notation that
the City had received some $2.8 million in claims from unpaid subcontractors
supplying labor and materials on the project.

       By letter dated June 15, 2001, Penn National requested that the City not release
any funds allocated to the project without Penn National’s written consent. The letter
stated that Penn National was investigating unpaid subcontractor claims and asserted
potential subrogation rights to contract funds. Despite the letter, however, the Pine
Bluff City Council approved a settlement and release with Mitchell a few days later,
paying Mitchell and Mitchell’s creditors approximately $2 million.3 Although the
record does not indicate whether this amount included FEMA monies the City
received prior to Penn National's June 15 letter, the City later received FEMA
payments totaling approximately $1.8 million. Dist. Ct. Order of Sept. 24, 2002 at
4.

n. 2; R.J. Bob Jones Excavating Contractor, Inc. v. Firemen's
Ins. Co., 

, 486 (Ark. 1996).
      3
        The City released $997,435.90 to Mitchell, $512,191.81 to Pine Bluff National
Bank, which had loaned money to Mitchell, and $465,752.03 to the Chancery Court
of Jefferson County to satisfy one of Mitchell’s judgment creditors.

                                         -5-
        Penn National brought suit against the City and others, originally seeking a
declaratory judgment and a bill quia timet.4 Various unpaid subcontractors also
intervened in the litigation or instituted separate suit against Penn National on the
payment bond. Penn National then investigated the various subcontractor claims as
litigation progressed.

        Penn National ultimately determined that two subcontractors, Rental Service
Corporation (Rental) and Cannon Contracting (Cannon), possessed valid bond claims.
Penn National settled with each, albeit in different ways. Rental originally alleged
claims totaling $204,492.24, but accepted an unconditional payment of $165,000.00
in full settlement. Cannon originally claimed an unpaid balance of $669,869.93, but
accepted an unconditional payment of $400,000.00 plus an escrowed $269,869.93,
the release of which is conditioned on Penn National’s success in this lawsuit.5 In
return, both Rental and Cannon expressly assigned their rights to Penn National.

       Penn National then sought to amend its complaint against the City to include
requests for declaratory and equitable relief, including equitable subrogation. After
consolidating related cases, the district court permitted amendment and
simultaneously considered the parties’ motions for summary judgment. In sum, the
district court rejected the City’s contention that it was immune from suit and
concluded that equitable subrogation did not furnish Penn National with actionable
rights against the City.

      4
        Literally meaning “because he fears,” quia timet is “[a] legal doctrine that
allows a person to seek equitable relief from a future probable harm to a specific right
or interest.” Blacks Law Dictionary 1260 (7th Ed. 1999).
      5
       If Penn National prevails, Cannon will receive the escrowed money in an
amount equaling whatever Penn National recovers beyond $400,000, up to the full
$269,869.93, plus half of any award greater than $669,869.93. If Penn National’s suit
is unsuccessful or does not recover more than $400,000, however, the escrowed
money will be returned to Penn National.

                                          -6-
                                         II.

       We review the district court’s summary judgment rulings de novo, Evergreen
Invs., LLC v. FCL Graphics, Inc., 

, 753 (8th Cir. 2003), and Arkansas
substantive law governs that inquiry. Erie R.R. Co. v. Tompkins, 

, 78
(1938); United Fire & Cas. Ins. Co. v. Garvey, 

, 413 (8th Cir. 2003).
Before reaching the merits, however, we must consider two threshold arguments.

       The City initially contends that Penn National never requested “damages” and
has therefore waived any request for monetary relief. We reject this argument
because a liberal reading of the amended complaint and a survey of the parties’
arguments before the district court reveals that Penn National was pursuing, inter
alia, recovery from municipal pockets. See Fed. R. Civ. P. 8(a); Conley v. Gibson,

, 47-48 (1957). Given that the City has consistently argued its immunity
from damages, it is difficult to understand how the City can now claim lack of notice
regarding Penn National’s request or prejudice arising therefrom.

       The City also mentions the election-of-remedies rule, asserting that Penn
National’s request for a declaration of priority to contract funds and to recover the
funds from others is necessarily repugnant to a recovery from City coffers. Once
again, we cannot fathom why. Designed to prevent double recovery for a single
injury, Smart v. Sunshine Potato Flakes, L.L.C. 

, 686 (8th Cir. 2002),
the election-of-remedies rule applies when a party possesses two appropriate but
inconsistent remedies and deliberately pursues one remedy to the other’s exclusion.
Van Curen v. Ark. Prof’l Bail Bondsman Licensing Bd., 

, 58 (Ark. App.
2002). The rule does not prohibit assertion of multiple causes of action, Sexton Law
Firm, P.A. v. Milligan, 

, 395 (Ark. 1997), nor does it preclude
pursuit of consistent remedies, even to final adjudication, so long as the plaintiff
receives but one satisfaction. Kapp v. Bob Sullivan Chevrolet Co., 

,
821 (Ark. 1960). Here, the City’s contention that Penn National elected only a

                                         -7-
declaratory remedy is misplaced because Penn National also requested equitable
subrogation and sought recovery of specified funds. Seeking a declaration of priority
to funds and pursuing judgment in an equal amount reflects no assertion of
inconsistent remedies. To establish that the City paid the wrong party and should be
liable, the court must first conclude that Penn National was entitled to priority
payment.

      We next consider the contours of equitable subrogation in suretyship.
Equitable subrogation is one of a surety’s principal mechanisms for reducing loss.
See Prairie State Bank v. United States, 

, 231 (1896) (recognizing
surety’s subrogation rights as “elementary.”). Arising by operation of law, the
doctrine permits the surety to acquire and assert the rights of those parties whom the
surety pays. Welch Foods, Inc. v. Chicago Title Ins. Co., 

, 470 (Ark.
2000).

       A prerequisite to equitable subrogation is the surety’s full satisfaction of any
underlying debt or obligation. American Sur. Co. of New York v. Westinghouse
Elec. Mfg. Co., 

, 137 (1935); St. Paul Fire & Marine Ins. Co. v. Murray
Guard, Inc., 

, 183 (Ark. 2001). The parties here dispute whether Penn
National’s settlement with Cannon satisfies this requirement because the settlement
involves a partially conditional payment. The district court thought the conditional
payment presented a “bootstrapping” problem and concluded that Penn National had
not fully satisfied Cannon’s claim, but we disagree.

       As noted by Justice Cardozo, full satisfaction is necessary because, “[i]f the
holding were different, the surety would reduce the protection of the bond to the
extent of its dividend in the assets of the debtor.” American Sur. 

.
Full satisfaction also prevents competition between the rights of the surety and the
original creditor to the original creditor’s detriment: “[U]ntil the creditor be wholly
satisfied, there ought to and can be no interference with his rights or his securities

                                          -8-
which might, even by bare possibility, prejudice or embarrass him in any way in the
collection of the residue of his claim.” Barton v. Matthews, 

, 694 (Ark.
1919) (internal quotation omitted); cf. Restatement (Third) of Suretyship and
Guaranty § 27 cmt. b.

       In this case, the debris-removal contract and associated bond created two
relevant obligations: removal of specified debris and payment for labor and materials.
The City unilaterally removed the former obligation, so Penn National was charged
with satisfying the latter under its payment bond – an event which has occurred.
Mitchell and the City owe nothing to Rental and Cannon by virtue of the
subcontractors’ settlement with Penn National. Despite Cannon’s derivative interest
in this lawsuit, Cannon does not possess any remaining claim for “residue” against
Mitchell or the City and there is no risk of competition between Penn National’s
rights and Cannon’s rights arising from the same undivided interest.

       As an intended beneficiary of the payment bond, Cannon was free to reject a
partially conditional payment and further litigate its rights under the bond. It instead
chose to avoid further litigation – and any potential defenses possessed by Penn
National – for a certain $400,000 plus the added risk of an uncertain interest in Penn
National’s lawsuit with the possible reward of monies beyond $669,869.93.6 This,
we think, was its contractual prerogative, and if Cannon was satisfied to accept it as
full payment, so are we. After settlement with Penn National, Cannon cannot (and
does not) “complain that . . . [Penn National’s] subrogation makes its position less



      6
       As indicated in footnote 

, the settlement provides that Cannon will
receive half of any recovered amount beyond $669,869.93. Our analysis might be
different if the subcontractor received no negotiated benefit beyond its initial claim,
in which case the surety would have merely placed its interest in reimbursement
ahead of the subcontractor’s right to payment – a situation contrary to the point of a
payment bond and suretyship generally.

                                          -9-
favorable than it would have been . . . .” Southern Cotton Oil Co. v. Napoleon Hill
Cotton Co., 

, 1084 (Ark. 1913).

       In Arkansas, as elsewhere, when a surety completes work or pays laborers and
material suppliers, equitable subrogation permits the surety to proceed against
retainage and remaining contract funds for reimbursement. Equilease Corp. v. United
States Fid. & Guar. Co., 

, 126 (Ark. 1978); Pearlman v. Reliance Ins.
Co., 

, 139 (1962) (“[T]he same equitable rules as to subrogation . . . exist
whether a surety completes a contract or whether, though not called upon to complete
the contract, it pays the laborers and materialmen.”). The surety’s right to these
monies is typically superior to the rights of the general contractor’s assignees or
estate in bankruptcy because the surety’s rights vest upon “full satisfaction for default
and relate back to the time the bond or contract of suretyship was entered into.”
Equilease 

(citation omitted); Restatement (Third) of
Suretyship and Guaranty § 31(b). Thus, if the City were still holding retainage or
contract funds, extant Arkansas law would provide for Penn National’s
reimbursement, and Penn National would be entitled to priority over Mitchell and
Mitchell’s creditors.

       The City promptly settled with and disbursed money to Mitchell, however, so
a finding that Penn National would have otherwise been entitled to withheld funds
through equitable subrogation is only part of the story. The district court aptly
observed that “[t]here is precious little Arkansas law which sheds light on what
happens when a government entity with notice from a surety that there may be
outstanding claims on the bond, ignores the notice and disburses the funds to the
[general] contractor and his creditor.” D. Ct. Order of Sept. 24, 2002, at 15. We
think this statement defines the issue well, and, absent controlling state authority, our
obligation is to predict how the Arkansas Supreme Court would rule on the issue. See
Smith v. Chemical Leaman Tank Lines, Inc., 

, 754 (8th Cir. 2002).



                                          -10-
       Penn National urges us to apply a series of federal decisions which support the
proposition that a bond obligee may not increase the surety’s risk or otherwise
undermine the surety’s subrogation rights. See e.g., Nat’l Sur. Corp. v. United States,

, 1544-46 (Fed. Cir. 1997); Transamerica Premier Ins. Co. v. United
States, 

, 313-14 (1994) (Transamerica); Home Indem. Co. v. United
States, 

, 892-93 (Ct. Cl. 1967). Although no Arkansas decision covers
these precise facts, we believe that the Arkansas Supreme Court would steer a course
consistent with federal decisions. See Seaboard Sur. Co. v. First Nat’l Bank & Trust
Co., 

, 291 (8th Cir. 1941) (predicting, in absence of state authority, that
South Dakota would follow federal cases regarding surety priority).

       In contracts for services that include payment in installments or upon
completion, unearned progress payments and retainage are security, or collateral,
ensuring discharge of the obligations created by the underlying contract. Restatement
(Third) of Suretyship and Guaranty § 31 cmt. a; 

.
Moreover, “[t]he surety bond embodies the principle that any material change in the
bonded contract, that increases the surety's risk or obligation without the surety's
consent, affects the surety relationship.” Nat’l Sur. 

; Hawkins
v. Mims, 

, 

, at *2 (1880) (“Of course, if the obligee
releases any of his securities, or enters into a new contract with the principal, varying
the terms of the original agreement . . . the non-assenting surety will be discharged,
for such acts increase the surety's risk.”). By settling with the general contractor and
releasing payments and retainage before they are due or not due at all, the obligee
increases the surety’s risk and impairs the surety’s ability to be made whole through
subrogation if the surety is later called upon to discharge the underlying obligation.
Restatement (Third) of Suretyship and Guaranty § 31 cmt. c; see also Kurrus v. Priest,

, 676 (Ark. 2000) (“[W]here collateral which has been pledged to
secure the repayment of bonds is removed, then the obligation of the contract between
the bondholder and the bond issuer has been impaired”); Myers v. First State Bank,



                                          -11-


, 461 (Ark. 1987) (Under Arkansas general suretyship law, a creditor
must preserve a surety's right of recourse in collateral.).

       These principles, considered with the equitable rights of laborers and material
suppliers (and therefore the subrogated surety) to payment from remaining funds,
have led federal courts to recognize the obligee’s duty as a “stakeholder” to ensure
proper application of collateral (contract funds and retainages) upon appropriate
notice of the general contractor’s default. See 

; Int’l
Fid. Ins. Co. v. United States, 

, 477 (1992); Home Indem. 

. Indeed, “the entire doctrine of subrogation in suretyship is dependent
upon the immediate investment of the creditor with the obligations of a trustee
whenever any rights or interests of the debtor, applicable to the debt, are placed in his
control . . . .” Arthur Adelbert Stearns, The Law of Suretyship §6.46 (James L. Elder,
ed., 5th Ed. 1951). If, after appropriate notice of default, the government chooses to
pay funds to the general contractor that are or become equitably owed to the surety,
the government is liable for the actual loss visited upon the surety. Nat’l Sur. 

; 

; Restatement (Third) of
Suretyship and Guaranty § 31 cmt. c.

        Here, faced with conflicting claims by the general contractor, the unpaid
subcontractors, and the surety, the City decided to pay Mitchell despite premature
termination of the contract, knowledge of Mitchell’s default, and notice from the
surety to preserve remaining security. The City incorrectly chose Mitchell over the
superior equitable claims of the unpaid subcontractors whose work earned the
contract funds in the first place. Because Penn National was independently obligated
to satisfy subcontractor claims under the payment bond, see R.J. Bob Jones
Excavating Contractor, Inc. v. Firemen's Ins. Co., 

, 486 (Ark. 1996),
the City’s decision to settle with Mitchell increased Penn National’s risk and impaired
its right to reimbursement from remaining security. The City is accordingly liable for



                                          -12-
Penn National’s actual loss. Nat’l Sur. 

; Restatement (Third)
of Suretyship and Guaranty § 37(4).

       Having concluded that the City must reimburse Penn National, we address the
City’s cross-appeal, in which the City asserts that it is immune from liability because
Penn National’s suit is one sounding in tort. In Arkansas, municipal corporations are
subject to suit in contract, Bankston v. Pulaski County Sch. Dist., 

,
862 (Ark. 1984), and for intentional torts, Battle v. Harris, 

, 433 (Ark.
1989), but not for negligence unless the City carries liability insurance covering the
particular negligent act. See Ark. Code. Ann. §21-9-301 (Michie 1996) (stating
municipalities are “immune from liability and from suit for damages . . . .”); Caddo
Valley v. George, 

, 484 (Ark. 2000) (“[A] municipal corporation's
immunity for negligent acts only begins where its insurance coverage leaves off.”).
There is no evidence here that the City carries liability insurance covering Penn
National’s suit, and the City focuses on Penn National’s assertion that the City
breached its duty as a stakeholder by making a “wrongful” payment to Mitchell. The
City contends that this language and the deposition testimony of Penn National’s
designated corporate representative make clear that Penn National’s claim is really
a negligence claim, from which the City is immune. We disagree.

       Although Penn National does claim that the City breached a duty, the duty is
more appropriately viewed as one arising from contract and equity. Bonds are
contracts, and suretyship status is created through a triparite agreement “whereby one
party (the surety) becomes liable for the principal’s or obligor’s debt or duty to the
third party obligee.” Balboa Ins. Co. v. United States, 

, 1160 (Fed. Cir.
1985). Thus, when the surety performs the underlying obligation by completing work
or paying subcontractors, the surety fulfills not only its contractual obligation under
the bond but also the general contractor’s contractual duties to the obligee and to
subcontractors. Likewise, the right of subcontractors and the subrogated surety to
be paid from funds held by the obligee arises in equity. Sureties bond projects with

                                         -13-
these rights in mind and with the legitimate expectation that the security ensuring
discharge of the underlying obligation will be properly applied. The obligee’s
ultimate failure to properly apply that security is thus not a tort. Cf. 

(finding that a school district was not immune from a suit for breach
of implied warranty involving defects in the sewer system of a home built by students
as a vocational project). “Clearly, a private party would be liable for causing contract
funds to be paid over to one not entitled to them. There is no reason to excuse the
[City] from such conduct here.” 

.

       The judgment is reversed, and the case is remanded to the district court with
directions to enter a judgment in favor of Penn National consistent with the views set
forth in this opinion.

RILEY, Circuit Judge, concurring.

        Although I agree with the court’s decision, I concur to express two concerns:
first, our imposition of federal equitable subrogation principles which may not
comport with how Arkansas courts would necessarily decide this case; and second,
our reversal of a respected Arkansas federal judge, who is more familiar with
Arkansas legal practices than we are. Nevertheless, I am convinced we reach a just
result.

       Given the lack of Arkansas precedent addressing the application of equitable
subrogation against a stakeholder in the City’s position, it is reasonable for this court
to anticipate Arkansas courts would utilize analogous precedent from the United
States Court of Federal Claims.7 We can take comfort in the Arkansas Supreme

      7
       See, e.g., Transamerica Premier Ins. Co. v. United States, 

,
313-14 (1994); Newark Ins. Co. v. United States, 

, 957 (Ct. Cl.
1959) (“Surely a stakeholder, caught in the middle between two competing claimants,
cannot, in effect, decide the merits of their claims by the mere physical act of

                                          -14-
Court’s repeated assurances that equity and justice are at the heart of equitable
subrogation. See, e.g., St. Paul Fire & Marine Ins. Co. v. Murray Guard, Inc., 

, 183 (Ark. 2001) (“The [equitable subrogation] doctrine is deeply rooted
and flexible and extends as far as needed to do justice. The doctrine has as its basis
the doing of complete and perfect justice between the parties without regard to form.
. . . Equitable subrogation is given a liberal application and is broad enough to
include every instance in which one person, not acting voluntarily, has paid a debt for
which another was primarily liable and which that other party should have paid.”)
(citations omitted); Fed. Land Bank of St. Louis v. Richland Farming Co., 

, 955 (Ark. 1929) (“[A]s the doctrine of subrogation was evolved by courts of
equity for the prevention of injustice, it is administered not as a legal right, but the
principle is applied to subserve the ends of justice and to do equity in the particular
case before the court. Therefore no rule can be laid down for its universal
application, and whether it is applicable or not depends upon the particular facts and
circumstances of each case as it arises.”); see also Welch Foods, Inc. v. Chicago Title
Ins. Co., 

, 470 (Ark. 2000) (Smith, J. Lavenski R.) (“Subrogation is a
doctrine steeped in equity and generally governed by equitable principles.”).

       The equities in this case clearly favor Penn National, not the City or Mitchell.
The City, as stakeholder of the disputed funds, should have retained those funds for
the protection of the unpaid subcontractors and the vulnerable surety. I am confident
our decision is not an affront to Arkansas law. Rather, our decision is a good-faith
endeavor to reach the just result Arkansas courts would have reached if faced with the
same equities.
                        ______________________________


delivering the stake to one of them. . . . If it is made to appear that the Government’s
officials, after due notice of the facts giving rise to an equitable right in the plaintiff
surety company, and of the plaintiff’s assertion of such a right, paid out, without a
valid reason for so doing, the money in question to someone other than the plaintiff,
the plaintiff will be entitled to a judgment.”).

                                           -15-