Summary
holding that without a provision in the controlling documents requiring the contractor to create and hold funds in a separate dedicated trust fund for the specific benefit of third persons, no constructive trust is created
Summary of this case from Trs. of the Iron Workers' Local No. 25 Pension Fund v. Mun. & Indus. Storage, Inc.Opinion
Case No. 01-60194
May 2, 2003
OPINION AND ORDER OF THE COURT DENYING PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT
I. INTRODUCTION
Before the Court is Plaintiff Merchants Bonding Co.'s Motion for Summary Judgment on its complaint against Defendants United States Internal Revenue Service ("IRS"), West Bloomfield School District("WB") and Utica Community Schools. Plaintiff and the IRS both assert claims to the outstanding balances of two construction contracts ("contract balances" or "funds") between Smelser Roofing Co. ("Smelser"), a contractor, and Defendant school districts. Plaintiff claims that it is entitled to the funds since it made payments to various subcontractors and suppliers pursuant to the terms of its surety agreement with Smelser, while the IRS asserts the priority of its federal tax lien on Smelser's property.
As preliminary matter, Defendant WB has been dismissed as a party to this lawsuit, and has interpleaded into Court the amount due on its contract with Smelser, or $91,947.56, pursuant to Fed.R.Civ.P. 67, for disbursal to the proper party when this matter is resolved. Defendant Utica has filed an answer and partial concurrence in Plaintiff's motion for summary judgment, except to the extent to which Plaintiff's motion seeks interests, costs, expenses and attorneys fees against Utica. Utica still has in its possession the amount due on its contract with Smelser.
In its Motion for Summary Judgment, Plaintiff first argues that the contract balances are not Smelser's "property" subject to federal tax liens, since they have been held in trust for the benefit of the subcontractors and suppliers who performed work on the construction contracts. In connection with that argument, Plaintiff also asserts that its rights have been equitably subrogated to the rights of these subcontractors and suppliers, and therefore, that it can assert any claim to the trust corpus that they may have had. Second, Plaintiff argues that it received a superior interest in the funds pursuant to the Indemnity Agreement it entered into with Smelser, and that this interest became effective prior to the IRS' tax lien. Finally, Plaintiff asserts that 26 U.S.C. § 6323(c) grants Plaintiff a lien superior to several of the liens held by the IRS.
In response, Defendant IRS argues that the Sixth Circuit's opinion in in re Constr. Alternatives. Inc., 2 F.3d 670 (6th Cir. 1993) controls the Court's analysis here. In reliance upon this case, the IRS maintains that the contract balances are "property" subject to the tax lien, since Smelser completed the construction projects, and earned the right to final payment from Defendant school districts. Second, Defendant argues that no trust was created for the benefit of unpaid claimants because the Indemnity Agreement and Payment Bonds do not reflect the parties' intent to reserve a specific portion of the funds in trust for the benefit of any ascertained beneficiaries, Third, Defendant contends that Plaintiff's rights were not subrogated to the rights of the subcontractors and suppliers because at the time the IRS filed its tax liens, the amounts owed to those suppliers and subcontractors had not been determined to any meaningful degree of certainty. Fourth, Defendant contests Plaintiff's assertion that it had a "security interest" in the funds, but argues, that even if it did, it did not "perfect" that interest by filing a financing statement with the Michigan Secretary of State. Therefore, because the IRS did "perfect" its lien by filing notices of tax liens, its interest takes priority over that of Plaintiff. For these same reasons, Defendant maintains that Plaintiff's argument under § 6323(c) also fails.
II. STANDARD OF REVIEW
F.R.C.P. 56 states that summary judgment "shall be rendered forthwith if the pleadings, [etc.,] show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed.R.Civ.P. 56. There is no genuine issue of material fact if there is no factual dispute that could affect the legal outcome on the issue. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248-49 (1986). In other words, the movant must show that it would prevail on the issue even if all factual disputes are conceded to the non-movant. Additionally, for the purposes of deciding on a motion for summary judgment, a court must draw all inferences from those facts in the light most favorable to the non-movant. Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986).
Accordingly, in the instant case, the Court evaluates this motion with the rule that it should defer to Defendant's factual account whenever that account clashes with Plaintiff's. The Court should keep in mind, however, that Defendant "may not rest upon the mere allegations or denials of [its] pleading, but . . . must set forth specific facts showing that there is a genuine issue for trial" Anderson, 477 U.S. at 248 (internal quotations and citation omitted). In other words, Defendant still has the burden of presenting facts that support its claims. As long as Defendant has presented such facts, however, it will get the benefit of the doubt in any factual disputes with Plaintiff.
III. STATEMENT OF FACTS
The record reflects that in November and December of 2000, Smelser entered into contracts with WB and Utica school districts to re-roof several of their elementary and high schools. In accordance with state law, Smelser provided performance and payment bonds to the school districts, which it obtained from Plaintiff on September 1, 1998.
As partial consideration for the issuance of the bonds, Plaintiff and Smelser entered into an Indemnity Agreement, which assigned to Plaintiff the right to receive the contract balance on "any bonded contract" if it had to pay claimants under the bond. This clause, which was triggered "as of the date of the execution of any bond," applied to the school project contracts.
On September 1, 1998, the date of the Indemnity Agreement, Plaintiff issued a Fringe Benefit Bond in favor of various Roofers Local # 149 in the penal sum of $25,000. Payment and performance bonds were thereafter issued on November 27, 2000 and December 11, 2000, for the WB projects, and on December 12 and 13, 2000, for the Utica projects. Each of these payment bonds stated that amounts owed by the "owner" (here, WB and Utica) to the contractor (Smelser) would be used to for the performance of the construction contract and to satisfy any claims under the bond agreement between Plaintiff and Smelser.
Meanwhile, pursuant to tax assessments made against Smelser for unpaid taxes, the IRS filed notices of tax lien against Smelser on August 30, 2000, January 2, 2001, May 21, 2001 and June 27, 2001, totaling $741,908.14. On June 20, 2001, the IRS filed issued a Notice of Levy to Utica in the amount of $829,232.23. Utica paid $274,814.00 of that amount to the IRS on July 23, 2001. On July 24, 2001, the IRS issued a second Notice of Levy to Utica in the amount of $777,840.98. On November 21, 2001, the IRS issued WB a Notice of Levy in the amount of $531,282.80.
According to Plaintiff, after the initial tax levy and payment by Utica Schools, Smelser did not have the income to pay its bills on the involved projects. Therefore, Plaintiff received several claims from subcontractors and suppliers on the fringe benefit bond, which it paid, as well as several claims on the Utica and West Bloomfield bonds, which it also paid. In total, Plaintiff asserts that it incurred losses, costs, and other expenses in the amount of $489.698.60.
All parties agree that Smelser completed its work on the schools, entitling it to final payment by Utica and WB. The actual date of completion, however, cannot be found in the record. The balance due on the WB contract is $91,947.56, and the amount outstanding on the Utica contract is approximately $213,803.61.
IV. ISSUES AND DISCUSSION
The issue before the Court is whether Plaintiff is entitled, as a matter of law, to the contract balances owed to Smelser by WB and Utica. In its Motion for Summary Judgment, Plaintiff asserts three separate grounds for its claim to the funds, and each will be discussed accordingly.
1. Equitable Subrogation and the Trust Theory
Plaintiff begins its argument by claiming its status as an equitable subrogee. Equitable subrogation is a "legal fiction through which a person who pays a debt for which another is primarily responsible is substituted or subrogated to all the rights and remedies of the other."Commercial Union Ins, Co. v. Med. Protective Co., 426 Mich. 109, 117 (1986). Merchants, having paid the claim of its principal, asserts that it is subrogated to the rights of the principal, the claimant receiving the payment, and the owner's right to withhold contract balances. The Court agrees that Plaintiff is, by a fiction of law, subrogated to whatever rights the claimant, principal, or owner may have in the contract balances, Pearlman v. Reliance Ins. Co., 371 U.S. 132 (1962).
Plaintiff seeks here to enforce its claim to the contract balances owed by WB and Utica as the subrogee of the Claimants. Those funds, according to Plaintiff, were the trust corpus held for the benefit of the unpaid subcontractors and suppliers — the Claimants. As trust fund money, Smelser did not have a property interest in it. Therefore, the IRS could not attach its lien.
In response, Defendant IRS asserts two grounds for its argument that Smelser had a property interest in the funds. First, the IRS argues that, according to Construction Alternatives, once a contractor completes work on a construction contract, as Smelser did here, it earns the right to receive payment. It is that right to receive payment that constitutes a property interest to which a tax lien may legally attach. Constr. Alternatives, 2 F.3d at 674-65. Second, the IRS asserts that the contract balances are not a separate trust fund, because the parties did not create such a trust for the benefit of any subcontractors or suppliers. In light of this, then, the IRS maintains that Plaintiff was not a subrogee of the rights of the so-called "trustees." Finally, the IRS argues that, in any event, a state law subrogation claim does not become perfected until the amounts owed to the claimants are determined with certainty. Here, the amounts owed to the claimants were uncertain at the time the IRS filed its federal tax liens, and, so, the claims were not perfected.
In determining whether or not Smelser had an interest in the funds, the Court's analysis is twofold. Setting aside Plaintiff's "trust" argument for the moment, the Court must first decide whether Smelser acquired an interest in the funds when it completed its work on the WB and Utica projects. The Court finds that it did. Construction Alternatives holds that once a contractor completes work on a construction contract, its "right to receive its final progress payment . . ." is deemed "property" under § 6321, and can be subject to a federal tax lien. Id. Here then, since the parties agree that Smelser completed its work on the WB and Utica construction projects, its right to receive final payment from the school districts is property that can be subject to the IRS tax lien.
This does not end the Court's inquiry, however, for it must now decide whether the contract balances were held in trust for the benefit of unpaid subcontractors and suppliers, leaving Smelser with no property interest in the funds. To prove that the funds at issue here were held in trust, Plaintiff must show either that: "1) [state] law provides that a portion of the progress payments were subject to a constructive trust for the benefit of unpaid suppliers and subcontractors; or, 2) the suretyship agreement created an express trust with the Fund as the trust corpus." Constr. Alternatives, 2 F.3d at 677.
Construction Alternatives involved the application of Ohio law, which Plaintiff claims renders it inapplicable to the facts at hand. The Court disagrees with Plaintiff, and finds that the Sixth Circuit's analysis in Construction Alternatives is applicable so long as appropriate allowances are made for Michigan law.
First, when a public construction contract is involved, as is the case here, Michigan law does not provide that a portion of an owner's payments are to be held in trust for the benefit of unpaid suppliers and subcontractors. The Michigan Building Contract Fund Act, Mich. Comp. L. 570.151 et. seq., ("MBCFA"), cited by Plaintiff, applies only to private construction contracts, and provides that, when such contracts are involved, balances paid to a contractor are to be held in trust for the benefit of subcontractors and suppliers. See In re Certified Question from U.S. Dist. Court for Eastern Dist. of Michigan, 311 N.W.2d 731, 733 (Mich. 1981) (holding "the [MBCFA] applies only to private construction contracts.") Here, however, the contracts were public, not private; therefore, the MBCFA does not apply.
Since the MBFCA does not apply to create a constructive trust, the Court must look to the agreements. Plaintiff argues that Smelser, WB and Utica created a trust, with the contract balances serving as the trust corpus. To determine whether a trust was created, the Court looks to state law. Constr. Alternatives, 2 F.3d at 675. In Michigan, "it is a general principle of trust law that a trust is created only if the settlor manifests an intention to create a trust, and it is essential that there be an explicit declaration of trust accompanied by a transfer of property to one for the benefit of another." Osius v. Dingell, 134 N.W.2d 657, 660 (Mich. 1965). Further, "[t]o create a trust, there must be an assignment of designated property to a trustee with the intention of passing title thereto, to hold for the benefit of others. There must be a separation of the legal estate from the beneficial enjoyments . . ." In re Americana Found., 387 N.W.2d 586, 588 (Mich.App. 1985) (quotation omitted).
Here, Plaintiff argues that the language of the payment bonds issued for the WB and Utica projects created an express trust for the benefit of subcontractors and suppliers. Specifically, Plaintiff notes that paragraph 8 of the payment bonds states as follows:
[a]mounts owed by the owners to the contractor under the construction contract shall be used for the performance of the construction contract and to satisfy claims, in any, under any construction performance bond. By the contractor furnishing and the owner accepting this bond, "they agree that all funds earned by the contractor in the performance of the construction contract are dedicated to satisfy obligations of the contractor and the surety under this bond . . ." (emphasis added)
Clearly, the bond at issue here identified Smelser's payment obligations with respect to the monies received from WB and Utica under the construction contracts. However, this language, by itself, does not establish that Smelser, WB and Utica created a trust in favor of the subcontractors and suppliers. Rather, as discussed above, to establish that a trust existed, Plaintiff must show that the parties involved intended to create a trust, and that they designated certain funds as trust property. Osius, 134 N.W.2d at 660; In re Americana Found., 387 N.W.2d at 588. The Court finds that this is not established here,
To begin, it is arguable that the use of the word "dedicated" in the payment bond signifies an intention or declaration on the part of Smelser, WB and Utica to create a trust for the benefit of the subcontractors and suppliers. Nevertheless, regardless of whether this language manifested such intent, Plaintiff's argument fails because none of the parties involved delivered any funds into trust in accordance with Michigan law. That is, the facts do not establish that the parties involved intended to set aside a certain portion of the funds "in trust" for the subcontractors or suppliers, and, in fact, at no time did Smelser create a separate trust account for the contract balances. The mere fact that Smelser earned the right to receive payment for the school projects by completing its construction work does not, by itself, make the money owed by WB and Utica trust property.
The Court's analysis is guided, in part, by Construction Alternatives, where the Sixth Circuit held that the language of an Indemnity Agreement between a surety and a contractor did not create a trust under Ohio Law. There, the Indemnity Agreement stated that "all monies due . . . are trust funds, for the benefit of and for payment of all such obligations in connection with any such contract . . . for which the Surety would be liable under any of the . . . bonds . . ." Constr. Alternatives, 2 F.3d at 676, n. 4. The Ohio law applied by the Sixth Circuit was very similar to Michigan law, and provided that "the manifested intention" of the parties governed whether or not the parties had created a trust.
In deciding whether a trust had been created in Construction Alternatives, the Sixth Circuit examined whether the parties intended that the money be kept or used as a separate fund for the benefit of third persons. Id. at 677 (quoting Guardian Trust Co. v. Kirby, 50 Ohio App. 539 (1935)). Ultimately, the Court concluded that despite the actual "trust" language contained in the Indemnity Agreement, no trust was created, because "no provision of [the indemnity agreement] required [the contractor] to keep any portion of the progress payments as a separate trust fund, and the record does not indicate that [the contractor] kept the progress payments in a separate account." Id. at 677. Similarly, here, because the language of the payment bond did not require Semlser to set aside a portion of the payments in a separate trust fund, no trust was created.
In light of this, Plaintiff's subrogation claim to a trust fund fails. This does not mean, however, that Plaintiff is not an equitable subrogee, for, as noted above, in paying Smelser's claims, Plaintiff became subrogated to whatever rights those claimants had in the contract balances, Pearlman v. Reliance Ins. Co., 371 U.S. 132 (1962). Consequently, as an equitable subrogee, Plaintiff must establish that its right to the funds takes priority over the IRS's tax lien.
Federal liens do not "automatically have priority over all other liens." Constr. Alternatives, 2 F.3d at 676 (quotations omitted). Rather, they are subject to the "first in time, first in right" rule.Id. For purposes of this rule, a federal tax lien is perfected at the time the notice of the lien is filed, Constr. Alternatives, 2 F.3d at 676 (citations omitted), while a state lien is perfected only "when the identity of the lienor, the property subject to the lien, and the amount of the lien are established." United States v. Dishman Indep. Oil Co., 46 F.3d 523, 526 (6th Cir. 1995) (quoting United States v. McDermott, 507 U.S. 447, 449 (1993)). In the context of equitable subrogation, the Sixth Circuit held in Construction Alternatives that a surety's alleged equitable lien did not have priority because "[t]he amounts owed to the unpaid persons on the project were not yet certain" at the time the tax liens were filed. Constr. Alternatives, 2 F.3d at 676.
Here, the IRS filed its notices of tax lien on August 30, 2000, January 2, 2001, May 21, 2001 and June 27, 2001. Plaintiff, however, has not established that its alleged equitable lien was perfected as of those dates, because it has not shown that the amounts owed to the unpaid subcontractors and suppliers were certain at that time. In fact, the record does not contain any evidence as to the dates and amounts of Plaintiff's payments, or to whom those payments were made. As such, the Court finds that as an equitable subrogee, Plaintiff has not established the priority of its lien, because there is a genuine issue of material fact with respect to the payments Plaintiff made under its bond agreement with Smelser.
2. Indemnity Agreement Theory
Plaintiff next argues that the Indemnity Agreement it entered into with Smelser gave it a superior interest in the contract balances. In particular, Plaintiff points to the language of the Agreement in which Smelser agreed to assign and transfer its rights in the monies owed by WB and Utica to Plaintiff as "collateral security" for performance of the bond contract. According to Plaintiff, that assignment became effective as of the date of execution of any bond, or September 1, 1998. And, since this preceded the dates upon which the IRS filed its notice of tax lien, Plaintiff contends that it's interest takes priority over the IRS lien.
In making this argument, Plaintiff acknowledges that, in most circumstances, parties are required by Article 9 of Michigan's Uniform Commercial Code to perfect their interests by filing financing statements with the Michigan Secretary of State. However, in reliance upon In Re V. Pangori Sons, Inc., 53 B.R. 711, 717 (Bankr. E.D. Mich. 1985), Plaintiff asserts that, in Michigan, Article 9 does not apply to indemnity agreements. In particular, Plaintiff relies on the language in Pangori that states that a surety may assert "its rights deriving from the agreement of indemnity because even though it did not take the steps necessary to perfect an Article 9 security interest, it did not need to do so." Id. This is so because "the assignment does not create a security interest" in the contract balances. Id. Therefore, Plaintiff maintains that it did not have to perfect its interest with the Secretary of State.
In response, the IRS counters that Plaintiff's claim to the funds is not superior to the IRS lien because Plaintiff was, in fact, required to perfect its interest by filing with the Secretary of State. In so arguing, Defendant asserts that Pangori, a 1985 bankruptcy case, was called into doubt by the Sixth Circuit's 1993 holding in Construction Alternatives, where an Ohio U.C.C. provision, identical to the Michigan statute relied upon by the Pangori court, was interpreted to require a bond company to perfect its interest by filing a financing statement with the Secretary of State. The IRS now asks this Court to extend the Sixth Circuit's holding to Michigan, and hold that, here, Plaintiff was required to file its Indemnity Agreement with the Secretary of State.
Defendant's argument is quite compelling. For, as Defendant points out, the relevant portion of the Michigan statute at issue in Pangori is precisely the same as the Ohio statute analyzed in Construction Alternatives. Both provisions provide that the UCC does not apply to "a transfer of a right to payment under a contract to an assignee who is also to do the performance under the contract. . . ." Ohio Rev. Code Ann. § 1309.04; Mich. Comp. Laws § 19.9104. Thus, one could reasonably argue, as the IRS does here, that the Sixth Circuit's interpretation and application of the Ohio statute should carry over to Michigan to require Plaintiff to file its Indemnity Agreement with the Secretary of State.
The Court, however, declines to apply the holding in Construction Alternatives to Michigan. The Sixth Circuit did not have the opportunity to consider the issues raised in Pangori, even though it may have been applying similar law. It simply held in one cursory sentence that a financing statement would have to be filed. Pangori, on the other hand, contained a more detailed analysis of Article 9 and its relationship to indemnity agreements. See Pangori, 53 B.R. at 717. Therefore, the Court will not disturb the Pangori decision, and what may have been the Michigan practice since 1985, unless it is clearly required to do so.
The Court's analysis does not end here, because it is still necessary to determine when Plaintiff's interest in the funds became effective. According to Plaintiff, the express language of the Indemnity Agreement provided that Smelser's assignment of the contract balances became immediately effective as of the date of any bond, or September 1, 1998, when the Fringe Benefit Bond was executed. In making this argument, Plaintiff relies on two Michigan cases, Pangori, discussed above, andEarly Dubey Sons v. Macomb Contracting, 97 Mich. App. 553 (1980). According to Plaintiff, the indemnity agreements at issue in those cases granted the plaintiffs assignment rights in construction funds. Unlike the Indemnity Agreement at issue here, however, those agreements provided that the operative date upon which the plaintiffs' assignment rights became effective was the date of the contractor's default. Here, according to Plaintiff, the Indemnity Agreement provided a different operative date, namely the date of the execution of any bond. Therefore, Plaintiff concludes that because the IRS did not have a lien on Smelser's property as of September 1, 1998, when the Fringe Benefit Bond was executed, the IRS does not have a superior claim to the funds.
The Court duly notes Plaintiff's argument, but finds that neitherPangori nor Dubey stand for the proposition advanced by Plaintiff that the language of the Indemnity Agreement governs the date upon which a surety's assignment rights become effective. First, in Pangori, the indemnity agreement contained language similar to the Indemnity Agreement here: in particular, it stated that the assignment was to "be effective as of the date of [a] bond or bonds . . ." Id. at 716. However, unlike the Indemnity Agreement in this case, the Pangori agreement contained additional language indicating that the surety's assignment rights did not become effective until "the event of default . . ." Id. Ultimately, the surety's claim was held to be inferior to the judgment lien creditor's competing claim, and the court did hold, as Plaintiff asserts, that the relevant date for analyzing the priority of the surety's claim was the date of the contractor's default.
Contrary to Plaintiff's assertion, however, the Pangori court did not seem to rest its decision on the language contained in the indemnity agreement. Rather, the court looked to Michigan law, which essentially dictated that a surety's claim did not become effective until the surety became obligated to pay under its bond agreement with the contractor. Specifically, the Pangori court held that:
Michigan law holds that a lien of a judicial lien creditor which attaches before a surety becomes obligated to perform under its bond is prior in right to the surety's claim. Thus, the rights of subrogation and indemnification are not permitted to relate back to the date of the initial suretyship agreement when a judicial lien intervenes. Accordingly, because [the surety's] claim to the proceeds by virtue of its contractual indemnity agreement is inferior to the rights of the [bankruptcy] trustee, it may thus be avoided.
Pangori, 53 B.R. at 721.
Similarly, in Dubey, the Michigan Court of Appeals found that the operative date upon which the surety's assignment rights became effective was the date of the contractor's default. Unlike Pangori, however, the Dubey court relied more heavily upon the language of the indemnity agreement, which also provided that the surety's assignment rights would "be effective as of the date of any such bond, but only in the event of a default . . ." Specifically, the Dubey court noted that "it is . . . clear from the contractual language that default, requiring completion of the project at [the surety's] expense, triggers [the surety's] right to claim, by assignment, [the contractor's] rights to the [construction] funds . . ." Dubey, 97 Mich. App. at 558. Thus, according to Dubey, the surety's assignment rights were triggered as of the date of the contractor's default, and those rights related back to the date of execution of any payment and performance bonds. Id. at 559.
A careful review of the Dubey opinion reveals that, when rendering its decision, the Michigan Court of Appeals did not rely entirely on the language of the indemnity agreement, but rather, paid considerable attention to the same Michigan law that governed the court in thePangori decision. In particular, the court noted that:
[a] number of cases . . . impel the conclusion that [defendant surety], as performance bond surety, had no contractual rights to the funds . . . because as of the date of plaintiff's writ of garnishment, [the surety] was not obligated to perform under its surety contract. [I]f in fact, [the surety] had become so obligated, then either under the terms of its indemnification agreement with [the contractor] or under equitable subrogation principles its rights would be superior to plaintiffs'.
Of particular importance to the Michigan Court of Appeals was the overarching principle that "[i]n order for a surety to prevail over competing creditors it is necessary that the contractor be in default as a matter of fact, and that the surety be obligated under its bond to perform . . ." Id. at 559-60.
Therefore, what appears to have guided the courts in Dubey and Pangori was not the language contained in the indemnity agreements itself, but rather, the well-founded principle that a surety's assignment rights are triggered upon the contractor's default. In fact, this is quite understandable given that a surety does not need to enforce its assignment rights unless and until it is obligated to perform under its agreement with the contractor; i.e., when the contractor defaults on its own payment responsibilities.
Here, the Indemnity Agreement stated that Smelser assigned the right to the contract balances to Plaintiff "as of the date of execution of any Bond . . ." The Court disagrees with Plaintiff's assertion that, for purposes of assessing priority, its claim to those funds became effective as of September 1, 1998, or the date it issued the Fringe Benefit Bond. Rather, in light of the rule of law stated in both Dubey and Pangori, Plaintiff's assignment rights were triggered when it became obligated to perform under its surety agreement. This is so despite the fact that the Indemnity Agreement did not contain any specific "default" language. For, the Court notes while not explicitly stated, it was implicit in the Indemnity Agreement that Smelser's assignment of the contract balances would occur only when Smelser defaulted. Therefore, the Court finds that Plaintiff's claim to the funds was not effective as of the date Plaintiff executed the Fringe Benefit Bond, but rather, as of date of Smelser's default. Since the facts are unclear as to when this occurred, the Court finds that Summary Judgment in Plaintiff's favor is inappropriate at this time.
3. Statutory Theory
Lastly, Plaintiff argues that in the event that the Court finds that Plaintiff is not entitled to all of the funds at issue here, it should still receive a portion of the contract balances pursuant to 26 U.S.C. § 6323(c). This provision provides, in pertinent part, as follows:
(1) In General. To the extent provided in this subsection, even though notice of a lien imposed by § 6321 has been filed, such lien shall not be valid with respect to a security interest which came into existence after tax lien filing but which —
(A) Is in qualified property covered by the terms of a written agreement entered into before tax lien filing and constituting —
. . .
(iii) an Obligatory Disbursement Agreement, and
(B) is protected under local law against a judgment lien arising, as of the time of tax lien filing, out of an unsecured obligation.
According to Plaintiff, the fringe benefit bond issued on September 1, 1998, and subsequent payment bonds issued in November and December, 2000, qualified as security interests within the meaning of the statute in that they were "obligatory disbursement agreements." Furthermore, with respect to 26 U.S.C. § 6323(c)(1)(B), Plaintiff argues that "a surety's right of equitable subrogation defeats a judgment lien, and therefore satisfies the second prong of the . . . statute." Thus, according to Plaintiff, it should be reimbursed, at the very least, for the amounts it paid on those bonds, or approximately $177,000.
In response, Defendant argues that Plaintiff did not have a "security interest" within the meaning of the statute, and therefore, cannot assert priority based on § 6323(c). In particular, Defendant argues that the contract between Plaintiff and Smelser was not an "obligatory disbursement agreement," and more importantly, that Plaintiff's interest was not protected under local law, since Plaintiff did not file its Indemnity Agreement with the Secretary of State.
First, an "obligatory disbursement agreement" is "an agreement (entered into by a person in the course of his trade or business) to make disbursements, but such an agreement shall be treated as coming within the term only to the extent of disbursements which are required to be made by reason of the intervention of the rights of a person other than the taxpayer." 26 U.S.C. § 6323(c)(4)(A). According to Amwest Sur. Ins. Co. v. United States, 870 F. Supp. 432, 434 (D. Conn. 1994), a surety bond constitutes an obligatory disbursement agreement within the meaning of the statute. Therefore, the Court agrees with Plaintiff that the bonds issued for the construction contracts are covered by the first prong of § 6323(c).
With respect to the second prong, the Court finds that Plaintiff has failed to establish that its security interest was "protected under local law" as required by § 6323(c)(1)(B). However, in so holding, the Court does not endorse Defendant's assertion that, in order to protect its interest under local law, Plaintiff was required to file its Indemnity Agreement with the Secretary of State. For the reasons discussed above, Plaintiff was not subject to the filing requirements of Article 9, Pangori, 53 B.R. at 717.
Plaintiff argues that it's interest was "protected under local law" because it became equitably subrogated to the rights of potential unpaid claimants on the dates it issued the bonds for the school projects. In so arguing, Plaintiff relies on Amwest, which provides that "[i]f the conditions of [§ 6323(c)] are met, a surety's interest in contract proceeds pursuant to a bond executed before a tax lien is filed, will prevail over the lien even if the surety payments are made after liens are filed." Amwest, 870 F. Supp. at 434 (citations omitted). Accordingly, Plaintiff argues that regardless of when it was actually called upon to make surety payments on its bonds, its claim to the funds is superior to Defendant's because it executed some of those bonds prior to the IRS liens.
The Court agrees with Plaintiff that in Amwest the court held that the surety's interest accrued on the date it executed the bond, not the date upon which it paid the contractor's outstanding debts to the unpaid subcontractors and suppliers. With that said, however, the Court notes that the Amwest decision is based on Connecticut, not Michigan, law, and therefore, does not control this Court's analysis.
Notably, in Amwest, the court's decision was based on Connecticut's endorsement of the relation back doctrine, which dictates that a surety's equitable subrogation rights relate back to the date of the bond.Amwest, 870 F. Supp. at 435, Michigan, however, has not adopted the relation back doctrine as it relates to a surety's equitable subrogation rights. Rather, in Michigan, "the right to subrogation accrues upon payment of the debt." Dubey, 296 N.W.2d at 585. Therefore, "[i]n order for the surety to prevail over competing creditors it is necessary that the contractor be in default as a matter of fact, and that the surety be obligated under its bond to perform . . ." Id.
After the court issued its ruling in Amwest, the United States moved for reconsideration, 1995 WL 452992, No. Civ. 3:92CV221 (D.Conn. May 10, 1995), arguing that the court improperly relied upon several cases that had been repudiated by the Eighth Circuit's holding in Int'l Fid. Ins. Co. v. U.S., 949 F.2d 1042 (8th Cir. 1991). Notably, the Eight Circuit in Int'l Fid. Ins. Co. rejected the relation back doctrine, and held that a surety's equitable subrogation claim to a contractor's progress payments did not accrue on the date the bonds were issued. Id. at 1046. Upon reconsideration, however, the Amwest court adhered to its original ruling, noting that Int'l Fid. Ins. Co. was based on Missouri, not Connecticut, law.
In Pangori, which Plaintiff relied on in the previous issue, the Court, when analyzing the surety's equitable subrogation claim, applied the Michigan Court of Appeals' holding in Dubey and found that "[i]n Michigan, as long as the surety's liability is contingent and has not become an actual obligation triggered by its principal's default, its equitable rights may be subordinated to an intervening judicial lien creditor." Pangori, 53 B.R. at 719. Therefore, the Pangori court held, "[t]he court's conclusion in Dubey may be summarized as stating that two elements were necessary for the surety to prevail: first, it must show that there was an actual default prior to garnishment; second, it must show that it actually became obligated to pay." Id. at 719-20 (citing Dubey, 97 Mich. App. at 559-60).
Clearly, then, Michigan law differs from that of Connecticut with respect to a surety's right of equitable subrogation and the relation back doctrine. In Michigan, the relation back doctrine does not apply in the context of equitable subrogation to make the effective date of a surety's interest, for priority purposes, the date upon which it issued its bond. Rather, an equitable subrogee's rights are triggered when it actually becomes obligated to pay on the bonds; i.e., when the principal defaults. The opposite is true in Connecticut. Amwest, 870 F. Supp. at 435.
Here, as the Court is bound by Michigan law, it must follow the holdings set forth in Dubey and Pangori. As such, the Court finds that Plaintiff's equitable subrogation rights did not accrue until it was obligated to perform under its bond agreement with Smelser. The Court cannot determine when this actually occurred, however, since the details of Plaintiff's payments under the bonds are unknown. Accordingly, since there is a genuine issue of material fact with respect to these issues, the Court must deny Plaintiff's Motion for Summary Judgment.
V. CONCLUSION
Therefore, for the reasons stated above, Plaintiff's Motion for Summary Judgment is hereby DENIED.
IT IS SO ORDERED.