Opinion
C.A. No. 18167
Submitted: January 23, 2001
Decided: March 16, 2001
M. Duncan Grant, Andrea B. Unterberger and Joseph S. Naylor, Esquires, of PEPPER, HAMILTON SCHEETZ, LLP, Wilmington, Delaware, and Chapin Cimino Cody, Esquire, of PEPPER, HAMILTON SCHEETZ, LLP, Philadelphia, Pennsylvania; and Peter F. Marvin and Justin K. Miller, Esquires, of TOLL, EBBY, LANGER MARVIN, P.C., Philadelphia, Pennsylvania; Attorneys for Plaintiff
David H. Williams, Esquire, of MORRIS, JAMES, HITCHENS WILLIAMS, LLP; Attorney for Defendant Colonial School District
Donald L. Logan and Joseph Scott Shannon, Esquires of TIGHE, COTTRELL LOGAN, P.A., Wilmington, Delaware; Attorneys for Defendant Casey Electric, Inc.
Janet Z. Charlton and Richard H. Cross, Jr., Esquires, of YOUNG, CONAWAY, STARGATT TAYLOR, LLP, Wilmington, Delaware; Attorneys for Defendant I.D. Griffith, Inc.
MEMORANDUM OPINION
Pending is a motion for summary judgment. The plaintiff, Travelers Casualty and Surety Company of America ("Travelers"), which is the moving party, was the performing surety of contractor Healy Management Services, Inc. ("Healy") under certain performance and payment bonds issued by Travelers and on which Healy later defaulted. The named defendants, Casey Electric, Inc. ("Casey") and J. D. Griffith, Inc. ("Griffith"), were subcontractors on separate unbonded projects, unrelated to the projects which were bonded by Travelers, on which Healy was the general contractor.
Healy did not pay Casey and Griffith on those unrelated projects. As a result, those defendants filed actions in the Superior Court of Delaware to garnish funds Healy had earned on the bonded projects but that remain in the custody of the owners, Colonial School District ("Colonial") and Electra Arms Senior Associates, L.P. ("Electra Arms"). Those garnished funds are also the would-be source of re-payment for Travelers, the plaintiff-surety on the bonds that are the subject of this action. Because Travelers and the defendants claim entitlement to the same funds, the issue in this lawsuit is who, as between Travelers and the subcontractor defendants, is entitled to priority of payment from those funds.
For purposes of this Opinion, "defendants" refers only to the unpaid subcontractor defendants, Casey Electric, Inc. ("Casey") and J.D. Griffith, Inc. ("Griffith"). Colonial and Electra Arms, the owners of the properties on which Healy undertook the bonded projects, were also named as defendants, but only for purposes of remedy, for which reason Colonial and Electra Arms are referred to in this Opinion by their proper names.
For the reasons discussed below, the Court concludes that Travelers has priority and is entitled to summary judgment.
I. FACTS
The material facts recited below are undisputed. On October 7, 1998, Travelers provided performance and payment bonds to owner-garnishee Electra Arms. Those bonds ensured that, if Healy defaulted on its construction contract with Electra Arms (the "Healy-Electra Arms contract"), Travelers, as surety, would step in and complete the contracted work and pay the subcontractors and suppliers on the project.
On April 19, 1999, Travelers entered into a separate suretyship agreement on a different Healy project, whereby Travelers provided performance and payment bonds to owner-garnishee Colonial. Those bonds provided that if Healy defaulted on its construction contract with Colonial (the "Healy-Colonial contract"), Travelers would step in and complete the contracted work and pay the subcontractors and suppliers on the project.
Thereafter, Healy's business began to fail. Healy fell into arrears on payments due to Casey and Griffith, who (as earlier stated) were subcontractors on projects unrelated to the Healy-Electra Arms and Healy-Colonial contracts. On February 17, 2000, and March 3, 2000, Healy executed promissory notes for the amounts owed to each of these two subcontractors. Healy then defaulted on those promissory notes, and Griffith obtained a default judgment against Healy on June 2, 2000 in the Superior Court for $398,491.60, plus fees, costs and interest. On July 6, 2000, Griffith filed a praecipe for attachment against Colonial, garnishing payments allegedly due Healy under its separate construction contract with Colonial. On July 11, 2000, Colonial informed Travelers that it intended to honor the Griffith attachment.
Because Healy had also defaulted on its promissory note to Casey, Casey filed a praecipe for attachment against Colonial on June 21, 2000, and against the Wilmington Housing Authority on July 11, 2000. On June 30, 2000, Colonial informed Travelers, in writing, of its intent to honor the Casey attachment.
At that time, Casey was under the mistaken impression that the Wilmington Housing Authority was a party to the Flealy-Electra Arms contract. Disabused of that impression, Casey has represented that it will serve execution papers on Electra Arms.
Unable to meet its obligations under its contracts with Colonial and Electra Arms, on July 12, 1999, Healy defaulted on those contracts as well. Upon Healy's default, Travelers, as surety, undertook to perform Healy's obligation to complete the work required under the contracts and to pay the subcontractors and materialmen on both projects, in accordance with the performance and payment bonds. As performing surety, Travelers claims that (i) it is entitled to payments due the defaulting contractor from the owner-garnishees, and (ii) its claims as surety have priority over the competing claims of Healy's third-party creditors.
Uncertain as to whether it should pay the monies it is holding under the Healy-Colonial Contract to Travelers or to the attaching Healy creditors, Colonial refused to pay the funds to either party. Instead, on July 13, 2000 Colonial informed Travelers in writing that it would retain approximately $558,657.24 that allegedly was owed to Healy until this Court determined who is the proper payee of the retained amount.
That figure represents the total of the Casey and Griffith funds that have been attached.
Electra Arms, the second of the two owner-defendants, has not taken a position on any dispute over monies owed under the Healy-Electra Arms contract, nor has it answered Travelers' complaint. Casey's filing of a praecipe against the Wilmington Housing Authority indicates that a dispute under the Healy-Electra Arms contract similar to that presented under the Healy-Colonial contract here discussed, is likely to arise. Because of the similarity of such a dispute to the dispute at hand, the same legal analysis and conclusion would apply.
II. THE APPLICABLE STANDARD AND THE PARTIES' CONTENTIONS
On a motion for summary judgment, the Court must view all the evidence in the light most favorable to the non-moving party and determine whether any material issues of fact are presented. If there are no disputed issues of material fact, the Court must then determine whether the moving party is entitled to judgment as a matter of law. In deciding the motion, the Court will assume the truth of uncontroverted facts shown by the record.This motion raises two sets of issues. The first is whether this Court has subject matter jurisdiction over this controversy. The plaintiff, Travelers, contends that this Court has subject mattel-jurisdiction because the remedies it seeks are equitable. The defendants respond that (i) Travelers has an adequate remedy at law, and (ii) that because this is a declaratory judgment action with no underlying independent equitable basis, Travelers' claim must be pursued in the Superior Court.
The second set of issues concerns the priority of Travelers' claim to the disputed monies held by Colonial and Electra Arms and owed for work done on the Colonial and Electra Arms projects. Travelers claims that as the performing surety, its claim of equitable subrogation is entitled to priority over the claims of the subcontractor-defendants, Casey and Griffith. Travelers also claims that, under the construction contracts and bonds it provided to Colonial and Electra Arms, it (Travelers) has a contractual right to a priority recovery of all funds presently held by Colonial and Electra Arms. Third, Travelers claims priority status on the basis of equitable considerations.
The defendants dispute Travelers' claim to priority. First, they argue that Travelers' entitlement to payment has not yet arisen or (in the alternative) matured. Second, the defendants deny that the disputed funds are held in constructive trust for the contractor and argue (alternatively) that a constructive trust cannot preclude garnishment of any funds in excess of the amount actually needed to complete the bonded projects. Third, the defendants argue that Travelers has no contractual right to the disputed funds. Finally, the defendants argue that it would be inequitable not to uphold their garnishment of the disputed funds.
The defendants also argue that, in any event, summary judgment cannot be granted based on the present record. I disagree, and conclude summary judgment is appropriate based upon the undisputed record facts.
Those issues are addressed in that order.
III. SUBJECT MATTER JURISDICTION
The defendants challenge this Court's subject matter jurisdiction on three separate grounds.
First, they contend that because in reality Travelers is seeking a legal remedy (a money recovery), the Court lacks subject matter jurisdiction over this controversy. The defendants argue that there exists an adequate remedy at law — the intervention by Travelers in the defendants' Superior Court garnishment actions.
The difficulty with this argument, however, is that that legal remedy was not available to the plaintiff at the inception of this lawsuit and is unavailable now. Equity's refusal to entertain a claim on the grounds that a remedy at law is available depends on the adequacy of that legal remedy. "[T]o be "adequate,' a legal remedy must be available as a matter of right, be full, fair and complete, and be as practical to the ends of justice and to prompt administration as the remedy in equity."'
See 10 Del. C. § 342 (establishing Court of Chancery lacks subject matter jurisdiction where an adequate legal remedy is available).
Clark v. Teeven Holding Co.. Inc., Del. Ch., 625 A.2d 869, 881 (1992)(citing Family Court v. Dep't of Labor and Indus. Relations, Del. Ch., 320 A.2d 777, 780 (1974)).
In this case, the proposed legal remedy — intervention in the defendants' Superior Court attachment actions — was not practically available to Travelers when its claim to the funds arose. The current dispute between the parties arose when Healy's default on its contracts with Colonial and Electra Arms forced Travelers, as surety, to step in on July 12, 2000. By that point, the defendants' earlier Superior Court garnishment actions had resulted in writs of attachment against the disputed funds, and as a result, there are no longer any pending proceedings in Superior Court in which to intervene. For that reason the intervention remedy is inadequate and does not oust this Court of subject matter jurisdiction.
Second, the defendants argue that Travelers is seeking declaratory judgment on a matter that falls outside this Court's jurisdiction. But, both the Superior Court and this Court have jurisdiction over declaratory judgment actions." [T]he jurisdiction of this Court to grant declaratory relief in a particular case . . . is dependent upon whether equity would independently have jurisdiction over the controversy, without reference to the declaratory judgment statute . . . if the subject matter of the controversy should develop to a later stage." Whether such an independent basis for equity jurisdiction exists, depends upon whether there "[is] an underlying basis for equity jurisdiction measured by traditional standards." Such an independent basis for equity jurisdiction has been found to exist, where a cloud against title requires extrinsic evidence to remove or where injunctive relief is required to maintain the status quo until the Court is able to determine disputed contract rights.
See 10 Del. C. § 6501 (establishing concurrent jurisdiction of Court of Chancery and Superior Court over declaratory judgment actions).
See 10 Del. C. § 6501; Clark, 625 A.2d at 879, citations omitted (discussing independent equity jurisdiction in Court of Chancery); Heatherareen Commons Condominium Ass'n v. Paul, Del. Ch., 503 A.2d 636, 642 (1985) (discussing the implications of the controversy's development at a later stage).
Heathergreen Commons, 503 A.2d at 642.
See id. (deciding an issue based on clouded title); Jefferson Chemical Co. v. Mobay Chemical Co., Del. Ch., 253 A.2d 512, 514 (1969) (enjoining interference with yet-to-be-determined contract rights). But see City of Wilmington v. Delaware Coach, 230 A.2d 762, 349 (1967) (holding that, although enforcement of remedy would require injunction, equitable jurisdiction was absent because there was no independent basis).
Here, the defendants' lack of jurisdiction argument fails for two reasons. First, there is an independent equitable basis for this Court's exercise of jurisdiction, namely, the doctrine of equitable subrogation. Second, this Court has jurisdiction because "the issues raised in the complaint would arise in an equitable action if coercive relief were being sought at a later stage." Travelers' claim for injunctive relief in its current complaint underscores that if any declaratory judgment in this action requires judicial enforcement, that enforcement would take the form of injunctive relief, which is equitable in character. Thus, to the extent that Travelers seeks declaratory relief, this Court has subject matter jurisdiction over that claim.
See Clark, 625 A.2d at 878 (stating that subrogation is only available in equity); Welch v. State, Del. Ch., C.A. No. 1060, Hartnett V.C., Mem. Op. at 4 (Feb. 18, 1991) (stating that subrogation is "cognizable in equity").
Heathergreen Commons, 503 A.2d at 644.
See Heathergreen Commons, 503 A.2d at 644, citations omitted; see also Diebold Computer Leasing. Inc. v. Commercial Credit Corporation, 267 A.2d 586, 591 (1970) (holding that, where plaintiff originally sought to enjoin defendant obtaining a zoning variance and obtained declaratory judgment upholding its rights under contract, the fact that court enforcement of that judgment would require it to issue an injunction merited bringing the cause in equity).
Third, and finally, the defendants contend that the relief Travelers is requesting is essentially a monetary judgment couched in equitable terms, which a court of law is fully capable of granting. That argument is untenable, because the monetary relief being sought is only a part of the relief requested. Injunctive relief is being sought as well. "[E]quity may also, at its discretion, exercise concurrent jurisdiction over a purely legal claim for which there is an adequate remedy at law in the course of deciding other claims for which equity jurisdiction exists." Moreover, "once equity has jurisdiction over a cause, it will deal with the entire controversy, even if, in doing so it must necessarily afford relief that is not purely equitable."
Clark 625 A.2d at 876; See also Pepsi-Cola Bottling Co. of Salisbury, Md. v. Handy, Del. Ch., C.A. No 1973-S, Jacobs, V.C., Mem. Op. at 13 (Mar. 15, 2000) (invoking the "clean-up doctrine" as basis for subject matter jurisdiction).
Heathergreen Commons, 503 A.2d at 645.
For these reasons, the defense based on lack of subject matter jurisdiction is rejected.
IV. THE PRIORITY ISSUE
The second set of issues concerns whose claims to the funds being withheld by Colonial and Electra Arms are entitled to priority — the claims of Travelers or the claims of the subcontractor-defendants. Travelers grounds its claim to priority upon three distinct theories: (1) the doctrine of equitable subrogation, (2) contract, and (3) equitable principles. Each of these theories is separately evaluated.
A. Equitable Subrogation
Under the doctrine of equitable subrogation, "a surety who pays the debt of another is entitled to all the rights of the person he paid to enforce his right to be reimbursed." The enforcement of this right is based in "equity, and is enforced solely for the purpose of accomplishing the ends of substantial justice . . ., and is independent of any contractual relations between the parties."
Pearlman v. Reliance Ins. Co., 371 U.S. 132, 137 (1962).
Id., n. 12, citations omitted.
The defendants do not dispute the principle that as surety, Travelers will be equitably subrogated to the rights of the owner-garnishees. They contend, however, that Travelers' right to equitable subrogation will not arise until the project is completed. Alternatively, the defendants argue that even if a subrogation right arose, it did not mature until Healy defaulted, by which point all funds earned by Healy before the default had been properly garnished. The defendants assert that because they perfected their attachments of the disputed funds before Healy's default and also before the project was completed, their claims have priority over Travelers' competing claims to those same funds. Moreover, the defendants insist, Travelers cannot argue that the owner's post-default retention of the disputed funds negates the defendants' priority as an equitable matter because it was Travelers' own protest of the garnishments that led to the monies being retained.
The defendants also contest Travelers' contention that the disputed funds are held by the owners in constructive trust for the surety. The defendants urge that to be a proper subject of a constructive trust, the funds must be held by the defaulting contractor, and not (as here) by the owners. Alternatively, the defendants argue that even if the Court determines that a constructive trust exists, the trust encompasses only that portion of the funds that is needed to pay laborers and materialmen who filed timely claims under the bonds. Any remaining funds, defendants contend, would remain subject to the defendants' garnishment. Lastly, the defendants urge, it has not yet been determined what portion of any trust is owed to Travelers, the surety and what portion is owed to Healy. Because the fund consists of the intermingled property of both the general contractor and various subcontractors (here represented by the surety) the funds remain subject to attachment until the portion properly belonging to the general contractor can be identified and separated. At the very least, the defendants maintain, until the final cost of the bonded projects is determined, summary judgment in Travelers' favor would be premature.
I disagree. It is well established that a surety's right of equitable subrogation arises at the time the suretyship agreement is entered into, and not on the date of the principal's default. From that time forward, the surety' s right of equitable subrogation places it in the position of the owner, and places the defaulting contractor's creditors in the position of the defaulting contractor, each asserting its respective rights by representation. Where the contractor fails to complete the project, the surety becomes subrogated to the owner's right to apply the funds that the owner holds to the completion of the project. Even where the owner wrongfully withholds funds that are owed to the contractor, those funds are treated as owner funds that the surety must devote to the bonded project's completion.
See International Underwriters v. Kinnamon. Schneider and Hugh Interiors. Inc., Del. Supr., 513 A.2d 1318 (TABLE) ( 1986 WL 16137, *5, (July 23, 1986)(citing United Pacific Ins. Co. v. Ripsom, Del. Ch., C.A. No. 7056, Hartnett, V.C., Mem. Op. at 8 (Sept. 25, 1984))). Hartford Accident and Indemnity Co. v. Long, Del. Ch., 245 A.2d 800, 804 (1968) (stating that right of equitable subrogation attaches before default date).
See United Pacific at 7; Hartford, 245 A.2d at 803.
See In Re Modular Structures. Inc., 27 F.3d 72, 78, n. 5 (3d Cir. 1994), citation omitted (stating that "[i]f the contractor fails to complete the job, the government can apply the retained funds and any remaining progress money to costs of completing the job"); see also Pearlman, 371 U.S. at 137-3 8 (stating that, via the doctrine of equitable subrogation, the surety succeeds to the owner's rights and remedies).
This Court recognizes that whether the disputed funds are wrongfully withheld by the owners is immaterial to the priority issue. In the eyes of equity "there is really no difference between retained percentages . . . and unearned funds which are still in the hands of the [owner]" where the relationship between the parties dictates such a result under the doctrine of equitable subrogation. See Hartford, 245 A.2d at 803, 805. Likewise, "any distinction between retainage and unpaid progress payments has been eliminated." Nat'1 Shawmut Bank of Boston v. New Amsterdam Cas. Co., C.A. Mass, 411 F.2d 843, 848, cited with approval in Int'l Underwriters at 4 and United Pacific at 2. Under this analysis, whether the disputed funds are held in a constructive trust is also immaterial. "[E]quitable subrogation is here based, not upon the character of the funds or credits withheld or in the hands of the owner but rather upon the nature of the relationship of the parties involved."Hartford, 245 A.2d at 803; See also United Pacific, at 7. Indeed, theNat'l Shawmut court held, because the surety succeeded to the owners rights, the surety's equitable subrogation to payments earned but wrongfully withheld from the contractor upon the contractors' default prevailed over the defaulting contractor's creditor's claims. 411 F.2d at 848.
As performing surety, Travelers is entitled to control the owner-held funds to the extent that is necessary to complete the bonded projects. Moreover, "the right of the contractor's surety to be subrogated with respect to unpaid funds is usually regarded as superior to the claims of general creditors, the contractor or his receiver or trustee, the assignee of funds due under the contract, and various other persons. Nor, as this Court has acknowledged, does the surety's right to priority through equitable subrogation require the prior completion of the bonded project. The requirement that the surety must complete the bonded project before it can invoke its right to equitable subrogation exists only in cases where it is necessary to prevent the surety from competing with the owner's rights against the contractor-principal.
Hartford, 345 A.2d at 804, citing 83 C.J.S. Subrogation § 59d (2).
By contrast, this Court has held that the principal's creditors' rights depend on the project's completion. Just as a contractor "would not have a right to demand a progress payment (even if earned) [from the owner] . . . if performance is not completed," the contractor's creditors, who now assert its rights through equitable subrogation, cannot assert their claims while obligations to the owners, now owed to the surety, are unmet. Hartford, 245 A.2d at 803.
See Restatement (Third) of Suretyship and Guaranty § 27 cmt. B (1995); Hardeastle v. Commercial Bank of Delaware, Del. Errors Appeals, 1 Harr. 374, 377 (discussing inequity of requiring a surety to stand by as third-party creditor devalues surety's interest in held back funds, merely because bonded project is incomplete).
Here, however, the owners do not face such competition from the surety. One owner (Colonial) has disengaged itself from the fray and is content to have the Court determine its proper disbursement of the disputed funds. Here, the only parties at risk are subcontractors who contracted with Travelers' principal, Healy, on projects unrelated to those for which Travelers issued the bonds. Indeed, in this case both the surety-plaintiff (Travelers) and the owner-garnishees (Colonial and Electra Arms) share a common interest in assuring that (1) Healy's contractual duty to complete the Colonial and Electra Arms projects is properly discharged, and (2) the security for the proper discharge of those obligations (i.e. the funds held by Colonial) remains unimpaired. Thus, there is no danger that Travelers, the surety, will "compete" with the owner-garnishee's rights against Healy, the principal. Rather, the danger in this case is that the owner-garnishees will impair thesurety's rights by releasing the surety's security to unrelated third parties i.e., the defendants. In such cases, where the obligee performs "an act that impairs the recourse of the [surety], the Restatement recognizes a specific exception to the requirement that the bonded project be complete."
Restatement (Third) of Suretyship and Guaranty § 27 cmt. B, illus. 4 ff § 3 9-46 (1995). As early as 1831, a Delaware court noted that "there is no propriety in distinguishing . . . between the [surety's] payment of the whole debt and the payment of a part, — at least as between principal and surety; but as it regards the creditor[,] this equitable lien cannot be [held to be enforceable by the surety only where] the whole debt is paid, without affecting his rights. . . ." Hardeastle, 1 Harr. at 733.
Similarly, Delaware case law also recognizes an exception to the requirement that performance under the bonded contract must be completed. In Hartford, supra, this Court noted that "where money is earned or where money has yet to be earned, the surety's right to subrogation may be asserted against lien claimants if such liens are taken without the knowledge or consent of the surety and where such liens are not contemplated by the surety bond." Although Travelers arguably had knowledge of the liens when it received notice from Colonial that the subcontractor-defendants attached the disputed funds, at no time did Travelers ever consent to the liens, nor were the liens "contemplated by the surety bond."
Hartford, 425 A.2d at 804 (emphasis added); see also Pearlman, 371 U.S. at 137-38, citing Prairie State Bank v. United States, 164 U.S. 227 (1896) (requiring surety's consent for owner's release to third parties of retainages owed to contractor because contract was complete; such funds are to be "held as a fund out of which [the surety] may be indemnified").
Applying those legal principles to the undisputed facts leads to the conclusion that Travelers' right to equitable subrogation arose on the date the suretyship agreement was executed. Under that doctrine, Travelers' claim to the withheld funds obtained priority over the defendants' claims to those funds even though its performance under the bonded contracts was not complete at the time of the subcontractor-defendants' attachment. As a further consequence of being subrogated to the rights of Colonial and Electra Arms, Travelers obtained an equitable lien on the funds in the owners' possession. To the extent the funds in the owners' possession are owed to Travelers, those funds never became Healy's property and, accordingly, never became subject to attachment by the defendants. For those reasons, Travelers is entitled to summary judgment on its claim for a declaration that (1) owners Colonial and Electra Arms are required to pay the funds to Travelers as performing surety; (2) Travelers is entitled to an equitable lien on the funds currently held by Colonial to the extent that they are owed to Travelers as a performing surety; and (3) Travelers is entitled to an injunction prohibiting the defendants from executing on their writs of garnishment.
The defendants argue in the alternative that, in lieu of equitable subrogation, the plaintiff is entitled to reimbursement. Because the plaintiff is equitably subrogated to the disputed funds and has not asserted a claim for reimbursement, treatment of that argument is unnecessary.
See Pearlman, 371 U.S. at 139 (holding that a surety has the property interest in the funds, the rights to which it is equitably subrogated); Hardcastle, 1 Harr. at 377 (stating that subrogation creates an equitable lien in favor of the surety).
See id.
Importantly, this aspect of the relief sought does not request payment of a specific amount, but merely preserves Travelers' right to future payment.
B. The Contract Claim
Travelers also claims that it is entitled to priority over the defendants' claims based on the bond language and Delaware contract law. It is undisputed that Travelers provided performance and payment bonds to owner-garnishees Colonial and Electra Arms. Those bonds ensured that, if Healy defaulted on their construction contracts, Travelers would step in to complete the contracted work and pay the subcontractors and suppliers on the projects. The parties agree that Travelers, as surety, is generally entitled to recoup the expenses it incurs in performing under the bonds. The dispute concerns whether that entitlement constitutes an enforceable contract claim to the disputed funds. Travelers contends it does. I agree, and find the defendants' contrary arguments to be without merit.
Under the bond language, Travelers, as surety, has an enforceable contract right to the disputed funds. By virtue of the bonds, the owner-garnishees contracted to (1) "dedicate" the funds "earned by the Contractor in the performance of the construction contract[s]" to the completion of the bonded projects only; (2) "satisfy the obligations of the contractor and the surety;" and (3) prioritize spending for the completion of the project. The effect of this language is to proscribe the use of those funds for unrelated purposes, specifically, payment of Healy's debts to subcontractors on unrelated projects. Further, because the doctrine of equitable subrogation causes Travelers to succeed to the owners' contractual right to prioritize spending, it prohibits the defendants from interfering with Travelers' contractual right to the funds. Just as Healy could not recover the funds (because the owners contractually promised those funds to the surety), Healy's creditors cannot recover the funds either.
Healy-Colonial Bond, at ¶ 8; Healy-Electra Arms Bond, at ¶ 8.
See United Pacific at 7 (holding that, in equitable subrogation, surety succeeds to owner's rights); Hartford 245 A.2d at 803 (holding the same).
See Hartford at 804 (stating that, because creditor succeeds only to defaulting contractor's rights, he cannot recover from owner-garnishee); John Julian Construction Co. v. Monarch Builders. Inc., Del. Super, 306 A.2d 29, 34 (1973), citations omitted (stating that "when a garnishee has contracts with the principal debtor that he will pay the money or deliver the property to some third person, the plaintiff in garnishment cannot recover because he is only placed in the position of the principal defendant, who could not himself recover from the person made garnishee"). By citing John Julian Construction as authority, the defendants argue that because a third-party beneficiary to a contract assuming the defaulting contractor's liability could bring suit against the garnishee, they, too, have the right to bring suit against the owner-garnishees. This argument has no merit. The defendants are not third-party beneficiaries of any agreement between Healy and the owner-garnishees and have no rights resulting from those contractual relationships. Moreover, the language of the construction contracts and the bonds precludes the defendants from similar recovery.
The construction contract language also supports that result. That contract provides that, "when the owner terminates the contract for [cause], the contractor shall not be entitled to receive further payment until the work is finished." Because the subcontractor-defendants are equitably subrogated to the defaulting contractor's rights and duties, they (like Healy) are precluded from recourse to the disputed funds until the completion of the bonded projects. Accordingly, the owner's obligation (to which the surety succeeds) to devote those funds to the completion of the bonded projects has priority over the defaulting contractor's right to payment.
General Conditions of the Contract for Construction, MA Document A201, Article 14.2.3, incorporated by reference in Healy Colonial Construction Contract, Article 9.1.2 and in Healy-Electra Arms Construction Contract, Article 1.2.
The defendants advance four contrary arguments. The first, (which consists of two sub-arguments) relies on the bond language which, the defendants urge, requires the surety to cover Healy's non-payment of subcontractors. This argument fails because the bond language does not support that result. The bond sets aside all funds owed to Healy on the bonded projects solely for use on those projects — and not for payment of unrelated debts.
See Healy Colonial Payment Bond, at ¶ 8 (stating that "[a]mounts owed by the Owner to the Contractor under the Construction Contract shall be used for the performance of the Construction Contract and to satisfy claims, if any, under any Construction Performance Bond"); Healy-Electra Arms Payment Bond, at ¶ 8 (stating the same).See also Healy-Colonial Performance Bond, at ¶ 7 (stating that "[t]he Surety shall not be liable to the Owner or others for obligations of the Contractor that are unrelated to the Construction Contract and the Balance of the Contract Price shall not be reduced or set off on account of any such unrelated obligations."); Healy-Electra Arms Performance Bond (stating the same).
The defendants' second bond interpretation argument relies on the provision which directs that progress payments must be made to Healy until the construction contract is terminated. Arguing from that provision, the defendants assert that the disputed funds must be treated as if they had already been released to Healy under that provision of the bond, in which case the subcontractor-defendants would have a clear right to garnish the disputed funds in Healy's hands. Defendants urge that the fact that the funds were wrongfully withheld from Healy should not strip them of their right to garnishment. This argument is flawed, however, because as previously discussed, the provision that Healy was to be paid until the contract's termination does not entitle the defendants to treat the disputed funds as if they had actually been released to Healy. Under Delaware case law, Healy's entitlement to wrongfully withheld funds remains subordinate to the surety's right to those funds under equitable subrogation.
See Nat'l Shawmut Bank of Boston, 411 F.2d at 848.
See id.
The subcontractor-defendants respond that because the disputed funds are owed to the contractor, the owners' contractual obligation to pay the contractor trumps the surety's contract right to have the funds dedicated to the surety's completion of the bonded projects. According to the defendants, the owners' obligations to the bonded project subcontractors were satisfied once the owners executed the bonds. Therefore, the defendants' garnishment of those funds constituted a proper attachment because the funds belonged to Healy, not Travelers. This argument is untenable. If accepted, it would defeat the very purpose of the bond, which is to assure that the remaining funds owed to the contractor are used to complete the bonded project.
The defendants cite a Louisiana case, A. F. Blair Co.. Inc. v. Mason, La. App., 406 So.2d 6, for this proposition.
The defendants next argue that, if the not-yet earned portion of the withheld funds is sufficient to complete the project, Travelers has no entitlement under the surety and performance bonds to the funds that were already-earned for "the performance of the construction contract." That argument is a non-starter because at this stage there is no way to know whether there will be sufficient funds to complete the project. Precisely for that reason, Travelers is not currently seeking to recover a specific sum, but rather, seeks only to establish its right to future payment. If at the projects' completion a surplus exists, that amount might then be considered as Healy "profit" and become subject to attachment by the unpaid subcontractors. At this stage, however, all that can be said is that none of the withheld funds is presently subject to attachment by the defendants.
Finally, the defendants argue that the injunctive relief that Travelers seeks is improper. I disagree. Travelers' contract rights, as described above, are properly protected by the injunction being sought, even though the amount needed to complete the bonded projects (and Travelers commensurate entitlement) is not yet known. Any execution process that threatens to interfere with the owner's contractual obligations to make payment to Travelers must halt until Travelers' claims are first satisfied. To ensure that payment, an equitable lien on the disputed funds and an order requiring that Travelers be paid as a performing surety, are also appropriate.
See Jefferson Chem., 253 A.2d at 514 (stating that, where rights under a contract have yet to be determined, it is proper to enjoin "interfer[ence] with the exercise of whatever rights [the plaintiff] is [later] found to have under the contract").
For these reasons, I find that Travelers is contractually entitled to the disputed funds, notwithstanding the defendants' garnishment actions and resulting attachment. Summary judgment in the plaintiffs favor is therefore appropriate on this basis as well.
C. The Equities
Lastly, the defendants argue that the equities favor their position. Specifically, the defendants urge that it would be inequitable not to honor their garnishment because by bonding Healy on the Colonial and Electra Arms projects, Travelers assumed the risk of Healy's financial failure. It was Travelers' obligation, the defendants argue, to exercise due diligence by investigating Healy' s finances and the extent of its debts before furnishing these bonds. Travelers' failure to so protect itself should not enable it to prevent the defendants from recouping the monies that were owed to Healy, their debtor.
Travelers responds that the equities favor its position. Travelers argues that the defendants, before agreeing to work for Healy, should first have investigated Healy's finances or insisted that their projects be bonded. Having failed to exercise due diligence, Travelers argues, the defendants' only remedy was to file mechanics lien returns against the projects for which they performed labor or supplied materials, and that the defendants' failure to do that should not entitle them to benefit from the surety and performance bonds issued by Travelers on unrelated projects. To force Travelers to pay the defendants risks that the subcontractors on the bonded projects will go unpaid — a highly inequitable result. Moreover, by bonding only two specific Healy projects, Travelers assumed Healy's risk only on those projects, whereas by choosing to work on unbonded projects, the subcontractor-defendants assumed the overall risk of Healy's default and its overall insolvency. I agree.
The purpose of state-required bonds on public works contracts is two-fold: (i) to assure that subcontractors are fully paid for labor and materials and (ii) to provide a substitute remedy for contractors, who are denied the right to impose a mechanics lien on public works projects. The Delaware Supreme Court has addressed the surety's protection of those otherwise unprotected subcontractors. It has determined that the funds owed by the contractor on a bonded project belong to the contractor's surety because those funds are held in trust "for the benefit of payment to material men, laborers and subcontractors." This Court will not countenance a result that would strip otherwise unprotected contractors of their statutorily guaranteed protection on bonded projects.
See 29 Del. C. § 6962 (d)(9) (imposing a bond requirement for public works contracts); Department of Community Affairs v. M. Davis Sons, Inc., Del. Supr., 412 A.2d 939, 942 (1980) (stating that, absent statutory or contractual authority to contrary, a mechanics lien will not attach to state owned property used for benefit of public); State v. Fidelity and Deposit Company of Maryland, Del. Supr., 194 A.2d 858, 862 (1963) (stating that the purpose of bond required for public works contracts is to assure full payment for labor and materials); cf. Nicholson Construction Co. v. The Standard Fire Insurance Co., 760 F.2d 74, 77 (3d Cir. 1985) (stating that aim of Pennsylvania state bonding law is to provide substitute remedy for contractors who are denied right to impose mechanics lien).
Int'l Underwriters, 1986 WL 16137 at **6, citing United Pacific at 10; Eastern States Petroleum Co. v. Universal Oil Prod. Co., Del. Ch., 44 A.2d 11, 14 (1945) (likening subrogation to constructive trust).
Healy cannot, by contracting with unrelated third parties, circumvent Travelers' equitable subrogation priority right to full payment as a performing surety. Nor can the defendants be permitted to deprive the performing surety of yet-to-be-determined amounts by depleting (through garnishment) the funds available for the surety's payment. The surety protects the interests of the public in completing bonded projects, and protects the interests of the subcontractors by assuring that they are paid.
See Hartford 245 A.2d at 804, quoting 7 AmJur 2d Contractors' Bonds § 112.
See Restatement (Third) of Suretyship and Guarantee § 27 cmt. B, illus. 4 ff. § 39-46.
Finally, it does not follow that because Travelers bonded Healy on two specific contracts, it assumed the risk of Healy's non-performance on all of its other unrelated contracts. The defendants, who are unbonded contractors on unrelated projects, seek payment from bonded project owners' funds that are already dedicated to the plaintiff-surety under those bonds. Having failed to protect themselves financially in their own dealings with Healy, the defendants nonetheless seek to avail themselves of the protections of these unrelated bonds. That they cannot be allowed to do. The plaintiff did not contract for, nor will this Court permit, that inequitable result.
IV. CONCLUSION
The plaintiffs motion for summary judgment will be granted. Counsel for the parties shall confer and submit a form of Order that implements the rulings in this Opinion.