Com. of Ky. for Ben. of United Pacific Ins. Co. v. Laurel County

• Decision Date: 14 November 1986
• Docket Number: Nos. 85-5498,85-5499,s. 85-5498
• Citation: 805 F.2d 628
• Parties: -6192, 87-1 USTC P 9119, 35 Ed. Law Rep. 1018 COMMONWEALTH OF KENTUCKY for the Benefit of UNITED PACIFIC INSURANCE COMPANY and United Pacific Insurance Company, Plaintiffs-Appellees, v. LAUREL COUNTY and Laurel County Fiscal Court, Defendants and Third Party Plaintiffs-Appellants. LAUREL COUNTY BOARD OF EDUCATION, Defendant-Appellant, v. UNITED STATES of America, Third Party Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 628

805 F.2d 628

58 A.F.T.R.2d 86-6192, 87-1 USTC P 9119,

35 Ed. Law Rep. 1018

COMMONWEALTH OF KENTUCKY for the Benefit of UNITED PACIFIC

INSURANCE COMPANY and United Pacific Insurance

Company, Plaintiffs-Appellees, v. LAUREL COUNTY and Laurel County Fiscal Court, Defendants and

Third Party Plaintiffs-Appellants.

LAUREL COUNTY BOARD OF EDUCATION, Defendant-Appellant, v. UNITED STATES of America, Third Party Defendant-Appellee.

Nos. 85-5498, 85-5499.

United States Court of Appeals, Sixth Circuit.

Argued July 14, 1986.

Decided Nov. 14, 1986.

Thomas H. Glover, argued, Hays, Moss and Lynn, Lexington, Ky., Elmer Cunnagin, Jr., Cunnagin & Cunnagin, London, Ky., for Laurel County and Laurel County Fiscal Court.

Thomas E. Meng, argued, Lexington, Ky., for Com. of Kentucky, and United Pacific Ins.

Roger M. Olsen, Tax Div., Dept. of Justice, Washington, D.C., William S. Estabrook, John A. Dudeck, Jr., for U.S.

Glenn L. Archer, Jr., Tax Div., Dept. of Justice, Washington, D.C., for amicus curiae.

William G. Crabtree, argued, London, Ky., for Laurel County Bd. of Educ.

Before LIVELY, Chief Judge; and WELLFORD and BOGGS, Circuit Judges.

WELLFORD, Circuit Judge.

Defendants Laurel County, Laurel County Fiscal Court, and Laurel County Board of Education (collectively, the "county agencies") appeal from an order of the district court granting plaintiff United Pacific Insurance Company (United Pacific), a performance and payment bond surety on a public construction project, summary judgment on its claim for funds payable under the construction contract. Defendant Laurel County Fiscal Court paid these funds over to the Internal Revenue Service (IRS) by virtue of a levy for unpaid taxes of the contractor Y & S Construction Company (Y & S). Defendants also appeal from an order of the district court dismissing their third-party complaint against the United States.

This damage action was brought in 1974 by United Pacific against the county agencies, the Laurel County Treasurer, and others with respect to a construction contract between Y & S and the county agencies for the construction of the Laurel County High School building at London, Kentucky. On July 28, 1975, the county agencies filed a third-party complaint against the United States. That claim was dismissed by the district court (Judge Moynahan) in a memorandum opinion entered on March 18, 1976. Thereafter, on January 16, 1985, the district court (Judge Bertelsman) entered findings of fact, conclusions of law, and a judgment, granting summary judgment in favor of United Pacific in the total amount of $197,728.39, including interest to November 8, 1984. On May 1, 1985, the district court filed an amended judgment adopting additional findings of fact and conclusions of law. The county agencies now appeal.

I.

Y & S contracted with the Laurel County Fiscal Court and the Laurel County Board of Education in 1969 for the construction of the school. At the time the construction contract was signed, Y & S, as principal, and the plaintiff, United Pacific, as surety, executed and delivered a performance bond in the amount of the contract price, $2,524,250, as well as a labor and material payment bond in the same amount.

On February 4, 1970, the IRS filed a notice of tax lien against taxpayer Y & S in the amount of $185,031.05. On March 11, 1970, a second and separate notice of tax lien was filed in the amount of $162,718.64. ¹ Y & S apparently failed to submit withholding taxes for its employees for July through December 1969. On or before March 4, 1970, Y & S defaulted in the performance of the construction contract when it was about 75 percent completed. United Pacific sent a letter to Leon Browning, the architect and owner's representative, requesting that no further contract funds be paid to the contractor or anyone else without its written consent. On March 15, 1970, Y & S sent letters to the Laurel County Fiscal Court and to Browning requesting that all funds due or about to be due on the contract be paid to United Pacific. The notice to the Fiscal Court was signed and returned by the County Treasurer, and the notice to Browning was signed and returned by him.

On April 17, 1970, Browning certified that $116,666.59 was due and payable to taxpayer Y & S. On or about May 15, 1970, United Pacific made demand on the Laurel County Fiscal Court for all sums coming due under the contract. The government's brief notes that on or about May 18, 1970, a notice of levy was served on the Laurel County Fiscal Court for taxes due and owing by Y & S in the amount of $100,833.91.

On May 18, 1970, when visited by an IRS Revenue Officer with this tax levy, ² the Laurel County Fiscal Court paid the sum of $100,833.91 to the IRS out of the School Construction Project Fund by a check endorsed by George Cloyd, Laurel County Treasurer. Prior to paying over the funds, Cloyd consulted two local attorneys, who advised that there might be personal liability if the IRS levy were not honored. Cloyd had earlier been authorized by resolution and order of the Laurel County Fiscal Court to make disbursements out of the School Construction Project Fund upon certification by Browning that the said funds were due and owing.

The Laurel County Treasurer advised United Pacific of the payment to the IRS in a letter dated May 18, 1970, and United Pacific duly and promptly protested the same. Ultimately, of the contract price of $2,554,532.15, $1,587,995.03 was in fact paid Y & S, $865,703.21 was paid to the surety, which completed the contract after Y & S's default, and $100,833.91 was paid to the IRS.

United Pacific seeks damages by a breach of contract action for the amount paid to the IRS (i.e., $100,833.91). The defendants joined the United States as a third-party defendant on July 28, 1975. In dismissing the claim against the United States, the district court held that the defendants had not complied with the nine-month limitations period for bringing actions for alleged wrongful tax levies.

The district court later found that as a matter of state law "the funds due under the contract had not become the property of the taxpayer" because "[t]he Kentucky statutory provision, KRS 376.070, establishes a trust fund for the benefit of unpaid materialmen, and as such the funds due under the contract were not and never became the property of the taxpayer." In so ruling, the court noted that Section 6332(d) of the Internal Revenue Code does not relieve a person mistakenly or erroneously making payment to the IRS pursuant to a tax levy from liability to the true owner of the funds. Accordingly, judgment against defendants was entered on January 16, 1985, in the sum of $197,728.39, including interest.

II.

In ruling on the motion of plaintiff United Pacific for summary judgment, Judge Bertelsman wrote in his January 16, 1985, conclusions of law:

4. This Court must look to state law to control the determination of the nature of the legal interest of the taxpayer in the property (funds due under the contract). Whether this property interest under state law constitutes "property or rights to property" subject to levy is strictly a matter of federal law. Aquilino v. United States, 363 U.S. 509, 80 S.Ct. 1277, 4 L.Ed.2d 1365 (1960); United States v. Lebanon Woolen Mills Corp., 241 F.Supp. 393 (1964); City of New York v. United States, 283 F.2d 829 ( [2nd Cir.] 1960).

5. That upon default by the taxpayer, Y & S Construction Company, the funds due under the contract had not become the property of the taxpayer under state law. KRS 376.070(1); In re D & B Elec., Inc., 4 B.R. 263 (W.D.Ky.1980); Blanton v. Commonwealth, Ky., 562 S.W.2d 90 ( [Ct.App.]1978).

6. The Kentucky statutory provision, KRS 376.070, establishes a trust fund for the benefit of unpaid materialmen, and as such the funds due under the contract were not and never became the property of the taxpayer.

7. Under federal law, the taxpayer, Y & S Construction Company, had no property interest under state law constituting "property or rights to property" subject to levy. United States v. Durham Lumber Co., 363 U.S. 522, 4 L.Ed.2d 1371, 80 S.Ct. 1282 (1958).

8. The rights of the Plaintiff, United Pacific Insurance Company, accrued as of the time of the execution of the bonds. Upon satisfying the materialmen and laborers, the Plaintiff surety became subrogated to all rights of the owner, laborers and materialmen to funds due under the contract. [Citations omitted].

Thus, the district court concluded that the IRS tax lien did not properly attach to the right of Y & S to receive payments under the construction contract and that the payment honoring the IRS levy on its lien by the county agencies was wrongful. See 26 U.S.C. Secs. 6321, 6332.

We note with concern the extreme delays, attributable to the handling of this case by the district judge originally assigned, and the inadequate record developed concerning the levy in this case. This litigation concerns events which occurred in early 1970; the initial complaint in this case was filed in 1974; and the final judgment below, disposing of this case on motions for summary judgment, was not entered until 1985. ³ Moreover, our resolution of the issues here is made more difficult by the failure of the parties to offer into evidence the notice of levy allegedly served on May 18, 1970. ⁴ Although the affidavit of the county treasurer, the responsible county officer who apparently received the IRS demand for payment and issued a check to the IRS, states that a "lawful levy" was made on May 18, 1970, for the progress payment at issue, the county treasurer's deposition is less than a model of clarity concerning the fact of the serving of the notice of levy. (By the time of the county treasurer's 1982 deposition, he was 87 years old, and by 1984 the other three individuals with personal knowledge of the levy--the two attorneys consulted by the treasurer and the IRS agent involved--were all deceased.) For...