Giuliano v. Ins. Co. of Pa. (In re LTC Holdings, Inc.)

• Decision Date: 18 August 2021
• Docket Number: No. 20-3057,20-3057
• Citation: 10 F.4th 177
• Parties: IN RE: LTC HOLDINGS, INC., et al., Debtors Alfred T. Giuliano, Chapter 7 Trustee for the Consolidated Estate of LTC Holdings, Inc., et al. v. Insurance Company of the State of Pennsylvania, Appellant v. Alfred T. Giuliano, Chapter 7 Trustee; BMO Harris Bank, N.A., Counterclaim Defendants
• Court: U.S. Court of Appeals — Third Circuit

10 F.4th 177

IN RE: LTC HOLDINGS, INC., et al., Debtors

Alfred T. Giuliano, Chapter 7 Trustee for the Consolidated Estate of LTC Holdings, Inc., et al.

v.Insurance Company of the State of Pennsylvania, Appellant

v.Alfred T. Giuliano, Chapter 7 Trustee; BMO Harris Bank, N.A., Counterclaim Defendants

No. 20-3057

United States Court of Appeals, Third Circuit.

Argued June 23, 2021

Filed: August 18, 2021

Andrew S. Kent [ARGUED], Chiesa Shahinian & Giantomasi, One Boland Drive, West Orange, NJ 07052, Counsel for Appellant

David T.B. Audley, Michael T. Benz [ARGUED], Chapman & Cutler, 111 West Monroe Street, 18th Floor, Chicago, IL 60603, Richard M. Beck, Glenn A. Wiener, Klehr Harrison Harvey Barnzburg, 1835 Market Street, Suite 1400, Philadelphia, PA 19103, Counsel for Appellee

Before: SMITH, Chief Judge, MATEY, and FISHER, Circuit Judges

OPINION OF THE COURT

SMITH, Chief Judge.

Lakeshore Toltest Company ("LTC") and its affiliates (collectively, the "Debtors") entered into construction contracts with the United States. The Appellant, Insurance Company of the State of Pennsylvania ("ICSP"), provided performance and payment bonds guaranteeing that the Debtors would complete those contracts. When the Debtors defaulted on the contract at issue here, ICSP stepped in to make sure that the work was completed. As a result, ICSP claims that it is subrogated to the United States’ rights to set off a tax refund (owed to one or more of the Debtors) against the losses that ICSP covered. However, to settle various claims in the Debtors’ Chapter 7 bankruptcy proceedings, the United States and the Trustee agreed that the United States would waive its setoff rights.

ICSP's claim to set off the tax refund raises three issues regarding a performance bond surety's subrogation rights under Section 509 of the Bankruptcy Code, 11 U.S.C. § 509. We conclude, first, that the United States had not yet been "paid in full," within the meaning of Section 509(c), when the Bankruptcy Court approved the settlement. So, pursuant to Section 509(c), ICSP's subrogation rights were subordinate to the remaining and superior claims of the United States at the time of the settlement. Second, the United States was entitled to waive its setoff rights in order to settle its remaining and superior claims. Third, the United States’ waiver of its setoff rights extinguished ICSP's ability to be subrogated to those rights. Therefore, for the reasons discussed below, we will affirm the order of the District Court affirming the Bankruptcy Court's ruling that ICSP is not entitled to the tax refund.

I. BACKGROUND FACTS AND PROCEDURAL HISTORY

A. The Parties

Before they filed for bankruptcy, the Debtors provided general contracting services for large construction projects, including many projects for departments of the United States Government. To enter into contracts with the United States, contractors are generally required to post both a performance bond and a payment bond signed by the contractor and a qualified surety (such as ICSP). See generally 40 U.S.C. § 3131 et seq. (the "Miller Act"). Performance and payment bonds guarantee that the contractor will properly perform its contract and pay its subcontractors. See Hartford Fire Ins. Co. v. United States , 108 Fed. Cl. 525, 531 (2012) ("A surety bond is a three-party relationship, in which the surety becomes liable for the principal's debt or duty to the third party obligee."). In 2009, LTC and its affiliates (as the principal obligors) began obtaining surety bonds from ICSP (the surety) for a series of construction contracts with United States Government entities (the obligees), including the Department of Defense ("DoD").

BMO Harris Bank N.A. ("BMO"), the Appellee here, provided credit to LTC and its affiliates pursuant to a May 2013 agreement that granted BMO security interests in most of the Debtors’ property. In September 2014, the Bankruptcy Court entered an order approving a Memorandum of Understanding ("MOU") between BMO and the Trustee. The MOU acknowledged that BMO has first-priority security interests in certain federal tax refunds of the Debtors, including the Tax Refund at issue in this appeal (as defined further below).

B. The NPCC Contract, Breach, and Tender Agreement

Just one of the ICSP-bonded contracts is relevant to this appeal. In March 2012, LTC entered into a contract with the United States to construct the National Police Command Center in Afghanistan (the "NPCC Contract"). The contract price was approximately $55 million. Shortly thereafter, LTC executed a performance bond and payment bond, with ICSP as surety, for the NPCC Contract.¹

In January 2014, the United States terminated LTC's right to proceed under the NPCC Contract due to default. The United States then demanded that ICSP perform its suretyship obligations pursuant to the bonds for the NPCC Contract. A performance bond surety (like ICSP) generally may satisfy its obligation to the government on a defaulted contract in a number of ways, including "taking over and completing performance" or "assuming liability for the government's costs in completing the contract which are in excess of the contract price." Ins. Co. of the W. v. United States , 243 F.3d 1367, 1370 (Fed. Cir. 2001).

To satisfy its obligations here, ICSP entered into an August 2014 contract (the "Tender Agreement") with the United States and a new contractor, Macro Vantage Levant JLT ("MVL"), to complete the unfinished work under the NPCC Contract. MVL agreed to finish the construction work, and ICSP agreed to pay any "excess costs" for that performance — meaning any amount due beyond the funds that the United States had set aside based on the original contract price for the NPCC Contract. The Tender Agreement expressly provided that the "Surety's [ICSP's] bonds shall remain in force and effect during the performance of Work by [MVL] up to the complete expenditure of the penal sum of the Performance Bond." A364.

C. Timing of Payments and Construction under the Tender Agreement

From October 2014 through September 2016, ICSP paid over $12 million to MVL to complete the NPCC. On December 26, 2015, the United States sent MVL a "Letter of Substantial Completion" for the NPCC facility. The letter explained that "construction progress is sufficiently complete to allow the Government use and possession of the facility effective December 26, 2015 ." A382 (emphasis in original). ICSP made the final three payments, of over $600,000 each, on July 25, August 18, and September 7, 2016. After the penultimate payment, on August 24, 2016, the United States sent MVL a letter that stated: "As a result of the final inspection conducted February 10, 2016, it has been determined that your construction progress is sufficiently complete to allow the Government use and occupancy of the facility effective February 11, 2016 ." A389 (emphasis in original). The letter "release[d] the surety [ICSP] from all further liability and responsibility." Id.

D. The Bankruptcy Petition and the Tax Refund

Separately, on May 2, 2014, the Debtors filed voluntary Chapter 7 bankruptcy petitions. Shortly before doing so, in April 2014, they filed a consolidated federal tax return for 2013. The return showed net operating losses for 2013 and sought a "carryback" refund of approximately $5.5 million in federal income taxes that one or more of the Debtors had paid in 2011 (the "Tax Refund").² Because the Debtors had defaulted on many United States contracts, including the NPCC Contract, the United States placed a hold on payment of the Tax Refund, asserting the right to set off the $5.5 million against losses caused by the Debtors.

E. The United States’ and the Debtors’ Bankruptcy Claims

On October 28, 2014, the United States filed, in the Debtors’ bankruptcy proceedings, a summary proof of claim against the Debtors for a total of approximately $222 million (the "USPOC"). The USPOC included an $84 million "DoD Surety Claim," which consisted of contingent claims "related to Debtors’ breach of contracts resulting in a surety ... attempting to complete numerous DoD contracts," including the NPCC Contract. A100. The NPCC Contract claim was contingent on whether ICSP and MVL "fail to complete the [NPCC] Contract via the Tender Agreement." A156. The United States "expressly reserv[ed] its rights, pursuant to 11 U.S.C. § 553, to offset any prepetition obligation of the [United States] ... against any portion of this claim." A102. The United States amended the USPOC on May 24, 2016, reducing the total claim to $170 million. The amendment stated that $84 million of the total claim still stemmed from the DoD Surety Claim, which remained "contingent upon the completion of certain contracts by the Debtors’ sureties." A636.

As for the Debtors, they were also engaged in the litigation of various claims against the United States. Most of those claims were for allegedly unpaid invoices on certain contracts (the "Requests for Equitable Adjustments" or "REAs"). The bankruptcy Trustee testified that the REAs had a face value of over $50 million.

F. The Settlement Stipulation and ICSP's Objection

In January 2016, the Trustee and the United States reached a comprehensive proposed settlement of all of the claims between the United States and the Debtors (the "Settlement Stipulation"). Among other things, the Settlement Stipulation provided that: (1) the United States would release the full amount of the Tax Refund to the Trustee, and the United States would waive its setoff rights against the Debtors; (2) the USPOC would be allowed as filed and the United States would have a non-priority general unsecured claim of approximately $222 million (the claim was later reduced to approximately $170 million per the amended USPOC); and (3) the Debtors would dismiss, with prejudice, most of their pending litigation against the United States, including the litigation of the REAs. The Settlement Stipulation said nothing about subrogation rights.

Paragraph 4 of the...