In re ADL Contracting Corp.

• Decision Date: 09 August 1995
• Docket Number: Bankruptcy No. 93-B-20725.
• Citation: In re ADL Contracting Corp., 184 B.R. 436 (Bankr. S.D.N.Y. 1995)
• Parties: In re ADL CONTRACTING CORPORATION, Debtor.
• Court: U.S. Bankruptcy Court — Southern District of New York

184 B.R. 436 (1995)

In re ADL CONTRACTING CORPORATION, Debtor.

Bankruptcy No. 93-B-20725.

United States Bankruptcy Court, S.D. New York.

July 27, 1995.

As Corrected August 9, 1995.

COPYRIGHT MATERIAL OMITTED

Law Office of Charles A Sherwood by Charles Sherwood, New Haven, CT, for F & W Welding Service Inc.

Lambert & Weiss by Richard Isgard, New York City, for Aetna Cas. and Sur. Co.

U.S. Atty. for the S.D. of N.Y. by Aimee Wolfson, New York City, for I.R.S.

Law Office of Jeffrey L. Sapir, by Gloria Herzig Indik, White Plains, NY, for ADL Contracting Corp.

Decision Determining Entitlement to Funds Withheld Pending Completion Of A Construction Project

JOHN J. CONNELLY,^* Bankruptcy Judge.

The question presented here is which of three creditors has priority to funds presently held in escrow by the attorney for the debtor, ADL Contracting Corporation ("ADL"). The escrowed funds represent the proceeds of a settlement of a breach of contract suit brought by ADL against the Town of Orange ("Town") over a construction project commenced in December 1986 ("the Project"). The first creditor, Aetna Casualty and Surety Company ("Aetna"), asserts entitlement to the proceeds as subrogee as a result of payments it made to various subcontractors of the debtor after ADL failed to complete the project. The second creditor, F & W Welding Service, Inc. ("F & W"), who leased certain equipment to ADL in connection with the project, argues that its judgment lien is superior to both Aetna's claim to the proceeds as well as the IRS's claim which is based upon a tax lien. The IRS, the third creditor, concedes that it does not have priority vís-a-vís Aetna, yet, asserts that its tax lien is superior to F & W's claim since its tax lien ripened prior to F & W's judgment lien. For the following reasons, I hold that F & W has the superior claim as an unpaid subcontractor under Connecticut law irrespective of its status as a judicial lien creditor.

BACKGROUND

On December 12, 1986, ADL, as general contractor, entered into a contract worth approximately $2.1 million with the Town for the installation of sewer pipelines.¹ Under the terms of the contract, the Town was authorized to make progress payments and withhold a certain percentage of the amount due monthly, pending completion of the project ("retainage"). Approximately $80,000 was held by the Town at the time F & W was informed that the project would not be completed. (Sherwood Aff. ¶ 30). Apparently, ADL failed to complete one of its final obligations to resurface the area housing the newly installed sewer pipelines. F & W Welding, 217 Conn. at 510-11, 587 A.2d at 94-95. As a consequence, an independent subcontractor finished the last phase of the project and the Town ultimately ended up paying more-or-less the amounts budgeted for that job. Id. On December 21, 1988, the Town announced that the contract had been "substantially completed." Id. Thereafter, however, a dispute erupted between the debtor and the Town over some of the work performed and on April 14, 1989, ADL notified the Town that it would not complete the contract. Id.

Skipping ahead for the moment, ADL filed a suit against the Town of Orange for breach of contract in the United States District court in Connecticut. While the action was pending, an involuntary chapter 11 petition was filed against ADL on April 13, 1993. Judge Schwartzberg signed an Order for Relief on December 15, 1993. Shortly thereafter, ADL and the Town of Orange agreed to resolve the suit for $50,000. (Isgard Aff. ¶ 6). After the settlement was approved by the District Court, $32,781.54, the balance of the proceeds after legal fees, was deposited in escrow with ADL's counsel, Jeffrey Sapir. (Isgard Aff. ¶ 7).²

F & W's claim to the settlement funds arises from events related to ADL's performance of the project. As part of the project, ADL rented certain equipment from F & W Welding Service which was used in the construction of the pipelines. F & W Welding, 217 Conn. at 510, 587 A.2d at 94. Apparently, ADL failed to pay the rental fees for the equipment and F & W pursued and obtained from the Superior Court of Connecticut an order authorizing F & W to garnish the retainage. Id. Along with this pre-judgment remedy, F & W commenced a suit in the Superior Court to collect the amounts owed. Id. at 511, 587 A.2d at 95. The suit was ultimately settled, and on June 9, 1989, the court so ordered a stipulation for judgment in favor of F & W in the amount of $25,153.34. Id. Execution of the judgment issued on July 20, 1989 when demand was made; the demand remained unsatisfied when the Town refused to pay. Id.

Thereafter, F & W both filed a judgment lien upon the property of ADL in accordance with Connecticut law and commenced an action attempting to compel the turnover of the retainage held by the Town of Orange. Id. The Connecticut Superior Court determined that the garnishment was ineffective since the retainage had yet to become ADL's property. F & W Welding, 217 Conn. at 513, 587 A.2d at 95. The lower court's ruling was ultimately affirmed by the Connecticut Supreme Court on February 26, 1991. Id. at 515, 587 A.2d at 96.

Shortly thereafter, as part of the garnishment action, on August 21, 1989, F & W commenced an action in state court seeking a determination of priorities as to the retainage held by the Town. (Sherwood Aff. ¶ 16; Sherwood Aff. Ex. E). The following creditors were named as defendants: the IRS, Aetna, the Town of Orange, Barclay's Bank of New York and Codesponti Design. Only Aetna and the IRS responded as contestants. (Sherwood Aff. ¶¶ 17, 18). Barclay's Bank of New York and Codesponti did not assert a claim to the proceeds. (Sherwood Aff. ¶ 18). The trial court found that since there was no fund available, a hearing determining priorities was similarly premature. (Sherwood Aff. ¶ 23).

Upon the filing of the bankruptcy petition, and after the suit between ADL and Town was settled and the portion of the retainage escrowed, this motion was made by F & W for an order determining priority as to the proceeds.³ F & W now asserts that its judgment lien is superior to Aetna's interest in the settlement funds because Aetna never completed the project as it contracted to do under the performance bond it issued. (F & W Mem. at 9-12). F & W also maintains that the retainage which was held by the Town of Orange at the time of the tax assessment was not ADL's "property" upon which the IRS's tax lien can attach. (F & W Mem. at 7-9).

Aetna's claim to the retainage flows from its issuance of a performance bond and a payment bond on the December 12, 1986 contract between the Town and ADL. (Isgard Aff. ¶ 2). As I just mentioned, Aetna chose not to complete the project as it had contracted to do under the performance bond, but instead paid a total of $175,022.26 to various subcontractors in satisfaction of its obligation under the payment bond. (Isgard Aff. ¶ 3; Sherwood Aff. ¶ 29). Aetna now argues that its claim to the retainage is superior to the other contestants under the case law of Connecticut.

The IRS's claim to the proceeds arises from a tax assessment made against ADL on May 6, 1989 for $113,678.38. (IRS's Mem. at 2; IRS's Ex. B). The IRS filed a Notice of Tax Lien with the Secretary of State of New York on May 30, 1989. (IRS's Mem. at 2). In a letter dated July 20, 1994, the IRS acknowledged that Aetna has priority over the IRS to the settlement proceeds. (Letter from IRS dated 7/20/94 at 1-2). However, as between F & W and the IRS, the IRS claims that its tax lien is superior to F & W's judgment lien. (IRS's Mem. at 2-5).

Shortly after my arrival in this district as a visiting judge, the parties appeared before me for oral argument on July 13, 1994 at the end of which I asked the parties to file shortly thereafter any memoranda which they wished me to consider in rendering my decision. At that hearing I heard arguments which surprisingly, neither side had raised in the written submissions which preceded the motion or even in submissions filed subsequent to the hearing. To be clear, F & W has not argued in any of its written submissions that it is entitled to share pari passu with Aetna or that it has equitable rights under Connecticut law which are superior to those of Aetna. Instead, its written submissions rely solely on its rights to the retainage as a judicial lien creditor. (F & W Mem at 6-7). Likewise, Aetna's written submissions failed to address either of these two possibilities. It was only at oral argument that counsel for F & W first surmised (in response to an argument raised by counsel for Aetna) that F & W had a superior equitable right to the retainage as an unpaid materialman. In response to this "new" argument, counsel for Aetna back-pedalled and urged that at a minimum his client was entitled to receive an amount in the vicinity of eighty-eight percent of the retainage (which figure he calculated assuming a pro rata distribution).

DISCUSSION

A. Performance and Payment Bonds Generally

When a surety issues a performance bond, the surety guarantees to the owner that the project will be completed at a certain price irrespective of whether the contractor is able to complete the project. See Pearlman v. Reliance Insurance Company, 371 U.S. 132, 140, 83 S.Ct. 232, 236, 9 L.Ed.2d 190 (1962); Trinity Universal Ins. Co. v. United States, 382 F.2d 317, 320 (5th Cir.), cert. denied, 390 U.S. 906, 88 S.Ct. 820, 19 L.Ed.2d 873 (1968) (quoting United States v. Munsey Trust Co., 332 U.S. 234, 244, 67 S.Ct. 1599, 1604, 91 L.Ed. 2022 (1947)); National Shawmut Bank of Boston v. New Amsterdam Casualty Co., 411 F.2d 843, 845 (1st Cir.1969) (discussing the business considerations of construction bond insurance). In contrast, a payment bond is an agreement whereby the surety agrees to pay those who furnish labor or materials to a project upon default by the contractor. See Pearlman, 371 U.S. at 140, 83 S.Ct. at 236; see also 40...