In re Bay State York Co., Inc., Bankruptcy No. 91-10187-JNG
| Decision Date | 29 May 1992 |
| Docket Number | Adv. No. 91-1425-JNG.,Bankruptcy No. 91-10187-JNG |
| Citation | 140 BR 608 |
| Court | U.S. Bankruptcy Court — District of Massachusetts |
| Parties | In re BAY STATE YORK COMPANY, INC., Debtor. Jeffrey A. KITAEFF, Chapter 7 Trustee of Bay State York Company, Inc., and Jager, Smith, Stetler & Arata, P.C., Plaintiffs, v. VAPPI & COMPANY, INC., Ronald F. Cahaly, as Trustee of the Union Square Development Trust, and Hartford Casualty Insurance Company, Defendants. |
Bruce F. Smith, Jager, Smith, Stetler & Arata, P.C., Boston, Mass., for plaintiffs.
Peter G. Hermes, Peabody & Arnold, Boston, Mass., for defendants.
This case is presently before the Court on cross-motions for summary judgment. The issue is whether Hartford Casualty Insurance Company ("Hartford") can set off an obligation it owes Bay State York Company, Inc. ("BSY"), a subcontractor protected by a payment bond executed between Hartford as surety and Vappi & Co., Inc. ("Vappi") as principal, against a debt that BSY owes Hartford from other, unrelated payment and performance bonds executed between BSY as principal and Hartford as surety. For the reasons set forth below, this Court will allow Hartford to utilize the setoff provisions of the Bankruptcy Code.
The parties have submitted a Statement of Agreed Facts for purposes of their cross-motions for summary judgment. Since there are no material facts in dispute, the matter is ripe for summary judgment. See Federal Rule of Bankruptcy Procedure 7056.
Hartford is an insurance and surety company organized under the laws of New Jersey. Hartford is in the business of issuing performance bonds and payment bonds to various contractors and subcontractors. BSY is a Massachusetts business corporation formerly in the heating, ventilating and air-conditioning ("HVAC") business.
On January 8, 1991, an involuntary bankruptcy petition was filed against BSY. Jeffrey A. Kitaeff is the duly appointed and qualified Chapter 7 Trustee.
Prior to November 13, 1990, Hartford as surety and BSY as principal executed various labor and material payment bonds and performance bonds in favor of various obligees in connection with HVAC contracts and subcontracts between BSY and various entities (the "BSY Bonds"). On or about May 15, 1987, and July 19, 1988, in connection with the BSY Bonds, BSY executed General Indemnity Agreements through which it agreed, inter alia, to indemnify Hartford against any loss resulting from the BSY Bonds.
Hartford incurred losses on the BSY Bonds as a result of having made payments and incurred other expenses in excess of two million dollars. Of this amount, Hartford paid in excess of $500,000 after November 13, 19901 but prior to January 8, 1991, the date the involuntary bankruptcy petition was filed against BSY.
On or about August 12, 1987, Hartford issued to Vappi a labor and material payment bond ("Vappi Bond") in connection with Vappi's obligations as general contractor on a project in Allston, Massachusetts, known as the Union Square Project.2 BSY was a subcontractor to Vappi on the Union Square Project.
Vappi failed to pay BSY for labor, services and materials rendered to and on behalf of Vappi on the Union Square Project. On October 27, 1989, BSY commenced an action against Vappi in the Massachusetts Superior Court of Suffolk County to recover $425,790.93 for labor, services and materials expended on the Union Square Project.
On June 8, 1990, BSY filed a motion in state court to amend its complaint to add Hartford as a defendant. BSY alleged that Hartford, as surety, was liable to BSY pursuant to the Vappi Bond for the amount that Vappi owed BSY. The Superior Court allowed BSY's Motion to Amend Complaint on July 11, 1991. Shortly thereafter, BSY served the Amended Complaint upon Hartford. On July 29, 1991, Hartford removed the Superior Court action to this Court, where it is now pending.
In Hartford's Answer to the Amended Complaint, Hartford asserted an affirmative defense of setoff to BSY's claim. Nevertheless, Hartford admitted that, subject to its defense of setoff and an additional contractual defense regarding a condition precedent for payment, BSY was owed not less than $320,000 for the Union Square project.
The parties agree that the asserted obligations of BSY to Hartford arose prior to the filing of the involuntary bankruptcy petition against BSY on January 8, 1991, and that the obligation of Hartford to BSY arose more than ninety days prior to the filing of the petition.
The Chapter 7 Trustee of Bay State York maintains that he is entitled to summary judgment on several grounds: 1) Hartford has no right of setoff arising from the doctrine of equitable subrogation; 2) Hartford cannot achieve a setoff under the doctrine of indemnification because there is a lack of mutual debt; and 3) it would be inequitable to allow a setoff under the circumstances of this case.
With respect to the first of his arguments, the Trustee principally relies on the case of Western Casualty and Surety Co. v. Brooks, 362 F.2d 486 (4th Cir.1966). In that case, the court articulated the issue before it as follows: "The question presented on this appeal is the right of a surety on two public construction contracts, both performed by the same contractor, to setoff losses incurred on one bond with the excess realized on the other." 362 F.2d at 487.
The facts in Western Casualty are straightforward. Western Casualty was surety on two bonds executed by a bankrupt company, Bruns Coal Company, Inc. ("Bruns"), with respect to two separate road construction projects undertaken for the State of Ohio.
In the application for the bonds, Bruns assigned to Western Casualty as collateral security all sums held by the state for Bruns at the time of any breach. These sums were to be available for Western Casualty to offset losses incurred on any other bonds between the two parties.
Bruns completed construction work on the two projects but failed to pay certain subcontractors, laborers and materialmen who then filed mechanic's liens with the state. The state withheld all sums due Bruns, and Western Casualty satisfied the various claims. Bruns notified the state to send all future payments to Western Casualty. On one project the payments by the state exceeded the payments made by Western Casualty to the subcontractors, while on the other project the surety suffered a significant loss.
When Bruns was adjudged a bankrupt, the trustee sought turnover of the sums paid to the surety, claiming the payments to Western Casualty were voidable preferences. The Referee agreed, finding that the equitable doctrine of subrogation was inapplicable. The Referee and the District Court determined that the excess payments realized on one project could not be applied to offset the losses incurred by Western Casualty on the other project.
The Court of Appeals, in affirming the lower court, began its discussion by noting that the surety acquired an equitable interest on the funds retained by the state. The court described this interest as a property interest that related back to the date of the surety bond and never became a part of the bankruptcy estate. See Pearlman v. Reliance Ins. Co., 371 U.S. 132, 83 S.Ct. 232, 9 L.Ed.2d 190 (1962). However, the court went on to state that the surety could not by way of subrogation assert any greater rights than the creditor in whose shoes it was substituted. Accordingly, the court determined that the surety could not retain any of the funds on either project in excess of the claims of laborers and materialmen it paid on each individual project because to do so "would be contrary to the equal equities which other general creditors have in the property of the bankrupt." 362 F.2d at 491.
Although the Trustee correctly notes that the present case does not involve contract balances, he argues that the legal principles set forth in Western Casualty should be applied to the instant case. In his words, "the laborers and materialmen who performed work on contracts entered by BSY, and who were paid by Hartford under the BSY Bonds, would not have equitable rights, to which Hartford would succeed, to recover monies due BSY under the Vappi Bond — other than those of a general unsecured creditor."
Hartford rejects the Trustee's subrogation argument in its entirety. It maintains that it has a right of indemnification against BSY arising from written contracts, not by way of subrogation, and that the proof of claim it filed so indicates. Indeed, it states that "subrogation has nothing to do with this adversary proceeding."
With respect to his indemnification argument, the Trustee asserts that Hartford cannot achieve a setoff by establishing BSY's liability under a theory of indemnification where it cannot achieve a setoff under a subrogation theory. With respect to this argument, the Trustee principally relies on Springfield Nat'l Bank v. American Surety Co. of N.Y., 7 F.2d 44 (6th Cir.1925). In that case, the American Surety Company executed two bonds, one as surety for the Springfield National Bank to secure a $50,000 deposit made by the State of Ohio in the Springfield National Bank and the other as surety on a bond executed by an individual named Penfield for the faithful performance of his duties as a bank cashier. Penfield defrauded the bank, resulting in its insolvency and the appointment of a Receiver. The State of Ohio filed a proof of claim against the bank which was allowed. The certificate of allowance issued to the state was assigned by the state to American Surety upon the payment by the surety of its full liability to the state on the deposit bond. Subsequently, the Receiver paid the surety company on the proof of claim filed by the state. The surety then sought to set off the difference between the amount it received on the assigned proof of claim and what it paid to the...
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