In re JV Gleason Co.

• Decision Date: 17 December 1971
• Docket Number: No. 71-1029.,71-1029.
• Citation: 452 F.2d 1219
• Parties: In the Matter of J. V. GLEASON CO., Inc., Bankrupt. J. J. MICKELSON, Trustee in Bankruptcy for J. V. Gleason Co., Inc., Appellant, v. AETNA CASUALTY AND SURETY COMPANY, Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

452 F.2d 1219 (1971)

In the Matter of J. V. GLEASON CO., Inc., Bankrupt.

J. J. MICKELSON, Trustee in Bankruptcy for J. V. Gleason Co., Inc., Appellant, v. AETNA CASUALTY AND SURETY COMPANY, Appellee.

No. 71-1029.

United States Court of Appeals, Eighth Circuit.

December 17, 1971.

Hyman Edelman, Minneapolis, Minn., for appellant.

Mary Jeanne Coyne, Minneapolis, Minn., for appellee.

Before JOHNSEN, Senior Circuit Judge, GIBSON and LAY, Circuit Judges.

GIBSON, Circuit Judge.

The sole issue presented for review is whether a surety's equitable subrogation claim constitutes a "security interest" under the Minnesota Uniform Commercial Code, M.S.A. § 336.1-101 et seq., and is thus required to be filed in order to perfect as a lien against a trustee in bankruptcy.¹ The Referee in bankruptcy held it was not. The District Court affirmed. We affirm.

The facts are not in dispute. In 1967 and 1968 the J. V. Gleason Co., Inc., (the bankrupt) entered into five construction contracts with the State of Minnesota or one of its local governmental entities and gave both performance and payment bonds for each contract, with Aetna Casualty & Surety Co. as the surety. Each contract provided for progress payments based on the percentage of the work completed, subject to withholding a retained percentage pending completion. Gleason was unable to complete these contracts and Aetna as surety was called on to and did perform.

Gleason filed a petition for an arrangement proceeding on January 27, 1969, and was declared a bankrupt on April 22, 1969. This action between the trustee and Aetna, as surety, concerns the entitlement to the retained percentages earned by the bankrupt prior to default.

The Referee and District Court held that under the doctrine of subrogation an equitable lien was created at the time the surety completed performance on the contracts, and the lien related back in time to the making of the suretyship contract, thus giving the surety superior rights to the retained percentages.

Prior to the adoption of the Uniform Commercial Code the doctrine of equitable subrogation as respects a surety's right to be subrogated for loss incurred under the surety's contract was firmly established. Prairie State National Bank of Chicago v. United States, 164 U.S. 227, 17 S.Ct. 142, 41 L.Ed. 412 (1896) ; Henningsen v. United States Fidelity & Guaranty Company, 208 U.S. 404, 28 S.Ct. 389, 52 L.Ed. 547 (1908).²

Before the advent of the Uniform Commercial Code many states made no provision for the filing of notice of equitable liens or of claims against future earnings such as might arise by way of operation of law through the equitable subrogation lien doctrine in surety cases. The Uniform Commercial Code provides that transactions involving a "security interest" shall be filed,³ and this broad requirement could be viewed as including equitable claims and suretyship agreements.

In this case Aetna paid the claims of laborers and materialmen, which were far in excess of the amounts retained during the performance period by the owner. It is conceded that the owner had the right to use the retained funds to complete the work and pay laborers and materialmen from the fund, that the laborers and materialmen had an equitable right to be paid out of these funds, and further that their claims were not required to be filed in order to be perfected.

The referee denied the claims of Aetna that were based upon the express assignment contained in each suretyship contract,⁴ but allowed the claims based on equitable subrogation. The liens allowed by the referee were those resulting by operation of law for funds expended by the surety in paying off obligations that were a proper charge against the retained funds held by the owner. Thus where the surety's claim could rest on the principle of equitable subrogation it was held not to be a "security interest" under the Uniform Commercial Code and consequently need not be filed.

The trustee directs a two-pronged attack, contending (1) that the surety's claim against retained funds is a "contract right" under the Uniform Commercial Code, operating as an assignment of future earnings given to secure performance by the principal, and thus is a "security interest" required to be filed under the Code, and further that the surety's right of equitable subrogation on retained funds arises from and relates back to the original contract of surety, citing Prairie State National Bank of Chicago v. United States, 164 U.S. 227, 17 S.Ct. 142, 41 L.Ed. 412 (1896), and (2) that the 1950 amendment of § 60 of the Bankruptcy Act, 11 U.S.C. § 96, abolishes equitable liens where available means of perfecting legal liens exists.

We first consider whether a surety claim arising under the doctrine of equitable subrogation is a "security interest" under the Uniform Commercial Code.

Section 1-103 of the Uniform Commercial Code, adopted as M.S.A. § 336.1-103, provides :

"Unless displaced by the particular provisions of this chapter, the principles of law and equity, including the law merchant and the law relative to capacity to contract, principal and agent, estoppel, fraud, misrepresentation, duress, coercion, mistake, bankruptcy, or other validating or invalidating cause shall supplement its provisions."

The Code is silent on the subject of subrogation and equitable liens created thereby ; however, some authorities have hypothesized that a provision which was considered, but not included by the drafters,⁵ indicates that they considered the equitable lien to be a security interest. This provision was rejected by the Editorial Board of the Code as being contrary to existing law and its failure to accept the provisions negates the trustee's claim that equitable subrogation rights constitute security interests. In fact this indicates an intentional recognition of and a desire to preserve the doctrine of equitable subrogation.⁶

The scope of the application of Article 9 is contained in § 9-102. It provides : "(1) * * * This article applies * * * (a) to any transaction (regardless of its form) which is intended to create a security interest in personal property * * * including * * * accounts or contract rights ; * * *." The official comment which accompanies this section indicates that this section was intended to apply to all consensual security arrangements under the Code.⁷ Obviously, the equitable lien, having been created by courts of equity, does not arise from the consent of the parties or by their intent, but by operation of law. Section 9-102(2) provides that the Article applies to "security interests created by contract." In the case of an equitable lien which arises because of the subrogation, the interest is not created by the contract but by law to avoid injustice. The Pennsylvania Supreme Court said :

"Rights of subrogation, although growing out of a contractual setting and ofttimes articulated by the contract, do not depend for their existence on a grant in the contract, but are created by law to avoid injustice. Therefore, subrogation rights are not `security interests\' within the meaning of Article 9." Jacobs v. Northeastern Corp., 416 Pa. 417, 429, 206 A.2d 49, 55 (1965).

In the instant case, where the lien arose by operation of law, independent of any consensual agreement, it would seem clear that Article 9 dealing with consensual security interests would not be applicable. The trustee's position would have substance as to the contract of suretyship, absent an applicability of any statutory exceptions in the Code, if the surety's lien claim rests solely on the contract.

There is no reason to assume that the provisions of Article 9, are applicable to the suretyship situation. The surety's position is quite different than that of the commercial lender, who is obviously the primary target of Article 9.⁸ The First Circuit appropriately pointed this out in National Shawmut Bank of Boston v. New Amsterdam Casualty Co., 411 F.2d 843, 845 (1969) :

"This unique accumulation of subrogation rights serves to induce a function that is neither ordinary insurance nor ordinary financing. * * * Neither is the business one of ordinary financing, for while the surety extends its credit to the owner * * *, as the ultimate guarantee that the job will be done, this is a credit that may either never have to be drawn upon or, if it is drawn upon at all, will in all likelihood be overdrawn."

The trustee's heavy emphasis on the need for notice is fully answered by the Court in Jacobs v. Northeastern Corp., 416 Pa. 417, 206 A.2d 49, 54 (1965) :

"None of the purposes or objectives of the Code\'s filing requirements would be served by holding that the subrogation to the contract balance now due is an assertion of a `security interest\' and therefore subject to the filing provisions of Article 9. The contract balance withheld would never have become due and payable * * * as long as Northeastern defaulted on its obligation to pay labor and materialmen. Payment of the retained balance became due and available only upon performance by the sureties of Northeastern\'s obligations. * * *.

* * * * * *

"It seems exceedingly clear that in the present suretyship situation filing is not needed to prevent deceiving or misleading the creditors about the state of the contractor\'s available assets. Furthermore, filing in this instance could in no conceivable way be beneficial to or protective of the general creditors. * * * Since the funds here at issue represent an asset never available to general creditors, there is no reason for requiring the filing of a financing statement by the sureties."

It should be noted that one of the express purposes and policies underlying the Code is "to make uniform the law among the various jurisdictions." § 1-102(2) (c). This purpose would be ill-served if we were to hold for the trustee. All of the still viable decisions hold that the doctrine of equitable subrogation in suretyship cases has not been...