In re Merts Equipment Co.

• Decision Date: 04 October 1977
• Docket Number: No. 76-56-ALB.,76-56-ALB.
• Citation: 438 F. Supp. 295
• Parties: In re MERTS EQUIPMENT COMPANY, Bankrupt. UNITED STATES FIDELITY AND GUARANTY COMPANY, Appellant, v. J. L. LEACH, trustee, Appellee.
• Court: U.S. District Court — Middle District of Georgia

438 F. Supp. 295

In re MERTS EQUIPMENT COMPANY, Bankrupt.

UNITED STATES FIDELITY AND GUARANTY COMPANY, Appellant, v. J. L. LEACH, trustee, Appellee.

No. 76-56-ALB.

United States District Court, M. D. Georgia, Albany Division.

October 4, 1977.

Walter H. Burt, III, Burt, Burt & Rentz, Albany, Ga., Jeffrey L. Sakas, Jessee, Ritchie & Duncan, Atlanta, Ga., for U. S. Fidelity & Guaranty.

E. Lewis Adams, Albany, Ga., for Trustee J. L. Leach, Albany, Ga.

OWENS, District Judge:

In this bankruptcy appeal, United States Fidelity and Guaranty Co. (U.S.F. & G.) challenges the decision of the bankruptcy judge that it had no secured interest in the bankrupt's equipment. U.S.F. & G. claimed it was secured by virtue of a master surety agreement which it entered into with the bankrupt. The agreement supposedly created an equitable lien on the equipment in question. The bankruptcy judge refused to find such a lien and held that in the absence of a security interest perfected in accordance with the Uniform Commercial Code, the surety could not prevail over the trustee with respect to the bankrupt's equipment.

I.

On April 11, 1974, Merts Equipment Company (Merts), the bankrupt, and R. H. Coody & Associates, Inc. (Coody) entered into a master surety agreement with U.S.F. & G. in which Merts promised to indemnify U.S.F. & G. against all loss occasioned by the default of Coody in any of its several construction projects. Although the record is not clear on this point, Merts apparently had an interest in the ability of Coody to post payment and performance bonds on various projects because Merts leased to Coody construction equipment necessary for the completion of the projects. During a period of approximately six months in 1974, U.S.F. & G. issued eight bonds on four separate Coody projects. However, in June 1975, Coody notified U.S.F. & G. that it would not complete the projects in question. The surety completed them as it was obligated to do under the bonds and, as a result, sustained losses of $850,000 on the four projects. In March 1976, the surety sought indemnification from its principals, Coody and Merts and, in consequence, Merts chose to go into bankruptcy. The trustee sold the equipment at public sale and U.S.F. & G. now seeks a priority with respect to the proceeds of that sale.

The surety argues that upon default of the contract the master surety agreement assigned automatically all contract fund retainages and all equipment of the contractor, thereby creating an equitable lien on the equipment of the principal-indemnitor, Merts. U.S.F. & G. further argues that this equitable lien is not subject to Article 9 of the U.C.C. and cites as authority for this proposition a recent Georgia court of appeals decision which held that the surety's equitable lien in contract retainages will prevail over an assignee bank's U.C.C. secured interest in those funds. Argonaut Ins. Co. v. C & S Bank of Tifton, 140 Ga.App. 807, 232 S.E.2d 135 (1976). In the instant case, however, the bankruptcy judge found compelling the distinction between equipment and contract funds, holding that equipment is always subject to the U.C.C. filing requirements. The bankruptcy judge viewed Merts not as the chief principal under suretyship, but rather as indemnitor. Thus he concluded that "an unperfected security interest cannot ride piggy-back on an equitable lien or subrogation right in order to give the surety priority over the general creditors of the principal, much less over general creditors of an indemnitor."

The trustee argues in this appeal that the bankruptcy judge's decision must be sustained for the sole reason that the surety did not file a financing statement as required by the U.C.C.

II.

The law is clear that the surety enjoys a special place with respect to retained contract funds which become available because the surety completes a construction project. Several courts have held that the surety has an equitable lien upon the contract funds and that by virtue of this lien the surety takes precedence over the trustee in bankruptcy of a bankrupt contractor. Collier's 4A Bankruptcy ¶ 70.62. This same line of cases has been followed in Georgia in Argonaut Ins. Co. v. C & S Bank of Tifton, supra, which involved not a trustee as hypothetical lien creditor, but rather the actual secured assignees of the contract funds who had perfected their secured interest in the funds in accordance with Article 9 of Georgia's Uniform Commercial Code. The court reasoned that because of the equitable doctrine of subrogation, the surety had priority over secured creditors to contract funds which became available as a result of the surety's completion of projects upon which the debtor-contractor had defaulted.

The equitable rights of the surety in these cases is founded upon the common sense proposition that the contract retainage funds would never become available to any creditor unless the surety completed the project. Stated differently, the contract funds were never really in the possession of the contractor, either as an asset for his general creditors or as collateral for the secured creditor, because the payment of the funds is conditioned upon the completion of the construction project:

This is not an interest in or lien upon, property or funds in the possession or control of the bankrupt contractor. Until the obligation to the city owner was fulfilled the bankrupt had no claim upon the retained funds.

In re Bray, 127 F.Supp. 627, 628 (D.Conn. 1954).

Thus, the surety who completes the project is given first chance at the contract funds even if other creditors of the bankrupt contractor have previously secured their interest in the funds. The consequence of this equitable lien or equitable subrogation doctrine is that an exception is created to the general rule that only those creditors who perfect a security interest by following the U.C.C. or by obtaining a lien judgment can prevail over the trustee in bankruptcy, who, as of the day of the filing of the petition, stands in the position of a judgment creditor.

The question in this case, however, is whether the surety can assert this equitable lien in the equipme...