Island Ins. Co. v. Hawaiian Foliage & Landscape
| Decision Date | 03 May 2002 |
| Docket Number | No. 00-16940.,No. 00-16874.,00-16874.,00-16940. |
| Citation | 288 F.3d 1161 |
| Parties | ISLAND INSURANCE COMPANY, LTD., Plaintiff-Appellee, v. HAWAIIAN FOLIAGE & LANDSCAPE, INC., a Hawaii corporation; Kenneth Kato; Oahu Construction Company, a Hawaii corporation; State of Hawaii, a governmental entity; Seiji Naya; Ray K. Kamikawa; Lorraine H. Akiba; CB Bancshares, Inc., a Hawaii corporation, Defendants, and United States of America, a governmental entity, Defendant-Appellant. Island Insurance Company, Ltd., Plaintiff-Appellee, v. Hawaiian Foliage & Landscape, Inc., a Hawaii corporation; Kenneth Kato; Oahu Construction Company, a Hawaii corporation; United States of America, a governmental entity; Seiji Naya; Ray K. Kamikawa; Lorraine H. Akiba; CB Bancshares, Inc., a Hawaii corporation, Defendants, and State of Hawaii, a governmental entity, Defendant-Appellant. |
| Court | U.S. Court of Appeals — Ninth Circuit |
John A. Dudeck, Jr., Tax Division, United States Department of Justice; Roxann C. Bulman and Kurt Kawafuchi, Department of the Attorney General, State of Hawaii, for the defendants-appellants.
Michael N. Tanoue, The Pacific Law Group, Honolulu, HI, for the plaintiff-appellee.
Appeal from the United States District Court for the District of Hawaii; David A. Ezra, District Judge, Presiding. D.C. No. CV-97-01084-DAE.
Before: THOMPSON, O'SCANNLAIN and BERZON, Circuit Judges.
The question in this case is whether the government is an intended beneficiary, for the purpose of securing the payment of taxes due, of the surety bond that insured a subcontractor's performance. Parties to surety contracts are free, of course, to choose whether or not to insure for tax obligations. We interpret the language of the contract in this case to have done so and therefore hold that both the state and federal governments are intended beneficiaries of the surety contract to the extent of the subcontractor's past due tax obligations.
Oahu Construction Co. ("Oahu" or "obligee" or "prime contractor") contracted with the City and County of Honolulu to build a golf course. Oahu subcontracted some landscaping work to Hawaiian Foliage & Landscape, Inc. ("Hawaiian" or "subcontractor" or "principal"). Plaintiff-appellee Island Insurance Co. ("Island" or "the surety") issued a "Subcontractor's Performance and Payment Bond" ("the bond") to insure Hawaiian's performance. Hawaiian was required by its contract with Oahu ("the subcontract") to obtain such a bond. The bond named Hawaiian as principal and Oahu as obligee and was for the amount of $2,698,787, the amount to be paid for work performed under the subcontract.
Hawaiian eventually defaulted on the subcontract, and Island paid various of Hawaiian's obligations. Island refused, however, to pay the subcontractor's tax debts. Instead, Island sought a judgment declaring that it is not liable under the bond for employment taxes owed to the United States and to Hawaii ("the governments"). The governments filed counterclaims demanding the unpaid taxes. With penalties and interest, these counter-claims amount to $426,039 by the United States and $133,259 by Hawaii. All the parties moved for partial summary judgment on the issue of the surety's liability.
The district court granted the surety's motion, finding that the governments were not intended beneficiaries of the bond and therefore the surety was not liable for the subcontractor's unpaid taxes.
As this case is before us on summary judgment, we review the judgment de novo. Branco v. UFCW-Northern California Employers Joint Pension Plan, 279 F.3d 1154, 1156 (9th Cir.2002). Here, the pivotal question is one of contract interpretation.
Federal courts look to state law to construe common law surety contracts. Mai Steel Serv., Inc. v. Blake Constr. Co., 981 F.2d 414, 420 (9th Cir.1992). In construing contractors' bonds, Hawaii law applies traditional principles of contract interpretation. See Van Dusen v. G.S. Shima Contracting, Inc., 4 Haw.App. 261, 664 P.2d 753, 754 (1983). Under those traditional contract principles, "the terms of a contract should be interpreted according to their plain, ordinary and accepted use in common speech, unless the contract indicates a different meaning." Pancakes of Hawaii, Inc. v. Pomare Properties Corp., 85 Hawai'i 300, 944 P.2d 97, 102 (App.1997) (internal citations and quotation marks omitted). Barring ambiguity, then, our focus should be on the contractual language.
Appellants make a simple and convincing argument from the texts of the subcontract and bond. The subcontract mentions taxes in two places. The first sentence of Article I states: "Subcontractor agrees to pay in full for all labor, materials, equipment, supplies, superintendence, insurance, taxes, and other items used in, upon, or for the work called for in this Agreement." (Emphasis added). Article XIV states:
(Emphasis added).
It is apparent from these two passages that the subcontract required the subcontractor to pay its payroll taxes.
The bond states:
"Now, therefore, if the said Principal [Hawaiian] shall duly and truly perform and complete said subcontract and pay for all materials used in the performance of same and shall hold the said Obligee [Oahu] free and harmless from and against all claims for any and all labor and materials used in the performance of said subcontract, which may or shall arise by reason of the failure of the said Principal to furnish, deliver and pay for any and all labor and materials in connection with the said subcontract, then this obligation shall be null and void; otherwise to remain in full force and effect." (Emphasis added).
The bond's language is archaic and awkward. As we read it, the bond lists three conditions in parallel, the breach of any of which will create an obligation on the part of the surety. The first of these conditions incorporates the entire subcontract: "Principal shall duly and truly perform and complete said subcontract."1 So, taken together, the texts of the two contracts do designate the payment of federal and state taxes as one of the bond's conditions for discharge. The subcontractor was bound to pay its taxes, the surety insured the subcontractor's obligations under the subcontract, and so the surety is now bound to pay the taxes the subcontractor defaulted upon.
Once we accept that the surety was bound to cover the subcontractor's tax obligations, it follows that the federal and state governments are intended beneficiaries of the surety contract. Under the Restatement (Second) of the Law of Contracts2 an individual or entity is an intended beneficiary of a contract if "recognition of a right to performance in the beneficiary is appropriate to effectuate the intention of the parties and either (a) the performance of the promise will satisfy an obligation to the promisee to pay money to the beneficiary or (b) the circumstances indicate that the promisee intends to give the beneficiary the benefit of the promised performance." Restatement (Second) of Contracts § 302(1) (1979 Main Vol.).
Term (a) applies in this case. Island, the promisor, has promised to ensure the performance of the subcontract entered into by Hawaiian, the promisee. That subcontract includes a commitment to pay taxes. Island will therefore "satisfy an obligation to the promisee to pay money to the beneficiary" by paying Hawaiian's unpaid taxes. And because the governments are intended beneficiaries, "a direct action by beneficiary against promisor is normally appropriate to carry out the intention of promisor and promisee." Restatement (Second) of Contracts § 302 Comment b. On this view, the governments are in an analogous position to that of other creditors — those that supplied materials, for example — who would suffer from the subcontractor's default.3
One of Island's arguments to the contrary is based not on the text of the contracts but on assertions concerning the purpose of surety bonds. Island maintains that the bond's primary beneficiary is the contractor, and the contractor is not liable for the subcontractor's unpaid taxes, so the government cannot be a third-party beneficiary to the bond.
A Tenth Circuit case, United States Fidelity & Guaranty Co. v. United States, 201 F.2d 118, 120 (10th Cir.1952), did rely on similar reasoning, noting that an employer's duty to pay taxes is his alone, and concluding from that premise that the surety and bond did not confer that obligation. There are, however, certain circumstances under which a third party can be held liable for unpaid withholding taxes, see 26 U.S.C. § 3505(a) & (b) and Haw. Rev.Stat. § 235-61(a)(3)(B), although these statutory provisions apply only when the third party either pays wages directly or controls the payment of wages.
The taxes sought in this case, however, accumulated at a time when Hawaiian controlled its funds and payment of wages.
The premise that the...
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