Universal Bonding Ins. Co. v. Gittens and Sprinkle Enterprises, Inc.

• Decision Date: 02 April 1992
• Docket Number: No. 91-5545,91-5545
• Citation: 960 F.2d 366
• Parties: , 26 Collier Bankr.Cas.2d 1073, 22 Bankr.Ct.Dec. 1461, Bankr. L. Rep. P 74,529 UNIVERSAL BONDING INSURANCE CO., North River Insurance Co., Westchester Fire Insurance Co., Appellants, v. GITTENS AND SPRINKLE ENTERPRISES, INC., Appellee, Gittens and Sprinkle Enterprises, Inc., Debtor, US Trustee, Trustee, Universal Bonding Insurance Company, North River Insurance Company and Westchester Fire Insurance Company, Appellants.
• Court: U.S. Court of Appeals — Third Circuit

Page 366

960 F.2d 366

60 USLW 2682, 26 Collier Bankr.Cas.2d 1073,

22 Bankr.Ct.Dec. 1461, Bankr. L. Rep. P 74,529

UNIVERSAL BONDING INSURANCE CO., North River Insurance Co Westchester Fire Insurance Co., Appellants, v. GITTENS AND SPRINKLE ENTERPRISES, INC., Appellee Gittens and Sprinkle Enterprises, Inc., Debtor US Trustee, Trustee Universal Bonding Insurance Company, North River Insurance Company and Westchester Fire Insurance Company, Appellants.

No. 91-5545.

United States Court of Appeals, Third Circuit.

Argued Jan. 9, 1992.

Decided April 2, 1992.

Robert W. McCann, Richard J. Allen, Jr. (argued), Klotz & McCann, Hawthorne, N.J., for appellants Universal Bonding Ins. Co., North River Ins. Co. and Westchester Fire Ins. Co.

Eric J. Clayman (argued), Jenkins & Jenkins, Haddon Heights, N.J., for appellee Gittens and Sprinkle Enterprises, Inc.

Before: COWEN, NYGAARD and GARTH, Circuit Judges.

OPINION OF THE COURT

GARTH, Circuit Judge:

Gittens and Sprinkle Enterprises, Inc. ("Gittens"), a contractor, filed for bankruptcy protection and attempted, as debtor in possession, to collect outstanding contract balances due from state, municipal and federal agencies, for the purposes of reorganizing and using such funds as capital in new ventures. Gittens' surety, Universal Bonding Insurance Company ("Universal"), objected and argued that these balances constituted statutory or equitable trusts for the benefit of laborers and materialmen and therefore could not become part of Gittens' general estate. Both the bankruptcy court and the district court rejected Universal's arguments and held that the contract balances belonged to the bankrupt's estate free of any liens of laborers and materialmen.

We agree with the bankruptcy court and the district court that monies owed but not yet paid to Gittens by state, municipal and federal agencies do not constitute statutory or equitable trusts in the hands of the government agencies and therefore may be collected by Gittens. We will therefore affirm the district court's order to the extent that it embodies this holding. However, we reach a different conclusion than did the bankruptcy court and district court regarding the status of monies owed to Gittens by state, municipal and federal agencies once they have been paid over to Gittens as debtor in possession.

Because we hold that the New Jersey Trust Fund Act directs that the monies paid by state and municipal agencies to Gittens be placed into a statutory trust fund for the benefit of laborers and materialmen, and because we hold that monies owed to Gittens by the federal agencies must, as a result of decisional law, be treated as a trust fund for the benefit of laborers and materialmen once paid to Gittens, we will vacate the district court's order and remand to the district court with instructions to the district court to, in turn, remand this case to the bankruptcy court for further proceedings consistent with this opinion.

I.

Gittens filed a voluntary Chapter 11 bankruptcy petition on December 14, 1990. At the time of the bankruptcy filing, various state, municipal and federal agencies owed money to Gittens for completed contracts, as follows:

                Collingswood Board of Education Thomas Sharp Elementary School       $ 5,401.00
                Point Pleasant Board of Education                                    $15,440.52
                Fort Dix--Department of the Army                                     $28,059.86
                Department of Building and Construction c/o State of New Jersey      $ 5,414.80
                  State Police Headquarters
                State of New Jersey--DBC Woodbine Developmental Ctr.                 $ 7,552.20
                Rancocas Valley Regional High School                                 $13,584.99
                Audubon Board of Education                                           $16,545.30
                Veterans Administration                                              $50,000.00
                                                                                         (est.)
                Waterford Township Board of Education                                $ 8,202.61
                

As debtor in possession, Gittens filed a motion seeking a declaration that these contract balances were property of Gittens' bankrupt's estate pursuant to 11 U.S.C. § 541.

Universal, Gittens' payment and performance bond surety on those contracts, opposed Gittens' motion. Universal argued that New Jersey law imposed a statutory or equitable trust on the contract proceeds for the benefit of materialmen and laborers who had furnished labor, material and equipment on the projects. If released to the bankrupt's estate, Universal complained, funds that had served as primary security for Universal would not be distributed to materialmen and laborers but would rather be used as venture capital or distributed to Gittens' unsecured creditors, leaving Universal fully liable for the claims of unpaid materialmen and laborers.

On March 4, 1991, the bankruptcy court granted Gittens' motion, holding that the contract balances claimed by Gittens properly belonged, without limitation, to the bankrupt's estate. The Court rejected Universal's argument that those contract balances constituted a trust for the benefit of materialmen, laborers and the surety. The Court relied on National Surety Corp. v. Barth, 11 N.J. 506, 95 A.2d 145 (1953), in which the New Jersey Supreme Court held that the New Jersey Trust Fund Act, N.J.S.A. 2A:44-148, on which Universal relied, only imposed a trust on funds that a government agency had already paid to a contractor and not on funds that the government agency still had in its possession. Because the agencies had not yet paid Gittens at the time that Gittens filed its petition in bankruptcy, the Court held that no statutory trust had been created, and that "[t]o the extent that the money is due to [Gittens], it goes to [Gittens] without the imposition of a trust." (A. 32a).

Universal, along with co-sureties North River Insurance Company and Westchester Fire Insurance Company, (collectively, "Universal"), appealed the bankruptcy court's order to the United States district court for the District of New Jersey. By memorandum and order of May 28, 1991, the district court affirmed the bankruptcy court's order. The district court agreed with the bankruptcy court that the New Jersey Trust Fund Act applied only to money that had already been paid by state and municipal agencies to contractors and therefore did not apply to funds that had not been paid to Gittens prior to Gittens' bankruptcy filing. The district court also held that "basic bankruptcy principles" would be violated if the Court were to impose an equitable trust on the contract proceeds or if the Court, under the common law principle of "exoneration," would order that those proceeds be used to pay contract obligations which, if unpaid, would become the obligation of Universal.

In addition to arguing that New Jersey law imposed a trust on contract balances held by New Jersey state and municipal agencies, Universal argued for the first time before the district court that, under federal law, contract balances held by federal agencies also constituted a trust for the benefit of laborers, materialmen and the surety. Universal cited Pearlman v. Reliance Ins. Co., 371 U.S. 132, 83 S.Ct. 232, 9 L.Ed.2d 190 (1962), in which the United States Supreme Court held that sureties to federal contracts who compensate laborers and materialmen for completed work possess a common law "subrogation" right to step into the shoes of the compensated laborers and materialmen and thus are to be reimbursed out of contract balances that otherwise would have been paid to the contractor. The district court rejected this argument and held that Pearlman only applied where the surety had already paid the laborers and materialmen. The Court held that a surety who, like Universal, had not yet made such payments, possessed no subrogation right under Pearlman.

Universal appealed the district court's order affirming the bankruptcy court's order. Universal now argues before us that the district court failed to recognize that the contract balances in the hands of the municipal, state and federal agencies, as well as those funds that have already been paid to Gittens, constitute trusts to assure payment of laborers and materialmen.

II.

A.

In order to determine whether contract balances owed to Gittens by state and municipal agencies constitute trust funds, we must look to New Jersey state law. See Butner v. United States, 440 U.S. 48, 54, 99 S.Ct. 914, 918, 59 L.Ed.2d 136 (1979) ("Congress has generally left the determination of property rights in the assets of a bankrupt's estate to state law"); In re Nejberger, 934 F.2d 1300, 1302 (3d Cir.1991) ("Although section 541 [of the Bankruptcy Code] defines property of the estate, we must look to state law to determine if a property right exists and to stake out its dimensions."). Universal claims that, under New Jersey law, the contract balances owed by New Jersey municipalities and by the state of New Jersey are either statutory trusts under the New Jersey Trust Fund Act or equitable trusts created pursuant to principles of equity, which include the common law principles of subrogation and exoneration.

The New Jersey Supreme Court's opinion in National Surety Corp. v. Barth, 11 N.J. 506, 95 A.2d 145 (1953), must serve as the starting point for any discussion of New Jersey law regarding statutory and equitable trusts imposed on contract balances owed by state and municipal agencies to contractors. Barth, a contractor, had defaulted on public housing contracts with the Public Housing and Development Authority ("Authority"), leaving completion of the contracts to the surety. The surety brought an action in the New Jersey Superior Court, Chancery Division, seeking the common law right of "exoneration;" i.e., the right to compel the Authority to pay contractual proceeds directly to unpaid materialmen and laborers rather than forwarding those proceeds to Barth. The surety also...