Insite Corp. v. Walsh Constr. Co. P.R. (In Re Insite Corp.)

United States Court of Appeals
For the First Circuit
No. 17-1436
IN RE: INSITE CORPORATION, INC.,
Debtor.
INSITE CORPORATION, INC.
Appellant,
v.
WALSH CONSTRUCTION COMPANY PUERTO RICO,
Appellee.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF PUERTO RICO
[Hon. Francisco A. Besosa, U.S. District Judge]
[Hon. Mildred Cabán-Flores, U.S. Bankruptcy Judge]
Before
Torruella, Lipez, and Barron,
Circuit Judges.
David Carrión-Baralt for appellant.
Paul T. DeVlieger, with whom DeVlieger Hilser P.C. was on
brief, for appellee.
October 5, 2018
LIPEZ, Circuit Judge. The appellant in this case is a
bankrupt subcontractor, Insite, which claims that a general
contractor, Walsh, improperly withheld payments belonging to its
bankruptcy estate. Insite sought to recover the payments by
initiating an adversary proceeding against Walsh in bankruptcy
court in Puerto Rico. The bankruptcy court found that the withheld
payments were not property of Insite's estate, the district court
affirmed, and Insite now appeals to us.
Applying the Supreme Court's decision in Pearlman v.
Reliance Insurance Co., 371 U.S. 132, 141-42 (1962), we have held
that, under Puerto Rico law, funds withheld by a general contractor
to cure a subcontractor's default and to complete a subcontractor's
work do not become property of the subcontractor, and hence are
not part of the subcontractor's bankruptcy estate. See Segovia
Dev. Corp. v. Constructora Maza, Inc., 628 F.2d 724, 729-30 (1st
Cir. 1980). The bankruptcy court found that this well-established
principle, known as the Pearlman doctrine, prevented Insite from
gaining a property interest in the funds withheld by Walsh, and it
accordingly granted summary judgment to Walsh.
Because we conclude that Insite had no right under the
subcontract with Walsh to any of the funds it claims were withheld,
we do not rely on the Pearlman doctrine. In the unusual
circumstances of this case, neither that doctrine nor the parties'
contract answers the question that determines Insite's right to
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payment: whether a defaulting subcontractor who has no contractual
right to compensation is nonetheless entitled to an equitable
recovery if the general contractor has benefited at the
subcontractor's expense. In that scenario, the subcontractor's
right to recovery, if any, must be determined by other principles
of local law. Thus, although we agree with the bankruptcy and
district courts that Insite is not due funds under its contract
with Walsh, the courts still must consider whether Walsh was
benefited by Insite's post-default performance in such a way that
Insite has an equitable claim under Puerto Rico law. We therefore
vacate the judgment and remand to allow the bankruptcy court to
address that issue in the first instance.
I.
A. Factual & Procedural Background
In September 2010, the Department of Veterans Affairs
awarded appellee Walsh Construction Company Puerto Rico ("Walsh")
a contract to build an addition to a VA facility in San Juan,
Puerto Rico. Two months later, Walsh subcontracted with appellant
Insite Corporation, Inc. ("Insite") for certain concrete and
masonry work. Insite in turn contracted with a number of sub-
subcontractors and suppliers (collectively, its "suppliers") and
began its work on the job site. The terms of the Walsh-Insite
contract entitled the latter to periodic progress payments,
subject to certain conditions. Insite regularly applied for, and
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Walsh regularly satisfied, such payments through the month of
November 2011.
More precisely, the last progress payment issued by
Walsh corresponded to work performed by Insite through November
21, 2011. Insite would later apply for three other progress
payments totaling $591,953: $179,897 for work performed from
November 22 to December 26, 2011; $70,750 for work performed from
December 27, 2011 through January 22, 2012; and $341,306 for work
performed from January 23 through March 7, 2012. Walsh did not
approve these payment applications for reasons that we shall
explain.
On the morning of December 30, 2011, Walsh hand-
delivered Insite a letter titled "Notice of Default," accusing
Insite of materially breaching the parties' subcontract by failing
to pay its suppliers. Specifically, Walsh asserted that a check
issued by Insite to pay a supplier for work performed in October
2011 was rejected for insufficient funds, and that Insite had
balances overdue by 60 to 120 days with two other suppliers.
Consistent with the terms of the parties' contract, the letter
provided Insite 72 hours to remedy its default, and demanded
assurance that Insite intended and was able to perform the balance
of its contracted work.
That evening, at 5:49 p.m., Insite filed for Chapter 11
bankruptcy. Insite subsequently notified Walsh of this
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development and assured Walsh that the protection afforded by
federal bankruptcy law would allow it to continue executing the
subcontract. Walsh responded with a letter contesting the adequacy
of Insite's assurance and accusing Insite of failing to timely pay
two more suppliers.
Meanwhile, Walsh notified Insite's surety, United Surety
& Indemnity Company ("USIC"), that Insite was in default of the
subcontract. USIC, however, refused to perform on its bond,
asserting that it had no obligation to perform until Walsh formally
terminated its subcontract with Insite. Though Walsh had accused
Insite of defaulting on the subcontract, it was unable to terminate
the agreement before Insite entered bankruptcy. And, once Insite
filed for bankruptcy, Walsh could not terminate the contract
without the bankruptcy court's approval. See, e.g., Computer
Commc'ns Inc. v. Codex Corp. (In re Computer Commc'ns), 824 F.2d
725, 728 (9th Cir. 1987) (holding that defendant was required to
obtain bankruptcy court's permission before terminating contract
with debtor).1
With Walsh unable to terminate Insite, and USIC refusing
to perform on its bond, Insite continued to execute at least some
work on the job site after it filed for bankruptcy. The value of
1 Walsh eventually moved to terminate the contract in both
June and September 2012, but the court denied the motions in
December 2012.
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the work performed by Insite during this time, and in the month
preceding its bankruptcy filing, is unclear. Taken at face value,
the progress payment applications submitted by Insite for its work
from November 22, 2011 to March 7, 2012 suggest that Insite
performed $591,953 worth of work for which it was not paid.
However, Walsh was not satisfied with Insite's performance during
this time. Walsh sent a number of letters to Insite accusing it
of repeatedly defaulting on the contract and of failing to timely
prosecute its work. Furthermore, to keep Insite's suppliers
working on the project, Walsh issued $63,927.15 in jointly payable
checks to Insite and its suppliers. Walsh contends that these
checks were intended to be deposited by the suppliers, but that
Insite appropriated the checks for its own purposes.
On February 29, 2012, Insite, USIC, and one of Insite's
creditors sought the bankruptcy court's approval of a stipulation
allowing Insite to "assume" its contracts with Walsh and Insite's
suppliers.2 The bankruptcy court approved the stipulation on March
2 In a Chapter 11 proceeding, the debtor (or its trustee) may
"assume or reject an executory contract . . . at any time before
the confirmation of a [reorganization] plan," subject to the
bankruptcy court's approval. 11 U.S.C. § 365(d)(2); id. § 365(a).
"This latitude allows the debtor in possession an opportunity to
determine which of the prepetition executory contracts are
beneficial to the estate and which should be assumed or rejected."
Mason v. FBI Distrib. Corp. (In re FBI Distrib. Corp.), 330 F.3d
36, 42 (1st Cir. 2003). An executory contract remains in effect
while the debtor is deciding whether to assume or reject it, as it
cannot be terminated without the bankruptcy court's consent. See
In re Computer Commc'ns, 824 F.2d at 728-31. If the bankruptcy
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1, and then formally granted the underlying motions to assume the
contracts on March 29.3 Following the court's March 1 approval of
the stipulation, Insite notified Walsh that its cash flow situation
was "critical," and declared it "imperative that Insite gets
payment for the work performed during the months of December 2011
and January 2012." Insite's letter closed by informing Walsh that
Insite would "be forced to suspend work until proper funding is
available" if it did not receive payment from Walsh by March 9.
Walsh responded with a letter on March 9, refusing to
make any payments to Insite. According to a spreadsheet attached
to the letter, Walsh issued direct payments to some of Insite's
suppliers, Insite continued to carry past-due balances with other
suppliers, and Walsh incurred certain other expenses related to
Insite's defaults. As a result, Walsh's "preliminary analysis"
court approves an assumption, the debtor "accepts both the burdens
and the benefits of the bargain." Eagle Ins. Co. v. BankVest
Capital Corp. (In re BankVest Capital Corp.), 360 F.3d 291, 296
(1st Cir. 2004).
3 The record reflects some confusion between the parties as
to the date on which Insite legally assumed the parties' contract.
There are three possible dates of assumption: (a) when the
bankruptcy court approved the stipulation on March 1, 2012; (b)
when the bankruptcy court approved the underlying motion to assume
on March 29; or (c) when the bankruptcy court's March 29 order
"became final and firm" on April 12. The precise date of
assumption makes no difference to our decision, and we see no need
to decide the issue. However, in the interest of simplicity, we
will refer to the date of assumption as March 29. We also note
that neither party challenges the bankruptcy court's decision to
allow Insite to assume the contract.
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showed that "Insite's liabilities on the project exceed the amount
otherwise due Insite on the project by over $180,000." However,
this "preliminary" analysis did not include Insite's $341,306
payment application for work performed from January 23 through
March 7, which Insite did not submit until March 19.4
Insite did not perform any work after it received Walsh's
March 9 letter. Accordingly, on March 14, Walsh notified Insite
of its intent to:
supply such numbers of workers and quantity of
materials, equipment and other facilities as
Walsh deems necessary for the completion of
Insite's Subcontract work; contract with one
or more additional contractors to perform such
part of Insite's Subcontract work . . . and/or
withhold payment of any moneys due Insite
pending corrective action to the extent
required by and to the satisfaction of Walsh
and the Architect/Engineer.
Believing that Walsh owed it $591,953 in unpaid progress
payments, Insite filed an adversary complaint in bankruptcy court
on May 29, 2012.5 The complaint asserted, inter alia, that the
unpaid progress payments were property of the bankruptcy estate;
that Walsh violated the Bankruptcy Code's automatic stay, 11 U.S.C.
4 In the proceedings below, the parties also disputed whether
Walsh's preliminary analysis accurately reflected the balance
between the parties at the time of the calculation. As that issue
has not been briefed on appeal, we express no opinion on the
matter.
5 Insite actually requested $586,600 in its complaint, but
its subsequent filings in this case have stated that Walsh owes it
$591,953. This discrepancy is immaterial to our decision.
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§ 362, by withholding the payments; and that Walsh breached the
subcontract. Insite subsequently filed a motion for summary
judgment in September 2013. The court denied the motion in January
2015, finding genuine issues of material fact about: (a) the amount
of monies withheld by Walsh; (b) the amount of work performed by
Insite; and (c) whether Insite's suppliers were paid, and if so,
by whom.
Walsh then filed a motion for summary judgment which the
bankruptcy court granted in October 2015. The court explained
that Insite's claims were all premised on the threshold proposition
that the unpaid progress payments were property of the estate.
However, applying the Pearlman doctrine, the court found it "well
settled . . . that contract funds in a construction project do not
become property of the estate until the debtor completes the
project and fully complies with the payment obligations to the
suppliers and laborers." Since it was undisputed that Insite
"never cured [its] arrears, even upon assumption of the contract
with Walsh," Insite "never became entitled to receive any funds."
The court found that Insite's failure to cure deprived it of any
property interest whatsoever in the funds at issue, and Walsh thus
"did not violate the automatic stay by withholding payment to
[Insite]." The bankruptcy court denied Insite's motion for
reconsideration, reiterating that "Insite never became entitled to
any payment under the subcontract." The district court affirmed
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the bankruptcy court on substantially the same reasoning, and this
appeal followed.
II.
A. Legal Principles
The filing of a bankruptcy petition creates an estate
comprised of "all legal or equitable interests of the debtor in
property as of the commencement of the case," with some exceptions
not applicable here. 11 U.S.C. § 541(a)(1). The Bankruptcy Code
then protects the property of the estate by imposing an "automatic
stay" that prevents creditors from taking certain actions adverse
to the estate's property interests. Id. § 362; see also Jamo v.
Katahdin Fed. Credit Union (In re Jamo), 283 F.3d 392, 398 (1st
Cir. 2002).
When a debtor believes that particular property belongs
to its estate, or that a person is violating the automatic stay,
it may file an adversary complaint asking the bankruptcy court to
resolve the matter. See Fed. R. Bankr. P. 7001; McMullen v.
Sevigny (In re McMullen), 386 F.3d 320, 324 (1st Cir. 2004); City
of Springfield v. Ostrander (In re LAN Tamers, Inc.), 329 F.3d
204, 208-09 (1st Cir. 2003). The bankruptcy court's judgment can
be appealed to either the district court or the bankruptcy
appellate panel, at the parties' discretion. See 28 U.S.C. § 158;6
6Section 158 requires the circuit courts to "establish a
bankruptcy appellate panel service composed of bankruptcy judges
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Vázquez Laboy v. Doral Mortg. Corp. (In re Vazquez Laboy), 647
F.3d 367, 373 (1st Cir. 2011). Any subsequent appeal comes to
this court. We "concentrate on the bankruptcy court's decision,
reviewing its findings of fact for clear error and its conclusions
of law de novo," and ceding "no special deference to the
intermediate decision." Stornawaye Fin. Corp. v. Hill (In re
Hill), 562 F.3d 29, 32 (1st Cir. 2009).
In assessing whether property belongs to a bankruptcy
estate, "we first must determine the scope of the debtor's property
rights under state law." Keach v. Wheeling & Lake Erie Ry. (In re
Montreal, Me. & Atl. Ry.), 888 F.3d 1, 7 (1st Cir. 2018). If the
debtor has a property interest under state law, we "then look to
federal law, which 'dictates to what extent that interest is
property of the estate.'" Id. (quoting Rent–A–Ctr. E., Inc. v.
of the districts in the circuit" unless a circuit's judicial
council finds that "there are insufficient judicial resources
available in the circuit" or that "establishment of such service
would result in undue delay or increased cost to parties." 28
U.S.C. § 158(b)(1). Five circuits, including the First Circuit,
have established bankruptcy appellate panels. See 8 Hon. William
L. Norton Jr., Norton Bankruptcy Law and Practice § 170:6 (3d ed.
July 2018 update). Section 158 makes the panels the default
destinations for bankruptcy appeals, unless "(A) the appellant
elects at the time of filing the appeal; or (B) any other party
elects, not later than 30 days after service of notice of the
appeal; to have such appeal heard by the district court." 28
U.S.C. § 158(c)(1). In this case, Insite appealed to the
bankruptcy appellate panel and Walsh elected to have the appeal
heard by the district court.
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Leonard (In re WEB2B Payment Sols., Inc.), 815 F.3d 400, 405 (8th
Cir. 2016)).
B. The Contract
As an initial matter, we can easily discard Insite's
contention that Walsh, rather than Insite, materially breached the
parties' agreement. In its bankruptcy court filings, Insite
admitted that it "had failed to make the contractually mandated
payments to its subcontractors and suppliers," and "was, in fact,
in default of its payment obligations." Furthermore, Insite
conceded that "as of December 30, 2011" -- the date on which Walsh
delivered to Insite its original notice of default and on which
Insite filed for bankruptcy -- "Insite had been fully paid for all
final Payment Applications which Insite submitted to Walsh."7
Nonetheless, Insite argues on appeal that its failure to pay
suppliers was not a material breach of the contract. And, since
its breach was not material, Insite believes that Puerto Rico law
required Walsh to continue issuing progress payments.
7 In light of this admission, the district court found that
Insite's insistence that Walsh was liable for the $179,897 progress
payment application it submitted for work performed from November
22 through December 26 was "disingenuous." However, the record
suggests that as of December 30, the $179,897 progress payment
application was not yet due and payable. It thus appears, subject
to further evaluation by the bankruptcy court, that Insite's
admission is not inconsistent with its reliance on the progress
payment application.
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Insite's argument is squarely foreclosed by Section 8.1
of the subcontract, which categorizes the failure to pay
subcontractors and suppliers as a material breach. Specifically,
that section provides that if Insite "refuses or fails to supply
enough properly skilled workers, proper materials, or maintain the
Schedule of Work, or it fails to make prompt payment for its
workers, subcontractors or suppliers, disregards Laws . . . or
otherwise materially breaches a provision of this Agreement,"
Walsh shall have certain rights to recourse. (Emphases added.)
The use of the phrase "otherwise materially breaches" in this
provision is conclusive, showing that the parties intended the
list of refusals or failures preceding it to be material breaches.
Cf. P.R. Laws Ann. tit. 31 § 3471 ("If the terms of a contract are
clear and leave no doubt as to the intentions of the contracting
parties, the literal sense of its stipulations shall be
observed."). Hence, Insite's admitted failure to timely pay its
suppliers was a material breach pursuant to Section 8.1 of the
subcontract.8
Once Insite defaulted on its obligations, at least three
provisions of the subcontract allowed Walsh to immediately begin
withholding progress payments from Insite. Section 3.6 expressly
8 Since we conclude that Insite's breach was material, we do
not need to decide whether Puerto Rico law would have required
Walsh to continue issuing progress payments in the face of a non-
material breach.
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conditioned Insite's entitlement to progress payments on its
compliance with the subcontract.
Time of Payment. If Subcontractor is in
compliance with this Subcontract and if, and
only if, Owner [first] pays Contractor . . .
Progress Payments shall be due to
Subcontractor no later than ten (10) days
after receipt of payment from Owner by
Contractor provided Subcontractor remains in
compliance with the terms of this Agreement.
(Emphases added.) Section 3.11 of the subcontract allowed Walsh
to intervene if it had reason to suspect that Insite was not
satisfying its labor and supplier obligations:
Subcontractor Payment Failure. In the event
Contractor has reason to believe that labor,
material or other obligations incurred in the
performance of the Subcontractor's Work are
not being paid, the Contractor may take any
steps Contractor deems necessary to insure
that such obligations are paid including, but
not limited to, issuance of checks jointly to
Subcontractor and the person to whom
Subcontractor owes an obligation, and direct
payment of labor . . . and Subcontractor's
subcontractors and suppliers . . . .
(Emphasis added.) And, Section 3.12 gave Walsh the right to
"withhold amounts otherwise due under this Agreement . . . to cover
[Walsh's] reasonable estimate of any costs or liability [it] has
incurred or may incur for which [Insite] may be responsible."
Once Insite failed to timely cure its defaults, Walsh
became entitled to take a number of additional remedial actions at
Insite's expense. Section 8.1 of the subcontract provided Insite
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with 72 hours to "commence and continue satisfactory correction of
[its] default[s]."9 After 72 hours, Section 8.1 allowed Walsh to
(i) supply . . . workers and . . . materials,
equipment and other facilities as the
Contractor deems necessary for the completion
of Subcontractor's Work . . . and charge the
cost thereof to the Subcontractor . . . (ii)
contract with . . . additional contractors to
perform . . . the Subcontractor's Work . . .
and charge the cost thereof to the
Subcontractor; and/or (iii) withhold payment
of any moneys due the Subcontractor pending
corrective action . . . .
As a result of these provisions, when Walsh accused
Insite of defaulting on the contract on December 30, 2011, Walsh
was entitled to immediately begin withholding progress payments
from Insite. It could use the withheld funds to pay Insite's
suppliers and laborers directly, and could apply the funds to cover
costs and liabilities reasonably related to Insite's defaults.
Once Insite failed to timely cure its defaults, Walsh could
additionally invoke the remedies found at Section 8.1 of the
subcontract. Thus, the subcontract gave Walsh the right to use
the progress payments to cure Insite's defaults and complete
Insite's work.
9 Walsh believes, and Insite does not disagree, that Insite's
filing of its bankruptcy petition paused this 72-hour window until
Insite assumed the subcontract on March 29, 2012. Walsh
accordingly calculates the 72 hours as extending until April 1,
2012. It is undisputed that at that time Insite had not performed
any work for over three weeks, and had not cured its defaults.
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C. The Pearlman Doctrine
As a general matter, it has been widely held that a
defaulting subcontractor does not have a property interest in funds
withheld by a general contractor to cover cure and completion
costs. This principle derives from the Supreme Court's opinion in
Pearlman v. Reliance Insurance Co., a case involving the competing
claims of a surety and a contractor's bankruptcy trustee to funds
withheld by a project owner. 371 U.S. 132 (1962). The owner in
Pearlman had accumulated $87,737 in retainages by the time its
contractor defaulted. Id. at 134. A surety stepped in and spent
over $350,000 to discharge the contractor's debts for labor and
materials. Id. The surety and the contractor's bankruptcy trustee
both claimed ownership of the $87,737 in withheld funds.
The Pearlman Court held that the surety owned the funds.
Importantly for our purposes, the Court's holding was based on its
conclusion that the project owner had a right to use the retainages
to satisfy the defaulting contractor's debts to its laborers. Id.
at 141. Once the surety stepped into the owner's shoes and
fulfilled its obligation to cover the subcontractor's debts, the
surety became subrogated to the owner's right to the funds "to the
extent necessary to reimburse it" for its costs. Id. Since the
surety had "paid out more than the amount of the [withheld] fund,
it ha[d] a right to all of it," and the fund thus did not become
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property of the defaulting contractor's bankruptcy estate. Id. at
141-42.
In a trio of cases building on Pearlman, we have made
clear that the Pearlman doctrine applies regardless of whether the
defaulting party is a general contractor or (as here) a
subcontractor, and regardless of whether the withheld funds are
retainages or (as here) unpaid progress payments. See Framingham
Trust Co. v. Gould-Nat'l Batteries, Inc., 427 F.2d 856 (1st Cir.
1970); Nat'l Shawmut Bank of Bos. v. New Amsterdam Cas. Co., 411
F.2d 843, 844 (1st Cir. 1969); Am. Fire & Cas. Co. v. First Nat'l
City Bank of N.Y., 411 F.2d 755, 757 (1st Cir. 1969). We
subsequently established that Puerto Rico law governing the
ownership of withheld funds aligns with the Pearlman doctrine.
See Segovia Dev. Corp. v. Constructora Maza, Inc., 628 F.2d 724,
725 (1st Cir. 1980). In Segovia Development, the contractor had
defaulted and filed for bankruptcy, and a surety stepped in and
"expended funds greatly in excess" of the $423,630 withheld by the
project owner. Id. at 726. We explained that under the law of
Puerto Rico, the surety was "subrogated to any rights which the
owner . . . has against [the contractor]," including the owner's
rights to apply the withheld funds to its cure and completion
costs. Id. The funds thus belonged to the surety rather than to
the defaulting contractor's bankruptcy estate. Id. at 725, 730.
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The bankruptcy court granted summary judgment to Walsh
because it found that, under the Pearlman doctrine, Insite had no
property interest in the funds at issue.10 The court made this
finding despite Insite's contention that the funds withheld by
Walsh exceeded Walsh's cure and completion costs and that it was
entitled to the excess amount. As we shall explain, the court
properly rejected Insite's entitlement to the funds at issue
insofar as its claim was premised on the parties' contract.
However, the court neither determined as a factual matter whether
Walsh benefited from Insite's post-default performance nor whether
Puerto Rico law would provide Insite a non-contractual property
interest in any such funds. Absent one or both of those
determinations, the grant of summary judgment for Walsh was
premature.
III.
Insite has consistently maintained that substantial
withheld funds remain after cure and completion expenses are
deducted, and it claims entitlement to the difference between the
total withheld -- i.e., the payments that would have been due
Insite for its work under the contract if Insite had not defaulted
-- and the amount attributable to the cost of remedying the
default. Otherwise, Insite complains, Walsh would receive a
10 The district court's opinion followed the same line of
reasoning.
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windfall. Walsh insists that there is no "excess" and that, in
any event, Insite's bankruptcy estate has no claim to any such
funds.
The bankruptcy court understandably bypassed both the
factual and legal questions pertinent to Insite's entitlement to
any excess funds. Although Insite broadly claims a right to
payment for the work it performed, its briefing has not clearly
distinguished between its contractual rights and any equitable or
other bases for its claim. Moreover, this case involves a complex
set of facts that are not easily untangled. With the bankruptcy
filing preventing Walsh from terminating the contract, Insite
continued to work on the project for more than two months despite
Walsh's evident dissatisfaction with its performance. The
"excess" that Insite claims appears largely attributable to that
seemingly unusual period of ongoing work.
Thus, while Insite could have more clearly articulated
the basis for its claim, we are reluctant to affirm summary
judgment for Walsh without careful review of its entitlement to
funds attributable to the work that Insite performed following its
bankruptcy filing and that, if not belonging to Walsh, might be
available to Insite's creditors. On remand, the bankruptcy court
will have the opportunity to answer the questions that remain.
First, however, we explain why the court correctly rejected
Insite's reliance on the contract.
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A. Insite's Rights under the Contract
In December 2011, when Walsh notified Insite that it was
in default of its contractual obligations, Insite was carrying
past-due balances with three of its suppliers totaling $45,832.66.
As Insite continued to work on the job site during the next two
months, it also continued to accumulate liabilities to its
suppliers. As the bankruptcy court observed, it is undisputed
that Insite "never cured [its] arrears." Meanwhile, Insite
continued to submit applications for progress payments, with the
total amount requested eventually reaching $591,953.
The bankruptcy court reasoned that Insite's failure to
cure its initial default deprived it of any property interest
whatsoever in the withheld funds, including excess funds. As a
matter of contract law, the bankruptcy court was correct. Under
standard principles governing the interpretation of contracts for
services, including for construction, the service provider is due
nothing until the full project is complete -- unless the contract
itself provides for a different arrangement. See Restatement
(Second) of Contracts § 234 & id. cmt. f11; see also Constructora
11
Comment f provides the following illustration of this
principle:
A contracts to do the concrete work on a
building being constructed by B for $10 a
cubic yard. In the absence of language or
circumstances indicating the contrary,
payment by B is not due until A has finished
the concrete work.
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Bauzá v. García López, 129 D.P.R. 579, 1991 P.R.-Eng. 735,859,
P.R. Offic. Trans. (1991) (noting that, "if one of the parties [in
a construction contract] does not fulfill his obligation, the other
party may consider the contract dissolved" (citing 31 P.R. Laws
Ann. § 3052)). The Walsh-Insite contract did specify a different
arrangement in the multiple provisions governing progress
payments, reflecting the parties' understanding that Insite would
need partial payment as the project moved forward so that it could
remain current with its subcontractors and suppliers. Two of the
progress-payment provisions are of particular significance to
Insite's claim here.
First, section 3.2 states that "the Subcontractor's
progress payment application shall be submitted to the Contractor
in a form and with content and documentation acceptable to
Contractor and Owner." The approved form, contained in the record,
requires Insite to certify that "the work covered by this
application for payment has been completed in accordance with the
contract documents, that all amounts have been paid by [Insite]
for work for which previous Certificates for payment were issued
and payments received from [Walsh], and that current payment shown
herein is due." (Emphasis added.) Second, section 3.6, which is
labeled "Time of Payment," conditions the progress payments on the
recipient's compliance with the contract. It provides that
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payments will be made to Insite according to the specified schedule
"[i]f Subcontractor is in compliance with this Subcontract."
These provisions are problematic for Insite because
both, in effect, require Insite to be up-to-date in paying its
suppliers and subcontractors, and Insite admits that it was not.
Insite acknowledges that, starting in at least November of 2011,
it did not pay all amounts due to its suppliers for work that was
the basis for progress payments previously made by Walsh. Unable
to certify that it had paid those debts, Insite could not submit
a proper application for progress payments. And, hence, the
applications for the progress payments at issue here could not
satisfy the section 3.6 contingency requiring Insite to be "in
compliance with this Subcontract." Having failed to comply with
the contract's requirements for receipt of progress payments,
Insite had no right to payment under the contract until -- under
ordinary contract principles -- it had completed the job. See
Restatement (Second) of Contracts § 234. Insite never fulfilled
that prerequisite.
B. Non-Contractual Recovery
As noted above, neither the bankruptcy court nor the
district court considered whether Insite would have an alternative
basis under Puerto Rico law for payment of any amount that, absent
its default, would have been due under the contract. In other
words, the question remains whether Insite may have an equitable
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claim against Walsh in the unusual circumstances of this case.
See Restatement (Second) of Contracts § 240 (noting that, in some
cases, a party's material breach may nonetheless leave open the
possibility of "restitution in accordance with the policy favoring
avoidance of unjust enrichment" (citing §§ 370-77)); see also U.S.
Steel v. M. DeMatteo Const. Co., 315 F.3d 43, 49–50 (1st Cir. 2002)
(noting that, under Massachusetts law, a subcontractor "who in
good faith substantially performs a contract may recover in quantum
meruit" (quoting J.A. Sullivan Corp. v. Commonwealth, 494 N.E.2d
374, 378 (Mass. 1986)).
Because the bankruptcy court here granted summary
judgment based on the Pearlman doctrine without addressing the
parties' contentions regarding the value of Insite's post-default
performance and the amount of Walsh's costs, those factual issues
remain undeveloped. Nor did the court address whether Insite, as
a defaulting subcontractor, would have a "legal or equitable"
property interest under Puerto Rico law if the court found that
the value of Insite's performance exceeded Walsh's costs. 11
U.S.C. § 541(a)(1).
Accordingly, we vacate the bankruptcy court's judgment
and remand for further proceedings to resolve the competing claims
of the parties about money owed or not owed. See First Indem. of
Am. Ins. Co. v. Modular Structures, Inc. (In re Modular Structures,
Inc.), 27 F.3d 72, 80 (3d Cir. 1994) (remanding under similar
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circumstances "to determine if any other factors might establish
that any part of the funds were 'owed' to [the defaulting
contractor]"). If the court finds that Walsh benefited at Insite's
expense, the court "first must determine the scope of [Insite's]
property rights" under state law, if any, in the value of its
performance. In re Montreal, Me. & Atl. Ry., 888 F.3d at 7. If
Insite has a property interest under state law, the bankruptcy
court should "then look to federal law, which 'dictates to what
extent that interest is property of the estate.'" Id. (quoting In
re WEB2B Payment Sols., Inc., 815 F.3d at 405).12
IV.
For the reasons stated, we vacate the judgment of the
district court and remand the matter to the district court with
directions to vacate the bankruptcy court's judgment and remand
the matter to the bankruptcy court for further proceedings
consistent with this opinion. The parties shall bear their own
costs on appeal.
So ordered.
12As a final matter, the bankruptcy court correctly
determined that the letters sent from Walsh to Insite accusing the
latter of being in default did not violate the automatic stay.
See Am-Haul Carting, Inc. v. Contractors Cas. and Sur. Co., 33 F.
Supp. 2d 235, 242 (S.D.N.Y. 1998) (finding that general
contractor's notice of default to subcontractor, in and of itself,
did not violate the automatic stay). The court astutely explained
that, unlike a case in which a creditor accuses a bankrupt debtor
of defaulting in order to collect a debt, here, the debtor (Insite)
was attempting to collect from Walsh. In this context, Walsh's
accusations of default were defensive, and were not attempts to
obtain property of the estate in violation of the automatic stay.
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