First Indemnity of America Insurance v. Modular Structures, Inc.

Opinions of the United
1994 Decisions States Court of Appeals
for the Third Circuit
6-21-1994
In re: Modular Structures, Inc.
Precedential or Non-Precedential:
Docket 92-5577
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1
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 92-5577
IN RE: MODULAR STRUCTURES, INC.
Debtor
FIRST INDEMNITY OF AMERICA INSURANCE COMPANY
Appellant
v.
MODULAR STRUCTURES, INC.;
FIRST FIDELITY BANK, N.A.
THEODORE LISCINSKI, ESQ.
Trustee
On Appeal From the United States District Court
For the District of New Jersey
(D.C. Civil Action No. 92-02024)
Argued July 2, 1993
Before: BECKER, ALITO and ROTH, Circuit Judges
(Opinion Filed June 23, 1994)
Armen Shahinian, Esquire (Argued)
Joseph Monaghan, Esquire
Wolff & Samson
5 Becker Farm Road
Roseland, NJ 07068
Attorney for appellant
2
Stephen M. Packman, Esquire (Argued)
Archer & Greiner
One Centennial Square
P.O. Box 3000
Haddonfield, NJ 08033
Attorney for First Fidelity Bank,
National Association and Trustee
Robert W. McCann, Esquire
Klotz & McCann
649 Lafayette Avenue
P.O. Box 64
Hawthorne, NJ 07507
Attorney for Amicus-appellant
Surety Association of America
OPINION OF THE COURT
ROTH, Circuit Judge:
This appeal arises from the Chapter 7 bankruptcy
proceedings of Modular Structures, Inc. ("Modular"). Prior to
filing for bankruptcy on March 8, 1991, Modular had contracted to
construct a new corporate headquarters in Newark, New Jersey, for
the Salvation Army. First Indemnity of America Insurance Company
("First Indemnity") issued a bond to the Salvation Army to secure
Modular's performance and payment obligations under the contract.
Eleven months after the institution of the bankruptcy
proceedings, First Fidelity Bank ("the Bank"), as a secured
creditor of Modular, filed a Notice of Motion for Turnover of
Funds to obtain the unearned contract proceeds and retainage held
by the Salvation Army. First Indemnity filed a cross-motion to
3
place the contract proceeds and retainage in escrow in order to
assure that the funds remained available to secure Modular's
obligations to pay subcontractors. On March 2, 1992, the
bankruptcy court denied First Indemnity's cross-motion and
entered an Order Allowing Turnover in favor of the Bank. First
Indemnity appealed this decision to the district court which
affirmed the bankruptcy court.
Because we conclude that the district court and the
bankruptcy court incorrectly determined that the contract
proceeds and retainage, which the Salvation Army was holding,
were part of the estate in bankruptcy, we will reverse the order
directing turnover to the Bank. We also conclude that the
bankruptcy court made an insufficient examination of whether
Modular had any legal or equitable interest in the funds held by
the Salvation Army. We will therefore remand this issue to the
bankruptcy court for further proceedings in this regard.
I.
On February 27, 1989, Modular entered into a contract
with the Salvation Army for the design and construction of a new
corporate headquarters in Newark, New Jersey. In accordance with
the terms of the contract, First Indemnity, as surety, issued its
Labor and Material Payment Bond and its Performance Bond to the
Salvation Army, as obligee, to secure Modular's performance of
the contract. The bonds bound Modular and First Indemnity to pay
3
Modular's laborers and materialmen in connection with the
contract, which was incorporated by reference into the bonds.1
In March 1989, the Bank loaned Modular the principal
sum of $1.5 Million to enable Modular to undertake construction
contracts such as the one with the Salvation Army. The Bank
entered into a General Security Agreement whereby it took a
security interest in all of Modular's accounts receivable,
contracts and proceeds thereof. Modular also executed a Uniform
Commercial Code Financing Statement which was filed on April 20,
1989, thereby perfecting the Bank's lien.
Modular commenced work on the Salvation Army project
but was unable to complete all of its obligations under the
contract. On March 8, 1991, Modular filed for protection under
Chapter 7 of the United States Bankruptcy Code, and a Trustee was
1
The surety on a construction surety bond guarantees to the owner
that the contractor will finish the job. If the contractor
defaults, the surety performs the work, mitigates loss by its
performance, and pays the subcontractors and suppliers. In
performing this function, the surety "stands in the shoes" of
other parties to the construction project through use of the
equitable doctrine of subrogation:
[T]he surety in cases like this undertakes
duties which entitle it to step into three
sets of shoes. When, on default of the
contractor, it pays all the bills of the job
to date and completes the job, it stands in
the shoes of the contractor insofar as there
are receivables due it; in the shoes of
laborers and materialmen who have been paid
by the surety -- who may have had liens; and
not least, in the shoes of the government
[owner], for whom the job was completed.
National Shawmut Bank of Boston v. New Amsterdam Casualty Co.,
411 F.2d 843, 847-49 (1st Cir. 1969).
4
appointed. Modular stated in its bankruptcy schedules that the
Bank maintained a first, perfected security interest in Modular's
accounts receivable and contracts and proceeds thereof. On
August 5, 1991, the Bank obtained a consent order from the
Trustee granting it a "Superpriority Lien" in Modular's account
receivables. Following the consent order, the Bank pursued
collection of Modular's accounts receivable.
First Indemnity contends that the unpaid contract
proceeds and retainage held by the Salvation Army were not
properly characterized as accounts receivable owing to Modular so
that the Bank's superpriority lien would apply to them. Pursuant
to Article 6 of the contract between Modular and the Salvation
Army, the Salvation Army was not obligated to make final payment
to Modular until: "(1) the Contract has been fully performed by
the contractor except for the Contractor's responsibility to
correct nonconforming work as provided in Subparagraph 12.2.2 of
the General Conditions and to satisfy other requirements, if any,
which necessarily survive final payment; and (2) a final
Certificate for Payment has been issued by the architect . . .."
App. at 79a. Article 9, section 1.2, of the Contract defined the
"General Conditions" as the General Conditions of the contract
for Construction, AIA Document A201, 1987 Edition. Those General
Conditions included Article 3, section 4.1, which stated that the
Contractor shall provide and pay for the labor, materials and
equipment necessary for the proper completion of the work, as
well as Article 9, section 3.1.2, which provided that a
Contractor's application for payment "may not include requests
5
for payments of amounts the Contractor does not intend to pay to
a Subcontractor or material supplier because of a dispute or
other reason." App. at 96a, 104a. Article 9, section 5.1.3,
permitted the Architect to withhold his certification for payment
to the extent necessary to protect the Owner from loss as the
result of the failure of the Contractor to make payments properly
to Subcontractors or for labor, materials or equipment. See app.
at 105a.
Additionally, Article 9, section 10.2, provided that:
Neither final payment nor any remaining
retained percentage shall become due until
the Contractor submits to the Architect (1)
an affidavit that payrolls, bills for
materials and equipment, and other
indebtedness connected with the Work for
which the Owner or the Owner's property might
be responsible or encumbered (less amounts
withheld by Owner) have been paid or
otherwise satisfied, . . . (4) consent of
surety, if any, to final payment and (5) if
required by the Owner, other data
establishing payment or satisfactions of
obligations, such as receipts, releases and
waivers of liens, claims, security interests
or encumbrances arising out of the Contract
to the extent and in such form as may be
designated by the Owner . . ..
App. at 106a. Finally, Article 14, section 2.1.2, provided that
the owner might terminate the contract if the contractor "fails
to make payment to Subcontractors for materials or labor in
accordance with the respective agreements between the Contractor
and the Subcontractors." Article 14, section 2.2, further
provided that upon such a termination, "the Contractor shall not
be entitled to receive further payment until the Work is
finished." See app. at 111a-112a. In sum, Modular was obligated
6
to pay its subcontractors before it could receive final payment
from the Salvation Army.
It is undisputed that First Indemnity, as surety for
Modular, has been called upon to pay proper claims of
subcontractors. First Indemnity, therefore, sent a letter, dated
April 2, 1991, to the Salvation Army explaining that it should
issue no additional payments to Modular so that any remaining
funds could properly be used to cure Modular's default. The
Bank, on the other hand, contends that, despite Modular's
apparent breach of its contract with the Salvation Army, a letter
sent by Charles R. Kramer, Jr., Esq., counsel for the Salvation
Army, to counsel for the Bank demonstrates that the Salvation
Army considered the contract terms to have been satisfied. The
letter stated, inter alia, that "The Army is prepared to pay the
final installment of $104,490.00, but wishes to do so only if
said payment will not expose The Army to duplicate payments."
App. at 114r. First Indemnity interprets this letter as
requiring that the funds held by the Salvation Army not be
payable to Modular until and unless Modular fully performed its
contract, including the payment of laborers and materialmen.2
2
We note that neither the bankruptcy court nor the district court
cited this letter in its decision on the turnover order. Our
reading of the clear language of the letter, in view of the
contract language discussed above, leads us to conclude that, in
view of the unpaid subcontractors, the Salvation Army would have
been exposed to "duplicate payments" if it had released the funds
to Modular. For that reason, we conclude that contract terms had
not been satisfied and the Salvation Army was not obligated to
release the funds to Modular.
7
On November 7, 1991, counsel for the Bank sent a letter
to the Salvation Army threatening to institute legal action if
the Salvation Army did not release the funds to the Bank by
November 22, 1991. The Salvation Army did not comply and the
Bank filed its motion for turnover of the funds in Modular's
bankruptcy proceeding.
The bankruptcy court found for the Bank on the basis
that the contract was not a public contract and therefore there
was no trust fund to protect the funds, and it issued an Order
for Turnover of the funds. App. at 241r. First Indemnity then
appealed to the district court which affirmed the decision of the
bankruptcy court. The district court considered whether under
New Jersey law the funds should be construed to be held in trust
for subcontractors and thus entitled to special priority in a
bankruptcy proceeding. The district court concluded that no
constructive trust for subcontractors was created by New Jersey
common law and affirmed the decision of the bankruptcy court.
App. at 343-44r.
II.
The bankruptcy court had subject matter jurisdiction
pursuant to 28 U.S.C. 157((b)(1) over this Chapter 7 bankruptcy
proceeding. The district court had appellate jurisdiction
pursuant to 28 U.S.C. § 158(a) to review the bankruptcy court's
turnover order. This Court has appellate jurisdiction pursuant
to 28 U.S.C. §§ 158(d), 1291 to review the district court's
affirmance of the turnover order. See In re Moody, 817 F.2d 365
8
(5th Cir. 1987) (turnover order entered by the bankruptcy court
in an adversary proceeding is a "final" order).
This court accepts the findings of fact of the
bankruptcy court unless clearly erroneous. The bankruptcy
court's conclusions of law and the district court's decision are
reviewed de novo. See J.P. Fyfe, Inc. v. Bradco Supply Corp.,
891 F.2d 66, 69 (3d Cir. 1989); In re Muncrief, 900 F.2d 1220,
1224 (8th Cir. 1990).
III.
As an initial matter, the Bank contends that First
Indemnity did not preserve the issue in the district and
bankruptcy courts of whether Modular had breached its contract
with The Salvation Army and that, therefore, First Indemnity has
waived its arguments based upon any alleged breach of contract.
We disagree. First Indemnity's position consistently has been
either that Modular defaulted on its obligations under the
contract by failing to pay subcontractors and as a consequence
was owed no money by the Salvation Army or alternatively that
under New Jersey law those funds were held by the Salvation Army
in constructive trust for the benefit of the subcontractors. The
breach of contract basis for argument was presented to the
bankruptcy court in First Indemnity's February 21, 1992, letter
brief in opposition to the Bank's motion for turnover: "Thus,
these contract monies never became part of the debtor's estate.
The contractor defaulted and has therefore lost its right to
these funds. . .." App. at 205r. First Indemnity repeated this
9
position at oral argument in its opposition to the turnover
order. App. at 182a.
First Indemnity then argued before the district court
that:
There is no right of payment of
retainage of the contract balance unless all
of the subcontractors or suppliers have been
paid in full. Only in that manner can it be
stated that all parties have complied with
their contractual obligations. A.I.A.
contract forms, as used in the case herein,
certify that all subcontractors and suppliers
are paid in full before payment will be made
from the owner.
In the case herein, it is quite clear
that many of the subcontractors and suppliers
were not paid. . ..
App. at 294r. Moreover, in its reply brief to the district
court, First Indemnity asserted that because of this alleged
breach of contract the Bank was precluded from attaching the
funds held by the Salvation Army. See app. at 204a-205a. We
find, therefore, that there has been no waiver of this issue.
IV.
First Indemnity's primary argument on appeal is that,
because Modular breached its contract with the Salvation Army,
none of the funds held by the Salvation Army were owing to
Modular and thus could not properly be considered part of the
bankruptcy estate, subject to the Bank's lien and amenable to a
turnover order. Based upon the record before us, we agree with
First Indemnity and will reverse the decisions of the district
10
and bankruptcy courts.3 We therefore hold, as a matter of law,
that, assuming the facts are as the present record indicates, the
funds held by the Salvation Army are not properly part of the
estate in bankruptcy.4
The filing of a bankruptcy petition creates an estate
in bankruptcy. This estate, pursuant to section 541(a)(1) of the
Code, contains "all legal or equitable interests of the debtor in
property as of the commencement of the case." 11 U.S.C.
§541(a)(1). "'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 Bonding Ins. Co. v. Gittens & Sprinkle
Enter., Inc., 960 F.2d 366, 369 (3d Cir. 1992) (quoting In re
Nejberger, 934 F.2d 1300, 1302 (3d Cir. 1991)); see also Butner
v. United States, 440 U.S. 48, 54 (1979) ("Congress has generally
left the determination of property rights in the assets of a
bankrupt's estate to state law."). We must look, therefore, to
New Jersey law to determine whether the funds held by The
3
Because we find that the funds held by the Salvation Army are
not owing to Modular and thus not part of the bankruptcy estate,
we find it unnecessary both to determine whether, under New
Jersey law, the funds should be considered held in constructive
trust for the benefit of subcontractors and to determine what
priority First Indemnity would have were the funds at issue part
of the bankruptcy estate and not held in constructive trust for
the benefit of subcontractors.
4
As explained in Part V infra, we will remand to the bankruptcy
court for a determination of whether any supplemental facts, not
in the present record, would demonstrate that Modular had a legal
or equitable interest in any part of the funds held by the
Salvation Army.
11
Salvation Army are properly the "property" of the bankruptcy
estate here.
The contract between Modular and the Salvation Army
requires Modular to pay its subcontractors before final payment
is due to Modular. Moreover, it is undisputed, based upon the
record currently available in this case, that Modular has failed
to pay some of its subcontractors. The question, then, is
whether Modular is owed the funds retained by the Salvation Army.
Under New Jersey law, "[a] contract right becomes an account as
performance is made under the contract." Continental Fin., Inc.
v. Cambridge Lee Metal Co., 241 A.2d 853, 860 (N.J. Super. Ct.
Law Div. 1968), aff'd, 252 A.2d 417 (N.J. Super. Ct. App. Div.
1969), aff'd, 265 A.2d 536 (N.J. 1970). Thus, if the contract is
not performed, nothing comes into existence upon which a lien
could attach. See Damato v. Leone Contr. Co., 25 A.2d 302 (N.J.
Super. App. Div. 1956) (holding that a tax lien could not attach
to the unpaid balance of a construction contract because of the
contractor's failure substantially to perform his contract); see
also United States v. Commonwealth of Pa. Dep't of Highways, 349
F. Supp. 1370, 1381-82 (E.D. Pa. 1972) (where contractor's
failure to pay subcontractors constituted a breach of its
contract, the remaining contract funds were not due to the
contractor and thus not part of the bankrupt estate); Atlantic
Ref. Co. v. Continental Casualty Co., 183 F. Supp. 478, 482-83
(W.D. Pa. 1960) (holding that "a failure by the contractor here
to pay for labor and materials is just as much a failure to
12
perform and carry out the terms of the contract as an abandonment
of the work would have been").
In the present case, Modular did not fulfill its
contractual obligation to pay all of its subcontractors. First
Indemnity, as surety for Modular, is required to pay any
subcontractor not paid by Modular. The funds held by the
Salvation Army must be employed to satisfy these claims, either
in direct payments to the subcontractors or in reimbursement to
First Indemnity for the payments it has made as surety, standing
in the Salvation Army's shoes, to the subcontractors. If the
Salvation Army were to be required to pay the monies it is
holding into the bankruptcy estate, First Indemnity apparently
would have to seek recovery for its payments to the
subcontractors only as an unsecured creditor, in competition with
the other unsecured creditors. This is a result contemplated
neither by the contract, as we have explained it, nor by New
Jersey law.
New Jersey has recognized in cases of government
contracts that payments held by the government, as owner of a
construction project, did not become part of the bankrupt's
estate. This concept was first enunciated by the United States
Supreme Court in Pearlman v. Reliance Ins. Co., 371 U.S. 132
(1962). In Pearlman, a priority dispute arose between the
trustee of the bankrupt estate and the surety with respect to
contract funds retained by the United States, the owner of the
construction project at issue. The court held that the monies at
issue had not become part of the bankrupt's estate; instead, the
13
retained funds remained the property of the owner, and by way of
subrogation,5 became the surety's property to the extent
necessary to reimburse it for its payment to laborers and
materialmen. See id. at 141. The Court explained:
Ownership of property rights before
bankruptcy is one thing; priority of
distribution in bankruptcy of property that
has passed unencumbered into a bankrupt's
estate is quite another. Property interest
in a fund not owned by a bankrupt at the time
of adjudication whether complete or partial,
legal or equitable, mortgages, liens or
simple priority or right are, of course, not
a part of the bankrupt's property and do not
vest in the trustee. The Bankruptcy Act
simply does not authorize a trustee to
distribute other people's property among a
bankrupt's creditors.
Id. at 135-36. The Court then concluded:
We therefore hold in accord with the
established legal principles stated above
that the government had a right to use the
retained funds to pay laborers and
materialmen; that the laborers and
materialmen had a right to be paid out of the
funds; that the contractor had he completed
his job and paid his laborers and materialmen
would have become entitled to the fund, and
that the surety having paid the laborers and
materialmen is entitled to the benefit of all
these rights to the extent necessary to
reimburse it.
5
The subrogation scheme that is part of the Pearlman doctrine has
been explained in National Shawmut Bank, see footnote 1, supra.
See also Trinity Universal Ins. Co. v. United States, 382 F.2d
317, 320 (5th Cir. 1967), cert. denied, 390 U.S. 906 (1968):
The surety is not only a subrogee of the
contractor, and therefore a creditor, but
also a subrogee of the government [owner] and
entitled to any rights the government has to
the retained funds. If the contractor fails
to complete the job, the government can apply
the retained funds and any remaining progress
money to costs of completing the job.
14
Id. at 141;6 see also Polish v. Johnson Serv. Co., 333 F.2d 545
(3d Cir. 1964) (following Pearlman); Framingham Trust Co. v.
Gould-National Batteries, Inc., 427 F.2d 856, 859 (1st. Cir.
1970) (explaining that "we cannot escape the conclusion that in
both a practical and a legal sense, the payment of previously
unpaid laborers and materialmen is a cost of completing the
6
The adoption of the Bankruptcy Code in 1978 has not undercut
Pearlman's vitality.
In [Pearlman], the Supreme Court found that
where by the doctrine of subrogation a surety
becomes the virtual owner of property that
would otherwise be the property of the
debtor, the property will not become an asset
of the estate. Although the attempt of the
Congress in enacting the Code was to give the
broadest possible scope to what are assets of
the estate, it is doubtful if that decision
has been overruled.
2 Daniel R. Cowans, Cowans Bankruptcy Law and Practice § 12.30 at
587-88 (West 1989); accord J. Michael Franks & Michael E. Evans,
A Defense of Established Landmarks: Claims of Construction
Sureties to Contract Funds Under Chapter 11, 25 Tort & Ins. L.J.
28, ___ (1989):
To the extent that a consensus developed, it
became generally accepted that enactment of
the Code would not weaken the principles of
Pearlman. The Pearlman decision itself
characterized the surety's entitlement to
benefits of subrogation in terms of a "firmly
established rule," which was not to be
"casually overruled." Certainly, the Code's
definition of a bankruptcy estate differs
from the estate that was created by the
former Bankruptcy Act and considered in
Pearlman. But, following the first wave of
decisions under the Code with respect to
sureties' rights, and through early 1985, it
could be said rather confidently that
Pearlman had weathered such assaults as the
Code made available against it.
15
contract"); In re Pacific Marine Dredging and Construction, 79
B.R. 924, 929 (Bankr. D. Or. 1987) (debtor's failure to pay for
labor and materials was breach of public construction contract;
consequently debtor had no legal or equitable interest in fund
retained by owner and fund was not part of bankruptcy estate).
This concept of surety was recognized by the New Jersey
Superior Court, Chancery Division in Stevlee Factors, Inc. v.
State, 346 A.2d 624 (N.J. Super. Ct. Ch. Div. 1975). There the
superior court, chancery division, broadly embraced and followed
the subrogation rationale and doctrine enunciated in Pearlman,
holding that "[s]ince the sureties stand in the place of those
whose claims they have paid, the funds must be paid to the
sureties just as the funds would have gone in the absence of a
bond -- to the labor and materialmen rather than to the general
creditors." 346 A.2d at 627. The court also cited Jacobs v.
Northeastern Corp., 206 A.2d 49, 54 (Pa. Super. 1965), which
stated, "Payment of the retained balance became due and available
only upon the performance by the sureties of Northeastern's
obligation. It is clear that all labor and materials claims must
be fully discharged before there is entitlement to the full
contract payment." Stevlee Factors, 346 A.2d at 627-28.7
7
Cf. Transamerica Ins. Co. v. Barnett Bank of Marion County, 540
S.2d 113 (Fla. 1989), where the court held that a surety's
equitable subrogation rights had priority over a bank's perfected
security interest. The court stated:
[T]he overwhelming and essentially unanimous
post U.C.C. decisions in this country,
federal as well as state courts, have held
that (1) the surety's equitable right of
subrogation is not a consensual security
16
We find that the reasoning in Stevlee Factors
represents an incorporation of Pearlman into New Jersey common
law. In the absence of contrary authority, we conclude that we
must apply the Pearlman doctrine, which convinces us to find,
based upon the record currently available in this case, that
Modular's failure to pay its subcontractors was a breach of its
contract such that it was not owed the funds held by the
Salvation Army. As a consequence, those funds did not become a
part of the estate in bankruptcy.
Our conclusion is not undercut by this Court's decision
in Universal Bonding Ins. Co. v. Gittens & Sprinkle, Entr., Inc.,
960 F.2d 366 (3d Cir. 1992), where we held 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." Id. at 367-68 (emphasis added). In contrast to the
situation in Gittens, in the present case, because of Modular's
failure to pay its subcontractors, Modular was not "owed" the
monies held by the Salvation Army. Indeed, the court's rationale
in Gittens is completely consistent with our holding here. If
the funds had been "owed" to Modular, they would have become
"accounts" under New Jersey law, see Continental Finance, 241
interest, (2) no U.C.C. filing is necessary
to perfect the surety's interest, and (3) the
surety's interest continues to be, as it was
under pre Code law, superior to the claim of
a contract assignee.
Id. at 116.
17
A.2d at 860. Because, however, Modular had not paid all the
subcontractors, under the terms of Modular's contract with the
Salvation Army the funds were not owed to Modular. If the
subcontractors had been paid and the monies held by the Salvation
Army were in fact owed to Modular, the Pearlman doctrine would
not then be applicable.
Moreover, we find unpersuasive the bankruptcy and
district courts' reasoning that the Pearlman doctrine applies
only to public contracts with the government and not to private
contracts. There is no such limitation mentioned or implied by
the court in Stevlee Factors. While Stevlee Factors also
involved a public contract, we find that it represents an
encompassing approval of Pearlman without limitation only to
public contracts. See 346 A.2d at 626-28. The basis cited by
the New Jersey court for the adoption of the Pearlman doctrine is
the equitable doctrine of subrogation which "has received wide
application by the courts of this State and is referred to as a
right highly favored in law." Id. at 627 (citing Standard
Accident Ins. Co. v. Pellecchia, 104 A.2d 288 (N.J. 1954); A.&B.
Auto Stores of Jones St., Inc. v. Newark, 279 A.2d 693 (N.J.
1971)).
Moreover, such a limitation of the equitable doctrine
of subrogation only to public contracts would be illogical. The
equitable obligation of the owner to pay subcontractors from
contract funds remaining in the owners hands is not confined to
government projects, see e.g. Mid-Continent Casualty Co. v. First
National Bank & Trust Co., 531 P.2d 1370, 1376 (Okla. 1975)
18
(surety has priority over secured lender in dispute over
remaining contract funds regardless of whether project is private
or public). The Supreme Court in Pearlman based its holding on
common law principles of property rights and subrogation, not
upon principles or rights arising from statutes governing public
contracts. See Pearlman, 371 U.S. at 139-40. There is also
nothing in the Court's reasoning in Pearlman that implies that
its doctrine should apply only to public contracts. The fact
that the issue arose in a Miller Act case would appear to be
fortuitous. As explained by the Court of Appeals for the First
Circuit in Framingham Trust Co. v. Gould-National Batteries,
Inc., 427 F.2d 856, 857-58 (1st Cir. 1970):
The government's well established right to
have the laborers and materialmen paid out of
the unpaid progress payments or unpaid
balance does not arise from any legal
obligation to such suppliers but simply from
its equitable obligation to those who provide
it with labor and materials. We see no
reason why that same equitable obligation to
the laborers and materialmen should not exist
on the part of the non-government owner, who
receives the same benefit from those
suppliers -- construction work and materials
-- as did the government in the
aforementioned cases. Moreover, the non-
government owner, like the government, has an
interest in seeing its suppliers paid so that
the work necessary for completion of the
contract can be done with minimum disruption
and expense.
(citations and footnotes omitted).
We conclude that, based upon the record currently
available in the present case, Modular breached its contractual
obligation to pay its subcontractors and was therefore not "owed"
19
the monies held by the Salvation Army. Under those
circumstances, those funds are not properly considered part of
the estate in bankruptcy and are not subject to the Bank's
superpriority lien. We will therefore reverse the bankruptcy
court's turnover order.
V.
With that said, we are uncomfortable with the
development of the record in the present case. Because of the
bankruptcy court's conclusion that the funds held by the
Salvation Army were part of the estate in bankruptcy, it did not
find it necessary to hold a hearing to determine if any other
factors might establish that any part of the funds were "owed" to
Modular. For example, the extent to which Modular failed to pay
its subcontractors has never been documented adequately. Nor did
the bankruptcy court undertake to explore whether Modular had any
other basis upon which to claim the funds being held by the
Salvation Army. We conclude that further proceedings may be
necessary to determine if Modular has grounds to claim any of
these funds. We will, therefore, remand this case to the
bankruptcy court to conduct such further proceedings it deems
appropriate in light of the above.
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VI.
For the foregoing reasons, we will reverse the order of
the district court and will remand this case to the district
court with directions to remand it to the bankruptcy court for
further proceedings consistent with this opinion.
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