Is Titan Indemnity-Triborough Bridge an aberration or sign of the times?

• Author: Malamy, Kenneth W.

Unfortunately, the Second Circuit's opinion could dissuade sureties from choosing to complete a project after a contractor's contended default

IN A RECENT decision of the U.S. Court of Appeals for the Second Circuit, Titan Indemnity Co. v. Triborough Bridge and Tunnel Authority Inc.,(1) a completing surety found little solace for its claims to be made whole from unpaid public improvement contract funds after it had completed a project for its defaulted principal. The decision derives, in part, apparently from a procedural estoppel by reason of the surety's failure during motion practice to object to a statement of undisputed facts submitted by a competing claimant, the Internal Revenue Service, and also, it appears, from the surety's failure to contest whether unpaid funds in the hands of the public improvement owner constituted trust funds under Article 3A of New York's Lien Law.

THE CASE

The factual underpinnings for the decision are not unusual. Titan wrote performance and payment bonds for D.H. Farney Contractors Inc. on its contracts with the Triborough Bridge and Tunnel Authority to repair the Triborough Bridge and the Verrazano Narrows Bridge in New York. During performance, the principal stopped working on the project and was declared in default, with the owner then holding a fund of $97,601.88. This consisted of monies withheld pursuant to liens, levies and restraining orders, including $21,495.65 withheld pursuant to a notice received from the New York Department of Labor. The remaining $6,447.98 was withheld as contract retainage.

The owner made demand on the surety to complete the project, which it did under a completion agreement by hiring another contractor to finish the job.

There were five creditors competing for the monies withheld: (1) the Internal Revenue Service, which sought $16,721.39 for income taxes and taxes withheld on behalf of Farney employees; (2) the New York State Department of Labor, which sought $48,450, representing its estimate of the principal's liability, including wages, interest and penalties for failure to pay two of its employees the prevailing wage rate under New York law; (3) a subcontractor that sought $3,458.30 for concrete and other materials provided to the principal; (4) a judgment creditor asserting a claim on an unrelated judgment against the principal; and (5) the surety, which sought $90,350.00 as the amount it paid to complete the project after giving the owner credit for the amounts the owner had paid the surety. The Second Circuit's opinion does not disclose how much or why the surety had been paid, but, in any event, the surety does not appear to have been seeking any "profits," but merely to be made whole.

The action began with a suit by the surety in New York state court seeking a determination of the parties' rights. The owner filed an answer and an interpleader claim seeking to deposit the fund with the court pending adjudication of the claims. The IRS removed the action to the federal district court, and all parties moved for summary judgment.

The district court found that the unpaid funds were trust funds under the New York Lien Law, with the order of priority for claims set forth in Section 77 of that law. A "completing surety," however, is not among the claimants listed in that section.

The court first granted the New York Department of Labor a "super priority" for $21,495.65, representing the money that the owner had withheld pursuant to the withholding notice. Following that, the court allowed the IRS's claim of $16,721.39, then the New York Department of Labor's claim of $10,610.77 on the remainder of its back wages and interest claim, then the subcontractor for $3,458.30, and the remainder of slightly in excess of $45,000 to the surety. The unrelated judgment creditor received nothing, and in addition, the New York Department of Labor received nothing on the penalty portion of its claim. Both, the court ruled, would have to pursue the principal independently.

The surety appealed, arguing that the lower court erred in finding that other claims took priority over its claim for various reasons, none of which proved successful in the Second Circuit.

One of the arguments raised by Titan was whether its principal had been defaulted at the time the Department of Labor's withholding notice was served. On this issue, the Second Circuit found that the surety's failure to respond to a required statement of undisputed facts served by the IRS on the motion below precluded that argument. While the details of the surety's argument were not spelled out, the surety was apparently contending, probably based on the termination clause of the principal's contract, that no monies were due the principal when the notice was served, and that there was nothing "due" the contractor to which the notice could attach under the New York Labor Law.

THE DECISION

1. The Holding

   The Second Circuit discussed the surety's claim versus the claims of Article 3-A Lien Law trust fund beneficiaries under New York law, pointing out that Section 70(1) of New York's Lien Law states that funds that are "received by a contractor" under or in connection with a contract for a public improvement constitute assets of a trust. After citing the statute, the court stated, "It is undisputed that the proceeds of the contract at issue are trust funds under Section 70 of the New York Lien Law." The court then examined the priority of claim holders under Section 77 of the New York Lien Law, but the decision does not discuss why the funds that had not been paid to the defaulted contractor, and therefore were not "received by a contractor," constituted trust funds under the statute.

   In fact, the New York case on which the Second Circuit chiefly relied--Tri-City Electric Co. v. People(2)--specifically held that funds that had not been paid did not yet constitute trust funds. Even the Tri-City court noted that funds appropriated for payment but unpaid and held by the state/ owner were "not trust funds pursuant to Article 3-A of the Lien Law."

   In defining trusts, Section 70(5) of the New York Lien Law specifies the assets of a trust "of which the owner is trustee," none of which items pertain to funds of the public owner from the public treasury. Section 70(5) states:

   The assets of the trust of which the owner is trustee are the funds received by him and his rights of action for payment thereof (a) under a building loan contract; (b) under a building loan mortgage or a home improvement loan; (c) under a mortgage recorded subsequent to the commencement of the improvement and before the expiration of four months after completion of the improvement; (d) as consideration for a conveyance recorded subsequent to the commencement of the improvement and before the expiration of four months after the completion thereof; (e) as consideration for, or advances secured by, an assignment of rents due or to become due under an existing or future lease or tenancy of the premises that are the subject of the improvement, or of any part of such premises, if the assignment is executed subsequent to the commencement of the improvement and before the expiration of four months after the completion of the improvement or if it is executed before the commencement of the improvement and an express promise to make an improvement, or an express representation that an improvement will be made, is contained in the assignment or given in the transaction in which the assignment is made; (f) as proceeds of any insurance payable because of the destruction of the improvement or its removal by fire or other casualty, except that the amount thereof required to reimburse the owner for premiums paid by him out of funds other than trust funds shall not be deemed part of the trust assets; (g) under an executory contract for the sale of real property and the improvement thereof by the construction of a building thereon. Nowhere in Section 70(5) is there a statement that the funds of a public improvement owner utilized for a public improvement project constitute such trust funds.

   In Canron Corp. v. City of New York, which was not cited in Titan, certain insurance proceeds were found to be trust funds under the New York Lien Law. The majority opinion of the New York Appellate Division pointed out:

   We have no quarrel with the dissenter that the city is not, ordinarily, a trustee pursuant to Lien Law [sections] 70(1). Under `a contract for a public improvement,' this provision impresses a trust only upon funds received by the contractor and not upon those received by the state or municipality, as the owner of public property upon which an improvement is erected.(3) Thus, it appears that the funds that were unpaid to Titan's principal at the time that it was defaulted and still in the hands of the public improvement owner--the Triborough Bridge and Tunnel Authority--could not have constituted trust funds under Section 70, and the characterization of those funds as "trust funds" should have been disputed, if it was not, as the decision indicates.

   While the contract between the authority and Titan's principal is not discussed in detail in the decision, it is likely that it contained a provision providing for forfeiture of all funds earned or unearned on a termination for default of the contractor by the owner for the owner's use in completing the project. These provisions often also state that any excess costs over and above the monies remaining unpaid and used for the completion will be chargeable to the contractor and its surety. These provisions have enabled the New York Court of Appeals to find priority rights on the part of sureties by reason of their subrogation to the public improvement owner's rights to those funds. That court has stated that even in the absence of such a clause, the surety is subrogated to the rights of the owner in such funds for the use of the completion of the project.

   Having put the completing surety, Titan...