When, by reason of the contractor's default, a surety on a
payment bond given by a contractor under the Miller Act, 49 Stat.
793, has been compelled to pay debts of the contractor for labor
and materials, the surety is entitled by subrogation to
reimbursement from a fund otherwise due to the contractor but
withheld by the Government pursuant to the terms of the contract --
even though the contractor has become bankrupt and the Government
has turned the withheld fund over to the contractor's trustee in
bankruptcy. Pp.
371 U. S.
133-142.
(a) This fund never became a part of the bankruptcy estate, and
its disposition is not controlled by the Bankruptcy Act. Pp.
371 U. S.
135-136.
(b)
Prairie State Bank v. United States, 164 U.
S. 227, and
Henningsen v. United States Fid. &
Guar. Co., 208 U. S. 404,
followed. Pp.
371 U. S.
137-139.
(c) The Miller Act, which requires separate performance and
payment bonds on Government contracts, did not change the law as
declared in the
Prairie State Bank and
Henningsen
cases. Pp.
371 U. S.
139-140.
(d) The
Prairie State Bank and
Henningsen
cases were not overruled by
United States v. Munsey Trust
Co., 332 U. S. 234. Pp.
371 U. S.
140-142.
298 F.2d 655 affirmed.
Page 371 U. S. 133
MR. JUSTICE BLACK delivered the opinion of the Court.
This is a dispute between the trustee in bankruptcy of a
government contractor and the contractor's payment bond surety over
which has the superior right and title to a fund withheld by the
Government out of earnings due the contractor.
The petitioner, Pearlman is trustee of the bankrupt estate of
the Dutcher Construction Corporation, which, in April, 1955,
entered into a contract with the United States to do work on the
Government's St. Lawrence Seaway project. At the same time, the
respondent, Reliance Insurance Company, [
Footnote 1] executed two surety bonds required of the
contractor by the Miller Act, one to guarantee performance of the
contract, the other to guarantee payment to all persons supplying
labor and material for the project. [
Footnote 2] Under the terms of the contract, which was
attached to and made a part of the payment bond, the United
States
Page 371 U. S. 134
was authorized to retain and hold a percentage of estimated
amounts due monthly until final completion and acceptance of all
work covered by the contract. Before completion, Dutcher had
financial trouble, and the United States terminated its contract by
agreement. Another contractor completed the job, which was finally
accepted by the Government. At this time, there was left in the
Government's withheld fund $87,737.35, which would have been due to
be paid to Dutcher had it carried out its obligation to pay its
laborers and materialmen. Since it had not met this obligation, its
surety had been compelled to pay about $350,000 to discharge debts
of the contractor for labor and materials. In this situation, the
Government was holding over $87,000 which plainly belonged to
someone else, and the fund was turned over to the bankrupt's
trustee, who held it on the assumption that it had been property of
the bankrupt at the time of adjudication, and therefore had vested
in the trustee "by operation of law" under § 70 of the Bankruptcy
Act. [
Footnote 3] The surety
then filed a petition in the District Court denying that the fund
had vested in the trustee, alleging that it, the surety, was "the
owner of said sum" of $87,737.35 "free and clear of the claims of
the Trustee in Bankruptcy or any other person, firm or
corporation," and seeking an order directing the trustee to pay
over the fund to the surety forthwith. [
Footnote 4] The referee in bankruptcy, relying chiefly on
this Court's opinion in
United States v. Munsey Trust Co.,
332 U. S. 234
(1947), held that the surety had no superior rights in the fund,
refused to direct payment to the surety, and
Page 371 U. S. 135
accordingly ordered the surety's claim to be allowed as that of
a general creditor only to share on an equality with the general
run of unsecured creditors. [
Footnote 5] The District Court vacated the referee's order
and held that cases decided prior to
Munsey had
established the right of a surety under circumstances like this to
be accorded priority over general creditors, and that
Munsey had not changed that rule. [
Footnote 6] The Second Circuit affirmed. [
Footnote 7] Other federal courts have reached
a contrary result, [
Footnote 8]
and, as the question is an important and recurring one, we granted
certiorari to decide it. [
Footnote
9]
One argument against the surety's claim is that this controversy
is governed entirely by the Bankruptcy Act, and that § 64, 11
U.S.C. § 104, which prescribes priorities for different classes of
creditors, gives no priority to a surety's claim for reimbursement.
But the present dispute -- who has the property interests in the
fund, and how much -- is not so simply solved. 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 interests 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 of rights, 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
Page 371 U. S. 136
people's property among a bankrupt's creditors. [
Footnote 10] So here, if the surety at the
time of adjudication was, as it claimed, either the outright legal
or equitable owner of this fund, or had an equitable lien or prior
right to it, this property interest of the surety never became a
part of the bankruptcy estate to be administered, liquidated, and
distributed to general creditors of the bankrupt. This Court has
recently reaffirmed that such property rights existing before
bankruptcy in persons other than the bankrupt must be recognized
and respected in bankruptcy. [
Footnote 11] Consequently, our question is not who was
entitled to priority in distributions under § 64, but whether the
surety had, as it claimed, ownership of, an equitable lien on, or a
prior right to this fund before bankruptcy adjudication.
Since there is no statute which expressly declares that a surety
does acquire a property interest in a fund like this under the
circumstances here, we must seek an answer in prior judicial
decisions. Some of the relevant factors in determining the question
are beyond dispute. Traditionally, sureties compelled to pay debts
for their principal have been deemed entitled to reimbursement,
even without a contractual promise such as the surety here had.
[
Footnote 12] And probably
there are few doctrines better established
Page 371 U. S. 137
than that a surety who pays the debt of another is entitled to
all the rights of the person he paid to enforce his right to be
reimbursed. [
Footnote 13]
This rule, widely applied in this country [
Footnote 14] and generally known as the right of
subrogation, was relied on by the Court of Appeals in this case. It
seems rather plain that at least two prior decisions of this Court
have held that there is a security interest in a withheld fund like
this to which the surety is subrogated, unless, as is argued, the
rule laid down in those cases has been changed by passage of the
Miller Act or by our holding in the
Munsey case. Those two
cases are
Prairie State Bank v. United States,
164 U. S. 227
(1896), and Henningsen v.
United States Fid. & Guar.
Co., 208 U. S. 404
(1908).
In the
Prairie Bank case, a surety who had been
compelled to complete a government contract upon the contractor's
default in performance claimed that he was entitled to be
reimbursed for his expenditure out of a fund that arose from the
Government's retention of 10% of the estimated value of the work
done under the terms of the contract between the original
contractor and the Government. That contract contained almost the
same provisions for retention of the fund as the contract presently
before us. The Prairie Bank, contesting the surety's claim,
asserted that it had a superior equitable lien arising from moneys
advanced by the bank to the contractor before the surety began to
complete the work. The Court, in a well reasoned opinion by Mr.
Justice White, held that this fund materially tended to protect the
surety,
Page 371 U. S. 138
that its creation raised an equity in the surety's favor, that
the United States was entitled to protect itself out of the fund,
and that the surety, by asserting the right of subrogation, could
protect itself by resort to the same securities and same remedies
which had been available to the United States for its protection
against the contractor. The Court then went on to quote with
obvious approval this statement from a state case:
"The law upon this subject seems to be, the reserved per cent.
to be withheld until the completion of the work to be done is as
much for the indemnity of him who may be a guarantor of the
performance of the contract as for him for whom it is to be
performed. And there is great justness in the rule adopted.
Equitably, therefore, the sureties in such cases are entitled to
have the sum agreed upon held as a fund out of which they may be
indemnified, and, if the principal releases it without their
consent, it discharges them from their undertaking."
164 U.S. at
164 U. S. 239,
quoting from
Finney v. Condon, 86 Ill. 78, 81 (1877).
The
Prairie Bank case thus followed an already
established doctrine that a surety who completes a contract has an
"equitable right" to indemnification out of a retained fund such as
the one claimed by the surety in the present case. The only
difference in the two cases is that here, the surety incurred his
losses by paying debts for the contractor, rather than by finishing
the contract.
The
Henningsen case, decided 12 years later, in 1908,
carried the
Prairie Bank case still closer to ours.
Henningsen had contracts with the United States to construct public
buildings. His surety stipulated not only that the contractor would
perform and construct the buildings, but also, as stated by the
Court, that he would "pay promptly
Page 371 U. S. 139
and in full all persons supplying labor and material in the
prosecution of the work contracted for." [
Footnote 15] Henningsen completed the buildings
according to contract, but failed to pay his laborers and
materialmen. The surety paid. This Court applied the equitable
principles declared in the
Prairie Bank case so as to
entitle the surety to the same equitable claim to the retained fund
that the surety in the
Prairie Bank case was held to have.
Thus the same equitable rules as to subrogation and property
interests in a retained fund were held to exist whether a surety
completes a contract or whether, though not called upon to complete
the contract, it pays the laborers and materialmen. These two cases
therefore, together with other cases that have followed them,
[
Footnote 16] establish the
surety's right to subrogation in such a fund whether its bond be
for performance or payment. Unless this rule has been changed, the
surety here has a right to this retained fund.
It is argued that the Miller Act [
Footnote 17] changed the law as declared in the
Prairie Bank and
Henningsen cases. We think not.
Certainly no language of the Act does, and we have been pointed to
no legislative history that indicates such a purpose. The
suggestion is, however, that a congressional purpose to repudiate
the equitable doctrine of the two cases should be implied from the
fact that the Miller Act required a public contract surety to
execute two bonds, instead of the one formerly required. It is true
that the Miller Act did require both a performance
Page 371 U. S. 140
bond and an additional payment bond, that is, one to assure
completion of the contract and one to assure payments by the
contractor for materials and labor. But the prior Acts on this
subject, while requiring only one bond, made it cover both
performance and payment. [
Footnote 18] Neither this slight difference in the new
and the old Acts nor any other argument presented persuades us that
Congress, in passing the Miller Act, intended to repudiate
equitable principles so deeply imbedded in our commercial
practices, our economy, and our law as those spelled out in the
Prairie Bank and
Henningsen cases. [
Footnote 19]
The final argument is that the
Prairie Bank and
Henningsen cases were, in effect, overruled by our holding
and opinion in
United States v. Munsey Trust Co., supra.
The point at issue in that case was whether the United States,
while holding a fund like the one in this case, could offset
against the contractor a claim bearing no relationship to the
contractor's claim there at issue. We held that the Government
could exercise the well established common law right of debtors to
offset claims of their own against their creditors. This was all we
held. The opinion contained statements which some have interpreted
[
Footnote 20] as meaning
that we were abandoning the established legal and equitable
principles of the
Prairie Bank and
Henningsen
cases under which sureties can indemnify themselves against losses.
But the equitable rights of a surety declared in the
Prairie
Bank case as to sureties who complete
Page 371 U. S. 141
the performance of a contract were expressly recognized and
approved in
Munsey, [
Footnote 21] and the
Henningsen rule as to
sureties who had not completed the contract, but had paid laborers,
was not mentioned.
Henningsen was not even cited in the
Munsey opinion. We hold that
Munsey left the rule
in
Prairie Bank and
Henningsen undisturbed. We
cannot say that such a firmly established rule was so casually
overruled. [
Footnote 22]
We therefore hold, in accord with the established legal
principles stated above, that the Government had a right to use the
retained fund to pay laborers and materialmen; that the laborers
and materialmen had a right to be paid out of the fund; 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. [
Footnote 23]
Consequently, since the surety in this case has paid
Page 371 U. S. 142
out more than the amount of the existing fund, it has a right to
all of it. On this basis, the judgment of the Court of Appeals
is
Affirmed.
MR. JUSTICE WHITE dissents.
[
Footnote 1]
The company was then known as Fire Association of
Philadelphia.
[
Footnote 2]
40 U.S.C. § 270a, provides in part as follows:
"(a) Before any contract, exceeding $2,000 in amount, for the
construction, alteration, or repair of any public building or
public work of the United States is awarded to any person, such
person shall furnish to the United States the following bonds,
which shall become binding upon the award of the contract to such
person, who is hereinafter designated as 'contractor':"
"(1) A performance bond with a surety or sureties satisfactory
to the officer awarding such contract, and in such amount as he
shall deem adequate, for the protection of the United States."
"(2) A payment bond with a surety or sureties satisfactory to
such officer for the protection of all persons supplying labor and
material in the prosecution of the work provided for in said
contract for the use of each such person."
[
Footnote 3]
30 Stat. 565 (1898), 11 U.S.C. § 110.
[
Footnote 4]
The surety appears also to have claimed some general priority
over all creditors for the entire $350,000 it had paid out for the
contractor, based on "liens, subrogation and assignment," but here
its petition for certiorari and briefs seem to limit its claim to
the net amount of the retained fund turned over to the trustee by
the Government.
[
Footnote 5]
35 J.N.A.Ref.Bankr. 81 (1961).
[
Footnote 6]
In re Dutcher Constr. Corp., 197 F.
Supp. 441 (D.C.W.D.N.Y.1961).
[
Footnote 7]
298 F.2d 655 (C.A.2d Cir. 1962).
[
Footnote 8]
See, e.g., American Sur. Co. v. Hinds, 260 F.2d 366
(C.A.10th Cir. 1958);
Phoenix Indem. Co. v. Earle, 218
F.2d 645 (C.A.9th Cir. 1955).
[
Footnote 9]
369 U.S. 847 (1962).
[
Footnote 10]
See Justice Holmes' discussion in
Sexton v. Kessler
& Co., 225 U. S. 90,
225 U. S. 98-99
(1912). As to the difficulties inherent in phrases like "equitable
lien,"
see Glenn, The "Equitable Pledge", Creditors'
Rights, and the Chandler Act, 25 Va.L.Rev. 422, 423 (1939).
[
Footnote 11]
United States v. Durham Lumber Co., 363 U.
S. 522 (1960).
See also Security Mortgage Co. v.
Powers, 278 U. S. 149
(1928), and cases collected in 6 Am.Jur., Bankruptcy, § 949 (rev.
ed. 1950).
Cf. Aquilino v. United States, 363 U.
S. 509 (1960).
[
Footnote 12]
"The right of subrogation is not founded on contract. It is a
creature of equity, is enforced solely for the purpose of
accomplishing the ends of substantial justice, and is independent
of any contractual relations between the parties."
Memphis & L. R.R. Co. v. Dow, 120 U.
S. 287,
120 U. S.
301-302 (1887).
[
Footnote 13]
See, e.g., Hampton v. Phipps, 108 U.
S. 260,
108 U. S. 263
(1883);
Lidderdale's Executors v.
Robinson's Executor, 12 Wheat. 594 (1827);
Duncan, Fox, & Co. v. North and South Wales Bank, 6
App.Cas. 1 (H.L. 1880).
See generally Sheldon,
Subrogation, § 11 (1882).
[
Footnote 14]
See cases collected in 50 Am.Jur., Subrogation, § 49
(1944).
[
Footnote 15]
208 U.S. at
208 U. S.
410.
[
Footnote 16]
See, e.g., Martin v. National Sur. Co., 85 F.2d 135
(C.A.8th Cir. 1936),
aff'd, 300 U.
S. 588 (1937);
In re Scofield Co., 215 F. 45
(C.A.2d Cir. 1914);
National Sur. Corp. v. United States,
133 F. Supp. 381, 132 Ct.Cl. 724,
cert. denied sub nom. First
Nat. Bank v. United States, 350 U.S. 902 (1955).
[
Footnote 17]
See note 2
supra.
[
Footnote 18]
28 Stat. 278 (1894), amended, 33 Stat. 811 (1905).
[
Footnote 19]
Among the problems which would be raised by a contrary result
would be the unsettling of the usual view, grounded in commercial
practice, that suretyship is not insurance. This distinction is
discussed in Cushman, Surety Bonds on Public and Private
Construction Projects, 46 A.B.A.J. 649, 652-653 (1960).
[
Footnote 20]
See note 8
supra.
[
Footnote 21]
332 U.S. at
332 U. S.
240.
[
Footnote 22]
State courts likewise apply the rule that sureties on public
contracts are entitled to the benefits of subrogation.
See
cases collected in 43 Am.Jur., Public Works and Contracts, § 197
(1942).
[
Footnote 23]
See the somewhat different but closely related
discussion by which Mr. Justice Cardozo, speaking for this Court,
reached a similar result in
Martin v. National Sur. Co.,
300 U. S. 588,
300 U. S.
597-598 (1937).
Our result has also been reached by the Court of Claims in cases
substantially like ours.
Continental Cas. Co. v. United
States, 169 F. Supp. 945, 145 Ct.Cl. 99 (1959);
National
Sur. Corp. v. United States, 133 F. Supp. 381, 132 Ct.Cl. 724,
cert. denied sub nom. First Nat. Bank v. United States,
350 U.S. 902 (1955);
Royal Indem. Co. v. United States, 93
F. Supp. 891,
117
Ct.Cl. 736 (1950).
See generally Speidel, "Stakeholder"
Payments Under Federal Construction Contracts: Payment Bond Surety
vs. Assignee, 47 Va.L.Rev. 640, 646-648 (1961); note,
Reconsideration of Subrogative Rights of the Miller Act Payment
Bond Surety, 71 Yale L.J. 1274 (1962); comment, 33 Cornell L.Q. 443
(1948).
MR. JUSTICE CLARK, with whom MR. JUSTICE DOUGLAS and MR. JUSTICE
BRENNAN join, concurring in the result.
The Court holds that the surety company here is entitled to the
funds the Government has paid into court on the theory that the
surety is subrogated to the claims of the laborers and materialmen
which it has paid. I cannot agree. None of the cases in this Court
so hold. Indeed, in
United States v. Munsey Trust Co.,
332 U. S. 234
(1947), this Court said:
"But nothing is more clear than that laborers and materialmen do
not have enforceable rights against the United States for their
compensation. . . . They cannot acquire a lien on public buildings
. . . , and, as a substitute for that more customary protection,
the various statutes were passed which require that a surety
guarantee their payment. Of these, the last and the one now in
force is the Miller Act, under which the bonds here were
drawn."
Id. at p.
332 U. S. 241.
"[I]t is elementary that one cannot acquire by subrogation what
another whose rights he claims did not have. . . ."
Id. at
p.
332 U. S.
242.
Since the laborers and materialmen have no right against the
funds, it follows as clear as rain that the surety could have none.
It appears to me that today's holding that laborers and materialmen
had "rights" to funds in the Government's hands might jeopardize
the rights of the United States and have serious consequences for
its building operations. The Congress has not so provided, and I
would not so hold.
Page 371 U. S. 143
However, this Court has held in two cases not necessary to the
decision in
Munsey that the surety who pays laborers' and
materialmen's claims stands in the shoes of the United States, and
is entitled to surplus funds remaining in its hands after the
contract is completed. The first is
Prairie State Bank v.
United States, 164 U. S. 227
(1896), and the other
Henningsen v. United States Fid. &
Guar. Co., 208 U. S. 404
(1908). In neither of those cases, however, did the Court find that
laborers and materialmen had any right against the United States,
but only that the "Guaranty Company [was] entitled to subrogation
to any right of the United States government arising through the
building contract."
Henningsen, supra, at p.
208 U. S.
410.
Since the funds here have been paid into court by the
Government, there is some question whether the doctrine of those
cases would apply. In each of them, the money was in the hands of
the United States at the time the suit was commenced, and was
clearly applicable to payment of any debt under the contract. It
would, therefore, be my view that the equities existing here in
favor of the surety grow out of the contract between it and the
contractor (in whose shoes the trustee now stands), which was made
in consideration of the execution of the bond. Under that
agreement, in the event of any breach or default in the
construction contract, all sums becoming due thereunder were
assigned to the surety to be credited against any loss or damage it
might suffer thereby. In
Martin v. National Surety Co.,
300 U. S. 588
(1937), this Court in an identical situation
* awarded such a
fund to
Page 371 U. S. 144
the surety. Mr. Justice Cardozo, for a unanimous Court,
said:
"In our view of the law, the equities in favor of materialmen
growing out of that agreement [between the surety and the
contractor] were impressed upon the fund in the possession of the
court."
Id. at pp.
300 U. S.
593-594. It is well to note also that the Court of
Appeals in
Martin had based its decision on the theory
announced by the Court today, but Mr. Justice Cardozo, for a
unanimous Court, chose the "narrower" ground of the assignment in
affirming the judgment for the surety. I agree with
Martin
as to the "narrower" ground, and believe the Court should keep the
opinion today "within the necessities of the specific controversy,"
rather than enlarging upon the rules of
Henningsen and
Prairie State Bank. In so doing, the Court would but
fulfill the prophecy made in
Martin that "the grounds
chosen . . . may be expected to be helpful as a guide in other
cases."
Id. at p.
300 U. S. 593.
I would affirm the judgment on this basis.
* In
Martin, the contractor assigned to the surety
"all the deferred payments and retained percentages, and any and
all moneys and properties that may be due and payable to the
undersigned at the time of any breach or default in said contract,
or . . . thereafter. . . ."
Id. at pp.
300 U. S.
590-591. Here, the assignment was of,
inter
alia,
"Any and all percentages of the contract price retained on
account of said contract, and any and all sums that may be due
under said contract at the time of such . . . forfeiture or breach,
or that thereafter may become due. . . ."