HARTFORD FIRE INSURANCE COMPANY v. USA
Filing
39
ORDER denying 12 Motion to Dismiss - Rule 12(b)(1) and (6). Joint Status Report due 11/15/12. Signed by Sr. Judge Bohdan A. Futey. (mp1) Copy to parties.
In the United States Court of Federal Claims
No. 11-499C
(Filed October 22, 2012)
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HARTFORD FIRE INSURANCE
COMPANY,
Plaintiff,
v.
THE UNITED STATES,
Defendant.
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Contract Disputes Act; Motion
to Dismiss for Failure to State a
Claim; Miller Act, 40 U.S.C. §
3131, Equitable Subrogation
Rights, Notice Requirement for
Stakeholder Duty, Reasonable
Discretion In Disbursing Funds
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OPINION AND ORDER
This case comes before the Court on defendant’s Motion to Dismiss.
On August 2, 2011, plaintiff Hartford Fire Insurance Company
(“Hartford”), a Connecticut corporation with its principal place of business in
Hartford, Connecticut, filed a complaint in the Court of Federal Claims against
the United States, acting specifically through the United States Army Corps of
Engineers (“the Corps”). The complaint alleged the Corps wrongfully disbursed
funds to Overstreet Electric Co. (“Overstreet”), a contractor for whom Hartford
had acted as a Miller Act surety on two federal contracts with the Corps. Hartford
seeks to exercise its right of equitable subrogation, and seeks damages of
$700,000, which it claims the Corps wrongfully paid to Overstreet in violation of
the government’s stakeholder duty to the surety. The government filed a motion
to dismiss under United States Court of Federal Claims Rules (“RCFC”) 12(b)(1)
and 12(b)(6), citing the Court’s jurisdictional statute of limitations, and a failure
to state a claim upon which relief may be granted. On April 11, 2012, the Court
granted Hartford’s unopposed motion to amend its complaint, clarifying
Hartford’s position on its accrual of its claim, damages, and settlement
negotiations concerning the payment at issue. In its response, defendant withdrew
its statute of limitations argument, but reiterated its arguments for dismissal under
RCFC 12(b)(6).
This is a case which plaintiff seeks to fit within the holding in
Transamerica, in which the Court of Appeals for the Federal Circuit held that a
performance bond surety stated a cause of action against the government for
equitable subrogation when it sought funds payable by the government to the
contractor on an equitable adjustment to a separate contract. Transamerica Ins.
Co. v. United States, 989 F.2d 1188, 1195 (Fed. Cir. 1993). This “two-contract”
theory of recovery allowed the surety as equitable subrogee, to offset its loss on
one contract with an amount due to the contractor on a second contract. Id.
Transamerica distinguished a line of prior cases, and limited its holding to cases
in which the balancing of the equities favored recovery. Id. at 1192-95.
I.
Background 1
This case involves two federal contracts, both procured through the Army
Corps of Engineers and awarded to Overstreet Electric Co. As required by the
Miller Act for all construction contracts over $100,000, a surety – here, Hartford
Fire Insurance Company – posted performance and payment bonds for the
projects. 2 See Miller Act, 40 U.S.C. § 3131(b) (2011). Upon the prime
contractor’s default, the performance bond surety has the option of either
completing the project itself, or of assuming liability for the government’s excess
costs in completing the contract. Ins. Co. of the West, 243 F.3d 1367, 1370 (Fed.
Cir. 2001); Aetna Cas. & Sur. Co. v. United States, 845 F.2d 971, 975 (Fed. Cir.
1988). A third alternative is to provide the funds to an insolvent contractor to
complete performance. Ins. Co. of the West, 243 F.3d at 1370.
On October 5, 2000, the Corps awarded Contract No. DACW27-01-C0001 to Overstreet for the rehabilitation of pumping stations along the Little
Calumet River in Lake County, Indiana (“Little Calumet Project”). Substantial
completion was to occur by October 24, 2004. In accordance with the Miller Act,
Hartford issued payment and performance bonds on the project in the amount of
$4 million. On September 13, 2001, the Corps awarded Contract No. DACW2101-C-001 to Overstreet for disposal area improvements and weir replacement in
an area of the Savannah Harbor near Savannah, Georgia (“Savannah Project”).
Hartford also issued payment and performance bonds for this project in the
amount of $4,306,035.86.
1
Unless otherwise indicated, the following facts are taken from plaintiff’s
amended complaint and exhibits.
2
A payment bond surety is required to pay subcontractors, materialmen, and
laborers in the event of a prime contractor’s default. See 40 U.S.C. § 3131(b)(2);
Aetna, 845 F.2d at 973. A performance bond surety guarantees that the project
will be completed if the contractor defaults. 40 U.S.C. § 3131(b)(1); Aetna, 845
F.2d at 973-74 (citing United States v. Munsey Trust Co., 332 U.S. 234, 244
(1947)).
2
Problems arose and on July 29, 2003, the Corps terminated Overstreet for
default on the Savannah Project. Overstreet submitted a claim pursuant to the
Contract Disputes Act (“CDA”) on January 30, 2004, seeking a conversion to a
termination for convenience based on its arguments of defective specifications,
differing site conditions, and delay in performance due to the defective
specifications. The Corps denied Overstreet’s request, and on June 30, 2004,
Overstreet filed suit against the Corps in the Court of Federal Claims. Fed. Cl.
Docket No. 04-1067C. The government filed a counterclaim in the suit for $1.48
million. 3
While the dispute over the Savannah Project was unfolding in late 2004
and early 2005, problems on the Little Calumet Project also developed. On
February 7, 2005, the Corps issued a “Show Cause Notice” to Overstreet and
Hartford, based upon Overstreet’s failure to complete work within the schedule,
and indicating it was considering a termination for default on the Little Calumet
Project. The Corps directed Overstreet to respond in three days, and provide any
information which would show the failure to perform was due to causes beyond
its control. Overstreet did not respond within the three days. The contracting
officer for the Little Calumet Project, Regina Blair, next sent a letter to Hartford,
indicating its concern and lack of confidence in Overstreet’s ability to complete
the project. The Corps had been awaiting the delivery of a complete work plan
since October 2004, which Overstreet never submitted, and failed again to submit
by its guaranteed February 16, 2005 deadline. On March 9, 2005, Overstreet sent
a letter to Hartford, indicating that it was “up against the wall on th[e] [Little
Calumet] project” and without involvement by Hartford, the Contracting Officer
would be “likely left with no viable option but to terminate the contract for
default.” On March 30, 2005, Blair sent a letter to Overstreet indicating default
was imminent unless Overstreet commenced work on all “punch list” and
incomplete on-site efforts that could be done without a pump rebuilding
subcontractor.
Three weeks later, on April 19, 2005, there was a settlement conference
regarding Overstreet’s suit against the Corps for the Savannah Project. Following
two days of negotiations, the Corps and Overstreet agreed to a complete
settlement of claims. By its terms, the termination for default would be changed to
a termination for convenience, and the United States would pay Overstreet
$700,000. The settlement was contingent upon the Department of Justice’s
approval. Hartford states that although its attorney attended the settlement
conference, “he did so as an observer to obtain information concerning the
government’s claim against Overstreet” and “did not actively participate in the
settlement negotiations.”
3
On August 2, 2005, pursuant to RCFC 41(a)(1), the parties stipulated and agreed
to dismiss the action with prejudice, in accordance with the Settlement
Agreement. Notice of Voluntary Dismissal, Aug. 2, 2005, ECF No. 14; Pl.’s Ex.
10.
3
On June 20, 2005, Gary Judd of Hartford sent an email to Blair, regarding
the Little Calumet Project. The email stated, among other things, that in their
conversation, he “advised and requested that the Corps exercise its rights as an
owner/obligee with other contracts with Overstreet Electrict [sic] to offset or
withhold payments that may be due Overstreet Electric to secure the Corps and
the Hartford to those funds by way of its equitable rights of subrogation that it has
as a result of Overstreet Electric’s default on this project and others.” In this
notice he specifically referred to the $700,000 in settlement funds owed from the
Savannah Project, which was scheduled to be paid to Overstreet. He requested
that the Corps “not release any further payments on either project with [the Little
Calumet contract] [ ] office or the project in the Savannah District.”
On July 8, 2005, the Department of Justice approved the settlement for the
Savannah Project, and the Corps and Overstreet executed the Settlement
Agreement. On July 26, 2005, Overstreet received payment in accordance with its
terms. On February 22, 2006, the Corps terminated the Little Calumet Project for
default due to “serious failure to prosecute the remaining work items under the
Contract.”
On August 14, 2006, Charles Moorer of Hartford sent a letter to Little
Calumet contracting officer Blair, reiterating that the Corps had failed to offset
the settlement proceeds from the Savannah Project; Blair replied, stating that she
could not collect monies to do so “because there was a formal claim issue at
hand.” Moorer responded on October 31, 2006, reiterating the Corps exercise its
right to offset and withhold payments due to Overstreet to secure Hartford’s
equitable subrogation rights. Following Overstreet’s default on the Little Calumet
Project, Hartford undertook completion pursuant to the terms of its bonds in
January 2008, and completed the project in 2009. Hartford’s costs in completing
the project exceeded the Little Calumet Project funds remaining, and even after
applying funds received from the Corps, Hartford spent more than $1.6 million.
Hartford therefore claims that the balance paid under the government’s
Settlement Agreement for the Savannah Project should not have been paid to
Overstreet, but rather that Hartford by its right of equitable subrogation, was
entitled to the settlement proceeds due Overstreet. In so arguing, Hartford asserts
that once the government was notified of Overstreet’s imminent default on the
Little Calumet Project, it became a “stakeholder” with a duty to Hartford in
administering funds. It further supports its case with the government’s wellestablished set-off right, which had the government been the one to complete the
Little Calumet Project, it may have offset its loss on that project with the amount
due Overstreet pursuant to the Savannah Project’s Settlement Agreement.
Defendant’s motion argues that the current case falls under the
Dependable line of cases, rather than the Transamerica decision, and as such,
Hartford’s recovery should be limited to the retained Little Calumet Project funds,
4
as that was the project generating the claim. See Dependable Ins. Co., Inc. v.
United States, 846 F.2d 65, 67 (Fed. Cir. 1988) (citing Security Ins. Co., 428 F.2d
838, 844 (Ct. Cl. 1970)). Defendant states that Transamerica involved an agencylevel, consensual equitable adjustment on the second contract, and specifically
limited its holding to cases in which the government did not have a “competing
claim” and where after “counterbalanc[ing] [ ] the other interests involved”, the
equities favor recovery. Def.’s Mot. to Dismiss 15-16; Transamerica, 989 F.2d at
1194-95. Defendant contends that the Settlement Agreement at issue here, in
which the Corps and Overstreet settled competing claims, is precisely the
“competing claim” situation envisioned by the Federal Circuit in limiting
Transamerica. Def.’s Mot. to Dismiss 16. It further argues that extending
Transamerica to this situation “strains the doctrine beyond its limits” and would
allow a surety to impede or prohibit the government’s settlement efforts. Id. at 18;
Def.’s Resp. to Pl.’s Sur-reply 2. It points out that rather than unexpended
contract funds, which may be sought by a surety, the settlement here came from
the Judgment Fund, which is distinct from funds allocated to a particular project.
Def.’s Reply in Supp. of Mot. to Dismiss 2-3.
Defendant also argues that plaintiff fails to state a claim because
Hartford’s notice to the government was insufficient, as the surety incorrectly
notified only Regina Blair, the Little Calumet contracting officer, and not the
Savannah contracting officer or the Department of Justice. Def.’s Mot. to Dismiss
20-22. It maintains that as the funds sought were paid from the Judgment Fund
pursuant to a settlement, no one in the Corps, let alone the contracting officer
from an unrelated office was responsible for the payment, and thus Hartford’s
notice was inadequate to impose a stakeholder duty. Id. at 20-22.
Defendant next contends that Hartford could not succeed to the
government’s right to set-off the funds, as on the date of the settlement payment,
the government itself did not even possess that right as it had not yet terminated
the Little Calumet Project for default, and thus nothing was owed it yet. Id. at 2224. It alleges that any lawsuit Hartford might have would be more akin to an
impairment of suretyship claim, which cannot be maintained against the United
States. Id. at 25. Finally, defendant argues that Hartford cannot assert that it was
damaged by the settlement payment because the Settlement Agreement actually
limited Overstreet’s liability to the government by dismissing the reprocurement
costs on the Savannah Project, and as Overstreet’s surety, Hartford actually
benefitted from the settlement through a limitation on its own liability. Id. at 2628.
Plaintiff responds that this case closely follows Transamerica, in which a
performing surety was permitted to state a claim to recover funds from an
equitable adjustment “settlement” on a second contract. Pl.’s Sur-reply to Def.’s
Mot. to Dismiss 2. As further evidence of its right to set-off, plaintiff introduces
the Applied decision, which stands for the government’s ability to use its right of
set-off even against settlement proceeds. Id. at 3; Applied Cos. v. United States,
5
144 F.3d 1470, 1475 (Fed. Cir. 1998). It maintains that just like in that case, the
Settlement Agreement at issue here did not expressly limit the government’s
common law right to set-off debts due to it. Pl.’s Sur-reply to Def.’s Mot. to
Dismiss 3. Defendant replies that the Settlement Agreement did limit the right to
set-off the debt, in that it expressly provided that Overstreet was the “sole owner”
of its claim, and would only dismiss its lawsuit after receiving payment pursuant
to the Agreement. Def.’s Reply to Pl.’s Sur-reply 6. Finally, plaintiff asserts that
the fact Overstreet was not terminated for default until February 2006 does not
displace the government’s stakeholder duty with respect to the funds, and that the
government’s delay in declaring a formal default cannot excuse its stakeholder
duty to consider Hartford’s interest in the funds. Pl.’s Sur-reply to Def.’s Mot. to
Dismiss 6.
II.
Discussion
A. Legal Standard
In order to survive a motion to dismiss under RCFC 12(b)(6), a plaintiff
must establish that the complaint “adequately states a claim,” that is, that the
complaint “contain[s] either direct or inferential allegations respecting all the
material elements necessary to sustain recovery under some viable legal theory.”
Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 562 (2007) (quoting Car Carriers,
Inc. v. Ford Motor Co., 745 F.2d 1101, 1106 (7th Cir. 1984)). A well-pleaded
complaint will survive a motion to dismiss even if it appears “that a recovery is
very remote and unlikely.” Id. at 556 (quoting Scheuer v. Rhodes, 416 U.S. 232,
236 (1974)). When reviewing a motion to dismiss for failure to state a claim
upon which relief may be granted, the court “must accept as true all the factual
allegations in the complaint . . . and [ ] indulge all reasonable inferences in favor
of the non-movant.” Sommers Oil Co. v. United States, 241 F.3d 1375, 1378
(Fed. Cir. 2001) (citations omitted). Allegations in the complaint need not be
overly detailed, but do need to “raise a right to relief above the speculative level”
or “nudge[ ][the] claims across the line from conceivable to plausible.” Twombly,
550 U.S. at 555, 570. “[O]nce a claim has been stated adequately,” however, “a
plaintiff receives the benefit of imagination so long as the hypotheses are
consistent with the complaint.” Id. at 563 (citation and internal quotes omitted).
B. Doctrine of Equitable Subrogation
A surety bond is a three-party relationship, in which the surety becomes
liable for the principal's debt or duty to the third party obligee (here, the
government). Ins. Co. of the West, 243 F.3d at 1370; United States Sur. Co. v.
United States, 83 Fed. Cl. 306, 310 (2008). A performance bond surety may
discharge its obligation to the government on a defaulted contract either by taking
over and completing performance of the contract or, if it lets the government
reprocure the contract, by assuming liability for the costs of completion that
6
exceed the original contract price. Westchester Fire Ins. Co. v. United States, 52
Fed. Cl. 567, 574 (2002) (citing Ins. Co. of the West, 243 F.3d at 1370).
It is well established 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.” See
e.g., Pearlman v. Reliance Ins. Co., 371 U.S. 132, 137 (1962). The remedy of
equitable subrogation thus allows a performing surety to step into the shoes of the
benefitted party. See id. The right of subrogation is not founded on contract but
“[i]t 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 & Little Rock R.R. Co. v. Dow, 120 U.S. 287, 30102 (1887).
A surety fulfilling an obligation under a performance bond has different
and more expansive rights than under a payment bond. Aetna, 845 F.2d at 974.
Unlike a payment bond surety, a performance bond surety may recover from
retained contract funds the amount it expended in completing the contract free
from set-off for taxes owed by the contractor. See Nova Cas. Co. v. United States,
69 Fed. Cl. 284, 293 (2006); United States Fid. Guar. Co. v. United States, 475
F.2d 1377, 1383 (Ct. Cl. 1973); Security Ins. Co., 428 F.2d at 839. The
performing surety is in this position due to its equitable right of subrogation to the
contract funds retained by the government. See Pearlman, 371 U.S. at 138. Thus,
where a surety takes over contract performance, the surety succeeds to the
contractual rights of both the defaulted contractor and the government itself.
United States Sur. Co., 83 Fed. Cl. at 310 (citing Security Ins. Co., 428 F.2d at
841-42). The surety is “entitled to the funds in the hands of the government not as
a creditor subject to set-off, but as a subrogee having the same right to the funds
as the government.” Id. (internal quotation omitted). The rationale for this rule is
that by performing the contract itself, the surety confers a benefit upon the
government by relieving it of performance. See Dependable Ins. Co., Inc., 846
F.2d at 67. But see United States Sur. Co., 83 Fed. Cl. at 311 (performance bond
surety who executes takeover agreement does not defeat government’s
entitlement to liquidated damages from contract funds).
Ordinarily, a Miller Act surety asserts the doctrine of equitable
subrogation to acquire retained contract funds that are still in the government's
possession after performance of the contract is complete. See, e.g., Prairie State
Nat'l Bank of Chicago v. United States, 164 U.S. 227, 227-28 (1896). The
doctrine, however, has been expanded to allow a surety to recover from the
government when the government abuses its discretion in disbursing earned
progress payments. See 40 U.S.C. § 3131; Nat’l Am. Ins. Co. v. United States, 72
Fed. Cl. 451, 458 (2006) (government liable for violating its stakeholder duty by
making a final payment to contractor after surety notified the government that it
was asserting a right to the contract funds); Capitol Indem. Corp. v. United States,
71 Fed. Cl. 98, 102 (2006).
7
It is well settled that the government, like any other creditor, retains the
right “to apply the unappropriated moneys of [its] debtor, in [its] hands, in
extinguishment of the debts due to [it].” Munsey Trust Co., 332 U.S. at 239
(internal citations omitted); Bank of Am. Nat'l Trust & Sav. Ass'n v. United States,
23 F.3d 380, 384 (Fed. Cir. 1994). The set-off right applies to government claims
both under other contracts and under the same contract. Johnson v. All-State
Constr., Inc., 329 F.3d 848, 852 (Fed. Cir. 2003) (citing William Green Constr.
Co. v. United States, 477 F.2d 930, 936 (Ct. Cl. 1973); Cecile Indus., Inc. v.
Cheney, 995 F.2d 1052, 1054 (Fed. Cir. 1993)). The right to set-off is preserved
unless there is explicit statutory or contractual provision that bars its exercise. See
Johnson, 329 F.3d at 853-54; Applied Cos., 144 F.3d at 1475.
In Applied, a contractor entered into several contracts to supply air
conditioning units to the government, one of which was terminated for default.
Applied Cos., 144 F.3d at 1473. The Armed Services Board of Contract Appeals
converted the termination for default into a termination for convenience, and the
parties arrived at a settlement agreement under which the government agreed to
pay approximately $2.8 million to resolve all claims from the terminated contract.
Id. Rather than pay that sum, however, the government paid only $911,604.11,
and used the remainder of the amount to offset two erroneous overpayments made
to Applied three years earlier on another contract. Id. Applied sought review in
this Court, which granted summary judgment for the government and held that
nothing in the agreement deprived the government of its common law set-off
right. Id. at 1475. The Federal Circuit affirmed, stating “[w]e are aware of no
principle of contract law that would justify prohibiting the government from
exercising its setoff right against the settlement agreement proceeds any more
than against any other obligation . . . to a party that owed the government money
in return.” Id.
Similarly, the Civilian Board of Contract Appeals in Global Ship Systems,
citing Applied, held that the government’s set-off right extended to a settlement
agreement on a separate contract, despite the “no exceptions” language in the
agreement, specific language to deposit funds in a designated account, and the
contractor’s subsequent statements that it would never have settled the appeal for
the amount had it known setoff would be claimed in an unrelated matter. Global
Ship Systems, LLC v. Dep’t of Homeland Security, CBCA 923, 10-2 BCA ¶
34,496. See also East Coast Security Services, Inc. v. Dep’t of Homeland Security,
DOT BCA 4469R, et al., 06-1 BCA ¶ 33,290 (permitting set-off from settlement
amount to pay down another of contractor’s debts to government still sufficiently
effectuated the intent of the agreement). Like the settlement agreement in Applied,
here too a termination for default was converted into a termination for
convenience with an amount of money to be paid the contractor to resolve all
claims from the terminated contract. Applied, 144 F.3d at 1473. Plaintiff argues
that it is precisely this set-off right that it is entitled to exercise as an equitable
subrogee.
8
After a consideration of the on-point surety case law, contrary to the
government’s assertions, the Court finds this case adheres more closely to the
Transamerica facts than the earlier Dependable line of cases limiting relief to the
single contract at issue. 4 In its decision in Transamerica, the Federal Circuit
emphasized the importance of relief for the surety, who would never undertake
the job of completion if doing so would leave it worse off than the government,
had it completed the job. Transamerica, 989 F.2d at 1192. On the facts of that
case, the Court found “nothing in the law of suretyship to cause us to favor
allowing [ ] the defaulting contractor, to be better off simply because the surety,
rather than the government, completed a contract and thereby incurred damages.”
Id. at 1194. The same incentives apply here, where if the Corps had taken it upon
itself to complete the Little Calumet Project, it may have offset the costs against
the settlement agreement payable to Overstreet. See Applied, 144 F.3d at 1475.
Referencing Transamerica, the government distinguishes that case by
citing the government’s competing claims and interest in settling claims and
maintaining its funds. Def.’s Mot. To Dismiss 15-16. Transamerica, however,
also involved the same interests of the government in securing contract
performance and value for the public fisc. This is the whole point of an equitable
adjustment, which frequently give rise to litigation under the CDA, similar to the
contested termination for default conversion in this case. Like in Transamerica in
which the government owed an amount to the contractor under a separate contract
(whether for an equitable adjustment or equitable adjustment “settlement”), here
too the parties arrived at a sum certain payable by the government to Overstreet
on the separate Savannah Project. Regardless of the lack of consensus and
litigation that ultimately brought about the owed amount, the government had
become a stakeholder to the sum, and Overstreet the only claimant. Like in
District of Columbia v. Aetna, which the Federal Circuit relied upon as the “only
case on point” in deciding Transamerica, except for the contractor, there was no
other claimant to the amount owed on the second contract, and thus where “the
only claimants to monies held by a government agency are the surety and a
defaulting contractor, the surety . . . is subrogated to all of the rights and remedies
which the government might have had against the principal had the government
been forced to complete the project itself.” Transamerica, 989 F.2d at 1190-91
(citing Dist. of Columbia v. Aetna Ins. Co., 462 A.2d 428, 432 (D.C. Ct. App.
4
In 1998, this Court in Intercargo Ins. Co. v. United States seemed to restate the
pre-Transamerica limitation on the surety’s ability to recover on a single contract.
Intercargo Ins. Co. v. United States, 41 Fed. Cl. 449, 457-58 (“the surety's right to
subrogation arises only as to the monies due under the contract in question.”)
(emphasis added). Rather than interpret this as revitalization of Dependable,
however, that case involved a surety’s attempt to reach funds not yet earned by
the contractor, and the Court likely intended the emphasis to be on the words
“only monies due.” Id. Any other reading would only serve as dictum to the
holding, and regardless, this Court remains bound by the Federal Circuit’s
decision in Transamerica.
9
1983)). These remedies include the common law right of set-off. See id. at 1191
(internal quotation omitted). Hartford should likewise be subrogated to the
government’s right of set-off with respect to the amount owed Overstreet.
The Court is also not persuaded that there is a great distinction between
the source of the settlement funds, such that it should deprive plaintiff of relief. In
Transamerica, the equitable adjustment was presumably to be paid from retained
contract funds for the separate Commissary contract. While contract funds are the
natural preference from which to pay disputed claims, once these are exhausted,
the judgment fund becomes the source of payments for awards under the CDA.
See 31 U.S.C. § 1304. The fact that the funds are not drawn directly from
appropriated contract funds would not prevent them from being collected by
Overstreet, and it should not prevent Hartford from seeking the same. This
outcome “avoids the anomalous result” whereby the performance bond surety
would be worse off for having undertaken performance, Security Ins. Co. v.
United States, 428 F.2d at 844, and addresses the Supreme Court’s concern in
Munsey that “a surety would rarely undertake to complete a job if it incurred the
risk that by completing it might lose more than if it had allowed the government
to proceed.” Munsey Trust Co., 332 U.S. at 244. The Sixth Circuit noted similar
concerns in the bankruptcy case In re Larbar, which reasoned that if “denied the
right to setoff than the surety might be tempted to ‘cut corners’ rather than
promptly and properly complete the losing contracts.” In re Larbar Corp., 177
F.3d 439, 447 (6th Cir. 1999).
Finally, Transamerica refutes the government’s contention that burdening
it as a “stakeholder” in that situation will lead to the parade of horribles, and
suggests that an interpleader action may be appropriate in some cases.
Transamerica, 989 F.2d at 1194. This Court finds the equities similar enough to
those in Transamerica that here too “it would be against fairness and good
conscience to allow the defaulting contractor to benefit . . . at the expense of the
fully performing surety.” Transamerica, 989 F.2d at 1195. See also In re Larbar,
177 F.3d at 445-47 (finding “mutuality” existed under Kentucky law such that the
surety for a contractor in Chapter 7 bankruptcy succeeded to the setoff rights of
the state in both state and federal contracts; the proceeds earned on some
government contracts could reimburse it for the loss taken on others).
The government contends that even had Hartford become equitably
subrogated to the government’s right to set-off, no right to set-off existed as of the
date the settlement payment was made. Def.’s Mot. to Dismiss 22-24. A surety’s
right to equitable subrogation relates back to the date on which it executed the
performance and payment bonds. Ins. Co. of the West v. United States, 55 Fed. Cl.
529, 543 (2003) (surety’s subrogation claim was not limited to last of three
progress payments made to a defaulting contractor on ground that surety did not
begin to finance performance until after the first two payments had been made). It
is, however, a general principle of equitable subrogation that “one cannot acquire
by subrogation from another, rights which that person did not have.” Ram Constr.
10
Co., Inc. v. Am. States Ins. Co., 749 F.2d 1049, 1055 (3d Cir. 1984) (quoting
Munsey Trust Co., 332 U.S. at 242). See also Intercargo Ins. Co, 41 Fed. Cl. at
458-59 (surety could not state claim for equitable subrogation when it sought
contract funds not earned by and therefore not due to the contractor). Similarly,
sureties cannot use equitable subrogation as a vehicle by which to pursue claims
against the government that the contractor neglected to pursue under the CDA.
See Universal Sur. Co. v. United States, 10 Cl. Ct. 794, 798 (1986) (surety could
not succeed to funds not sought by the prime contractor pursuant to the CDA).
Instead, it is limited to agreed upon contractual liabilities, and the surety does not
have the right to convert disputed amounts into “liquidated and therefore certain
sums.” Id. Thus, equitable subrogation exists to allocate proceeds of alreadyestablished rights, not to create new ones.
Defendant’s timing argument does create an obstacle to plaintiff’s
recovery; however, if as plaintiff asserts, “Overstreet was certainly indebted to the
Government” such that the Corps could have collected on the Little Calumet
Project, or alternatively, that the Corps unreasonably delayed in its termination for
default in violation of its stakeholder duty to the surety, see infra Part II.B.2, then
Hartford maintains an avenue for relief. Pl.’s Sur-reply to Def.’s Mot. to Dismiss
5-6. Because the Court assumes all reasonable inferences in plaintiff’s favor,
plaintiff has succeeded in alleging a theory of recovery sufficient to withstand the
government’s motion to dismiss.
1. Notice Requirement for Stakeholder Duty
The government owes no duty to a surety until it may be called upon to
perform, and when it may become a party to the bonded contract. Fireman’s Fund
Ins. Co. v. United States, 909 F.2d 495, 499 (Fed. Cir. 1990). To assert the
doctrine of equitable subrogation to hold the government liable for improper
payments, the surety must notify the government that the contractor is or is close
to being in default. See Capitol Indem. Corp., 71 Fed. Cl. at 102; Nova Cas. Co.,
69 Fed. Cl. at 297; Ransom v. United States, 17 Cl. Ct. 263, 272 (1989), aff'd, 900
F.2d 242 (Fed. Cir. 1990) (“[B]efore any obligation arises to withhold or divert
funds, the Government must be notified that the sureties believe the contractor is
in default and cannot complete the contract.”).
Thus, notice that the contractor is in default and that the surety is invoking
its rights to the remaining contract proceeds converts the government into a
stakeholder with duties to the surety. United States Fire Ins. Co. v. United States,
78 Fed. Cl. 308, 326 (2007) (internal quotations omitted); Nova Cas. Co., 69 Fed.
Cl. at 297; Am. Ins. Co. v. United States, 62 Fed. Cl. 151, 155 (2004); Ins. Co. of
the West v. United States, 55 Fed. Cl. 529, 539 (2003); Transamerica Premier Ins.
Co. v. United States, 32 Fed. Cl. 308, 314 (1994); Ransom, 900 F.2d at 245.
Without such notice, the duty, and the concomitant ability to invoke this court's
jurisdiction, generally do not attach. See Ins. Co. of West, 243 F.3d at 1371. It is
irrelevant whether the surety is claiming rights to funds during performance of the
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contract or after it is completed; when the government functions as “stakeholder”
of funds owed but not yet paid, notice by surety is essential before any
governmental duty exists. Fireman’s Fund Ins. Co., 909 F.2d at 498.
In examining what constitutes adequate notice, the contractor’s default
alone is not sufficient to trigger a government obligation to consider the surety’s
interests or to withhold progress payments to the contractor. Capitol Indem.
Corp., 71 Fed. Cl. at 103 (citing Ransom, 900 F.2d at 242). Rather, the surety
must explicitly notify the government of the default or threatened default, and not
vice versa. United Sur. and Indem. Co. v. United States, 87 Fed. Cl. 580, 593-94
(2009) (warnings of the contractor’s payment deficiencies from subcontractors
and suppliers to the government does not substitute for Miller Act surety’s notice
to trigger stakeholder duty; “[t]he Government’s independent knowledge of
contractor default is irrelevant.”); Ins. Co. of the West, 83 Fed. Cl. at 541
(“Government owes no duty to consider the interests of the surety until the surety
itself expresses its own concern. . . .”) (emphasis added); Travelers Indem. Co. v.
United States, 72 Fed. Cl. 56, 67 (2006) (“[N]otice must be by the surety and not
a third party.”) (citing Fireman’s Fund Ins. Co., 909 F.2d at 499); Fireman’s
Fund Ins. Co. v. United States, 909 F.2d 495, 498 (Fed. Cir. 1990) (“[N]otice by
the surety is essential before any governmental duty exists.”); Random, 900 F.2d
243 (finding surety could not assert the equitable doctrine of subrogation when the
government notified the surety it was concerned as to the contractor’s default)
(emphasis added). See also Capitol Indem. Corp., 71 Fed. Cl. at 103-04 (preexisting escrow account arrangement for payment on contract did not constitute
notice by surety as to contractor’s imminent default, nor could constructive notice
be assumed from progress reports showing contractor’s deficient progress).
Because the surety may decide that its interests are best served by
continuing to have payments sent directly to the principal contractor, constructive
notice that a contractor has defaulted and the surety has taken over the
performance of the contract is insufficient, standing alone, to trigger equitable
subrogation whereby the government has a duty to withhold or divert funds. Am.
Ins. Co. v. United States, 62 Fed. Cl. 151, 155 (2004). But see Capitol Indem.
Corp, 71 Fed. Cl. at 104 (“[G]overnment’s equitable duty to consider the surety’s
interests is not triggered absent explicit notice either directly or indirectly from
the surety.”) (emphasis added) (citing Ransom, 900 F.2d at 245). Notice must
also be specific enough to alert the government to the contract at issue. Ins. Co of
the West, 83 Fed. Cl. at 542 (letter to contracting officer reasonably provided
notice as to potential default on all bonded contracts referenced in the caption).
Further, notice of even a potential default can suffice to trigger the
government’s stakeholder duty. Ins. Co of the West, 83 Fed. Cl. at 540-41; Capitol
Indem. Corp., 71 Fed. Cl. at 102-03 (“[I]s [defaulted] or is close to being in
default . . . [T]he surety must explicitly notify the government of the default or
threatened default.”); Lumbermens Mut. Cas. Co. v. United States, 67 Fed. Cl.
253, 255 (2005) (no relief where surety did not notify government that contractor
was “approaching default”); Hartford Fire Ins. Co. v. United States, 40 Fed. Cl.
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520, 522-23 (1998) (“has defaulted or is in danger or defaulting”); Am. Fid. Fire
Ins. Co. v. United States, 513 F.2d 1375, 1379-80 (Ct. Cl. 1975) (finding surety’s
letter containing citations to California Civil Code and “danger signals” of default
triggered government’s stakeholder duty).
Once this adequate notice is given, the government becomes a stakeholder
in the funds and, effectively, “the government pays out to the contractor at its own
risk beyond that point.” Universal Sur. Co., 10 Cl. Ct. at 798. Thus the act of
releasing money does not save the government from liability to the party who
rightfully should have been paid. District of Columbia v. Aetna, 462 A.2d at 432
(“Interpleader was created precisely for situations such as this . . . .”). Although
the vast majority of cases in this line all stand for the government’s stakeholder
duty with regard to retained contract funds, a similar stakeholder duty extends to
amounts due a contractor under the settlement of a separate contract. See
Transamerica, 989 F.2d at 1194.
Here, Hartford sent its notice in an email to Regina Blair, the contracting
officer for the Little Calumet Project, and stated that it could not find the number
for the Savannah contacting officer, Julie Anderson. Pl.’s Ex. 9. The government
argues that the Department of Justice, as the agency responsible for the settlement
funds called for by the agreement, would have been the proper contact to stop the
payment. The Court finds that for this stage of stating a claim, petitioner’s email
to Blair may have been adequate to put the Corps on notice of its stakeholder
duty. The existence of some means of trying to contact the Corps is apparent in
the complaint, and the fact that Blair in turn contacted the Savannah office to
inquire about collecting monies from that contract show that the government
could be found on notice of Hartford’s assertion of its rights enough to impose a
stakeholder’s duty. See Pl.’s Ex. 13. The government’s assertion that notice was
required to be to the Justice Department as guardian of the Judgment Fund is
unconvincing. Had Overstreet violated the terms of the proposed settlement
agreement, the Corps likely would not have hesitated to contact the Department of
Justice to prevent payment. Since notice is all plaintiff must assert in order to
survive a motion to dismiss, and we give plaintiff every benefit of the doubt at
this stage, this issue is best left to be decided on the merits.
2. Reasonable Discretion in Disbursing the Funds
The “stakeholder” duty to act with reasoned discretion does not
automatically require the government to withhold progress payments, but rather
requires consideration of the surety’s interest in any decision to disburse payment.
Ins. Co. of the West, 83 Fed. Cl. at 543. Compare Argonaut Ins. Co. v. United
States, 434 F.2d 1362, 1368-69 (Ct. Cl. 1970) (government did exercise discretion
responsibly when refusing to withhold a progress payment), with Nat’l Am. Ins.
Co. 72 Fed. Cl. 451, 458-59 (2006) (government liable when violated stakeholder
duty and unresasonably made payment to contractor, despite notice by surety that
it was asserting rights to the funds).
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The scope of reasonable discretion afforded varies. In cases in which the
surety notifies the government that the contractor is in default on one of its bonds,
but performance under the contract has not been completed, the government has
“broad discretion and flexibility” in deciding whether to withhold payments.
Balboa Ins. Co. v. United States, 775 F.2d 1158, 1164 (Fed. Cir. 1985). “During
the performance of the contract, the Government has a duty to exercise its
discretion responsibly and to consider the surety's interest in conjunction with
other problems encountered in the administration of the contract.” Argonaut Ins.
Co., 434 F.2d at 1368. See also Nat'l Surety Corp. v. United States, 118 F.3d
1542, 1546 (Fed. Cir. 1997); United States Fire Ins. Co., 78 Fed. Cl. at 334;
United States Fid. & Guar. Co., 475 F.2d at 1384.
Where performance is complete and the government has already accepted
the performance, however, it is bound by the traditional duty of reasonableness,
and is not accorded the greater discretion it otherwise would have been permitted
had the contractor not completed performance. Travelers Indem. Co., 72 Fed. Cl.
at 67 (finding government violated its duty as stakeholder by releasing contract
retainage after accepting performance, despite surety’s notification that contractor
had defaulted on its payment bond); Int’l Fid. Ins. Co. v. United States, 25 Cl. Ct.
469, 477 (1992) (discussing the government’s interest in paying the contractor
during performance in order to insure timely completion of the project, but
finding “[a]fter completion, the government has no valid reason to decide the
merits itself.”). Thus, after performance, the government's interest in retaining
funds to ensure contract completion disappears and the contractor's and surety's
interests in the retained funds become paramount. Transamerica Premier Ins. Co.,
32 Fed. Cl. at 315. “Bluntly put, the Government's interest at this point does not
extend beyond avoiding liability for sending the retained funds to the wrong
party.” Id. at 315-16.
Ultimately, the reasonableness of the government’s actions, including the
decision to release payments to the contractor, is a factual question to be
determined at trial. Ins. Co of the West, 83 Fed. Cl. at 543 (citing Balboa, 775
F.2d at 1162). In Balboa, the Federal Circuit considered eight factors to determine
whether the government exercised reasoned discretion in distributing funds once
it was alerted to the potential default. Balboa, 775 F.2d at 1164.
Here, Hartford alleges that the government’s breach of discretion with
regard to disbursing the funds stems from its failure to exercise its right of set-off
on the Little Calumet Project, and allocate this amount to Hartford as the
equitable subrogee. Pl.’s Am. Compl. ¶¶ 32-35. Hartford maintains that the
government did in fact have the right to set-off its debt from the settlement
proceeds, or that its delay in terminating the Little Calumet Project for default
violated its stakeholder duty to consider the surety’s interest. Pl.’s Sur-reply to
Def.’s Mot to Dismiss 5-6. These are questions of fact, which are not to be
decided at this stage. See Int’l Fid. Ins. Co., 25 Cl. Ct. at 480 (precluding
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summary judgment because “[w]hether the government has acted within a
reasonable time after default is a question of fact” and the reasonableness of the
Postal Service’s conduct in terminating for default presented a genuine issue of
material fact).
Therefore, the question of whether the government used reasonable
discretion in distributing the funds to Overstreet, or as plaintiff contends, failed to
promptly terminate the Little Calumet Project and exercise its right to set-off for
the surety’s benefit are questions of fact, not to be resolved in a motion to dismiss.
III.
Conclusion
The Court finds that Hartford has adequately stated its claim, because it
has alleged sufficient facts “respecting all the material elements necessary to
sustain recovery under some viable legal theory.” Twombly, 550 U.S. at 544.
Accordingly, the government's motion to dismiss this case pursuant to Rule
12(b)(6) of the RCFC for failure to state a claim upon which relief can be granted
is hereby DENIED. As factual questions remain in dispute, the parties shall file a
joint status report by Thursday, November 15, 2012 regarding the course of
further pretrial proceedings.
IT IS SO ORDERED.
s/Bohdan A. Futey___
BOHDAN A. FUTEY
Judge
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