Pearlman v. Reliance Insurance Company – Oral Argument – October 09, 1962

Media for Pearlman v. Reliance Insurance Company

Audio Transcription for Oral Argument – October 10, 1962 in Pearlman v. Reliance Insurance Company

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Earl Warren:

Number 78, Chester A. Pearlman, Trustee, Petitioner, versus Reliance Insurance Company.

Mr. Miles, you may proceed with your arguments.

Raymond T. Miles:

Mr. Chief Justice and may it please the Court.

This Court on Monday of this week issued some orders, permitting the amicus curiae.

Murphy, Mr. Murphy from Oregon and the Association of Surety Company represented by Mr. Morgulas to file amicus curiae brief.

That brief was served on the — late last night as far as the amicus curiae, Mr. Morgulas, the other brief has not been served of course and I would like to ask that this Court give us a short period of time say 10 or 12 days to have an opportunity to examine the one brief that has been submitted and to make any reply that we deemed necessary.

Earl Warren:

You may do so.

Raymond T. Miles:

Thank you.

Now, well this case is here before this Court pursuant to a writ of certiorari then in directing the review of the judgment of the Second Circuit Court of Appeals.

The Second Circuit Court of Appeals affirmed a judgment of the United States District Court for the Western District of New York which in turn had reversed a decision of the referee in bankruptcy in that Court.

I would like to review very briefly the facts which will only take about a minute or a minute and a half but will put the matter in proper focus.

The Dutcher Construction Corporation entered into a contract with the United States Core of Engineers for the doing of certain work from the St. Lawrence Seaway project.

This was in April of 1955.

At that time, the Dutcher Construction Corporation secured from the Fire Association of Philadelphia the issuance of two bonds.

These bonds were issued pursuant to the Miller Act.

There’s one as a performance bond and the other is a payment bond.

They run in favor of the United States Core of Engineers.

Subsequently, the Fire Association of Philadelphia changed its name to the Reliance Insurance Company and that is the name of the respondent in this matter today.

In April of 1956, the Core of Engineers terminated the contract being performed by the Dutcher Construction Corporation on the St. Lawrence Seaway.

It did so for the convenience of the Government and at that time the bankrupt corporation was not in default.

However, there was owed to suppliers and materialmen, some $329,000 which the Reliance Insurance Company has since paid.

As a matter of fact, the Reliance Insurance Company had certainly tended the expenses and then later discovered, I believe that there was another supplier that came under the roof that was known to the Reliance Insurance Company at the time of the termination of the contract so that the Reliance Insurance Company also paid that supplier and the total amount paid by the Reliance Insurance Company to date is approximately $389,000.

The contract was terminated in April of 1956 and Dutcher Construction Corporation became and adjudged bankrupt in August of 1956.

At that time and when I say at that time, I mean the time of the contract was terminated, that was due to the Dutcher Construction Corporation by way of retainages upon the Government contract the sum of $127,000, but the engineers took the position that there should be some additional work done by the bankrupt contractor.

And accordingly an arrangement was entered into between the trustees in bankruptcy of Dutcher Construction Corporation, the Reliance Insurance Company representatives and representatives of the Corp of Engineers by which a group of joint venturers went in and did certain work which the Corp of Engineers said should have been done by the Dutcher Construction Corporation.

And this was pursuant to an agreement whereby the joint venturers whether to receive not over $40,000 upon the completion of the work by the joint venturers on the St. Lawrence Seaway.

The joint venturers received the sum of $40,000 from the United States Core of Engineers.

William J. Brennan, Jr.:

Out of the 127,000 that is retained?

Raymond T. Miles:

Yes sir and the balance of $87,000 is the amount that has been contended for today.

Now the position of the trustee in bankruptcy is that this $87,000 should come into his hands as part of the general assets in the bankruptcy and be subject to the claims of general creditors of whom the Reliance Insurance Company would be one.

Raymond T. Miles:

The position however of the Reliance Insurance Company is that it has a right to these $87,000 which is superior to the rights of the general creditors of the bankruptcy.

Now primarily we res — we rely in our positions —

Arthur J. Goldberg:

[Inaudible]

Raymond T. Miles:

I think that all of this is for the suppliers and materialmen as distinct from wages.

Arthur J. Goldberg:

Those — those men are laborers?

Raymond T. Miles:

I don’t believe that there’s any laborers.

Now, our position is that we are sustained by three cases primarily the — in the case of the United States against the Munsey Trust Company which was decided in this Court in 1947.

Now that case was decided by Mr. Justice Jackson who wrote the opinion.

There was a situation there in which a contractor had a number of jobs to do for the United States Government and there were bonds furnished in all of these jobs.

The jobs were completed, but the materialmen and the suppliers were not paid.

The contractor also had another job to do for the Government.

There was no bond furnished.

There is no indication in the opinion itself as to why no bond was furnished, but that was the case that the contractor never went into the performance of this particular contract.

Consequently, the Government had to secure another contractor which it did, but the other contractor succeeded the first contractor, did the job at a cost to the Government which exceeded the cost which would have been the Government’s cost if the first contractor had gone through with the job.

Consequently, the Government took the position that it was entitled to setoff the excess completion cost for the performance of this unbonded job against the amounts which the contractor had earned and which were being held by the Government as retained for certitudes and this Court held with the Government’s position.

It stated that it did so for two reasons.

The first was the strength of the Government’s position as a creditor which had a setoff against that which it owed to its debtor.

But the second reason and the reason which we stress and which was stressed by Mr. Justice Jackson in his opinion was the weakness of the surety’s position.

You pointed out that the surety had paid the materialmen, the suppliers, laborers, and that is therefore succeeded only to the materialmen and the laborers and consequently could rise no higher than they could and they had no enforceable rights against the Government.

So on those two basis, the position of the Government was sustained.

Now, along in 1958 came the American Surety Company against Hinds case which was decided in the Tenth Circuit and that case is an all force was the case before this Court today.

Arthur J. Goldberg:

Well then you won’t be —

Raymond T. Miles:

— certainly.

Arthur J. Goldberg:

[Inaudible] if you look at the records on one — the petitioners filed [Inaudible] argument that that’s what they’re asking, what complication you think [Inaudible]

Raymond T. Miles:

Well, I think — I think that the answer — the thrust is that those persons who have wages within the connotation of Bankruptcy Act can all pay in particular case.

Arthur J. Goldberg:

So it was there with the Act?

Raymond T. Miles:

Yes sir.

Arthur J. Goldberg:

And the laborers could have preferred to be here with the other laborers other than those who had their [Inaudible]

Raymond T. Miles:

That’s right.

Now the American Surety Company case against — American Surety Company against Hinds decided in the Tenth Circuit was a situation in which there was a contract with the United States Government.

Raymond T. Miles:

The contractor did some of the work but failed to finish.

Accordingly, the trustee went ahead and actually performed the work and finished the job.

The Surety Company, one of the moneys that had been retained by the Government for the performance of the contractor up until the time that he failed to continue in his performance and the Court held that the surety would have to fail.

The surety hadn’t established its right to priority.

It had all the cases that the respondent has cited in this matter before it, a large number of which were Court of Claims cases, a large number were state cases applying state law.

And in fact, the Court and the Tenth Circuit stated that the position of the surety in a matter before it was not unsupported by authority.

But on the basis or the second basis set forth by Mr. Justice Jackson it held against the surety and made this statement.

We’re not convinced however of the merit of reason which limits the clear holding of Munsey to factual situations where the Government is a direct claimant.

Mr. Justice Jackson speaking for the Court notes that claim with the surety must fail for two reasons, both the strength of the Government’s right to setoff and the weakness of the surety’s claim to equitable rights in the fund.

The reasoning of the opinion in a latter regard is in no way dependent upon the United States being the claimant.

Now we have one other case that we rely on to sustain our position, that’s the case of Phoenix Indemnity Company against Earle which was decided in 1955 in the Ninth Circuit.

And there, the United States Government tried to assert certain tax liens against funds which had come into the hands of the trustee in bankruptcy.

The trustee in bankruptcy had retained these funds from the Government that they were previously been retainages.

In that case too, the surety had paid the laborers and materialmen, but the Court held that the Government’s tax liens were impressed upon the moneys received by the trustee in bankruptcy and stated that an assertion to the contrary which seems to have been laid to rest by the Munsey case.

Now these are the three doc — cases that we rely upon and as against that, the surety has in this case characterized the Munsey case as a violent doctrine seeking to discredit the Munsey case except to those situations where the Government is a party and seeking to discredit these two cases which had followed.

Now primarily the surety’s position is that it follows the cases set forth as the Prairie State National Bank against the United States and the case of Henningsen against the United States Fidelity & Guaranty Company.

The Prairie State case was decided in 1896.

We have no argument whatsoever with that case.

It’s a case where a contractor did some work then failed to complete the job, the surety ran and completed the job.

So the surety is here in a performance rather than a payment situation.

In that particular situation, the contractor had assigned moneys that were to come due from the performance of the contract to a bank and the contest therefore was whether the assignee bank should retain the retainages or whether the surety should succeed and the Court held that the surety should succeed.

Now we think that that’s a logical case and we point out why it’s logical and why a contrary result would be illogical.

We say this that here the surety has come in and actually performed and the first thing that occurs is it’s perhaps created the fund which it subsequently gets.

It should be rewarded by the creation of its own efforts.

The second thing is that the United States by the very nature things can be forced to perform upon a contractor.

That the United States has a million dollar contract and it spends $500,000 and the job is half done, and the contractor defaults, the United States by the nature of things might be forced to go in and complete the contract, to complete the building, to protect its investments and the time and the money, but under no circumstances can the United States of America be forced to pay the materialmen and the laborers.

So as I’ve said before, we have no argument whatsoever with the Prairie State case, but then the next case which is cited by the surety is Henningsen against United States Fidelity & Guaranty, decided in this Court in 1908 and it again seems to be a case that is equally cited, but this is an entirely different case.

In the Henningsen case, we have a somewhat similar situation in that the contractor assigned the moneys to be earned by the contractor from a performance of the Government’s bond to a bank.

The contractor did some of the work.

If the work failed to pay the suppliers and the materialmen surety stepped in paid.

Raymond T. Miles:

Now the strange thing here is that the surety again prevailed, but the Court and the only citation contained in the text of its opinion cited the Prairie State case.

And as far as it can be determined by the opinion itself, it made no distinction between payment and performance, nevertheless the surety prevailed in that case.

The Court stated the Prairie State case controlled.

There is no reference to the arguments which we have made here that the United States can by the nature of things be forced to complete a contract but can never be forced to pay, then proceeded into the Henningsen case and made the statement that the surety was obligated to pay by contract, that the bank was a volunteer.

Well to me that which did not seem to be the cheap reason in the case is to point out a different situation in this case before this Court, we point out that we represent all of the creditors, some of whom obtained a creditor status before the issuance of these bonds and before the execution of this contract with the United States Government.

And we’d hardly think that they qualify as volunteers in the sense that the Court used that phrase in the Henningsen case.

However, the Court went along and put the basis for the recovery by the surety in this case on the basis that the surety by the payment of laborers and materialmen had released the Government from its obligation to those persons and to the same extent had released the Government from its obligation to see that the laborers and materialmen were paid.

So that at this stage, we now come into the cases which hold that the surety is subrogated to the position because of its satisfactions of the Government’s equitable obligation to the materialmen and the laborers.

Now this has been a matter which has been criticized over the course of time and various law journals we’ve been citing University of Cincinnati Law Journal.

It’s been criticized in Yale Law Journal which was published, I think, in the later part of the summer although the issue itself is dated as recently as June of 1962.

It was pointed out in that particular article that what the Court seemed to be saying was either that the surety had a claim for simple reimbursement from the Government as a secondary principle or it was stating that the satisfaction of the Government’s obligation as an equitable obligor put it in the position of holding the retainages which the Government had at the time of dissatisfaction.

Well in either case we say that this isn’t a proper subject for subrogation because we’re only satisfying what is an equitable obligation and not a legal obligation.

And I should like to point out that at this time that in the Henningsen case that was as far as it went and that was the basis of the recovery.

It did not state in the Henningsen case that the laborers and materialmen had any equitable liens or equitable priorities as against the retainages.

That was a development of cases which followed.

Now the cases that have followed have not explained how the satisfaction of this equitable obligation as it’s described in Henningsen in effect creates a legal right in the surety.

The Belknap case is probably the case most cited by attorneys in this field.

Belknap case was decided in 1921 and that case attempted to spell out the reasoning of the Henningsen case and made this statement.

The surety’s claim of prior argument with the fund was sustained and this was done on the stated theory of subrogation since it cannot be the transfer of a right by subrogation unless there is a right to be transferred.

We think the necessary effect of the decision is to hold that the laborers and materialmen in spite of or in addition to the giving of the bond had an original and continuing equitable priority to the bond and it was this right to which the surety was subrogated.

So now we have an evolution, a next step where they say that there is an equitable priority to which the surety has succeeded.

Arthur J. Goldberg:

Yes, but this Court had not been [Inaudible] with the government that the laborers and materialmen would have been protected by their liens, is that so?

Raymond T. Miles:

No sir.

Arthur J. Goldberg:

Why not?

Raymond T. Miles:

Because you can’t have a lien against the United States Government.

Arthur J. Goldberg:

Right, so this work had not been —

Raymond T. Miles:

Had not been —

Arthur J. Goldberg:

(Inaudible) by the Government.

Raymond T. Miles:

Quite right, under most all state statutes that’s true, and certainly that would be true in my own statement.

Arthur J. Goldberg:

[Inaudible] is equitable obligation his rights and the fact that since some of the action is really been [Inaudible] on the present Government and of course [Inaudible] protections that would have enforced the [Inaudible] on the private parties.

Raymond T. Miles:

That maybe the background of it, but the fact of the matter is that the Government has here done something more than would be the case what a private individual were if a contract was done in New York State, material man was not paid, he has a right to assert a mechanics lien against the property.

Here the Government we think has satisfied this equitable obligation by the payment bonds.

Arthur J. Goldberg:

For the two companies?

Raymond T. Miles:

Yes sir.

Now what we’ve stated here is that the Government is asserted by the Court to be in a certain sort of ought to pay situation, that’s badly said but that’s the situation as we see it and we say does that create a right to payment of the laborers and if that’s the position, then that position will apply in the face of all the cases that say that the laborers and the materialmen have no rights in the fund.

The strange thing about the Belknap case was that after it came to this equitable priority theory, and it had noted that the Henningsen case that favored the surety on the basis of the subrogation theory, the Belknap case then described its subrogation and so stated in the opinion itself, and made these rather interesting comments which I’d like to read to the Court but which one follows exactly after the other in the text of the opinion.

The Belknap case goes back to the Prairie State case which is the performance bond case with which petitioner in this matter has no argument whatsoever and referring to the performance bond case made in this statement.

When the surety in the later case stepped in the United States was the obligee in an unperformed contract holding security for its performance and the surety was subrogated.

We go right along, then the next sentence refers to the Henningsen case, the payment bond case and makes this statement.

When Henningsen Surety paid up, the United States, and secured creditors had been satisfied and had no further claim of the fund unless it was the duty to devote the fund to the labor and material claimants and hence the proposition must be considered as established.

In other words, Belknap jumped to the conclusion that there had to be this equitable priority without giving a basis for it and without following any subrogation theory which had been followed in the Henningsen case and then in the very next sentence made this statement.

Obviously the retained fund is devoted to the payment for such labor and material as maybe necessary to finish the work after the contractor defaults.

Whether it is devoted to pay the contractor’s debts of this class is a distinctive question and the cited cases suggest to us confusion of thought.

In other words when you quarrel with all and you have the Henningsen case, a payment bond case resulting in a decision favorable to the surety on the basis of subrogation to an equitable obligation of the Government.

In the Belknap case the surety again prevails not on a theory subrogation, but on a new theory of equitable priority comparable to an equitable lien.

And we say that it can’t be an equitable lien because it doesn’t meet any of the elements for such a thing.

To have an equitable lien, there would have to be a debtor and creditor relationship.

There is no debtor-creditor relationship between the United States and the materialmen.

The second thing that would have to be present would be a raise.

There is no raise because the funds which are identified as retainages are only so-called, they are not a separate identifiable fund but rather they are part of the general assets of the United States.

The third thing has been no act of appropriation by the Government identifying this raise as set aside for the use of the materialmen and the laborers.

Earl Warren:

We’ll recess now.