United Structures v. G.R.G. Engineering

USCA1 Opinion











UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT

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No. 93-1354

UNITED STRUCTURES OF AMERICA, INC. AND
UNITED STATES OF AMERICA FOR THE USE OF
UNITED STRUCTURES OF AMERICA, INC.,

Plaintiffs, Appellees,

v.

G.R.G. ENGINEERING, S.E.
AND NEW HAMPSHIRE INSURANCE COMPANY,

Defendants, Appellants.


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APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF PUERTO RICO


[Hon. Juan M. Perez-Gimenez, U.S. District Judge]
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Before

Breyer, Chief Judge,
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Selya and Stahl, Circuit Judges.
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John E. Mudd with whom Cordero, Miranda & Pinto was on brief for
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appellants.
Mark S. Finkelstein with whom Elizabeth D. Alvarado, Shannon,
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Martin, Finkelstein & Sayre, David P. Freedman, and O'Neill & Borges
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were on brief for appellee United Structures of America, Inc.


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November 18, 1993
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BREYER, Chief Judge. The plaintiff, having
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supplied steel to a now bankrupt subcontractor, has sued the

general contractor, seeking to recover payment for the steel

from the bond that a federal statute, the Miller Act,

requires certain general contractors to provide. 40 U.S.C.

270a-270b. The general contractor says the steel was

defective, and it wants to deduct from the promised purchase

price the amount that it says it had to spend to cure the

defects. The district court, relying upon a Ninth Circuit

case, United States ex rel. Martin Steel Constructors v.
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Avanti Steel Constructors, 750 F.2d 759 (9th Cir. 1984),
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cert. denied sub nom. Harvis Construction v. United States
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ex rel. Martin Steel Constructors, 474 U.S. 817 (1985), held
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that where the supplier has a contract with a subcontractor

but not with the general contractor, the Miller Act forbids

the general contractor from taking such "offsetting"

deductions. We disagree with the Ninth Circuit. We

therefore vacate the district court's judgment.

I

Background
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The Miller Act requires general contractors

working on federal government projects to furnish a payment

bond "for the protection of all persons supplying labor and























material" to the project. 40 U.S.C. 270a(a)(2). It

permits a supplier who has a "direct contractual

relationship with a subcontractor but no contractual

relationship . . . with the contractor furnishing" the bond

to sue on the bond for "the balance . . . unpaid at the time

of institution" of the suit, and to recover "judgment for

the sum or sums justly due him," as long as he complies with

certain notice requirements. Id. 270b(a). Puerto Rico's
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"Little Miller Act" sets up a similar scheme for work on

projects undertaken by the Puerto Rican government. 22

L.P.R.A. 47, 51.

The plaintiff, United Structures of America

("United"), supplied steel to a subcontractor on two

projects, one for the United States government at Roosevelt

Roads Naval Station, the other for the Puerto Rican

government at Hato Rey Police Headquarters. Defendant

G.R.G. Engineering ("GRG") was the general contractor on

both projects. The subcontractor did not pay United in

full. When the subcontractor went bankrupt, United gave GRG

proper notice, and then sued GRG (and GRG's insurer) on the

payment bond for the amounts it believed were still due,

approximately $105,000 for the Roosevelt Roads project and

$177,000 for the police station project.


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United moved for summary judgment, attaching

various bills and receipts in support of its claims. GRG

opposed the summary judgment motion. An affidavit (and a

few working papers) of Luis Marin Aponte, a GRG partner and

licensed engineer, constituted GRG's only effort to "set

forth specific facts showing that there is a genuine issue"

that might warrant a trial, Fed. R. Civ. P. 56(e). Marin's

affidavit said that GRG did not owe United any money because

(1) United engaged in a fraudulent billing practice known as

"front loading"; (2) GRG had to spend "$88,887 . . . due to"

United's "non-compliance with the specifications of the

equipment supplied" for the Roosevelt Roads project; and (3)

GRG had to spend an additional "$107,622 . . . to correct

defects and/or deficiencies in the materials" that United

"furnished" for the police station project.

The district court granted summary judgment in

favor of United, holding (1) that this affidavit failed to

provide, or to point to, any specific factual evidence

supporting GRG's "front loading" theory; (2) that the

evidence regarding allegedly defective steel was irrelevant

because the law does not give GRG "the right to assert a

set-off defense"; and (3) that GRG, in any event, had not

"offered specific evidence in support of" its allegations,


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"for example, an affidavit prepared by an engineer

testifying that the materials were indeed defective."

GRG then moved for reconsideration. It pointed

out that Marin, its affiant, was indeed a licensed engineer,

and it provided a few additional documents and bills

suggesting possible defects and related costs. The district

court, although it acknowledged Marin's professional

qualifications, denied the motion for reconsideration,

solely on the basis of the Ninth Circuit's holding that the

Miller Act does not "allow[] a set-off defense by a general

contractor not in privity with" a supplier. Avanti, 750
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F.2d at 762.

GRG now appeals, claiming primarily that the

district court and the Ninth Circuit have not correctly

interpreted the Miller Act with regard to the "set-off"

issue. We agree with GRG.

II

Analyzing the "Set-off"
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In Avanti, the Ninth Circuit considered a set of
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facts virtually identical to the facts before us. A

subcontractor on a government project bought steel from a

supplier; the subcontractor went bankrupt; the supplier sued

the general contractor on its Miller Act bond; and the


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general contractor asserted, as a defense, a claim of

damages arising from "late and defective shipments."

Avanti, 750 F.2d at 760. The Ninth Circuit held that "a
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set-off defense is not available in a Miller Act claim in

the absence of privity." It added that "allowing a set-off

defense by a general contractor not in privity with [the

supplier] would unduly burden the enforcement of the rights

created by the Act." Id. at 762.
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We disagree with the Ninth Circuit. We believe it

appropriate to draw a distinction that the Ninth Circuit did

not draw, namely a technical distinction between what the

law normally calls a "setoff" (or "set-off," or "offset"),

and what it calls "recoupment." The law dictionary defines

a "setoff" as a "counter-claim demand which defendant holds

against plaintiff, arising out of a transaction extrinsic of
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plaintiff's cause of action." Black's Law Dictionary 1230
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(5th ed. 1979) (emphasis added). If Smith sues Jones for

$10,000 for grain that Smith supplied, and Jones seeks to

reduce the judgment by $5,000 representing Smith's

(unrelated) unpaid rental of Jones' summer cottage, Jones is

seeking a setoff. "Recoupment," on the other hand, is "a
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reduction or rebate by the defendant of part of the

plaintiff's claim because of a right in the defendant


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arising out of the same transaction." Id. at 1147 (emphasis
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added). If Smith sues Jones for $10,000 for grain that

Smith supplied, and Jones seeks to reduce the judgment by

$5,000 representing Jones' expenditure to dry out Smith's

(defectively) wet grain (or the cost of buying replacement

grain, or the grain's lost value), Jones is seeking a

recoupment.
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This distinction, although somewhat technical, is

well established in the law. See, e.g., In re B & L Oil
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Co., 782 F.2d 155, 157 (10th Cir. 1986); 1 David G. Epstein
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et al., Bankruptcy 6-45, at 703 (1992) ("setoff involves

mutual debts arising from unrelated transactions and
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recoupment covers reciprocal obligations arising out of the

same transaction") (footnotes omitted); Michael E. Tigar,
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Comment, 53 Cal. L. Rev. 224, 225 n.9 (1965) ("'Recoupment

is contradistinguished from setoff in these . . . essential

particulars: 1st. In being confined to matters arising out

of, and connected with, the transaction or contract upon

which the suit is brought . . . .'" (quoting Waterman, Set-

Off, Recoupment and Counterclaim 480 (2d ed. 1872))). See
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generally 20 Am. Jur. 2d Counterclaim, Recoupment, and
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Setoff 11, 16-18 (1965).
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This technical legal terminology does not

necessarily reflect ordinary usage. After all, a grain

buyer who wants to deduct from the contract price the cost

of drying the defectively wet grain might say that he simply

wants to "set off" the drying costs against the contract

price. Lawyers, too, might fall into this manner of

speaking, for often the technical legal distinction does not

matter. See, e.g., B & L Oil, 782 F.2d at 157 ("Modern
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rules of pleading have diminished the importance of the

common-law distinctions surrounding recoupment and its

companion, setoff."); 20 Am. Jur. 2d 10 (1965) ("The

distinctions between . . . recoupment and setoff are no

longer of much importance . . . ."). In a few specialized

circumstances, however, the difference takes on more

significance.

One such circumstance is bankruptcy. The unusual

nature of bankruptcy proceedings means that certain devices,

ordinarily available to creditors seeking to recover from

debtors, may be unavailable when the debtor is in, or near,

bankruptcy. Among these devices is setoff, which may be

used by a creditor against an insolvent debtor who later

files for bankruptcy only under the circumstances described

in 11 U.S.C. 553, and against a debtor already in


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bankruptcy only by seeking relief from the automatic stay,

11 U.S.C. 362(a)(7). See 1 Epstein et al., supra, 3-
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15, 6-38 to 6-44. The reason is that the bankruptcy laws

are generally designed to maximize the debtor's assets for

the benefit of all creditors, and allowing a creditor to

invoke setoff might allow the creditor an unfair advantage

over other creditors (the creditor, by reducing the debt he

owes the debtor dollar for dollar against the debt owed him

by the debtor, receives full value for the latter simply

because he owed money to the debtor). Thus, returning to

our earlier example, if Smith is in bankruptcy and Jones is

permitted to reduce his $10,000 grain debt to Smith by

$5,000 because of the unpaid cottage rental, Jones has (1)

deprived the estate of $5,000 it would otherwise have had to

benefit other creditors; and (2) received full value on his

$5,000 claim against Smith, even though other creditors

might not receive full value.

Recoupment, on the other hand, is not a mechanism

which reduces mutual debts "for the sake of convenience,"

id. 6-45, at 704 (describing setoff), but rather is "in
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the nature of a defense" and is intended to "permit . . .

judgment to be rendered that does justice in view of the one

transaction as a whole." Rothensies v. Electric Storage
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Battery Co., 329 U.S. 296, 299 (1946); see also 4 Collier on
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Bankruptcy 553.03, at 553-17 (Lawrence P. King, ed., 15th

ed. 1993) (point of recoupment is to "arriv[e] at a just and

proper liability" on the plaintiff's claim). As such, when

a debtor in bankruptcy seeks to recover from a creditor

whose claim against the debtor arises out of the same

transaction, allowing the creditor to recoup damages simply

allows the debtor precisely what it is due when viewing the

transaction "as a whole." So although it might not make

sense to allow Jones to claim a setoff in Smith's
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bankruptcy, allowing Jones to recoup the $5,000 that he had
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to spend to dry out Smith's defective grain seems fair to

all concerned, perhaps because a debtor has, in a sense, no

right to funds subject to recoupment. See In re Holford,
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896 F.2d 176, 179 (5th Cir. 1990). This explains why

recoupment is not expressly regulated by the Bankruptcy

Code; some courts even find recoupment unaffected by the

automatic stay. See id.; 1 Epstein et al., supra, 6-45,
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at 712 & n.36. Whether a creditor's action against a

bankrupt debtor is characterized as a setoff or a recoupment

will, therefore, have important effects on the creditor's

ability to prosecute the action.




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The Miller Act seems to us to offer another

situation in which one should distinguish setoff from

recoupment. The language of the Act permits a supplier to

recover, not the full contract price, but the "sums justly

due him." 40 U.S.C. 270b(a). In our view, the aim of

recoupment, "do[ing] justice in view of the one transaction

as a whole," Rothensies, 329 U.S. at 299, would seem to
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match the statute's requirement of determining the sums

"justly due" a supplier, making recoupment an appropriate

defense in Miller Act cases. Indeed, we do not see how the

full contract price of goods supplied can possibly be

"justly due" a person who supplied defective goods. Setoff,

on the other hand, has less bearing on whether a particular

sum is "justly due" the claimant, since setoff functions

mostly as a convenient method of dealing with mutual,

unrelated debts. Since a true setoff is not before us,

however, we need only note the difference and need not go

beyond the subject of recoupment to consider when or whether

setoff is unavailable under the Miller Act.

Further, the policies underlying the Miller Act

seem to permit recoupment. The Act is intended "to protect

those whose labor and materials go into public projects,"

Clifford F. MacEvoy Co. v. United States ex rel. Calvin
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Tomkins Co., 322 U.S. 102, 107 (1944), but this
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"protect[ion]" does not include payments to which the

supplier's underlying contract does not entitle him. We

know this is true because a Miller Act claim brought by a

subcontractor who is in privity with the general contractor
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"is subject to reduction" for "defective articles or work,"

even though the subcontractor's "labor and materials" were

as much a part of the project as were those of an out-of-

privity supplier. 8 John C. McBride & Thomas J. Touhey,

Government Contracts 49.490[4], at 49-658 (1993); see,
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e.g., United States ex rel. Browne & Bryan Lumber Co. v.
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Massachusetts Bonding & Ins. Co., 303 F.2d 823, 828 (2d Cir.
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1962), cert. denied sub nom. Ove Gustavsson Contracting Co.
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v. Browne & Bryan Lumber Co., 371 U.S. 942 (1962); United
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States ex rel. Acme Maintenance Engineering Co. v.
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Wunderlich Contracting Co., 228 F.2d 66, 68 (10th Cir. 1955)
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(defense of defective workmanship available against

subcontractor; failed in this case because general

contractor did not meet its burden of proof). We do not

understand why the existence or nonexistence of privity of

contract should make any difference with regard to these

general policies. Nor do we understand how permitting a

general contractor to reduce a supplier's claim by the


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amount that the general contractor spent remedying the

supplier's failure to comply with his contract somehow

"unduly burdens" the supplier's Miller Act rights. But cf.
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Avanti, 750 F.2d at 762. On the contrary, disallowing
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recoupment would seem to give the supplier "rights" to which

his contract does not entitle him.

In short, neither United nor the Avanti court
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itself has pointed to any policy of the Miller Act which

would be served by the Avanti rule, nor can we imagine what
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such a policy would be. We have examined the legislative

history of the Miller Act, and the cases and treatises

discussing it, but we have found nothing that suggests the

conclusion reached in Avanti. The materials and policies we
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have considered, and the language of the statute, point the

other way.

For these reasons, we conclude that the general

contractor in this case is entitled to assert a recoupment

type of defense. Insofar as GRG shows that United delivered

defective goods that failed to meet contract specifications,

and proves reasonably foreseeable damages caused by those

defects, GRG may reduce the award to United by the amount of

those damages.




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United also asserted a claim under Puerto Rico's

Little Miller Act (for the police station project). Our

review of that Act has suggested no reason why the result

should be different. We note our belief that

"compensation," the Puerto Rican equivalent of setoff

discussed at length by the parties and the district court,

see 31 L.P.R.A. 3221-22; Garcia Mendez v. Vazquez Bruno,
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440 F. Supp. 985, 988-89 (D.P.R. 1977), is as inapplicable

to this case as setoff itself, since compensation, like

setoff, is primarily a device allowing the convenient

simplification of relations between mutually indebted

parties. See Walla Corp. v. Banco Comercial de Mayaguez,
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114 D.P.R. 216, transl. at 285 (1983).

III

Application of the Law to This Case
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Applying our interpretation of the law to the

record before us, we conclude the following:

First, the district court correctly granted

summary judgment in respect to GRG's "front loading" claim.

We find no specific facts in GRG's opposition to summary

judgment that demonstrate a "genuine" or "material" issue of

fact with respect to that claim.




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Second, we believe that the district court's grant

of summary judgment, at least by the time it denied the

motion for reconsideration, rested upon an erroneous view of

the law. The district court, therefore, should reconsider

the motion. The summary judgment record, however, is

somewhat confused because GRG presented some pieces of

evidence in its initial opposition and other pieces of

evidence when it moved for reconsideration. Under these

circumstances, we shall ask the district court to begin the

summary judgment proceedings anew, so that the parties and

the court may proceed under the proper legal standard. GRG,

however, may raise only the issue of recoupment. In all

other respects, the court will assume that United is

entitled to summary judgment.

The judgment of the district court is vacated.

The plaintiff may file a new motion for summary judgment in

the district court. The defendant may not oppose that

motion on the issue of liability, but may contest damages

based on the principles of recoupment as outlined in this

opinion.

So ordered.
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