Martin v. National Surety Corp.

Opinion by

Mr. Justice Cohen,

Appellant is the trustee in bankruptcy for James J. O’Brien and Daniel L. Redmond, Jr., trading as O’Brien and Redmond, who, prior to their financial embarrassment, were primarily engaged in the construction of highways for the Commonwealth of Pennsylvania. During the period that bankrupts’ financial difficulties were developing they had nine active contracts with the Commonwealth, the total value of which was $114,-616.65. National Surety Corporation, one of the appellees here, was surety on six of the contracts. When bankrupts became unable to fulfill their contractual obligations the sureties were required to step into the breach and complete the contracts. Construction was completed and most laborers, materialmen and subcontractors were paid; some claims, however, remained outstanding.

Some time after the contracts were completed the Commonwealth paid the entire $114,616.65 due on the nine jobs to National. National in return signed and gave to' the Commonwealth an indemnification bond holding the Commonwealth harmless from any claims that might be made against it for releasing that sum to National.

Appellant first brought suit against National in the United States District Court for the Eastern District of Pennsylvania, alleging jurisdiction under Section 23 of the Bankruptcy Act, 11 U.S.C. §46. That court decided that it did not have jurisdiction and dismissed the complaint. Appellant then filed this action in assumpsit against National and the Commonwealth. Preliminary objections were filed by both defendants; the Commonwealth claimed that the Common Pleas Court of Philadelphia County lacked jurisdiction, and National claimed that the complaint failed to state a cause of action. Both preliminary objections were sustained and this appeal followed.

The lower court correctly concluded that it was without jurisdiction over the Commonwealth. It also properly concluded that appellant was not a third party beneficiary of the indemnity agreement between National and the Commonwealth. The unavailability of that theory, however, does not preclude the existence of other theories upon which appellant may proceed.

A trustee in bankruptcy takes title to the property of the bankrupt under §70a of the Bankruptcy Act, 11 U.S.C. §110a. Relevant to this case is §70a(6) which vests in the trustee, as of the date of the filing of the petition, title to “rights of action arising upon contracts ... or the unlawful taking or detention of . . . his property.” Because this appeal is from the granting of appellee’s preliminary objections, the court must accept as true all allegations of fact in appellant’s complaint, plus all reasonable inferences therefrom. In paragraph 8, appellant alleges that at the time of the filing of the petition there were funds due and owing by the Commonwealth for work performed on the nine projects. Appellant also alleges that these funds are now in the hands of appellee. Thus, as of the day the petition was filed, we must assume the trustee acquired title to a valid contract right of action and a fund of money that that action represented.

Absent the sovereign immunity doctrine, appellant could proceed against the Commonwealth on the right of action which arose out of a contract. That is impossible, and as a practical matter, appellant will not be able to take his claim to the Board of Arbitration of Claims because the short six months statute of limitations has expired. Therefore, if he is to have any remedy at all, it must be against this appellee. The bankrupts apparently did not have a right of action against National Surety arising upon a contract, and so the trustee can proceed only if the appellee has unlawfully appropriated the bankrupts’ property. Since we must assume the Commonwealth actually owed this money, the trustee can trace that property to its present possessor if the appellee has unlawfully taken or detained it.

The leading case in this area is Pearlman v. Reliance Insurance Company, 371 U.S. 132 (1962), which involved a dispute between a trustee in bankruptcy and a surety over $87,000 in a federal government withheld fund. The bankrupt had not carried out its obligation to pay laborers and materialmen, and the surety had to pay debts totalling $350,000. The trustee asserted title to the money under §70 and claimed the surety had only the status of a general creditor. The surety claimed the entire amount free and clear of any claims by the trustee. The Supreme Court held that the bankrupt did not have title to the property the day the petition was filed and so the trustee never gained title to it. This was because the surety having paid the laborers and materialmen acquired an equitable lien on the fund, a lien which gave it priority over the trustee. The Court said at page 136: “[0]ur 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.” It does not matter that the government in the Pearlmcm. case was holding a small percentage of the total contract amount while in this case the total amount due seems to have been retained. Thus, on the surface it would appear that the appellee had a right to this money as the appellant admits that it paid certain subcontractors, laborers and materialmen.

The situation is much more complicated. First, on three of the nine contracts National was not the surety. Hence, it is difficult to see how it could establish a prior right to the funds represented by those contracts. Even if it had actually paid claims owing under those contracts, it would have been a volunteer and not entitled to the equity of subrogation. “Those who are in the situation of a surety, in the sense that they pay the debt of another, but who are under no obligation to pay such debt, and who do not, by paying, preserve and protect some interest in their own property, are mere volunteers and not within the equity of subrogation.” Feinsinger, Stearns Law of Suretyship, §259 at 467 (1934). Appellee has given no indication (1) that it made any payment on these three contracts or (2) if it had, how the payment was to preserve or protect some property interest of its own. Thus, it seems clear that as to the proceeds of these three contracts appellee has no prior claim under the Pearhnan doctrine. Therefore, retention of this money (approximately $52,000) is a conversion of appellant’s property.

Prosser defines conversion as follows: “(a) Acquiring possession of the goods, with an intent to assert a right to them which is in fact adverse to that of the owner, (c) Unreasonably withholding possession from one who has the right to it.” Prosser, Torts §15 (2d ed. 1955). Since it has been shown that the appellee has no prior right to this money, and since it must be assumed that the money was owed to appellant, the elements of a cause of action for conversion have been met. See also, Restatement (Second), Torts §222A (1965).

Appellee was the surety on the other six contracts, and thus the Pearlman doctrine could possibly apply. One central element is missing, however. Appellant alleges (and we must assume) that not all claims for taxes and not all claims of subcontractors, laborers and materialmen have been paid to date. The law is clear that “the claim of the creditor must be fully satisfied before there can arise any equity of subrogation.” Feinsinger, supra §245 at 430; 17 Am. Jur. 2d, Contractors’ Bonds, §107 (1964) ; Williston, Contracts, 3d ed. §1269 (1967) ; Restatement, Security, §141 (1941). The Supreme Court, in Pearlman, specifically refers to the fact that the surety had paid the laborers and materialmen. 371 U.S. at 141. Even though the surety has an inchoate right (to the equity of subrogation) as soon as the contract of suretyship is signed, the right is not capable of present enforcement until the surety has fulfilled his obligation by paying in full all debts of the principal. 17 Am. Jur. 2d, Contractors’ Bonds, §107 at 284. Consequently, in this action the appellee is not able to use the Pearlman doctrine to assert a prior right to this fund, and the trustee can trace the fund to and recover it from appellee because the retention of it is, likewise, a wrongful conversion of appellant’s property.

As to the proceeds of all nine contracts, the bankrupts had a “property” right as of the day the petition was filed; this was a right to specific monies being held by the Commonwealth (absent sovereign immunity) as a §70(a) (6) contract claim and against appellee because the inapplicability of the Pewrlman doctrine makes its retention of the money a wrongful conversion.

We should not be quick to dismiss appellant’s complaint in this complicated action, especially when National Surety clearly has possession of at least some money to which it is not entitled. Therefore, appellant should be permitted to amend its complaint to state a cause of action for conversion, or to state with greater particularity a cause of action for assumpsit, Humbird v. Davis, 210 Pa. 311, 59 Atl. 1082 (1904), or state an equity cause on a trustee ex maleficio theory.

The order of the court below is reversed.