Priority of Payment for Funds Withheld Under a Contract

The United States Forest Service has requested the opinion of GAO regarding the priority of payment for funds withheld under a contract in which the surety has executed a takeover agreement because the contractor has defaulted on its bonds. GAO recognizes that a surety completing a defaulted contract under a performance bond is entitled to reimbursement for expenses incurred in completing the contract balance free from setoff by the Government of the debts of the contractor. The surety must show that it has fully satisfied the claims of all laborers and materialmen, however, before it can share in the retained funds on the basis of its payment bond obligation. On the other hand, the payment bond surety may not be reimbursed from unexpended funds earned by the contractor prior to default. The Government is merely a stakeholder of the funds in its possession, and any funds remaining in the Government's hand after reimbursement to the surety should be retained pending resolution of the litigation between the defaulting contractor and the surety.