B-132347, SEP. 20, 1957

B-132347: Sep 20, 1957

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D.C.: REFERENCE IS MADE TO YOUR LETTER OF JUNE 25. THE VOUCHER IS STATED IN THE AMOUNT OF $196. WHICH IS DUE UNDER CONTRACT NO. IS PAYABLE TO THE FIRST NATIONAL CITY BANK OF NEW YORK. PROJECT CONSTRUCTION CORPORATION IS INDEBTED TO THE UNITED STATES FOR OVER $200. WE HAVE BEEN REQUESTED BY THE COMMISSIONER OF INTERNAL REVENUE TO DETERMINE WHETHER THE AMOUNT DUE UNDER THE CONTRACT MAY BE SET OFF AGAINST THE TAX CLAIM. LOANS WERE MADE BY THE ASSIGNEE BANK TO PROJECT. THERE WOULD APPEAR TO BE LITTLE DOUBT THAT THE AMOUNT PAYABLE UNDER THE CONTRACT IS NOT SUBJECT TO SET-OFF AND SHOULD BE PAID TO THE ASSIGNEE BANK. SEABOARD'S LOSS UNDER ITS CONTRACT BOND OBLIGATIONS IS UNDERSTOOD TO BE IN EXCESS OF $1.

B-132347, SEP. 20, 1957

TO U.S. NAVY REGIONAL ACCOUNTS OFFICE, WASHINGTON 25, D.C.:

REFERENCE IS MADE TO YOUR LETTER OF JUNE 25, 1957, REQUESTING AN ADVANCE DECISION AS TO THE PROPRIETY OF PAYMENT ON A VOUCHER TRANSMITTED WITH YOUR LETTER. THE VOUCHER IS STATED IN THE AMOUNT OF $196,909.79, WHICH IS DUE UNDER CONTRACT NO. MST-222 WITH THE PROJECT CONSTRUCTION CORPORATION, AND IS PAYABLE TO THE FIRST NATIONAL CITY BANK OF NEW YORK, AS ASSIGNEE UNDER THAT CONTRACT.

PROJECT CONSTRUCTION CORPORATION IS INDEBTED TO THE UNITED STATES FOR OVER $200,000 IN UNPAID TAXES, AND WE HAVE BEEN REQUESTED BY THE COMMISSIONER OF INTERNAL REVENUE TO DETERMINE WHETHER THE AMOUNT DUE UNDER THE CONTRACT MAY BE SET OFF AGAINST THE TAX CLAIM, DESPITE THE ASSIGNMENT. ARTICLE 16 OF THE CONTRACT, AS AMENDED JULY 1, 1952, PROVIDES THAT, IF THE CONTRACT PROVIDES FOR PAYMENTS AGGREGATING $1,000 OR MORE, CLAIMS FOR MONEYS DUE OR TO BECOME DUE MAY BE ASSIGNED PURSUANT TO THE ASSIGNMENT OF CLAIMS ACT OF 1940 AS AMENDED. ARTICLE 16 ALSO CONTAINS THE SO-CALLED "NO SET-OFF" CLAUSE, WHICH PROVIDES THAT PAYMENTS TO AN ASSIGNEE SHALL NOT BE SUBJECT TO REDUCTION OR SET OFF ON ACCOUNT OF TAX OR OTHER INDEBTEDNESS OF THE CONTRACTOR TO THE GOVERNMENT. ON JANUARY 16, 1953, THE PROJECT CONSTRUCTION CORPORATION MADE AN ASSIGNMENT OF ALL MONEYS DUE OR TO BECOME DUE UNDER THE CONTRACT TO THE NATIONAL CITY BANK OF NEW YORK (NOW THE FIRST NATIONAL CITY BANK OF NEW YORK). AT THAT TIME PAYMENTS DUE OR TO BECOME DUE UNDER THE CONTRACT AGGREGATED MORE THAN $1,000. LOANS WERE MADE BY THE ASSIGNEE BANK TO PROJECT, OF WHICH OVER $400,000 PRESENTLY REMAINS UNPAID.

SOLELY ON THE BASIS OF THE FOREGOING, THERE WOULD APPEAR TO BE LITTLE DOUBT THAT THE AMOUNT PAYABLE UNDER THE CONTRACT IS NOT SUBJECT TO SET-OFF AND SHOULD BE PAID TO THE ASSIGNEE BANK. QUESTION HAS BEEN RAISED BY THE COMMISSIONER OF INTERNAL REVENUE, HOWEVER, AS TO THE VALIDITY OF THE CONTRACTOR'S ASSIGNMENT TO THE BANK BECAUSE OF THE CONTRACT SURETY'S INTEREST IN AND CONTROL OVER CONTRACT PAYMENTS. THE SEABOARD SURETY COMPANY HAD ISSUED PERFORMANCE AND PAYMENT BONDS TO THE UNITED STATES IN CONNECTION WITH WORK UNDER THE CONTRACT IN AN AMOUNT EXCEEDING $2,000,000. DURING THE LATTER PART OF 1952, PROJECT RAN INTO FINANCIAL DIFFICULTIES, AS A RESULT OF WHICH ON NOVEMBER 20, 1952, PROJECT AND SEABOARD ENTERED INTO AGREEMENTS UNDER WHICH PROJECT ASSIGNED THE CONTRACT BALANCES TO SEABOARD, SEABOARD ISSUED PAYMENT BONDS DIRECTLY TO TWO OF PROJECT'S SUBCONTRACTORS, AND PROJECT AGREED TO THE DEPOSIT OF ALL FUTURE CONTRACT PAYMENTS IN A JOINT TRUST ACCOUNT FROM WHICH WITHDRAWALS COULD BE MADE ONLY FOR PAYMENT OF LABOR, MATERIAL, AND OTHER CONTRACT COSTS UPON SIGNATURE BY BOTH PROJECT AND SEABOARD. THEREAFTER, IN JANUARY 1953, PROJECT MADE AN ASSIGNMENT OF ALL MONEYS DUE OR TO BECOME DUE UNDER THE CONTRACT TO THE NATIONAL CITY BANK, AND THE BANK MADE LOANS TO PROJECT. SEABOARD INDEMNIFIED THE ASSIGNEE BANK AGAINST LOSS ON ITS LOANS TO PROJECT. SEABOARD'S LOSS UNDER ITS CONTRACT BOND OBLIGATIONS IS UNDERSTOOD TO BE IN EXCESS OF $1,000,000.

THE ARGUMENT IS ADVANCED BY THE COMMISSIONER OF INTERNAL REVENUE THAT THE ASSIGNMENT OF CLAIMS ACT PERMITS ASSIGNMENTS BY CONTRACTORS ONLY TO FINANCIAL INSTITUTIONS, NOT TO CONTRACT SURETIES, AND THAT THE "NO SET- OFF" PROVISIONS OF THE ACT WERE INTENDED TO AFFORD PROTECTION TO SUCH FINANCIAL INSTITUTIONS, NOT TO CONTRACTORS' SURETIES. IT IS THE POSITION OF THE COMMISSIONER THAT THE ASSIGNMENT IN THIS CASE WAS MADE IN REALITY BY THE SURETY RATHER THAN BY THE CONTRACTOR, AND THAT THE PURPOSE OF SUCH ASSIGNMENT WAS TO IMMUNIZE THE CONTRACT PROCEEDS AGAINST SET-OFF BY THE GOVERNMENT. FOR THESE REASONS, THE COMMISSIONER REQUESTS THAT THE ASSIGNMENT BE CONSIDERED INVALID AS AN ATTEMPT TO EXTEND THE PROTECTION OF THE "NO SET-OFF" CLAUSE TO A PARTY INELIGIBLE TO BECOME AN ASSIGNEE.

WE DO NOT DISAGREE WITH THE CONTENTION THAT THE PRIMARY PURPOSE OF THE "NO SET-OFF" PROVISIONS OF THE ASSIGNMENT OF CLAIMS ACT WAS TO AFFORD PROTECTION TO FINANCIAL INSTITUTIONS MAKING LOANS TO GOVERNMENT CONTRACTORS. IT IS EVIDENT ALSO THAT THE ACT DOES NOT PERMIT ASSIGNMENTS TO CONTRACT SURETIES. SUCH ASSIGNMENTS IF MADE ARE NOT REQUIRED TO BE RECOGNIZED BY THE UNITED STATES, ALTHOUGH THEY MAY HAVE VALIDITY AS BETWEEN THE ASSIGNOR AND ASSIGNEE. CF. HALL V. CHANDLER, 289 FED. 675, WITH COASTAL COMMERCIAL CORP. V. CENTRAL NATIONAL BANK OF YONKERS, 140 N.Y.S.2D 887. THESE PRINCIPLES, HOWEVER, ARE NOT IN OUR OPINION NECESSARILY DETERMINATIVE OF THE QUESTION PRESENTED IN THE INSTANT CASE.

THE RIGHTS AND OBLIGATIONS OF A CONTRACT SURETY WHICH HAS GUARANTEED BY ITS BONDS THE COMPLETION OF THE CONTRACT WORK AND THE PAYMENT OF CONTRACT LABOR AND MATERIAL BILLS ARE INESCAPABLY LINKED TO THE RIGHTS AND OBLIGATIONS OF THE CONTRACTOR. BOTH CONTRACTOR AND SURETY ARE RESPONSIBLE FOR FULFILLMENT OF THESE OBLIGATIONS, THE CONTRACTOR ABSOLUTELY AS PRINCIPAL, AND THE SURETY SECONDARILY TO THE EXTENT OF THE PENALTY OF ITS BONDS. WHEN A CONTRACTOR ENCOUNTERS FINANCIAL DIFFICULTIES IN THE PERFORMANCE OF A BONDED CONTRACT, THE SURETY IS UNDER NO LEGAL OBLIGATION TO PROVIDE FUNDS OR OTHER ASSISTANCE TO THE CONTRACTOR TO ENABLE HIM TO COMPLETE THE WORK FOR THE OWNER. THE SURETY'S MAXIMUM LEGAL OBLIGATION IS MEASURED BY THE PENALTY OF ITS BONDS, AND IT MAY CHOOSE TO PERMIT THE CONTRACTOR TO DEFAULT IN PERFORMANCE WITH ASSURANCE THAT IT WILL SUFFER NO LOSS GREATER THAN THE BOND PENALTY. SELF INTEREST MAY, OF COURSE, PERSUADE A SURETY TO ASSIST THE CONTRACTOR IN COMPLETING HIS CONTRACT IF THIS COURSE OF ACTION APPEARS LIKELY TO BE LESS COSTLY THAN REIMBURSING THE OWNER FOR EXCESS COSTS OF COMPLETION BY ANOTHER CONTRACTOR.

IF THE SURETY ELECTS TO PERMIT ITS PRINCIPAL TO DEFAULT IN PERFORMANCE, ALL CONTRACT BALANCES IN THE HANDS OF THE OWNER MUST BE APPLIED TOWARD COMPLETION COSTS, REGARDLESS OF ANY INDEPENDENT INDEBTEDNESS OF THE CONTRACTOR TO THE OWNER. IT IS CLEAR, IN VIEW OF THE DECISION IN CENTRAL BANK V. UNITED STATES, 345 U.S. 639, THAT THE TAXES OWED BY PROJECT IN THE PRESENT CASE ARE SUCH A DEBT. IN CASES WHERE THE SURETY COMES TO THE CONTRACTOR'S ASSISTANCE EITHER BY DIRECT FINANCIAL HELP OR, AS IN THE INSTANT CASE, BY GUARANTEEING LOANS MADE TO THE CONTRACTOR BY A BANK, IT MAY BE IMPOSSIBLE TO STATE WITH CERTAINTY THAT THE CONTRACTOR WOULD HAVE DEFAULTED WITHOUT SUCH ASSISTANCE. IN VIEW OF THE LOSSES SUFFERED BY SEABOARD IN THE PRESENT CASE, IT SEEMS ALMOST CERTAIN THAT PROJECT WOULD HAVE DEFAULTED HAD IT NOT RECEIVED ASSISTANCE THROUGH THE SURETY. SEABOARD HAD PERMITTED PROJECT TO DEFAULT AND HAD ELECTED TO LET THE GOVERNMENT COMPLETE THE CONTRACT WORK, IT SEEMS PROBABLE THAT THE PRESENT CONTRACT BALANCE OF $196,909.79 WOULD HAVE BEEN APPLIED TOWARD EXCESS COMPLETION COSTS, REGARDLESS OF PROJECT'S TAX DEBT, THEREBY REDUCING TO THAT EXTENT SEABOARD'S LIABILITY UNDER ITS PERFORMANCE BONDS.

IT WOULD SEEM INEQUITABLE, IN THE EVENT A SURETY ELECTS TO ASSIST A CONTRACTOR TO COMPLETE HIS CONTRACT, OR WHERE THE SURETY ITSELF COMPLETES THE WORK UPON DEFAULT OF ITS PRINCIPAL, THAT IT BE PLACED IN A WORSE POSITION THAN IT WOULD HAVE BEEN IN IF IT HAD CHOSEN TO REQUIRE THE OWNER TO HAVE THE WORK COMPLETED BY OTHERS. SUCH CONSIDERATIONS WERE THE BASIS FOR OUR APPROVAL IN 31 COMP. GEN. 103 OF A SO-CALLED "TAKEOVER AGREEMENT" BY WHICH THE GOVERNMENT AGREED TO PAY THE SURETY ALL CONTRACT BALANCES UP TO THE COST OF COMPLETION, DESPITE TAXES OWED BY THE CONTRACTOR, IN RETURN FOR THE SURETY'S PROMISE TO COMPLETE THE CONTRACT WORK.

WE DO NOT BELIEVE THE PRESENT CASE DIFFERS IN PRINCIPLE FROM THE BYERS CASE, 35 COMP. GEN. 104. WHETHER A JOINT TRUST ACCOUNT PROCEDURE WITH THE SURETY IS ESTABLISHED BEFORE OR CONCURRENTLY WITH AN ASSIGNMENT TO A BANK WOULD NOT APPEAR TO BE MATERIAL SINCE IN BOTH CASES THE SURETY HAS THE SAME DEGREE OF CONTROL OVER PAYMENTS MADE AFTER THE ASSIGNMENT, WHICH ARE THE ONLY PAYMENTS HERE INVOLVED.

FOR THE FOREGOING REASONS, WE ARE OF THE OPINION THAT THE CONCLUSION REACHED IN THE BYERS CASE IS EQUALLY APPLICABLE TO THE PRESENT SITUATION. YOU ARE THEREFORE ADVISED THAT PAYMENT ON THE VOUCHER SUBMITTED, WHICH IS RETURNED HEREWITH, IS AUTHORIZED.