Now Updating
In re: DIANN MARIE CATES

Summarizing by Lars Fuller

In re LTC Holdings, INC.

Case Type:
Business
Case Status:
Affirmed
Citation:
20-3057 (3rd Circuit, Aug 18,2021) Published
Tag(s):
Ruling:
In a case pitting a surety that had secured the completion of a project for the U.S. upon the default of the debtors (DRs) per a performance bond against the DRs' first lien creditor, the Third Circuit agreed with each lower court: as the U.S. had not been "fully paid" under § 509(c) when the bankruptcy court (BC) approved a settlement in which the U.S. waived its setoff rights, the surety's subrogation rights were subordinate to the U.S.' superior ones, and the U.S.' legal waiver thus obviated the former's--and its claim to a prepetition tax refund withheld by the U.S. per § 509(c).
Procedural context:
On May 2, 2014, Lakeshore Toltest Company (LTC) and its affiliates, the DRs here, had filed separate chapter 7 petition for relief in the U.S. Bankruptcy Court for the District of Delaware (BC). At the time, the DRs had defaulted under numerous contracts with the U.S., including, but limited to, the Department of Defense (DOD). As such, the U.S. put a hold on the $5.5 million refund that would have been due based on the DRs' 2014 consolidated federal tax return, one filed shortly before the DRs' petitions (Tax Refund). It did so based on its right to set off its purported value ($5.5 million) against the steep losses caused by the DRs' almost uniformly deficient performances. On October 28, 2014, the U.S. therefore filed a summary proof of claim against the DRs for a total of approximately $222 million (the USPOC). The USPOC included an $84 million DOD Surety Claim, which itself subsumed the sums owed under the NPCC Contract. As the attached documents set forth, the NPCC Contract claim was contingent on whether uhe Insurance Company of the State of Pennsylvania (ICSP), the original surety for LTC's promised construction of the National Police Command Center in Afghanistan (hence the name).under this accord, and its new contractor, Macro Vantage Levant JLT (MVL). would fail to complete the NPCC Contract as the trio had later agreed. The U.S. later amended the USPOC, reducing the total claim to $170 million, but did not otherwise reduce the DOD Surety Claim, whose total value remains contingent on MVL's performance. In January 2016, the trustee for the DRs' estates (TR) and the U.S. reached a comprehensive proposed settlement of all of the claims between the United States and the Debtors (the SMT). Paragraph 4 of the SMT contained a waiver of its setoff rights by the U.S., including any right to set off the Tax Refund. Yet, the SMT also said nothing about subrogation rights. ICSP objected, arguing that the SMT should not be construed to release or impair claims belonging to ICSP based upon ICSP's existing rights as a subrogee. After holding a hearing, the BC sent all parties, including BMO Harris Bank N.A. (BMO) in its capacity as the DRs' first lien creditor, to mediation. On June 9, 2016, after mediation and negotiation, counsel for the TR informed the BC that the parties had resolved ICSP’s objection and agreed to a proposed order. The BC entered this proposed order within three weeks (SMT Order). July 2016 witnessed the events that led to this appeal. In that month, the TR , the TR commenced an adversary proceeding against ICSP, seeking a declaratory judgment that the DRs'’ estates were entitled to the entire $5.5 million Tax Refund. ICSP countered with an answer and a bevy of counterclaims, having joined BMO as an additional counterclaim defendant. It sought a declaratory judgment that ICSP was entitled to the full refund. Both ICSP and BMO, here aligned with the TR, moved for summary judgment. The BC granted summary judgment to BMO and denied ICSP’s motion for summary judgment on the Tax Refund claims. As it reasoned, the SMT Order had been entered at a time when the U.S. had not yet been paid in full. As such, ICSP's subrogation rights remained subordinate, and the U.S. was then, and later, entitled to waive its setoff rights to settle its remaining and superior claim. Its legally valid waiver necessarily extinguished ICSP's ability to be subrogated to those setoff rights. Its decision, as the Circuit later concluded, rendered the later resurrected dispute between BMO and ICSP over who legally owned the Tax Refund moot, as ICSP lacked the one thing -- a right of setoff -- that would render this dispute more than academic. ICSP timely appealed the BC's conclusion as to its right's extinguishment to the Third Circuit (or, to be more complete, the U.S. Court of Appeals for the Third Circuit). While ICSP renewed debate over the Tax Refund's legal ownership, and although BMO continued to dispute ICSP's views, the Circuit dismissed this issue's pertinence in a single footnote. The effect of a waiver of the setoff rights protected by § 509 on a surety's subrogation rights was their chief, if not quite only, concern.
Facts:
Before they filed for bankruptcy, the DRs provided general contracting services for large construction projects, including many projects for various U.S. federal entities. Under federal non-bankruptcy law, so as to enter into contracts with the U.S., contractors are generally required to post both a performance bond and a payment bond signed by the contractor and a qualified surety. Consistent with this statutory framework, beginning in 2009, the DRs, as the principal obligors, obtained surety bonds from ICSP, making it the surety, for a series of construction contracts with a raft of U.S. agencies, including the DOD. Among the subsequent ICSP-bonded contracts was only one, the NPCC Contract: a $55 million March 2012 contract with the U.S. under which LTC was to construct a so-called (and likely ill-fated, as of August 2021) National Police Command Center in Afghanistan. Years later, BMO sauntered unto the stage by providing credit to the DR pursuant to a May 2013 agreement. Among other provisions, this accord granted BMO security interests in most of the DRs' property. For awhile at least, for all the complexity of these arrangements, nothing seemed obviously amiss. January 2014 revealed otherwise. In that month, the U.S. terminated LTC's right to proceed under the NPCC Contract upon the latter's default. The U.S. then demanded that ICSP perform the suretyship obligations guaranteed by its performance bonds. Its hands tied, ICSP entered into a 2014 contract with the U.S. and MVL. As would later prove significant, per this agreement, MVL agreed to finish the construction work, and ICSP agreed to pay any “excess costs” for that performance, i.e. "any amount due beyond the funds that the United States had set aside based on the original contract price for the NPCC Contract." After ICSP paid over $12 million to MVL to complete construction from October 2014 through September 2016, the U.S. sent it a letter of substantial completion, after which ICSP made three final payments of over $600,000 each. After the dispatch of the penultimate payment, the U.S. issued a second completion letter, this time releasing ICSP, as the surety, from all further liability and responsibility. As noted above, years before this happy date, the DRs had run to the BC, having just recently filed the consolidated tax return pursuant to which they demanded the refund that ICSP would later seek.
Judge(s):
D. Brooks Smith; Paul B. Matey; and D. Michael Fisher

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