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PEARLMAN v. RELIANCE INSURANCE CO.

decided: December 3, 1962.

PEARLMAN, TRUSTEE IN BANKRUPTCY
v.
RELIANCE INSURANCE CO.



CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT.

Warren, Black, Douglas, Clark, Harlan, Brennan, Stewart, White, Goldberg

Author: Black

[ 371 U.S. Page 133]

 MR. JUSTICE BLACK delivered the opinion of the Court.

This is a dispute between the trustee in bankruptcy of a government contractor and the contractor's payment bond surety over which has the superior right and title to a fund withheld by the Government out of earnings due the contractor.

The petitioner, Pearlman, is trustee of the bankrupt estate of the Dutcher Construction Corporation, which in April 1955 entered into a contract with the United States to do work on the Government's St. Lawrence Seaway project. At the same time the respondent, Reliance Insurance Company,*fn1 executed two surety bonds required of the contractor by the Miller Act, one to guarantee performance of the contract, the other to guarantee payment to all persons supplying labor and material for the project.*fn2 Under the terms of the contract, which was attached to and made a part of the payment bond, the United States

[ 371 U.S. Page 134]

     was authorized to retain and hold a percentage of estimated amounts due monthly until final completion and acceptance of all work covered by the contract. Before completion Dutcher had financial trouble and the United States terminated its contract by agreement. Another contractor completed the job, which was finally accepted by the Government. At this time there was left in the Government's withheld fund $87,737.35, which would have been due to be paid to Dutcher had it carried out its obligation to pay its laborers and materialmen. Since it had not met this obligation, its surety had been compelled to pay about $350,000 to discharge debts of the contractor for labor and materials. In this situation the Government was holding over $87,000 which plainly belonged to someone else, and the fund was turned over to the bankrupt's trustee, who held it on the assumption that it had been property of the bankrupt at the time of adjudication and therefore had vested in the trustee "by operation of law" under § 70 of the Bankruptcy Act.*fn3 The surety then filed a petition in the District Court denying that the fund had vested in the trustee, alleging that it, the surety, was "the owner of said sum" of $87,737.35 "free and clear of the claims of the Trustee in Bankruptcy or any other person, firm or corporation," and seeking an order directing the trustee to pay over the fund to the surety forthwith.*fn4 The referee in bankruptcy, relying chiefly on this Court's opinion in United States v. Munsey Trust Co., 332 U.S. 234 (1947), held that the surety had no superior rights in the fund, refused to direct payment to the surety, and

[ 371 U.S. Page 135]

     accordingly ordered the surety's claim to be allowed as that of a general creditor only to share on an equality with the general run of unsecured creditors.*fn5 The District Court vacated the referee's order and held that cases decided prior to Munsey had established the right of a surety under circumstances like this to be accorded priority over general creditors and that Munsey had not changed that rule.*fn6 The Second Circuit affirmed.*fn7 Other federal courts have reached a contrary result,*fn8 and as the question is an important and recurring one, we granted certiorari to decide it.*fn9

One argument against the surety's claim is that this controversy is governed entirely by the Bankruptcy Act and that § 64, 11 U. S. C. § 104, which prescribes priorities for different classes of creditors, gives no priority to a surety's claim for reimbursement. But the present dispute -- who has the property interests in the fund, and how much -- is not so simply solved. Ownership of property rights before bankruptcy is one thing; priority of distribution in bankruptcy of property that has passed unencumbered into a bankrupt's estate is quite another. Property interests in a fund not owned by a bankrupt at the time of adjudication, whether complete or partial, legal or equitable, mortgages, liens, or simple priority of rights, are of course not a part of the bankrupt's property and do not vest in the trustee. The Bankruptcy Act simply does not authorize a trustee to distribute other people's

[ 371 U.S. Page 136]

     property among a bankrupt's creditors.*fn10 So here if the surety at the time of adjudication was, as it claimed, either the outright legal or equitable owner of this fund, or had an equitable lien or prior right to it, this property interest of the surety never became a part of the bankruptcy estate to be administered, liquidated, and distributed to general creditors of the bankrupt. This Court has recently reaffirmed that such property rights existing before bankruptcy in persons other than the bankrupt must be recognized and respected in bankruptcy.*fn11 Consequently our 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.

Since there is no statute which expressly declares that a surety does acquire a property interest in a fund like this under the circumstances here, we must seek an answer in prior judicial decisions. Some of the relevant factors in determining the question are beyond dispute. Traditionally sureties compelled to pay debts for their principal have been deemed entitled to reimbursement, even without a ...


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