                                                                                                                           Opinions of the United
1994 Decisions                                                                                                             States Court of Appeals
                                                                                                                              for the Third Circuit


6-21-1994

In re: Modular Structures, Inc.
Precedential or Non-Precedential:

Docket 92-5577




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1
                 UNITED STATES COURT OF APPEALS
                     FOR THE THIRD CIRCUIT



                            No. 92-5577


                IN RE:    MODULAR STRUCTURES, INC.

                                          Debtor

          FIRST INDEMNITY OF AMERICA INSURANCE COMPANY

                                          Appellant

                                 v.

                   MODULAR STRUCTURES, INC.;
                   FIRST FIDELITY BANK, N.A.

                    THEODORE LISCINSKI, ESQ.

                                          Trustee



         On Appeal From the United States District Court
                 For the District of New Jersey
                (D.C. Civil Action No. 92-02024)



                         Argued July 2, 1993

         Before: BECKER, ALITO and ROTH, Circuit Judges

                  (Opinion Filed June 23, 1994)




Armen Shahinian, Esquire (Argued)
Joseph Monaghan, Esquire
Wolff & Samson
5 Becker Farm Road
Roseland, NJ 07068
          Attorney for appellant


                                                           2
Stephen M. Packman, Esquire (Argued)
Archer & Greiner
One Centennial Square
P.O. Box 3000
Haddonfield, NJ 08033
          Attorney for First Fidelity Bank,
          National Association and Trustee

Robert W. McCann, Esquire
Klotz & McCann
649 Lafayette Avenue
P.O. Box 64
Hawthorne, NJ 07507
          Attorney for Amicus-appellant
          Surety Association of America



                         OPINION OF THE COURT




ROTH, Circuit Judge:

          This appeal arises from the Chapter 7 bankruptcy

proceedings of Modular Structures, Inc. ("Modular").    Prior to

filing for bankruptcy on March 8, 1991, Modular had contracted to

construct a new corporate headquarters in Newark, New Jersey, for

the Salvation Army.    First Indemnity of America Insurance Company

("First Indemnity") issued a bond to the Salvation Army to secure

Modular's performance and payment obligations under the contract.

Eleven months after the institution of the bankruptcy

proceedings, First Fidelity Bank ("the Bank"), as a secured

creditor of Modular, filed a Notice of Motion for Turnover of

Funds to obtain the unearned contract proceeds and retainage held

by the Salvation Army.    First Indemnity filed a cross-motion to



                                                                    3
place the contract proceeds and retainage in escrow in order to

assure that the funds remained available to secure Modular's

obligations to pay subcontractors.     On March 2, 1992, the

bankruptcy court denied First Indemnity's cross-motion and

entered an Order Allowing Turnover in favor of the Bank.       First

Indemnity appealed this decision to the district court which

affirmed the bankruptcy court.

          Because we conclude that the district court and the

bankruptcy court incorrectly determined that the contract

proceeds and retainage, which the Salvation Army was holding,

were part of the estate in bankruptcy, we will reverse the order

directing turnover to the Bank.    We also conclude that the

bankruptcy court made an insufficient examination of whether

Modular had any legal or equitable interest in the funds held by

the Salvation Army.   We will therefore remand this issue to the

bankruptcy court for further proceedings in this regard.

                                  I.

          On February 27, 1989, Modular entered into a contract

with the Salvation Army for the design and construction of a new

corporate headquarters in Newark, New Jersey.     In accordance with

the terms of the contract, First Indemnity, as surety, issued its

Labor and Material Payment Bond and its Performance Bond to the

Salvation Army, as obligee, to secure Modular's performance of

the contract.   The bonds bound Modular and First Indemnity to pay




                                                                       3
Modular's laborers and materialmen in connection with the

contract, which was incorporated by reference into the bonds.1

            In March 1989, the Bank loaned Modular the principal

sum of $1.5 Million to enable Modular to undertake construction

contracts such as the one with the Salvation Army.   The Bank

entered into a General Security Agreement whereby it took a

security interest in all of Modular's accounts receivable,

contracts and proceeds thereof.   Modular also executed a Uniform

Commercial Code Financing Statement which was filed on April 20,

1989, thereby perfecting the Bank's lien.

            Modular commenced work on the Salvation Army project

but was unable to complete all of its obligations under the

contract.   On March 8, 1991, Modular filed for protection under

Chapter 7 of the United States Bankruptcy Code, and a Trustee was


1
The surety on a construction surety bond guarantees to the owner
that the contractor will finish the job. If the contractor
defaults, the surety performs the work, mitigates loss by its
performance, and pays the subcontractors and suppliers. In
performing this function, the surety "stands in the shoes" of
other parties to the construction project through use of the
equitable doctrine of subrogation:

            [T]he surety in cases like this undertakes
            duties which entitle it to step into three
            sets of shoes. When, on default of the
            contractor, it pays all the bills of the job
            to date and completes the job, it stands in
            the shoes of the contractor insofar as there
            are receivables due it; in the shoes of
            laborers and materialmen who have been paid
            by the surety -- who may have had liens; and
            not least, in the shoes of the government
            [owner], for whom the job was completed.

National Shawmut Bank of Boston v. New Amsterdam Casualty Co.,
411 F.2d 843, 847-49 (1st Cir. 1969).


                                                                    4
appointed.     Modular stated in its bankruptcy schedules that the

Bank maintained a first, perfected security interest in Modular's

accounts receivable and contracts and proceeds thereof.    On

August 5, 1991, the Bank obtained a consent order from the

Trustee granting it a "Superpriority Lien" in Modular's account

receivables.    Following the consent order, the Bank pursued

collection of Modular's accounts receivable.

          First Indemnity contends that the unpaid contract

proceeds and retainage held by the Salvation Army were not

properly characterized as accounts receivable owing to Modular so

that the Bank's superpriority lien would apply to them.    Pursuant

to Article 6 of the contract between Modular and the Salvation

Army, the Salvation Army was not obligated to make final payment

to Modular until:    "(1) the Contract has been fully performed by

the contractor except for the Contractor's responsibility to

correct nonconforming work as provided in Subparagraph 12.2.2 of

the General Conditions and to satisfy other requirements, if any,

which necessarily survive final payment; and (2) a final

Certificate for Payment has been issued by the architect . . .."

App. at 79a.    Article 9, section 1.2, of the Contract defined the

"General Conditions" as the General Conditions of the contract

for Construction, AIA Document A201, 1987 Edition.    Those General

Conditions included Article 3, section 4.1, which stated that the

Contractor shall provide and pay for the labor, materials and

equipment necessary for the proper completion of the work, as

well as Article 9, section 3.1.2, which provided that a

Contractor's application for payment "may not include requests


                                                                     5
for payments of amounts the Contractor does not intend to pay to

a Subcontractor or material supplier because of a dispute or

other reason."   App. at 96a, 104a.   Article 9, section 5.1.3,

permitted the Architect to withhold his certification for payment

to the extent necessary to protect the Owner from loss as the

result of the failure of the Contractor to make payments properly

to Subcontractors or for labor, materials or equipment.    See app.

at 105a.

           Additionally, Article 9, section 10.2, provided that:
           Neither final payment nor any remaining
           retained percentage shall become due until
           the Contractor submits to the Architect (1)
           an affidavit that payrolls, bills for
           materials and equipment, and other
           indebtedness connected with the Work for
           which the Owner or the Owner's property might
           be responsible or encumbered (less amounts
           withheld by Owner) have been paid or
           otherwise satisfied, . . . (4) consent of
           surety, if any, to final payment and (5) if
           required by the Owner, other data
           establishing payment or satisfactions of
           obligations, such as receipts, releases and
           waivers of liens, claims, security interests
           or encumbrances arising out of the Contract
           to the extent and in such form as may be
           designated by the Owner . . ..

App. at 106a.    Finally, Article 14, section 2.1.2, provided that

the owner might terminate the contract if the contractor "fails

to make payment to Subcontractors for materials or labor in

accordance with the respective agreements between the Contractor

and the Subcontractors."   Article 14, section 2.2, further

provided that upon such a termination, "the Contractor shall not

be entitled to receive further payment until the Work is

finished."   See app. at 111a-112a.   In sum, Modular was obligated


                                                                   6
to pay its subcontractors before it could receive final payment

from the Salvation Army.

          It is undisputed that First Indemnity, as surety for

Modular, has been called upon to pay proper claims of

subcontractors.    First Indemnity, therefore, sent a letter, dated

April 2, 1991, to the Salvation Army explaining that it should

issue no additional payments to Modular so that any remaining

funds could properly be used to cure Modular's default.       The

Bank, on the other hand, contends that, despite Modular's

apparent breach of its contract with the Salvation Army, a letter

sent by Charles R. Kramer, Jr., Esq., counsel for the Salvation

Army, to counsel for the Bank demonstrates that the Salvation

Army considered the contract terms to have been satisfied.       The

letter stated, inter alia, that "The Army is prepared to pay the

final installment of $104,490.00, but wishes to do so only if

said payment will not expose The Army to duplicate payments."

App. at 114r.     First Indemnity interprets this letter as

requiring that the funds held by the Salvation Army not be

payable to Modular until and unless Modular fully performed its

contract, including the payment of laborers and materialmen.2




2
We note that neither the bankruptcy court nor the district court
cited this letter in its decision on the turnover order. Our
reading of the clear language of the letter, in view of the
contract language discussed above, leads us to conclude that, in
view of the unpaid subcontractors, the Salvation Army would have
been exposed to "duplicate payments" if it had released the funds
to Modular. For that reason, we conclude that contract terms had
not been satisfied and the Salvation Army was not obligated to
release the funds to Modular.


                                                                       7
          On November 7, 1991, counsel for the Bank sent a letter

to the Salvation Army threatening to institute legal action if

the Salvation Army did not release the funds to the Bank by

November 22, 1991.    The Salvation Army did not comply and the

Bank filed its motion for turnover of the funds in Modular's

bankruptcy proceeding.

          The bankruptcy court found for the Bank on the basis

that the contract was not a public contract and therefore there

was no trust fund to protect the funds, and it issued an Order

for Turnover of the funds.    App. at 241r.    First Indemnity then

appealed to the district court which affirmed the decision of the

bankruptcy court.    The district court considered whether under

New Jersey law the funds should be construed to be held in trust

for subcontractors and thus entitled to special priority in a

bankruptcy proceeding.    The district court concluded that no

constructive trust for subcontractors was created by New Jersey

common law and affirmed the decision of the bankruptcy court.

App. at 343-44r.

                                 II.

          The bankruptcy court had subject matter jurisdiction

pursuant to 28 U.S.C. 157((b)(1) over this Chapter 7 bankruptcy

proceeding.   The district court had appellate jurisdiction

pursuant to 28 U.S.C. § 158(a) to review the bankruptcy court's

turnover order.     This Court has appellate jurisdiction pursuant

to 28 U.S.C. §§ 158(d), 1291 to review the district court's

affirmance of the turnover order.      See In re Moody, 817 F.2d 365




                                                                       8
(5th Cir. 1987) (turnover order entered by the bankruptcy court

in an adversary proceeding is a "final" order).

          This court accepts the findings of fact of the

bankruptcy court unless clearly erroneous.     The bankruptcy

court's conclusions of law and the district court's decision are

reviewed de novo.    See J.P. Fyfe, Inc. v. Bradco Supply Corp.,

891 F.2d 66, 69 (3d Cir. 1989); In re Muncrief, 900 F.2d 1220,

1224 (8th Cir. 1990).

                                III.

          As an initial matter, the Bank contends that First

Indemnity did not preserve the issue in the district and

bankruptcy courts of whether Modular had breached its contract

with The Salvation Army and that, therefore, First Indemnity has

waived its arguments based upon any alleged breach of contract.

We disagree.   First Indemnity's position consistently has been

either that Modular defaulted on its obligations under the

contract by failing to pay subcontractors and as a consequence

was owed no money by the Salvation Army or alternatively that

under New Jersey law those funds were held by the Salvation Army

in constructive trust for the benefit of the subcontractors.       The

breach of contract basis for argument was presented to the

bankruptcy court in First Indemnity's February 21, 1992, letter

brief in opposition to the Bank's motion for turnover:     "Thus,

these contract monies never became part of the debtor's estate.

The contractor defaulted and has therefore lost its right to

these funds. . .."   App. at 205r.     First Indemnity repeated this



                                                                       9
position at oral argument in its opposition to the turnover

order.   App. at 182a.

           First Indemnity then argued before the district court

that:
                There is no right of payment of
           retainage of the contract balance unless all
           of the subcontractors or suppliers have been
           paid in full. Only in that manner can it be
           stated that all parties have complied with
           their contractual obligations. A.I.A.
           contract forms, as used in the case herein,
           certify that all subcontractors and suppliers
           are paid in full before payment will be made
           from the owner.

                In the case herein, it is quite clear
           that many of the subcontractors and suppliers
           were not paid. . ..

App. at 294r.   Moreover, in its reply brief to the district

court, First Indemnity asserted that because of this alleged

breach of contract the Bank was precluded from attaching the

funds held by the Salvation Army.    See app. at 204a-205a.   We

find, therefore, that there has been no waiver of this issue.

                               IV.
           First Indemnity's primary argument on appeal is that,

because Modular breached its contract with the Salvation Army,

none of the funds held by the Salvation Army were owing to

Modular and thus could not properly be considered part of the

bankruptcy estate, subject to the Bank's lien and amenable to a

turnover order.   Based upon the record before us, we agree with

First Indemnity and will reverse the decisions of the district




                                                                   10
and bankruptcy courts.3   We therefore hold, as a matter of law,

that, assuming the facts are as the present record indicates, the

funds held by the Salvation Army are not properly part of the

estate in bankruptcy.4

          The filing of a bankruptcy petition creates an estate

in bankruptcy.   This estate, pursuant to section 541(a)(1) of the

Code, contains "all legal or equitable interests of the debtor in

property as of the commencement of the case."   11 U.S.C.

§541(a)(1).   "'Although section 541 [of the Bankruptcy Code]

defines property of the estate, we must look to state law to

determine if a property right exists and to stake out its

dimensions.'"    Universal Bonding Ins. Co. v. Gittens & Sprinkle

Enter., Inc., 960 F.2d 366, 369 (3d Cir. 1992) (quoting In re

Nejberger, 934 F.2d 1300, 1302 (3d Cir. 1991)); see also Butner

v. United States, 440 U.S. 48, 54 (1979) ("Congress has generally

left the determination of property rights in the assets of a

bankrupt's estate to state law.").    We must look, therefore, to

New Jersey law to determine whether the funds held by The



3
 Because we find that the funds held by the Salvation Army are
not owing to Modular and thus not part of the bankruptcy estate,
we find it unnecessary both to determine whether, under New
Jersey law, the funds should be considered held in constructive
trust for the benefit of subcontractors and to determine what
priority First Indemnity would have were the funds at issue part
of the bankruptcy estate and not held in constructive trust for
the benefit of subcontractors.
4
 As explained in Part V infra, we will remand to the bankruptcy
court for a determination of whether any supplemental facts, not
in the present record, would demonstrate that Modular had a legal
or equitable interest in any part of the funds held by the
Salvation Army.


                                                                    11
Salvation Army are properly the "property" of the bankruptcy

estate here.

          The contract between Modular and the Salvation Army

requires Modular to pay its subcontractors before final payment

is due to Modular.   Moreover, it is undisputed, based upon the

record currently available in this case, that Modular has failed

to pay some of its subcontractors.   The question, then, is

whether Modular is owed the funds retained by the Salvation Army.

Under New Jersey law, "[a] contract right becomes an account as

performance is made under the contract."    Continental Fin., Inc.

v. Cambridge Lee Metal Co., 241 A.2d 853, 860 (N.J. Super. Ct.

Law Div. 1968), aff'd, 252 A.2d 417 (N.J. Super. Ct. App. Div.

1969), aff'd, 265 A.2d 536 (N.J. 1970).    Thus, if the contract is

not performed, nothing comes into existence upon which a lien

could attach.   See Damato v. Leone Contr. Co., 25 A.2d 302 (N.J.

Super. App. Div. 1956) (holding that a tax lien could not attach

to the unpaid balance of a construction contract because of the

contractor's failure substantially to perform his contract); see

also United States v. Commonwealth of Pa. Dep't of Highways, 349

F. Supp. 1370, 1381-82 (E.D. Pa. 1972) (where contractor's

failure to pay subcontractors constituted a breach of its

contract, the remaining contract funds were not due to the

contractor and thus not part of the bankrupt estate); Atlantic
Ref. Co. v. Continental Casualty Co., 183 F. Supp. 478, 482-83

(W.D. Pa. 1960) (holding that "a failure by the contractor here

to pay for labor and materials is just as much a failure to



                                                                  12
perform and carry out the terms of the contract as an abandonment

of the work would have been").

          In the present case, Modular did not fulfill its

contractual obligation to pay all of its subcontractors.     First

Indemnity, as surety for Modular, is required to pay any

subcontractor not paid by Modular.   The funds held by the

Salvation Army must be employed to satisfy these claims, either

in direct payments to the subcontractors or in reimbursement to

First Indemnity for the payments it has made as surety, standing

in the Salvation Army's shoes, to the subcontractors.   If the

Salvation Army were to be required to pay the monies it is

holding into the bankruptcy estate, First Indemnity apparently

would have to seek recovery for its payments to the

subcontractors only as an unsecured creditor, in competition with

the other unsecured creditors.   This is a result contemplated

neither by the contract, as we have explained it, nor by New

Jersey law.

          New Jersey has recognized in cases of government

contracts that payments held by the government, as owner of a

construction project, did not become part of the bankrupt's

estate.   This concept was first enunciated by the United States

Supreme Court in Pearlman v. Reliance Ins. Co., 371 U.S. 132

(1962).   In Pearlman, a priority dispute arose between the

trustee of the bankrupt estate and the surety with respect to

contract funds retained by the United States, the owner of the

construction project at issue.   The court held that the monies at

issue had not become part of the bankrupt's estate; instead, the

                                                                     13
retained funds remained the property of the owner, and by way of

subrogation,5 became the surety's property to the extent

necessary to reimburse it for its payment to laborers and

materialmen. See id. at 141. The Court explained:
          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 interest
          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 or right 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 property among a
          bankrupt's creditors.

Id. at 135-36. The Court then concluded:
          We therefore hold in accord with the
          established legal principles stated above
          that the government had a right to use the
          retained funds to pay laborers and
          materialmen; that the laborers and
          materialmen had a right to be paid out of the
          funds; that the contractor had he completed
          his job and paid his laborers and materialmen
          would have become entitled to the fund, and
          that the surety having paid the laborers and
          materialmen is entitled to the benefit of all
          these rights to the extent necessary to
          reimburse it.
5
The subrogation scheme that is part of the Pearlman doctrine has
been explained in National Shawmut Bank, see footnote 1, supra.
See also Trinity Universal Ins. Co. v. United States, 382 F.2d
317, 320 (5th Cir. 1967), cert. denied, 390 U.S. 906 (1968):

          The surety is not only a subrogee of the
          contractor, and therefore a creditor, but
          also a subrogee of the government [owner] and
          entitled to any rights the government has to
          the retained funds. If the contractor fails
          to complete the job, the government can apply
          the retained funds and any remaining progress
          money to costs of completing the job.


                                                               14
Id. at 141;6 see also Polish v. Johnson Serv. Co., 333 F.2d 545

(3d Cir. 1964) (following Pearlman); Framingham Trust Co. v.

Gould-National Batteries, Inc., 427 F.2d 856, 859 (1st. Cir.

1970) (explaining that "we cannot escape the conclusion that in

both a practical and a legal sense, the payment of previously

unpaid laborers and materialmen is a cost of completing the


6
The adoption of the Bankruptcy Code in 1978 has not undercut
Pearlman's vitality.

          In [Pearlman], the Supreme Court found that
          where by the doctrine of subrogation a surety
          becomes the virtual owner of property that
          would otherwise be the property of the
          debtor, the property will not become an asset
          of the estate. Although the attempt of the
          Congress in enacting the Code was to give the
          broadest possible scope to what are assets of
          the estate, it is doubtful if that decision
          has been overruled.

2 Daniel R. Cowans, Cowans Bankruptcy Law and Practice § 12.30 at
587-88 (West 1989); accord J. Michael Franks & Michael E. Evans,
A Defense of Established Landmarks: Claims of Construction
Sureties to Contract Funds Under Chapter 11, 25 Tort & Ins. L.J.
28, ___ (1989):

          To the extent that a consensus developed, it
          became generally accepted that enactment of
          the Code would not weaken the principles of
          Pearlman. The Pearlman decision itself
          characterized the surety's entitlement to
          benefits of subrogation in terms of a "firmly
          established rule," which was not to be
          "casually overruled." Certainly, the Code's
          definition of a bankruptcy estate differs
          from the estate that was created by the
          former Bankruptcy Act and considered in
          Pearlman. But, following the first wave of
          decisions under the Code with respect to
          sureties' rights, and through early 1985, it
          could be said rather confidently that
          Pearlman had weathered such assaults as the
          Code made available against it.


                                                                  15
contract"); In re Pacific Marine Dredging and Construction, 79

B.R. 924, 929 (Bankr. D. Or. 1987) (debtor's failure to pay for

labor and materials was breach of public construction contract;

consequently debtor had no legal or equitable interest in fund

retained by owner and fund was not part of bankruptcy estate).

          This concept of surety was recognized by the New Jersey

Superior Court, Chancery Division in Stevlee Factors, Inc. v.

State, 346 A.2d 624 (N.J. Super. Ct. Ch. Div. 1975).    There the

superior court, chancery division, broadly embraced and followed

the subrogation rationale and doctrine enunciated in Pearlman,

holding that "[s]ince the sureties stand in the place of those

whose claims they have paid, the funds must be paid to the

sureties just as the funds would have gone in the absence of a

bond -- to the labor and materialmen rather than to the general

creditors."   346 A.2d at 627.   The court also cited Jacobs v.

Northeastern Corp., 206 A.2d 49, 54 (Pa. Super. 1965), which

stated, "Payment of the retained balance became due and available

only upon the performance by the sureties of Northeastern's

obligation.   It is clear that all labor and materials claims must

be fully discharged before there is entitlement to the full

contract payment."   Stevlee Factors, 346 A.2d at 627-28.7
7
Cf. Transamerica Ins. Co. v. Barnett Bank of Marion County, 540
S.2d 113 (Fla. 1989), where the court held that a surety's
equitable subrogation rights had priority over a bank's perfected
security interest. The court stated:

          [T]he overwhelming and essentially unanimous
          post U.C.C. decisions in this country,
          federal as well as state courts, have held
          that (1) the surety's equitable right of
          subrogation is not a consensual security


                                                                    16
            We find that the reasoning in Stevlee Factors

represents an incorporation of Pearlman into New Jersey common

law.   In the absence of contrary authority, we conclude that we

must apply the Pearlman doctrine, which convinces us to find,

based upon the record currently available in this case, that

Modular's failure to pay its subcontractors was a breach of its

contract such that it was not owed the funds held by the

Salvation Army.     As a consequence, those funds did not become a

part of the estate in bankruptcy.

            Our conclusion is not undercut by this Court's decision

in Universal Bonding Ins. Co. v. Gittens & Sprinkle, Entr., Inc.,

960 F.2d 366 (3d Cir. 1992), where we held that "monies owed but

not yet paid to Gittens by state, municipal and federal agencies

do not constitute statutory or equitable trusts in the hands of

the government agencies and therefore may be collected by

Gittens."   Id. at 367-68 (emphasis added).   In contrast to the

situation in Gittens, in the present case, because of Modular's

failure to pay its subcontractors, Modular was not "owed" the

monies held by the Salvation Army.    Indeed, the court's rationale

in Gittens is completely consistent with our holding here.     If

the funds had been "owed" to Modular, they would have become

"accounts" under New Jersey law, see Continental Finance, 241


            interest, (2) no U.C.C. filing is necessary
            to perfect the surety's interest, and (3) the
            surety's interest continues to be, as it was
            under pre Code law, superior to the claim of
            a contract assignee.

Id. at 116.


                                                                    17
A.2d at 860.    Because, however, Modular had not paid all the

subcontractors, under the terms of Modular's contract with the

Salvation Army the funds were not owed to Modular.     If the

subcontractors had been paid and the monies held by the Salvation

Army were in fact owed to Modular, the Pearlman doctrine would

not then be applicable.

          Moreover, we find unpersuasive the bankruptcy and

district courts' reasoning that the Pearlman doctrine applies

only to public contracts with the government and not to private

contracts.     There is no such limitation mentioned or implied by

the court in Stevlee Factors.     While Stevlee Factors also

involved a public contract, we find that it represents an

encompassing approval of Pearlman without limitation only to

public contracts.     See 346 A.2d at 626-28.   The basis cited by

the New Jersey court for the adoption of the Pearlman doctrine is

the equitable doctrine of subrogation which "has received wide

application by the courts of this State and is referred to as a

right highly favored in law."    Id. at 627 (citing Standard

Accident Ins. Co. v. Pellecchia, 104 A.2d 288 (N.J. 1954); A.&B.
Auto Stores of Jones St., Inc. v. Newark, 279 A.2d 693 (N.J.

1971)).

          Moreover, such a limitation of the equitable doctrine

of subrogation only to public contracts would be illogical.      The

equitable obligation of the owner to pay subcontractors from

contract funds remaining in the owners hands is not confined to

government projects, see e.g. Mid-Continent Casualty Co. v. First
National Bank & Trust Co., 531 P.2d 1370, 1376 (Okla. 1975)


                                                                     18
(surety has priority over secured lender in dispute over

remaining contract funds regardless of whether project is private

or public).    The Supreme Court in Pearlman based its holding on

common law principles of property rights and subrogation, not

upon principles or rights arising from statutes governing public

contracts.    See Pearlman, 371 U.S. at 139-40.   There is also

nothing in the Court's reasoning in Pearlman that implies that

its doctrine should apply only to public contracts.     The fact

that the issue arose in a Miller Act case would appear to be

fortuitous.    As explained by the Court of Appeals for the First

Circuit in Framingham Trust Co. v. Gould-National Batteries,

Inc., 427 F.2d 856, 857-58 (1st Cir. 1970):
          The government's well established right to
          have the laborers and materialmen paid out of
          the unpaid progress payments or unpaid
          balance does not arise from any legal
          obligation to such suppliers but simply from
          its equitable obligation to those who provide
          it with labor and materials. We see no
          reason why that same equitable obligation to
          the laborers and materialmen should not exist
          on the part of the non-government owner, who
          receives the same benefit from those
          suppliers -- construction work and materials
          -- as did the government in the
          aforementioned cases. Moreover, the non-
          government owner, like the government, has an
          interest in seeing its suppliers paid so that
          the work necessary for completion of the
          contract can be done with minimum disruption
          and expense.

(citations and footnotes omitted).

             We conclude that, based upon the record currently

available in the present case, Modular breached its contractual

obligation to pay its subcontractors and was therefore not "owed"



                                                                    19
the monies held by the Salvation Army.   Under those

circumstances, those funds are not properly considered part of

the estate in bankruptcy and are not subject to the Bank's

superpriority lien.   We will therefore reverse the bankruptcy

court's turnover order.

                                V.

           With that said, we are uncomfortable with the

development of the record in the present case.   Because of the

bankruptcy court's conclusion that the funds held by the

Salvation Army were part of the estate in bankruptcy, it did not

find it necessary to hold a hearing to determine if any other

factors might establish that any part of the funds were "owed" to

Modular.   For example, the extent to which Modular failed to pay

its subcontractors has never been documented adequately.     Nor did

the bankruptcy court undertake to explore whether Modular had any

other basis upon which to claim the funds being held by the

Salvation Army.   We conclude that further proceedings may be

necessary to determine if Modular has grounds to claim any of

these funds.   We will, therefore, remand this case to the

bankruptcy court to conduct such further proceedings it deems

appropriate in light of the above.




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                              VI.

          For the foregoing reasons, we will reverse the order of

the district court and will remand this case to the district

court with directions to remand it to the bankruptcy court for

further proceedings consistent with this opinion.




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