     In the United States Court of Federal Claims
                                  No. 16-999C
                            (Filed: August 24, 2017)

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THE HANOVER INSURANCE COMPANY,

                      Plaintiff,                         Equitable Subrogation;
                                                         W r o n g f u l
v.                                                       Disbursement; Breach
                                                         of Stakeholder Duty.
UNITED STATES,

                      Defendant.

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       Eric H. Loeffler, Boston, MA, for plaintiff.

        Vito S. Solitro, United States Department of Justice, Civil Division,
Washington, DC, with whom were Claudia Burke, Assistant Director, Chad
A. Readler, Acting Assistant Attorney General, and Robert E. Kirschman,
Jr., Director, for defendant.

                                   OPINION

Bruggink, Judge.

        In its amended complaint, plaintiff, Hanover Insurance Company
(“Hanover”), seeks to recover $440,000 from the United States on a theory of
equitable subrogation. Hanover executed payment and performance bonds on
behalf of its principal, B&J Multi Service Corporation (“B&J”), in connection
with a contract between B&J and the Department of Veterans Affairs (“VA”)
to repair the steam system at a VA facility in West Haven, Connecticut.
Plaintiff contends that it notified the VA of a default by B&J, triggering its
right to be equitably subrogated to B&J’s right to the contract balance.
Defendant moved to dismiss pursuant to Rule 12(b)(6) of the Rules of the
United States Court of Federal Claims (“RCFC”), arguing that Hanover’s
complaint is deficient as a matter of law because it does not allege that plaintiff
put the VA on notice of B&J’s default until after the contract balance had been
paid to B&J. Oral argument was held on May 2, 2017. As part of the briefing
on defendant’s motion, both parties submitted materials outside of the
complaint. The court therefore converted defendant’s motion to dismiss to one
for summary judgment pursuant to RCFC 56 and afforded the parties an
opportunity to submit supplemental materials to further support their positions.
Supplemental briefing is now complete. Because defendant has not
established that Hanover failed to give notice of default, defendant’s motion
must be denied.

                        FACTUAL BACKGROUND

       The following facts are undisputed. On August 4, 2009, B&J and the
VA entered into Contract No. VA241-C-1241 (“West Haven Contract”),
pursuant to which B&J was to provide tools, labor, materials and equipment
to repair the steam system at a VA facility in West Haven, Connecticut. As
required by the West Haven Contract, B&J separately contracted with Hanover
on August 20, 2009, to provide performance and payment bonds in support of
B&J in the amount of $2,505,000.

       Shortly thereafter, B&J commenced work but was suspended by the VA
on February 17, 2010, for walking off the site, not paying subcontractors, and
incorrectly certifying that subcontractors were being paid. During the course
of the West Haven Contract, a number of B&J’s subcontractors and suppliers
made claims against Hanover’s payment bonds.

       On December 22, 2010, Hanover forwarded to the VA a fully executed
assignment and direction of the contract funds from B&J to Hanover, but with
respect to a contract not at issue here:

       . . . B&J Multi Service Corp. . . . does hereby assign, transfer
       and set over to Hanover Insurance Group . . . all of the
       Principal’s right, title, and interest in and to any and all
       payments . . . and retainage . . . any other money now due or
       hereafter to become due, arising out of [the contract] . . . .

Pl’s. Suppl. Br., Ex. A. That assignment was acknowledged by John Zizik of
the VA, who noted that, “I am in receipt of your Notice of Assignment. I’ll be
working this week on determining payment and change order requests.”

       On February 2, 2011, Hanover informed the VA by email that it had

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been “writing large checks” to “ensure that the work for your project (West
Haven Contract) is being performed without disruption.” Pl’s. Resp. to Mot.
for Summ. J., Ex. A. In an email exchange on May 9, 2011, between Ms.
Ruggiero, a contracting officer for the VA, and Mr. McDevitt, counsel for
Hanover, Ms. Ruggiero stated that she had a “basis for termination for default”
of the West Haven Contract. Pl’s. Supp. Br., Ex. D. On August 3, 2011, Mr.
Zizik, another contracting officer for the VA, sent an email to a subcontractor
on the West Haven project, NG Environmental Contractors, directing it to
address payment issues with Hanover. On August 11, 2011, another
subcontractor, EnviroMed, emailed Hanover’s Mr. McDevitt to assert a claim
against the surety, on which Mr. Zizik was copied. On March 7, 2012, the VA
terminated the West Haven Contract for convenience.

        On February 23, 2013, the VA copied Hanover on an email containing
its response to B&J’s settlement proposal for termination for convenience
costs. Hanover responded on February 25, 2013, instructing the VA that “[n]o
monies are to be paid to B&J. If this matter is resolved, all payments will be
to Hanover.” Pl’s. Resp. to Mot. for Summ. J., Ex. B. On May 7, 2013, the
VA agreed with B&J to pay it $440,000 to settle all of B&J’s claims under the
West Haven Contract.

       On June 4, 2013, Ms. Ruggiero emailed Hanover’s counsel, Eric
Loeffler, notifying Hanover of the settlement with B&J and inquiring whether
payment was to go directly to the surety. Mr. Loeffler replied to the email
saying that he is “doubtful of the authority of B&J to enter into such
agreement, given Hanover’s equitable and contractual rights as surety” and
again requested that funds not be released to B&J without Hanover’s written
consent. Pl’s. Resp. to Mot. for Summ. J., Ex. C. Ms. Ruggiero then emailed
B&J employees on June 6, 2013, stating that she still had “an issue to resolve
with the bonding company requesting payment directly to them.” Id. Ex. D.
Several weeks later, after learning of further communications between B&J
and the VA, Hanover reminded the VA by letter, dated June 25, 2013, of its
subrogation claim. The relevant portion of the June 25 letter is set out below:

       This firm represents Hanover Insurance Group which issued the
       above referenced bond, as surety, on behalf of [B&J], principal
       . . . . Hanover was recently contacted by B&J about the status
       of the final negotiated payment due under the contract, and I
       understand you may have been in communication with B&J
       about the documents required to close-out the contract such that

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       the final negotiated payment can be processed. For the reasons
       set forth below, it is important that Hanover be involved in that
       process. Please give me a call at your earliest convenience to
       discuss.

       Also, I wish to reiterate Hanover’s demand that no further
       contract funds, either earned, unearned or retained, or settlement
       proceeds, be released to B&J or any other person or entity
       without the express written consent and direction of Hanover.
       Hanover has received claims and incurred losses against the . .
       . bond, as well as other bonds issued by Hanover on behalf of
       B&J. Pursuant to Hanover’s common law rights of equitable
       subrogation, its perfected security interest, along with Hanover’s
       express assignment and trust fund rights as set forth in a written
       Agreement of Indemnity between Hanover and B&J, Hanover
       owns and/or otherwise has a priority interest to the funds.

Am. Compl., Ex. 3.

        Despite Hanover’s communications with the VA, the agency paid B&J
$440,000 on September 10, 2013. Defs. Mot. for Summ. J., Ex. 1. On
September 17, 2013, counsel for Hanover sent a certified letter to the CO
demanding payment of the $440,000, stating that “B&J is in default of the
Bonds.” Am. Compl., Ex. 4. Having already made the final payment on the
West Haven Contract, the VA refused. Hanover filed suit here on August 12,
2016, seeking to recover the amount of the contract close-out payment, which
it alleges was wrongfully paid to B&J in violation of plaintiff’s rights as an
equitably subrogated surety.

                                DISCUSSION

        Even in the absence of contractual privity between the United States
and a surety provider, a legally enforceable duty can arise between the
government and a surety if the surety notifies the government that its principal
is in default of the bond agreement. Balboa Ins. Co. v. United States, 775 F.2d
1158, 1164 (Fed. Cir. 1985). At that point, the government must take
“reasonable steps to determine for itself that the contractor had the capacity
and intention to complete the job.” Id. Defenant’s motion puts into question
whether Hanover’s pre-payment communications with the VA adequately
notified the government of B&J’s default, thereby triggering the government’s

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equitable subrogation duty to Hanover. As we explain below, we find that the
surety’s letter of June 25, 2013 adequately notified the government of the
contractor’s default.

        The theory of equitable subrogation “is based on the view that the
triggering of a surety’s bond obligation gives rise to an implied assignment of
rights by operation of law whereby the surety ‘is subrogated to the [principal
obligor’s] property rights in the contract balance.’” Lumbermens Mut. Cas.
Co. v. United States, 654 F.3d 1305, 1312 (Fed. Cir. 2011) (quoting Balboa
Ins. Co. v. United States, 775 F.2d 1158, 1164 (Fed. Cir. 1985)). Those rights
do not arise vis-a-vis the government, however, unless the surety notifies the
government of the default. The law in this regard is succinctly summarized by
the Federal Circuit’s decision in Fireman’s Fund Insurance Co. v. United
States:

       [T]he government as obligee owes no equitable duty to a surety
       like Fireman’s Fund unless the surety notifies the government
       that the principal has defaulted under the bond. It is irrelevant
       whether the surety claims a right to funds during performance of
       the contract, or after it is completed when the government
       functions as a ‘stakeholder’ of funds owed but not yet paid. In
       either event, notice by the surety is essential before any
       governmental duty exists.

909 F.2d 495, 498 (Fed. Cir. 1990). In Fireman’s Fund, although
subcontractors and suppliers informed the government that they had not been
paid by the contractor, that did not satisfy the surety’s requirement to give
notice and therefore it did not trigger the government’s equitable duty towards
Fireman’s Fund. Id. at 499.

       Defendant’s argument here can be reduced to one point: Hanover did
not invoke the precise words “the principal is in default” prior to the VA’s
payment to B&J. Defendant principally cites Firemen’s Fund in support.

       Notice of a potential default can also be sufficient to trigger the
Government’s obligation to protect the interests of the surety in remaining
contract funds. Ins. Co. of W. v. United States, 83 Fed. Cl. 535, 541 (2008).
In Hartford Fire Insurance Co. v. United States, the court stated that the
Government’s equitable subrogation duty can arise when “the surety notifies
the government that the contractor has defaulted or is in danger of defaulting

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under the bond.” 40 Fed.Cl. 520, 522–23 (1998) (emphasis added), aff’d, 185
F.3d 885 (Fed. Cir. 1999); see also Capitol Indem. Corp. v. United States 71
Fed. Cl. 98, 102–03 (2006) (stating that “a payment bond surety must notify
the government that the contractor is or is close to being in default,” and later
stating that “the surety must explicitly notify the government of the default or
threatened default”). Thus the notice requirement cannot be as explicit as
defendant would have it.

        Hanover’s June 25, 2013 letter was adequate to put the agency on notice
of default. Hanover informed the VA that it had made payments under its
payment bond and that it was therefore exercising its equitable subrogation
rights. It is not too much to assume that the VA should have understood this
as tantamount to saying that the principal had defaulted. Under these
circumstances, Hanover’s invocation of its “rights of equitable subrogation”
could mean only one thing: the surety was invoking its legal right to payment
because it had incurred costs due to the principal’s default.

       Under the case law in this circuit, the language of the June 25 letter is
sufficient to put the government on notice that the principal has defaulted and
the surety has been called upon to perform under its bond obligations. In
Lumbermens Mutual, for example, the circuit court makes it clear that notice
similar to that furnished here would be sufficient: “The Claims Court
dismissed Lumbermens’ ‘equitable subrogation’ claim here because, before the
payments were made, Lumbermens ‘did not notify the Government was
approaching default or that the Navy should withhold or divert progress
payments.’ We agree.” 654 F.3d at 1309 (internal citations omitted). The
implication is that notice to the government that it should not make progress
payments to the principal would be sufficient to trigger the surety’s rights as
an equitable subrogee and the government’s duties to it.

      Similarly, in American Fidelity Fire Insurance Co. v. United States, 513
F.2d 1375 (Ct. Cl. 1975), the Court of Claims held that the government
became a stakeholder when the surety there notified it that,

       In reference to the above captioned matter and pursuant to that
       General Agreement of Indemnity as between Fidelity Fire
       Insurance Company and [contractor], a copy of which is
       attached hereto, and further pursuant to California Code of Civil
       Procedure, Section 2847, 2848, and 2849, please consider this
       letter formal demand that any monies due under the above

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       captioned contract be forthwith distributed to and placed with
       American Fidelity Fire Insurance Company.

Id. at 1377 n.1. The word “default” was not present in that notice. The court
pointed out that the references to the California Code were only relevant if the
principal on the bond had failed to pay laborers and materialmen. “None of
the sections has any application unless there is a defaulting principal or one
who is about to default. Once there is a default by the principal, the sections
provide in surety’s favor suitable rights, including subrogation.” Id. at 1380.
The court thus rejected the government’s argument that the notice from the
surety was insufficient to trigger its equitable subrogation rights. Id. at 1380-
81.

         Hanover’s letter in this case was more pointed than the notices in either
American Fidelity or Lumbermens’ Mutual and certainly would have satisfied
the test set out in Fireman’s Fund, where the circuit court faulted the surety for
not notifying the government of “Westech’s failure to pay its subcontractors
or suppliers or ask that payments to Westech be withheld until December 22,
1983, almost five months after the government had fully released the retainage
. . . .” 909 F.2d at 499. In Balboa, the court treated notice that the principal
“was in financial straits and would not be able to fulfill its payment and
performance obligations” as tantamount to asserting that the contractor
breached by defaulting under one of the bonds. 775 F.2d at 1160, 1164. In
light of this precedent, we hold the notice here to have been sufficient.

       In sum, in view of the evidence indicating that the agency paid the
principal in the face of notice of the principal’s bond default, we cannot grant
summary judgment for the government against the surety.

                                CONCLUSION

       The parties agree that the court has before it all the materials it needs
to resolve defendant’s converted motion for summary judgment. Because
defendant has not established that plaintiff failed to notify defendant of B&J’s
default, the motion is denied. The parties are directed to consult and propose
by September 8, 2017, in a status report, their recommendations for further
proceedings.




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    s/Eric G. Bruggink
    ERIC G. BRUGGINK
    Senior Judge




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