In re Fiberglass Speciality Company, Inc.

Full title: IN RE FIBERGLASS SPECIALITY COMPANY, INC

Court: United States District Court, D. Minnesota, Third Division in Bankruptcy

Date published: Apr 7, 1980

No. 3-78-367(D) (D. Minn. Apr. 7, 1980)

Opinion

No. 3-78-367(D)

April 7, 1980

Former Bankruptcy Act — Arrangements-Unsecured Debts — Title to Property — Contractors — Retainage — Automatic Stay

DIM, Bankruptcy Judge

Subsequent to the filing of a Chapter XI petition, a contractor may not make voluntary payments to subcontractors of its subcontractor — the debtore — from funds retained under its contract with the debtor, in order to pay off liens and recover payment for the project. Title to the retainage passes to the debtor's estate at the filing of the petition and therefore the contractor must seek and order from the bankruptcy court to lift the automatic stay under Section 314 of the Bankruptcy Act and Rule 11-44 of the Bankruptcy Rules of Procedure prior to disposing of the funds. See Sec. 314 at ¶ 3321 and Sec. 362 at ¶ 8602, and Rule 11-44 at ¶ 20,744.

Former Bankruptcy Act — Automatic Stay — Violation — Set off

Although a contractor had violated the automatic stay of Section 314 of the Bankruptcy Act and Rule 11-44 of the Bankruptcy Rules of Procedure by voluntarily making payments to subcontractors of its subcontractor — the debtor — from funds retained under its contract with the debtor subsequent to the filing of the Chapter XI petition, the contractor may set off the claims of the subcontractors against its liability to the debtor to the extent it benefited the debtor's estate. See Sec. 68a at ¶ 2671 and Sec. 553 at ¶ 9556, Sec. 314 at ¶ 3321 and Sec. 362 at ¶ 8602, and Rule 11-44 at ¶ 20,744.

Former Bankruptcy Act — Automatic Stay — Violation — Set Off — Payment of Interests

Interest paid by a contractor on the claims of subcontractors of its subcontractor — the debtor — subsequent to the filing of the Chapter XI petition may not be set off under Section 68 of the Bankruptcy Act against the contractor's liability to the debtor. Interest does not accrue subsequent to the filing of the petition unless the debtor is ultimately proved solvent. As that was not the case in this proceeding, the court would not permit the interest paid to be set off by the contractor. See Sec. 68a at ¶ 2671 and Sec. 553 at ¶ 9556.

[Digest of Opinion]

The debtor had entered into a construction subcontract with the creditor-contractor and in turn contracted with various subcontractors. Upon completion of its work, the contractor retained $66,191.31 of the contract money to ensure payment of all liens from the work of the debtor.

The subcontractors of the debtor filed liens and the creditor continued to retain the funds. The debtor then filed its petition under Chapter XI. At that time, pursuant to Rule 11-44, an automatic restraint on any actions against the debtor and his property became effective. Further, an order from this court restrained every action and proceeding against the debtor and its property. Subsequently, the creditor was notified of the filing and a demand was made for the funds retained by the creditor. Later the debtor commenced an action to recover the funds.

The creditor then notified the debtor that certain work had to be redone as it was defective and covered by the debtor's warranty. As the debtor took no steps to correct the work, the creditor had the work redone and backcharged the debtor $3,872.00. The creditor notified the debtor that all subcontractors would be paid by the creditor if they were not paid by the debtor. These payments were eventually made by the creditor in order to recover the money held by the contract-vendee and the creditor filed its claim against the debtor for $66,184.12.

Under the contract, the creditor had a right to retain the funds in question, but had no claim of title to the funds after the debtor completed the work, nor, under the contract, could it dispose of the money. It had retained the money to ensure that all liens would be satisfied. The creditor contended that under the doctrine of Pearlman v. Reliance Ins. Co., CCH Dec. at ¶ 9009-17, it had a right to make the payments to the subcontractors despite its knowledge of the Chapter XI proceeding.

The court found the creditor's reliance misplaced. Pearlman held that a surety obligated to make payments on its bond to subcontractors and employees of a contractor employed by the United States had title to the funds retained by the United States prior to the time title passed to the estate of the debtor. However, in the instant case, title to the retainage passed to the estate of the debtor before any payments were made by the creditor. Payment was made out of the funds of the debtor. Further, the creditor had no obligation to make the payments but did so voluntarily, contrary to the order of the court, solely to collect the funds due it on the total project.

While the payments made by the creditor cannot be allowed to stand under the stay provision of Section 314 of the Bankruptcy Act, and Bankruptcy Rule 11-44, to the extent the creditor benefited the estate by paying claims which would be allowed against the debtor, its payments were considered assignments of the claims. "To the extent allowed by this court, these claims may be set off against its liability to Fiberglass."

However, the creditor had paid interest on the claims of the subcontractors. "It is well settled that interest is not accrued after the filing of the petition . . . . Only in cases where the debtor is ultimately proved solvent is interest allowed." Because the debtor was not solvent, the interest paid to the subcontractors could not be set off against the creditor's liability to the debtor.