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Fidelity and Deposit Co. of Maryland v. Ohio Department of Transportation

United States District Court, S.D. Ohio, Western Division

November 22, 2017


          Dlott, J.


          Stephanie K. Bowman United States Magistrate Judge

         This case involves competing claims for funds (“Funds”) currently held by this Court. The Internal Revenue Service (“IRS”) seeks the Funds in partial payment of a tax bill, while Plaintiff Fidelity and Deposit Company of Maryland (“F&D”) asserts that it is entitled to the same Funds, because the identified taxpayer never acquired any property interest in the Funds that would be subject to an IRS levy. The case has been referred to the undersigned magistrate judge for all pretrial proceedings. (Doc. 31).

         Currently pending are the parties' cross-motions for summary judgment. For the following reasons, I recommend that F&D's motion be GRANTED and that the cross-motion of the IRS be DENIED.

         I. Background

         Plaintiff F&D filed this declaratory judgment action seeking a judgment that the Funds were wrongfully levied upon by the IRS and instead belong to F&D.[1] (Doc. 12 at ¶47; see also generally ¶¶38-48). F&D claims entitlement to the Funds based upon its performance as surety on bonds issued to the delinquent taxpayer, Cosmos Industrial Services, LLC (“Cosmos”). The Funds, in the amount of $589, 049.49, were deposited into the registry of this Court through a supplemental interpleader action after the IRS filed a Notice of Tax Levy against the third-party custodian of the Funds.[2]

         F&D's surety bonds relate to contracts that were awarded to Cosmos by the Ohio Department of Transportation (“ODOT”) for public road and bridge projects throughout Ohio.[3] The total amount of the Funds constitutes far less than the tax bill or the amount paid out by F&D as surety; thus, both IRS and F&D seek the Funds to recoup only a portion of their respective losses.

         II. Findings of Fact

         Both parties have submitted proposed undisputed findings of fact in this case. To the extent any dispute exists, all reasonable inferences have been drawn in favor of the IRS, as the party against which summary judgment is recommended.

         Beginning in 2013, Cosmos failed to remit its Form 941 payroll taxes to the IRS as required by federal law. Ultimately, delinquent taxes were assessed against Cosmos covering periods ending on December 31, 2013, December 31, 2014, and June 30, 2015 in amounts that presently total more than $1.5 million. Notices of Federal Tax Liens were filed by the IRS on January 6, 2015, September 3, 2015, and September 30, 2015. All three tax liens were submitted to the Cuyahoga County Office of Fiscal Officer, where they were recorded against Cosmos.

         Beginning in 2012 and continuing until 2015, F&D issued both payment bonds and separate performance bonds in conformity with public works contracts that Cosmos secured to perform work for ODOT. (See Docs. 45-15, 45-16); see also generally Beasley v. Monoko, Inc., 195 Ohio App.3d 93, 96958 N.E.2d 1003, 1005 (Ohio Ct. App. 2011) (explaining that payment bonds ensure that all laborers, suppliers, and subcontractors are paid in full, while performance bonds ensure that the work is completed to Ohio's satisfaction). F&D issued its bonds based in part upon false and misleading financial information provided to F&D by Cosmos.[4] F&D also entered into a separate indemnity agreement with Cosmos.

         The bonded projects are the sole source of Funds currently on deposit with this Court. Seven ODOT Projects generated the Funds, identified by Project numbers 120629, 140182, 140186, 140244, 140540, 150154, 150214, where the first two digits represent the year in which the contract was executed.

         Under the terms of the contracts, ODOT was to make monthly progress payments to Cosmos based upon the amount of work deemed to have been completed by the state's engineer. ODOT required the submission of periodic Pay Applications to support those payments.

         By 2015, in addition to failing to pay its employment taxes to the IRS, Cosmos had failed to pay a number of the projects' sub-contractors and suppliers. Beginning on August 7, 2015 and continuing through September 29, 2015, those unpaid entities served ODOT with thirteen notices under Ohio R.C. § 1311.26, a state law that allows the claimant to claim “a lien upon the unpaid portion of the contract” between the prime contractor and the State of Ohio on any public project (“mechanic's lien”). The state law ensures that work on public projects is completed without the disruption that otherwise could ensue if unpaid subcontractors and suppliers elected to stop their work. Upon receipt of the notices under R.C. §1311.26, ODOT was required to retain or withhold payment from sums that would otherwise be payable to the principal contractor, an amount that equaled but did not exceed the total amount of the claims. See R.C. §1311.28 (mandating that, upon receipt of “the affidavit required by section 1311.26 of the Revised Code, the public authority shall detain” the amount of the claim or claims).

         Upon receipt of affidavits verifying claims that totaled $553, 590.71, ODOT withheld that amount from payment on Payment Applications submitted by Cosmos dating from August 2015. (Doc. 45-20). Pursuant to the referenced Ohio law, ODOT segregated the funds and placed them into a separate bank or escrow account.

         Because ODOT received federal funding from the Federal Highway Administration, ODOT also had a federal contractual obligation to withhold funds otherwise payable to a contractor to ensure compliance with Federal Highway Administration wage and fringe benefit provisions. The federally mandated contract provisions included multiple elements concerning the periodic payment of both payments for wages and contributions for fringe benefits under the Davis-Bacon Act. See 40 U.S.C. § 3141, et seq. Those provisions included the following:

• The contracting agency shall upon its own action or upon written request of an authorized representative of the Department of Labor withhold or cause to be withheld from the contractor under this contract … so much of the accrued payments or advances as may be considered necessary to pay laborers and mechanics … employed by the contractor or any subcontractor the full amount of wages required by the contract.
• If the contractor or subcontractor fails to submit the required records or to make them available, the Federal agency may, after written notice to the contractor [or the contracting agency or the State's DOT]…, take such action as may be necessary to cause the suspension of any further payment, advance or guarantee of funds.

29 C.F.R. §§ 5.5(a)(2) and (a)(3); see also 40 U.S.C. §3142(c)(3).

         Due to the discovery by September 1, 2015 that Cosmos had not paid the federally mandated fringe benefits, ODOT withheld additional amounts under the Davis-Bacon Act. Although a spreadsheet originally provided by ODOT in discovery identified the retained amount of fringe benefits as totaling $71, 756.34, (see Doc. 45-20), F&D's trial counsel has attested, based upon the supplemental deposition testimony of Danette Shuler of ODOT, that ODOT withheld a total of $458, 833.76 for fringe benefits on 8 projects.[5] (Doc. 56-1 at 3).

         After September 1, 2015, Cosmos never made any payments that would have permitted ODOT to release any of the payments retained under Ohio law or under the Davis-Bacon contractual provisions to Cosmos. ODOT later agreed to release the funds, but only after F&D provided assurances that it had paid all claims.

         On or about September 1, 2015, Cosmos alerted F&D that it was no longer able to meet its payroll obligations and therefore was seeking assistance under the surety bonds. F&D agreed to provide financial assistance under the bonds, conditioned on the execution of Letters of Direction wherein Cosmos “irrevocably request[ed] that all payments due or to become due on account of the [bonded]” contracts be provided to F&D, directing ODOT to pay to F&D any funds that otherwise would become due to Cosmos. The Letters of Direction are dated September 8, 2015, and were transmitted to ODOT by letter dated September 15, 2015. (See Docs. 12-1 through 12-10).

         Acting through its consultant, Nicholson Professional Consulting (“Nicholson”), F&D established a Control Account in a bank in Georgia through which F&D funneled funds to pay for the continuation of work on the bonded projects after Cosmos requested F&D's assistance, and F&D began to perform as surety. Nicholson managed and controlled the Control Account, as to which Cosmos had no interest or influence. F&D deposited advances into the Control Account to complete the bonded work, including the payment of all claims and payment of basic operating expenses of Cosmos to maintain a skeletal crew in the main office to process payroll, and to review claims as they were submitted. The Control Account funds were not co-mingled with any other funds.

         Between September 2, 2014 and November 19, 2015, F&D also paid all thirteen outstanding mechanics' liens that ODOT had received. (Doc. 43-4 at 4-5, ¶¶ 10-11). In addition, by March 1, 2016, F&D provided ODOT with the necessary and required evidence showing that it had paid all past-due and current fringe benefit payments. (Doc. 43-4 at ¶¶30-34). In total, F&D paid out more than $700, 000 in fringe benefits, although the precise amount withheld by ODOT and attributable to past-due claims (as of September 1, 2015), versus ongoing fringe benefits contributions after September 1, 2015, is not clear from the record.

         On September 2, 2015, a non-party to this litigation filed suit against Cosmos in state court, seeking the appointment of a Receiver to take possession of all of Cosmos's existing property and assets. (Doc. 51-1).[6] A state court Order dated October 2, 2015 placed Cosmos into Receivership, with the appointed Receiver retaining “authority to operate and manage the subject business property, to collect all profits, rents and revenues generated there from to pay all necessary expense[s] relating to said management, subject to existing letters of direction with F&D.” (Doc. 12-11 at 4).

         Prior to Cosmos being placed into Receivership or the Letters of Direction being executed, substantial work remained to be performed on the bonded projects. Pursuant to its role as surety under the bonds, F&D provided funds to complete that remaining field work. After September 1, 2015, F&D took action to pay all outstanding lien and fringe benefit claims for which ODOT had retained payments, and paid for all ongoing wages, fringe benefits, and materials. In short, F&D provided 100% of all funding required to complete the contracted work, including but not limited to all ongoing labor and materials costs and payroll taxes for the employees of Cosmos.

         Despite performing as surety on the bonds through payments that exceeded one million dollars for the bonded work, and notwithstanding the fact that Cosmos was in Receivership, F&D did not immediately take over all of the operations of Cosmos. Therefore, Cosmos remained listed as the general contractor on the bond for a period of time. However, Cosmos expended no funds for that bonded work after September 1, 2015. In order to continue the work, Cosmos relied solely on the performance of F&D as surety to advance all necessary funds to: “(a) pay the workers in the field to continue performing the work…; (b) to pay claims as they were reviewed and approved; (c) to satisfy lien claims filed against the funds payable on the bonded projects, (d) to pay fringe benefits…and (e) to pay selective expenses for the continued operation of the main office [of Cosmos] to retain key employees of Cosmos to review claims as they came in and to coordinate the work in the field.” (Doc. 43-2 at ¶14, Affidavit; see also Doc. 43 at 5, asserting that F&D advanced funds to pay for “field labor and selected office personnel to maintain Cosmos' operations for several months as the work on the Bonded Projects proceeded.”). F&D continued to advance funds through the established Control Account from September 1, 2015 through January 2016, when F&D finally ceased advancing funds to Cosmos. (Doc. 43-4 at ¶16).

         Consistent with its performance as surety for work conducted after September 1, 2015, F&D prepared Payment Applications and vouchers reflecting invoices dated between November 2015 and March 2016. Those Payment Applications had not been prepared or approved by ODOT at the time that F&D began to perform as ...

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