H. B. Agsten & Sons, Inc. v. Huntington Trust & Savings Bank

388 F.2d 156

• Court: Court of Appeals for the Fourth Circuit
• Decided: December 4, 1967
• Docket: No. 11028
• Status: Published

Opinions

SOBELOFF, Circuit Judge:

With the facts undisputed, the only issue for our determination in this circuity of lien priorities case is the proper distribution of the proceeds from a judicial sale of property.¹ We think that the District Court’s disposition satisfactorily accommodates the competing interests of state and federal law and the opposing claims of the three litigants — a mechanic’s lienor, a mortgagee bank and the Small Business Administration. Accordingly, we affirm the court’s decision to give priority to the bank and the remainder to the SBA, while requiring the bank to satisfy the mechanic’s lien in full from its recovery.

On June 1, 1964, plaintiff H. B. Ag-sten & Son, Inc. began construction of a motel for the West Virginia Industries Development Corporation on a 31-acre tract of land owned by the developer in Mason County, West Virginia. Almost four months thereafter, on September 22, 1964, to help finance the venture, West Virginia Industries borrowed from the Huntington Trust & Savings Bank $400,000.00, secured by a recorded deed of trust conveying the tract to the Bank’s trustees. Finding itself in need of more capital one month later, West Virginia Industries executed and on October 30, 1964, recorded a second deed of trust conveying the same property to secure a loan of $1,042,500.00 from the Small Business Administration. This agreement provided:

“This Deed of Trust and warranty of title herein are made subject to and subordinate to a prior deed of trust executed by the grantor herein to secure a loan in the amount of $400,000.-00 over the premises herein conveyed, and now of record in the office of the Clerk of the County Court of Mason County, West Virginia.”

There can be no doubt, as the Special Master to whom the District Court referred this case found, that this language alluded to the Bank’s earlier loan to West Virginia Industries.

After substantially completing the motel in June, 1965, Agsten timely recorded a notice of mechanic’s lien in the county clerk’s office for $217,098.33, the balance admittedly due the contractor. With its debtor insolvent, Agsten instituted this action in a state court of West Virginia, seeking a determination of the validity and priority of outstanding liens against the property of West Virginia Industries, and requesting a sale to satisfy these liens. SBA, a named defendant, had the case removed to the Federal District Court.

The circuity of lien priorities arises because of an apparent conflict between certain federal and state statutes, whose applicability in this case is undisputed. The Federal Insolvency Statute, 31 U.S.C. § 191, provides:

“Whenever any person indebted to the United States is insolvent * * *, the debts due to the United States shall be first satisfied; and the priority established shall extend * * * to cases in which an act of bankruptcy is committed.”

Since the parties do not contest the Special Master’s finding that West Virginia Industries was insolvent and had committed the requisite act of bankruptcy, it is clear that the claim of the SBA, a federal agency, is entitled to preference over Agsten’s mechanic’s lien, which was inchoate when the SBA loan was made. See Small Business Administration v. McClellan, 364 U.S. 446, 81 S.Ct. 191, 5 L.Ed.2d 200 (1960); W. T. Jones & Co. v. Foodco Realty, Inc., 318 F.2d 881 (4th Cir. 1963). The Bank, however, enjoys a priority over SBA both because of the explicit language in SBA’s deed of trust and because of a judicially-created exception to the insolvency statute in favor of previously executed mortgages. See United States v. State of Texas, 314 U.S. 480, 484, 62 S.Ct. 350, 86 L.Ed. 356 (1941). To complete the circle, Agsten has a claim superior to the Bank’s by virtue of the laws of West Virginia.² The resulting paradox is that the Bank is behind the contractor and ahead of the SBA, which is in turn ahead of the contractor.

In resolving this problem, we follow what has been correctly termed the “federal policy” ³ in this area. We start with the basic proposition that federal law determines the relative priority of conflicting claims where a federal agency is involved. United States v. Clover Spinning Mills Co., 373 F.2d 274, 276 (4th Cir. 1966). It is by applying federal law that we have determined that SBA’s claim is superior to Agsten’s but inferior to the Bank’s. Federal law demands only that after the payment of the $400,000.00 to which the SBA is subordinated, this federal agency should be recompensed for its loan to the extent possible. At this point, the interest of the federal government terminates, and the ultimate disposition of the $400,000.00 is purely a matter of state concern. United States v. City of New Britain, 347 U.S. 81, 88, 74 S.Ct. 367, 98 L.Ed. 520 (1954). In our case, the State of West Virginia has determined by its statutes that the contractor is to be paid in full before the mortgagee’s claim is satisfied.

New Britain is precisely in point here. Applying federal law, the Supreme Court found that certain liens of the United States were superior to a number of municipal liens but inferior to outstanding mortgage and judgment liens. However, under the relevant state law, the mortgage and judgment liens were inferior to the municipal liens. In reversing a disposition similar to one of those contended for by the appellant here, the Court declared:

“The United States is not interested in whether the State receives its taxes and water rents prior to mortgages and judgment creditors. That is a matter of state law. But as to any funds in excess of the amount ‘necessary to pay the mortgage and judgment creditors, Congress intended to assert the federal lien. (Emphasis added.)

On remand, the state court set aside the amount of the mortgage and judgment liens, ordered the remainder paid to the federal government, and directed payment of the municipal liens from the funds appropriated to the mortgage and judgment liens. Brown v. General Laundry Service, 19 Conn.Supp. 335, 113 (1955). This is the very method employed by the District Court in the instant case and by a consistent line of federal authorities. See, e. g., In Re Lieb Bros., Inc., 251 F.2d 305 (3rd Cir. 1957); Exchange Bank & Trust Co. v. Tubbs Manufacturing Co., 246 F.2d 141 (5th Cir. 1957); United States v. Lord, 155 F.Supp. 105 (D.N.H.1957). See also Samms v. Chicago Title & Trust Co., 349 Ill.App. 413, 111 N.E.2d 172, 176 (1953). The fact that the lien in New Britain arose under the federal tax laws while in this case the priority emanates from a contractual obligation, is not a legally significant distinction in resolving the issue before us. Although, as we shall show^the substantive scope of the federal tax laws differs from that of the Federal Insolvency Statute, the technique to be utilized in reconciling the divergent interests, once they have been determined, should be the same.

The result we reach here is justified not only by precedent but also by sound policy considerations. Agsten began improving the land in June, 1964, secure in the knowledge that state law accorded it a priority over any subsequent local mortgage. When the bank advanced money to West Virginia Industries nearly four months later, it must be presumed to have been well aware that its repayment would be subordinated to the prior mechanic’s lien. The fortuitous appearance of a federal agency one month later should not inure to the Bank’s benefit by depriving the contractor of its $217,000. Similarly, it is proper that SBA be paid all of the excess over $400,000, the specific amount by which the law and its agreement purported to subordinate its claim. If the SBA were subordinated not only to previously executed mortgages but also to inchoate mechanic’s liens, there is a possibility it would refuse to make such loans, thereby diminishing the effectiveness of the Small Business Act, 15 U.S.C. §§ 631-651. And had the SBA declined to make its million dollar loan, the Bank might on insolvency of the landowner recover less because, as no federal law would be involved, Ag-sten would come ahead of the Bank in the distribution of a fund not enhanced by the massive federal investment.

Neither of the Bank’s suggested alternative solutions achieves a similarly desirable reconciliation of the respective interests. The Bank first posits a theory whereby $217,000 is awarded to Agsten, then the Bank is paid in full, and finally SBA is decreed the remainder. This alternative, which would emasculate the Federal Insolvency Statute, was specifically rejected by the Supreme Court in the New Britian case, supra.

The second approach, which the Bank urges more strenuously, would first set aside the $217,000 owed to Agsten, but pay it to the SBA instead of Agsten, for SBA is superior to the building contractor under the federal statute. The Bank would then be repaid in full, with the remainder going to SBA. The net result would be that the Bank would enjoy full recovery, the SBA would recoup more than half of its outlay and Agsten would be cut out completely. This solution offends the West Virginia lien statutes, which unequivocally afford a preference to mechanic’s liens; the Federal Insolvency Statute, which is not meant to inure to the benefit of private creditors vis-a-vis other private creditors; and our sense of equity, which demands that this contractor who improved the land should not go uncompensated.

In short, while the Bank complains that it is the only party which suffers from the District Court’s disposition, the fact is that it “suffers” only in the sense that by the operation of the West Virginia law and not by reason of the Federal Insolvency Statute, it will regain only about half of its loan. It should also be noted that the Bank is the one party involved which could have protected itself. It could have safeguarded its interest by obtaining a waiver of earlier mechanics’ liens before making the loan. By contrast, SBA had no reason to guard against a mechanic’s lien, from which it is protected by federal law. Similarly, Agsten had no need to seek protection against the Bank’s future mortgage, for the West Virginia statute explicitly afforded it this security.

It has been suggested that the Federal Tax Lien Act of 1966, Pub.L.No. 89-719, 80 Stat. 1125, amending 26 U.S.C. § 6323, impliedly calls for a different result in this case. The thesis is that since the recent legislation subordinates unrecorded federal tax liens to mechanics’ liens, federal contractual claims should be similarly affected. If accepted, this theory would result in paying both the contractor and the Bank in full before applying any of the proceeds to SBA’s claim. The language and legislative history of the statute, however, convince us that Congress did not purpose to elevate inchoate mechanics’ liens over federal contractual claims. The terms of the statute and the detailed Committee reports of both houses of Congress⁴ speak repeatedly of subordinating federal unrecorded tax liens to mechanics’ liens, never intimating a design to broaden the subordination to include other federal claims.

The 1966 amendment, insofar as it pertains to our present inquiry, is simply the latest in a series designed to effect precisely limited expansions of the category of secured creditors protected from secret federal tax liens.⁵ The insolvency statute at issue here, and the tax lien law are entirely separate entities, no matter how related they may become upon occasion. Covering all debts owing the federal government by an insolvent debtor, the insolvency statute, as has long been established, does not create a lien but simply establishes a priority. Beaston v. Farmers’ Bank of Delaware, 12 Peters 102, 134, 9 L.Ed. 117 (U.S.1838); United States v. Fisher, 2 Cranch 358, 390, 2 L.Ed. 304 (U.S.1805). On the other hand, the revenue act, by its terms applies only to tax debts, does create a lien and encompasses all taxpayers regardless of their solvency. In the most scholarly and comprehensive article yet written about the new tax law, Professor Young of Columbia Law School observes that the Federal Insolvency Statute and the 1966 Federal Tax Lien Act raise an “entirely different set of issues.” Young, Priority of the Federal Tax Lien, 34 U.Chi.L.Rev. 723, 725 (1967).

The inapplicability of the tax law is underscored by a recent Supreme Court decision, which ruled that the tests for determining the choateness of an earlier lien differ depending upon whether the insolvency statute or the tax lien law is involved. United States v. State of Vermont, 377 U.S. 351, 357, 358, 84 S.Ct. 1267, 12 L.Ed.2d 370 (1964). Interestingly, the Court’s approach is consistent with the 1966 amendment insofar as the decision gives a prior lien a better chance against a federal tax lien than against an insolvency priority.

We cannot say that it is illogical for Congress to deem it desirable to retain a priority for money it loans, while relinquishing the priority for its tax liens, which represent no financial outlay. Whatever may be the merits of symmetry in these two quite distinct, if cognate, areas the argument seems more properly addressed to Congress than to this court.

Finally, in brief response to our Brother Bryan we observe, with deference, that his dissent is marked by two basic fallacies. The first is the unsupportable interpretation of the SBA-Landowner contract that the SBA not only subordinated its mortgage to the extent of $400,000, but that it in some unexplained fashion obligated itself to pay off the Bank’s mortgage in full. Of course no such obligation has been stipulated by the parties or implied by law. The second erroneous assumption is that the priority accorded by federal law to the SBA mortgage over the mechanic’s lien must be converted into a priority in favor of the bank over the mechanic’s lien. There is no justification for giving the bank a windfall at the expense of the mechanic in disregard of the order of priorities set by state law as between the mechanic and the bank.

The judgment of the District Court is

Affirmed.

1 . The property was sold prior to the hearing of this appeal for $700,000. The aggregate amount due the three principal lienors is approximately $1,600,000 as follows : The Small Business Administration $1,042,500.00, Huntington Trust & Savings Bank $400,000.00 and H. B. Agsten & Son, Inc. $217,098.33. Therefore, we ignore in this opinion a myriad of inferior liens also outstanding against the insolvent debtor.

2 . West Virginia Code (Michie ed. 1966) § 38-2-1. Lien of Contractor.

“Every person, firm or corporation, which shall erect, build, construct, alter, remove or repair any building or other structure, or other improvement appurtenant to any such building or other structure, under and by virtue of a contract with the owner for such erection, building, construction, alteration, removal or repair, either for an agreed lump sum or upon any other basis of settlement and payment, shall have a lien upon such building or other structure or improvement appurtenant thereto, and upon the interest of the owner thereof in the lot of land whereon the same stands, or to which it may have been removed, to secure the payment of such contract price or other compensation therefor.”

§ 38-2-17. Priority of Mechanics’ Liens Over Other Liens.

“All of the liens authorized and created by this article shall * * * have priority over any and all liens created by trust deed or otherwise, on such building or other structure and improvements appurtenant thereto and on the interest of the owner in the lot of ground whereon the same stands or to which the same may have been removed, subsequently to the time when such labor shall have begun to be performed, or such material or machinery or other necessary equipment shall have begun to be furnished.”

3 . Kennedy, The Relative Priority of the Federal Government: The Pernicious Career of the Inchoate and General Lien, 63 Tale L.J. 905, 927 n. 128 (1954).

4 . S.Rep. No. 1708, 89th Cong.2d Sess. (1966); H.Rep. No. 1884, 89th Cong.2d Sess. (1966), U.S.Code Cong. & Admin. News 1966, p. 3722.

5 . Professor Kennedy chronicles the amendments whereby purchasers, mortgagees and judgment creditors (37 Stat. 1016 [1913]) and pledgees (53 Stat. 882-883 [1939]) were accorded protection from unfiled federal tax liens. Kennedy, op. cit., at 921-2.