Kappa Dev. & Gen. Contracting Inc. v. Hanover Ins. Co. (In re Kappa Dev. & Gen. Contracting Inc.)

IN RE: KAPPA DEVELOPMENT AND GENERAL CONTRACTING INC. DEBTOR

KAPPA DEVELOPMENT AND GENERAL CONTRACTING INC. PLAINTIFF v. HANOVER INSURANCE COMPANY DEFENDANTHANOVER INSURANCE COMPANY COUNTER-CLAIMANT v. KAPPA DEVELOPMENT AND GENERAL CONTRACTING INC. COUNTER-DEFENDANTHANOVER INSURANCE COMPANY THIRD-PARTY PLAINTIFF v. THE FIRST, A NATIONAL BANKING ASSOCIATION THIRD-PARTY DEFENDANTTHE FIRST, A NATIONAL BANKING ASSOCIATION CROSS-CLAIMANT v. KAPPA DEVELOPMENT AND GENERAL CONTRACTING INC. CROSS-DEFENDANT

CASE NO. 17-51155-KMS

ADV. NO. 17-06046-KMS

UNITED STATES BANKRUPTCY COURT FOR THE SOUTHERN DISTRICT OF MISSISSIPPI

July 2, 2019

The Order of the Court is set forth below. The docket reflects the date entered.

CHAPTER 11

OPINION AND ORDER GRANTING MOTION FOR SUMMARY JUDGMENT BY HANOVER AND DENYING MOTION FOR SUMMARY JUDGMENT BY THE FIRST

This matter is before the Court on cross-motions for summary judgment by Third-Party Plaintiff Hanover Insurance Company ("Hanover"), ECF No. 34, and Third-Party Defendant The First, a national banking association ("The First"), ECF No. 42.¹ Each party asserts entitlement to funds ("Disputed Funds") currently held in part by Plaintiff Kappa Development and General Contracting Inc. ("Kappa") as Debtor in possession and in part in the registry of the Court. Kappa takes no affirmative position because, whatever the outcome, Kappa expects not to receive any of the Disputed Funds. Answer, ECF No. 29. This proceeding is core under 28 U.S.C. § 157(b)(2)(K) ("determinations of the validity, extent, or priority of liens").

The Disputed Funds were disbursed by the project owners under construction contracts for two unrelated government projects. Kappa, the contractor for both projects, failed to pay all its subcontractors and material suppliers and also failed to pay a workers' compensation premium. Hanover, Kappa's surety under both projects' payment and performance bonds, paid the subcontractors and suppliers and the workers' compensation premium that Kappa did not pay.

Hanover asserts that it is therefore entitled to the Disputed Funds—$130,107.60 for one project and $58,019.77 for the other—under the principle of equitable subrogation, which gives a surety the right to the retainage withheld on public works contracts to ensure project completion and payment of materialmen and laborers. The First asserts that it is entitled to the Disputed Funds because its security interest in Kappa's accounts receivable, general intangibles, and accountproceeds was perfected before the payment and performance bonds were executed and is therefore superior to Hanover's rights.

The right of a surety to retainage is superior to a creditor's security interest in accounts receivable, general intangibles, and account proceeds regardless of when the creditor's security interest was perfected. Accordingly, summary judgment is granted to Hanover and denied to The First. Hanover is entitled to the Disputed Funds in the amounts Hanover was required to pay under each project's payment and performance bonds. Hanover is also entitled to attorney's fees and expenses in an amount yet to be determined. The First is entitled to any remaining balance.

UNDISPUTED FACTS

I. The First's Perfected Security Interest.

1. On September 3, 2010, Kappa executed a Promissory Note for Loan No. XXX0631 in favor of The First in the principal amount of $850,000.00, as modified by Promissory Note dated December 10, 2011; Promissory Note dated April 9, 2013; Promissory Note dated July 10, 2014; Promissory Note dated October 1, 2015; and Loan Modification Agreement dated March 14, 2017 (together, "2010 Note"). The First MSJ Ex. A, Cl. No. 2, ECF No. 42-1 at 4-14.

2. Also on September 3, 2010, and in connection with the 2010 Note, Kappa executed a Commercial Security Agreement, as modified by Commercial Security Agreement dated December 10, 2011; Commercial Security Agreement dated April 9, 2013; Commercial Security Agreement dated July 10, 2014; and Commercial Security Agreement dated October 1, 2015 (together, "2010 Security Agreement). Id. at 15-39.

3. On September 13, 2010, and in connection with the 2010 Note and the 2010 Security Agreement, The First filed UCC Financing Statement Number 20100194368A, which covered the following collateral:

All inventory, accounts receivable and equipment, whether any of the foregoing it owned now or acquired later; all accessions, additions, replacements, and substitutions relating to any of the foregoing, all records of any kind relating to the foregoing, all proceeds relating to any of the foregoing (including insurance, general tangibles and accounts proceeds).

Id. at 40.

4. Kappa is in default on the 2010 Note. The amount due and owing on Loan No. xxx0631 as of June 12, 2017, the date of the bankruptcy petition, was $859,137.50. The First MSJ, Fact No. 6, ECF No. 42 at 4; Hanover Resp., Fact No. 6, ECF No. 51 at 3.

II. City of Waveland Project

5. On October 9, 2014, Kappa entered into a contract with the City of Waveland, Mississippi, designated as FEMA Hazard Mitigation Program ("City of Waveland Project"). The First MSJ, Fact No. 7, ECF No. 42 at 4; Hanover MSJ, Fact No. 3, ECF No. 34 at 2.

6. On October 9, 2014, Hanover executed and issued a Performance Bond and a Payment Bond as surety for Kappa with respect to its contract for the City of Waveland Project. Hanover MSJ Ex. 2, Moses Aff. Exs. C, D, ECF No. 34-2 at 11-16.

7. Hanover paid a total of $67,683.92 to the following subcontractors and suppliers that provided labor or materials on the City of Waveland Project and made claims on Hanover's Payment Bond:

Delta Industries - $12,656.34

Soil Tech Consultants- $30,027.58

Precision Pipe & Products Company - $25,000.00

Hanover MSJ Ex. 2, Moses Aff. ¶¶ 14-15, ECF No. 34-2 at 3.

8. Kappa failed to pay these subcontractors and suppliers. Id. ¶ 15.9. Kappa's payment defaults on the City of Waveland Project occurred pre-petition. Cl. No. 7 (Delta Industries); Sch. E/F: Creditors Who Have Unsecured Claims, Cl. No. 3.45, Case ECF No. 9 at 28 (Soil Tech Consultants); Sch E/F, Cl. No. 3.41, Case ECF No. 9 at 26 (Precision Pipe & Products Company).

10. The Payment Bond required Hanover to pay subcontractors and suppliers that Kappa failed to pay. Hanover MSJ Ex. 2, Moses Aff. Ex. D, Payment Bond para. beginning "NOW, THEREFORE," ECF No. 34-2 at 14.

11. During the City of Waveland Project, disputes arose between Kappa, the City of Waveland, and The Pickering Firm, which was the engineering firm of record for the City of Waveland Project. These disputes were still unresolved when Kappa filed its bankruptcy case. The First MSJ, Fact No. 8, ECF No. 42 at 4; Hanover Resp. Fact No. 8, ECF No. 51 at 3.

12. On March 26, 2018, Kappa asked the Court to approve a settlement between Kappa, the City of Waveland, and The Pickering Firm. See The First MSJ Ex. B, Mot. to Approve Settlement & Compromise, ECF No. 42-2. Under the proposed settlement agreement ("Settlement Agreement"), the City of Waveland would pay Kappa $421,731.76 in "final payment for closeout of the Project." Id. at 8. Of that amount, $130,107.60 was identified as "Retainage." Mot. to Approve Settlement & Compromise Ex. 2, Kappa-Waveland Global Settlement, id. at 73.

13. The Court approved the Settlement Agreement in an order ("Order Approving Settlement Agreement") that defined $130,107.60 of the settlement funds as "Retainage," ordered that the Retainage be paid into the registry of the Court and held there until further order resolving the priority of Hanover's and The First's claims, and found "that the Retainageshall maintain and retain its form and substance as retainage while in the Court's registry to the same extent as if continued to be held by Waveland." Order ¶¶ 2, 3, Case ECF No. 209 at 2.

14. The First consented to the Order Approving Settlement Agreement. Id. at 4.

15. The amount certified for final payment to Kappa for the City of Waveland Project included retainage of $130,107.60. Phelan Aff. ¶ 5, ECF No. 51-3 at 2.

III. Camp Shelby Project

16. On October 28, 2015, Kappa entered into a contract with the Mississippi Military Department designated as Repairs to the Sanitary Sewer System Drainage Basin ("Camp Shelby Project"). The First MSJ, Fact No. 18, ECF No. 42 at 6; Hanover MSJ, Fact No. 1, ECF No. 34 at 2.

17. On November 4, 2015, Hanover executed and issued a Performance Bond and a Payment Bond as surety for Kappa with respect to Kappa's contract for the Camp Shelby Project. Hanover MSJ Ex. 2, Moses Aff. Exs. A, B, ECF No. 34-2 at 5-10.

18. Hanover paid a total of $121,146.78 to the following subcontractors and suppliers that provided labor or materials on the Camp Shelby Project and made claims on Hanover's Payment Bond:

Mississippi Utilities Supply Co. - $65,570.66

Ruiz Contracting Solutions - $38,325.25

Burns Dewatering Services - $17,250.87

Hanover MSJ Ex. 2, Moses Aff. ¶¶ 13, 15, ECF No. 34-2 at 3.

19. Kappa failed to pay these subcontractors and suppliers. Id. ¶ 15.20. Kappa's payment defaults on the Camp Shelby Project occurred pre-petition. Sch. E/F: Creditors Who Have Unsecured Claims, Cl. No. 3.36, Case ECF No. 9 at 25 (Mississippi Utilities Supply Co.); Sch. E/F, Cl. No. 3.44, Case ECF No. 9 at 27 (Ruiz Contracting Solutions); Sch. E/F, Cl. No. 3.6, Case ECF No. 9 at 15 (Burns Dewatering Services).

21. The Payment Bond required Hanover to pay subcontractors and suppliers that Kappa failed to pay. Hanover MSJ Ex. 2, Moses Aff. Ex. B, Payment Bond para. beginning "The above obligation is void," ECF No. 34-2 at 8.

22. The amount approved for final payment to Kappa for the Camp Shelby Project was $67,516.06, of which $58,019.77 was retainage. Bryant Aff. ¶¶ 5-6, ECF No. 34-3 at 2.

23. The $67,516.06 was paid to Kappa pre-petition. The First MSJ, Fact No. 19, ECF No. 42 at 6; Hanover Resp., Fact No. 19, ECF No. 51 at 4.

24. The Court authorized Kappa to use up to $5,000.00 of the final payment to pay a workers' compensation premium and ordered the remaining funds

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