
    The State, ex rel. The Southern Surety Co., v. Schlesinger, Dir. of Highways and Pub. Works of Ohio, et al.
    
      Suretyship—Public work completed by surety after abandonment by contractor—Surety subrogated to state’s rights in fund remaining at forfeiture—Surety entitled to balance and priority over assignee of contractor—Balance assigned to secure loans to pay laborers and materialmen— Although surety obligated to pay such claims—And money loaned and claims paid before forfeiture declared.
    
    A surety on the bond of a contractor for public work, who completes the work after abandonment by the contractor, is subrogated to all the rights of the state in the fund remaining at the time of declaration of forfeiture, and entitled to priority of payment of the balance of said fund as against the assignee of such contractor, to whom the balance of said fund had been assigned to secure loans received by him, the proceeds of which were used in making payment of the claims of laborers and material-men, even though the surety on such bond was obligated to pay all claims of laborers and materialmen, and even though such money was loaned and such claims paid before declaration of forfeiture.
    Subrogation, 37 Cyc. pp. 414, 428.
    (No. 19346
    Decided March 16, 1926.)
    In Mandamus.
    This is an original action in this court in which the relator, the Southern Surety Company, seeks by the writ of mandamus to compel the state highway commissioner to issue vouchers payable to relator in the total sum $2,539.93, and to compel the auditor of state to deliver his warrant in favor of relator upon the treasurer of state for such sum. Relator is surety upon the bond of Walsh & McDaniel, contractors, for the building of a certain highway for the sum of $47,391.95. Relator became surety upon the bond of said contractors in the penal sum of $24,521.45. The contractors entered upon performance, and, as the work progressed, estimates were made and vouchers issued in the total sum of $45,598.18. During the performance of the work the contractors borrowed money from the Huntington National Bank of Columbus, from time to time, for which notes were given, and to secure the payment of such notes pledged as collateral security an assignment to the bank, dated September 17, 1923, of all moneys then due and thereafter to become due from the state of Ohio upon said contract. Notice of the pledge and assignment was given to the director of highways and to the auditor of state, and a like pledge was made on December 21, 1923, of all moneys due and payable by Licking and Knox counties on account of said contract, and proper notices given to the auditors of those counties. After the date of said pledges and assignments, all vouchers upon earned estimates were mailed to the contractors in care of said bank.
    On October 20, 1923, the contractors borrowed the sum of $800, for which note was given payable in -15 days, and on November 10, 1923, a voucher was issued upon an earned estimate in the sum of $1,506.10, which was not delivered. The proceeds of the loan of $800, as well as all previous loans made by the bank to the contractors, were used in the payment of labor performed and materials used prior to November 2, 1923, in connection with the contract. The voucher in the sum of $1,506.10 was withheld because of the claims made by the relator herein, viz, that the contractor was unable to complete his contract, and that the surety company would be obliged to complete it. On November 20, 1923, the director of highways made a finding of abandonment on the part of the contractor and a demand upon the surety company to complete the contract.
    At the time the aforesaid voucher was withheld, there remained in the fund only the sum of $2,539.93, and the surety company, in completing the contract, was compelled to expend the sum of $7,082.74. The relator is a compensated surety, and the bond contains therein written a condition whereby the. suriety agreed to “pay all lawful claims of sub-contractors, materialmen and laborers for labor performed and materials furnished in carrying forward, performing or completing said contract, said principal and surety agreeing and assenting that this undertaking shall be for the benefit of any materialman or laborer having a just claim.”
    The director of highways filed an interpleader, praying that the Huntington National Bank and the contractors be made parties defendant, and be required to set up their respective claims in relation to the payment of the balance of said fund, and asking that the court determine the respective claims of the parties. Thereupon the bank filed an answer and cross-petition setting up its note and collateral pledge, and prayed that said sum of $800 and interest be paid to it. The controversy relates only to the sum of $800, and interest.
    
      
      Messrs. Atkinson, Smith & Hogan and Mr. Frank Cipriano, for relator.
    
      'Mr. C. C. Qrabbe, attorney general, and Mr. J. C. Williamson, assistant attorney general, for defendant.
    
      Messrs. Arnold, Wright & Harlor, for the Huntington National Bank.
   Marshall, C. J.

Sections 2365-1 and 2365-2, General Code, require that the surety bond shall contain “an additional obligation for the payment by the contractor, and by all subcontractors, for all labor performed or materials furnished in the construction, erection, alteration or repair of such building, works or improvements.” The condition in the bond fully complies with the statutory requirement. The bank loaned money in good faith to the contractor upon a pledge of the amount due and to become due under the contract, and the money was used by the contractor in paying for labor; and materials which entered into the contract. Upon these facts it must be determined whether the bank is entitled to priority of payment of its claim of $800 and interest.

It is the claim of the surety that it stands in the position of the state, and that it is subrogated to all rights which the state would have had if the state had forfeited the contract and proceeded to complete the work. The surety further contends that the contractor could not make a valid assignment of the funds to the bank as collateral security for a loan, even though the money so loaned was used to pay claims which the surety would otherwise have been compelled to pay under the law and its contract and its bond, if the effect of such deprives the surety of its right to stand in the position of- the state.

This question has never heretofore been before this court. It is claimed that the case of Amick v. Woodworth, 58 Ohio St., 86, 50 N. E., 437, sustains the contention of the bank, but that case is wholly dissimilar, and, when carefully examined, does not support the contentions of the bank in the instant case. The case of Caraway v. Robinson, 85 Ohio St., 485, 98 N. E., 1121, involved. the principle of offset between a creditor of a decedent estate and a debt claimed by the estate, and is also without value. The only other Ohio Supreme Court case cited by the bank is that of W. E. Wright Co. v. Ear shall, 101 Ohio St., 517, 130 N. E., 942. That case does declare that the doctrine of subrogation will not be applied to prefer one creditor over another, where an inequitable result will be accomplished thereby. In the instant case it must be apparent that the equities are equal. In that case the laborers and materialmen had perfected liens prior to the forfeiture, as they had a right to do in cases of contracts by municipalities, and in addition to that fact, the laborers and material-men were entitled to. be paid by the surety. The difference between that case and the instant. case is that the bank was not a laborer or materialman, but merely a volunteer lender of money. In the absence of any direct authority among the former decisions of this court, we must turn to the Supreme Court of the United States and the courts of last resort of the states.

The case of Prairie State Bank v. United States, 164 U. S., 227, 17 S. Ct., 142, 41 L. Ed., 412, clearly states the right of the surety to subrogation, and that case differs from the instant case only in the fact that the surety was not liable in that case to pay the claims of laborers and materialmen. The Supreme Court of the United States reaffirmed this doctrine upon similar facts in the case of Henningsen v. United States Fidelity & Guaranty Co., 208 U. S., 404, 28 S. Ct., 389, 52 L. Ed., 547.

Other cases more directly in point, because the surety for the contractor in those cases was obliged either by statute or by the contract to pay the claims of laborers and materialmen, are as follows: People’s National Bank v. Corse, 133 Tenn., 720, 182 S. W., 917; First Nat. Bank of Seattle v. City Trust, Safe Deposit & Surety Co., 52 C. C. A., 313, 114 F., 529; Am. Bonding Co. v. Central Trust Co., 153 C. C. A., 326, 240 F., 400; Wasco County v. New Eng. Equit. Ins. Co., 88 Or., 465, 172 P., 126, L. R. A., 1918D, 732, Ann. Cas., 1918E, 656; Derby v. United States Fid. & Guaranty Co., 87 Or., 34, 169 P., 500; First Nat. Bank v. Pesha, 99 Neb., 785, 157 N. W., 924; Neodesha Nat. Bank v. Russell, 109 Kan., 562, 200 P., 281; Massachusetts Bonding & Ins. Co. v. Ripley County Bank, 208 Mo. App., 560, 237 S. W., 182.

The foregoing cases declare that the surety is subrogated, to the extent necessary to protect it from loss, to all the rights which the state might have asserted by virtue of Section 1209, General Code, against the funds in its hands, and that such right attaches at the time the contract is made, and is one of the valuable rights which accrue to the surety by reason of its obligation of suretyship, and is not defeated by an assignment of the fund to secure a loan of money by a bank. They further establish the principle that, by reason of the assignment of the moneys due and to become due to the contractor from the state, the assignee of the contractor took no greater rights than the contractor himself might have asserted against the state.

Other cases declare that a bank in loaning money to a contractor is under no obligation to do so, and is therefore to be treated as a volunteer, and for that additional reason acquires no right by assignment superior to the right of the contractor himself. Hemmingsen v. U. S. Fidelity & G. Co., supra; Lion Bonding & Surety Co. v. First State Bank of Paris, (Tex. Civ. App.), 194 S. W., 1012; Carr Hardware Co. v. Chicago Bonding & S. Co., 190 Iowa, 1320, 181 N. W., 680; Hess & Skinner Engineering Co. v. Turney, 110 Tex., 148, 216 S. W., 621; American Bonding Co. v. Central Trust Co., supra.

It is also declared in the case of Derby v. U. S. Fidelity Co., 87 Or., 34, 169 P., 500, that the fact of suretyship upon the bond of the contractor is notice to a bank or other lender of the surety’s right of subrogation.

The case of Hardaway v. National Surety Co., 211 IT. S., 552, 29 S. Ct., 202, 53 L. Ed., 321, was an appeal from a decree of the Circuit Court of Appeals of the Sixth Judicial District, and the opinion was delivered by Mr. Justice Day. The facts of that case, while not parallel to the facts of the instant case, were, nevertheless, such that the same legal principles are necessarily applicable. A contract had been entered into for a public improvement between the United States and Willard & Cornwell. Thereafter Willard & Cornwell entered into a contract with Hardaway & Prowell for the completion of the work, and the Supreme Court of the United States construed that contract as follows:

“Hardaway and Prowell bound themselves to furnish superintendence and to furnish the money to complete the work which Coyne had undertaken to do. These things were all that Hardaway and Prowell undertook to do; they were not subcontractors in our view who undertake to furnish labor and materials upon a contract with the original contractor. The extent of the agreement was to furnish funds to complete the work and to superintend it. For this they were to be paid by the assignment of the reserve funds in the hands of the Government and the checks or payments under the original contract. There was no undertaking on the part of the surety company that the contract should be profitable to its principal or to any other substituted in the contract by assignment or otherwise. The surety did agree by the terms of the bond that the original contractors should make full payment to all persons supplying them with labor and materials in the prosecution of the work.”

Upon these facts the Supreme Court held that the surety company was not obligated to pay for labor and materials supplied by Hardaway & Prowell in the completion of the work.

All the foregoing cases quite clearly and uniformly support the claims of the surety in the instant case. As against this long line of authorities we are cited by counsel for the bank to the case of Puget Sound State Bank v. Gallucci, 82 Wash., 445, 144 P., 698, Ann. Cas., 1916A, 767, but a careful examination of that case discloses that it was decided upon the peculiar language of the statute governing such matters in force at that time in the state of Washington. By virtue of that statute, and more especially by virtue of the contract made pursuant to that statute, the surety became obligated, not only to pay the claims of laborers and materialmen, but to pay “all just debts, dues, and demands incurred in the performance of said work.” Whatever force that case might have had as an authority in the instant case, much of that force was destroyed by the fact that at a subsequent date the Legislature of the state of Washington amended the law, leaving out the words above quoted, thereby indicating that it was not the intention of the. Legislature, in the declaration of a sound public policy for that state, to destroy the rights of sureties to subrogation upon public contracts in that state.

Another case cited by counsel for the bank is that of Fidelity & Deposit Co. of Maryland v. City of Stafford, 93 Kan., 539, 144 P., 852. In that case the Supreme Court of Kansas permitted a bank, under circumstances . quite similar to the facts of the instant case, to prorate with the surety company in the funds remaining in the city treasury, but in the opinion the court cites with approval the case of Prairie State Bank v. United States, supra, and First National Bank of Seattle v. City Trust Co., supra, and, notwithstanding that court’s approval of those authorities, permitted the bank and the surety to prorate. It was stated by the court in the opinion that the case was decided upon its own peculiar facts, and it is apparently not of much value in support of the bank’s contentions in the instant case. Whatever may be said about the Washington and Kansas authorities, they are certainly in a hopeless minority, and the larger number of cases which support the contentions of the surety state the sounder doctrine.

It is urged on behalf of the bank that by reason of its assignment of the contract it becomes entitled to all the security of the contract. Even if this should be admitted, it adds no strength to the position of the bank. Conceding that the bank by the assignment had transferred to it all the value of the contract, it turns out in this particular case that the contract had no value. Whether of not a contract has value depends upon whether the contractor made a good bid. If the contract can be executed at a profit, it has value. If it is executed at a loss, it becomes a liability. And this is perhaps the best answer to the contentions of the bank—that it had transferred to it what turned out to be a liability instead of an asset.

It may clearly be deduced from all the foregoing authorities, and it must further be resolved upon principle, that the right of subrogation in the surety operates as an equitable assignment, and that, inasmuch as the surety is a party to the original contract, such equitable assignment takes priority over any assignment, legal or equitable, which may be given by the contractor to any third party who enters the transaction after its inception.

It has further been urged on behalf of the bank that it is entitled to be subrogated, and therefore entitled to claim an equitable assignment of the claims of laborers and materialmen who were paid by the funds loaned by the bank to the contractor. This question was fully met in the case of Illinois Surety Co. v. City of Galion, (D. C.), 211 F., 161, where the court determined to the contrary. Laborers and materialmen who were paid by the money loaned by the bank to the contractor had no liens and the bank cannot therefore be said to have acquired existing and vested liens. We therefore hold upon principle, as well as authority, that the surety company must prevail.

Judgment for relator.

Matthias, Allen and Robinson, JJ., concur.

Jones, J.,

dissenting. The salient and controlling facts in this case are not disputed. Walsh & McDaniel entered into a contract with the director of highways in the sum of $47,391.95, for the improvement of a state highway. For the purpose of financing this improvement the contractors, who are customers of the Huntington National Bank, entered into an arrangement with the bank, on September 17, 1923, whereby loans were obtained from the bank, including the loan in question. On the same day the contractors assigned all moneys then or thereafter to become due to the bank as collateral security, and authorized the bank to indorse and receive all vouchers and warrants for future payment of moneys under the contract. From time to time vouchers were issued to the contractors upon estimates made by the state, all of which were mailed to the contractors in care of the bank.

Notice of the pledge and assignment, as here indicated, was, on the 17th day of September, 1923, given by the bank to the state auditor and the director of highways of the state. Under the arrangement so made, on October 20, 1923, the contractors borrowed $800 from the bank, payable 15 days after date, the proceeds of which “were used by Walsh & McDaniel [contractors] in the payment of labor performed and materials used, prior to November 2, 1923, in connection with the improvement contract.” On November 10, 1923, the state issued a voucher to the contractors covering an estimate dated November 2, 1923, which was not transmitted to the bank, “because of the claim made thereto by the Southern Surety Company.” Thirty days after the bank loan became due, and 9 days after the issuance of the voucher in controversy, the contractors notified the director of highways that they were unable to complete the contract, and the latter called upon the contractors ’ surety to complete the improvement. The last voucher, dated November 10, 1923, was for $1,506.10, and was more than the amount due the bank.

It is important to note that the state makes no claim to the funds represented by this voucher, but has entered the case by way of interpleader, holding the same solely for the determination of the equitable priorities between the bank and the surety.

The claim of the surety company is two-fold: (1) That it is subrpgated to all the rights of the state and entitled to all the remedies that the state might have in the interpleaded fund; (2) that, under the facts developed, the equities of the surety company are equal to or prior to the equities of the bank.

Were the state claiming a fund in its hands, consisting of a reserved percentage, for the purpose of completing the contract, under a stipulation therefor, we do not doubt that the state would have that right as against the bank who loaned the money, even though the money may have been used for the purpose of paying for materials and labor that entered into the improvement. But the state is making no such claim in the instant case. It has brought the fund into court by way of inter-pleader.- It is merely a stakeholder, asking the court to determine where the equities between the interested parties lie, and to whom the fund shall be paid. When the voucher of November 10, 1923, was issued for the sum of $1,506.10, the $800 borrowed from the bank was overdue, and the voucher would have been forwarded to the bank in the usual course had it not been for the claim of the surety company. If the claim be made that the surety company is subrogated to the rights of the state, a complete answer thereto is the fact that, not only does the state make no claim to the fund under any contractual provision, but, on the contrary, would have paid it to the bank under its collateral pledge and assignment, of which the state had due notice; nor, in view of its action, as hereinafter indicated, could the state in good conscience assert this right against the bank. The amount paid by the bank, and used for the payment of material and labor, was to that extent beneficial to the surety company. Had the loaner, instead of advancing the sum of $800 for the payment of materials, actually furnished the materials, there could be no doubt that it would have a lienable claim for that amount.

Counsel on both sides of the case have cited numerous authorities in support of their respective contentions. However, none of the cases cited presents such equitable considerations as appear here that seem to justify, as against the surety, the claim of priority on the part of the bank.

We do not have here a case like some that have been cited by plaintiff, where a city or state, under a similar assignment, was endeavoring to claim a fund especially reserved for the purpose of completing an improvement after the contractor’s default. The bank is simply attempting, under its assignment, to claim a fund earned by the contractors under estimates of the engineer, and payable to the contractors under the contract, and for which sum a voucher had been approved by the state. When this voucher was issued, the sum named therein had been appropriated to the contractors, in pursuance of contract, before its abandonment, and before the surety- company asserted any claim thereto. Bates v. Salt Springs Natl. Bank, 157 N. Y., 322, 51 N. E., 1033; Dowling v. City of Seattle, 22 Wash., 592, 61 P., 709.

Had the bank in the instant case been a general creditor of the contractor, and had the money loaned not been traced into the improvement, the claim of the surety company might be sustained under equitable principles. Maryland Casualty Co. v. Wash. Natl. Bank, 92 Wash., 497, 159 P., 689; Henningsen v. U. S. Fidelity & Guaranty Co. of Baltimore, 208 U. S., 404, 28 S. Ct., 389, 52 L. Ed., 547.

As we have said, a great many authorities have' been cited by counsel upon both sides, but necessarily the determination of each case requires the application of the principles of equity to each individual case as the facts are developed. “Subrogation or equitable assignment is based on principles of natural justice and essential fairness without regard to form—its object being the prevention of injustice.” Fidelity & Deposit Co. of Maryland v. City of Stafford, 93 Kan., 539, 144 P., 852.

There is a line of cases that holds that where a contract between the contractor and the owner of the improvement stipulates that payments shall be made to the contractor from time to time, on earned estimates, and provides also that a balance consisting of a certain percentage shall be retained by the owner for the completion of the improvement on default of the contractor, then the surety, being subrogated to the rights of the owner, steps into the shoes of the latter, and is entitled to be subrogated only to the percentage retained for the completion of the improvement under the terms of such contract. Among other cases supporting that view are the following cited by counsel for plaintiff: Prairie State Bank v. United States, 164 U. S., 227, 17 S. Ct., 142, 41 L. Ed., 412; Wasco County v. New England Equitable Ins. Co., 88 Or., 465, 172 P., 126, L. R. A., 1918D, 732, Ann. Cas., 1918E, 656; First Natl. Bank of Seattle v. City Trust, Safe Deposit & Surety Co., 114 F., 529, 52 C. C. A., 313.

In Bank, of Seattle v. City Trust, S. D. & S. Co., supra, two of the members of the Circuit Court of Appeals held that the surety’s right of subrogation extended not only to the reserved percentage, but to the entire fund. However, it appears on page 534 that Mr. Justice McKenna, sitting on that bench, dissented, holding that, on abandonment of the contract, the right of subrogation extended only to the percentage reserved under the contract; that the 70 per cent, earned “was a vested substantive right of the contractors, and passed by their assignment to the bank.” The justice then adds: ‘ ‘ This view is sustained, in my opinion, not opposed, by the case of Prairie State Nat. Bank v. U. S., 164 U. S., 227, 17 S. Ct., 142, 41 L. Ed., 412.”

Many of the cited cases are dissimilar to the case at bar. In Henningsen v. U. S. Fidelity & Guaranty Co., 208 U. S., 404, 405, 408, 28 S. Ct., 389, 52 L. Ed., 547, it appears from the statement of the case, and from the brief of counsel for the surety company, that, not only did the bank advance its money as a general loan to the contractor, but there was no proof that the proceeds of the loan were used in the improvement. It does not appear from this record what the contract was between the state and the contractor, or whether the state was authorized thereby to reserve any percentage for the completion of the improvement upon default. The record only discloses that the contractor was to be paid certain amounts, which were approved by the engineers’ estimates. Certainly the right of the surety company cannot rise higher than that of the state under the situation here presented. As stated in the opinion of Mr. Justice McKenna, above quoted, under this contract the contractors acquired a “vested substantive right,” which “passed by * * * assignment to the bank.”

Since we aré dealing with equities, there is an additional reason why in this case,'assuming that the surety can be subrogated to the right of the state, the state ought not, in good conscience, deny priority to the bank. Before the loan had been made by the bank, the latter forwarded to the director of highways the original assignment made by the contractors, and also sent a copy thereof to the state auditor. In its letter to each of them the bank said:

“If for any reason this assignment could not be accepted and recognized, please notify us promptly.”

The record does not disclose that either the director or the state auditor responded to this letter, but, to the contrary, permitted the loan to be made, and thereafter transmitted to the Huntington National Bank the vouchers issued to the contractors under the contract made by them with the state. Certainly the surety company cannot now advance a claim which, under the circumstances developed in this case, the state itself cannot justifiably advance.

But, were we to concede that the authorities were at variance as to the application of the equitable principles under consideration, we think that the Supreme Court of this state has been fully committed to the equitable doctrine herein announced. In Maryland Casualty Co. v. Citizens’ Natl. Bank of Caldwell, 18 Ohio App., 193, while the facts are dissimilar from the instant case, the bank prevailed in the Court of Appeals, and a motion to certify the cause was denied by this court. In its opinion the Court of Appeals states :

“There being no equitable lien upon the fund in favor of the casualty company, when the warrant for the final estimate was delivered to the cashier of the bank it [the bank] received same with the right to apply it upon the amount of money then due from the contractors,” etc.

Another case, tried in the Court of Appeals of Stark' county, is Ætna Casualty & Surety Co. v. Harter Bank. In that case the Downs Company had contracted with the city of Akron to complete a sewer improvement for the sum of $171,291.57. Ten per cent, of the estimate of work done on the improvement was to be retained until the completion of the contract, when five per cent, thereof was to be paid. The other five per cent, was to be paid one year after the completion. The contractors gave bond with the HDtna Surety Company, containing the same terms as did the bond in the instant case. During the progress of the work the contractor assigned to the Harter Bank the 10 per cent, retained upon the estimate for work performed and materials furnished. After such assignment, the city officials, its auditor and director of public service, consented to the assignment. Afterwards persons filed attested accounts with the city for labor and materials furnished. Later these were withdrawn, and after withdrawal their claims were paid by the surety company. The city of Akron filed an interpleader in court asking a determination of the priorities of the fund in its hands. At that time there was in court for distribution, due from the city, the sum of $20,386.63, of which $17,129.16 comprised the retained percentage, and $3,257.47 was the amount due from the city under the contract over and above the 10 per cent, retained. The Harter Bank claimed a lien for the sum of $10,710.10 for money advanced to the contractor. The surety company, having, after the assignment, paid the claims of the labor and materialmen, who had previously filed attested accounts, but later withdrew them, in the amount of $9,570, claimed an equitable lien to the fund prior to that of the bank. However, the Court of Appeals held that, while materialmen might have claimed a lien at the time they filed their attested accounts, since they later withdrew those accounts, the surety, by later paying the claims, could not claim a lien by way of subrogation as against the bank. This court, on May 31, 1922, refused to entertain a motion to certify the case (Supreme Court No. 17458).

We are utterly unable to see why a surety who has guaranteed against its principal’s default should avail itself of that default and recover as against a creditor who had in good faith loaned its money to pay for labor and materials furnished that surety’s principal.

Day and Kinkade, JJ., concur in this dissenting opinion.  