Grochal v. Ocean Technical Services , 476 F.3d 238 ( 2007 )

PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
In Re: BALTIMORE MARINE 
INDUSTRIES, INCORPORATED,
Debtor.
ALAN M. GROCHAL,
Appellant,
and
MAERSK LINE, LIMITED; MILITARY  No. 06-1206
SEALIFT COMMAND,
Plaintiffs,
v.
OCEAN TECHNICAL SERVICES
CORPORATION; MCALLISTER
TOWING OF BALTIMORE,
INCORPORATED,
Defendants-Appellees.

2 IN RE: BALTIMORE MARINE INDUSTRIES
In Re: BALTIMORE MARINE 
INDUSTRIES, INCORPORATED,
Debtor.
ALAN M. GROCHAL, Liquidating
Agent,
Appellant,  No. 06-1207
v.
OCEAN TECHNICAL SERVICES
CORPORATION; MCALLISTER
TOWING OF BALTIMORE,
INCORPORATED,
Defendants-Appellees.

Appeals from the United States District Court
for the District of Maryland, at Baltimore.
William D. Quarles, Jr., District Judge.
(1:05-cv-01441-WDQ; 1:05-cv-02102-WDQ; BK-03-80215-JS;
AP-03-08154-JS; AP-04-01871-JS)
Argued: December 1, 2006
Decided: February 9, 2007
Before MOTZ and TRAXLER, Circuit Judges, and
David A. FABER, Chief United States District Judge
for the Southern District of West Virginia,
sitting by designation.
Vacated and remanded by published opinion. Judge Motz wrote the
opinion, in which Judge Traxler and Judge Faber joined.
IN RE: BALTIMORE MARINE INDUSTRIES 3
COUNSEL
ARGUED: Alan M. Grochal, TYDINGS & ROSENBERG, Balti-
more, Maryland, for Appellant. Robert K. Gross, EATON & VAN
WINKLE, New York, New York, for Appellees. ON BRIEF: Alan
Van Praag, EATON & VAN WINKLE, New York, New York, James
W. Bartlett, III, Alexander M. Giles, SEMMES, BOWEN &
SEMMES, P.C., Baltimore, Maryland, for Appellee Ocean Technical
Services Corporation; J. Stephen Simms, SIMMS SHOWERS, L.L.P.,
Baltimore, Maryland, for Appellee McAllister Towing of Baltimore,
Incorporated.
OPINION
DIANA GRIBBON MOTZ, Circuit Judge:
This appeal from a bankruptcy court order raises the question
whether unpaid subcontractors have an absolute right to interpleaded
funds owed to a government contractor, when the contractor has peti-
tioned for bankruptcy. The courts below awarded the funds directly
to the subcontractors and thus excluded the sums from the contrac-
tor’s bankruptcy estate. Because the funds constitute part of the bank-
ruptcy estate of the contractor, we must vacate and remand for further
proceedings.
I.
Baltimore Marine Industries, Inc. (BMI) owned a full-service ship-
yard engaged in ship repair and reconditioning. BMI agreed with
Maersk Line, Ltd., the operator of the M/V PFC William B. Baugh (a
ship owned by the United States), to repair the ship. BMI then sub-
contracted with, inter alia, Ocean Technical Services Corp. (OTS) for
the latter to provide skilled labor for work on the Baugh. BMI and its
subcontractors completed work on the Baugh and Maersk accepted
redelivery of the ship.
On June 11, 2003, BMI filed a voluntary petition for relief under
Chapter 11 of the Bankruptcy Code in the United States Bankruptcy
4 IN RE: BALTIMORE MARINE INDUSTRIES
Court for the District of Maryland. On July 31, 2003, Maersk filed an
interpleader action in the bankruptcy court, seeking to deposit
$270,357.74, the amount it owed BMI for repair of two ships; of that
sum, $245,989.95 was for work on the Baugh. The contract between
Maersk and BMI allowed Maersk to retain ten percent of progress
payments until completion of the project, but it is unclear what por-
tion (if any) of the interpleaded sum represents these retained funds.
OTS, the subcontractor, filed a claim against the interpleaded funds
for $110,405, asserting that BMI owed it that amount for its work on
the Baugh. Other parties either asserted claims against the funds and
later settled with BMI or waived any claim they may have had to the
funds by failing to answer the interpleader complaint.
The court had appointed Alan M. Grochal to serve as the Liquidat-
ing Agent for BMI in its ongoing bankruptcy proceedings. Accord-
ingly, Grochal was substituted for BMI as the proper party in the
interpleader action.
OTS and Grochal each moved for summary judgment. Grochal
argued that the funds were part of the bankruptcy estate and that OTS
"[did] not possess any lien or right in the Interpleaded Funds, equita-
ble or otherwise, that would entitle [it] to priority over BMI’s bank-
ruptcy estate or other creditors of BMI." OTS contended that the
interpleaded funds were excluded from the bankruptcy estate and
should be awarded directly to OTS in payment for the work it had
performed on the Baugh.
The bankruptcy court agreed with OTS. It ordered that $110,405,
plus prejudgment interest and costs, be paid directly to OTS from the
interpleaded funds and excluded from the bankruptcy estate. The
court found it was undisputed that OTS had not been paid, and also
found that "[t]he purpose of the fund in question is to protect the
unpaid materialmen and subcontractors." It reasoned that Pearlman v.
Reliance Insurance Co., 371 U.S. 132 (1962), "control[led] the rights
of unpaid materialmen and subcontractors" and required the conclu-
sion that OTS had "the right to the fund." Accordingly, the court
ordered that $110,405 be awarded directly to OTS and excluded from
the bankruptcy estate. The court made clear that it viewed the ques-
tion as "not one of priorities under the Bankruptcy Code but . . .
whether the liquidating agent in a bankruptcy case can administer
IN RE: BALTIMORE MARINE INDUSTRIES 5
property that is not that of the debtor." The district court affirmed for
essentially the same reasons.1
We review the judgment of a district court sitting in review of a
bankruptcy court de novo, applying the same standards of review
applied by the district court. Thus, we review the bankruptcy court’s
factual findings for clear error and its decisions of law de novo.
Devan v. Phoenix Am. Life Ins. Co. (In re Merry-Go-Round Enters.,
Inc.), 400 F.3d 219, 224 (4th Cir. 2005).
II.
Section 541 of the Bankruptcy Code governs the composition of
the bankruptcy estate and provides a broad definition of "[p]roperty
of the estate." 11 U.S.C.A. § 541 (West 2006); see United States v.
Whiting Pools, Inc., 462 U.S. 198, 205-06 (1983) (recognizing "broad
scope of [the] reorganization estate"); Tignor v. Parkinson, 729 F.2d
977, 980 (4th Cir. 1984) (explaining that § 541 includes within the
bankruptcy estate "all kinds of property, including tangible or intangi-
ble property" (internal quotation marks omitted)). Subject to excep-
tions not relevant here, § 541 mandates that the bankruptcy estate
contain "all legal or equitable interests of the debtor in property as of
the commencement of the case." 11 U.S.C.A. § 541(a)(1) (emphasis
added). Amounts owed to the debtor under existing contracts are
included within the estate. Ralar Distribs., Inc. v. Rubbermaid, Inc.
(In re Ralar Distribs., Inc.), 4 F.3d 62, 67 (1st Cir. 1993). Not only
was the contract in this case in place at the time BMI filed for bank-
ruptcy protection, but also prior to that filing BMI had performed the
work required under the contracts. Consequently, § 541 would seem
to require that BMI’s interests in these funds constitute part of BMI’s
bankruptcy estate.
1
BMI also contracted with OTS and McAllister Towing, Inc. for work
on other government ships. The bankruptcy and district courts reached
the same result with respect to claims arising out of those contracts in a
related interpleader proceeding; on appeal, the parties waived oral argu-
ment in that case, No. 06-1207. Because the principles articulated in this
opinion also control our decision in 06-1207, we vacate the district
court’s order in that case and remand for proceedings consistent with the
principles articulated in this opinion.
6 IN RE: BALTIMORE MARINE INDUSTRIES
The bankruptcy court apparently believed that BMI had no interest
in the funds — legal or equitable — because under Pearlman, 371
U.S. 132, OTS had an absolute right to the interpleaded funds; it was
mistaken. This application of Pearlman rests on a faulty premise —
that unpaid subcontractors enjoy the same rights as the surety in
Pearlman.
In Pearlman, the Government had hired a contractor for a public
works project. As required by statute, the contractor had obtained two
bonds through a surety: one to guarantee completion of the work and
the other to guarantee payment of laborers and suppliers.2 Id. at 133.
Pursuant to its agreement with the contractor, the Government
retained a set percentage of the amount due monthly, to be paid upon
completion of the project. Id. at 133-34. Before finishing the work,
the contractor ran into financial problems and the Government termi-
nated the agreement. Id. at 134. The contractor’s surety then paid the
unpaid laborers and suppliers the amounts that they were owed. Id.After another contractor finished the project, the Government paid the
previously retained funds to the first contractor. Id. Because that con-
tractor had filed for bankruptcy, the bankruptcy trustee took posses-
sion of the retained funds. Id. The surety sued, claiming that it owned
the funds — that ownership had never vested in the bankrupt contrac-
tor or its trustee. Id.In resolving this question, the Supreme Court focused on whether,
and to what extent, the surety had a property interest in the retained
funds, reasoning that "[t]he Bankruptcy Act simply does not authorize
a trustee to distribute other people’s property among a bankrupt’s
creditors." Id. at 135-36.3 It noted that no statute "expressly declare[d]
2
Notwithstanding this requirement, see 40 U.S.C.A. § 3131 (West
2006), BMI was apparently not required to provide surety bonds in this
case. The Secretary of the Navy has authority to waive the bonding
requirement "with respect to contracts for . . . repairing . . . vessels," 40
U.S.C.A. § 3134 (West 2006), which might explain the absence of any
bond in this case.
3
As Grochal points out, the Supreme Court decided Pearlman under
the Bankruptcy Act, which contained a narrower definition of "property
of the estate" than that set forth in the Bankruptcy Code. See Whiting
Pools, 462 U.S. at 205-06. However, the Supreme Court has cited Pearl-
IN RE: BALTIMORE MARINE INDUSTRIES 7
that a surety does acquire a property interest" in such a fund. Id. at
136. Therefore, the Court looked to prior judicial decisions establish-
ing a surety’s rights and found "beyond dispute" that "sureties com-
pelled to pay debts for their principal have been deemed entitled to
reimbursement" and that "a surety who pays the debt of another is
entitled to all the rights of the person he paid." Id. at 136-37. The
Court concluded:
We therefore hold in accord with the established legal prin-
ciples stated above that the Government had a right to use
the retained fund to pay laborers and materialmen; that the
laborers and materialmen had a right to be paid out of the
fund; that the contractor, had he completed his job and paid
his laborers and materialmen, would have become entitled
to the fund; and that the surety, having paid the laborers and
materialmen, is entitled to the benefit of all these rights to
the extent necessary to reimburse it.
Id. at 141. In recognition of the surety’s right to the funds, the Court
awarded those funds directly to the surety, bypassing the bankruptcy
estate. Id. at 141-42.
The right of a surety like that in Pearlman — who has fully paid
all subcontractors — to retained funds is greater than that of an
unpaid subcontractor, like OTS, because the surety combines the sub-
contractor’s interest in the funds with those of the Government and
the general contractor. See id. at 141. Unlike an unpaid subcontractor,
a surety steps into the shoes of the general contractor and thus
acquires his legal title and any other rights he has to the withheld
funds, legal and equitable. See id. at 137-42. The surety in Pearlman
possessed all of the rights that the bankrupt contractor would other-
man since enactment of the Bankruptcy Code, without questioning its
validity. See Dep’t of the Army v. Blue Fox, Inc., 525 U.S. 255, 264
(1999). In this case, we can distinguish Pearlman solely on the basis of
the difference in rights possessed by OTS and those possessed by the
surety in Pearlman. We need not and do not rely on the statutory change
in the definition of "property of the estate" or suggest that Pearlman is
no longer good law.
8 IN RE: BALTIMORE MARINE INDUSTRIES
wise have had; thus the bankrupt contractor was left with no interest
that could become part of the bankruptcy estate. In contrast, unpaid
subcontractors, like OTS, possess literally a fraction of such a surety’s
rights. See id. at 141. Because an unpaid subcontractor is not subro-
gated to the contractor’s interest in the funds, the contractor’s interest
remains and must be included in the bankruptcy estate. Consequently,
the bankruptcy court and district court erred in relying upon Pearlman
to award the interpleaded funds directly to OTS.
We note that in so holding, those courts cited several appellate
cases applying Pearlman. On examination, these cases involve very
different facts. None provide authority for awarding the interpleaded
funds directly to OTS. Indeed, in the most recent of those cases, the
Third Circuit held that "funds owed by the federal agencies to [a
bankrupt contractor] should be paid to [it] as debtor in possession pur-
suant to the broad language of section 541 of the Code." Universal
Bonding Ins. Co. v. Gittens & Sprinkle Enters., Inc., 960 F.2d 366,
376 (3d Cir. 1992); see also O’Rourke v. Seaboard Sur. Co. (In re
E.R. Fegert, Inc.), 887 F.2d 955, 958-59 (9th Cir. 1989) (holding that
bankruptcy trustee for contractor could not avoid pre-petition pay-
ment of funds from contractor to subcontractors); Active Fire Sprin-
kler Corp. v. U.S. Postal Serv., 811 F.2d 747, 756 (2d Cir. 1987)
(holding, in a non-bankruptcy case, that unpaid subcontractors can
recover in lien action against unpaid contract funds held by United
States Postal Service, which had waived sovereign immunity); West-
ern Cas. & Sur. Co. v. Brooks (In the Matter of Bruns Coal Co., Inc.),
362 F.2d 486, 491 (4th Cir. 1966) (holding that sureties that had paid
materialmen of bankrupt contractor had no subrogation rights to any
funds in excess of amounts paid to materialmen).
Some of these cases, however, do involve an issue not yet reached
by the bankruptcy or district court in this case (and not fully briefed
by the parties): the nature of OTS’s interest in the funds once they are
part of the bankruptcy estate. For example, the Third Circuit held that,
under the facts of the case before it, the bankrupt debtor held the "re-
tained" funds owed to it by federal agencies in "an equitable trust" for
the unpaid subcontractors’ benefit. Universal Bonding, 960 F.2d at
375-76; see also Henningsen v. U.S. Fid. & Guar. Co., 208 U.S. 404,
410 (1908) (stating, prior to the enactment of the Bankruptcy Code,
that the Government had an "equitable obligation[ ]" to ensure the
IN RE: BALTIMORE MARINE INDUSTRIES 9
payment of laborers and suppliers on public construction projects);
Active Fire Sprinkler, 811 F.2d at 755 (noting, in a non-bankruptcy
case, that "[it] is not new law that unpaid subcontractors hold an equi-
table interest in a contract balance owed by a building owner to a gen-
eral contractor" (citing Restatement of Security § 141 & cmt. e
(1941))).
On remand, the bankruptcy court will have to examine the facts of
the case at hand to determine if there is any basis for finding that OTS
has a similar equitable interest.4 The court will also have to determine
how that interest is treated under the Bankruptcy Code. See, e.g., 11
U.S.C.A. §§ 506, 507, 510 (West 2006) (governing secured interests,
priorities, and subordination). These questions — involving rights and
equities under the Bankruptcy Code — are best determined in the first
instance by the bankruptcy court.
III.
For the foregoing reasons the judgment of the district court is
VACATED AND REMANDED.
4
For instance, some commentators place significance on whether the
fund at issue was withheld to protect the subcontractor’s interest. See,
e.g., Brown, The Law of Debtors & Creditors § 9:13 (West 2006).
Although the bankruptcy court found that the "purpose of the fund in
question is to protect the unpaid materialmen and subcontractors," it did
not explain the basis for this finding. If this finding is necessary to the
outcome on remand, the bankruptcy court must explain its rationale.