Fidelity and Deposit Company of Maryland and the Internal Revenue Service (IRS) claimed they were entitled to funds from construction contracts between Cosmos Industrial Services, Inc. and the Ohio Department of Transportation. ODOT owed monthly progress payments to Cosmos. Fidelity served as surety for Cosmos contracts by providing performance payments bonds for the projects.
When Cosmos was unable to meet its obligations, Fidelity took over its operations by providing funding to ensure that projects were completed and liens were covered. Fidelity sought the remainder of the progress payments ODOT would have owed Cosmos. However, ODOT withheld payment because the IRS claimed entitlement to the remaining progress payments due to Cosmos’ unpaid tax obligations.
Fidelity filed a lawsuit in U.S. District Court against ODOT and Cosmos for wrongful levy. It argued the IRS’ tax liens never attached to Cosmos’ rights to future progress payments from ODOT and Fidelity was entitled to the funds under the doctrine of equitable subrogation.
The District Court granted summary judgment in favor of Fidelity. It that concluded that Cosmos lacked a property interest in any of the funds at issue.
Cosmos entered into contract with ODOT between 2012 and 2015. Seven projects in this time period received Federal Highway Administration (FHA) funding. As a condition for receiving the FHA funding, the FHA required ODOT to make monthly progress payments to Cosmos. These payments were based upon the work that Cosmos completed, and were paid after Cosmos submitted applications for payment to ODOT.
In accordance with the Davis-Bacon Act, ODOT was required to withhold funds payable to Cosmos if it failed to pay the fringe benefits required by the FHA. The contracts were also subject to Ohio rules for mechanic’s lien’s claims, which allow subcontractors to file a lien against a contractor for unpaid services. Ohio lien law requires ODOT to withhold funds payable to the contractor in the amount required to pay the liens.
In October 2015, the IRS demanded that ODOT turn over Cosmos’ “property and rights to property…that you have or which you are already required to pay” for $294,026.89 in the 2013 tax year. In February 2016, Fidelity filed a complaint against ODOT, the Ohio Department of Management (ODBM), and the IRS to resolve the dispute over the funds.
ODOT and ODBM filed motions to interplead the funds and to be dismissed as parties, while Fidelity and the IRS filed motions for summary judgment. Fidelity argued that the IRS was not entitled to the funds because Cosmos had no property interest and was never entitled to receive them. Fidelity stated that it was entitled to the funds based on the “doctrine of equitable subrogation and its status as the performing and completing surety.”
The Davis-Bacon Act applies to contractors and subcontractors that perform federally-funded contracts in excess of $2,000 for the construction, repair, or alteration of public buildings or public works. The Act requires contractors and subcontractors to pay their laborers and mechanics employed under the contract “no less than the locally prevailing wages and fringe benefits for corresponding work on similar projects in the area.
Pursuant to the Davis-Bacon Act, ODOT was required to withhold funds to Cosmos if it failed to pay fringe benefits required by the FHA.
The contracts were subject to Ohio’s procedure for mechanic’s lien claims, which allow subcontractors to procure a lien against a contractor for unpaid services. These lien rules required ODOT to withhold funds that would otherwise be paid to the contractor, in order to pay the outstanding liens.
Pursuant to 26 U.S.C. § 6321, the IRS challenged the District Court’s decision regarding the funds that became payable after Fidelity became involved as surety in 2015. The statute holds that “if any person liable to pay any tax neglects or refuses to pay the same after demand, the amount… shall be a lien in favor of the United States upon all property and rights to property… belonging to such person.”
The U.S. Court of Appeals noted that to satisfy a tax deficiency, the Government can impose a lien on any ‘property’ or ‘rights to a property’ that belong to a taxpayer. It also cited the case, United States v. Nat'l Bank of Commerce, 472 U.S. 713, 721, 105 S. Ct. 2919, 2924, 86 L. Ed. 2d 565 (1985), which says that a levy does not give the IRS an automatic right to the property. The levy only serves to protect the government’s interest while any disputes are resolved.
The Court of Appeals said that entities claiming an interest in a levied property, such as Fidelity, may file a wrongful levy action, as described in in 26 U.S.C. § 7426. A levy is wrongful if it is made “upon property in which the taxpayer had no interest at the time the lien arose or thereafter.” The Appeals Court said that the key issue was whether Cosmos had any property or rights to the property at the time of the lien.
The District Court relied on the doctrine of equitable subrogation to determine if Cosmos had any rights to the property. Subrogation is “the substitution of one party for another whose debt the party pays, entitling the paying party to rights, remedies, or securities that would otherwise belong to the debtor.” The District Court concluded that Cosmos had no property rights in the funds because Fidelity, as a performing surety, was entitled to them.
The Court of Appeals disagreed with the District Court. It said that tax liens stay with the property after the property passes to another person. The Court ruled that this is “the very nature and essence of a lien.” The Appeals Court held that if the tax liens attached to Cosmos’ interests in the future payments, the liens would remain with the interests after they passed to Fidelity.
The U.S. Court of Appeals remanded the case back to the District Court for further consideration of the Davis-Bacon violations. The court noted that the record did not indicate when ODOT placed holds on Cosmos’ funds in response to the Davis Bacon violations. It found that even if the IRS tax liens were attached to Cosmos’ interests in future progress payments, “it would not speculate as to the legal effect of the holds on the funds for the Davis-Bacon violations without knowing whether the funds were encumbered by the IRS’ tax liens.
The Court of Appeals remanded the case to the District Court so that the lower court could make additional findings of fact regarding when the ODOT filed liens due to possible Davis-Bacon Act violations. The District Court will then be able to resolve the tax lien issues in accordance with the Court of Appeals’ decision. If the government has alleged that your company committed Davis-Bacon violations, contact a Whitcomb Selinsky PC attorney to discuss your case. The first consultation is always free, and you can reach us at 866-476-4558.