# Petition for Writ of Certiorari — Dakota Electric Supply Co. v. St. Paul Fire & Marine Insurance > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385601_0785%3A2 ## Record - **Collection:** Supreme Court brief - **Document type:** Petition for Writ of Certiorari - **Published:** January 1, 1963 - **Citation:** 372 U.S. 936 ## Text WIBRARY, 7 | Gepen cn us = CoOuPT, q¢. 2. 4 JAN 23 1963 JOHN F. DAVIS, CLERK | In The @usceme Court of the Bnited States No. 769 UNITED STATES OF AMERICA for the use of DAKOTA. ELECTRIC SUPPLY COMPANY, a North Dakota cor- poration, sahniier, aN . vs. ST. PAUL FIRE AND MARINE INSURANCE | COMPANY, ass Respondent. PETITION FOR WRIT OF CERTIORARI TO THE EIGHTH CIRCUIT CQURT OF APPEALS ‘ PHiuir B. VoGEL Fargo, North Dakota (Counsel of Record ) Myron H. Bsicut .. Fargo, North Dakota oe | Attorneys for Petitioner eee 4 1963--Northwest Brief Printing Co., 22 S. Fourth St., Minneapolis 15, Minn. FE. 86-5078, 0 9° INDEX : | 7 Page Jurisdiction of This Court : l Questions Presented for Review 2 Statutes = A Concise Statement of the Case 2 Argument ene peck 4 Appendix : te Lae Opinion , Seiad 11 Judgment ; 7 26 Statutes ; 27 TABLE OF AUTHORITIES e CASES: < ; Page Colunrbia Digger Co. v. Sparks (thi. Cir. 1915 »), 297 Fed. Se 7 R. P. Farnsworth & Co. v. Electrical Te Co. (5th_ Cir. 1940), 1t2 F.2d 150, cert. den. 311 US. 700, . ay ; Ed. 454, 61 S.C. 139 5,6, 7,9 Koehring Company v. United States ae Cir. 1962), 303 F.2d 468 5,7 F. H. McGraw & Co. v. Mileor Steel Co, (2nd Cir. 1945), 149 F.2d 301, cert. den. 326 ToS, 753, 90 L.Ed. 452, 66 S.C, 92 nae 9 Standard Oi] Co. vy. Day (sup Ct. Minn, 19: 24), 201 N.W. ES settiawacaas x 9 _United States v. Beck (eh Cir. 194: >), 151 F.2d O64 5,6 United States v. Johnson, Smathers and Rollins (4th - Cie, 1003), 67 P38: 121.22... 5,6 Utah State Building Commission v, Great “American In- demnity Co. (Sup. Ct. Utah, 1943), 140 P.2d 763 9 TEXT Books: Restatement of the Law, Contracts, Sec, 887, p. 729 4 3 7 v - In The a Supreme ‘Court of the Anited States UNITED STATES OF AMERICA for the use of rs ELECTRIC SUPPLY COMPANY, @ North Dakota cor- poration, : . ; se Petition, ee ee a ae, ST. PAUL FIRE AND MARINE INSURANCE COMPANY, e js ei . Respondent. ww PETITION FOR WRIT OF CERTIORARI TO THE EIGHTH CIRCUIT COURT OF APPEALS - To the Honorable, the Chief Justice and the Associate Jus- tices of the Supreme Court of the United States: ., The petitioner, Dakota Electric Supply Company, prays that a writ of certiorari issue t6 review the judgment of the Eighth Circuit Court of Appeals entgred and rengdgped against the petitioner on the 18th day of October, 1962. The opinion is reported as Case No. 16,914 in 309 F.2d 22. Copy of the opinion is ineluded in the Appendix. . : 4 a JURISDICTION OF THIS COURT The iudgment sought to be,reviewed is “dated October 18, 1962. It was entered on that date. A petition for rehearing was denied by order entered November 19, 1962. The petitioner relies upon the provisions of 28 U.S.C., Sec- tion 1254 and Section 2101 to sustain the jurisdiction of this - Court. 7 << 2 “* Petitioner believes that now is the: appropriate time to petition for a writ because the decision of the Court of Ap- peals is final cone erning the fundamental issues of this ¢ase. "QUESTIONS PRESENTED FOR REVIEW In the absence of fraud or bad faith, can the surety under a “Miller Act;’ payment bond invoke a special rule requiring application of payments to a guaranteed debt, thus defeating *-@ materialman’s claim; and if so, can such special rule be invoked when payments from the subcontractor debtor to the" materialman creditor are applied, to other matured debts ac- cording to the debtor’s direc sen, such payments not being identifiable as having their source in any proceeds of the-gov- ernment construction contract covered by the bond? [ / STATUTES ~The statutory provisions involved are Sections = yeid) 270b of Title 40, U.S.C%A., as set out at page 296 gnd’ pie 345, thereaf. The provisions of Section 270b(b) of Title 40, mf S.C. 7 are set out at page 64 of the 1961 pocket supple- ment of that title. The pertinént text of these sections-is set out as an appendix to this petition. $ A CONCISE STATEMENT OF THE CASE Thé essential facts are not disputed. - On April 6, 1959, the Jo&eph A. Bass Company (herein- after called Bass) contracted with the United States for dormitory construction at the Minot Aird orce Base in North Dakota. The respondent, St. Paul Fire and Marine Insur-_ ance Company, was the surety on the required perment bond. Thereafter, Bass subcontracted with John M.Sc — oder, Ine. (hereinafter called Schroeder), for the electrical i, . ylation at a total price of $39,147.00 (R. p. 63). The subcontract called for a performance bond by Schroeder. This require- e e | _ ee ment was waived by Bass, as the subcontract permitted, and the bond was not furnished (R. p. 69). Schroeder ordered supplies for the Bass job from petitioner, which arrived at the site on various dates between June 17, 1959, and March _ 24, 1960, The price of these supplies was $6,705.98 (R. pp. 7, 102, 103). earns | During 1959, Schroeder was performing other contracts for Federal, State and local governments, either as a prime contractor or asa subcontractor. It ordered materials for these jobs from petitioner and other®(R. p. 103). r Schroeder maintained a ,zeneral control bank account in which it deposited all receipts from these contracts, as well as from bank loans and over-the-counter sales. Out of the general account Schroeder made substantial deposits to a separate. checking account for payroll. All operating ex- penses and payments to its creditors were disbursed .out of the general account (R. p. 108). On various dates between August 21, 1959, and March 18 1960, Bass made monthly progress pay ments to Schroeder totaling $80,9! 53.85 in connection with the Minot Air Force Rase Project (R. p. 104) without specific direction as to ap- plication by Schroeder. Because of other payments by Bass to complete .the project, no amount is presently due from Rass to Schroeder. The Bass progress payments were inter, mingled in Schroeder's general account. From Angust of 1959 through May® of 1960. deposits of more than a million dollars were made in this account (Circuit Court Opinion, p. 3). E On varions other dates from Angust of 19. no up to March 28,1960, Schroeder made periodi¢ pay menta to petitioner totaling in excess of $42,000.00. Schroeder specifically desig- nated that the paynients be anplied against certain,of peti- tioner’s invoices other and older than those for the Naks job. This-was in line with Schroeder's policy, followed nince its or- 9% #> 4 | ganization, of paying a supplier's oldest invoices first ( R. p. 6). Petifioner knew that Schroeder was receiving progress payments from Bass and others, but. did not know when these payments were received (R. p. 51). Petitioner did not have ‘access to the. books and records of Schroeder and did not know the source of the money paid to it by Schroeder (R. p. 51). The Schroeder payments to petitioner cannot be identified or traced as having their source in the Bass pay- ments to Schroeder, since contemporaneously with. Schroe- der’s receipt of Bass payments, Schroeder made withdrawals for payroll and pay rments to other creditors in an amount greatly in excess of the Bass payments (R. p. 105). On March 28, ‘1960, petitioner received $380,000.00 from ’ Schroeder, after .petitioner learned Schroeder was insolvent (R. p. 43). This payment was voluntarily turned over to the trustee in bankruptey (R. p. 43). me Petitioner’s account for materials furnished forethe Tass ‘job was not paid and after giving the requisite notice, suit was filed in Federal District Court pirsuant to the provi- sions of 40 U.S.C. 270b( b). Petitioner secured judgment. - : ‘The Court of Appeals for the Eighth Circuit reversed. . u ARGUMENT ‘The general rules concerning. application of payments to existing debts are set out in Restatement, Contracts, tion 387 (1932), as follows: : 7 “Where more than one matured contractual duty is owed to the same person and these duties are for performances of identical character, such as the payment of money, a payment or other performance capable of discharging in whole or in part either one or another of these duties, is . applied, subject to the rules stated in Sections 388-393. . “(a) As the debtor, at or before the ‘time of payment or performance, manifests to the creditor, an intention to . have it applied; or, , oe f e ““(b) If the debtor makes.no snch manifestation, as’ the creditor within a reasonable time manifests an = tention to have it applied; or, t *“i¢) Ifp neither the debtor nor creditor makes a seasonable manifestation of intention, as q@ just regard © its effect upon the debtor, the creditor, and third per- sons makes it desirable that it should be applied.” These rules have been followed by Federal Courts. Koehring | Company v. U nited States (10th Cir. i963) , 303 F.2d 468. ¢ The Opinion of the Cc mwah of pew has applied a different ani £ aay rule stated s as follows: he debtor is under a duty to a third person to devote funds paid by him to the. discharge of a particular debt, the payment must ‘be applied if the creditor knows or has reason to know of that duty. This is #0 despite the debtor's contrary direction.” (Cireuit. Cour Opinion, p. 6, Appendix p. T4.) The rule was purportedly applied in accordance with the Miller Act cases of United States v. Beck (6th Cir. 1945), |. 151 F.2d 964; R. P. Farnsworth €& Co. v. Electrical Supply Company (Sth Cir. 1940), 112 F.2d 150, cert. denied, 311 U.S. 700, 85 L.Ed. 454, 61 8.C: 139, and United States v, Johnson, Smathers and Rolling (4th Cir. 1933), 67 F.2d 121. Actually, the special rule adopted by the Court of Appeals is contrary to and an unwarranted extension of Re doctrine of the Miller Act cases cited in support of such rule. As we read Beck, Farnsirorth, and Johnson, in order to apply the special rule, the following must he established : (1) The debtor has more than one matured debt owing to the creditor. § (2) The debtor receives money from a third party. (3) The debtor is under a duty to the third party to use the money received to pay a particular debt. (4) The debtor makes a payment to the creditor. at (5). The mopey paid the credit ‘r can be established as hav- ing its sourvesin the third party’s or to the “debtor. "i ° ~ (6) The creditor knows, or should know, the source of the money received fsom the debtor... . (7) The creditor is aware of the duty tlie debtor owes to | *s the third party to pay the: particular debt.) .* When all of the above are established, this special rule re- quires that the- debtor's pay mett’ to the creditor-be applied against the debt which the debtor ‘is under a duty to the third party to pay, regardless of any attempted designation by either the debtor or creditor. ' No case applies the special rule unless the third party's ‘funds are used in Payment of the debt between creditor and debtor. The Court of Appeals acknowledges that in Farns- worth, Beck and Johnson, “* * * the flow of finds from the general contractor threugh the subeontractor to the st plier was more readily identifiable than is the situation here.” (Cirenit. Court Opinion, page 18, Appendix paze 24.) The ~ stipulated facts and undisputed findings submitted to the Court of Appeals were that the subcontractor debtor was engaged in work and received progress payments from a num- ber of bonded governmental construction jobs, both State and Federal, that all receipts were deposited in a general acconnt and disbursements made therefrom. With relation to the payments made from the general contractor Bass to the subcontractor Schroeder, the following was the uncon-, tradicted finding: ia “That the receipt ‘and disbursement record of John M. Schroeder, Inc., indicates that its receipts of payments from Joseph A. Bass Company on account of the Bass contract were deposited in its general bank’account and funds were used for the payment of general expenses of operation -of John M. Schroeder, Inc., including pay- 7 rolls, payments of accounts, ete., and that said proceeds are not traceable to the payments received by the Use Plaintiff front the subcontractor; * * *.” (R. p. 105.) Thus, it is not possible that the above language, of the Court of Appeals can be construed as a determination that the Schroeder payments to petitioner could be‘identified as hav-— ing their source in the Bass payments .to Se ‘hroeder. The opinion must stand for the proposition that establishing the source of pay ments is not an essential prerequisite to apply- ' ing the special rule. a ; In the AKoehring case, which was also a suit under the ‘Miller Act, the 10th Circuit refused to apply the special rule of application of payments because it was not established that the creditpr was aware of the duty owed by the debtor to the third nc to apply the payment ipainst a specific debt. We see no basis for reconciling the Koeehring case with the Court of Appeals’ Opinion. Failure to establish the source of the money paid to the creditor seems equally as erncial as failure to establish that % § creditor was aware of the debtor’ s duty to the third party. In the non-Miller Act case of Columbia Digger Co, ». Sparks (9th Cir. 1915), 227 Fed. 780, the source of the pay- ments was established. The majority opinion apparently did not require that the creditor have notice as to the source, as a prerequisite to invoking the special rule concerning ap- plication of payments. To this extent the Opinion seems in 3 conflict with Farnsirorth, and was criticizel therein as ap- - parently going too far. In the present case, not only does the Court of Appeals waive the requirement that the source of the Schroeder payments to petitioner be established, -but also charges the petitfoner with knowledge that these payments had their.sonrce in the Bass payments to Schroeder. The com- ment of the dissenting jndge in Sparks, as follows, seems . “y 8 even more appropriate when applied to the Opinion of the Court of Appeals: | ; “The decision of the majority exhibits a tender regard for the rights of sureties, but a woeful disregard for the obligation of private contracts.” 227 Fed. 780 at 76. Petitioner does not construe‘the Opinion of the Court of Appeals as including a finding that during the period from June of 1959 through March of 1960, petitioner controlled Schroeder so that Bass payments to Schroeder coutd be treated as payments to petitioner. The Opinion does not say this. The trial court rejected respondent’s proposed find- ings concerning control (R. p. 110). There is substantial evidence in the record indicating that petitioner did not control Schroeder (R. pp. 36, 38, 59,51, 54,60). Admittedly there was a close relationship between Schroeder and _peti- tioner.. The Court of Appeals considered the facts of this relationship and petitioner’s knowledge of Schroeder's op- eration as a bar to petitioner's rights under the Miller Agt (Cirenit Court Opinion, pages 8-11, 16, 17, Appendix pages 16-19, 22-24). The Distriet Court deemed these facts un- necessary to its decision (Cirenit Court Opinion, page 8, Ap- pendix page 16; R. Pp. 108-111). One of petitioner's officers stated that he knew that Schroeder was probably receiv: _ ing progress payments from Bass during the period in ; question (R. p. 51). Advance payments and progress pay- ments area normal method of financing construction projects, both public and private. All materialmen know or should know that these payments are made. The close relationship between petitioner and Schroeder provided information which petitioner was alresdy aware of as a material ne a in the construction industry. We do not believe that this knowl- edge can be used as a substitute for estahlislfing that Bass money was used by Schroeder th pav petitioner. Tf it can, the result will be a substantial impact on the protection Con- Pa ‘ > w 9. gress provided subcontractors, laborers and materialmen in government construction, an area of ever-increasing import- ance to the nation’s economy. There are a substantial nimber of cases which reject the special rule of application used in Farnsiwerth and compan- ion Federal cases. ‘These include F.. 11. MeGraw & Co. v. Milcor Steel Co, (2nd Cir, 1915), 149 F.2d 301 (applying New York law), cert. denied, 326 U.S. 753. 90 L.Ed. 452, 66 S.C,.92; Utah State Building Commission vr. Great Ameri- can Indemnity Co, (Sup. Ct. Utah, 1943), 140 P.2d 763; and Ntandard Oil Co. vr. Day (Sup.-Ct.. Minn. 1924), 201 NW. 410. These cases take the position that money paid to a con- tractor (or ao subeontrattor is received without “attaching equities” in favor of a surety. In the Great American In- demnity Co, case, the Utah Supreme Court stated that the role requiring application of payments to the debt for which the surety was liable had its origin in the days when sureties were gratuitous and were given) special consideriitjon hv courts of equity. Concerning modern day sureties, the Court sid as follows: . | ’ e “Sureties in modern business are quite able to take care of themselves, They select their own risks and can, by contract, maintain surveillance over the disposition of the funds received on the contract upon which they are surety. The misapplication of funds is one of the haz- ards of suretyship.” 140 P.2d 763 at 770 Petitioner submits that the special rule concerning appli- cation of payments to existing debts as ennneiated in the cited Federal cases is not in accord with the modern day realities of the construction industry, well illustrated by the textiniony of the.president of Schroeder that contractors must necessarily use spec ifie contract monies for payment of other obligations such as other payrolls and stock items (R. pp. 62-63). By allowing sureties to avoid their contractual ob- 10 ligations under the guise of “attaching equities” the very purpose of the Miller Act is defeated, in that unpaid sup- pliers remain unpaid. In the absence of fraud or bad faith, we see no reason why sureties should be afforded this special protection. We note that the Court of Appedls did not ques- tion or impugn the honesty of petitioner or its representa- tives (Circuit Court Opinion, pp. 17, 18, Appendix pp. 24-25) .. We realize that writs are sparingly granted. Nevertheless, we believe that the following factors weigh heavily in favor of granting a writ in this case: (1) The conflict hetween the Opinion of the Court of Ap- peals and the Opinions of the 4th, 5th, 6th and 10th Circuits concerning application of an important rule of law to an important Federal statute. (2) The impact that the Opinion of fhe Court of Appeals will have on, the protection provided subcontractors, laborers and materialmen under the Miller Act. (3) The continuing uncertainty as to the validity of the special rule of application of payments to guaranteed debts as reflected in both the Federal and State cases * of the past fiftv or more vears. ’ WHEREFORE, it is respectfully submitted that petitioner's prayer for a writ of certiorari to review the judgment of the Eighth Cirenit Court of Appeals should he granted. Dated this 18th dav of Jannarv, 1963. a Respieetfully submitted, Prmir B. Voer. °c «@ Fargo, North Dakota ° < (Counsel of Record) Myron H. Bricut Fargo, North Dakota Attorneys for Petitioner 6 11 ’ APPENDIX: 4 . —_—_ (Opinion) — UNITED STATES‘COURT OF APPEALS For THE CicuTn Crmcvir -_—__—— 4 \ No. 16,914 St. Paul Fire and Marine Insurance Company, . >} Appellant, VS. United States of America for the Use of Dakéta Electric Supply Company, a North Dakota Corporation, Appellee. Appeal from the United States District Court for the District of North Dakota. é f- [October 18, 1962] . sefore VAN OosTPRINT and BLACKMUN, Cirenit Judges, and HENLEY, District Jndge. 7 —- BLACKMUN, Cirenit Judge. This Miller, Ast case arises ont of dormitory construction at the United States Air Force base at Minot, North Dakota. Tried to the court, it resulted in a jndgment for the plaintiff supplier and against ghe defendant stirety. The latter has appealed. 7 : The general contractor was Joseph A. Bass Company. Its electrical subcontrator (hereinafter called “Schroeder” ) was dohn M. Schroeder, Inc. The supplier, or use piaintiff, is Dakota Electric Supply Company. The defendant St. Paul Fire and Marine Insurance Company is the surety on the & a) ‘12! payment bond required .of Bass by §Tia) (2) of the Act, 40) S.C. §270aia)y (2). The basic facts are not in dispute and, indeed, the parties have stipulated here that, with stated exceptions, the find: ings made by the trial court are acceptable as facts relevant to the issues of this appeal : ; (a) The prime contract was executed by the United States and Bass on April 621959. Bass and Schroeder then entered into the subcontract for the electrical installation. The sub- contract cailed for a performance bond by Schroeder; this requirement, however, was waived by Bass, as the subcontract permitted, au@ the bond was not furnished. ib) The electrical equipment ordered by Schroeder from Dakota for the Bass job arrived at the site on various dates between June 17, 1959, and March 24, 1960. Tt commanded a total agreed price of 86,705.98. te) During 1959 Schroeder was also engaged in electrical work on several other government and public contracts and on ventures of a private nature. It ordered materials for those projects from Dakota and other suppliers. Schroeder maintained at the First National Bank of Grand Forks a single general control bank account in which it deposited all payments received by it in the operation of its entire busi. ness. From this general account it disbursed operating ex penses, payments fo creditors, and transfers to another ac eount it maintained fer payroll, Although Schroeder kept 4 separate record for each of the several projects on which it was engaged and for its general inventory items, it did uot maintain a separate bank account for each project (d) Qn various dates from August, 1959, to March, 1960, Bass made progress payments to Schroeder for labor and materials furnished to its job. These totaled more than £20,000, Schroeder deposited these payments in its general bank account. Later Bass made some direct payments for shor and materials in order te complete Schroeder's portion of the job. (e) During the same period receipts of more than a million dollars were deposited in the Schroeder bank account. The Bass payments were thus about 3% of thestotal deposits. if) During the same period Schroeder made payments to 2 1S Dakota aggregating ln excess of $72,000. These were spe- cifically designated by Schroeder for Dakota invoices other and ofder than those for the Bass contract. This was in line with Schroeder's polic\, followed since its organization, of paving a supplier's oldest invoices first. Because of interven: ing withdrawals for operating expenses, repayment of bank loans, and the like, the Bass payments deposited in Schroe- der’s general account cannot be traced through that account to specific payments made from it by Schroeder to Dakota. ig) Bass did not know that its progress paivments were net being applied te Daketa’s inveices for the Bass joh. AL thoneh its checks for these payments carried referefices to The deb. Rass designated no specific application of the prog: ress puviments : . thea hy the end of Pebruary, 1960, Schroeder was, insol- vent. A trustee in bankruptey was subsequently appointed for it. Dakota turned over to this trustee S20.000 (ineluded in the STZ.000 figure mentioned above) which it had obtained from Sehroeder in March after Dakota had learned of Schroe- ders inselveney (it After complying with the notice provisions of the Act, Dakete brought this suit in Nevember, 1960. Dakota asserts that these facts add up to the classic sit. nation which, when present in a Miller Act controversy, pre- sents a case for recovery against the surety: Dakota supplied materials to a subcontractor engaged in the performance of a government contract; it did not receive payment for those materials; and it complied’ with the notice provisions of the Act: , This prompts us to make at this point some general obser- vations before setting forth additional facts which the surety claims are significant: 1. Comments which appear in the authorities te the effect that a surety is a favorite of the law and ‘that his contract is to he strietly construed (see, for example, Stete rv. Padgett, 1926, 54 ND) 211, 200 NOW. 38s, 392) have never heen held het to apply te compensated surety companies, American Cas. Cn. vr. Bresina Constr. Co. 8 Cir... 1961, 205 F.2d 6028, 607, footnote 6; Massachusetts Bonding & lus. Co. rv. Feuts, & Cir, 1950, 182 F.2d 752. TH6; T2 CUES.. Principal and Surety, £102: 50 Am. Jur, Suretyship, $8382, 248. [ed 14 ° Sf 2. Although there is diversity of citizenship between Da- kota and the surety here, this is not a diversity case. The amount in controversy is Jess than the statutory minimum prescribed by 28 U.S.C. §13321a). The action, instead, is instituted under §2(b) of the Miller Act, 40 U.S.C. §270b ib), which authorizes suit in federal court irrespective of the amount in controversy, and it is based on, the payment bond required by $1(a)(2) of that Act. The xituation there. fore is not one where state law necessarily governs.! BF. Farnsugiyth & Co. vr. Electrical Supply Co.. 5 Cir., 1940, 112 F.2d 158, 154, cert. den. 311 U.S. 700. Compare United States er rei erroll r. Beck, 6 Cir, 1945, 151 F.2d 964, 966, and First Camden Nat'l. Bank & Trust Co. vr. Aetna Cas & Nur. Co., 3 Cir., 1942, 132. F.2d 114, 116, cert den. 319 U.S. 749. 3. The Miller Act has for its purpose the protectign of those who supply labor or materiais for: use in goversiipnt construction. It is to be liberally construed. It is designed to give the supplier the same protection he weuld ordinarily receive under state: lien laws., The bond protection it pre- scribes is in lien of those liens. [onited States ex rel Sher- man v. Carter, 1957, 343 U.S. 210, 216-7: Continental Cas. Co. vr. United States ex rel Robertaon Lumber Co.. & Cir., » 1962, 305 F.2d 794, 797 (petition for certiorari pending | ¢ Tnited States ex rel Hopper Bros, Quarries vr, Peerless Cas. fo, & Cir, 198, 255 F.2d 137, 14.8, cert. den. 358 UUS. S31. It has even been said that the Act was not designed to pro- tect general contractors.: St. Pael-Mercury Indem. Co. rv. I nited States ex rel Jones, 10 Cir., 1956, 288 F.2d 917, 921. 4. Where, as here, there are outstanding two or more matured and similar obligations of a debtor to one creditor and a payme at by that debtor to the creditor, the question of proper application of that payment arises. This fact situa: tion and its variations have provoked widespread litigation and have resulted in claimed conflict in the cases. It is per ° !Nevertheless. we note, for what it may be worth, that §22-05-06 of the North Dakota Century Code provides as follows “A surety is exonerated: ° ° ° “3. To the extent to which he is prejudiced by anv act of the creditor which would naturally prove injurious to the remedies of the surety or inconsistent with his rights, or which lessens his security. * © °" @ 15 haps not incyrrect to say, however, that the law today shapes up generally as follows: e (i) The payment is applied as the debtor intends and se manifests to the creditor before or at the time of the payment. (ii) If the debtor fails se to indicate, the payment is applied as the creditor, within a reasonable time. de-_ f, \iii) If neither the debtor nor the creditor season- _ ably so indicates, the payment is applied as a just regard to its effect upon the debtor, the creditor, and third .per- sons Inakes it desirable that it should be applied. This usually tesults in its apylication to the oldest unsecured account, : : - é (iv) If the debtor is ‘under a duty to a third person to devote funds paid by him to.the discharge of a pur: ticular debt, the payment must be so applied if the credi- tor knows or has reason to know of that duty. This is xo despite the debtor's contrary direction, This “rule of freedom of application rests upon the concept that the money which the debtor is utilizing to make the pay- ment is his own and is free for use as he pleases. The noted exception, phrased in terms of duty, rests on’ equitable con- siderations. Examples which the cases recognize without much conflict are where the surety itself makes a payment to the debtor or where money which comes to the creditor from the debtor is the same money for the payment of which the surety is hound and the creditor knows the source of that fund ‘ These rules? are outlined in detail, and with Mustrations, in the Restatement of the Law of Contracts, §$387, 38% and 34, and dre noted in such general compendia as 70 C..8., Payment, §§50- 80; 72. CUIS., Principal and: Surety, $144; and 40 Am. Jur., Payment? $§108.150, and dn the notes at 21 ALR. 704 and 57 A.L.R.2d 855, and at 41 A.L.R. 1297, 130 A.L.R. 198 and 166 A.L.R. 641. Representative cases are cited in these works. We mention.the following only as illus- trative: Herrman rv. Daffin, Mo. App., 1957, 802 S8.W.2d 313, 2We note also, again for what it is worth, that these rules have’ heen largely adopted by statute m North Dakota) North Dakota Century Code, §9-12-07. “16 315-6; Mar yland Cas, Co. v. City of South Norfolk, 4 Cir., 1932, 54 F.2d 1032, 1038, cert. den. 286 U.S. 562; Firat Nat'l Bank of Mandan v. Larsson, 1937, “67 N.D. 243, 271 N.W. 289, 291; Depositors’ Holding Co. v. Brown, 1933, 64 N.D. 222, 251 N.W. 295, 298; United States er rel General Electric Distrib, Corp. v, Bell Constr. Co., 7 Cir., 1955, 226 F.2d 99. Much of the conflict in the cases revolves about the stated’ . exception and in the determination whether under the facts there is a duty toApply a payment in a particular way. Com- pare, for example, the opposite approaches, taken with re-° spect to the significance of knowledge on.the part of the credi- tor of the source of payment ei of an existing surety rela- tanetin, in Standard Oil Co, vr. Day, 1924, 161 Minn. 281, 5-7, 201 N.W. 410, 412, 4d A. LR. 1291, and in Ash Grore kane, €& Portland Cement Co. vr. Méran Conatr. Co., 1941, 139 Neb. 176, 296 N.W. 761, 762-3. : Dakota takes the position that these rules, as applied to - the undisputed facts outlined above, compel a judgment in its favor. It entphasizes that Schroeder, as it made its pav- ments to Dakota, specifically earmarked those payments for application to older ohiigations owing bv it to Dakota and not to invoices issned with respect to the Rass contract, and that Dakota seasonably so applied those payments. It ures, too, that, althongh Dakota mav have known of the payments bv Bass to Schroeder, it did not know when those payments were made and, in anv event, the funds which Dakota received were not funds which had originated with Bass. The surety's response is that Senroeder was under a.duty to Bass and to it to devote the Rass payments to the discharge of the obliga. tion for which the payment bond was given, that Dakota knew or ‘had reason to know of that duty, and that Schroe- der’s designation of the older obligations owing to Dakota was of no effect. It is at this point where additional fac ts in the record, also largelv undisputed, assume importance, These have to do with knowledge and:claimed control of Schroeder by Dakota throughout the period of the Bass payments. The trial cort deemed it unnecessary té®make specific findings with respect to them. Those facts are the following: (j) Dakota was organized i in 1954. It pirrchased its inven- torv and business from Red River Industries, Ine. which - > e 17 theretofore had also been known as Dakota Electrie Supply Company. In that transaction Red River received $225,000 redeemable non-voting stock of Dakota and loaned $100,000 to Dagota on an open note: A part of this loan was still out standings in June, 1959. (k) Joseph D. Farnham was president of Red River and owned about 605 of its shares. (1) By June, 1959, Schroeder owed Dakota over $120,000. ~(m) John M, Schroeder was Shroeder’s president, He owned its outstanding 540 shares, Of those shares 520 were pledged to Red. River to secure Schroeder's note, Mr, Schroe- der was also personally indebted to Red Riyer. Farnham had known Mr, Se hrodder since 1951. (n) In May, 1959, Harold H, Berg, Dakota's credit man- ager, vice-president and treasifrer, and Fred R. Orth, presi- dent ef the First National Bank of Grand Forks, requested il niveting., This was held at Dakota's Fargo office on June 2 I 1959. It was attended by Mr. Schroeder, Berg, Orth, Farn- ham, and Richard H. Barry, Dakota’s chairman and presi- dent. Barry presided, The purpose of the meéting, as Berg testified, “was to make a determination as te how much ma- terials might-be ordered” by Schroeder, “where the account would possibly peak, and where it could be reduced to,* * * we werestrying to determine *.* * could we handle it, and alse toind out what Mr. Schroeder's plans were as to how much further hegvas going to go * * *. Ong could probably say that one of the purposes of the meeting was upgrading the organization, but there was no thoughts as to changing the management * * *, We felt that we should be kept close- iy informed of the over-all operatian” of Schroeder. - It ap- porrcd at the meeting that Dakota avas the source of-sapplt of 10 te 50% of Schroeder's. materials and that. what Dakota did “probably would influenve other sources of supply.” It ‘was decided that a trust of the controlling interest in Schroe- der should be established: A voting trust agreement was pre- pared and execnted as of June 24, pFarnham was named sole voting trustee, The frost res congisted of Mr. Schroeder's N20 pledged shares, Red River, as pledgee, was a party to the agreement. By it Farnham received the power to vote the trusteed shares and thus came into control of Schroeder, Af ter discussion as to whether Orth or someone from Dakéta «* P d _ 18 . k ee should go on Schroeder’s new board, Farnham elected him- © self, Mr. Schroeder (as the agreement specified), and, at the suggestion of Dakota’s Berg, Maynard Helmeke, who was Dakota's auditor and who had also done auditing work for Schroeder. After the estabishment of the voting trust Da- kota extended additional credit to Schroeder. {o) Farnham thereupon performed certain general man- agement activities for Schroeder. He analyzed the company’s statements and operations, went over accounts payable and receivable, made recommendations to management, discussed payrolls, reviewed pending jobs, correspondence and ac- counts, recommended bidding limitations, and was influen- tial in management policies and procedures including the formation of an executive committee. (p) Schroeder's office was at Grand Forks. From June, 1959, when the voting trust was established, until April, 1960, some of the meetings of Schroeder's board, however, were held in Fargo at Barry's office. Rarry and Berg were _ present at a number of the board meetings. There is evidence that at these meetings Barry participated in discussions of shipments by Dakota and that company’s anticipated collec- tions from Schroeder and of other matters, including the possibility of developing “an ownership situation” so that two of Schroeder's personnel could become shareholders with Mr. Schroeder. Berg also conferred about Schroeder's book- keeping procedures and examined that company’s statements and progress reports. Schroeder’s $30,000 payment of March, 1960, to Dakota was made at the suggestion and instance of Rarry and Helmeke. ¥ fq) There was an evident desire on the part of Dakota to he kept closely informed about Schroeder's operations, After June, 1959, it was furnished with copies of Schroeder's state- ments, schedules of payables and receivables, and some re- ports and correspondence, There were meetings of Schroe- der people with Dakota representatives, These concerned Schroeder’s business operations and the status of Schroe- der’s jobs, Berg frequently stomped at the Schroeder office to see if there were funds available to ‘make a payment to Dakota. He was aware that Schroeder was making its pay- ments on old invoices and net on jobs currently in process. 19 « The payment of bills was discussed at the directors’ meetings attended by Barry and Berg. . (r) «Between the end of July, 1959, and the end‘ of Jan- - uarvy, 1960, Schroeder's indebtedness to Dakota ine reased from $140,000 to $228,000. (s) Farnham retired as a direc ‘tor of Schroeder in April, 1960, * Dakota asserts that these additional facts disclose only the doings:of a vigilant creditor ae ting honestly. The surety . Claims that these facts establisit a complete defense to Dako: ta’s present action; it cites four cases from four separate cirenits as its primary authority 1 es this position: 1. The first exe is the Miller Act case of R. P. Farne- worth & Co, v, Elektrical Supply Co., supra, 5 Cir., 1940, 12 P.2d 150, cert. dan’ 811 U.S. 700, 130 .A.L.R. 192. There the subcontractor had dealt with the suppliar, Electrical, for vedrs and owed it about $20,000, The subcontractor was fi- nane ially shaky and later became’ insolvent. Theajury could have found on the evidence that the supplier insisted on hav- ing everything the subcontractor received, net, from the, gen- eral; that the supplier received permission to inspect the subcentractor’s books and. did inspect them; and that the supplier was aware that the funds, received by it came from the job even thongh paid by personal check of the subcontrac- tor's officer. The Fifth Circuit held that the direction of a verdict against the prime contrac tor was error, It said, p. 158 of 112 F.2d: © f : “We think the question of application of payments was “ wrongly decided. * * * There is no trust attaching to the monthly payments made to the contractor which pre- vents his using them generally as his own; but when he pays them over to a furnisher of materials for the job who knows their source, there is a duty to apply the ‘money to the payment of thone niaterials rather than to some other debt.” " . The surety stresses that here, as in Farnaivorth, the sub- contractor Schroeder had dealt with Dakota for many years; that it was substantially indebted to Dakota; that Dakota checked on Schroeder and inspected its books; that. Schroe- der was financially shaky and became insolvent; ‘and that ~~ ° 20 the funds received by Schroeder came from sources which Dakota knew included the progress payments made by Bass. Dakota would explain Farnsicorth on the ground that the eqsiitable doctrine it expresses requires that the surety have a special interest in the identica] fund used for the payment to the supplier. It asserts that in Fa¥hsivorth the very funds paid by the prime contractor to the subcontractor came over to the supplier and that the supplier knew of this despite the payment’s being effected by personal check. It claims that, in contrast, the facts here show that after each payment by Bass to Schroeder there were payments out from Schroe- der’s account to payees other than es in amounts exceed- ing the Bass payments. " 2. The second is the Miller Act case of United States ex rel Carroll v; Beck, supra, 6 Cir., 1945, 151 F.2d 964, 166 A.L.R. 637. There the supplier also loaned the subcontrac- tor money for the latter’s payrolls on the job and checks is- sned by the prime contractor to the subcontractor were in- dorsed by the latter and delivered to and cashed by the sup- plier under an agreement that tliev would be credited on the loan aecount. The Sixth Circuit affirmed a judgment for the prime, contractor and its surety. It recognized the general mile that,a debtor may usually apply the payments he re- ceives as he sees fit and made reference to the Restatement expressions. It cited Farnsirorth sad apie it, saving, p. 9660f 151 F.2d: | c “The federal cases * * * generally deny the debtor's power to control application, ins@far as the interests of others are affected, when the creditor knows where the money comes from. This is sometimes grounded upon abstract considerations of equity and justice, and some- times upon an implied contractual obligation to the surety and his principal, in cases bearing similarity to this.” The surety here stresses that in Beck it was urged that the supplier, to be defeated in‘ his suit, “must have known the source of the money” but that the court ma‘e it clear that direct knowledge of this was not a prerequisit + for the sure- tv’s defense and that it was sufficient if the creditor had rea- son to know of the source of the funds? Dakota explains Beck, as it did Farnairorth, by pointing to the identity of the af ta 9 . el funds flowing fgim the prime contractor to the sub and-on to the supplier, 3. The re is the Miller Act case of United States er rel Crane Co, Johsuson, Smathers & Rollins, 4 © ir., Af 33, 6 F.2d 120. There the supplier sued for a balance claimed to ad due for materials furnished to,a post office project. The sub- contractor received $4,000 from the general contractor and turned it over to the supplier. The latter applied it on an old schoolhouse account. Under instructions that if the jury found that the supplier knew that the funds came from the veneral contractor in respect te the post ofiice job, the appli- cation to the schoolhouse acconnt was wrongful, a verdict acainst the supplier on this $4,000 issne was rendered. The vPourth Cirenit affirmed. After recognizing the general rule of free application and its lack of absolnteness where equi- table considerations appear, the court said, pp. 123-4 of 67 F.2d: x = “Such an equity exists under the admitted facts of this case, in accordance with the rule announced by decisions in this and other federal cirenits, We are in-accord with these decisions in so far as they hold that when a surety © is hound on one of several debts of the principal debtor “ti a creditor, and a payment ismade by the debtor to the creditor with the identical anoney for the payment of which the surety is bound, er with the proceeds or fruits of the very corftract, business, or transaction covered by the obligation of the surety, the application ef the pay- ment to some other debt, with or without the direction or consent of the debtor, does not bind the surety; at least if the source of tle funds is known to the creditor or person rereiving the payment. The surety in such- case is entitled to have the payment applied to the debt for which he is hound. * * *, P . : “There are decisions. to the 7 fillig lal a © wThich distingpish between cases where the money ues the identical money for the. payment of which the surety is bound, and cases where the payment is made merely ° from the proceeus of the contract, business, or trausae- tion covered by the obligations of the surety. * * * These.considerations are net without weight, but, invour view, it places no birden or hardship upon @ creditor who kas knowledge of the source of the money to require him to apply the payment to the guaranteed debt * * *.” The surety here strésses the Johnson case's reference, not only to “identical money”, but, as well, to the “fruits of the very contract, business or transaction.” Dakota emphasizes. that here again was money identifiably received by the sub- contractor from the general? , 4. The ee is the non-Miller Ace ase of Columble Dig- ger Coz v. Sparks,3 Cir., 1915, 227 F. 780. Here the supplier sued the surety on the céntractor’s bond for materials it had supplied to a'city job. City funds for, this job which came to the supplier were applied on the contractor's. preexisting un- ~ secured account with the supplier. The Ninth Circuit decid- ed the case in favor of the surety and approved the following statement of the law: ’ “Where a surety has become responsible for the pay- ment of money by the principal, and the Tatter receives money under his contract, which he pays over, the credi- tor or obligee has no right to apply such payments in any. other way than to the relief of the surety. One Judge dissented with the observation that the supplier was without notice of the source from Which the money came. This, Dakota claims, is g another case of identifiable funds. Compare our own cise of Cor rv. New England Equit- able Ins. Co., 8 Cir., 1917, 247 FP. 955. In summary, then, Dakota takes the position that these four Cases represent an exc eption to the general rule of free application ‘by the debtor, that the exception does not apply anyway unless the money paid by the subcontractor was the identical or identifiable fund received by it from the general contractor and arose out of the contract with respect to which the surety was bound; and that, because the money réceived by Se -hroeder from Bass was not traceable to the payments Schroeder made to Dakota, the four cases are nof in point ‘and actually support the judgment for Dakota. We recognize the existence of certain features which weigh against the surety’s position here; (a) Bass itself did not specifically direct the application of its progress payments to those Dakota invoices covering the materials supplied to the Bass job; (b) Bass could have obtained a measure of 23 protection for itself and its surety by enforcing the provision in the>subcontract calling for a performance bond from Schroeder; (¢) Dakota did not know exactly when the Bass ‘payments were received by Schroeder; and (d) the four tases primarily relied upon by the surety all present a degree of fund tracing. Nevertheless, we are impressed by what we feel is the over- riding equity of the situation before us in favor of the surety and we conclude that this brings this litigation within the orbit of the Miller Act cases of Farnsworth, Beck and Johun- son. We have in mind particularly the following: : 1. Dakota, Schroeder, Mr. Schroeder, Farnham, and Red . River were, in a very real sense, interrelated during the period from June 1959 to!March 1960 when the supplies in question were furnished and when Schroeder reached a state, of insolvency, Dakota, Schroeder, and Mr. Schroeder were all indebted to Red Rivers Red River was a shareholder, al- though a non-voting one,-of Dakota.’ Red River was con- trolled by Farnham. Mr. Schroeder was also indebted to Parnham, Schroeder was deeply obligated to Dakota. By the voting trust agreement, Farnham, as sole voting trustee, came into contral of Schroeder to a degree not theretofore ex- istent under the pledge of Mr. Schroeder's shares of Sehroe- der to Red River. 2. Dakota, through its. officers, Barry sand Berg, and through Helmeke, iis auditor, during this period came into close familiarity with the affairs of Schroeder. They knew its financial situation. They knew the precariouxsness of that situation and its cohsistent worsening as the’months passed. They knew or had access to knowledge that progress pay- ments were being made to Schroeder by Bass on the dormi- téry job. They knew, inferentially at least, because of Da- kota’s experience with government projects, of the existence of a snrety obligation on the Base contract.’ 3. Tt was distinctly to Dakota’s advantage to hav@every available dollar coming from Schroeder applied to its oldest - obligation to Dakota. : Under these circumstances we believe that lakota, if it _ did not have actual knowledge, at least Pad reason to helieve, taking the realities of the situation seriously into considera- eae 3] 24 tion, that, despite the activity in the Schroeder bank account and, through the accidents of chronology, the consequent in- ability to trace a particular dollar from Bass through Schroe- der to Dakota, the receipt of funds hy Dakota was made pos- sible to the proportionate extent by the progress payments by Bass. This, we think, is enough to bring this case within the equitable doctrine expressed in Farnsirorth and its cém- panion cases. We are not content to dismiss or wave aside these interre- lationships with the conclusion that Dakota's actions were no more than those of a vigilant. major creditor performing honestly and ‘participating only in informational meetings’ We do not question or impugn the honesty of Dakota or that of any of the named individuals in any way whatsoever. What Dakota and its officers jd constituted steps undoubt- edly justified by past relations with Schroeder, by the s. '- contractor’s financial involvement and. by the extent of Schroeder’s obligations to Dakota. But it does not follow from this that the steps taken by Dakota did not then result -in a saving equity for this surety. We merely conclude that the closeness of the relationship of the named parties during ‘the vital nine month period was such as to create an equity of the kind.described in the general rules outlined above, and that that equity required the application of so much of the Bass progress payments received by Schroeder as was re- quired for the niaterials supplied I® Dakota to the Bass job. We may state the matter another way by saving that we do not see how we ¢ avoid the holdings and the implica- tions of the Miller Act Pases of Farnsworth, Beck, and John- son. It is to be admitted, as we have noted, that in these cases the flow of funds from the general contractor throngh the subcontractor to the supplier was more readily id@& tifi- able than is the situation here. But the decisions in those eases, and their significance for Miller Act purposes, are broader than the ability to identify funds as they pass from the prime to the sub to the supplier. The Fourth Cireuit in Johnson speaks with particularity of “The proceeds or fri Mager of the very contract, business, or transaction covered by the obligation of the surety” and does not restrict its observa- tions to “identical money.” That case broadly applies the necessary facto? of creditor’s knowledge of the source of 25 funds to situations where the creditor onght to have known that source. And Farnsirorth is impressive because of its re- liance upon the factor of inspection of the subcontractor’s books; that case seems to us to present a far less significant fact situation than does the present case where Dakota's in- volvement with the affairs of Schroeder is more evident and striking. In no Miller Act case of which we are aware have Farnsworth; Beck, and Johnson been disavowed. As we have said above, we conclude that we. cannot avoid their impact here. | Finally, we are not convinced by Dakota’s argument that because the contract price for the Schroeder portion of the Bass job was Jess than its final cost to Schroeder and because the difference between that cost and that price was greater than the price of the materials supplied to the job by Dakota and for which this action is brought, the surety sustained no detriment. The answer to this argument lies in the fact that the amounts paid by Schroeder to Dakota during the period the Bass payments were being made far exceeded the cost of the supplies for the Bass job. The surety thus has sustained. detriment in their non-application to the obligation for;which it was bound. The case is reversed and remanded for the entry of appro- priate additional findings and for further proceedings con- sistent with this opinion. Judgment - Unrrep States Court or APPEALS For The Eighth Circuit No. 16,914. September Term, 1962 ~& St. Paul Fire and Marine Insurance Company, Appellant, , v8. United States of America for the use of Dakota Electric Supply Company, 4 North Dakota corporation. APPEAL from the United States District Court for the. District of North Dakota. THis CAUSE. came on to be he@rd on the record from the United States District Court for the a District of North Dakota, and was argued by counsel. On CONSIDERATION WHEREOF, it is now here ordered and adjudged by this Court, that the judgment of the said Dis- trict Court, in this cause, be, and the same is hereby, reversed with costs; and ‘that St. Paul Fire and Marine Insurance Company have and recover against United States of America for the use of Dakota Electric Supply Company, a North Da- kota Corporation, the sum of Four Hundred Forty-three and 15/100 ($443.15) Dollars for its costs in this behalf expend- ed, and have execution therefor. And it is further Ordered by this Cuart that this cause nn and the same is hereby, remanded for the entry of appropri- ate additioval findings and for further proc ‘ceedings consis. tent witli the opinion of this Court this day filed herein, October TS, 162. Approved for the Court: /s/ Rosert C. TUCKER ® Clerk, United States Court of Appeals for the Eighth Circuit. Statutes Tit. 40, $270) Purtic Bur_pines, Prorvertry & Works “§270a. Bonds of contractors for public buildings or works; waiver of bonds covering contract paaeee med in foreign country. ” te (a) Before any contract, exceeding $2,000 in amount, for the construction, alteration, or repair of any public building or public work of the United States is awarded to any per- son, such person shall furnish to the United States the fol- lowing bonds, which shall become binding upon the award of the contract to such person, who is hereinafter designated as “contractor” : : +. . Ss * 2) A payment bond with a surety or sureties satisfac- tory to such officer for the protection of all persons supplying labor and material -in the prosecution of the work provided for in said ceatract for the use of each syeh person, * * * SUT0b. Sania rights of persons furnishing labor or material, (a) Every person who has furnished laborsor material in the prosecution of the work provided for in such contract, in respect of which a payment bond is furnisved under section 2T0a of this title and who has not been paid in full therefor hefore the expiration of a period of ninety days after the day on which the last of the labor was done or performed by him or material was furnished or supplied by him for whie h such claim is made, shall have the right to sne on such payment bond for the amount, or the balance thereof, unpaid at the tine of institution of such snit and to prosecute said action to figeal execution and judgment for the sum or sums justiy due him: Provided, howerer, That any person having direct contractual relationship with a sufeontractor but ne con- tractual relationship express or implied with the contractor furnishing said payment bond shall have a right of action npon the said payment bond opon giving written notice to said contractor within ninety days from the date on which such person did or performed tie last of the labor or fur- nished or supplied the last of dhe material for which sneh claim is made, stating with substantial accuracy the ameunt claimed and the name of the party te whom the material was furnished or supplied or for whom the labor was done or per: 28 ‘ formed, Such netice shall be served by mailing the same by registered mail, postage prepaid, in an envelope addressed to the contractor at any place he maintains an office or conducts his business, or his residence, or in any manner in which the United States marshal of the district in which the public im- provement is sitaated is a@thorized by law to urve SHMmMmOns, (b) Every suit instituted under this sec tion shall he brought in the ef the United States for the use of the person suing, Pa States District Court for any district in which fie contract was to be performed and exe- cuted and not elsewhere, irrespective of the amount in. con- troversy in such suit, but no such suit shall be commenced after the expiration of one vear after the day on which the last of the labor was performed or material was supplied by him. The United States shall not be liable for the payment of any costs or capenass of any such suit. --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385601_0785%3A2. Public record. Not legal advice.