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United States v. A & M Gregos Inc.

decided: October 4, 1979.

UNITED STATES EX RELATIONE FOR THE USE OF K & M CORP., A NEW JERSEY CORPORATION, APPELLANT,
v.
A & M GREGOS, INC., A CORPORATION OF THE STATE OF NEW JERSEY, NEW HAMPSHIRE INSURANCE CO., A CORPORATION OF THE STATE OF NEW HAMPSHIRE, AND F & Y MECHANICAL CONTRACTORS, INC., A CORPORATION OF THE STATE OF NEW JERSEY, APPELLEES, V. EASTERN MECHANICAL CO-OP, INC., A CORPORATION OF THE STATE OF NEW JERSEY, EASTERN AIR CONDITIONING AND REFRIGERATION CORP., A CORPORATION OF THE STATE OF NEW JERSEY, AND KENNETH KLEIN, APPELLEES.



Before Seitz, Chief Judge, Gibbons and Sloviter, Circuit Judges.

Author: Seitz

Opinion OF THE COURT

Appellant K & M Corporation, a subcontractor on a government construction contract, seeks to enforce a claim against the payment bond executed by the project's prime contractor. The district court granted summary judgment for appellees, concluding that K & M was too remotely related to the prime contractor to be protected by the statutory bond.

The United States Postal Service awarded A & M Gregos, Inc., a contract to perform certain construction work on the main post office building at Elizabeth, New Jersey. Pursuant to the requirements of the Miller Act, 40 U.S.C. § 270a (1976), Gregos executed bonds to secure payment and performance, with New Hampshire Insurance Co. as surety.

This suit concerns subcontracts executed by Gregos with Eastern Air Conditioning and Refrigeration Corp. ("Eastern ACR") and Eastern Mechanical Co-op, Inc. ("Eastern Mechanical"), two companies operating from a single location and under the principal control of Kenneth Klein. On July 9, 1975, Gregos awarded Eastern ACR a subcontract for the plumbing and drainage requirements of the project. Sometime prior to November 24, 1975, Eastern ACR further subcontracted all of this work to F & Y Mechanical Contractors, Inc. On November 24, 1975, Gregos awarded Eastern Mechanical a subcontract for heating, ventilation, and air conditioning work. Eastern Mechanical took the heating, ventilation, and air conditioning subcontract on the express condition that it would, within 48 hours, further subcontract all of the required work to F & Y Plumbing, Inc. In compliance with this provision, Eastern Mechanical executed a contract on November 24, 1975, with F & Y Mechanical, which we are told is the same company as F & Y Plumbing, Inc. The reason for this indirect method of bringing F & Y Mechanical in as a subcontractor, according to the deposition of George Liadis, the president of Gregos, was that Gregos became aware of F & Y's suitability through Eastern Mechanical and believed that to contract directly with F & Y Mechanical would, in this situation, be an improper interference with Eastern Mechanical's business relationship with F & Y Mechanical.

On June 14, 1976, F & Y Mechanical contracted with appellant K & M for the insulation requirements of these two subcontracts. At this time, officers of K & M were unaware of the role played by the Eastern companies in this arrangement and believed that F & Y Mechanical had a direct contractual relationship with Gregos. The affidavit of William Kretzmer, president of K & M, states that this misunderstanding resulted from the absence of any labor or supplies from the Eastern companies at the work site. The record contains no evidence of any person misrepresenting facts to K & M.

Appellant K & M performed insulation work from June 26, 1976, to December 8, 1976. It refused to resume work in January 1977 because F & Y Mechanical had failed to pay for any of the work already completed. During the course of its efforts to collect, K & M first learned that the Eastern companies, and not F & Y Mechanical, had direct subcontracts with Gregos.

When it failed to obtain full payment, K & M filed this action under the Miller Act, 40 U.S.C. § 270b (1976), against Gregos, New Hampshire Insurance Co., and F & Y Mechanical*fn1, asserting a right to enforce its claim against the payment bond. The district court granted defendants-appellees' motion for summary judgment and issued an order dismissing K & M's claim and all pendent claims. This court has jurisdiction to hear the appeal under 28 U.S.C. § 1291 (1976).

On any construction contract with the United States exceeding $25,000 in amount, the Miller Act requires the prime contractor to execute a bond "for the protection of all persons supplying labor and materials." 40 U.S.C. § 270a(a)(2) (1976). Any protected supplier of materials or labor may sue on the bond for amounts due him. Id. § 270b(a). But the Act imposes limitations on this right. A person "having a direct contractual relationship with a subcontractor" but no privity of contract with the prime contractor may sue only if he gives the prime contractor notice of his claim within ninety days of the completion of his work. Id.

The Supreme Court, and prior to its decision a majority of the federal circuits, read this last provision as limiting the right to sue on a payment bond to persons with a direct contractual relationship with either the prime contractor or a subcontractor, and it read the term "subcontractor" as meaning first-tier subcontractor. J. W. Bateson Co. v. United States ex rel. Board of the Trustees of National Automatic Sprinkler Industry Pension Fund, 434 U.S. 586, 98 S. Ct. 873, 55 L. Ed. 2d 50 (1978). See also In re Garden State Erectors, Inc. v. A. Leo Nash Steel Corp., 599 F.2d 1279 (3d Cir. 1979). Because K & M's only contract is with F & Y Mechanical, a second-tier subcontractor, the rule of the Bateson case would seem to deny the right to sue on the bond.

Appellant argues that the position of the Eastern companies should be ignored and that F & Y Mechanical should be deemed a first-tier subcontractor. Appellant asserts that the Eastern companies are not subcontractors within the meaning of that term under the Miller Act because they provided neither labor nor materials and that F & Y Mechanical actually carried out the function of the first-tier subcontractor. They argue that unless we give the term "subcontractor" this functional definition, a prime contractor and his surety would be free to set up sham subcontractors for the purpose of limiting their liability on a payment bond. The district court rejected appellant's argument because it read Bateson to preclude such an examination and found that the bona fide nature of the contracts between Gregos and the Eastern companies could not be disputed.

We agree that Bateson rules out a holding that the court may look to the functions carried out by contracting parties, rather than to the position they occupy in the contractual structure, to identify the first-tier subcontractor. In Bateson, the court of appeals had ruled that a certain company, formally a second-tier subcontractor, should be deemed a first-tier subcontractor on the basis of its close and substantial working relationship with the prime contractor. The Supreme Court found this reasoning inconsistent with the language and legislative history of the Miller Act. 434 U.S. at 593-94, 98 S. Ct. 873. The clear import of Bateson Is that Congress imposed a structurally defined limitation on the right to sue on a payment bond, which was not to be overstepped by a functional examination of the relationships of the contracting parties.

Appellant's brief cites cases in which a court has distinguished between a subcontractor and a materialman on the basis of the substantiality of a company's relationship with the prime contractor. For example, in F. D. Rich Co. v. United States ex rel. Industrial Lumber Co., 417 U.S. 116, 121-24, 94 S. Ct. 2157, 40 L. Ed. 2d 703 (1974), the Court held that a company which had contracted not only to supply the plywood required for a defense housing contract but also to select, modify, detail, and install all custom millwork was a subcontractor. However, neither this case nor any other case that applies this analysis is authority for expanding the meaning of "subcontractor" to cover companies that do not have the requisite contractual relationship. The company in F. D. Rich, as in all of these cases, had a direct contractual relationship with the prime contractor. Moreover, the consequence of classifying a company as a materialman is to deny to its suppliers of materials and services the right to bring suit on the payment bond. It is not to treat some company further down the contractual chain as a subcontractor. See Clifford F. MacEvoy Co. v. United States ex rel. Calvin Tomkins Co., 322 U.S. 102, 64 S. Ct. 890, 88 L. Ed. 1163 (1944).

We also find unpersuasive appellant's argument that a functional approach is necessary to prevent the establishment of sham subcontractors. This concern led the Tenth Circuit to look past formal contractual arrangements in Glens Falls Insurance Co. v. Newton Lumber & Manufacturing Co., 388 F.2d 66 (10th Cir. 1967), Cert. denied, 390 U.S. 905, 88 S. Ct. 821, 19 L. Ed. 2d 873 (1968). The prime contractor on a defense housing project, DMH Enterprises, Inc., had fully negotiated a subcontract with Whiteside Construction Co. for carpentry and millwork but had arranged the contract so that Whiteside was only a second-tier subcontractor. The first-tier subcontractor, Earl M. Campbell, was a close friend and relative of the president of DMH. In a suit by suppliers of Whiteside to enforce claims against the payment bond, the court upheld a determination that the contract between DMH and Campbell was a sham and that Whiteside was the true subcontractor. The court took into consideration not only the ...


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