New Mexico State Highway & Transportation Department v. Gulf Insurance
2000 NMCA 007, 996 P.2d 424, 128 N.M. 634 (1999)
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Rule of Law:
Under the doctrine of equitable subrogation, a surety that pays a defaulting contractor's laborers and materialmen has a superior right to unpaid contract funds held by the project owner over a creditor with a perfected security interest in the contractor's accounts receivable.
Facts:
- Leburt Saulsberry, d/b/a Saulsberry Construction (Saulsberry), was awarded two fence construction projects by the New Mexico State Highway and Transportation Department (State).
- Gulf Insurance Company (Gulf) issued performance and payment bonds on behalf of Saulsberry for these projects.
- First State Bank of Socorro (First State) loaned Saulsberry $57,193.04, taking as security an assignment of the 'contract proceeds' from the State projects.
- First State perfected its security interest by filing a financing statement under the Uniform Commercial Code (U.C.C.).
- Saulsberry defaulted on its obligations with the State by failing to pay its laborers, materialmen, and subcontractors.
- Gulf, as surety, investigated the claims and paid $80,278.73 to Saulsberry's creditors.
- Upon completion of the projects, the State held $86,522.07 in final progress payments and retainage.
- Both Gulf and First State made demands upon the State for these funds.
Procedural Posture:
- The State filed an interpleader action in district court against Gulf, First State, and Saulsberry, depositing the $86,522.07 in disputed funds with the court.
- The State was subsequently dismissed from the action.
- First State filed a complaint to foreclose its lien against Saulsberry and Gulf.
- Gulf filed a cross-claim against First State and Saulsberry.
- The district court entered a default judgment in favor of Gulf against Saulsberry.
- Gulf filed a motion for summary judgment against First State, asserting priority to the interpleaded funds.
- The district court denied Gulf's motion and entered a judgment apportioning the funds between Gulf ($47,693.58) and First State ($38,828.49).
- Gulf, as appellant, appealed the district court's judgment to the New Mexico Court of Appeals.
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Issue:
Does a surety who pays a defaulting contractor's laborers and materialmen have, through the doctrine of equitable subrogation, a superior right to unpaid contract funds held by the project owner over a creditor with a perfected security interest in the contractor's contract proceeds?
Opinions:
Majority - Bustamante, J.
Yes, a surety's rights under equitable subrogation are superior to those of a secured creditor. By fulfilling its obligations under the payment bond, a surety 'steps into the shoes' of three different parties: the contractor (to receive payments due), the laborers and materialmen it has paid, and the project owner (who has the right to use the funds to complete the project). This right of subrogation arises by operation of law and is not a 'security interest' under the U.C.C. that requires filing for perfection. Adopting the overwhelming weight of federal authority, particularly the U.S. Supreme Court's decision in Pearlman v. Reliance Ins. Co., the court held that this well-established principle gives the surety priority to the funds necessary to reimburse it for payments made on the contractor's behalf. To rule otherwise would undermine the purpose of requiring surety bonds on public works projects.
Analysis:
This decision formally aligns New Mexico law with the dominant federal rule regarding the priority of a surety's subrogation rights. By doing so, it clarifies that a surety's claim to contract retainage is not governed by the U.C.C.'s priority scheme and will defeat a prior perfected security interest held by a lender. This holding provides significant protection and predictability for sureties operating in the state, reinforcing their role in public construction projects. Conversely, it serves as a crucial caution for financial institutions, making clear that their security interests in a contractor's receivables are subordinate to the potential subrogation claims of a surety if the contractor defaults.
