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Safeco Insurance Co. v. Wheaton Bank and Trust Co.

August 4, 2009


The opinion of the court was delivered by: Rebecca R. Pallmeyer United States District Judge

Judge Rebecca R. Pallmeyer


Safeco Insurance Company ("Safeco" or "Plaintiff") contracted to act as a surety for Integrated Construction Technology Corporation ("ICTC"), an Illinois construction contractor. ICTC had a deposit account with Wheaton Bank and Trust Company ("the Bank" or "Defendant"), and also borrowed more than $4 million from the Bank. When a portion of the debt had matured, the Bank set off a total of $515,000 from ICTC's deposits in order to satisfy its debt. In this action, Safeco contends that this set-off was improper, and that Safeco, which has paid more than $1.6 million to satisfy ICTC's debts to subcontractors, is entitled to the deposits that the Bank seized.

In an opinion dated August 26, 2008, this court dismissed Safeco's Third Amended Complaint without prejudice, but gave Safeco a final opportunity to state a claim for relief. (Aug. 26, 2008 Mem. [75].) Safeco's Fourth Amended Complaint asserts that it is entitled to recover some of its losses from the Bank under theories of conversion (Count I) and constructive trust (Count II). Defendant again moves to dismiss, and for the reasons set forth here, that motion is denied.


For a detailed review of the factual background, the reader is referred to the court's prior opinions, including the opinion dismissing Safeco's Second Amended Complaint, Safeco Ins. Co. v. Wheaton Bank & Tr. Co., No. 07 C 2397, 2008 WL 216396, at *1-2 (N.D. Ill. Jan. 24, 2 008). As explained there, the court concluded that Safeco had failed to state valid claims for conversion and constructive trust for several reasons: First, Safeco claims it is subrogated to the rights of ICTC and its subcontractors vis-a-vis Defendant, but has consistently neglected to allege ICTC's default, a necessary precondition to subrogation. Further, in its Response to Defendant's Motion to Dismiss Plaintiff's Third Amended Complaint, Safeco did not address the Bank's argument that its perfected security interest in the set-off funds trumps Safeco's subrogation rights. Finally, Safeco failed to respond to the Bank's contention that the funds in ICTC's account were not "specific chattel" and that Defendant's set-off of those funds would therefore not constitute conversion. The court addresses each of these deficiencies in light of Safeco's most recent complaint as well as Safeco's new allegations of fact in support of its constructive trust claim, presenting the facts in the light most favorable to Safeco.

ICTC's Default and Safeco's Subrogation Rights

Both of Safeco's claims rest on its status as subrogee to the rights of ICTC. As explained in this court's earlier opinion, Safeco's original complaint did not establish the fourth requirement for a claim as subrogee; Plaintiff now attempts to cure that defect by alleging that Defendant's wrongful set-off caused ICTC to default on its obligation to pay its subcontractors, and as a result, Safeco was compelled to fulfill ICTC's contractual obligation to pay subcontractors who had supplied labor or materials for projects. (4th Am. Compl. ¶¶ 10-12, 16-18.) In support of its allegations of default, Plaintiff has attached to its Complaint claims from various subcontractors assigning to Plaintiff all rights under their contracts with ICTC in exchange for compensation owed by ICTC pursuant to those contracts. ("Releases and Assignments," Group Ex. H to 3rd Am. Compl.) Plaintiff alleges that Safeco's subsequent performance subrogated Safeco, by operation of law, to the rights of ICTC, the bond obligees, and the subcontractors Safeco paid and, further, that the subcontractors it paid in ICTC's stead assigned their rights to Safeco under the Bond Agreement. See Nat'l Shawmut Bank of Boston v. New Amsterdam Casualty Co., 411 F.2d 843, 848 (1st Cir. 1969) (recognizing that a surety is subrogated to the rights of the principal contractor, the project owner, and the subcontractors and suppliers the surety has paid). (4th Am. Compl. ¶¶ 12, 14-17.) No greater specificity is required at this stage to give Defendant "fair notice of what the plaintiff's claim is and the grounds upon which it rests." Bell Atlantic Corp. v. Twombly,550 U.S. 544, 554 (2007).

The Perfected Security Interest

The Bank contends that, as the holder of a perfected security interest in the deposited funds, it possesses rights superior to any conflicting security interest belonging to Plaintiff as subrogee to ICTC's rights as trustee. (Def. Reply at 8.) On January 27, 2005, Defendant and ICTC signed a Commitment Letter granting Defendant a "Blanket Lien on all general business assets of the Borrower," and providing that "[t]he Borrower shall maintain its primary local deposit and disbursement accounts at the Bank." ("Commitment Letter," Ex. D to 3d Am. Compl.) This security interest in ICTC's assets was automatically perfected when Defendant took possession of the funds via deposits to ICTC's account. See 810 ILCS 5/0-312(b)(1); 810 ILCS 5/9-314(a). In its most recent Complaint, Plaintiff does not dispute that Defendant possesses a perfected security interest, but argues that as subrogee to ICTC's rights, its interests are equitable in nature and thus prevail over Defendant's rights, which are governed by Article 9 of the Uniform Commercial Code. Nat'l Shawmut Bank, 411 F.2d at 846 (surety's subrogation rights exist independently of security interest created by contract).

Plaintiff is correct that a surety's interests as subrogee sound in equity, not contract law, and Article 9 is therefore inapplicable here. As Professors White and Summers have written with respect to sureties to construction contracts, Article 9 applies only to consensual security interests. The surety's subrogation claim is not consensual, but is based on the "status . . . inhering in a surety." Accordingly, conflicts between the rights of the surety and third parties must be resolved outside Article 9. And outside Article 9, sureties generally prevail over banks with perfected Article 9 security interests in money retained by the owner.

4 JAMES J. WHITE & ROBERT S. SUMMERS, UNIFORM COMMERCIAL CODE § 30-6 (5th ed. 2002) (quoting Nat'l Shawmut Bank, 411 F.2d at 846.); see also Pearlman v. Reliance Ins. Co.,371 U.S. 132 (1962)("The right of subrogation is not founded on contract. It is a creature of equity; is enforced solely for the purpose of accomplishing the ends of substantial justice; and is independent of any contractual relations between the parties." (quoting Memphis & L.R.R. Co. v. Dow, 120 U.S. 287, 301-302, 7 S.Ct. 482, 488, 489, 30 L.Ed. 595 (1887)); Michele L. Killebrew, Whose Money Is It? The Surety's Claim Against Its Principal's Bank, DRI FOR THE DEFENSE, March 2008, available at 50 No. 3 DRIFTD 36 (discussing limitations on a bank's set-off rights where funds are held in trust for third party). In the context of this case in particular, it is worth noting that White and Summers believed sureties should be left outside of Article 9 because "third parties who extend credit to contractors are almost always aware of the presence of a surety standing behind the contractor."

4 WHITE & SUMMERS, UNIFORM COMMERCIAL CODE § 30-6. The court concludes that Plaintiff's Fourth Amended Complaint survives this challenge, and turns to Safeco's substantive claims. Safeco's Conversion Claim

In addressing Defendant's Motion to Dismiss Plaintiff's Third Amended Complaint, Plaintiff failed to respond to Defendant's argument that the set-off funds constituted "specific chattel," a necessary element of a common law claim for conversion.*fn1 In re Thebus, 108 Ill. 2d 255, 259-60, 483 N.E.2d 1258, 1260 (1985). To be a specific chattel, money need not be "segregated or earmarked," but it must at least be "a specific fund or specific money in coin or bills," of "determinate amount and identifiably distinct." Doing Steel, Inc. v. Castle Constr. Corp., No. 02 C 1674, 2003 WL 21254345, at *2 (N.D. Ill. May 23, 2003); see Horbach v. Kaczmarek, 288 F.3d 969, 975 (7th Cir. 2002) ("In order to establish the conversion of money under Illinois law, a plaintiff must show that he had 'a right to a specific fund or specific money in coin or bills." Sutherland v. O'Malley, 882 F.2d 1196, 1200 (7th Cir.1989)). As this court observed in its order of August 26, 2008, "[a]s a rule, when money is deposited with a bank, title to it passes and the bank becomes a debtor to the extent of the deposit; and to that extent, the depositor becomes a creditor." Id. (quoting Mid-City Nat'l Bank v. Mar Bldg. Corp., 33 Ill. App. 3d 1083, 1089, 339 N.E.2d 497, 502 (1975)); see Gluth Bros. Const. Inc. v. Union Nat. Bank, 166 Ill. App. 3d 18, 23, 518 N.E.2d 1345, 1349 (2d Dist. 1988). Because money representing a general debt or obligation is not a specific piece of chattel, bank account funds, even when held in trust for a third party, typically cannot be the basis for a conversion claim by the ...

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