Surety lacked priority in contested funds

Listen to this article

Where appellee, a surety company, issued performance and payment bonds to a construction company that later defaulted on its obligations, the surety lacks a priority interest in the company’s deposits held by appellee bank.

The bank had a perfected security interest in the deposit funds, which were used to offset the company’s outstanding debt. The surety, as the company’s subrogee, cannot acquire greater rights than the company to the funds on deposit.

Overview

In 2017, Dominion, a construction project subcontractor, obtained an $8 million line of credit from FVCbank. The collateral was the bank’s perfected security interest in all of Dominion’s deposit accounts in FVCbank and any other financial institution. Dominion was required to deposit all income with FCVbank.

In the event of a default, the bank could accelerate the loan and offset the outstanding debt from Dominion’s deposits.

Arch Insurance is a surety. Arch issued performance and payment bonds in 2018 that would satisfy creditors in the event that Dominion could not.
The bonds “were accompanied by the General Indemnity Agreement (the ‘GIA’) [.] …The GIA stated that it was a security agreement under the UCC and contained an assignment provision, in which Dominion assigned all of its rights under bonded contracts to Arch, in the event of default. …

“Crucially, FVCbank was not a party to the GIA or related agreement, and therefore not an Indemnitor.”

Dominion defaulted. FVC provided a $1.5 million term loan subject to the same terms as the line of credit regarding default and remedies. Dominion executed a promissory note.

Later, Dominion “began to seek financial assistance from Arch to pay Suppliers.” Arch’s financial consultant reported that FVCbank would not provide Dominion with additional financial support. …

“Arch and Dominion entered into an Interim Financial Assistance Agreement (‘IFAA’). The IFAA contained voluntary letters of default indicating that Dominion was in default to Arch under the GIA, and that Dominion would request that FVCbank establish a segregated account for bonded funds.

“In conjunction with the IFAA, Dominion executed a promissory note in favor of Arch for $3,865,079.69. Arch advanced the same amount to Dominion for payment to the Suppliers.”

Despite Arch’s requests, FVCbank did not set up a trust account for “bonded receivables.”

“Dominion continued to deposit bonded and nonbonded receivables into its general deposit accounts at FVCbank[.] … FVCbank froze Dominion’s accounts. FVCbank swept approximately $2,500,000 from Dominion’s accounts to pay down the term loan and the line of credit.”

Arch and Dominion sued FVCbank for conversion and unjust enrichment. They sought to introduce expert testimony from Stryjewski relating to tracing bonded funds in the Dominion accounts.

The circuit court ruled that Stryjewski could not testify and held that FVCbank had a superior interest in Dominion’s deposits. The court granted the bank’s motion to strike Arch’s claims.

Loan documents

“FVCbank’s interest in Dominion’s bank deposits is governed by the loan documents. FVCbank first obtained a security interest in Dominion’s deposit accounts in 2017, as part of the Line of Credit Agreement, the Security Agreement, and the Collateral Assignment and Security Agreement.

“Additionally, a UCC-1 financing statement was filed with the State Corporation Commission, reflecting the bank’s security interest. …

“Importantly, FVCbank’s security interest was perfected by its control over the deposit accounts. … The loan documents provided that, in the event of default, FVCbank had the right to offset any of Dominion’s accounts against the company’s outstanding debts to FVCbank.

“Neither party contests on appeal that Dominion was in default at the time FVCbank exercised its rights under the loan documents, and neither party raised the issue of default with respect to the relevance of Stryjewski’s testimony.

“Therefore, as between FVCbank and Dominion, given Dominion’s default, FVCbank had a clear right under the loan documents to offset Dominion’s deposit accounts against the company’s debt.”

Dominion and Arch

“Arch’s interest in Dominion’s deposit accounts is set forth in the GIA and the IFAA. The GIA stated that it was a security agreement under the UCC and authorized the filing of a UCC financing statement reflecting the same. Yet, the record contains no evidence that Arch filed a UCC financing statement prior to FVCbank sweeping Dominion’s deposit accounts. …

“Under the UCC, FVCbank’s perfected security interest takes priority over Arch’s unperfected security interest. …

“Code § 8.9A-327(1) provides that ‘[a] security interest held by a secured party having control of the deposit account under § 8.9A-104 has priority over a conflicting security interest held by a secured party that does not have control.’ FVCbank has a perfected security interest through control of the deposit; Arch does not. …

“Arch argues that it nonetheless had a superior interest in the bonded deposits under the doctrine of equitable subrogation, and that FVCbank was on notice of Arch’s claimed right to the funds because of their trust status. This argument fails for two reasons.

“First, Arch’s interest is a claimed right of subrogation and cannot exceed the rights of Dominion. … Second, Arch’s argument fails because FVCbank never agreed to hold the bonded funds in trust. …

“FVCbank was not required to treat the funds as trust deposits simply because Dominion and Arch claimed as much. Nor was it required to pick its own pocket and enable Arch to circumvent the bank’s priority interest under the UCC.

Under the UCC and Virginia caselaw, FVCbank’s interest in Dominion’s deposit accounts was superior to Arch’s interest as a matter of law. As a result, in the evidentiary proceeding below, any testimony on the tracing of accounts was irrelevant, because FVCbank’s claim was superior regardless of the bonded character of the deposits.”

Because FVCbank had a superior interest in the contested funds, the circuit court properly struck Arch’s conversion and unjust enrichment claims.

Affirmed.

Arch Insurance Co. v. FVCbank, Record No. 2110050; (Mann) Dec. 29, 2022. From the Circuit Court of Fairfax County. Thomas J. Moran (Richard T. Pledger; Eric G. Korphage; Wright, Constable & Skeen; Pike & Gilliss, on briefs), for appellant. Monica T. Monday (Edward W. Cameron; Matthew H. Sorensen; Eric S. Waldman; Gentry Locke; Cameron/McEvoy, on brief), for appellee. Amicus Curiae: The Surety & Fidelity Association of America (Marguerite Lee DeVoll; Jennifer L. Kneeland; Watt, Tieder, Hoffar & Fitzgerald, on brief), in support of appellant. Amicus Curiae: Virginia Bankers Association (J.P. McGuire Boyd, Jr.; Williams Mullen, on brief), in support of appellee. VLW 022-6-061, 19 pp.