of all "legitimate job cost obligations" including withholding taxes, that Fidelity breached their contract and accordingly Fidelity owes the plaintiff that amount which he personally paid the Internal Revenue Service.
Plaintiff further contends that the defendant's actions constitute a breach of the June 14 agreement, a breach of trust and fiduciary obligation, and that as a result of this breach plaintiff should recover the $10,000 working capital deposited by him at the insistence of the defendant in the joint accounts.
The defendant contends, however, that only "legitimate bonded liabilities" were covered by the agreement and that withholding taxes were not included under bonded liabilities.
Plaintiff relies principally on Pacific National Insurance Company v. United States, 270 F. Supp. 165 (N.D. Calif. 1967), aff'd 422 F.2d 26 (9th Cir.), cert. denied, 398 U.S. 937, 90 S. Ct. 1838, 26 L. Ed. 2d 269 (1970) where the Court held that the surety was liable to the United States for withholding taxes in a situation where it was established that the surety exercised control and dominion over disbursement of the contractor's funds.
There, as in the instant case, the contractor encountered financial difficulties. It advised the surety of its difficulties and indicated its inability to meet its obligations unless the surety came to its assistance. The surety offered to advance to the contractor sufficient funds to enable it to continue its work under the construction contracts under an agreement whereby: (1) Special accounts were to be established for each of the contractor's construction jobs; (2) all of the contractor's receivables, as well as a "loan" from the surety, were to be deposited in the special accounts; (3) all payments to be made by the contractors were to be subject to approval by the surety; (4) following approval, the surety was to certify monies out of the special accounts into the contractor's general account to meet obligations.
The surety, however, refused to approve the payment of withholding taxes claiming (as does the surety here) that it was not liable for payment of withholding taxes under Section 6672 because payment of such taxes was not one of the obligations under the surety bond,
and because it was not the "employer" of the employees from whose wages the taxes were withheld.
The Court however held that Section 6672 was broad enough to reach an entity which assumes the function of determining whether or not an employer will pay taxes withheld from the employees.
The Court found (1) that the surety exercised dominion and control over the contractor's funds and determined which of the contractor's obligations would be paid and when; and (2) that the contractor would not have placed all its potential income under the control of the surety if it had known that the surety would not release funds to provide for withholding taxes.
The facts in the instant case are strikingly similar to those of Pacific National.4 Clearly in this case the surety exercised dominion and control over the funds available for payment of "job cost obligations" incurred by Oxford in completing work on its two contracts. The procedure for drawing checks fairly illuminates this dominion and control.
When Oxford placed all its cash and receivables in the joint accounts which were effectively controlled by Fidelity, it placed itself completely at the mercy of Fidelity. It could do nothing unless Fidelity approved. And it is inconceivable that Oxford would have taken such a step if it had known that the surety would refuse to co-sign checks for withholding taxes thereby leaving the officers of Oxford subject to criminal sanctions. This clearly could not have been the intent of the parties. Thus the surety having assumed responsibility for paying employee's wages also assumed responsibility for the taxes withheld from those wages -- i.e., the surety became a "person required to collect, truthfully account for, and pay all withholding taxes" within the meaning of Section 6672.
As Judge Browning said in Pacific National, this section
"was designed to cut through the shield of organizational form and impose liability upon those actually responsible for an employer's failure to withhold and pay over the tax. It would frustrate this purpose needlessly to imply a condition limiting the application of the section to those nominally charged with controlling disbursements of a corporate employer, thus immunizing those who, through agreement with or default of those nominally responsible have exercised this corporate function in fact." Pacific National Insurance Company v. United States, supra 422 F.2d at 31.
To hold contrariwise would "permit the surety to use tax moneys in discharging its obligations to complete performance of the contract and limit thereby its liability by channeling funds for the work through the distressed contractor." Id. This is an unacceptable result.
It is immaterial that Oxford might have gone out of business in any event even if the surety had signed the withholding tax checks. The fact remains that the taxes were part of the legitimate job obligations and that Oxford had assigned all its funds to the joint accounts.
The Court, therefore, concludes that plaintiff is entitled to reimbursement from the surety for that amount of money he personally paid over to the Internal Revenue Service to cover withholding taxes.
The Court also concludes, however, that the plaintiff is not entitled to recover the $10,000 working capital additionally contributed by the plaintiff to Oxford. There is no question but that such working capital was devoted to the payment of the day by day operations of Oxford in an attempt to keep the company afloat. There is no direct relationship between the imposition of tax and penalties after the company had failed and abandoned the jobs, and the earlier contribution of capital which had been dissipated before the tax problem arose.
Counsel for plaintiff will submit an appropriate order within ten (10) days.