The Surety and Interpleader
January 31, 2023
By: Marc A. Campsen, Esq. and Michael A. Stover, Esq.
In this Surety Today Blog post we will discuss the Surety and Interpleader. From time to time a surety will be faced with multiple claims that exceed the penal amount of the bond. This typically arises in the commercial bond setting, but can also happen with payment bonds. In our careers we have had many of these situations. In this scenario, the surety needs to exercise caution. There are cases around the country that essentially hold that if the surety is aware that there may be multiple claims against a bond that will exceed the penal sum, the surety must ensure an equal distribution of the penal sum and cannot simply payout the penal sum on a first come, first served basis. See Durant v. Changing, Inc., 891 P.2d 628, 631–32 (Okla. App. 1995) (“we hold that a surety with actual notice of competing claims to the proceeds of a . . . bond, who exhausts the bond proceeds by electing to pay one of two or more competing claimants does so at its own risk . . . and subjects the surety to liability beyond the terms of the bond.”); Shebester v. Triple Crown Insurers, 826 P.2d 603, 610-11 (Okla. 1992); New Amsterdam Cas. Co. v. Hyde, 148 Or. 229, 241, 34 P.2d 930, 934 (1934); Curry v. Homer, 62 Ohio St. 233, 235, 56 N.E. 870, 871 (1900)(“Of this the surety cannot complain; for, although he will in fact pay more than the amount of the bond, it results from his own wrong in paying the entire amount of the bond to a part of the beneficiaries, in disregard of the rights of the others.”); Am. Surety of New York v. Mills, 232 F. 841, 843-44 (9th Cir. 1916) (surety who pays one claim knowing there is another outstanding claim from an equal obligee may be liable for additional pro rata payment); Commonwealth v. City Tr., S. Dep. & Sur. Co., 224 Pa. 223, 73 Atl. 425 (1909); Deluxe Bldg. Sys., Inc. v. Constructamax, Inc., No. CV 06-2996, 2016 WL 4150746, at *4 (D.N.J. Aug. 1, 2016). Indeed, according to these cases, if the surety fails to ensure an equal distribution, it could be liable in excess of the penal sum. Fortunately, there is a clear procedural path to avoid such unpleasantness – Interpleader.
NATURE AND PURPOSE OF INTERPLEADER ACTIONS
An interpleader action is a procedural device used to resolve conflicting claims over money or property. The disputed property is known as the “stake.” In the surety industry, the stake would usually be the penal sum of the bond. Essentially, an interpleader action permits an entity holding money or property, known as the “stakeholder,” to deposit the stake into the court and let the court decide who is entitled to it and how much each claimant should get. Dividing the stake among the claimants like this is often referred to as “pie slicing” – each claimant gets their share of the pie.
One purpose of an interpleader action is to protect the stakeholder against excessive litigation when there are multiple claims to a single stake. State Farm Fir & Cas. Co. v. Tashire, 386 U.S. 523, 534 (1967). Specifically, interpleader “affords a party who fears being exposed to the vexation of defending multiple claims to a limited fund or property that is under his control a procedure to settle the controversy and satisfy his obligation in a single proceeding.” PNC Bank, N.A. v. Balsamo & Norino Properties, LLC, No. CV RDB-20-2922, 2021 WL 2474398, at *4 (D. Md. June 16, 2021)(quoting 7 Wright, Miller, & Kane, Federal Practice & Procedure § 1704, at 540-41 (3d ed. 2001). Without interpleader actions, a stakeholder would be “left with the unappealing prospect of either choosing one claimant over the other and facing action by the disappointed suitor or holding the stake and awaiting suit by both.” Commerce Funding Corp. v. Southern Financial Bank, 80 F. Supp.2d 582, 584–85 (E.D. Va. 1999).
In addition to protecting the stakeholder, an interpleader action also protects the claimants to the stake when the claims exceed the total amount of the stake, because the court will distribute the limited stake equitably among claimants to ensure the fund is not depleted so that all claimants are at least partially compensated. U.S. v. Major Oil Corp., 583 F.2d 1152, 1160 (10th Cir. 1978); American Fidelity Fire Insurance Company v. Construcciones Werl, Inc., 407 F. Supp. 164 (D.C.V.I. 1975). Thus, one purpose of an interpleader action is to give each claimant a share of the fund proportionate to the share of the total claims by establishing an “orderly contest” for the limited fund so as to prevent early claimants from securing a “disproportionate slice.” Tashire, 386 U.S. at 533-34.
Interpleader actions are available in federal court and in most state courts. In this blog post we will limit our focus to federal interpleader. In federal court, there are two ways to initiate an interpleader action, either under the federal rules of civil procedure or by federal statute. A “Rule Interpleader” is permitted under Rule 22 of the Federal Rules of Civil Procedure. Rule Interpleader does not give rise to jurisdiction in federal court without another independent basis, such as a federal question or diversity of citizenship among the parties. The other main point to consider about Rule Interpleader is that it does not require a deposit of the stake into the court. So, if you pursue a Rule Interpleader in the surety context, you don’t have to write the check for the entire amount of the penal sum right in the beginning of the litigation.
“Statutory Interpleader” is based on the federal Interpleader Act – 28 U.S.C. §1335. Unlike Rule Interpleader, Statutory Interpleader expressly provides jurisdiction in federal court as well as providing certain remedies that flow directly to the stakeholder that are not afforded in Rule Interpleader. One of the main differences between Rule Interpleader and Statutory Interpleader is that Statutory Interpleader does require deposit of the stake with the court.
There are two forms of interpleader conceptually. One is “strict or true interpleader,” and the other is “in the nature of interpleader.” If the action is a strict or true interpleader, the stakeholder asserts no claim to the stake. In other words, the stakeholder is disinterested in the money or property that it is depositing with the court. In the surety context, that could arise in circumstances where the surety recognizes the validity of all claims on the bond that exceed the penal sum. The surety does not claim any rights to retain any of the penal sum, and it just wants to deposit it into the court and let the court sort out who gets what. By contrast, if the action is in the nature of interpleader, then the stakeholder claims an interest in the stake. By way of example, the surety would claim an interest in the penal sum, and this would arise in cases where, although there are multiple claimants, some of those claims the surety may feel are not valid, or it may feel they have proper defenses to certain claims, and think they can retain at least a portion of the penal sum or the stake that’s deposited in the court.
An interpleader action typically involves two steps or stages. 7 Charles A. Wright, Arthur R. Miller, & Mary K. Kane, Federal Practice and Procedure § 1714 (3d ed. 2001). During the first stage, the court must determine whether the stakeholder has properly invoked interpleader. United States v. High Tech. Prods., Inc., 497 F.3d 637, 641 (6th Cir. 2007); Fed. Ins. Co. v. Parnell, No. 6:09CV00033, 2009 WL 2848667, at *4 (W.D. Va. Sept. 3, 2009). During the second stage, the stakeholder is discharged and a scheduling order is issued so that the case can continue between the claimants to determine their respective rights. Leventis v. First Nat’l Ins. Co. of Am., No. 3:09–1561–JFA, 2010 WL 2595305, at *2 (D.S.C. June 23, 2010). The claimants then engage in the “normal litigation processes, including pleading, discovery, motions, and trial.” High Tech., 497 F.3d at 641.
The propriety of interpleader depends on whether the stakeholder “legitimately fears” multiple litigation over a single fund. Nash & Assocs., LLC v. Gwynn, No. 14-cv-0376-WDQ, 2014 WL 3428933, at *3 (D. Md. July 10, 2014). In the first step, the court must consider whether: (1) it has jurisdiction over the suit; (2) a single fund is at issue; (3) there are adverse claimants to the fund; (4) the stakeholder is actually threatened with multiple liability; and (5) whether any equitable concerns prevent the use of interpleader. Rhoades v. Casey, 196 F.3d 592, 600 (5th Cir. 1999). The Interpleader Act expressly provides that an interpleader action is appropriate to resolve potential claims. “In order to achieve the important benefits of securing a prompt and inclusive determination in a single action of the rights of all the parties claiming an interest in the stake, courts should not hesitate to allow interpleader even when prospective claims are involved” as long as they do not “fall below any meaningful threshold level of substantiality.” Talcott Resol. Life Ins. Co. v. Carlyle, No. CV DKC 19-1796, 2022 WL 2343252, at *3–5 (D. Md. June 29, 2022).
If interpleader is held to be proper, the Court is to direct the funds to be deposited with the clerk, dismiss the stakeholder with prejudice and discharge it from all liability with respect to the deposited funds, and issue its injunction to prohibit the claimants from initiating or pursuing any action or proceeding against the stakeholder regarding the matter. High Tech., 497 F.3d at 641; Companion Life Ins. Co. v. Haislett, No. 3:10-1586-JFA, 2010 WL 3879338, at *3 (D.S.C. Sept. 28, 2010).
The federal Interpleader Statute is remedial in nature, and is to be given a broad construction. Tashire, 386 U.S. at 533 (1967). Accordingly, courts have broad discretion to order interpleader relief as an equitable remedy designed to achieve an orderly distribution of a limited fund. Star Ins. Co. v. Cedar Valley Express, LLC, 273 F.Supp.2d 38, 40 (D.D.C. 2002).
ATTRIBUTES OF FEDERAL STATUTORY INTERPLEADER ACTIONS
The first attribute of federal statutory interpleder is the concept of “minimum diversity.” Ordinarily, in order to obtain federal subject matter jurisdiction, you would need to have either federal question jurisdiction or complete diversity. Federal question jurisdiction would be something like the Miller Act. In traditional diversity jurisdiction the plaintiffs must all be from a different state/citizens of a different state from all of the defendants, and the amount in controversy must exceed $75,000. See 28 U.S.C. §1332. For example, if one of three plaintiffs is from Maryland and one of ten defendants is also from Maryland, you do not have complete diversity and there would be no jurisdiction. You need to have complete diversity in order to meet diversity jurisdiction, in general.
However, under the federal interpleader statute, the amount of the stake only needs to meet the minimum of $500, as opposed to traditional diversity, which requires a minimum of $75,000 to meet diversity. See 28 U.S.C. § 1335 (a). Further, under the interpleader statute to satisfy minimum diversity there only needs to be two claimants who are citizens of different states. Legacy Inv. & Mgmt., LLC v. Susquehanna Bank, No. CIV. WDQ-12-2877, 2013 WL 5423919, at *4 (D. Md. Sept. 26, 2013). So, if the plaintiff is a citizen of Maryland and one of ten defendants is from Maryland, that’s fine because the citizenship of the plaintiff is irrelevant in Statutory Interpleader actions. As long as at least two of the claimants are from different jurisdictions/different citizenships, then you meet the minimum diversity requirement for federal interpleader. Unlike Statutory Interpleader, under federal Rule Interpleader, you would still need to meet the traditional diversity requirements.
A second attribute of federal Statutory Interpleader is that you can achieve nationwide jurisdiction. Ordinarily, in order to sue someone in a particular court, you need to have a statute that allows you to do that like the long arm statute, the person has to consent to the jurisdiction or they have to have constitutionally required minimum contacts with the jurisdiction in order to obtain personal jurisdiction over that individual in a given forum. But, in federal Statutory Interpleader, the court is given nationwide jurisdiction over all claimants to the stake wherever they reside. 28 U.S.C.A. § 2361 states that a district court may issue its process for all claimants, where they reside or may be found. Thus, in Statutory Interpleaders, the minimum contacts of the claimant with the jurisdiction are irrelevant and this gives the surety maximum flexibility in instituting the action and allows the interpleader action to bring all claimants and potential claimants before the same court, thereby furthering the nature and purpose of the interpleader action.
Finally, one of the primary features or benefits of an interpleader action is the injunctive relief and discharge that will be granted to the stakeholder. 28 U.S.C. §2361 permits the federal court, where the interpleader action has been filed, to issue an injunction. The statute provides that in any civil action of interpleader or in the nature of interpleader, the district court may enter its order restraining any claimant from instituting or prosecuting any proceeding in any state or federal court affecting the property, instrument or obligation involved in the interpleader action. This is nationwide injunctive power. It applies to all courts, federal and state, it is broad and extensive, and gives the court the ability to stop ongoing cases or prevent cases from being filed against the surety or the bond once you have instituted the interpleader action. The injunctive relief can be obtained immediately after the filing of the case without any notice or opportunity of the opposing party to be heard or to come before the court. In that regard, the injunctive relief is kind of like the automatic stay in bankruptcy. You can also get a discharge. Once you have deposited the penal sum of the bond, you can petition the court to be discharged and you can obtain a discharge absolving you from any further liability on that bond.
RECOVERY OF ATTORNEY’S FEES
Another potential benefit of an interpleader action is that the stakeholder may be able to recover its costs and attorney’s fees incurred in bringing the action. Initially under federal law, there is no express provision in either Rule or Statutory Interpleader for fees and costs. However, the case law makes clear that courts have the discretion to award fees and costs under traditional rules of equity. Mutual Life Ins. Co. v. Bondusant, 27 F.2d 464 (6th Cir. 1928); Treinies v. Sunshine Mining Co., 99 F.2d 651 (9th Cir. 1938), aff’d., 308 U.S. 66 (1939); Septembertide Publ’g, B.V. v. Stein and Day, Inc., 884 F.2d 675, 683 (2d Cir. 1989); Prudential Ins. Co. v. Boyd, 781 F.2d 1494, 1498 (11th Cir. 1986); U.S. Fidelity & Guar. Co. v. Sidwell, 525 F.2d 472, 475 (10th Cir. 1975); New York Life Ins. Co. v. Miller, 139 F.2d 657, 658 (8th Cir. 1944). The cases regarding recovery of fees and costs generally make clear that such recovery is only available to the disinterested stakeholder under true or strict interpleader. Importantly, requesting fees does not constitute an interest in the stake, which could turn a disinterested stakeholder into an interested stakeholder. Courts have held that even if you want your attorneys’ fees to be paid from the stake, that does not make you an interested party.
The philosophy behind the awarding of costs and fees is that the plaintiff has benefited the claimants by promoting early litigation on ownership of the fund, thus preventing dissipation and that the plaintiff should not have to pay attorney fees in order to guard himself against the harassment of multiple litigation. Trustees of Directors Guild of Am–Producer Pension Benefits Plans v. Tise, 234 F.3d 415, 426–27 (9th Cir. 2000); San Rafael Compania Naviera, S.A. v. Am. Smelting & Refining Co., 327 F.2d 581, 587 (9th Cir. 1964). The disinterested stakeholder has been forced to expend time and money to resolve the dispute that it had no hand in creating. W. Conf. of Teamsters Pension Plan v. Jennings, No. C-10-03629 EDL, 2011 WL 2609858, at *6 (N.D. Cal. June 6, 2011). In the surety context, this arises generally because the surety is just providing the bond; it is clear that the principal’s failures are what are creating the disputes and claims and the need for interpleader actions in the first instance.
The amount of the fees and costs recoverable are generally limited to those incurred in initiating the interpleader action and are also limited generally by reasonableness. So, when you are seeking fees, you will be limited to only the cost of drafting and filing a complaint and related motions to the complaint, such as motions for depositing fees, affidavits and other forms like that, service of process and for the court costs that you have incurred in filing. 7 Charles Alan Wright, Arthur R. Miller & Mary Kay Kane, Federal Practice & Procedure § 1719 & n. 20 (1986). Finally, the smaller the stake, the general rule of thumb is the smaller the recovery of attorneys’ fees, if any.
If you have any questions regarding the issues addressed in this blog post please contact Michael A. Stover, Esq. (firstname.lastname@example.org) or Marc A. Campsen, Esq. (email@example.com) or any member of the Surety and Fidelity Practice Group.
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