In re LTC Holdings, Inc.

The Department of Defense awarded a general contracting firm the contract to construct the National Police Command Center in Afghanistan. As is typically required in government contracts, the general contractor was required to secure performance and payment bonds that guarantee the contractor will properly perform its contract and pay its subcontractors. Here, the general contractor secured those bonds from the appellant, Insurance Company of the State of Pennsylvania (ICSP). The firm filed tax returns indicating it was due $5.5 million in refunds. A few days later, it declared Chapter 7 bankruptcy and defaulted on its obligations in Afghanistan (those last six words sure have been in the news a lot lately). ICSP paid someone else to complete the job. At issue was the tax refund. ICSP claimed that it is subrogated to the United States’ rights to set off a tax refund against the losses that ICSP covered. First, the Third Circuit concluded that the United States had not yet been “paid in full” within the meaning of Section 509(c) when the Bankruptcy Court approved the settlement. So, under Section 509(c), ICSP’s subrogation rights were subordinate to the remaining and superior claims of the United States at the time of the settlement. Second, the United States was entitled to waive its set-off rights to settle its remaining and superior claims. Third, the United States’ waiver of its setoff rights extinguished ICSP’s ability to be subrogated to those rights

LTC