Johnson v. Root Manufacturing Co.

Background

A railroad hired the Warren Construction Company, which in turn subcontracted work and materials to the Root Manufacturing Company. Root claimed it had not been fully paid for materials and filed notices of lien after $12,895.34 remained unpaid. On January 12, 1912, the railroad, Warren, and Warren’s sureties agreed to set aside $42,000, with $20,000 put into a trustee’s hands, to pay "lienable claims." On April 10, the railroad and Root agreed to pay Root $6,447.67 in compromise, Root assigned its claim to the trustee, and Root released its claim. Warren later went bankrupt and the trustee sued to recover the April payment as an improper preference.

Reasoning

The central question was whether the January 12 agreement created an equitable lien that justified payments from the set-aside fund, even for claims that might have been disputed or unenforceable. The Court explained that the parties intended to clear the railroad’s property of claims and deliberately put a specific fund in a third party’s hands for that purpose. Because the parties acted in good faith, expected disputed claims to be compromised, and had appropriated the fund to pay "lienable claims," the Court treated the arrangement as creating an equitable lien that protected payments made under it. The Court noted it would not decide whether Root’s formal lien could have been defeated, but held there was no reasonable doubt the payment was justified.

Real world impact

The decision lets parties use agreed funds and trustees to settle disputed contractor and supplier claims without those negotiated payments being automatically undone in bankruptcy, so long as the arrangement is made in good faith and for the purpose of clearing property claims. The lower court decree was affirmed.