Corporate Officer Can Owe Fiduciary Duty to Company Creditors – IL Court in ‘Deep Cut’* Case

Five years in, Workforce Solutions v. Urban Services of America, Inc., 2012 IL App (1st) 111410 is still a go-to authority for its penetrating analysis of the scope of post-judgment proceedings, the nature of fraudulent transfer claims and the legal relationship between corporate officers and creditors.

Here are some key questions and answers from the case:

Q1: Is a judgment creditor seeking a turnover order from a third party on theory of fraudulent transfer (from debtor to third party) entitled to an evidentiary hearing?

A1: YES

Q2: Does the denial of a turnover motion preclude that creditor from filing a direct action against the same turnover defendants?

A2: NO.

Q3: Can officer of a debtor corporation owe fiduciary duty to creditor of that corporation?

Q3: YES.

The plaintiff supplier of contract employees sued the defendant in 2006 for breach of contract.  After securing a $1M default judgment in 2008, the plaintiff instituted supplementary proceedings to collect on the judgment.  Through post-judgment discovery, plaintiff learned that the defendant and its officers were operating through a labyrinthine network of related business entities.  In 2010, plaintiff sought a turnover order from several third parties based on a 2008 transfer of assets and a 2005 loan from the debtor to third parties.

That same year (2010), plaintiff filed a new lawsuit against some of the entities that were targets of the motion for turnover order in the 2006 case.

In the 2006 case, the court denied the turnover motion on the basis that the plaintiff failed to establish that the turnover defendants received fraudulent transfers from the judgment debtor and that the fraudulent transfer claims were time-barred.  740 ILCS 160/10 (UFTA claims are subject to four-year limitations period.)

The court in the 2010 case dismissed plaintiff’s claims based on the denial of plaintiff’s turnover motion in the 2006 case.  Plaintiff appealed from both lawsuits.

Section 2-1402 of the Code permits a judgment creditor to initiate supplementary proceedings against a judgment debtor to discover assets of the debtor and apply those assets to satisfy an unpaid judgment

A court has broad powers to compel the application of discovered assets to satisfy a judgment and it can compel a third party to turn over assets belonging to the judgment debtor.

The only relevant inquiries in a supplementary proceeding are (1) whether the judgment debtor is holding assets that should be applied to the judgment; and (2) whether a third-party citation respondent is holding assets of the judgment debtor that should be applied to the judgment. .  If the facts are right, an UFTA claim can be brought in supplementary proceedings

But where there are competing claimants to the same asset pool, they are entitled to a trial on the merits (e.g. an evidentiary hearing) unless they waive the trial and stipulate to have the turnover motion decided on the written papers.

Here, the court disposed of the turnover motion on the bare arguments of counsel.  It didn’t conduct the necessary evidentiary hearing and therefore committed reversible error when it denied the motion.

The defendants moved to dismiss the 2010 case – which alleged breach of fiduciary duty, among other things – on the basis of collateral estoppel.  They argued that the denial of the plaintiff’s motion for turnover order in the 2006 precluded them from pursuing the same claims in the 2010 case.  Collateral estoppel or “issue preclusion” applies where: (1) an issue previously adjudicated is identical to the one in a pending action; (2) a final judgment on the merits exists in the prior case; and (3) the prior action involved the same parties or their privies.

The appeals court found that there was no final judgment on the merits in the 2006 case.  Since the trial court failed to conduct an evidentiary hearing, the denial of the turnover order wasn’t final.  Since there was no final judgment in the 2006 suit, the plaintiff was not barred from filing its breach of fiduciary duty and alter ego claims in 2010.

The Court also reversed the trial court’s dismissal of the plaintiff’s breach of fiduciary duty claims against the corporate debtor’s promoters.  To state a claim for breach of fiduciary duty, a plaintiff must allege that the defendant owes him a fiduciary duty; that the defendant breached that duty; and that he was injured as a proximate result of that breach.

The promoter defendants argued plaintiff lacked standing to sue since Illinois doesn’t saddle corporate officers with fiduciary duties to a corporation’s creditors. The Court allowed that as a general rule, corporate officers only owe fiduciary duties to the corporation and shareholders.  “However, under certain circumstances, an officer may owe a fiduciary duty to the corporation’s creditors….specifically, once a corporation becomes insolvent, an officer’s fiduciary duty extends to the creditors of the corporation because, from the moment insolvency arises, the corporation’s assets are deemed to be held in trust for the benefit of its creditors.

Since plaintiff alleged the corporate defendant was insolvent, that the individual defendants owed plaintiff a duty to manage the corporate assets, and a breach of that duty by making fraudulent transfers to various third parties, this was enough to sustain its breach of fiduciary duty claim against defendants’ motion to dismiss. (¶¶ 83-84).

Afterwords:

1/ A motion for turnover order, if contested, merits a full trial with live witnesses and exhibits.

2/ A denial of a motion for a turnover order won’t have preclusive collateral estoppel effect on a later fraudulent transfer action where there was no evidentiary hearing to decide the turnover motion

3/ Once a corporation becomes insolvent, an officer’s fiduciary duty extends to creditors of the corporation.  This is because once insolvency occurs, corporate assets are deemed held in trust for the benefit of creditors.


* In the rock radio realm, a deep cut denotes an obscure song – a “B-side” – from a popular recording artist or album.  Examples: “Walter’s Walk” (Zeppelin); “Children of the Sea” (Sabbath); “By-Tor And the Snow Dog” (Rush).

Technically Non-Final Default Judgment Still Final Enough to Support Post-Judgment Enforcement Action – IL Fed Court (From the Vault)

Dexia Credit Local v. Rogan, 629 F.3d 612 (7th Cir. 2011) reminds me of a recent case I handled in a sales commission dispute.  A Cook County Law Division Commercial Calendar arbitrator ruled for our client and against a corporate defendant and found for the individual defendant (an officer of the corporate defendant) against our client on a separate claim.  On the judgment on award (JOA) date, the corporate defendant moved to extend the seven-day rejection period.  The judge denied the motion and entered judgment on the arbitration award.

Inadvertently, the order recited only the plaintiff’s money award against the corporate defendant: it was silent on the “not liable” finding for the individual defendant.  To pre-empt the corporate defendant’s attempt to argue the judgment wasn’t a final order (and not enforceable), we moved to correct the order retroactively or, nunc pro tunc, to the JOA date so that it recited both the plaintiff’s award against the corporation and the corporate officer’s award versus the plaintiff.  This “backdated” clarification to the judgment order permitted us to immediately issue a Citation to Discover Assets to the corporate defendant without risking a motion to quash the Citation.

While our case didn’t involve Dexia’s big bucks or complicated facts, one commonality between our case and Dexia was the importance of clarifying whether an ostensibly final order is enforceable through post-judgment proceedings.

After getting a $124M default judgment against the debtor, the Dexia plaintiff filed a flurry of citations against the judgment debtor and three trusts the debtor created for his adult children’s’ benefit.

The trial court ordered the trustee to turnover almost all of the trust assets (save for some gifted monies) and the debtor’s children appealed.

Affirming, the Seventh Circuit first discussed the importance of final vs. non-final orders.

The defendants argued that the default judgment wasn’t final since it was silent as to one of the judgment debtor’s co-defendants – a company that filed bankruptcy during the lawsuit.  The defendants asserted that since the judgment didn’t dispose of plaintiff’s claims against all defendants, the judgment wasn’t final and the creditor’s post-judgment citations were premature.

In Illinois, supplementary proceedings like Citations to Discover Assets are unavailable until after a creditor first obtains a judgment “capable of enforcement.”  735 ILCS 5/2-1402.  The debtor’s children argued that the default judgment that was the basis for the citations wasn’t enforceable since it did not resolve all pending claims.   As a result, according to debtor’s children, the citations were void from the start.

The Court rejected this argument as vaunting form over substance.  The only action taken by the court after the default judgment was dismissing nondiverse, dispensable parties – which it had discretion to do under Federal Rule 21.  Under the case law, a court’s dismissal of dispensable, non-diverse parties retroactively makes a pre-dismissal order final and enforceable.

Requiring the plaintiff to reissue post-judgment citations after the dismissal of the bankrupt co-defendant would waste court and party resources and serve no useful purpose.  Once the court dismissed the non-diverse defendants, it “finalized” the earlier default judgment.

Afterwords:

A final order is normally required for post-judgment enforcement proceedings.  However, where an order is technically not final since there are pending claims against dispensable parties, the order can retroactively become final (and therefore enforceable) after the court dismisses those parties and claims.

The case serves as a good example of a court looking at an order’s substance instead of its technical aspects to determine whether it is sufficiently final to underlie supplementary proceedings.

The case also makes clear that a creditor’s request for a third party to turn over assets to the creditor is not an action at law that would give the third party the right to a jury trial.  Instead, the turnover order is coercive or equitable in nature and there is no right to a jury trial in actions that seek equitable relief.