7th Circuit Provides Primer on Fraudulent Transfer and Alter Ego Doctrine In Contract Dispute

The Seventh Circuit affirmed an almost $3M judgment against the defendants under fraudulent transfer, successor liability and alter ego rules in Center Point v. Halim, 2014 WL 697501.

The plaintiff energy company entered into a written contract to supply natural gas to defendants’ 41 Chicago area rental properties.  The individual defendants – a husband and wife – managed the properties through a management company (Company 1).

Over a two-year period, defendants used over $1.2M worth of plaintiff’s gas and didn’t pay for it.  Plaintiff sued Company 1 in state court and got a $1.7M judgment.  When plaintiff discovered that defendants transferred all of Company 1’s assets to Company 2, plaintiff sued Company 2 and the husband and wife in Federal court alleging a fraudulent transfer and successor liability.  The Northern District entered summary judgment for plaintiff in the amount of $2.7M on all claims and defendants appealed.

Affirming, the Seventh Circuit first found that the defendants’ conduct violated the Illinois Fraudulent Transfer Act, 740 ILCS 160/1 (the “Act”).  The Act punishes debtor attempts to avoid creditors through actual fraud or constructive fraud.

Constructive fraud applies where (1) a debtor transfers assets without receiving a reasonably equivalent value in exchange for the transfer and (2) the debtor intends to incur or reasonably should believe he will incur debts beyond his ability to pay them as they become due.  Halim, *2, 740 ILCS 160/5.

The Court found that the defendants’ actions were constructively fraudulent. First, the Court noted that during a three-year time span, Company 1 (the state court judgment debtor) transferred almost $11M to the individual defendants; ostensibly to repay loans.

But the Court found it odd there was no documentation of loans or a paper trail showing where the millions of dollars went.  The suspicious timing of defendants’ creation of a new company – Company 2 – coupled with the defendants’ inability to account for the millions’ whereabouts, bolstered the Court’s constructive fraud finding.

Since the individual defendants’ depletion of Company 1’s assets made it impossible for it to pay the state court judgment, the defendants’ actions were constructively fraudulent under the Act. *3.

The Court also affirmed summary judgment for the plaintiff under successor liability and alter ego theories.  In Illinois, the general rule is that a company that purchases assets of another company does not assume the liabilities of the purchased company.

A common exception to this rule is where there is an express assumption (of liability) by the purchasing company.  Here, the record showed that Company 2 assumed all rights, obligations, contracts and employees of Company 1.  As a result, the unsatisfied state court judgment attached to Company 2 under successor liability rules.

The Court also affirmed the judgment under the alter ego doctrine.  Alter ego applies where there is virtually no difference between the business entity and that entity’s controlling shareholders.  That is, the dominant shareholders don’t treat the corporation as a separate entity and fail to follow basic corporate formalities (e.g. minutes, stock issuance, incorporation papers, etc.).

The individual defendants treated Company 1 as their personal piggy bank by commingling their personal assets with the corporate assets.  There were no earmarks of “separateness” between the individual defendants’ assets and Company 1’s corporate assets.  *3-4.

Because of this, the husband and wife defendants were responsible (in the Federal suit) for the unsatisfied state court judgment entered against the defunct Company 1.

Take-away: Halim illustrates that where a judgment debtor corporation or controlling shareholders of that corporation transfer all corporate assets to a new, similarly named (or not) entity shortly after a lawsuit is filed, it will likely look suspicious and can lead to a constructive fraud finding.

The case also underscores the importance of following corporate formalities and keeping corporate assets separate from individual/personal assets – especially where the corporation is controlled by only two individuals.  A failure to treat the corporation as distinct from the dominant individuals, can lead to alter ego liability for those individuals.

Joint Mortgage Debt Means No Tenancy By Entirety Protection for Homeowners

The Illinois First District recently affirmed a mortgage foreclosure summary judgment for a plaintiff mortgage lender in a case involving the protection given to tenancy by the entirety (TBE) property.

In Marquette Bank v. Heartland Bank and Trust, 2015 IL App (1st) 142627, the main issue was whether a marital home was protected from foreclosure where it was owned by a land trust, the beneficiaries of which were a husband and wife; each owning beneficial interests TBE.

The defendants argued that since their home was owned by a land trust and they were the TBE beneficial owners of that land trust, the plaintiff could not foreclose its mortgage.

Affirming summary judgment, the appeals court examined the interplay between land trust law and how TBE property impacts judgment creditors’ rights.

The Illinois Joint Tenancy Act (765 ILCS 1005/1c) allows land trust beneficiaries to own their interests TBE and Code Section 12-112 (735 ILCS 5/12-112) provides that a TBE land trust beneficial interest “shall not be liable to be sold upon judgment entered….against only one of the tenants, except if the property was transferred into [TBE] with the sole intent to avoid the payment of debts existing at the time of the transfer beyond the transferor’s ability to pay those debts as they become due.”

TBE ownership protects marital residence property from a foreclosing creditor of only one spouse.  In TBE ownership, a husband and wife are considered a single unit – they each own 100% of the home – and the judgment creditors of one spouse normally can’t enforce a money judgment against the other spouse by forcing the home’s sale.

An exception to this rule is where property is conveyed into TBE solely to evade one spouse’s debt.  Another limitation on TBE protection is where both spouses are jointly liable on a debt.  In the joint debt setting, a judgment against one spouse will attach to the marital home and can be foreclosed on by the judgment creditor.

Code Section 12-112 provides that where property is held in a land trust and the trust’s beneficial owners are husband and wife, a creditor of only one of them can’t sell the other spouse’s beneficial land trust interest. 735 ILCS 5/12-112.

The Court rejected the defendants argument that as TBE land trust beneficiaries of the marital home, the spouse defendants were immune from foreclosure.  It noted that both spouses signed letters of direction authorizing the land trustee (owner) to mortgage the property, the mortgage documents allowed the plaintiff to foreclose in the event of default and empowered the lender to sell all or any part of the property. (¶¶ 16-18)

Summary Quick-Hits:

  • TBE property ownership protects an innocent spouse by saving the marital home from a judgment creditor’s foreclosure suit where only one spouse is liable on a debt;
  • A land trust beneficial interest is considered personal property and can be jointly owned in tenancy by the entirety;
  • Where spouses are jointly (both) liable on an underlying debt, TBE property can be sold to satisfy the joint debt.

 

Denial of Motion for Judgment in Citation Proceedings Not Final – Appeal Dismissed (IL 1st Dist.)

While there are nuances and some exceptions to it, the general rule is that only “final” orders are appealable.  If a trial court’s order is final, the losing party can appeal it.  If the order isn’t final – meaning, the case is still going on – the losing party can’t appeal it.  Whether an order is final is often overlooked during the heat of trial battle.  However, as today’s feature case illustrates, the failure to appreciate the final versus non-final order distinction can doom an appeal as premature.

National Life Real Estate Holdings, LLC v. International Bank of Chicago, 2016 IL App (1st) 151446, the plaintiff judgment creditor won a $3MM-plus judgment against an individual and two LLC defendants. In trying to enforce the money judgment, the plaintiff issued a third-party citation to IBC, the respondent and defendant.

Upon learning that after IBC disbursed $3.5MM in loan funds to two businesses associated with the individual judgment debtor after it received the third-party citation, the plaintiff moved for judgment against IBC on the basis that it violated its obligations as a third-party citation respondent (to not transfer any of the judgment debtor’s property).

The circuit court denied the plaintiff’s motion.  It found that since the loan funds disbursed by IBC were not paid to and didn’t belong to the judgment debtor, IBC did not flout the citation’s “restraining provision” (which prevents a citation respondent from disposing of property belonging to a judgment debtor).  Affirming, the appeals court discussed the pertinent rules governing when orders entered in post-judgment proceedings can be appealed.

  • An appeal can only be taken from a “final order”‘
  • An order is final where it disposes of the rights of the parties, either upon the entire lawsuit or upon a separate and definite part of it;
  • A final order entered in a post-judgment proceeding is appealable, too;
  • A post-judgment order is deemed final when the judgment creditor is in a position to collect against the judgment debtor or third-party or the judgment creditor is prevented from doing so by court order;
  • A post-judgment order that does not (a) leave a creditor in position to collect a judgment or that (b) conclusively bars the creditor from collecting, is not final for purposes of appeal. 

(¶10); See 735 ILCS 5/2-1402; Ill. Sup. Ct. R. 304(b)(4).

The trial court’s order denying the judgment creditor’s motion for judgment wasn’t final as it didn’t end the lawsuit.  The appeals court noted the case is still pending and the judgment creditor may still have valid claims against IBC.  Since the trial court’s denial of the judgment creditor’s motion didn’t foreclose it from future collection efforts, the denial of the motion wasn’t a final and appealable order.  As a consequence, the creditor’s appeal was premature and properly dismissed.

Afterwords:

In hindsight, the plaintiff should have requested a Rule 304(a) finding that the order denying the motion for judgment was appealable.  While the court could have denied the motion, it would have at least give the creditor a shot at having an appeals court review the trial court’s order.

Going forward, the plaintiff should issue third-party citations to the loan recipients (the two business entities) and see if it can link the individual debtor to those businesses.  The plaintiff should also issue discovery to IBC to obtain specifics concerning the post-citation loan.  This information could give the plaintiff ammunition for future litigation against IBC relating to the loans.