Former LLC Member’s Claim for Distributions Not Tangible Enough to Undergird Conversion Claim – IL ND

The Northern District of Illinois considers a plethora of signature complex litigation issues in FW Associates, LLC v. WM Associates, LLC, 2019 WL 354953 (N.D.Ill. 2019), the culmination of a years’ long dispute between LLC members over ownership and management of Smart Bar –  a company that made an automatic cocktail dispenser [the Smartender].

After a flurry of lawsuits and an arbitration hearing that resulted in a nearly half-million dollar money judgment, the judgment creditor plaintiff brought fraudulent transfer claims against a former LLC member and his family-owned entity to whom the ex-member transferred his Smart Bar ownership interest.

The former member and his family enterprise swiftly countersued to dissolve Smart Bar, to force plaintiff to buy-out the member’s Smart Bar interest, and for conversion of the counter-plaintiff’s distributional interest in Smart Bar.

Granting the plaintiff/counter-defendant’s motion to dismiss all counts of the Counterclaim, the Court first rejected the Counter-Plaintiffs LLC Act claims under Sections 15-20 and 35-1.  It held that the individual Counter-Plaintiff lacked standing to sue under the former section as he was no longer a Smart Bar member.  The court nixed the counter-plaintiff’s Section 35-1 buy-out claim because he failed to sue the Smart Bar entity as a necessary party defendant. According to the Court, Section 35-1 does not provide an independent basis for a member to sue another member for a buyout.

In rejecting the conversion claim [premised on the claim that Plaintiffs pilfered the individual Counter-Plaintiff’s distributional interest in Smart Bar], the Court focused on the intangible nature of LLC distributions. Illinois courts do not recognize claim for conversion of intangible rights.  A conversion action to recover funds based on bare obligation to pay money is not actionable.

Citing another Federal case as precedent, the Court found that a member’s right to LLC distributions was too nebulous to anchor a conversion suit. Conversion requires theft of tangible property or property readily reduceable to cash.  Since the expectancy interest in future distributions couldn’t quickly be monetized, the Court found that the claim to future LLC distributions would not support a conversion claim.

The Court then considered Plaintiff’s res judicata and collateral estoppel defenses.

Claim preclusion, or res judicata, applies where (1) there is a final judgment on the merits rendered by a court of competent jurisdiction; (2) an identity of cause of action exists; and (3) the parties or their privies are identical in both actions.

Whether the causes of action are identical turns on whether “they arise from a single group of operative facts, regardless of whether they assert different theories of relief.”

The Court found res judicata did not bar the Counter-claim because there was no identity of causes of action between the earlier arbitration hearing and the instant case.  The Court noted that the counterclaim related to facts arising after the arbitration hearing – including the wrongful removal of two Smart Bar board members and plaintiffs’ clandestine purchase of member interests without notice to the counter-plaintiffs.  Since the predicate counterclaim allegations involved actions that post-dated the arbitration hearing, the claims were not barred by claim preclusion.

Issue preclusion, a/k/a collateral estoppel, applies where (1) the issue decided in the prior adjudication is identical with the one presented in the suit in question, (2) there was a final judgment on the merits in the prior adjudication, and (3) the party against whom estoppel is asserted was a party or in privity with a party to the prior adjudication.

Here, the court found that there was clearly a final judgment on the merits and the same parties involved.

The Court also found element (1) was satisfied.  It ruled that the arbitrator’s ruling on whether the individual defendant/counter-plaintiff breached the Smart Bar Operating Agreement was an identical issue raised in the Federal case.  This was so because three counts of the Counterclaim sought to enforce the terms of the Operating Agreement.

Since the counterclaim turned on whether the counter-plaintiff satisfactorily performed his Operating Agreement duties, and the arbitrator ruled definitively that he did not, the counterclaim counts alleging [Smart Bar] Operating Agreement infractions were barred by collateral estoppel/issue preclusion.

Afterwords:

To sue for a forced buy-out under Section 180/35-1(b) of the LLC Act, the claimant must name the LLC entity as party defendant.  The statute provides no independent basis for an aggrieved LLC member to sue another member.

A conversion suit won’t lie for a member suing to recover a judgment debtor’s LLC distribution.  Future and unknown LLC distributions are too ephemeral to support a conversion action.  If a distribution isn’t readily reduceable to cash money, the conversion claim will fail.

An arbitrator’s ruling can satisfy the final judgment on merits component of both claim preclusion [res judicata] and issue preclusion [collateral estoppel]

 

 

 

‘Half a Mil’ Conditional Judgment Too Harsh for Anemic Citation Response – IL First Dist.

Hayward v. Scorte, 2020 IL App (1st) 190476, reads like a creditors’ rights practice manual for its detailed discussion of the nature and scope of various creditor remedies under the Illinois supplementary proceedings and garnishment statutes.  (735 ILCS 5/2-1402 and 735 ILCS 5/12-701 et seq., respectively.)

The plaintiffs confirmed a half-million dollar arbitration award against a corporate defendant in a construction dispute and sought to collect. In post-judgment discovery, the post-judgment court (the Law Division’s Tax and Misc. Remedies Div.) found that the corporate debtor’s two owners failed to properly respond to citations served upon them by plaintiffs’ counsel.

The trial court entered a conditional judgment (later converted to a final one) against each corporate officer for the full amount of the underlying judgment.  The officers appealed.

Reversing, the First District first noted that supplementary proceedings in Illinois allow a judgment creditor to pursue any assets in the judgment debtor’s possession or that are being held by third parties and apply those assets to satisfy the judgment. See 735 ILCS 5/2-1402.

In the garnishment context, 735 ILCS 5/12-701 et seq., where a third party fails to respond to a garnishment summons, the creditor garnisher can request a conditional judgment against the garnishee. 735 ILCS 5/12-706.

Once the conditional judgment is entered, the creditor issues a summons to the respondent.  If the respondent still fails to answer the garnishment summons, the conditional judgment is confirmed or finalized. Once the garnishee responds to the conditional judgment summons, it isn’t bound by the earlier default and can litigate afresh. [21]

Section 12-706’s twin goals is to provide an incentive for respondents to answer a properly served garnishment summons and to protect a respondent from Draconian consequences of a single oversight. 735 ILCS 5/12-706. [21]

Code Section 2-1402 permits a court to enter any order or judgment that could be entered in a garnishment proceeding. 735 ILCS 5/2-1402(k-3).

But while Section 2-1402(k-3) incorporates the garnishment act’s full range of remedies, the section does not give a creditor broader rights than exist under garnishment law.  [23]

Conditional judgments are only allowed where a garnishee fails to appear and answer.  Here, the third-party respondents (the two corporate officers) did appear and answer the citation; the trial judge just deemed the answer incomplete.

The Court then noted that garnishment act Section 12-711(a) speaks to the precise situation here: it allows a judgment creditor to challenge the sufficiency of a garnishee’s answer and request a trial on those issues.  735 ILCS 5/12-711(a).

The garnishment statute is silent on the consequences of incomplete or insufficient answers.  Since the corporate officers did answer the underlying citations, the Court held that the trial court lacked statutory authority to enter a full money judgment against the individual defendants under Code Section 2-1402(k-3). [26]

Next, the Court examined the interplay between Section 2-1402(c)(3) and (c)(6).  The former section speaks to situations where a third party has embezzled or converted a judgment debtor’s assets.  The latter permits a  judgment creditor to sue a third party (i.e. to bring a separate cause of action) where that third party is indebted to a judgment debtor.

The Court pointed out that neither section allowed a court to assess the entire underlying judgment against a third party without a specific finding that party converted or embezzled a debtor’s assets. [27]

In fact, the lone statutory basis for a court to enter a full judgment against a third-party is where it violates the citation’s restraining provision – Section 2-1402(f)(1).

This section allows a court to punish a third party that transfers, disposes of or interferes with a judgment debtor’s non-exempt property – after a citation is served – by entering a money judgment for the lesser of (a) the unpaid amount of a judgment or (b) the value of the asset transferred. [27, 28]

The Court then stressed that a citation lien applies only to property transfers occurring after a citation is served.  Pre-citation transfers, by contrast, cannot form the basis of a money judgment against a third party.  Since the plaintiffs’ conditional judgment motion was predicated in part on property transfers occurring some two years before the citations were issued, they fell beyond the scope of sanctions considered by the trial court.

An additional ground for the First District’s reversal lay in the absence of proof that the corporate officers held any corporate assets.  Illinois law is clear that before a court can enter a judgment against a third party, there must be some record evidence that the third party possesses assets belonging to the debtor.

Since there was no statutory bases to assess the full money judgment against the two erstwhile corporate principals and since there was no evidence either principal had any corporate debtor assets in their possession, the trial court overstepped by entering a money judgment against the individual corporate officer defendants.

Take-aways:

A third party must be in possession of a debtor’s assets before a money judgment can issue against that third party;

While the garnishment act allows for a conditional judgment where a respondent fails to appear and answer a garnishment summons, and Illinois’s supplementary proceedings statute incorporates garnishment remedies, the garnishment act does not permit a conditional judgment against a garnishee who does in fact answer a garnishment summons;

A judgment creditor should file a separate veil-piercing suit against a defunct corporation’s principals if the creditor believes they are holding erstwhile corporate assets.