Cal. Court Validates Reverse-Piercing; Creditor Can Add LLC to Prior Judgment Against Member

I previously featured (here) a 2018 4th Circuit decision that discussed reverse veil-piercing under Delaware law.  In 2017, a California court provided its own trenchant analysis of reverse veil-piercing and how that remedy relates to a charging order against an LLC member’s distributional interest.

The judgment creditor plaintiff in Curci Investments, LLC v. Baldwin, 14 Cal.App.5th 214 (2017) won a $7.2M judgment against a prominent real estate developer. In post-judgment discovery, the creditor learned the developer was sheltering his assets in an LLC; an entity through which he also loaned over $40M to family members and partnerships in the years leading up to the judgment.

The trial court denied the creditor’s motion to “reverse pierce” and hold the LLC responsible for the judgment.  The court reasoned that reverse-piercing was not a recognized remedy in California. The creditor appealed.

First, the court noted, under California law, a judgment creditor can move to modify a judgment to add additional judgment debtors. See Cal. CCP 187.

The court then stressed that an LLC’s legal separation from its members may be disregarded where the LLC is utilized to “perpetrate a fraud, circumvent a statute, or accomplish some other wrongful or inequitable purpose.”

In such circumstances, the acts of the LLC will be imputed to the individual members or managers who dominate the LLC. Under this alter-ego doctrine, individuals or other entities cannot abuse the corporate form to commit a fraud or elude creditors.

The appeals court broke with the trial judge and held that California recognizes “outside reverse veil piercing.” This applies where a third-party creditor tries to satisfy an individual’s debt by attaching assets of an entity controlled by that individual.

The reasons typically given by courts that decline to reverse pierce are discouraging creditor’s from bypassing standard judgment collection protocols, the protection of innocent shareholders and preventing the use of equitable remedies where legal theories or remedies are available.

Here, however, those policy concerns weren’t present.

First, the court noted that unlike in the corporate debtor context – where a creditor can step into a shareholder’s shoes and obtain shares, the right to vote and to dividends – a creditor’s rights against an LLC member are limited.

With an LLC, a plaintiff can only get a charging order against the LLC member’s distributional interest. The member remains an LLC member and keeps all of his/her rights to manage and control the LLC.

And since the individual defendant in Curci retained complete control to decide if and when LLC distributions would be made, the charging order was an illusory remedy.

This last point was blinding in light of the evidence that the defendant caused the LLC to distribute nearly $180M in the six years leading up to the judgment and no distributions had been made in the five years after the judgment.

The Court further distinguished the charging order remedy from reverse piercing in that the former only affixes to an LLC member’s distributional interest while the latter remedy reaches the LLC’s assets; not the individual member’s. [7]

Second, there was no possibility that an innocent shareholder would be harmed. This was because the judgment debtor owned a 99% interest in the LLC. (The 1% holder was the debtor’s wife who, under California community property laws, was also liable for the debt owed to the plaintiff.)

Lastly, there was no concern of the plaintiff using reverse-piercing to circumvent legal remedies like conversion or a fraudulent transfer suit. The court found that burdening the creditor with showing the absence of a legal remedy would sufficiently protect against indiscriminate reverse piercing.

Afterwords:

While Curci presents an extreme example of an individual using the corporate form to elude a money judgment, the case illustrates the clear proposition that if an individual judgment debtor is using a business entity to shield him/herself from a judgment, the court will reverse pierce and hold the sheltering business jointly responsible with the individual for a money judgment.

The case should be required reading for any creditor’s rights practitioners; especially on the West Coast.

Court Weighs In On Constructive Fraud in Contractor Lien Dispute, Summary Judgment Burdens – IL First Dist.

The First District affirmed partial summary judgment for a restaurant tenant in a contractor’s mechanics lien claim in MEP Construction, LLC v. Truco MP, LLC, 2019 IL App (1st) 180539.

The contractor sued to foreclose its $250,000-plus mechanics lien for unpaid construction management services furnished under a written contract between the contractor and restaurant lessee.

The lessee moved for summary judgment arguing the contractor completed only about $120,000 worth of work and so the lien was doubly inflated.  The lessee further contended that the majority of the liened work was done by plaintiff’s sub-contractors; not the plaintiff. The trial court sided with the lessee and found the plaintiff’s lien constructively fraudulent.

Affirming, the appeals court first restated the familiar, governing summary judgment standards and the contours of constructive fraud in the mechanics’ lien context.

The “put up or shut up” litigation moment – summary judgment requires the opposing party to come forward with evidence that supports its skeletal pleadings allegations.

Statements in an affidavit opposing summary judgment based on information and belief or that are unsupported conclusions, opinions or speculation are insufficient to raise a genuine issue of material fact.

Section 7 of the Illinois mechanics lien act (770 ILCS 60/7) provides that no lien shall be defeated due to an error or overcharging unless the overcharge (or error) is “made with intent to defraud.” Section 7 aims to protect the honest lien claimant who makes a mistake rather than the dishonest claimant who makes a knowingly false statement. Benign mistakes are OK; purposeful lien inflation is not.
An intent to defraud can be inferred from “documents containing overstated lien amounts combined with additional evidence.” The additional evidence or “plus factor” requires more than a bare overcharge on a document: there must be additional evidence at play before a court invalidates a lien as constructively fraudulent.

Affirming the trial court’s constructive fraud ruling, the First District pointed to plaintiff’s president’s sworn statement which indicated plaintiff only performed a fraction of the liened work and that the majority of the lien was from subcontractors who dealt directly with the lessee. Critical to the court’s conclusion was that the plaintiff did not have contractual relationships with its supposed sub-contractors.

Looking to Illinois lien law case precedent, the Court noted that lien overstatements of 38%, 82% and 79% – all substantially less than the more than 100% overstatement here – were all deemed constructively fraudulent by other courts. [⁋ 17]

The Court also affirmed the lower court’s denial of the contractor’s motion for more discovery. (The contractor argued summary judgment was premature absent additional discovery.) Illinois Supreme Court Rule 191(b) allows a party opposing summary judgment to file an affidavit stating that material facts are known only to persons whose affidavits can’t be obtained due to hostility or otherwise. The failure to file a 191(b) motion precludes that party from trying to reverse a summary judgment after-the-fact on the basis of denied discovery. [⁋ 20]

Here, the contractor’s failure to seek additional time to take discovery before responding to the lessee’s summary judgment motion doomed its argument that the court entered judgment for the lessee too soon.

Take-aways:

Constructive fraud requires more than a simple math error. Instead, there must be a substantial overcharge coupled with other evidence. Here, that consisted of the fact the contractor neither performed much of the underlying services nor had contractual relationships with the various subcontractors supposedly working under it.

The case also solidifies the proposition that while there is no magic lien inflation percentage that is per se fraudulent, an overstatement of more than 100% meets the threshold.

Procedurally, the case lesson is for a summary judgment respondent to timely move for more discovery under Rule 191(b) and to specifically identify the material evidence the summary judgment respondent needs to unearth in the requested discovery.

Contingent, ‘PI’ Firm’s Dearth of Time Records Dooms Attorneys’ Fee Award in Real Estate Spat

A personal injury firm’s (Goldberg, Weisman and Cairo) failure to properly document its attorney time records resulted in an almost 88% fee reduction after the defendants appealed from a real estate dispute bench trial verdict.

The plaintiffs – one of whom is a GWC attorney – in Kroot v. Chan, 2019 IL App (1st) 181392 sued the former property owners for violating Illinois Residential Real Property Disclosure Act, 765 ILCS 77/1 et. seq. (the Act) after they failed to disclose known property defects to the plaintiffs.

The trial court found for the plaintiffs on their Act claims and common law fraud claims and assessed nearly $70,000 in attorneys’ fees and costs against defendants. The defendants appealed citing the plaintiffs’ dearth of competent fee support.

Reversing, the First District emphasized how crucial it is for even a “contingent fee law firm” like GWC to sedulously document its attorney time and services.

Under Illinois law, a plaintiff seeking an attorney fee award had the burden of proving entitlement to fees. Additionally, an attorneys’ fee award must be based on facts admissible in evidence and cannot rest on speculation, conjecture or guess-work as to time spent on a given task.

Unless there is a contractual fee-shifting provision or a statute that provides for fees, an unsuccessful litigant is not responsible for the winner’s fees. And while the Act does provide a “hook” for attorneys’ fees, the common law fraud claim did not. As a result, the First District held that the fraud verdict against one defendant wasn’t properly subject to a fee petition.

“Reasonable attorneys’ fees” in the context of a fee-shifting statute (like the Act) denotes fees utilizing the prevailing market rate. The Act’s fee language differs from other statutes in that it provides that fees can be awarded to a winning party only where fees are incurred by that party. “Incurred,” in turn, means “to render liable or subject to” [⁋⁋ 11-12 citing Webster’s Third New International Dictionary 1146 (1981)]. As a consequence, unless attorneys’ fees have actually been incurred by a prevailing party, the trial court has no authority to award fees under the Act.

At the evidentiary hearing on plaintiff’s fee petition, three GWC attorneys admitted they didn’t enter contemporaneous timesheets during the litigation and that a document purportedly summarizing GWC’s attorney time was only an estimate. The lawyers also conceded that plaintiffs didn’t actually pay any legal fees to GWC. Still another attorney witness acknowledged she tried to reconstruct her time nearly 8 months after the underlying work was performed. [⁋ 19]

The appeals court noted the record was devoid of any evidence that (1) plaintiffs ever agreed to pay for legal services, (2) plaintiffs were ever billed for GWC’s legal services, (3) plaintiff ever paid for those services, or (4) that GWC expected plaintiffs’ to pay for its services. The court also found that the supporting affidavits submitted in support of the fee petition were inadmissible hearsay documents. (It’s not clear from my reading of the opinion why the affidavits and billing record did not get into evidence under the business records hearsay exception.)

In the end, the Court found the absence of either simultaneous time records or testimony that the attorney working on the matter had an independent recollection of the time and tasks incurred/performed rendered the fee petition too speculative.

Kroot provides a useful gloss on the governing standards that control when a plaintiff can recover attorneys’ fees. Aside from stressing the importance of making contemporaneous time records and offering proper supporting fee evidence, the case’s lesson is that in the context of a statute like the Act that only provides for fees actually incurred, the plaintiff must actually pay attorneys’ fees to merit a fee award. Since the evidence was that the prevailing plaintiffs never actually were billed or paid any fees to their attorneys, the plaintiffs’ lawyers failed to carry their burden of proof on the fees issue.