Class Plaintiffs’ Consumer Fraud Claim Against Headphone Maker Survives Motion to Dismiss

The class action plaintiffs in Zak v. Bose Corp., 2019 WL 1437909 (N.D.Ill. 2019) sued the Massachusetts-based headphone behemoth claiming its mobile application (“App”) secretly intercepted plaintiffs’ music selections and sold the information to a third party.

Plaintiffs sued under the Federal wiretap act, and lodged state law claims under Illinois’s eavesdropping and consumer fraud statutes. Bose moved to dismiss the entire Complaint.

Partially granting and partially denying Bose’s motion, the Northern District provides a useful summary of the overlap between Federal wiretap and State law eavesdropping claims and engages in a creative and decidedly post-modern application of the Illinois Consumer Fraud Act, 815 ILCS 505/2 et seq. (the “CFA”).

Plaintiffs alleged that when they selected music to be streamed to their smartphones, Bose’s App “recorded” the selected song, artist and album while in transit to Spotify (or similar music streamers) and sold that data to a data miner.  According to plaintiffs, Bose used the recorded information to create detailed user profiles without his/her consent.

Federal Wiretap and State Eavesdropping Claims

The Federal Wiretap Act (18 U.S.C. s. 2511(a) and Illinois’s Eavesdropping statute, 720 ILCS 5/14-2(a) outlaw the interception (or attempts to intercept) of any electronic communication.

Liability under each statute only attaches to intercepted electronic communications by someone who is not party to the communication.

There is no wiretap or eavesdropping liability for a person who is party to a communication or where a party gives prior consent to the interception of the communication.

The Court rejected plaintiffs’ wiretap and eavesdropping claims as Bose was a party to the communication. The Court found that Bose “participated” in the user-to-streamer communication by first conveying the user’s song selection to the streamer and then processing the streamer’s song information back to the user.

Since the main purpose of the App was to facilitate communication between a headphone consumer and Spotify, the plaintiff failed to sufficiently allege that Bose was not a participant in the underlying communications.

Illinois Consumer Fraud Act

The plaintiffs’ consumer fraud claim survived.  The CFA prohibits “unfair or deceptive acts or practices” including the misrepresentation, omission or concealment of a material fact. 815 ILCS 505/2.

To state a CFA claim, the plaintiff must allege: (1) a deceptive act or practice by defendant, (2) defendant’s intent that plaintiff rely on the deception, (3) the deception occurred in the course of conduct involving trade or commerce, and (4) actual damage to the plaintiff as a result of the deception.

A colorable CFA claim also requires that the plaintiff actually be deceived by a defendant’s statement or omission – a plaintiff must actually receive a communication from the defendant.

For an omission to be actionable, it must involve a “material fact.”  A fact is material where it is information a reasonable buyer would be expected to rely on in deciding whether to purchase a product or one that would have led a buyer to act differently had it known of the omitted fact.

The Court found the plaintiffs sufficiently stated a CFA claim.  Plaintiffs pled a deceptive act by alleging that Bose advertised the headphones and App on its packaging and website, and omitted that the App secretly collected user data which was then sold to a third party.

The plaintiffs also adequately pled that the deceptive act was material as plaintiffs would not have purchased Bose products and installed the App had they known defendants were going to secretly collect and transmit plaintiffs’ streamed music choices.

Finally, according to the Court, plaintiffs adequately alleged both Bose’s intention that Plaintiffs rely on the omission “because it knew that consumers would not otherwise purchase their products” and actual damages – that Bose charged a higher price for its products and plaintiffs wouldn’t have bought the products had they known the App would collect and disclose their information. [*6]

The Court rejected Bose’s arguments that the alleged deceptive act didn’t relate to a material fact and the plaintiffs’ failed to plead actual damages since they did not ascribe a value to the “free and optional” App. The Court held that whether an alleged statement or omission is material is not properly decided on a motion to dismiss.

On the damages question, the Court credited class plaintiffs’ allegations that they paid $350 for the headphones in part because of the App and would not have done so had they known about the App’s information tracking.

Take-aways:

Zak and cases like it lie at the confluence of consumer law, tort law and cyber security. Aside from presenting a useful summary of the Illinois consumer fraud act as well as the Federal wiretap law, the case showcases the liberal pleading plausibility standard that governs Rule 12(b)(6) motions.

While it is unclear whether plaintiffs will ultimately win, Zak demonstrates that so long as a consumer fraud plaintiff pleads at least some facts in support of its omission claim, it can likely survive a motion to dismiss.

Fourth Circuit Considers Reverse Piercing, Charging Orders, and Jurisdictional Challenges in Pilfered Cable Case

Sky Cable v. Coley (http://www.ca4.uscourts.gov/opinions/161920.P.pdf) examines the interplay between reverse piercing the corporate veil, the exclusivity of the charging order remedy, and jurisdiction over an unserved (with process) LLC based on its member’s acts.

In 2011, the plaintiff cable distributor sued two LLCs affiliated with an individual defendant (“Individual Defendant”) who was secretly supplying cable TV to over 2,000 rooms and pocketing the revenue.

After unsuccessfully trying to collect on a $2.3M judgment, plaintiff later moved to amend the judgment to include three LLCs connected to the Individual Defendant under a reverse veil-piercing theory. The Individual Defendant and one of the LLCs appealed the District Court order that broadened the scope of the judgment.

Affirming, the Fourth Circuit, applying Delaware law, found that the District Court properly reverse-pierced the Individual Defendant to reach LLC assets.

‘Reverse’ Veil Piercing

Unlike traditional veil piercing, which permits a court to hold an individual  shareholder personally liable for a corporate judgment, reverse piercing attaches liability to the entity for a judgment against a controlling individual. [10, 11]

Reverse piercing is especially apt in the one-member LLC context as there is no concern about prejudicing the rights of others LLC members if the LLC veil is pierced.

In predicting that a Delaware court would recognize reverse piercing, the Court held that if Delaware courts immunized an LLC from liability for a member’s debts, LLC members could hide assets with impunity to shirk creditors. [18, 19]

Charging Order Exclusivity?

The Court also rejected the Individual Defendant’s argument that Delaware’s charging statute, 6 Del. Code s. 18-703 was the judgment creditor’s exclusive remedy against an LLC member.

Delaware’s charging statute specifies that attachment, garnishment and foreclosure “or other legal or equitable remedies” are not available to the judgment creditor of an LLC member.

However, the Court found that piercing “is not the type of remedy that the [charging statute] was designed to prohibit” since the piercing remedy differs substantively from the creditor remedies mentioned in the charging statute.  The Court found that unlike common law creditor actions aimed at seizing a debtor’s property – piercing (or reverse-piercing) challenges the legitimacy of the LLC entity itself. As a result, the Court found that the plaintiff wasn’t confined to a charging order against the Individual Defendant’s LLC distributions.

The Court further held that applying Delaware’s charging law in a manner that precludes reverse piercing would impede Delaware’s interest in preventing its state-chartered corporate entities from being used as “vehicles for fraud”
by debtors trying to escape its debts. [20-22]

Alter Ego Finding

The Court also agreed with the lower court’s finding that the LLC judgment debtor was the Individual Defendant’s alter ego.  In Delaware, a creditor can establish does not have to show actual fraud. Instead, it (the creditor) can establish alter ego liability by demonstrating a “mingling of the operations of the entity and its owner plus an ‘overall element of injustice or unfairness.” [24-25]

Here, the evidence in the record established that the Individual Defendant and his three LLCs operated as a single economic unit.  The Court also noted the Individual Defendant’s failure to observe basic corporate formalities, lack of accounting records and obvious commingling of funds as alter ego signposts.

The most egregious commingling examples cited by the court included one LLC paying another entity’s taxes, insurance and mortgage obligations. The Court found it suspicious (to say the least) that the individual Defendant took mortgage interest deductions on his personal tax returns when an LLC was ostensibly paying a separate LLC’s mortgage.

Still more alter ego evidence lay in Defendant’s reporting an LLC’s profit and loss on his individual return. Defendant also could not explain at his deposition what amounts he received as income from the various LLCs.

Can LLC Member’s Post-Judgment Acts Subject LLC to Jurisdiction?

The Court also affirmed the District Court’s exercise of jurisdiction over the LLC judgment debtor based on the Individual Defendant’s acts even though the LLC was never served with process in the underlying suit.

Normally, service of summons and the operative pleading on a defendant is a precondition to a court’s exercise of personal jurisdiction over him. However, a court has “vicarious jurisdiction” over an individual where his corporate alter ego is properly before the court.  In such a case, an individual’s jurisdictional contacts are imputed to the alter ego entity.

The reverse can be true, too: where an LLC’s lone member is already before the Court, there is no concern that the LLC receive independent notice (through service of summons, e.g.) of the litigation. (This is because there are no other members to give due process protections to.)

Applying these rules, the Fourth Circuit found jurisdiction over the LLC was proper since the Individual Defendant appeared and participated in post-judgment proceedings. [30-36]

Afterwords:

Sky Cable presents a thorough discussion of the genesis and evolution of reverse veil-piercing and a creditor’s dogged and creative efforts to reach assets of a single-member LLC.

Among other things, the case makes clear that where an LLC is so dominated and controlled by one of its members at both the financial and business policy levels, the LLC and member will be considered alter egos of each other.

Another case lesson is that a judgment creditor of an LLC member won’t be limited to a charging order where the creditor seeks to challenge the LLC’s legitimacy; through either a traditional piercing or non-traditional reverse-piercing remedy.

Limitation of Damages Clause Doesn’t Bar Trade Secrets, Copyright Claims – IL ND

A Federal district court in Illinois recently addressed the scope of a limitation of damages provision in a dispute over automotive marketing software. The  developer plaintiff in Aculocity, LLC v. Force Marketing Holdings, LLC, 2019 WL 764040 (N.D. Ill. 2019), sued the marketing company defendant for breach of contract – based on the defendant’s failure to pay for plaintiff’s software – and joined statutory copyright and trade secrets claims – based on the allegation that the defendant disclosed plaintiff’s software source code to third parties.

The defendant moved for partial summary judgment that plaintiff’s claimed damages were foreclosed by the contract’s damage limitation provision. The court denied as premature since no discovery had been taken on plaintiff’s claimed damages.

The agreement limited plaintiff’s damages to the total amount the software developer plaintiff was to be paid under the contract and broadly excluded recovery of any “consequential, incidental, indirect, punitive or special damages (including loss of profits, data, business or goodwill).”  The contractual damage limitation broadly applied to all contract, tort, strict liability, breach of warranty and failure of essential purpose claims.

In Illinois, parties can limit remedies and damages for a contractual breach if the agreement provision is unambiguous and doesn’t violate public policy.

Illinois law recognizes a distinction between direct damages and consequential damages. The former, also known as “general damages” are damages that the law presumes flow from the type of wrong complained of.

Consequential damages, by contrast, are losses that do not flow directly and immediately from a defendant’s wrongful act but result indirectly from the act. Whether lost profits are considered direct damages depends on their (the lost profits) degree of foreseeability. In one oft-cited case, Midland Hotel Corp. v. Reuben H. Donnelley Corp., 515 N.E.2d 61, 67 (Ill.1987), the Illinois Supreme Court held that a plaintiff’s lost profits were direct damages where the publisher defendant failed to include plaintiff’s advertisement in a newly published directory.

The District Court in Aculocity found that whether the plaintiff’s lost profits claims were direct damages (and therefore outside the scope of the consequential damages disclaimer) couldn’t be answered at the case’s pleading stage.  And while the contract specifically listed lost profits as an example of barred consequential damages, this disclaimer did not apply to direct lost profits. As a result, the Court denied the defendant’s motion for partial summary judgment on this point. [*3]

The Court also held that the plaintiff’s statutory trade secrets and copyright claims survived summary judgment. The Court noted that the contract’s damage limitation clause spoke only to tort claims and contractual duties. It was silent on whether the limitation applied to statutory claims – claims the court recognized as independent of the contract. [*4] Since the clause didn’t specifically mention statutory causes of action, the Court refused to expand the limitation’s reach to plaintiff’s copyright and trade secrets Complaint counts.

Take-aways:

Aculocity and cases like it provide an interesting discussion of the scope of consequential damage limitations in the context of a lost profits damages claim. While lost profits are often quintessential consequential damages (and therefore defeated by a damage limitation provision), where a plaintiff’s lost profits are foreseeable and arise naturally from a breach of contract, the damages will be considered general, direct damages that can survive a limitation of damages provision.