Discovery Screw-Up Not Enough To Sustain Negligence Claim – 7th Cir.

Nixing an $8M Federal jury verdict, the Seventh Circuit recently held, among other things, that a discovery rule violation cannot undergird a negligent misrepresentation claim.

The plaintiffs in Turubchuk v. Southern Illinois Asphalt Company, 958 F.3d 541 (7thCir. 2020), twice sued a joint venture consisting of two paving contractors for personal injuries sustained in a 2005 traffic accident.  The first lawsuit, sounding in negligence, settled for $1MM, the amount plaintiff believed was the maximum available insurance coverage based on the defendant’s for the JV defendant’s attorneys’ pretrial discovery disclosures.

When the plaintiffs learned that the $1MM coverage cap only applied to the joint venture entity and not to the venture’s component companies, they sued again.  This second suit alleged fraud and negligent misrepresentation – that the defendant’s counsel misrepresented its insurance coverage limits.  Plaintiffs eventually went to trial only on their negligent misrepresentation claim.

This second suit culminated in the jury’s $8MM-plus verdict.  Defendant appealed citing a slew of trial court errors.

Reversing, the Court first considered the effect of Defendant’s erroneous Rule 26 disclosure.   Under Illinois law, an actionable negligent misrepresentation claim requires proof of a legal duty on the person making the challenged statement to convey accurate information.

The Plaintiffs alleged the Defendant’s duty was found in the disclosure requirements of Rule 26 – the Federal rule governing pre-trial witness and document disclosures.  The Court found no case authority that grounded a negligence duty in a federal procedural rule.  Instead, the Court noted, cases from the 9thCircuit and 7thCircuit held just the opposite and further opined that discovery rules are “self-policing:” a discovery violation subjects the violator to sanctions under Rules 26 and 37.

The 7thCircuit also ruled that the District Court erred in finding as a matter of law (on pretrial summary judgment and in-limine orders) that defendant breached its duty to plaintiffs and that plaintiffs justifiably relied on the representations.

Whether a defendant breaches a legal duty and whether a plaintiff reasonably relies on a representation are natural fact questions. Here, on the existence of a legal duty prong, there were a plethora of unanswered questions – i.e. what information did the attorney have at his disposal when plaintiff made a $1MM policy limits (or so he thought) demand before discovery even started? – that raised possible disputed fact questions that are normally jury questions.  The District Court’s pre-trial ruling on these issues hamstrung the defendant’s efforts to challenge whether defendant’s counsel acted negligently. [15]

Another trial court error stemmed from the non-reliance clause contained in the written release that settled the Plaintiffs’ first negligence lawsuit.  A non-reliance clause will normally foreclose a future fraud suit since reliance is one of the salient fraud elements.

That said, Illinois case law is in flux as to whether a non-reliance clause precludes a later fraud action.

In addition, whether reliance is justified in a given fact setting is quintessentially a triable fact question involving what a statement recipient knew or could have learned through the exercise of ordinary prudence.  This case authority uncertainty coupled with the multiple fact issues endemic to the justifiable reliance inquiry made it improper for the District judge to make a per se, pre-trial finding that plaintiffs justifiably relied on the defendant’s counsel’s insurance coverage disclosure.

The evidence was also conflicting on whether the defendant entities even had a joint venture.  Whether or not defendants were a joint venture was integral to the amount of insurance available to settle Plaintiffs’ claims and so it impacted the causation and damages elements of plaintiffs’ negligent misrepresentation case.

A hallmark of a joint venture is joint ownership or control of a business enterprise. See http://paulporvaznik.com/joint-ventures-in-illinois-features-and-effects/6699. This created disputed fact questions that should have been decided by the jury.

Next, the Court overturned the jury’s finding that Plaintiffs’ established that Defendant’s attorney intended to induce Plaintiffs’ reliance on the amount of available insurance coverage. [The intent to induce reliance element was the only negligent misrepresentation element that went to the jury.]

Federal Rule of Evidence 602 requires a witness to testify based on personal knowledge.

However, there was no such testimony adduced at trial. Instead, the only trial evidence on this negligent misrepresentation element was  Plaintiffs’ counsel’s self-serving speculative testimony that defendant’s counsel misrepresented the available insurance coverage to induce Plaintiffs’ to accept a relatively paltry $1MM to settle the case. [21, n. 11]. Moreover, the District Court improperly excluded evidence of Plaintiff’s counsel’s credibility since he had previously surrendered his law license in lieu of disbarment for alleged acts of dishonesty, fraud or misrepresentation. See FRE 608.

In the end, the Court found there was insufficient evidence at trial for the jury to find that Defendant’s counsel intended to induce Plaintiffs’ reliance on the Rule 26 discovery disclosures of insurance coverage.

Afterwords:

A negligent misrepresentation claim cannot be premised on violation of a Federal discovery rule;

The court invades province of the jury when it rules on elements that are inherently fact-driven;

Evidence Rules 602 and 608 respectively limit a trial witness to testifying to matters of personal knowledge and allow an opponent to probe that witness’s credibility by delving into his/her reputation for truthfulness.

 

 

 

Business Expectancy Not A Transferrable ‘Asset’ Under IL Fraudulent Transfer Statute [Deconstructing Andersen Law LLC v. 3 Build Construction LLC]

Andersen Law LLC v. 3 Build Construction, LLC, 2019 IL App (1st) 181575-U, the subject of my most recent post, here , examines the nature and reach of Illinois’s Fraudulent Transfer Act, 740 ILCS 160/1 et seq. [“IFTA”] and the ‘continuation’ exception to the successor liability rule.

The Plaintiffs’ IFTA claims were based on allegations that former members of the LLC debtors’ systematically raided company bank accounts and formed a new business entity to evade a money judgment.

A colorable IFTA claim – whether it sounds in actual or constructive fraud – requires a creditor-debtor relationship.  It also requires the plaintiff to allege a transfer of an identifiable asset.

Here, the Court found the Plaintiffs failed to allege either a debtor-creditor relationship between the judgment creditor and the individual LLC members or a transfer of debtor assets.  The Plaintiffs’ failure to allege that the debtor made transfers without receiving a reasonably equivalent value in exchange for the transfer also doomed their constructive fraud complaint count.

Next, the Court jettisoned the Plaintiffs’ actual fraud claims under IFTA Section 5(a)(1).  In an actual fraud claim, the plaintiff must show a specific intent to defraud a creditor. This Section goes on to list some eleven (11) “badges” of fraud ranging from whether the transfer was concealed, to whether the transferee was a corporate insider to whether a transfer encompassed the bulk of a debtor’s assets.  740 ILCS 160/5(b)

The Plaintiffs’ allegation that the transfers were fraudulent because they occurred within a year of the judgment or went to pay members’ personal expenses were deemed too conclusory to satisfy the pleading requirements for an IFTA actual fraud claim.

The Court then rejected the Plaintiffs’ IFTA Section 6(a) [which governs claims arising before a transfer] claim based on the debtors forming a new corporation and diverting debtors’ business opportunities to that new entity.

An IFTA claim requires a transfer.  “Transfer” is defined as “every mode….of disposing of or parting with an asset or an interest in an asset…” 740 ILCS 160/2(l).

“Asset” is defined as “property of a debtor” while “property,” in turn, means anything that may be the subject of ownership.  740 ILCS 160/2(b), (j) [¶ 84]

But a transfer is not made until the debtor acquires rights in the asset transferred.

The Court held the plaintiffs did not allege an asset or a transfer under the IFTA.  Following Illinois case precedent, the Court found that unfulfilled business opportunities were not transferrable assets under the statute.  [¶¶ 84-85]

Finally, the Court rejected the Plaintiffs’ successor liability claim.  The Plaintiffs alleged the debtors’ members formed a new business entity for the purpose of avoiding the judgment.

The general rule is that a corporation that purchases the assets of another business is not liable for the debts or liabilities of the purchased corporation.  An exception to this rule applies where the purchaser is a mere continuation of the seller. [¶ 95]

To invoke the continuation exception, the plaintiff must show the purchasing corporation maintains the same or similar management and ownership as the purchased entity.

The test is whether there is a continuation of the selling business’s entity; not merely a continuation of the seller’s business.  A commonality among the seller and buyer businesses’ officers, directors, and stock are the key ingredients of a continuation. [¶ 97]

The Court found the plaintiffs’ continuation exception arguments lacking.  The plaintiffs failed to allege a purchase or transfer of the corporate debtors’ assets or stock by/to the new entity.  And while the plaintiffs did allege some common management between the corporate debtors and the new entity, the plaintiffs failed to allege a commonality of stock between the companies.

Afterwords:

A conjectural business expectancy is not tangible enough to constitute a transferable asset under IFTA;

A creditor’s attempt to impute a corporate judgment to individual shareholders is improper in a post-judgment fraudulent transfer case.  Instead, the creditor should file separate action against the individual shareholder(s) for breach of fiduciary duty, usurpation of corporate opportunities, piercing the corporate veil or similar theories;

An identify of ownership between former and successor corporation is key element to invoke continuation exception to rule of no successor liability.

 

 

 

 

Plaintiffs’ Are ‘SOL’ Based on IFTA’s SOLs

The First District recently considered when the discovery rule can mitigate the harshness of a statute of limitations [the SOL] in a fraudulent transfer case.

The plaintiffs in Andersen Law LLC v. 3 Build Construction, LLC, 2019 IL App (1st) 181575-U, a judgment creditor’s former counsel and her new law firm who secured a $200K judgment against two limited liability companies, sued under the Illinois Fraudulent Transfer Act, 740 ILCS 160/1 et seq. [the “IFTA”] alleging two members of the debtor LLCs pilfered corporate bank accounts and formed a corporation to avoid the judgment.

The judgment debtors and third party defendants moved to dismiss the IFTA claims on statute of limitation grounds and for failure to state a cause of action. The trial court granted the motion to dismiss and the plaintiff appealed.

Affirming the lower court’s dismissal, the First District noted that while an SOL motion to dismiss is normally brought under Code Section 2-619 [which involves affirmative matter], the SOL issue can be disposed of on a Code Section 2-615 [which looks at the four-corners of a pleading] motion where the complaint’s allegations make clear that claim(s) is time-barred.

An IFTA actual fraud [a/k/a fraud-in-fact] claim is subject to a four year limitations period, measured from the date of transfer. [740 ILCS 160/10(a)]. This section has a built-in discovery rule:  where the fraud could not have reasonably been discovered within the 4-year post-transfer period, the fraud-in-fact claim must be brought within one year after the transfer was or could have reasonably been discovered. [¶42]

To determine whether the discovery rule preserves a too-late claim, the court considers whether an injured party has (1) sufficient knowledge that its injury was caused by actions of another, and (2) sufficient information to ‘spark inquiry in a reasonable person’ as to whether the conduct of the party causing an injury is actionable. [¶51]

Constructive fraud [a/k/a fraud-in-law] claims, by contrast, must be brought within 4 years of the transfer.  There is no discovery rule that extends the limitations term.

Looking to the plain text of IFTA Section 10, the First District affirmed the trial court’s dismissal of the plaintiffs’ constructive fraud claims.  It held that the IFTA statute of limitations runs from the date of transfer, not, as plaintiffs argued, from the judgment. [¶48]

The Court then rejected plaintiffs’ assertion that IFTA’s discovery rule saved the otherwise time-barred actual fraud claims.  It found the plaintiffs failed to allege specific facts or a chronology as to when they reasonably learned the defendants’ diverting funds from the corporate debtors’ accounts.  As a result, the Court affirmed trial court’s dismissal of plaintiffs’ actual fraud claim.

The Court also nixed the plaintiffs’ related argument that the discovery rule applied based on the obstructionist actions of their former client [from whom the IFTA claim was assigned].  It made clear that the fraudulent concealment of a cause of action must be based on the conduct of thedefendant, not a third-party. The lone exception is where the person concealing a claim is in privity with or an agent of the defendant.  In such a case, the statute of limitations period can be tolled. [¶59]

Here, the plaintiffs failed to plead facts that the former client/underlying creditor acted in concert with the judgment debtor or the transferees.

Take-aways:

Some key take-aways from the Anderson Law LLCcase include that in a fraudulent transfer case, the four-year limitations period runs from the date of transfer, not from the date of the underlying judgment.

The case also makes clear that it is the plaintiff’s burden to successfully invoke the discovery rule to breathe life into a stale IFTA fraud-in-fact claim. [The one-year discovery extension period doesn’t apply to fraud-in-law claims.]  If a plaintiff fails to plead specific facts to carry its burden of demonstrating that its time-barred claim should be saved by the discovery rule, its claim is subject to Code Section 2-615 dismissal.