Partnership’s Incorporation Insulates Partners From Personal Contractual Liability

Today’s post features the case law equivalent of a Deep Cut.  The Deep Cut – as musical buzz-phrase and phenomenon – appears to be gaining traction in the FM radio realm.

The moniker denotes an obscure song from a well-known artist that’s not normally associated with the artist.

For example, a Styx fan likely connects that band with radio staples “Babe” or “Renegade”; instead of their lesser-known cuts “Queen of Spades” or “Castle Walls.”

“Hair metal” fans might associate Guns N’ Roses with its FM stalwarts like “Welcome to the Jungle” or “Sweet Child O’ Mine” instead of its more remote offerings, “One in a Million” or “Coma.”

Jensen Sound Laboratories v. Long, 113 Ill.App.3d 331 (4th Dist. 1983)  is “deep” in the sense that it’s both dated (1983) and geographically remote (4th District).  But the case is still post-worthy because its salient issue  – corporate vs. personal contractual liability – continues to recur in my practice.

The plaintiff creditor sued the defendants – a husband and wife who were also officers of a defunct corporation – for breach of contract after the corporation dissolved.  The defendants had previously operated a partnership before incorporating under a similar sounding name.

The plaintiff had done business with the partnership under an open-end credit agreement where the plaintiff would provide services to the partnership and then submit invoices to it.  After the defendants dissolved the partnership and began operating as a corporation, they continued ordering services from the plaintiff and would pay with checks bearing the corporate name.

Defendants never formally notified plaintiff of the incorporation and plaintiff never asked why a corporate entity was paying plaintiff’s invoices.

When the corporation dissolved, plaintiff sued the individual defendants for past-due invoices.  After a bench trial, the court ruled in favor of the defendants and found that plaintiff’s remedy was against the defunct corporation; not the individual defendants.

Held: Affirmed.

Why?

Normally, a partnership must give creditors notice of the partnership’s dissolution in order to relieve the partners of personal liability for debts incurred in the partnership’s name.

But where a partnership morphs into a corporation, the (former) partnership is no longer liable for partnership debts unless the partnership continues to deal with third parties in the same manner as before and fails to give notice of the partnership’s dissolution or change in form.

The critical fact relied on by the court was that the plaintiff received corporate checks for almost two years before it sued the individual defendants.

Since there was no evidence that the defendants continued to deal with the plaintiff as a partnership once the defendants incorporated, the trial court correctly found that the plaintiff was (or should have been) on notice of the change in business form.

Take-aways:

1/ where a business entity changes forms (e.g. partnership to a corporation), the members of that entity should notify creditors to possible personal liability to those creditors.

2/ Where someone fails to notify creditors of a change in business form, he can still avoid personal liability if the parties’ course of conduct demonstrates that the creditor was objectively put on notice of the structural change.

3/  A lengthy time span of receiving payment via corporate checks without objection can be viewed as constructive notice of a business entity change.

 

 

Illinois Replevin Law: Who Gets to Keep (Broken) Engagement Ring?

cheatin

The (diabolical?) Joey Greco (I think that’s the ‘Cheaters’ Host’s name) would love this one.  In Carroll v. Curry, 912 N.E.2d 273 (2nd Dist. 2009), the plaintiff filed a replevin suit against his ex-fiancée (defendant) seeking the return of an engagement ring that he previously bought.

The couple was engaged to be married for several years until the defendant broke it off after she accused the plaintiff of cheating.  After kicking plaintiff out of their home, the defendant refused to return the ring since plaintiff’s infidelity caused the relationship to end.  Plaintiff filed a replevin suit to get the ring back and eventually moved for summary judgment.  The trial court granted the motion and the defendant appealed.

Held: Affirmed.  Plaintiff gets the ring back.

Siding for the plaintiff, the Court noted that replevin is a strict, statutory proceeding that does not look at the concept of “fault.”  This means a court will not look at the underlying reasons why someone refuses to return an item of personal property.

The primary purpose of the replevin statute is to test the right of possession of personal property and place the successful party in possession of the property.  735 ILCS 5/19-101. 

A replevin plaintiff must prove he is (1) lawfully entitled to possession of property, (2) the defendant wrongfully detains the property and (3) refuses to deliver the possession of the property to the plaintiff.

“Wrongful” in the replevin context doesn’t mean immoral or “bad.”  It’s wrongful in the legal sense; meaning one person has a superior right to an object over the other.

Normally, the replevin plaintiff must make a demand for return of the item.  However, where a demand would be pointless (“demand futility”), the plaintiff is excused from the demand requirement.

The Second District described an engagement ring as a gift in contemplation of marriage.  The plaintiff here bought the ring to induce defendant to marry him.  The gift of the ring was contingent on defendant following through with the marriage.  Since defendant was the one that terminated the engagement, the contingency (marriage) didn’t occur and defendant no longer had a claim to the ring: “the party who fails to perform on the condition of the gift has no right to property acquired under such pretenses.”

The court then rejected the defendant’s argument that plaintiff’s infidelity was the reason for the break-up.  Delving into fault-based inquiries, the court said, would mire it in examining parties’ subjective motivations as opposed to objectively deciding who has a better claim to possession of an object.

Take-aways:

– Replevin is narrowly focused on the question of a party’s right to possession;

– The replevin calculus doesn’t concern itself with questions of who’s at fault or the cause of a dispute;

– Occasionally,  where there is fraud or unjust enrichment, equitable considerations can factor in a replevin case.  Here, however, since the plaintiff paid for the ring, there was no unjust enrichment in allowing him to reclaim it.

Medical Practice Break-Up Spawns Non-Compete Dispute

imageThe bitter breakup of a medical practice provides the setting for the Illinois Fifth District to consider the scope of a non-compete clause and how it impacts a minority shareholder’s buy-out rights.

Gingrich v. Midkiff, 2014 IL App (5th) 120332-U presents a dispute between two former partners in a medical corporation.  At the medical practice’s inception – in the late 1990s – the parties signed a stock purchase agreement that contained a 5-year/20-mile non-compete provision (the “Non-Compete”).

The Non-Compete only applied in two situations: (1) if a shareholder withdrew from the practice after giving the required written notice; or (2) where a shareholder was expelled from the practice.  The parties’ relationship quickly soured and in 2002, a decade-long cycle of litigation between the two doctors ensued.

The 2002 Lawsuit

A 2002 lawsuit between the parties culminated in the plaintiff buying defendant’s stock in the medical corporation.  The court in the 2002 case didn’t rule on whether the Non-Compete was enforceable.

The 2007 (and current) Lawsuit

In the 2007 case, plaintiff sued defendant alleging the defendant violated the Non-Compete by going to work for a rival practice within 20 miles of plaintiff’s office. 

The trial court dismissed.  It held that the Non-Compete didn’t apply because defendant didn’t withdraw and wasn’t expelled from the medical corporation.  Plaintiff appealed.

Ruling: Affirmed.

Reasoning:

The court rejected plaintiff’s law of the case (LOTC) argument.  The LOTC doctrine prevents relitigation of an issue of fact or law previously decided in the same case.  ¶ 14.  Its purpose is to avoid repetitive litigation of the same issues and to foster finality and consistency in litigation.  LOTC reflects the court’s preference to generally not reopen previously decided issues.

Here, there was no adjudication of the Non-Compete in the 2002 case.  The core issue litigated in that first suit was the valuation of defendant’s shares and whether plaintiff served a proper election to purchase those shares.

Since the cardinal issues in the 2002 and 2007 Lawsuits substantively differed, LOTC didn’t prevent defendant from challenging the Non-Compete in the 2007 case. ¶¶  17-19.

The court also found the Non-Compete wasn’t enforceable.  In Illinois, noncompetition clauses in the medical services context are heavily scrutinized and only validated where they have reasonable time and space limits.

¶¶ 22-24.

Finding the Non-Compete unambiguous, the Court held that the 5 year/20-mile strictures attached in only two circumstances: where a shareholder either (1) withdrew or (2) was expelled from the practice.  Here, defendant  didn’t withdraw and she wasn’t expelled.  As a result, the Non-Compete didn’t prevent the defendant from practicing within twenty miles of plaintiff’s office.  ¶¶ 25-29.

Afterwords: Clarity in contract drafting is critical.  The case illustrates that a Court won’t strain to find ambiguity where contract language is facially clear.  Gingrich also illustrates that a restrictive covenant will be construed in favor of permitting, instead of stifling, competition.  In hindsight, the plaintiff should have made it clear that if a shareholder departed the medical practice for any reason: whether voluntary, forced, or after a buy-out, the non-compete would still govern.