Archives for August 2014

Illinois Appeals Court Provides Partnership Primer

DeSouza v. Tradelink, LLC, 2014 IL App (1st) 131456-U provides an excellent – though unpublished – primer on Illinois partnership law and contract interpretation rules. The case also illustrates the confusion that can result when parties to a business deal have several conflicting and parallel documents that govern a single transaction.

Plaintiff entered into a four-way business arrangement with a software developer, another individual and a trading firm to share profits from a unique software trading module invented by the developer.  Three documents governed the parties’ relationship.   A Term Sheet, a Trader Agreement , a Side Letter (which contained a separate rider) codified the parties venture and assigned each participant’s profits split. The plaintiff, who introduced the software developer to the trading firm, was to receive 5% of all trading profits realized by the developer (who was to be paid 55%) from the software. The payments to the plaintiff were to flow through the developer who would pay plaintiff his share after he (the developer) was paid by the trading company.

When the trading firm severed ties with the developer, the plaintiff sued to recover several million dollars in profits that the company earned over several years based on its use of the trading software. The trial court granted summary judgment for the trading firm on plaintiff’s claims on the basis that no partnership was formed between the parties.  Plaintiff appealed.

Held: Reversed. Questions of fact exist as to whether the parties intended to form a partnership.

Rules/Reasoning:

The Uniform Partnership Act (810 ILCS 206/100, 202(a))(the UPA) defines a partnership as the association of two or more persons to carry on as co-owners a business for profit – regardless of whether that was the persons’ intent. The sharing of gross revenues by 2 or more people doesn’t establish a partnership by itself but where a person receives a share of business profits, he is presumed to be a partner unless he was paid (a) wages as an employee or (b) compensated as an independent contractor. UPA Section 206/202(c); (¶21).

Illinois courts describe a partnership as a contractual relationship and a partnership is controlled by the parties’ oral or written agreement. The caselaw echoes the UPA and finds a partnership where parties join together to carry on a business venture for their common benefit and each party contributes property or services to the enterprise and has a community interest in the business profits.

Other indices of a partnership include the manner in which the parties deal with one another, the mode in which each alleged partner dealt with third parties with the other partners’ knowledge and whether the two (or more) persons advertised their business using a firm name. (¶ 21).  The Court also looks at whether the business has filed a partnership certificate with the county clerk, whether the business has a checking account and files partnership tax returns as part of its partnership inquiry.  And while the parties’ intent isn’t the decisive factor (in deciding whether there is a partnership), it’s still something the court considers when determining whether a partnership exists. (¶¶33, 42).

The Court reversed summary judgment for the trading company because there were disputed fact questions as to whether the parties formed a legal partnership.  The various documents and the parties’ conduct was both consistent and inconsistent with the existence of a partnership.  The pro-partnership factors included multiple references to the terms “partner” and “partnership” and the fact that plaintiff was assigned a specific percentage of the business arrangement’s profits.

Factors that ran counter to a partnership finding included the plaintiff not contributing property or funding for the business and not having any role in the day-to-day business of the trading firm. that plaintiff didn’t contribute any money to the enterprise, didn’t run the trading business or share in business losses.  Because there were so many factual and textual incongruities in the various documents, it wasn’t clear whether the parties meant to form a partnership.   (¶¶ 22-28)

The other key fact dispute that led to the court’s summary judgment reversal involved plaintiff’s role in the enterprise.  The trial court found that plaintiff was merely a “finder” who connected to developer with the trading company and was entitled to a “finder’s fee.”  But there was evidence in the record that plaintiff expended time , energy and money in consummating the developer-trading firm connection.  Because of this, it was conceivable that the plaintiff contributed property or services to the business venture.  If plaintiff’s time and money efforts were considered contributions of property or services, this would indicate the existence of a partnership.  More facts needed to be developed for the court to rule definitively on the partnership question.  (¶¶ 31-32). 

Take-aways: Confusion results where multiple documents govern the same transaction.  Where multiple agreements control a single transaction, the agreements should incorporate each other by reference and specifically state what document trumps the other(s) if there is a dispute or conflict among the different terms.  The case’s real value, though, lies in its excellent summary of Illinois partnership law under the UPA and the construing caselaw.  De Souza provides a fairly exhaustive summary of the key elements a court considers when deciding whether the parties’ conduct evidences a formal partnership.

 

Corporate Successor Liability: Continuation and Fraud Exceptions (IL Law)

 


NOTE: PLEASE SEE UPDATE AT http://www.davismcgrath.com/#!Property-Is-Subject-to-Turnover-Order-Where-Buyer-Is-‘Continuation’-of-TwiceRemoved-Seller-–-Corporate-Successor-Liability-in-Illinois/cq5o/565ca4a20cf2c000e92858f0

Advocate Financial Group, LLC v. 5434 North Winthrop, LLC, 2014 IL App (2d) 130998 applies the “mere continuation” rule (a successor company that is the continuation of a prior company can be responsible for the prior company’s debts) in a creditor’s post- judgment action against a corporation twice removed from the judgment debtor.

The plaintiff was hired to help the condo developer defendant (Company 1) obtain financing to pay off a defaulted mortgage.  Company 1’s sole asset was a Chicago condo building.  When Company 1 defaulted on its payment obligations to plaintiff, the plaintiff sued and got a $90K money judgment.  After the judgment, Company 1 sold the building to another entity (Company 2) who in turn sold it to another entity (Company 3) – the building’s current owner. 

Plaintiff sought an order requiring Company 3 to convey the building to plaintiff so plaintiff could sell the building and satisfy its judgment with the sale proceeds. The trial court granted the turnover motion and found that Company 3 was the continuation of Company 1.  Company 3 appealed.

Held: Reversed. 

Rules/Reasons:

The trial court misapplied the continuation exception and failed to consider whether the fraud exception (to no successor liability) applied. 

– A corporation that purchases the assets of another corporation is generally not liable for the debts or liabilities of the transferor corporation. The rule’s purpose is to protect good faith purchasers from unassumed liability and seeks to foster the fluidity of corporate assets.  

– The “continuation” and “fraudulent purpose” exceptions to this rule apply where the purchaser is merely the continuation of the seller (continuation rule) and where the transaction is for the fraudulent purpose of escaping liability for the seller’s obligations (fraud exception). 

– Mere continuation requires a showing that the successor entity “maintains the same or similar management and ownership, but merely wears different clothes.”  The test is not whether the seller’s business operation continues in the purchaser, but whether the seller’s corporate entity continues in the purchaser. 

– The key continuation question is always identity of ownership: does the “before” company and “after” company have the same officers, directors, and stockholders?  (¶¶ 22-26). 

The trial court held that the continuation exception applied since Company 3 was basically the same (a “corporate clone”) as Company 1.  The two companies shareholders were virtually identical and Company 3 now owned the condo building. 

The appeals court noted that no Illinois court has found that the continuation doctrine applies to facts involving multiple transfers of an asset from a judgment debtor.  The critical issue here was whether Company 2 was a bonafide purchaser of the condo building.  If it was, then plaintiff couldn’t get a turn over order from Company 3. 

Had there been a direct transfer of assets from Company 1 to Company 3, the Court found that the continuation exception would apply and Company 3 would have to dispense with the building.  But the factual anomaly here was that Company 1 first transferred the building to an intermediary – Company 2 – before the building ended up in Company 3’s hands. 

If Company 2 was a “straw buyer”, then the fraud exception to the corporate successor liability rule would apply: Company 3 would be responsible for Company 1’s debt.  Another question the Court wants answered (on remand) is whether Company 2 is a sham buyer.  The record isn’t clear whether Company 2 consciously participated in a concerted plan by Company 1 to dispense with the building so that it ended up in Company 3’s hands.  According to the court, if the facts show that Company 2 was only a conduit from Company 1 to 3, the fraud exception could apply.   (¶¶ 37-39). 

Afterwords:  This case illustrates that while an intervening sale of an asset won’t always immunize the ultimate buyer from a creditor’s reach, the court will still look into the specifics of a middle-man transaction.  If the buyer intemediary has any connection to the debtor in terms of similar management personnel or other suspicious likenesses, a court can void the transaction and deem it a fraudulent effort to evade a creditor. 

 

 

Bank’s Guaranty Claims Prevail Over Guarantor’s Estate (Part II of II)

In addition to affirming the trial court’s striking the Estate’s affirmative defenses, the First District in JPMorgan Chase Bank, N.A. v. East-West Logistics, LLC, 2014 IL App (1st) 121111 also upheld the Section 2-615 dismissal of the Estate’s fraud-based counterclaims and the summary judgment awarded the plaintiff bank on its breach of guaranty claim against the Estate.  

Fraud and Consumer Fraud

To state a common law fraud claim  in Illinois, a plaintiff must allege (1) a false statement of material fact; (2) by one who knows or believes it to be false; (3) made with the intent to induce action by another in reliance on the statement; (4) action by the other in reliance on the truthfulness of the statement; and (5) injury to the other resulting from that reliance.  Intentional concealment of a material fact is  the same as an express false statement under the law.  Where a person has a duty to speak, his failure to disclose material information constitutes fraudulent concealment.  (¶¶ 65-68).                                                                                                              

A colorable consumer fraud claim requires allegations of (1) a deceptive act or practice by defendant, (2) an intent on the defendant’s part that plaintiff rely on the deception, and (3) deception that occurs in the course of conduct involving trade or business.  The plaintiff must also show that the consumer fraud proximately caused his injury.

The Court rejected the Estate’s argument that the plaintiff committed fraud by not telling the deceased guarantor that the bank was increasing his risk by continuing to loan monies to a financially distressed corporate borrower.  The Estate argued that this amounted to deceptive conduct.  The Court disagreed.  Under the plain text of the guaranty, the plaintiff bank had no duty to give information to the guarantor that could increase his risk of liability under the guaranty.  In fact, it was just the opposite: the guaranty required the guarantor to actively monitor the borrower’s economic condition and loan status.  The guaranty didn’t saddle the plaintiff bank with a duty to continually update the guarantor on the loan or borrower. (¶¶ 69-70).

The Estate also failed to adequately plead reliance – another common law fraud element.  A fraud claimant must show he justifiably reliance on a material false statement.  To determine whether reliance is justified, the court considers the facts the party knew and those facts it could have learned through ordinary prudence. 

Since the Estate didn’t allege that the guarantor made any effort to obtain information about the loan he guaranteed, the Estate wasn’t able to plead that the bank deceived the guarantor.  The Court found the Estate also pled insufficient facts to back up its consumer fraud claims that the plaintiff planned to deceive the guarantor by hiding the corporate borrower’s precarious monetary condition from the guarantor.  Absent more factual specifics, the Estate’s fraud counterclaims failed. (¶¶ 73-78).

Summary Judgment Affidavits and Computerized Business Records – Supreme Court Rule 191, IRE 803(6)

Affirming summary judgment for the plaintiff on its breach of guaranty count, the Court sustained the plaintiff’s two supporting affidavits: one from a bank vice president, the other from a bank analyst. Both agents testified that they reviewed the loan documents, payment history and pay-off documents. They also swore that the supporting documents were prepared and kept in the regular course of plaintiff’s business. (¶¶ ‏86-93).

Supreme Court Rule 191 governs summary judgment affidavits.  It requires that affidavits be made on personal knowledge, to be based on admissible facts and to attach sworn or certified copies referenced in the affidavit. See Ill. S.Ct. R. 191(a).  In the context of business records, the author or creator of the record doesn’t have to testify. Instead, the custodian or other person familiar with the business and its mode of operation can provide the foundational testimony. A record author’s failure to testify affects only weight, not admissibility of the record.  (¶¶94-98).

Evidence Rule 803(6) – the business records rule – allows the introduction of computerized and paper “records of regularly conducted activity” 99-101. A computer-generated business record is admissible where it’s shown that(1) the computing equipment is recognized as standard; (2) the input is entered in the regular course of business reasonably close in time to the happening of the recorded event and (3) the source of the information, method and time of preparation are trustworthy.  (¶¶ 99-101).

The Estate’s main challenge to plaintiff’s summary judgment affidavit involved a “pay off calculator” document that itemized the loan payments and history.  The Court found that the “Calculator Document” complied with Rule 803(6).  The Court found that the payoff calculator document satisfied the admission standards for a computerized business records.  It was prepared at or near the time of the events recorded, it was kept in the regular course of the bank’s lending business and it was authenticated via affidavit by someone who qualified as a custodian because of her (the affiant) personal knowledge of the bank’s lending and record-keeping processes.  (¶¶104-105).

Take-aways: For commercial litigators, the case is a useful summary of computerized business records foundation rules and summary judgment affidavit requirements. The case also provides some needed clarity on (IL) Supreme Court Rule 236 – the rule that governed business records before Evidence Rule 803(6)’s adoption.  The Court makes it clear that the two rules can be viewed in tandem and that caselaw construing Rule 236 is still relevant to the business records admissibility question.  Finally, East-West Logistics cements the proposition that a fraud plaintiff must prove that the deceptive conduct or misrepresentation actually reached him.  Otherwise, he won’t be able to establish the reliance element.