LLC That Pays Itself and Insiders to Exclusion of Creditor Plaintiff Violates Fraudulent Transfer Statute – Illinois Court

Applying Delaware corporate law, an Illinois appeals court in A.G. Cullen Construction, Inc. v. Burnham Partners, LLC, 2015 IL App (1st) 122538, reversed the dismissal of a contractor’s claim against a LLC and its sole member to enforce an out-of-state arbitration award.  In finding for the plaintiff contractor, the court considered some important and recurring questions concerning the level of protection LLCs provide a lone member and the reach of the Uniform Fraudulent Transfer Act, 740 ILCS 160/1 et seq. (“UFTA”), as it applies to commercial disputes.

The plaintiff sued  a Delaware LLC and its principal member, an Illinois LLC, to enforce a $450K Pennsylvania arbitration award against the Delaware LLC.  The plaintiff added UFTA and breach of fiduciary duty claims against the Delaware and Illinois LLCs based on pre-arbitration transfers made by the Delaware LLC of over $3M.

After a bench trial, the trial court ruled in favor of the LLC defendants and plaintiff appealed.

Reversing, the appeals court noted that the thrust of the UFTA claim was that the Delaware LLC enriched itself and its constituents when it wound down the company and paid itself and its member (the Illinois LLC) to the exclusion of plaintiff.

The UFTA was enacted to allow a creditor to defeat a debtor’s transfer of assets to which the creditor was entitled.  The UFTA has two separate schemes of liability: (1) actual fraud, a/k/a “fraud in fact” and (2) constructive fraud or “fraud in law” claims.  To prevail on an actual fraud claim, the plaintiff must prove a defendant’s intent to defraud, hinder or delay creditors.

By contrast, a constructive fraud UFTA claim doesn’t require proof of an intent to defraud.  Instead, the court looks to whether a transfer was made by a debtor for less than reasonably equivalent value leaving the debtor unable to pay any of its debts. (¶¶ 26-27); 740 ILCS 160/5(a)(1)(actual fraud), 160/5(a)(2)(constructive fraud).

When determining whether a debtor had an actual intent to defraud a creditor, a court considers up to eleven (11) “badges”of fraud which, in the aggregate, hone in on when a transfer was made, to whom, and what consideration flowed to the debtor in exchange for the transfer.

The court found that the Delaware LLC’s transfers of over $3M before the arbitration hearing had several attributes of actual fraud. Chief among them were that (i) the transfer was to an “insider” (i.e. a corporate officer and his relative), (ii) the Delaware LLC transferred assets without telling the plaintiff knowing that the plaintiff had a claim against it; (iii) the Delaware LLC received no consideration a $400K “management fee” paid to the Illinois LLC (the Delaware LLC’s sole member); and (iv) the Delaware LLC was insolvent after the  transfers.

Aside from reversing the UFTA judgment, the court also found the plaintiff should have won on its piercing the corporate veil and breach of fiduciary duty claims.  On the former, piercing claim, the court held that the evidence of fraudulent transfers by the Delaware LLC to the Illinois LLC presented a strong presumption of unjust circumstances that would merit piercing.  Under Delaware law (Delaware law governed since the defendant was based there), a court will pierce the corporate veil of limited liability where there is fraud or where a subsidiary is an alter ego of its corporate parent.  (¶ 41)

On the fiduciary duty count, the court held that once the Delaware LLC became insolvent, the Illinois LLC’s manager owed a fiduciary duty to creditors like the plaintiff to manage the Delaware LLC’s assets in the best interest of creditors. (¶¶ 45-46)

Afterwords:

A pro-creditor case in that it cements proposition that a UFTA plaintiff can prevail where he shows the convergence of several suspicious circumstances or “fraud badges” (i.e., transfer to insider, for little or no consideration, hiding the transfer from the creditor, etc.).  The case illustrates a court closely scrutinizing the timing and content of transfers that resulted in a company have no assets left to pay creditors.

Another important take-away lies in the court’s pronouncement that a corporate officer owes a fiduciary duty to corporate creditors upon the company’s dissolution.

Finally, the case shows the analytical overlap between UFTA claims and piercing claims.  It’s clear here at least, that where a plaintiff can show grounds for UFTA liability based on fraudulent transfers, this will also establish a basis to pierce the corporate veil.

 

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PaulP

Litigation attorney at Fisher Kanaris, P.C. representing businesses and individuals in all types of commercial disputes.