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.

 

LOI From Hell (?) – It’s Too Illusory For Car Dealership Manager to Enforce – IL 1st Dist.

A complicated Letter of Intent (LOI) involving parties to a planned car sales venture lies at the heart of Dicosola v. Ryan, 2015 IL App(1st) 150007, a case that addresses the level of consideration required to support a written contract in Illinois.

The plaintiff alleged that under the LOI, the defendant was to invest $1M with the plaintiff who would, along with her business partner, use those funds to establish and run the dealership.  In return for her investment, the defendant would get a 10% share of the business.  The LOI also called for the defendant to establish a 401(k) account for the benefit of the parties. 

Decried as a “drafting nightmare” by the court for its chaotic structure, the LOI was silent on the timing: it didn’t say when the dealership would open, how plaintiff would utilize defendant’s funds or even what the plaintiff’s and her partner’s roles were once the dealership went live.

When the defendant pulled out of the deal, the plaintiff sued for breach of contract and specific performance.  The trial court dismissed the complaint with prejudice and the plaintiff appealed.

Held: Dismissal affirmed

Reasons/Rules:

An LOI, like any other contract, must show offer, acceptance, consideration as well as definite and certain terms.

Consideration means a bargained-for exchange of promises or performances and can consist of a promise, an act or a forbearance. Consideration requires one party getting and the other giving something of value.  Otherwise, it’s an illusory promise.  A promise is illusory where the promisor isn’t really promising to do anything or where his promised performance is optional.

Contractual performance will deemed optional (and illusory) where there is no fixed time or duration for the contemplated services or where one parties obligations are terminable at will.

Here, the plaintiff’s promise was illusory since the LOI didn’t specify when she would perform general manager services for the inchoate dealership. Since the LOI lacked a specific start and end date, the Court held the LOI was too indefinite to be enforced.  The lack of clarity on the timing question led the court to conclude there was no consideration to support the plaintiff’s breach of contract claims. (¶¶ 18-20)

Afterwords:

1 – Parties should craft their business agreements with enough specifics for it to be enforced. By only providing aspirational language (“I will do this” or “I plan to do this”) with no specific timing requirements, a contracting party risks a contract being deemed illusory and unenforceable.

2 – Where one party to a contract’s obligations are to occur in the future, the contract language should provide an end date or duration for those services.

UCC Bars Bank Customer Suit Versus Bank For Estranged Husband’s Unauthorized Account Withdrawals

Kaplan v. JPMorgan Chase Bank, NA (2015 WL 2358240 (N.D.Ill. 2015)), starkly illustrates the challenges a bank customer faces when trying to pin liability on a bank that pays out on a fraudulent transaction involving the customer’s account.  There, the plaintiff bank customer sued JPMorgan Chase for breach of contract and negligence after the plaintiff’s estranged husband was able to siphon about $1M from two of plaintiff’s accounts over an 18-month period starting in 2009.  Plaintiff filed suit in 2014.

The plaintiff claimed the bank breached its contractual obligations and its duty of care by allowing the husband to forge plaintiff’s name on two account signature cards which enabled him to transfer the money from the accounts behind plaintiff’s back.

The Northern District granted summary judgment for the bank and in doing so, provides a good primer on a bank customer’s duties to monitor account statements and the reach of a bank’s liability for unauthorized withdrawals from a customer’s account.

Summary judgment Standards

To defeat summary judgment, a plaintiff must show there is a genuine disputed material fact that can only be resolved after a full trial on the merits

A disputed fact is “material” if it might affect the outcome of the case. A dispute is “genuine” where the evidence is such that a reasonable jury could return a verdict for the nonmoving party.

The moving party has the initial burden of showing that it is entitled to judgment as a matter of law and can make this showing by establishing that the other party has no evidence on an issue that it has the burden of proof.

Once the moving party meets this burden, the nonmovant must come forward with specific facts that demonstrate there is a genuine issue for trial and may not rely on conclusions, allegations or a “scintilla” (a trace or spark http://www.merriam-webster.com/dictionary/scintilla) of evidence to show that facts exist that will defeat summary judgment.

The Bank-Customer Contractual Relationship

The signature card defines the relationship between plaintiff and the bank defendant. A contract between a bank and its depositor is created by signature cards and a deposit agreement.

The signature card here incorporated Account Rules and Regulations (“Account Rules”) by reference.  These Rules, in turn, required the Plaintiff to notify the bank of any errors or unauthorized items within 30 days of the date on which the error or unauthorized item was made available to the plaintiff. If the plaintiff failed to do so within that 30-day window, the error or item would be enforceable against her.

The unauthorized transfers occurred over an 18 month time span starting in 2009 and ending in 2011. But the plaintiff didn’t notify the bank until nearly a year later in April 2012. As a result, the plaintiff missed the Account Rules’ 30-day time limit.

The UCC – Article 4

Plaintiff’s claims were also too late under the Uniform Commercial Code (UCC).  Section 4-406 of the UCC provides that where a bank makes a statement available to a customer, the customer must exercise “reasonable promptness” in notifying the bank of any errors. This section also immunizes a bank from liability where it pays in good faith on an unauthorized signature or alteration and the customer doesn’t notify the bank within a reasonable time, “not exceeding 30 days.” 4-406(c)-(d)

The UCC contains a one-year repose period, too. Section 4-406(f) provides that regardless of whether a bank exhibits a lack of care in paying an item, if a customer fails to notify the bank of an unauthorized signature or alteration within one year of a statement being made available, the customer’s claim is barred.

The court held that since the bank filed affidavits stating that plaintiff had free on-line access to her accounts on a monthly basis, the bank “made available” the account information under the UCC. The court held making account information available under 4-406(c) did not require a customer’s physical receipt of the statements.

Turning to whether the bank exhibited good faith in allowing the plaintiff’s husband to withdraw nearly $1M from the accounts, the court noted that good faith is defined by the UCC as “honesty in fact and the observance of reasonable commercial standards of fair dealing.” UCC 3-103(a)(4). Since the plaintiff came forth with no evidence that the bank knew either that the signature cards were forged by the husband or that he lacked authority to add himself as an account signer, there was no showing that the bank lacked good faith.

UCC Article 3

Another UCC section that barred the plaintiff’s claims was 3-118(g). This section provides a 3 year limitations period for claims involving conversion of an instrument, breach of warranty or to enforce any other UCC rights not covered by another section.

The discovery rule – a judge-made rule that delays the start of a statute of limitations until an injured plaintiff knows or reasonably should know she has been injured – doesn’t apply to claims that fall within 3-118(g). This is because applying a discovery rule to an unauthorized monetary transaction would undermine the UCC’s stated goals of finality, predictability, uniformity and efficiency in commercial transactions.

Take-aways:

1/ A bank defendant has an arsenal of statutory defenses under the UCC to actions brought by customers;

2/ The UCC’s goals of fostering fluidity in commercial transactions trumps any opposing claims of individual customers;

3/  Harmed bank customers will at least have a chance to defraying her economic damages by vigilantly reviewing account statements and promptly notifying her bank within 30 days of any statement discrepancies.