‘Half a Mil’ Conditional Judgment Too Harsh for Anemic Citation Response – IL First Dist.

Hayward v. Scorte, 2020 IL App (1st) 190476, reads like a creditors’ rights practice manual for its detailed discussion of the nature and scope of various creditor remedies under the Illinois supplementary proceedings and garnishment statutes.  (735 ILCS 5/2-1402 and 735 ILCS 5/12-701 et seq., respectively.)

The plaintiffs confirmed a half-million dollar arbitration award against a corporate defendant in a construction dispute and sought to collect. In post-judgment discovery, the post-judgment court (the Law Division’s Tax and Misc. Remedies Div.) found that the corporate debtor’s two owners failed to properly respond to citations served upon them by plaintiffs’ counsel.

The trial court entered a conditional judgment (later converted to a final one) against each corporate officer for the full amount of the underlying judgment.  The officers appealed.

Reversing, the First District first noted that supplementary proceedings in Illinois allow a judgment creditor to pursue any assets in the judgment debtor’s possession or that are being held by third parties and apply those assets to satisfy the judgment. See 735 ILCS 5/2-1402.

In the garnishment context, 735 ILCS 5/12-701 et seq., where a third party fails to respond to a garnishment summons, the creditor garnisher can request a conditional judgment against the garnishee. 735 ILCS 5/12-706.

Once the conditional judgment is entered, the creditor issues a summons to the respondent.  If the respondent still fails to answer the garnishment summons, the conditional judgment is confirmed or finalized. Once the garnishee responds to the conditional judgment summons, it isn’t bound by the earlier default and can litigate afresh. [21]

Section 12-706’s twin goals is to provide an incentive for respondents to answer a properly served garnishment summons and to protect a respondent from Draconian consequences of a single oversight. 735 ILCS 5/12-706. [21]

Code Section 2-1402 permits a court to enter any order or judgment that could be entered in a garnishment proceeding. 735 ILCS 5/2-1402(k-3).

But while Section 2-1402(k-3) incorporates the garnishment act’s full range of remedies, the section does not give a creditor broader rights than exist under garnishment law.  [23]

Conditional judgments are only allowed where a garnishee fails to appear and answer.  Here, the third-party respondents (the two corporate officers) did appear and answer the citation; the trial judge just deemed the answer incomplete.

The Court then noted that garnishment act Section 12-711(a) speaks to the precise situation here: it allows a judgment creditor to challenge the sufficiency of a garnishee’s answer and request a trial on those issues.  735 ILCS 5/12-711(a).

The garnishment statute is silent on the consequences of incomplete or insufficient answers.  Since the corporate officers did answer the underlying citations, the Court held that the trial court lacked statutory authority to enter a full money judgment against the individual defendants under Code Section 2-1402(k-3). [26]

Next, the Court examined the interplay between Section 2-1402(c)(3) and (c)(6).  The former section speaks to situations where a third party has embezzled or converted a judgment debtor’s assets.  The latter permits a  judgment creditor to sue a third party (i.e. to bring a separate cause of action) where that third party is indebted to a judgment debtor.

The Court pointed out that neither section allowed a court to assess the entire underlying judgment against a third party without a specific finding that party converted or embezzled a debtor’s assets. [27]

In fact, the lone statutory basis for a court to enter a full judgment against a third-party is where it violates the citation’s restraining provision – Section 2-1402(f)(1).

This section allows a court to punish a third party that transfers, disposes of or interferes with a judgment debtor’s non-exempt property – after a citation is served – by entering a money judgment for the lesser of (a) the unpaid amount of a judgment or (b) the value of the asset transferred. [27, 28]

The Court then stressed that a citation lien applies only to property transfers occurring after a citation is served.  Pre-citation transfers, by contrast, cannot form the basis of a money judgment against a third party.  Since the plaintiffs’ conditional judgment motion was predicated in part on property transfers occurring some two years before the citations were issued, they fell beyond the scope of sanctions considered by the trial court.

An additional ground for the First District’s reversal lay in the absence of proof that the corporate officers held any corporate assets.  Illinois law is clear that before a court can enter a judgment against a third party, there must be some record evidence that the third party possesses assets belonging to the debtor.

Since there was no statutory bases to assess the full money judgment against the two erstwhile corporate principals and since there was no evidence either principal had any corporate debtor assets in their possession, the trial court overstepped by entering a money judgment against the individual corporate officer defendants.

Take-aways:

A third party must be in possession of a debtor’s assets before a money judgment can issue against that third party;

While the garnishment act allows for a conditional judgment where a respondent fails to appear and answer a garnishment summons, and Illinois’s supplementary proceedings statute incorporates garnishment remedies, the garnishment act does not permit a conditional judgment against a garnishee who does in fact answer a garnishment summons;

A judgment creditor should file a separate veil-piercing suit against a defunct corporation’s principals if the creditor believes they are holding erstwhile corporate assets.

Turnover Order Against Debtor’s Wife’s Company Upheld – IL First District

While the amount of the turnover order – less than $6,000 – challenged in Xcel Supply, LLC v. Horowitz, 2018 IL App (1st) 162986 was but a fraction of the underlying judgment – over $600,000 – the case provides a useful discussion of the interplay between Section 2-1402 and Rule 277 – Illinois’s twin supplementary (post-judgment) proceedings authorities – and when a third-party citation respondent is entitled to an evidentiary hearing.

About a month after a trial court entered a money judgment against defendant, his wife – through her company – wrote six checks to the defendant/ judgment debtor over a three-month span totaling $5,220.

On the creditor’s turnover motion, the trial court ordered the debtor’s wife and third-party citation respondent (the Respondent) to turn over $5,220 to plaintiff’s counsel (defendant’s wife’s company). The Respondent appealed.

Affirming, the Court examined Code Section 2-1402 and Rule 277 to assess whether the turnover order was supported by competent proof.

Code Section 2-1402(a) permits a judgment creditor to prosecute supplementary proceedings to discover assets or income of the debtor and apply assets or income discovered toward the payment of the judgment.

The creditor can initiate post-judgment proceedings against the debtor or any other third party who may have information concerning income or assets belonging to the judgment debtor.

Code Section 2-1402 vests the Court with broad powers to compel any person to deliver assets to be applied towards satisfaction of the judgment in situations where the judgment debtor can recover those assets. An order compelling a third-party to deliver assets in full or partial satisfaction of the judgment is called a turnover order. A court can enter judgement against someone who violates a citation’s restraining provision in the amount of the property transferred or up to the judgment amount. 2-1402(f)(1); ⁋⁋ 40-41.

Rule 277 works in tandem with Section 2-1402 and specifies how supplementary proceedings are conducted. Among other things, the Rule allows “any interested party” to subpoena witnesses and adduce evidence in the same manner it could at a civil trial.

Where a judgment creditor and third-party citation respondent each claim superior rights to the same debtor assets, the trial court should conduct an evidentiary hearing. However, where only the judgment creditor is claiming rights in the debtor’s assets, the trial court can decide the post-judgment proceeding without an evidentiary hearing.

Here, because the Respondent was the debtor’s wife – the Court viewed her as an illusory citation respondent. That is, the debtor and Respondent acted as a united front. Because this was not the prototypical “tug-of-war” between a judgment creditor and third-party citation respondent, the trial court was able to rule on the respondent’s argument without an evidentiary hearing.

The Court also rejected the respondent’s argument that the turnover order lacked an evidentiary basis. The Court noted that the judgment debtor admitted in his affidavit to cashing all six checks from the Respondent’s company and that Respondent did nothing to stop him from cashing the checks.

Since the Respondent never challenged the debtor’s right to cash the checks, the Court viewed it as strong proof that the checks were the debtor’s property to spend as he pleased.

Finally, the Court rejected Respondent’s argument that the money sent to the debtor wasn’t really his money as the funds were earmarked for their children’s expenses. According to the court, since both the debtor and Respondent had equal parental obligations to pay their children’s expenses, whether or not the money was for child expenses didn’t negate the trial court’s finding that the checks were defendant’s property and Respondent violated the citation by transferring the checks to the defendant after the date of the money judgment.

Afterwords: This case shows that citation restraining provisions which bar a third-party citation respondent from transferring money or property belonging to or to become due a judgment debtor have teeth.

While an evidentiary hearing is normally required where there are competing claimants to the same pool of assets, this rule is relaxed where the citation respondent is aligned (here, through marriage) with the debtor. In such a case, the court will look beyond the legal nomenclature and assess the reality of the parties’ relationship. Where the third-party citation respondent doesn’t have a meaningful claim to transferred debtor assets, the Court can decide a turnover motion without hearing live witness testimony.

Lender Lambasted for Loaning Funds to Judgment Debtor’s Related Business – IL Court

The issue on appeal in National Life Real Estate Holdings, LLC v. Scarlato, 2017 IL App (1st) 161943 was whether a judgment creditor could reach loan proceeds flowing from a lender to a judgment debtor’s associated business entity where the debtor himself lacked access to the proceeds.

Answering “yes,” the Court considered some of Illinois post-judgment law’s philosophical foundations and the scope and mechanics of third-party judgment enforcement practice.

The plaintiff obtained a 2012 money judgment of over $3.4M against the debtor and two LLC’s managed by the debtor.   During supplementary proceedings, the plaintiff learned that International Bank of Chicago (“IBC”) loaned $3.5M to two other LLC’s associated with the debtor after plaintiff served a third-party citation on IBC.  The purpose of the loan was to pay for construction improvements on debtor’s industrial property.  And while the debtor wasn’t a payee of the loan, he did sign the relevant loan documents and loan disbursement request.

Plaintiff moved for judgment against IBC in the unpaid judgment amount for violating the third-party citation.  The trial court denied the motion and sided with IBC; it held that since the loan funds were paid to entities other than the debtor, the loan moneys did not belong to the debtor under Code Section 2-1402(f)(1) – the section that prevents a third party from disposing of debtor property in its possession until further order of court.  735 ILCS 5/2-1402(f)(1).

The Plaintiff appealed.  It argued that the debtor sufficiently controlled IBC’s construction loan and the proceeds were effectively, debtor’s property and subject to Plaintiff’s third-party citation.

Reversing, the First District rejected IBC’s two key arguments: first, that the loan proceeds did not belong to the debtor and so were beyond the reach of the third-party citation and second, IBC had set-off rights to the loan proceeds (assuming the funds did belong to debtor) and could set-off the $3.5M loan against debtor’ outstanding, other loan debt.

On the question of whether the post-citation loan was debtor’s property, the Court wrote:

  • Once a citation is served, it becomes a lien for the judgment or balance due on the judgment. Section 2-1402(m);
  • A judgment creditor can have judgment entered against a third party who violates the citation restraining provision by dissipating debtor property or disposing of any moneys belonging to the debtor Section 2-1402(f)(1);
  • Section 2-1402’s purpose is to enable a judgment debtor or third party from frustrating a creditor before that creditor has a chance to reach assets in the debtor’s or third party’s possession. Courts apply supplemental proceedings rules broadly to prevent artful debtors from drafting loan documents in such a way that they elude a citation’s grasp.
  • The only relevant inquiries in supplementary proceedings are (1) whether the judgment debtor is in possession of assets that should be applied to satisfy the judgment, or (2) whether a third party is holding assets of the judgment debtor that should be applied to satisfy the judgment.
  • Section 2-1402 is construed liberally and is the product of a legislative intent to broadly define “property” and whether property “belong[s] to a judgment debtor or to which he or she may be entitled” is an “open-ended” inquiry. (¶¶ 35-36)

The ‘Badges’ of Debtors Control Over the Post-Citation Loan and Case Precedent

In finding the debtor exercised enough control over the IBC loan to subject it to the third-party citation, the Court focused on: (i) the debtor signed the main loan documents including the note, an assignment, the disbursement request and authorization, (ii) the loan funds passed through the bank accounts of two LLC’s of which debtor was a managing member, and (iii) the debtor had sole authority to request advances from IBC.

While conceding the loan funds did end up going to pay for completed construction work and not to the debtor, the Court still believed IBC tried to “game” plaintiff’s citation by making a multi-million dollar loan to businesses allied with the debtor even though the loans never funneled directly to the debtor.

Noting a dearth of Illinois state court case law on the subject, the Court cited with approval the Seventh Circuit’s holding in U.S. v. Kristofic, 847 F.2d 1295 (7th Cir. 1988), a criminal embezzlement case.  There, the appeals court squarely held that loan proceeds do not remain the lender’s property and that a borrower is not a lender’s trustee vis a vis the funds.  Applying the same logic here, the First District found that the loan proceeds were not IBC’s property but were instead, the debtor’s.  Because of this, the loan was subject to the plaintiff’s citation lien.

The Court bolstered its holding with policy arguments.  It opined that if judgment debtors could enter into loan agreements with third parties (like IBC) that restrict a debtor’s access to the loan yet still give a debtor power to direct the loan’s disbursement, it would allow industrious debtors to avoid a judgment. (¶ 39)

The Court also rejected IBC’s set-off argument – that set-off language in other loan documents allowed it to apply the challenged $3.5 loan amount against other loan indebtedness.  Noting that IBC didn’t try to set-off debtor’s other loan obligations with the loan under attack until after it was served with the citation and after the plaintiff filed its motion for judgment, the Court found that IBC forfeited its set-off rights.

In dissent, Judge Mikva wrote that since IBC’s loan was earmarked for a specific purpose and to specific payees, the debtor didn’t have enough control over the loan for it to belong to the debtor within the meaning of Section 2-1402.

The dissent also applied Illinois’s collection law axiom that a judgment creditor has no greater rights in an asset than does the judgment debtor.  Since the debtor here could not access the IBC loan proceeds (again, they were earmarked for specific purpose and payable to business entities – not the debtor individually), the plaintiff creditor couldn’t either.  And since the debtor lacked legal access rights to the loan proceeds, they were not property belonging to him under Section 2-1402 and IBC’s loan distribution did not violate the citation. (¶¶ 55-56)

Afterwords

A big victory for creditor’s counsel.   The Court broadly construes “property under a debtor’s control” in the context of a third-party citation under Section 2-1402 and harshly scrutinized a lender’s artful attempts to dodge a citation.

The case reaffirms that loan proceeds don’t remain the lender’s property and that a borrower doesn’t hold loan proceeds in trust for the lender.

The case also makes clear that where loan proceeds are paid to someone other than the debtor, the Court may still find the debtor has enough dominion over funds to subject them to the citation restraining provisions if there are enough earmarks of debtor control over the funds

Finally, in the context of lender set-off rights, Scarlato cautions a lender to timely assert its set-off rights against a defaulting borrower or else it runs the risk of forfeiting its set-off rights against a competing judgment creditor.