Tag: assumption

7th Circuit Provides Primer on Fraudulent Transfer and Alter Ego Doctrine In Contract Dispute

The Seventh Circuit affirmed an almost $3M judgment against the defendants under fraudulent transfer, successor liability and alter ego rules in Center Point v. Halim, 2014 WL 697501.

The plaintiff energy company entered into a written contract to supply natural gas to defendants’ 41 Chicago area rental properties.  The individual defendants – a husband and wife – managed the properties through a management company (Company 1).

Over a two-year period, defendants used over $1.2M worth of plaintiff’s gas and didn’t pay for it.  Plaintiff sued Company 1 in state court and got a $1.7M judgment.  When plaintiff discovered that defendants transferred all of Company 1’s assets to Company 2, plaintiff sued Company 2 and the husband and wife in Federal court alleging a fraudulent transfer and successor liability.  The Northern District entered summary judgment for plaintiff in the amount of $2.7M on all claims and defendants appealed.

Affirming, the Seventh Circuit first found that the defendants’ conduct violated the Illinois Fraudulent Transfer Act, 740 ILCS 160/1 (the “Act”).  The Act punishes debtor attempts to avoid creditors through actual fraud or constructive fraud.

Constructive fraud applies where (1) a debtor transfers assets without receiving a reasonably equivalent value in exchange for the transfer and (2) the debtor intends to incur or reasonably should believe he will incur debts beyond his ability to pay them as they become due.  Halim, *2, 740 ILCS 160/5.

The Court found that the defendants’ actions were constructively fraudulent. First, the Court noted that during a three-year time span, Company 1 (the state court judgment debtor) transferred almost $11M to the individual defendants; ostensibly to repay loans.

But the Court found it odd there was no documentation of loans or a paper trail showing where the millions of dollars went.  The suspicious timing of defendants’ creation of a new company – Company 2 – coupled with the defendants’ inability to account for the millions’ whereabouts, bolstered the Court’s constructive fraud finding.

Since the individual defendants’ depletion of Company 1’s assets made it impossible for it to pay the state court judgment, the defendants’ actions were constructively fraudulent under the Act. *3.

The Court also affirmed summary judgment for the plaintiff under successor liability and alter ego theories.  In Illinois, the general rule is that a company that purchases assets of another company does not assume the liabilities of the purchased company.

A common exception to this rule is where there is an express assumption (of liability) by the purchasing company.  Here, the record showed that Company 2 assumed all rights, obligations, contracts and employees of Company 1.  As a result, the unsatisfied state court judgment attached to Company 2 under successor liability rules.

The Court also affirmed the judgment under the alter ego doctrine.  Alter ego applies where there is virtually no difference between the business entity and that entity’s controlling shareholders.  That is, the dominant shareholders don’t treat the corporation as a separate entity and fail to follow basic corporate formalities (e.g. minutes, stock issuance, incorporation papers, etc.).

The individual defendants treated Company 1 as their personal piggy bank by commingling their personal assets with the corporate assets.  There were no earmarks of “separateness” between the individual defendants’ assets and Company 1’s corporate assets.  *3-4.

Because of this, the husband and wife defendants were responsible (in the Federal suit) for the unsatisfied state court judgment entered against the defunct Company 1.

Take-away: Halim illustrates that where a judgment debtor corporation or controlling shareholders of that corporation transfer all corporate assets to a new, similarly named (or not) entity shortly after a lawsuit is filed, it will likely look suspicious and can lead to a constructive fraud finding.

The case also underscores the importance of following corporate formalities and keeping corporate assets separate from individual/personal assets – especially where the corporation is controlled by only two individuals.  A failure to treat the corporation as distinct from the dominant individuals, can lead to alter ego liability for those individuals.

Bagel Shop Successor Tenant Hit For Rent Damages and Attorneys’ Fees in Commercial Lease Case – IL First Dist.

6945015869_a7cf0dd963_bThe First District affirmed a money judgment of about $150,000 (including $70,000 in attorneys’ fees) in a commercial lease dispute  in Alecta v. BAB Operations, Inc., 2015 IL App (1st) 132916-U.  An unpublished opinion, it’s useful for its vivid illustration of the importance of lease drafting clarity and an assigning tenant documenting its intent to not be responsible for post-assignment rent payments.

For over 15 years, the plaintiff landlord leased the property to various bagel shops.  The master lease was assigned six times over that time span. When the sixth assignee defaulted, the plaintiff sued multiple defendants including the third lease assignee – the defendant who ultimately got hit with the money judgment. (The other defendants either settled out or were defaulted.)

On appeal, the defendant (the third lease assignee) argued it was immunized from lease liability after it assigned the lease to a successor (the fourth assignee) several years earlier and that the trial court shouldn’t have awarded the landlord’s attorneys’ fees.

Affirming the money judgment, the First District provides a useful primer on contract interpretation rules applied in the commercial lease context.

– A court interprets a contract by looking to its plain language to discern the intent of the contracting parties;

– The court considers the contract in its totality and tries to harmonize each part of the contract;

– If the contract is unambiguous, the court interprets it without considering any outside evidence as to what the contract is supposed to mean;

– if the contract is ambiguous – meaning it’s susceptible to more than one meaning, the court can consider external evidence to try to resolve the ambiguity;

– a contract can be modified but the changes must materially alter the parties’ rights and duties before the change is regarded as a new contract or agreement;

– A contract can be assigned.  An assignment operates to transfer to the assignee all of the assignor’s right, title or interest in the thing assigned, and the assignee then stands in the shoes of the assignor;

– A lease is a type of contract that is governed by general contract law and can be assigned;

– It (a lease) creates privity of contract (which obligates a tenant to pay rent) and privity of estate (right to possession, basically) between the lessor and the lessee;

– Where a lease is assigned, but not assumed, there is privity of estate between the landlord and the assignee but not privity of contract.  This means the assignee can avoid further lease liability by vacating the premises or assigning to someone else;

– By contrast, where a lease is assumed (“assumption of the lease”), the party assuming the lease remains responsible to the landlord through the life of the lease even after the assuming party decamps the premises or assigns the lease;

¶¶ 40-61.

Here, the court found the assignment from the defendant to the fourth assignee ambiguous.  The assignment’s text was conflicting because at one point it said the defendant was released from further lease obligations while another section provided the assignor/defendant’s liability to the landlord remained intact.  Because the assignment language clashed on the defendant’s future (after the assignment) lease liability, the court heard trial testimony as to what the parties intended when they drafted the assignment and ultimately found for the landlord.

Afterwords:

This case serves as a good reminder of how a court interprets a written contract and handles textual ambiguity.  Any contractual ambiguity will be determined against the drafter of the contract.  Since the defendant is the one who drafted the assignment here, the court sided against it and found it liable for the lease breaches of the later assignees.

The case is also useful for its discussion of lease assignments versus lease assumptions and the different liability rules that flow from that dichotomy.  If the parties intent is to relieve an assignor from further liability, they should take pains to document that intent.

 

 

 

 

7th Circuit Affirms Fraudulent Transfer and Alter Ego Judgment Against Corporate Officers

The Seventh Circuit affirmed an almost $3M judgment against the defendants under fraudulent transfer, successor liability and alter ego rules in Center Point v. Halim, 2014 WL 697501.

The plaintiff energy company entered into a written contract to supply natural gas to defendants’ 41 Chicago area rental properties.  The individual defendants – a husband and wife – managed the properties through a management company (Company 1).

Over a two-year period, defendants used over $1.2M worth of plaintiff’s gas and didn’t pay for it.  Plaintiff sued Company 1 in state court and got a $1.7M judgment.  When plaintiff discovered that defendants transferred all of Company 1’s assets to Company 2, plaintiff sued Company 2 and the husband and wife in Federal court alleging a fraudulent transfer and successor liability.  The Northern District entered summary judgment for plaintiff in the amount of $2.7M on all claims and defendants appealed.

Affirming, the Seventh Circuit first found that the defendants’ conduct violated the Illinois Fraudulent Transfer Act, 740 ILCS 160/1 (the “Act”).  The Act punishes debtor attempts to avoid creditors through actual fraud or constructive fraud.

Constructive fraud applies where (1) a debtor transfers assets without receiving a reasonably equivalent value in exchange for the transfer and (2) the debtor intends to incur or reasonably should believe he will incur debts beyond his ability to pay them as they become due.  Halim, *2, 740 ILCS 160/5.

The Court found that the defendants’ actions were constructively fraudulent. First, the Court noted that during a three-year time span, Company 1 (the state court judgment debtor) transferred almost $11M to the individual defendants; ostensibly to repay loans.

But the Court found it odd there was no documentation of loans or a paper trail showing where the millions of dollars went.  The suspicious timing of defendants’ creation of a new company – Company 2 – coupled with the defendants’ inability to account for the millions’ whereabouts, bolstered the Court’s constructive fraud finding.

Since the individual defendants’ depletion of Company 1’s assets made it impossible for it to pay the state court judgment, the defendants’ actions were constructively fraudulent under the Act. *3.

The Court also affirmed summary judgment for the plaintiff under successor liability and alter ego theories.  In Illinois, the general rule is that a company that purchases assets of another company does not assume the liabilities of the purchased company.

A common exception to this rule is where there is an express assumption (of liability) by the purchasing company.  Here, the record showed that Company 2 assumed all rights, obligations, contracts and employees of Company 1.  As a result, the unsatisfied state court judgment attached to Company 2 under successor liability rules.

The Court also affirmed the judgment under the alter ego doctrine.  Alter ego applies where there is virtually no difference between the business entity and that entity’s controlling shareholders.  That is, the dominant shareholders don’t treat the corporation as a separate entity and fail to follow basic corporate formalities (e.g. minutes, stock issuance, incorporation papers, etc.).

The individual defendants treated Company 1 as their personal piggy bank by commingling their personal assets with the corporate assets.  There were no earmarks of “separateness” between the individual defendants’ assets and Company 1’s corporate assets.  *3-4.

Because of this, the husband and wife defendants were responsible (in the Federal suit) for the unsatisfied state court judgment entered against the defunct Company 1.

Take-away: Halim illustrates that where a judgment debtor corporation or controlling shareholders of that corporation transfer all corporate assets to a new, similarly named (or not) entity shortly after a lawsuit is filed, it will likely look suspicious and can lead to a constructive fraud finding.

The case also underscores the importance of following corporate formalities and keeping corporate assets separate from individual/personal assets – especially where the corporation is controlled by only two individuals.  A failure to treat the corporation as distinct from the dominant individuals, can lead to alter ego liability for those individuals.