Binding LLC to Operating Agreement A Substantive Change in Illinois Law; No Retroactive Effect – IL Court

The summer of 2017 ushered in a slew of changes, to Illinois’ limited liability company statute, 805 ILCS 180/15-1 et seq. (the “Act”).  Some of the key Act amendments included clarifying LLC member rights to access company records, explaining if and when a member or manager’s fiduciary duties can be eliminated or reduced, tweaking the Act’s judgment creditor remedies section, and changing the Act’s conversion (e.g. partnership to LLC or vice versa) and domestication rules.

Q Restaurant Group Holdings, LLC v. Lapidus, 2017 IL App (2d) 170804-U, examines another statutory change – one that binds an LLC to an operating agreement (OA) even where the LLC doesn’t sign it. See 805 ILCS 180/15-5.

The OA is the LLC’s governing document that sets forth each member’s (or manager’s) respective rights and obligations concerning contribution, distribution, voting rights and the like. The OA’s signing parties are typically the LLC members/managers – not the LLC itself.  Legally, this is significant because under privity of contract principles – only a party to a written agreement can sue to enforce it.

2017’s LLC Act changes make it clear that the LLC entity has standing to sue and be sued under the OA regardless of whether or not the LLC signed it.

The plaintiff in Lapidus sued the defendant for various business torts including conversion and tortious interference with contract. The defendant moved to dismiss the suit based on mandatory arbitration language in the OA.  Denying defendant’s Section 2-619 motion, the Court held that since the amended Section 15-5 of the Act worked a substantive change to the former LLC Act section, it didn’t apply retroactively. (The OA in Lapidus preceded the 2017 amendments.)

Rules/reasoning:

Affirming the trial court, the First District examined the dichotomy between procedural and substantive changes to legislation.  Where a statutory amendment is enacted after a lawsuit is filed, the Court looks to whether the legislature specified the reach (i.e. does it apply retroactively?) of the amendment.  Where new legislation is silent on its scope, the Court determines whether a given amendment is procedural or substantive.  If procedural, the amendment has retroactive effect.  If the change is substantive, however, it will only apply prospectively.

A procedural change is one that “prescribes the method of enforcing rights or obtaining redress” such as pleadings, evidence and practice.  A substantive change, by contrast, is one that establishes, creates or defines legal rights.  (¶¶ 15-16; citing to Landgraf v. USI Film Products, 511 U.S. 244, 280 (1994); 5 ILCS 70/4 (Illinois’s Statute on Statutes))

In finding that amended Section 15-5 was a substantive change to Illinois’ LLC Act (and therefore couldn’t be applied retroactively) the court noted the amended statute “established a contractual right” by binding the LLC to an OA it never signed.

Since the plaintiff LLC in Lapidus never signed the OA, the Court couldn’t require the plaintiff to follow the OA’s arbitration clause without substantially altering the LLC’s contract rights.  As a result, the Court held that amended Section 15-5 did not apply to the pre-amendment OA and the plaintiff didn’t have to adhere to the arbitration clause.t have to adhere to the OA’s arbitration provisions. (¶¶ 18-19).

Afterwords:

I. To decide if a statutory amendment applies retroactively (as opposed to only being forward-looking), the court considers whether the change is procedural or substantive.

II. While the distinction between procedural and substantive isn’t always clear, Lapidus stands for proposition a change in the law that alters a parties basic contract rights (such as by making a non-party a party to an operating agreement) is substantive and will only apply in the future.

III.  And though the case is unpublished, Lapidus still makes for interesting reading in light of Illinois’ manifold LLC Act changes.  With so many recent statutory changes (see here_for example), this case likely augurs an uptick in cases interpreting the 2017 LLC Act amendments.

Truthful Information Can’t Support An Intentional Interference With Employment Suit – IL Court

 

 

The Illinois First District recently discussed the contours of pre-suit discovery requests in cases that implicate fee speech concerns and whether truthful information can ever support an intentional interference with employment claim.

After relocating from another state to take a compliance role with a large bank, the plaintiff in Calabro v. Northern Trust Corporation, 2017 IL App (1st) 163079-U, was fired after only two weeks on the job for failing to disclose his forced removal from a prior compliance position.

When the defendant refused to identify the person who informed it of plaintiff’s prior firing, plaintiff sued to unearth the informant’s identity.  Plaintiff planned to sue that person for intentional interference with plaintiff’s employment contract.

The trial court dismissed plaintiff’s petition for pre-suit discovery and the plaintiff appealed.

Affirming, the Court construed pre-suit discovery request under Supreme Court Rule 224 narrowly.  That rule allows a petitioner to discover the identity of someone who may be responsible in damages to petitioner.

To initiate a request for discovery under Rule 224, the petitioner files a verified petition that names as defendant the person(s) from whom discovery is sought and states why discovery (along with a description of the discovery sought) is necessary.  An order granting a Rule 224 petition is limited to allowing the plaintiff to learn the identity of the responsible party or to at least depose him/her.

To show that discovery is necessary, the petitioner must present sufficient allegations of actionable harm to survive a Section 2-615 motion to dismiss.  That is, the petition must state sufficient facts to state a recognized cause of action.

But Rule 224 limits discovery to the identity of someone who may be responsible to the petitioner.  A petitioner cannot use Rule 224 to engage in a “vague and speculative quest to determine whether a cause of action actually exists.”

Here, the petitioner didn’t know what was actually said by the third party who alerted defendant to petitioner’s prior compliance role ouster.  The Court viewed this as petitioner’s tacit admission he didn’t know whether he possessed a valid interference claim.

The Court then focused on the veracity of the third-party’s statement.  To be actionable, an intentional interference claim requires the supply of false data about a plaintiff.  Accurate and truthful information, no matter how harmful, cannot underlie an intentional interference action. This is because allowing someone to sue another for imparting truthful information would raise First Amendment problems and discourage dissemination of accurate facts.

Truthful statement immunity is also supported by Section 772 of the Restatement (Second) of Torts which makes clear that one who purposely causes another not to perform a contract or enter into a business relationship is not liable for improper interference where that person gives truthful information.  And while the Court pointed out that the Restatement hadn’t been formally adopted the Illinois Supreme Court, appeals courts still looked to the Restatement for guidance on tortious interference questions.  (¶¶ 18-19).

Afterwords:

This case portrays an interesting application of Rule 224 – a device often employed in the personal injury context instead of in the commercial or employment law arenas.  While the rule provides a valuable tool for plaintiffs trying to identify possible defendants, it doesn’t give a petitioner a blank check to engage in wide-ranging, “fishing expedition” requests.  The discovery petitioner must still state a colorable claim as a precondition to obtaining a pre-suit discovery order from the court.

Calabro also vaunts the importance of free speech in our society.  After all, the petitioner’s intentional interference claim was predicated on a true statement – the petitioner was fired from a former compliance role.  The Court makes clear that a valid interference action requires a false statement and that accurate information isn’t actionable interference.

Clearly, the Court viewed the potential for chilling truthful information as more concerning than an individual’s private contract rights with an employer.

 

 

Fraudulent Transfer Action Can Be Brought In Post-Judgment Proceedings – No Separate Lawsuit Required – IL Court

Despite its vintage (over two decades), Kennedy v. Four Boys Labor Service, 664 N.E.2d 1088 (2nd Dist.  1996), is still relevant and instructional for its detailed discussion of Illinois’ fraudulent transfer statute and what post-judgment claims do and don’t fall within a supplementary proceeding to collect a judgment in Illinois.

The plaintiff won a $70K breach of contract judgment against his former employer and issued citations to discover assets to collect the judgment.

While plaintiff’s lawsuit was pending, the employer transferred its assets to another entity that had some of the same shareholders as the employer.  The “new” entity did business under the same name (Four Boys Labor Service) as the predecessor.

Plaintiff obtained an $82K judgment against the corporate officer who engineered the employer’s asset sale and the officer appealed.

Held: Judgment for plaintiff affirmed

Rules/reasons:

The Court applied several principles in rejecting the corporate officer’s main argument that a fraudulent transfer suit had to be filed in a separate action and couldn’t be brought within the context of the post-judgment proceeding.  Chief among them:

– Supplementary proceedings can only be initiated after a judgment has entered;

– The purpose of supplementary proceedings is to assist a creditor in discovering assets of the judgment debtor to apply to the judgment;

– Once a creditor discovers assets belonging to a judgment debtor in the hands of a third party, the court can order that third party to deliver up those assets to    satisfy the judgment;

– A court can authorize a creditor to maintain an action against any person or corporation that owes money to the judgment debtor, for recovery of the debt (See 735 ILCS 5/2-1402(c)(6);

– A corporate director who dissolves a company without providing proper notice to known creditors can be held personally liable for corporate debts (805 ILCS 5/8.65, 12.75);

– An action to impose personal liability on a corporate director who fails to give notice of dissolution must be filed as a separate lawsuit and cannot be brought in a post-judgment/supplementary proceeding;

– Where a third party transfers assets of a corporate debtor for consideration and with full knowledge of a creditor’s claim, the creditor may treat the proceeds from the sale of the assets as debtor’s property and recover them under Code Section 2-1402;

– A transfer of assets from one entity to another generally does not make the transferee liable for the transferor’s debts;

– But where the transferee company is a “mere continuation” of the selling entity, the transferee can be held responsible for the seller’s debt.  The key inquiry in determining successor liability under the mere continuation framework is whether there is continuity of shareholder or directors from the first entity to the second one;

– An action brought under the Uniform Fraudulent Transfer Act (FTA), 740 ILCS 160/1, is considered one that directly concerns the assets of the judgment debtor and imposes liability on the recipient/transferee based on the value of the transferred assets;

– A transfer is not voidable against one who takes in good faith and provides reasonably equivalent value.  740 ILCS 160/9;

– A court has discretion to sanction a party that disobeys a court order including by entering a money judgment against the offending party;

(664 N.E.2d at 1091-1093)

Applying these rules, the Court found that plaintiff could properly pursue its FTA claim within the supplementary proceeding and didn’t have to file a separate lawsuit.  This is because an FTA claim does not affix personal liability for a corporate debt (like in a corporate veil piercing or alter ego setting) but instead tries to avoid or undo a transfer and claw back the assets actually transferred.

FTA Section 160/5 sets forth eleven (11) factors that can point to a debtor’s actual intent to hinder, delay or defraud a creditor.   Some of the factors or “badges” of fraud that applied here included the transfer was made to corporate insiders, the failure to inform the plaintiff creditor of the transfer of the defendant’s assets, the transfer occurred after plaintiff filed suit, the transfer rendered defendant insolvent, and all of the defendant’s assets were transferred.  Taken together, this was enough evidence to support the trial court’s summary judgment for the plaintiff on his FTA count.

Take-away: Kennedy’s value lies in its stark lesson that commercial litigators should leave no financial stones unturned when trying to collect judgments.  Kennedy also clarifies that fraudulent transfer actions – where the creditor is trying to undo a transfer to a third party and not hold an individual liable for a corporate debt can be brought within the confines of a supplementary proceeding.