Constructive Fraud in IL Mechanics’ Lien Suits: A Case Study

ACHere’s one from the vault.  While dated, the case is still relevant for its cogent discussion of important and recurring mechanics’ lien litigation issues.  In Springfield Heating and Air Conditioning, Inc. v. 3947-55 King Drive at Oakwood, LLC, 387 Ill App 3d 906 (1st Dist. 2009), the First District examined the concept of constructive fraud and discussed when a subcontractor can bring alternative unjust enrichment and quantum meruit claims in a lien suit.

The plaintiff was a subcontractor who installed HVAC materials on a construction project consisting of two adjoining properties  for a total contract sum of about $400,000.  When the general contractor fired it, the plaintiff liened both parcels each for $300,000 – the total amount plaintiff was then due for its HVAC work.  The result was a “blanket lien” on the properties for a total of about $600K – double the proper amount.

The plaintiff sued to foreclose its liens and filed companion (and alternative) claims for quantum meruit and unjust enrichment against the general contractor and owner defendants.  The trial court granted the defendants’ motion to dismiss the plaintiff’s claims.  The court held that the lien claim was constructively fraudulent since it was inflated by almost two times the actual lien amount and because the lien wasn’t apportioned among the two property parcels.  The Court dismissed the plaintiff’s quantum meruit and unjust enrichment claims because it held that a subcontractor’s only remedy against an owner is a mechanics lien foreclosure action.

Held: Affirmed in part; reversed in part

 Constructive Fraud

The First District found there was no evidence of constructive fraud by the subcontractor; noting that Section 7 of the Lien Act aims to protect honest lien claimants who make a mistake rather than claimants who intentionally make a false statement or who knowingly inflates their lien.  That’s why someone must show an intent to defraud in order to nullify a lien.

While acknowledging that the plaintiff subcontractor’s lien totaled about $600K – nearly double of the amount it was actually owed – the Court looked beyond the liens’ numerical overcharge and found no additional evidence of fraudulent intent. 

This holding amplifies the First District’s Cordeck Sales, Inc. v. Construction Systems, Inc. (382 Ill.App.3d 334(1st. Dist. 2008)) ruling – a case viewed with near-Biblical reverence in Illinois mechanics lien circles – that a mechanics lien won’t be invalidated for constructive fraud simply because its inflated.  There must be an overstatement “in combination” with other record evidence that allows the court to infer fraudulent intent.  Here, there was no additional fraud evidence and the Court reinstated the subcontractor’s lien claim.

Quantum Meruit/Unjust Enrichment

The Court sustained the trial court’s dismissal of the plaintiff’s equitable counts of quantum meruit and unjust enrichment.  The general rule is that a subcontractor like plaintiff can’t recover for unjust enrichment where the entire work to be performed by the subcontractor is under a contract with the general contractor.  See Premier Electrical Construction Co. v. La Salle National Bank, 132 Ill. App. 3d 485, 496 (1st Dist. 1985). 

In such a case (no privity between owner and subcontractor), the general contractor has the power to employ whom he chooses and the owner is entitled to presume that any subcontracting work is being done for the contractor; not the owner.  Since there is normally no direct contract between a subcontractor and the owner, a subcontractor can’t claim that its work unjustly enriched the owner.

So, unless the subcontractor proves that it dealt directly with a property owner, its exclusive remedy against an owner is a statutory, mechanics lien suit.  Swansea Concrete Products, Inc. v. Distler, 126 Ill. App. 3d 927, 932 (5th Dist. 1984).  If the subcontractor misses the time deadlines to record its lien (four months, usually) or fails to timely file suit to foreclose the lien (two years post-completion of job), the subcontractor can’t then try to recover against the property owner under quantum meruit or unjust enrichment. 

Here, since the plaintiff’s contract was with the general contractor and not the owner, the plaintiff’s remedy against the general contractor was for breach of contract and its remedy against the owner was a mechanics’ lien suit.  As a result, the plaintiff’s quantum meruit and unjust enrichment claims were properly dismissed.

Afterwords: Even though the case is now several years old, Springfield Heating has continued relevance in construction lien litigation because it is the First District’s most recent word on the showing a property owner must make to prove a subcontractor’s constructive fraud when attempting to defeat a lien on the owner’s property.  Clearly, a numerical overcharge isn’t enough to defeat a lien. 

The owner must show additional “plus factors” which signals  fraudulent intent by the lien claimant.  The case also further supports the black-letter proposition that a subcontractor’s sole remedy against a property owner is a mechanics’ lien suit.  This rule will always apply unless the subcontractor can prove that the owner specifically requested or induced the subcontractor’s labor and materials on the owner’s property.

 

 

Contractors’ Honest Mistake in Lien Completion Date And Amounts Doesn’t Doom Mechanic’s Lien Case (IL Law)

imageThe First District recently validated the mechanics liens of two “ma and pa” construction companies against a competing lienholder’s argument that the  liens contained a flawed completion date and an exaggerated lien amount.

North Shore Community Bank v. Sheffield Wellington LLC, 2014 IL App (1st) 123784 is a priority dispute between mortgage lenders and mechanics lien claimants on commercial property.  In examining the parties’ competing claims, the Court addresses what consequences flow from a contractor’s failure to accurately state and prove its completion date under the Illinois Mechanics’ Lien Act, 770 ILCS 60/1 et seq. (the “Lien Act”) and whether that failure defeats its lien claim.

The lender sued to foreclose its mortgage and two contractors counterclaimed to foreclose their mechanics liens on the site.  One lien claimant – who built an office at the site – misstated its completion date by about a week while a roofing contractor couldn’t prove (in its deposition testimony and documents) that it actually performed on its stated completion date.  In addition, the office builder’s principal admitted in his deposition that the lien amount could be off by as much as 10%.  Based on the completion date and lien amount discrepancies, the lender moved for summary judgment against both contractors.  The trial court granted the lender’s motion and found that the mortgage lien trumped the mechanics’ liens.

Held: Summary judgment reversed.

Rules/Reasons:

Reversing summary judgment for the lender, the Court expanded on the Lien Act’s purpose and discussed whether misstated recorded lien information was a binding judicial admission:

The Mechanics’ Lien Act’s Purpose

– The Lien Act’s purpose is to allow someone who has improved property by furnishing labor or materials to lien that property;

– Section 7 of the Lien Act requires a contractor to file its lien  within 4 months after completion in order to enforce his lien against third-party creditors or other lienholders;

While the Act is silent on completion date, the courts have interpreted Section 7 to require a lien claimant to include a completion date in order to be enforceable;

– Section 24 of the Act governs subcontractors and requires them to serve notice of their lien to the lender (“lending agency”) within 90 days after the completion date;

– Completion date under Section 7 and 24 doesn’t mean completion of the project in total; it just means completion of the work sought to be liened;

– The purpose of Section 7 (which governs contractors) and 24 (which governs subs) is to provide notice to third parties of the existence of a lien claim.

Overstated Liens – What Is ‘Intent to Defraud’?

– An overstated lien can be deemed fraudulent only where an “intent to defraud” is shown (770 ILCS 60/7a);

– A lien will be defeated where it contains a (1) knowing and (2) substantial overcharge;

– An intent to defraud can be proven by executed documents that overstate the amount in combination with some other evidence (i.e. a “Plus Factor”) from which fraudulent intent can be inferred;

Section 7 of the Act is designed to protect the honest lien claimant who makes a mistake; not a dishonest claimant who knowingly makes a false statement;

Judicial Admissions – What Are They?

A judicial admission is a “deliberate, clear, unequivocal statement” by a party about a concrete fact within that party’s knowledge;

– The effect of a judicial admission is that is withdraws a fact from dispute and makes unnecessary any need to prove the fact at trial;

– A statement that is the product of mistake or inadvertence is not a binding judicial admission;

– Judicial admissions are designed to deter perjury; they aren’t designed to punish honest mistakes;

– A litigant can’t contradict a prior judicial admission in summary judgment proceedings or at trial;

(¶¶ 81-90, 101-103, 126).

Applying these rules, the Court found that plaintiffs’ incorrect completion dates didn’t impact the mortgage lender’s notice rights.  Both liens were facially valid since they were timely filed; even with a technically wrong completion date.  The office subcontractor served its lien notice on the lender within 90 days of the completion of its work and the roofing general contractor filed its lien within the four-month period required Section 7.

The Court also noted that any incorrect completion dates were the results of honest mistakes – they weren’t binding judicial admissions.  This was because the lien claimants were “ma and pa” companies with limited resources.  One claimant was a single-person entity while the other had two employees that operated from a home office.  The Court also credited testimony by one of the contractors that it had never filed a lien before and wasn’t sure what information was key to the completion date or lien amount questions.  (¶¶129-130).

Finally, the Court rejected the lender’s constructive fraud argument – premised on the subcontractor’s officer admitting in a deposition that the lien amount could be “about 10% off.”  There was no evidence that the subcontractor intentionally made a substantial overcharge and that any flawed numbering was the result of an honest mistake.  An inflated lien amount – without more – is not enough for a constructive fraud finding.

Now What?: This case serves as a strong example of a court refusing to elevate form over substance.  While a completion date is required, a minor error in that date won’t defeat the lien if its otherwise facially valid (i.e. timely filed).  Also, constructive fraud in the lien context is hard to prove.  If a lien claimant can show that a lien error is an honest mistake and not purposely exaggerated, that lien claimant may still be able to prosecute his lien foreclosure suit.

Uniform Fraudulent Transfer Act: Actual Fraud, Constructive Fraud and Transfers for Insufficient Value: IL Law Basics

The Illinois Fraudulent Transfer Act (“FTA”) – 740 ILCS 160/1 et seq. – is a powerful creditor enforcement tool aimed at capturing assets transferred by a judgment debtor to elude a money judgment.  

In United Central Bank v. Sindhu, 2014 WL 3748555, the bank obtained a $4.3M judgment against the defendant.  After initiating various citations to discover assets, the bank learned that several months after the judgment, the defendant transferred three properties to his sister – including one residence property valued at over $3M.   He also received and turned over several rent checks on one of the transferred commercial properties.

 The plaintiff filed an FTA suit against the defendant and his sister seeking the turnover of the $3M property and the rent checks.  The defendants moved to dismiss all complaint counts.  The Court denied the bulk of the motion.

Operative Rules and Reasoning:

FTA Sections 5(a)(1), (2) and 6 govern claims based on actual fraud, constructive fraud and for pre-transfer claims, respectively.

The FTA’s actual fraud provision – Section 5(a)(1) – requires a plaintiff to plead that a debtor transferred property with actual intent to hinder or defraud a creditor, whether the claim arose before or after the transfer was made. 

Actual fraud factors include whether (1) the transfer or obligation was to an insider;

(2) the transfer or obligation was disclosed or concealed;

(3) before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit;

(4) the transfer was of substantially all the debtor’s assets;

(5) the debtor removed or concealed assets;

(6) the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred. 

To plead FTA constructive fraud (Section 5(a)(2)), the plaintiff must allege that the transfer was made, before or after a creditor’s claim matured, and the debtor never received reasonably equivalent value in exchange for the transfer.

The constructive fraud plaintiff must also allege that the debtor engaged in or was about to engage in a transaction that left the debtor with zero or unreasonably small remaining assets, or should have believed that he (the debtor) would incur debts beyond his ability to pay as they became due. (*3).

FTA Section 6(a) applies only to creditor claims that arose before a debtor’s transfer of assets.  

An FTA Section 6(a) plaintiff must establish that (1) the debtor made a transfer without receiving a reasonably equivalent in exchange for the transfer; (2) that the debtor was insolvent at that time or became insolvent as the result of the transfer; and (3) the creditor’s claim arose before the transfer.  (*3).

The Court found that the plaintiff sufficiently alleged valid FTA claims under all three sections.

The thrust of the complaint was that (a) several months after the money judgment, (b) the defendant secretly transferred multiple million dollar properties and rent checks to a family member (an insider) and (c) received little or nothing in return for the transfers. 

Defendant’s sister (the transferee) argued that she retired over $1.5M in the debtor’s mortgage debt in return for the conveyance of the $3M residence property. 

However, since the property was worth more than twice the amount of the retired mortgage debt, the Court found that the defendant didn’t receive a reasonably equivalent value in exchange. 

Taken together, the Court found these allegations satisfied the pleading standards for an FTA actual fraud and constructive fraud claim for transfers made before or after a creditor’s claim arose. 

Take-aways:

Sindhu shows in sharp relief the fruits of aggressive post-judgment collection efforts.  

Had the plaintiff not so ardently pursued its claims, the defendant could have transferred substantial assets properties and likely escaped the judgment.