Corporate Officer Can Owe Fiduciary Duty to Company Creditors – IL Court in ‘Deep Cut’* Case

Five years in, Workforce Solutions v. Urban Services of America, Inc., 2012 IL App (1st) 111410 is still a go-to authority for its penetrating analysis of the scope of post-judgment proceedings, the nature of fraudulent transfer claims and the legal relationship between corporate officers and creditors.

Here are some key questions and answers from the case:

Q1: Is a judgment creditor seeking a turnover order from a third party on theory of fraudulent transfer (from debtor to third party) entitled to an evidentiary hearing?

A1: YES

Q2: Does the denial of a turnover motion preclude that creditor from filing a direct action against the same turnover defendants?

A2: NO.

Q3: Can officer of a debtor corporation owe fiduciary duty to creditor of that corporation?

Q3: YES.

The plaintiff supplier of contract employees sued the defendant in 2006 for breach of contract.  After securing a $1M default judgment in 2008, the plaintiff instituted supplementary proceedings to collect on the judgment.  Through post-judgment discovery, plaintiff learned that the defendant and its officers were operating through a labyrinthine network of related business entities.  In 2010, plaintiff sought a turnover order from several third parties based on a 2008 transfer of assets and a 2005 loan from the debtor to third parties.

That same year (2010), plaintiff filed a new lawsuit against some of the entities that were targets of the motion for turnover order in the 2006 case.

In the 2006 case, the court denied the turnover motion on the basis that the plaintiff failed to establish that the turnover defendants received fraudulent transfers from the judgment debtor and that the fraudulent transfer claims were time-barred.  740 ILCS 160/10 (UFTA claims are subject to four-year limitations period.)

The court in the 2010 case dismissed plaintiff’s claims based on the denial of plaintiff’s turnover motion in the 2006 case.  Plaintiff appealed from both lawsuits.

Section 2-1402 of the Code permits a judgment creditor to initiate supplementary proceedings against a judgment debtor to discover assets of the debtor and apply those assets to satisfy an unpaid judgment

A court has broad powers to compel the application of discovered assets to satisfy a judgment and it can compel a third party to turn over assets belonging to the judgment debtor.

The only relevant inquiries in a supplementary proceeding are (1) whether the judgment debtor is holding assets that should be applied to the judgment; and (2) whether a third-party citation respondent is holding assets of the judgment debtor that should be applied to the judgment. .  If the facts are right, an UFTA claim can be brought in supplementary proceedings

But where there are competing claimants to the same asset pool, they are entitled to a trial on the merits (e.g. an evidentiary hearing) unless they waive the trial and stipulate to have the turnover motion decided on the written papers.

Here, the court disposed of the turnover motion on the bare arguments of counsel.  It didn’t conduct the necessary evidentiary hearing and therefore committed reversible error when it denied the motion.

The defendants moved to dismiss the 2010 case – which alleged breach of fiduciary duty, among other things – on the basis of collateral estoppel.  They argued that the denial of the plaintiff’s motion for turnover order in the 2006 precluded them from pursuing the same claims in the 2010 case.  Collateral estoppel or “issue preclusion” applies where: (1) an issue previously adjudicated is identical to the one in a pending action; (2) a final judgment on the merits exists in the prior case; and (3) the prior action involved the same parties or their privies.

The appeals court found that there was no final judgment on the merits in the 2006 case.  Since the trial court failed to conduct an evidentiary hearing, the denial of the turnover order wasn’t final.  Since there was no final judgment in the 2006 suit, the plaintiff was not barred from filing its breach of fiduciary duty and alter ego claims in 2010.

The Court also reversed the trial court’s dismissal of the plaintiff’s breach of fiduciary duty claims against the corporate debtor’s promoters.  To state a claim for breach of fiduciary duty, a plaintiff must allege that the defendant owes him a fiduciary duty; that the defendant breached that duty; and that he was injured as a proximate result of that breach.

The promoter defendants argued plaintiff lacked standing to sue since Illinois doesn’t saddle corporate officers with fiduciary duties to a corporation’s creditors. The Court allowed that as a general rule, corporate officers only owe fiduciary duties to the corporation and shareholders.  “However, under certain circumstances, an officer may owe a fiduciary duty to the corporation’s creditors….specifically, once a corporation becomes insolvent, an officer’s fiduciary duty extends to the creditors of the corporation because, from the moment insolvency arises, the corporation’s assets are deemed to be held in trust for the benefit of its creditors.

Since plaintiff alleged the corporate defendant was insolvent, that the individual defendants owed plaintiff a duty to manage the corporate assets, and a breach of that duty by making fraudulent transfers to various third parties, this was enough to sustain its breach of fiduciary duty claim against defendants’ motion to dismiss. (¶¶ 83-84).

Afterwords:

1/ A motion for turnover order, if contested, merits a full trial with live witnesses and exhibits.

2/ A denial of a motion for a turnover order won’t have preclusive collateral estoppel effect on a later fraudulent transfer action where there was no evidentiary hearing to decide the turnover motion

3/ Once a corporation becomes insolvent, an officer’s fiduciary duty extends to creditors of the corporation.  This is because once insolvency occurs, corporate assets are deemed held in trust for the benefit of creditors.


* In the rock radio realm, a deep cut denotes an obscure song – a “B-side” – from a popular recording artist or album.  Examples: “Walter’s Walk” (Zeppelin); “Children of the Sea” (Sabbath); “By-Tor And the Snow Dog” (Rush).

The (Ruthless?) Illinois Credit Agreements Act

The Illinois Credit Agreements Act, 815 ILCS 160/1, et seq. (the “ICAA”) and its requirement that credit agreements be in writing and signed by both creditor and debtor, recently doomed a borrower’s counterclaim in a multi-million dollar loan default case.

The plaintiff in Contractors Lien Services, Inc. v. The Kedzie Project, LLC, 2015 IL App (1st) 130617-U, sued to foreclose on a commercial real estate loan and sued various guarantors along with the corporate borrower.

The borrower counterclaimed, arguing that a “side letter agreement” (“SLA”) signed by an officer of the lender established the parties’ intent for the lender to release additional funds to the borrower – funds the borrower claims would have gotten it current or “in balance” under the loan. The trial court disagreed and entered a $14M-plus judgment for the lender plaintiff.  The corporate borrower and two guarantors appealed.

Held: Affirmed

Rules/Reasoning:

The ICAA provides that a debtor cannot maintain an action based on a “credit agreement” unless it’s (1) in writing, (2) expresses an agreement or commitment to lend money or extend credit or (2)(a) delay or forbear repayment of money and (3) is signed by the creditor and the debtor. 815 ILCS 160/2

An ICAA “credit agreement” expansively denotes “an agreement or commitment by a creditor to lend money or extend credit or delay or forbear repayment of money not primarily for personal, family or household purposes, and not in connection with the issuance of credit cards.”  So, the ICAA does not apply to consumer transactions.  It only governs business/commercial arrangements.

The ICAA covers and excludes claims that are premised on unwritten agreements that are even tangentially related to a credit agreement as defined by the ICAA.

The borrower argued that the court should construe the SLA with the underlying loan as a single transaction: an Illinois contract axiom provides that where two instruments are signed as part of the same transaction, they will be read and considered together as one instrument.

The court rejected this single transaction argument.  It found the SLA was separate and unrelated to the loan documents.  The SLA post-dated the loan documents as evidenced by the fact that the  SLA specifically referenced the loan.  Conversely, the loan made no mention of the SLA (since it didn’t exist when the loan documents were signed).

All these facts militated against the court finding the SLA was part-and-parcel of the underlying loan transaction.

Another key factor in the court’s analysis was the defendants admitting that the SLA post-dated the loan (and so was a separate and distinct writing).  The court viewed this as a judicial admission – defined under the law as “deliberate, clear, unequivocal statement by a party about a concrete fact within that party’s knowledge.”

Here, since the SLA was not part of the loan modification, it stood or fell on whether it met the requirements of the ICAA.  It did not since it wasn’t signed by both lender and borrower.  The ICAA dictates that both creditor and debtor sign a credit agreement.  Here, since the debtor didn’t sign the SLA (it was only signed by lender’s agent), the SLA agreement was unenforceable.  As a consequence, the lender’s summary judgment on the counterclaim was proper.

Afterwords:

This case and others like it show that a commercially sophisticated borrower – be it a business entity or an individual – will likely be shown no mercy by a court.  This is especially true where there is no fraud, duress or unequal bargaining power underlying a given loan transaction.

Contractor’s Lien Services also illustrates in stark relief that ICAA statutory signature requirement will be enforced to the letter.  Since the borrower didn’t sign the SLA (which would have arguably cured the subject default), the borrower couldn’t rely on it and the lender’s multi-million dollar judgment was validated on appeal.