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.

 

 

Student Loan Discharge In Bankruptcy: How Hard Is It?

In Steven Harper’s The Lawyer Bubble: A Profession In Crisis, the author (quoting a newspaper article) describes Federally guaranteed student loans as the closest thing to a debtor prison in existence.  Lawyer Bubble, p. 11.  This statement, while jarring, has some empirical support.  In the book, Harper cites bankruptcy code changes that have made it virtually impossible to get student loan debt relief in all but the most extreme (and trying) circumstances.  He also provides anecdotes, documented examples and profuse research to back up his arguments.

Hard data aside, the “knowledge” that student loans can’t be discharged in bankruptcy has permeated the collective consciousness.  Indeed, the difficulties a bankrupt debtor must surmount to get a discharge from student loan debt have assumed near-mythic proportions.  The popular narrative is that student loan relief is given in only the most severe (think physical and mental infirmities coupled with fiscal calamity) circumstances and that it’s basically not even worth trying to get a discharge.  And in many cases, the belief is accurate: it is nearly impossible to convince a bankruptcy judge to grant a student loan discharge.  

This extreme difficulty in securing a discharge is graphically illustrated by the depressing fact patterns that underlie many student loan discharge cases where relief is granted only under the sadness-tinged “certainty of hopelessness” standard.  In many of these cases – in which the court does grant discharge relief – the court chronicles the lives of borrowers who live in abject poverty and in desperate conditions, all the while trying to support themselves and their dependents.  Yet, for other student borrowers whose circumstances aren’t as severe, the courts often refuse their discharge requests.  

But in the Seventh Circuit, as shown by a recent decision, getting a discharge may not be as difficult as previously understood.  In Krieger v. Educational Credit Management Corp., 213 F.3d 882 (7th Cir. 2013), the Court seems to relax the austere requirements for a borrower who seeks to discharge student loan debt.  In that case, the Court discharged nearly $25,000 in student loans where the borrower was in good health, educated and had solid academic credentials.

Like other cases in the student loan discharge milieu, Krieger’s underlying facts aren’t sunny.  The debtor was in her fifties and lived with her elderly mother.  She was divorced and lived in a rural area where jobs are scarce.  She hadn’t worked in over twenty years, lacked income, assets and reliable transportation.  The debtor filed an adversary proceeding to discharge student loan debt which she acquired to attend paralegal school.  The lender objected and after a trial, the bankruptcy judge sided with the debtor and discharged the loans.  The lender appealed and the District Court (bankruptcy  orders are appealed to District court) reversed on the grounds that the debtor didn’t show undue hardship.  The Seventh Circuit reversed and found that the debtor was entitled to a discharge.

 Rules/Reasoning:

Section 523(a)(8) of the Bankruptcy Code provides that student loans are generally excepted from discharge unless “excepting such debt from discharge….would impose an undue hardship on the debtor.”  11 U.S.C. 523(a)(8).  Undue hardship isn’t defined in the Code but the standard’s content is instead established by the caselaw from various jurisdictions.

To analyze undue hardship (whether the borrower demonstrates undue hardship) 7th Circuit applies the three-part test espoused by the Second Circuit in In re Brunner (831 F.2d 395 (2nd Cir. 1987) – a seminal Second Circuit case from the late 1980s.  To establish undue hardship, the borrower must show, by a preponderance of the evidence that (1)  the debtor can’t maintain a “minimal standard of living” based on current income and expenses; (2) “additional circumstances” exist that show that the state of affairs is likely to persist for a significant portion of the repayment period of the loans (the so-called “persistence” element); and (3) that the debtor-borrower has made good faith efforts to repay the loans.

The Seventh Circuit found that all three undue hardship factors were met.  The debtor showed that she was destitute, lived in a remote area that was “out of the money economy”, and hadn’t worked in over two decades.  The Court also found that the debtor’s circumstances were likely to persist and unlikely to financially improve in the future.  On this second factor – the “persistence” factor – the court rejected other courts’ requirement of the debtor showing “certainty of hopelessness”, finding that the undue hardship standard is a more flexible test.

Noticeably absent from the analysis though, is any discussion of the debtor’s “good faith.”  Other cases look to whether the debtor took advantage of reduced-payment options as well as the debtor’s past payment efforts.  Here, though, the Court simply held that the good faith element of the undue hardship test involves a fact-specific analysis that requires “clear error” for reversal.  The Court also held that a debtor is not required to exhaust all reduced-payment options as a predicate for showing good faith.  In finding good faith, the Seventh Circuit found that the bankruptcy judge’s good faith determination based on the debtor’s 200 unsuccessful job applications over the years wasn’t clearly erroneous and should have been upheld.

Manion’s cautionary concurrence:

In his concurrence, Judge Manion notes that the debtor is physically healthy, intelligent and graduated from paralegal school with a high GPA.  Judge Manion didn’t think the debtor’s circumstances were egregious enough to merit a discharge and even wondered whether other student borrowers will use this case as an “excuse to avoid their own student loan obligations?”  He pointed out that debtor’s applying for 200 jobs over a 10-year period amounted to less than two applications per month.  Hardly a Herculean job search effort.

Take-aways: Compared to other student discharge decisions – where the debtor is either physically or mentally impaired or is responsible for  sick parents or children – Krieger arguably establishes a more lenient discharge standard.  Clearly, the debtor was insolvent, destitute and hadn’t worked in decades.  But she was also physically healthy and educated.  The debtor’s circumstances seem to be missing an element of “certainty of hopelessness” – the standard that governed Seventh Circuit  discharge cases before Krieger.  At any rate, it’s too early to tell if this case represents a sea-change in student loan discharge cases.  It’s also unclear whether this case will result in an uptick in student discharge attempts.  Still, the case is worth reading for its topical relevance as well as its statistical description of the Federal loan-student borrower bankruptcy crisis.

 

Shocking! The Company That Owes You $ Dissolved: The Illinois Corporate ‘Survival’ Statute

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The Illinois corporate “survival” statute, 805 ILCS 5/12.80, allows a plaintiff to sue a dissolved corporation for up to five years after the corporation’s existence ends.  So, if a corporation was dissolved on April 29, 2014, a plaintiff who had a claim against the corporation prior to April 29, 2014, has through April 29, 2019 to file suit against that dissolved corporation. 

Any recovery would attach to corporate (as opposed to individual shareholder) assets.  And because the survival act is a legislative creation, its timing requirements are strictly construed and only relaxed in limited circumstances. 

The five-year claims period tries to strike a balance between protecting injured plaintiffs and setting a definite chronological end point for a dissolved corporation’s liability.

Michigan Indiana Condominium Association v. Michigan Place, LLC, 2014 IL App (1st) 123764 presents a recent example of a court’s rigid application of and the harsh results flowing from the five-year corporate survival period in a construction dispute involving various contractors.

In 2011, the plaintiff sued the general contractor for latent defects nine years after construction was complete.  The general contractor in turn filed third-party contribution claims against two masonry subcontractors in 2012.  Both subcontractor defendants were long defunct.  One subcontractor dissolved in 2003; the other, in 2006. 

The subcontractors moved to dismiss the general contractor’s claims under Code Section 2-619, arguing that the claims were time-barred since they were filed (in 2012) after the five-year survival period expired.  The trial court agreed and dismissed the contractor’s third-party claims.

Held: Affirmed.

In upholding the trial court’s dismissal of the general contractor’s third-party complaint, the First District stated the governing corporate law principles: 

– A corporation only exists under the express laws of the State in which it was created; 

– The right to sue a dissolved corporation (and the right of a dissolved corporation to sue) is limited to the time established by the legislature;

 – Corporation dissolution has the same legal effect as the death of a natural person;

 – Corporate survival actions are based on the legislative determination that corporate creditors should be able to sue a dissolved corporation and apply any corporate property to the debt;

 – Once the five-year survival period lapses, the corporation’s “life” also ends and no lawsuit can be filed against the corporation after the survival period expires;

– A dissolved corporation can be served with process through the Illinois Secretary of State (805 ILCS 5/1.01)

(¶¶ 12-13).

In certain situations, courts have relaxed the five-year survival period for public policy reasons.  Key exceptions to the five-year rule concern (1) actions involving minor plaintiffs; and (2) where there is an element of corporate misconduct and resulting unfairness.  (¶¶ 18-21).

  Here, since neither exception applied, the Court held that the survival act’s plain language dictated dismissal of the contractor’s third-party complaint.

 The Court recognized that barring the contractor’s claims was harsh since the contractor’s right to sue expired before it even knew it had claims against the defunct subcontractors. 

Yet because the statutory language was clear, the Court held that it was required to strictly apply the five-year survival rule and time-bar the contractor’s third-party action. (¶¶ 22-23). 

To bolster its decision, the Court noted that in legal and medical malpractice cases, courts strictly apply statutory repose periods (4 years for medical malpractice; 6 years for legal malpractice) that often doom injured plaintiff’s cases.  (¶ 24).  This gave the Court added precedential support for its rejection of the contractor’s third-party claims. 

Take-away: This case presents a good summary of the philosophical underpinnings and statement of the law governing actions by and against dissolved corporations.

Michigan Place also underscores that extending or relaxing a repose or survival period is a legislative (not a judicial) function.