Faulty Service on Defunct LLC Spells Trouble for Judgment Creditor – IL 1st Dist.

In a case whose procedural progression spans more than a decade, the First District in John Isfan Construction v. Longwood Towers, LLC, 2016 IL App (1st) 143211 examines the litigation aftershocks flowing from a failure to properly serve a limited liability company (LLC).

The case also illustrates when a money judgment can be vacated under the “substantial justice” standard governing non-final judgments.

The tortured case chronology went like this:

2003 – plaintiff files a mechanics lien suit against LLC for unpaid construction work on an 80-unit condominium development;

2005 – LLC dissolves involuntarily;

2005 – lien suit voluntarily dismissed;

2006 – plaintiff breach of contract action filed against LLC;

2009 – default judgment entered against LLC for about $800K;

2011 – plaintiff issues citations to discover assets to LLC’s former members and files complaint against the members to hold them liable for the 2009 default judgment (on the theory that the LLC made unlawful distributions to the members);

2014 – LLC members move to vacate the 2009 judgment. Motion is denied by the trial court and LLC members appeal.

Holding: The appeals court reversed the trial court and found that the 2009 default judgment was void.

The reason: Plaintiff’s failure to properly serve the defunct LLC under Illinois law. As a result, a hefty money judgment was vacated.

Q:           Why?

A:            A defendant must be served with process for a court to exercise personal jurisdiction over him.  A judgment entered against a party who is not properly served is void.  

Section 50 of the LLC Act (805 ILCS 180/1-50) provides that service of process on an LLC defendant must be made on (a) the LLC’s registered agent or (b) the Secretary of State if the LLC doesn’t appoint a registered agent or where the LLC’s registered agent cannot be found at the LLC’s registered office or principal place of business.

In the context of a dissolved LLC, the LLC Act provides that an LLC continues post-dissolution solely for the purpose of winding up.  This is in contrast to the corporate survival statute that provides that a dissolved (non-LLC) corporation continues for five years after dissolution (This means the defunct corporation can be sued and served for up to five years after dissolution.)  805 ILCS 5/5.05.

Here, the plaintiff sued the LLC’s former registered agent over a year after the LLC dissolved.  This was improper service under the LLC Act.  By failing to serve the Secretary of State in accordance with the LLC Act, the court lacked jurisdiction over the LLC.  (¶¶ 37-40)

The Court also rejected the plaintiff’s argument that the erstwhile LLC members waived their objection to jurisdiction over the LLC by participating in post-judgment proceedings.

Since a party who submits to a court’s jurisdiction does so only prospectively, not retroactively, the party’s appearance doesn’t activate an earlier order entered in the case before the appearance was filed. (¶¶ 40-42)

Another reason the Court voided the default judgment was the “substantial justice” standard which governs whether a court will vacate a judgment under Code Section 2-1301(e). 

The reason Section 2-1301 applied instead of the harsher 2-1401 was because the judgment wasn’t final.  It wasn’t final because at the time the judgment was entered, the plaintiff had a pending claim against another party that wasn’t disposed of.  ((¶¶ 46-47)

Under Illinois law, a default judgment is a drastic remedy and Illinois courts have a long and strong policy of deciding cases on the merits instead of on procedural grounds.  In addition, when seeking to vacate a non-final default order, the movant does not have to show a meritorious defense or diligence in presenting the defense.

Applying these default order guideposts, the Court found that substantial justice considerations dictated that the default judgment be vacated.  Even though the judgment was entered some five years before the motion to vacate was filed, it wasn’t a final order. 

This meant the LLC member movants did not have to show diligence in defending the action or a meritorious defense.  All the members had to demonstrate was that it was fair and just that they have their day in court and that they should be able to defend the plaintiff’s unlawful transfers allegations. (¶¶ 49, 51)

Afterwords: This case provides a useful summary of the key rules that govern how to serve LLC’s and particularly, dissolved LLC’s.  The case’s “cautionary tales” are to (i) serve corporate defendants in accordance with statutory direction; and (ii) always request a finding of finality for default judgments where there are multiple parties or claims involved.

Had the plaintiff received a finding of finality, the LLC members’ motion to vacate would have been untimely under Section 2-1401 – which requires a motion to attack a final judgment to be brought within two years and has a heavier proof burden than a 2-1301 motion.  Still, it wouldn’t have mattered here. The plaintiff’s failure to properly serve the LLC meant the judgment was void and could have been attacked at any time.

 

Paralegal Fees Can Be Tacked On to Attorney Fees Sanctions Award – IL First Dist.

Aside from its trenchant discussion of the constructive fraud rule in mechanics lien litigation, the Illinois First District in Father & Sons Home Improvement II, Inc. v. Stuart, 2016 IL App (1st) 143666 clarified that a paralegal’s time and services can be added to a claim for attorneys’ fees as a sanction against a losing party who files false pleadings.

In an earlier post, I discussed how the lien claimant in this case lost its lien foreclosure suit for misstating the completion of work date and inflating the monetary value of work and materials it affixed to the subject site.  The property owner and a lender defendant filed a fee petition and sanctions motion, respectively.

Examining the lender’s motion for Rule 137 sanctions, the Court stated some black-letter rules that govern fee petitions:

  • Under Rule 137, a party can recover attorneys’ fees incurred as a result of a sanctionable pleading or paper (one filed without an objectively reasonable legal basis);
  • Typically, “overhead” expenses aren’t compensable in a fee motion.  The theory is that overhead costs are already built into an attorneys’ hourly rate;
  •   Overhead includes telephone charges, in-house delivery charges, photocopying, check processing, and in-house paralegal and secretarial services;
  • However, when a paralegal performs a specialized legal task that would normally be performed by an attorney, the paralegal’s fees are recoverable since those services would not be considered overhead.

The Court found that the lender’s paralegals performed myriad services that would normally be done by an attorney – namely, researching the title history of the subject property and preparing a memorandum summarizing the title history.  By contrast, a paralegal’s general administrative tasks were disallowed by the court and could not be sought in the sanctions motion.

Afterwords:

When preparing a fee petition, the prevailing party should also include paralegal time and services; especially if they involve researching real estate land records and summarizing a title history.  While the line separating legal services (which are recoverable) and administrative or overhead expenses (which aren’t) is blurry, Father & Sons stands for the proposition that a fee petition or Rule 137 sanctions motion can be augmented by paralegal fees where the paralegal performs specialized work that contains an element of legal analysis.

 

Lien Inflation and “Plus Factors” – Constructive Fraud in Illinois Mechanics Lien Litigation

The contractor plaintiff in Father & Sons Home Improvement II, Inc. v. Stuart, 2016 IL App (1st) 143666 was caught in several lies in the process of recording and trying to foreclose its mechanics lien.  The misstatements resulted in the nullification of its lien and the plaintiff being on the hook for over $40K in opponent attorneys’ fees.

The plaintiff was hired to construct a deck, garage and basement on the defendant owner’s residence.  Inexplicably, the plaintiff recorded its mechanics lien 8 months before it finished its work. This was a problem because the lien contained the sworn testimony of plaintiff’s principal (via affidavit) that stated a completion date that was several months off.

Plaintiff then sued to foreclose the lien; again stating an inaccurate completion date in the complaint.  The owner and mortgage lender defendants filed separate summary judgment motions on the basis that the plaintiff committed constructive fraud by (1) falsely stating the lien completion date and (2) inflating the dollar value of its work in sworn documents (the affidavit and verified complaint).

Affirming summary judgment and separate fee awards for the defendants, the Court distilled the following mechanics lien constructive fraud principles:

  • The purpose of the mechanics lien act (Lien Act) is to require someone with an interest in real property to pay for property improvements or benefits he encouraged by his conduct.  Section 7 of the Lien Act provides that no lien will be defeated because of an error or if it states an inflated amount unless it is shown that the erroneous lien amount was made with “intent to defraud.”  770 ILCS 60/7;
  • The intent to defraud requirement aims to protect the honest lien claimant who simply makes a mistake in computing his lien amount.  But where there is evidence a lien claimant knowingly filed a false lien (either in completion date or amount), the lien claim will be defeated.  (¶¶ 30-31);
  • Where there is no direct proof of a contractor’s intent to defraud, “constructive fraud” can negate a lien where there is an overstated lien amount or false completion date combined with additional evidence;
  • The additional evidence or “plus factor” can come in the form of a false affidavit signed by the lien claimant that falsely states the underlying completion date or the amount of the improvements furnished to the property.  (¶ 35).

Based on the plaintiff’s multiple false statements – namely, a fabricated completion date and a grossly exaggerated lien amount based on the amount of work done – both in its mechanics lien and in its pleadings, the court found that at the very least, the plaintiff committed constructive fraud and invalidated the lien.

Attorneys’ Fees and Rule 137 Sanctions

The court also taxed the property owners’ attorneys’ fees to the losing contractor.  Section 17 of the Lien Act provides that an owner can recover its attorneys’ fees where a contractor files a lien action “without just cause or right.”  The Lien Act also specifies that only the owner – not any other party involved in the chain of contracts or other lienholders – can recover its attorneys’ fees.  A lien claim giving rise to a fee award is one that is “not well grounded in fact and warranted by existing law or a good faith argument for the extension, modification or reversal of existing law.”  770 ILCS 60/17(d).

Based on the contractor’s clear case of constructive fraud in filing a lien with a false completion date and in a grossly excessive sum, the court ordered the contractor to pay the owner defendants’ attorneys’ fees.

The lender – who is not the property owner – wasn’t entitled to fees under Section 17 of the Lien Act.  Enter Rule 137 sanctions.  In Illinois, Rule 137 sanctions are awarded to prevent abuse of the judicial process by penalizing those who file vexatious and harassing lawsuit based on unsupported statements of fact or law.  Before assessing sanctions, a court does not engage in hindsight but instead looks at what was objectively reasonable at the time an attorney signed a document or filed a motion.

Because the plaintiff contractor repeatedly submitted false documents in the course of the litigation, the court awarded the mortgage lender its attorneys’ fees incurred in defending the lien suit and in successfully moving for summary judgment.  All told,  the Court sanctioned the contractor to the tune of over $26,000; awarding this sum to the lender defendant.

Afterwords:

This case serves as an obvious cautionary tale for mechanics lien plaintiffs.  Plainly, a lien claimant must state an accurate completion date and properly state the monetary value of improvements.  If the claimant realizes it has made a mistake, it should amend the lien.  And even though an amended lien usually won’t bind third parties (e.g. lenders, other lienholders, etc.), it’s better to correct known lien errors than to risk a hefty fee award at case’s end.