‘Half a Mil’ Conditional Judgment Too Harsh for Anemic Citation Response – IL First Dist.

Hayward v. Scorte, 2020 IL App (1st) 190476, reads like a creditors’ rights practice manual for its detailed discussion of the nature and scope of various creditor remedies under the Illinois supplementary proceedings and garnishment statutes.  (735 ILCS 5/2-1402 and 735 ILCS 5/12-701 et seq., respectively.)

The plaintiffs confirmed a half-million dollar arbitration award against a corporate defendant in a construction dispute and sought to collect. In post-judgment discovery, the post-judgment court (the Law Division’s Tax and Misc. Remedies Div.) found that the corporate debtor’s two owners failed to properly respond to citations served upon them by plaintiffs’ counsel.

The trial court entered a conditional judgment (later converted to a final one) against each corporate officer for the full amount of the underlying judgment.  The officers appealed.

Reversing, the First District first noted that supplementary proceedings in Illinois allow a judgment creditor to pursue any assets in the judgment debtor’s possession or that are being held by third parties and apply those assets to satisfy the judgment. See 735 ILCS 5/2-1402.

In the garnishment context, 735 ILCS 5/12-701 et seq., where a third party fails to respond to a garnishment summons, the creditor garnisher can request a conditional judgment against the garnishee. 735 ILCS 5/12-706.

Once the conditional judgment is entered, the creditor issues a summons to the respondent.  If the respondent still fails to answer the garnishment summons, the conditional judgment is confirmed or finalized. Once the garnishee responds to the conditional judgment summons, it isn’t bound by the earlier default and can litigate afresh. [21]

Section 12-706’s twin goals is to provide an incentive for respondents to answer a properly served garnishment summons and to protect a respondent from Draconian consequences of a single oversight. 735 ILCS 5/12-706. [21]

Code Section 2-1402 permits a court to enter any order or judgment that could be entered in a garnishment proceeding. 735 ILCS 5/2-1402(k-3).

But while Section 2-1402(k-3) incorporates the garnishment act’s full range of remedies, the section does not give a creditor broader rights than exist under garnishment law.  [23]

Conditional judgments are only allowed where a garnishee fails to appear and answer.  Here, the third-party respondents (the two corporate officers) did appear and answer the citation; the trial judge just deemed the answer incomplete.

The Court then noted that garnishment act Section 12-711(a) speaks to the precise situation here: it allows a judgment creditor to challenge the sufficiency of a garnishee’s answer and request a trial on those issues.  735 ILCS 5/12-711(a).

The garnishment statute is silent on the consequences of incomplete or insufficient answers.  Since the corporate officers did answer the underlying citations, the Court held that the trial court lacked statutory authority to enter a full money judgment against the individual defendants under Code Section 2-1402(k-3). [26]

Next, the Court examined the interplay between Section 2-1402(c)(3) and (c)(6).  The former section speaks to situations where a third party has embezzled or converted a judgment debtor’s assets.  The latter permits a  judgment creditor to sue a third party (i.e. to bring a separate cause of action) where that third party is indebted to a judgment debtor.

The Court pointed out that neither section allowed a court to assess the entire underlying judgment against a third party without a specific finding that party converted or embezzled a debtor’s assets. [27]

In fact, the lone statutory basis for a court to enter a full judgment against a third-party is where it violates the citation’s restraining provision – Section 2-1402(f)(1).

This section allows a court to punish a third party that transfers, disposes of or interferes with a judgment debtor’s non-exempt property – after a citation is served – by entering a money judgment for the lesser of (a) the unpaid amount of a judgment or (b) the value of the asset transferred. [27, 28]

The Court then stressed that a citation lien applies only to property transfers occurring after a citation is served.  Pre-citation transfers, by contrast, cannot form the basis of a money judgment against a third party.  Since the plaintiffs’ conditional judgment motion was predicated in part on property transfers occurring some two years before the citations were issued, they fell beyond the scope of sanctions considered by the trial court.

An additional ground for the First District’s reversal lay in the absence of proof that the corporate officers held any corporate assets.  Illinois law is clear that before a court can enter a judgment against a third party, there must be some record evidence that the third party possesses assets belonging to the debtor.

Since there was no statutory bases to assess the full money judgment against the two erstwhile corporate principals and since there was no evidence either principal had any corporate debtor assets in their possession, the trial court overstepped by entering a money judgment against the individual corporate officer defendants.

Take-aways:

A third party must be in possession of a debtor’s assets before a money judgment can issue against that third party;

While the garnishment act allows for a conditional judgment where a respondent fails to appear and answer a garnishment summons, and Illinois’s supplementary proceedings statute incorporates garnishment remedies, the garnishment act does not permit a conditional judgment against a garnishee who does in fact answer a garnishment summons;

A judgment creditor should file a separate veil-piercing suit against a defunct corporation’s principals if the creditor believes they are holding erstwhile corporate assets.

Don’t Confuse Joint Tenancy with Tenancy-By-Entirety Ownership – Indiana Court Cautions

Title to real estate is typically held in one of three ways: tenancy in common, joint tenancy and tenancy by the entirety.

The salient characteristic of tenancy in common is that each owner holds a ½ interest in the property and that upon an owner’s death, his/her share passes to his/her heir.

Joint tenancy’s hallmark is its survivorship feature: when a joint tenant dies, his/her share passes to the surviving joint tenant. The deceased’s interest will not pass to an heir.

With tenancy by entirety (“TBE”) ownership, sometimes described as “joint tenancy with marriage,” the property is immune from one spouse’s creditor’s judgment lien. This means the creditor of one spouse cannot foreclose on the TBE property. However, to qualify for TBE protection, the parties must be married and live in the property as a primary residence. If the property owners are married but do not use the home as the marital homestead, TBE won’t shield the property from creditor collection efforts.

In Flatrock River Lodge v. Stout, 130 N.E.2d 96 (Ind. Ct. App. 2019), an Indiana appeals court delved into the joint tenancy vs. TBE dichotomy and how the difference between the two realty title vehicles dramatically impacts a judgment lien’s enforceability.  The trial court denied the creditor’s motion to foreclose a judgment lien because the subject real estate was held in joint tenancy. On appeal, the Court considered whether a judgment creditor could foreclose on joint tenancy property, force its sale, and apply the proceeds against the judgment.

The judgment debtor owned real estate in joint tenancy with his daughter. The debtor died during pendency of the lawsuit and by operation of law, the title to the property vested in the daughter. Before the debtor died, however, the plaintiff/creditor recorded its judgment lien against the property.

The creditor moved to foreclose its judgment lien against the property. The debtor’s daughter argued the property was exempt from execution by Indiana’s tenancy-by-entirety statute (the TBE statute). Indiana Code Section 34-55-10-2(c)(5).  The trial court agreed with debtor’s daughter and denied the creditor’s motion.

Reversing, the Indiana appeals court first rejected the defendants’ argument that since the debtor died, the property escaped plaintiff’s lien. The court noted that the plaintiff’s judgment lien attached from the moment it recorded its judgment against the property – some two years before debtor’s death. As a result, the debtor’s daughter took the property subject to the plaintiff’s lien.

Next, the appeals court rejected the trial court’s finding that the property was immune from the plaintiff’s judgment lien.

In a joint tenancy, each tenant acquires an equal right to share in the enjoyment of the land during their lives. A joint tenant is severed where one joint tenant conveys his/her interest to another and destroys the right to survivorship in the other joint tenant(s). Once a joint tenancy conveys his/her share to another, he/she becomes a tenant in common with the other co-tenant.

Each joint tenant can sell or mortgage his/her interest in property to a third party and most importantly (for this case at least), each joint tenant is subject to a judgment creditor’s execution. [8]

TBE ownership only exists between spouses and is grounded in legal fiction that husband and wife a single unit. A TBE cannot be severed by the unilateral action of one tenant. An attempted transfer of a TBE ownership interest by only one spouse is a legal nullity. The key difference between joint tenancy and TBE is that with the latter, a creditor of only one spouse cannot execute on the jointly owned property

The Court noted that under Indiana Code 34-55-10-2(c)(5), property held in TBE is exempt from execution of a judgment lien. However, this statute applies uniquely to TBE ownership; not to joint tenancy. According to the court, “[h]ad the Indiana legislature intended to exempt from execution real estate owned as joint tenants, it would have done so.” [14]

Take-away:

This case shows in stark relief the perils of conflating joint tenancy and tenants-by-entirety ownership. If a property deed does not specifically state tenancy by the entirety, the property will not be exempt from attachment by only one spouse’s creditor.

Fourth Circuit Considers Reverse Piercing, Charging Orders, and Jurisdictional Challenges in Pilfered Cable Case

Sky Cable v. Coley (http://www.ca4.uscourts.gov/opinions/161920.P.pdf) examines the interplay between reverse piercing the corporate veil, the exclusivity of the charging order remedy, and jurisdiction over an unserved (with process) LLC based on its member’s acts.

In 2011, the plaintiff cable distributor sued two LLCs affiliated with an individual defendant (“Individual Defendant”) who was secretly supplying cable TV to over 2,000 rooms and pocketing the revenue.

After unsuccessfully trying to collect on a $2.3M judgment, plaintiff later moved to amend the judgment to include three LLCs connected to the Individual Defendant under a reverse veil-piercing theory. The Individual Defendant and one of the LLCs appealed the District Court order that broadened the scope of the judgment.

Affirming, the Fourth Circuit, applying Delaware law, found that the District Court properly reverse-pierced the Individual Defendant to reach LLC assets.

‘Reverse’ Veil Piercing

Unlike traditional veil piercing, which permits a court to hold an individual  shareholder personally liable for a corporate judgment, reverse piercing attaches liability to the entity for a judgment against a controlling individual. [10, 11]

Reverse piercing is especially apt in the one-member LLC context as there is no concern about prejudicing the rights of others LLC members if the LLC veil is pierced.

In predicting that a Delaware court would recognize reverse piercing, the Court held that if Delaware courts immunized an LLC from liability for a member’s debts, LLC members could hide assets with impunity to shirk creditors. [18, 19]

Charging Order Exclusivity?

The Court also rejected the Individual Defendant’s argument that Delaware’s charging statute, 6 Del. Code s. 18-703 was the judgment creditor’s exclusive remedy against an LLC member.

Delaware’s charging statute specifies that attachment, garnishment and foreclosure “or other legal or equitable remedies” are not available to the judgment creditor of an LLC member.

However, the Court found that piercing “is not the type of remedy that the [charging statute] was designed to prohibit” since the piercing remedy differs substantively from the creditor remedies mentioned in the charging statute.  The Court found that unlike common law creditor actions aimed at seizing a debtor’s property – piercing (or reverse-piercing) challenges the legitimacy of the LLC entity itself. As a result, the Court found that the plaintiff wasn’t confined to a charging order against the Individual Defendant’s LLC distributions.

The Court further held that applying Delaware’s charging law in a manner that precludes reverse piercing would impede Delaware’s interest in preventing its state-chartered corporate entities from being used as “vehicles for fraud”
by debtors trying to escape its debts. [20-22]

Alter Ego Finding

The Court also agreed with the lower court’s finding that the LLC judgment debtor was the Individual Defendant’s alter ego.  In Delaware, a creditor can establish does not have to show actual fraud. Instead, it (the creditor) can establish alter ego liability by demonstrating a “mingling of the operations of the entity and its owner plus an ‘overall element of injustice or unfairness.” [24-25]

Here, the evidence in the record established that the Individual Defendant and his three LLCs operated as a single economic unit.  The Court also noted the Individual Defendant’s failure to observe basic corporate formalities, lack of accounting records and obvious commingling of funds as alter ego signposts.

The most egregious commingling examples cited by the court included one LLC paying another entity’s taxes, insurance and mortgage obligations. The Court found it suspicious (to say the least) that the individual Defendant took mortgage interest deductions on his personal tax returns when an LLC was ostensibly paying a separate LLC’s mortgage.

Still more alter ego evidence lay in Defendant’s reporting an LLC’s profit and loss on his individual return. Defendant also could not explain at his deposition what amounts he received as income from the various LLCs.

Can LLC Member’s Post-Judgment Acts Subject LLC to Jurisdiction?

The Court also affirmed the District Court’s exercise of jurisdiction over the LLC judgment debtor based on the Individual Defendant’s acts even though the LLC was never served with process in the underlying suit.

Normally, service of summons and the operative pleading on a defendant is a precondition to a court’s exercise of personal jurisdiction over him. However, a court has “vicarious jurisdiction” over an individual where his corporate alter ego is properly before the court.  In such a case, an individual’s jurisdictional contacts are imputed to the alter ego entity.

The reverse can be true, too: where an LLC’s lone member is already before the Court, there is no concern that the LLC receive independent notice (through service of summons, e.g.) of the litigation. (This is because there are no other members to give due process protections to.)

Applying these rules, the Fourth Circuit found jurisdiction over the LLC was proper since the Individual Defendant appeared and participated in post-judgment proceedings. [30-36]

Afterwords:

Sky Cable presents a thorough discussion of the genesis and evolution of reverse veil-piercing and a creditor’s dogged and creative efforts to reach assets of a single-member LLC.

Among other things, the case makes clear that where an LLC is so dominated and controlled by one of its members at both the financial and business policy levels, the LLC and member will be considered alter egos of each other.

Another case lesson is that a judgment creditor of an LLC member won’t be limited to a charging order where the creditor seeks to challenge the LLC’s legitimacy; through either a traditional piercing or non-traditional reverse-piercing remedy.