Feelin’ Minnesota? Most Likely (Court Pierces Corporate Veil of Copyright Trolling Firm To Reach Lawyer’s Personal Assets)

After being widely lambasted for its heavy-handed and ethically ambiguous (challenged?) BitTorrent litigation tactics over the past few years, an incarnation of the infamous Prenda law firm was recently hit with a piercing the corporate veil judgment by a Minnesota state court.

In Guava, LLC v. Merkel, 2015 WL 4877851 (Minn. 2015), the plaintiff pornographic film producer, represented by the Alpha, LLC law firm (“Alpha”), filed a civil conspiracy suit and state wiretapping claim against various defendants whom plaintiff claimed illegally downloaded adult films owned by the plaintiff.

Alpha’s lone member is Minnesota attorney and Prenda alum Paul Hansmeier, who has garnered some negative press of his own both for his copyright trolling efforts and his more recent ADA violation suits against small businesses.  In October 2015, the Supreme Court of Minnesota instituted formal disciplinary proceedings against Hansmeier for various lawyer misconduct charges.

The Alpha firm’s litigation strategy in the Guava case followed the familiar script of issuing a subpoena blitz against some 300 internet service providers (ISPs) to learn the identity of the movie downloaders.  Many of the ISP customers fought back with motions to quash the subpoenas.

After assessing monetary sanctions against Alpha for bad faith conduct – trying to extract settlements from the ISP customers with no real intent to litigate – the trial court entered a money judgment against Alpha for the subpoena respondents and John Doe defendants.

Through post-judgment discovery, the subpoena defendants learned that Hansmeier had transferred over $150,000 from Alpha, defunding it in the process.

The judgment creditor defendants then moved to amend the judgment to add Hansmeier individually under a piercing the corporate veil theory. After the trial court granted the motion, Alpha and Hansmeier appealed.

Held: Affirmed

Rules/Reasoning:

In Minnesota, a district court has jurisdiction to take actions to enforce a judgment when the judgment is uncollectable and where refusing to amend a judgment would be inequitable.

A classic example of an equitable remedy that a court can apply to amend an unsatisfied money judgment is piercing the corporate veil. A Minnesota court will pierce the corporate veil where (1) a judgment debtor is the alter ego of another person or entity and (2) where there is fraud.

The alter ego analysis looks at a medley of factors including, among others, whether the judgment debtor was sufficiently capitalized, whether corporate formalities were followed, payment or nonpayment of dividends, and whether the dominant shareholder siphoned funds from an entity to avoid paying the entity’s debts.

The fraud piercing factor considers whether an individual has used the corporate form to gain an undeserved advantage. The party trying to pierce the corporate veil doesn’t have to show actual (read: intentional) fraud but must instead show the corporate entity operated as a constructive fraud on the judgment creditor.

Here, the defendants established both piercing prongs. The evidence clearly showed Alpha was used to further Hansmeier’s personal purposes, there was a disregard for basic corporate formalities and the firm was insufficiently and deliberately undercapitalized.

The court also found that it would be fundamentally unfair for Hansmeier to escape judgment here; noting that Hansmeier emptied Alpha’s bank accounts after it became clear that defendants were trying to enforce the money judgment against the Alpha firm.

Afterword:

While a Minnesota state court ruling won’t bind other jurisdictions, the case is post-worthy The case lesson is clear: if a court (at least in Minnesota) sees suspicious emptying of corporate assets when it’s about to enter a money judgment, it has equitable authority to modify a judgment so that it binds any individual who is siphoning the corporate assets.

The case is also significant because it breaks from states like Illinois that specify that piercing the corporate veil is not available in post-judgment proceedings. In Illinois and other states, a judgment creditor like the Guava defendants would have to file a separate lawsuit to pierce the corporate veil.  This obviously would entail spending time and money trying to attach assets that likely would be dissipated by case’s end.  The court here avoided what it viewed as an unfair result simply by amending the money judgment to add Hansmeier as a judgment debtor even though he was never a party to the lawsuit.

LLC Stopped From Selling Member’s Residence In Violation of Prior Charging Order – Utah Federal Court

Q: Can A Court Stop An LLC That Pays the Monthly Mortgage of One of Its Members From Selling that Member’s Home Where A Charging Order Has Issued Against the LLC to Enforce a Money Judgment Against the LLC Member?

A: Yes.

Q2: How So?

A2: By selling the member’s property and paying off the member’s mortgage with the sale proceeds, the LLC is effectively “paying the member” to the exclusion of the plaintiff judgment creditor.

Source: Earthgrains Baking Companies, Inc. v. Sycamore Family Bakery, Inc., et al, USDC Utah 2015 (https://casetext.com/case/earthgrains-baking-cos-v-sycamore-family-bakery-inc-3)

In this case, the plaintiff won a multi-million dollar money judgment against a corporate and individual defendant in a trademark dispute.  The plaintiff then secured a charging order against a LLC of which the individual defendant was a 48% member.  When the LLC failed to respond to the charging order, the plaintiff moved for an order of contempt against the LLC and sought to stop the LLC from selling the defendant’s home.

The court granted the contempt motion.  First, the court found that it had jurisdiction over the LLC.  The LLC argued that Utah lacked jurisdiction over it since the LLC was formed in Nevada.  The LLC claimed that under the “internal affairs” doctrine, the state of the LLC’s formation – Nevada – governs legal matters concerning the LLC.

Disagreeing, the court noted that a LLC’s internal affairs are limited only to “matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders.”  The internal affairs doctrine does not apply to claims of third party creditors.  Here, since the plaintiff was a creditor of the LLC’s member, this was not a dispute between LLC and member.  As a result, the internal affairs rule didn’t apply and the Utah court had jurisdiction over the LLC since a LLC member lived in Utah.  (See Cosgrove v. Bartolotta, 150 F.3d 729, 731 (7th Cir. 1998)).

The Charging Order required the LLC to pay any distribution that would normally go to the member directly to the plaintiff until the money judgment was satisfied.  The Charging Order specifically mentions transfers characterized or designated as payment for defendant’s “loans,” among other things.

The LLC was making monthly mortgage payments on the member’s home and listed the home for sale in the amount of $4M.  Plaintiff wanted to prevent the sale since there was a prior $2M mortgage on the home.

In blocking the sale, the court found that if the LLC sold the member’s home and paid off the member’s mortgage lender with the proceeds, this would violate the Charging Order since it would constitute an indirect payment to the member.  The court deemed any payoff of the member’s mortgage a “distribution” (a direct or indirect transfer of money or property from LLC to member) under the Utah’s LLC Act. (Utah Code Ann. § 48-2c-102(5)(a)).

Since the Charging Order provided that any loan payments involving the member were to be paid to the plaintiff until the judgment is satisfied, the court found that to allow the LLC to sell the property and disburse the proceeds to a third party (the lender) would harm the plaintiff in its ability to satisfy the judgment.

Afterwords:

An interesting case that discusses the intricacies of charging orders and the thorny questions that arise when trying to figure out where to sue an LLC that has contacts in several states.  The case portrays a court willing to give an expansive interpretation of what constitutes an indirect distribution from an LLC to its member. 

Earthgrains also reflects a court endeavoring to protect a creditor’s judgment rights where an LLC and its member appear to be engaging in misdirection (if not outright deception) in order to elude the creditor.

[A special thanks to attorney and Forbes contributor Jay Adkisson for alerting me to this case (http://www.forbes.com/sites/jayadkisson/)]

 

Seventh Circuit Files: Court Voids LLC Member’s Attempt to Pre-empt LLC’s Suit Against That Member

In Carhart v. Carhart – Halaska International, LLC, (http://law.justia.com/cases/federal/appellate-courts/ca7/14-2968/14-2968-2015-06-08.html) the plaintiff LLC member tried to shield himself from a lawsuit filed against him by the LLC by (1) taking an assignment of a third-party’s claim against the LLC; (2) getting and then registering a default judgment against the LLC; (3) seizing the LLC’s lone asset: its lawsuit against the plaintiff; and (4) buying the lawsuit for $10K.  This four-step progression allowed the plaintiff to extinguish the LLC’s claim against him.

Plaintiff was co-owner of the defendant LLC.  After a third-party sued the LLC in Minnesota Federal court (the “Minnesota Federal Case”), Plaintiff paid the third-party $150,000 for an assignment of that case.  Plaintiff then obtained a $240K default judgment against the LLC.

Meanwhile, the LLC, through its other owner, sued the plaintiff in Wisconsin State Court (the “Wisconsin State Case”) for breach of fiduciary duty in connection with plaintiff’s alleged plundering of the LLC.  While the Wisconsin State Case was pending, Plaintiff registered the Minnesota judgment against the LLC in Wisconsin Federal court.

Plaintiff, now a judgment creditor of the LLC, filed suit in Wisconsin Federal Court (the “Wisconsin Federal Case”) to execute on the $240K judgment against the LLC.  The Wisconsin District Court allowed the plaintiff to seize the LLC’s lone asset – the Wisconsin State Case (the LLC’s breach of fiduciary duty claim against plaintiff) – for $10,000.  This immunized the plaintiff from liability in the Wisconsin State Case as there was no longer a claim for the LLC to pursue against the plaintiff.  The LLC appealed.

The Seventh Circuit voided the sale of the Wisconsin State Case finding the sale price disproportionately low.

Under Wisconsin law, a chose in action is normally considered intangible property that can be assigned and seized to satisfy a judgment.  However, the amount paid for a chose in action must not be so low as to shock the conscience of the court.

In this case, the court branded the plaintiff a “troll of sorts”: it noted the plaintiff buying the LLC’s claim (the Wisconsin State Case) at a steep discount: the defendant paid $150,000 for an assignment of a third-party claim against the LLC and then paid only $10,000 for the LLC’s breach of fiduciary duty claim against plaintiff.

The court found that under Wisconsin law, the $10,000 the plaintiff paid for the LLC’s claim against him was conscience-shockingly low compared to the dollar value of the LLC’s claim.  The plaintiff did not purchase the LLC’s lawsuit in good faith.  The Seventh Circuit reversed the District Court’s validation of plaintiff’s $10K purchase so the LLC could pursue its breach of fiduciary duty claim against the plaintiff in the Wisconsin State Case.

Take-aways:

This seems like the right result.  The court guarded against a litigant essentially buying his way out of a lawsuit (at least it had the appearance of this) by paying a mere fraction of what the suit was possibly worth.  

The case serves as an example of a court looking beneath the surface of a what looks like a routine judgment enforcement tool (seizing assets of a judgment debtor) and adjusting the equities between the parties.  By voiding the sale, the LLC will now have an opportunity to pursue its breach of fiduciary duty claim against the plaintiff in state court.