Substantial Performance Doctrine: Contractor Defeats Finicky Homeowners in Construction Case (the ‘You Missed A Spot’ Post)

Two diva-esque homeowners (I don’t judge; I just report) who demanded impossible perfection from a contractor got slapped with a $100,000-plus bench trial verdict in Wolfe Construction v. Knight, 2014 IL App (5th) 130115-U. Affirming the damage award, the appeals court gave content to the substantial performance doctrine, expanded on the requirement of contractual definiteness and applied the governing standards for recovering contractual interest and attorneys’ fees,

The plaintiff contractor was hired to perform renovation work on the defendants’ home after a fire damaged the home.  The written contract required the homeowners to pay for any extras and to also foot the bill for any services not covered by their homeowners’ insurance.  Over a span of about a year, the contractor completed nearly all of the restoration work (about 95% of it) and performed some $30,000 of additional work including interior painting, building a new porch and custom-ordering and installing kitchen cabinets – all at the defendants’ specific request.  But according to the homeowners, the contractor’s work was lacking and the homeowners refused to pay and kicked the contractor off the job.  The contractor sued for breach of contract and after a bench trial, won a $100,000-plus judgment against the homeowners, including amounts for unpaid services, extras, contractual interest and attorneys’ fees.  The homeowners appealed.

Held: Money judgment for the contractor affirmed.

Rules/Reasoning:

The Court upheld the judgment for the contractor; noting that the defendants demanded “perfection and the impossible.”  The law doesn’t require surgical precision in construction contract performance.  Instead, the contractor is held only to the duty of substantial performance in a workmanlike manner.  For substantial performance, a contractor must show there was an honest and faithful performance of the contract in its material and substantial aspects.  The contractor must also demonstrate there was no willful departure from, or omission of the contract’s essential elements.  A nebulous standard, the substantial performance test depends on the unique facts of each case.  (¶33).

During trial, both sides presented expert testimony in support of their position and the Court found that the contractor completed about 95% of the job before the defendants fired it (the contractor).  (¶¶ 25-26).  And since the defects asserted by the homeowners involved items which pre-dated the contractor’s involvement, the Court found those deficiencies weren’t the contractor’s fault.  The Court also found the homeowner’s blatantly biased expert’s testimony to be incredible and even “laughable.”  For these reasons, the Court sided with the contractor on all issues. (¶34).

The Court also affirmed the trial court’s award of interest and attorneys’ fees under the contract; but against only one of the homeowners.  Interest and attorneys’ fees generally are not recoverable unless specified in a written contract.  ¶¶36-37.  If a contract does provide for interest and attorneys’ fees, only the party that signs the contract will have to pay them.  (¶ 37).  Here, the parties’ construction contract clearly delineated that the homeowners would be responsible for the contractor’s attorneys’ fees and would have to pay monthly interest at 1.5% on tardy amounts if the contractor sued. The Court held that since the contractual interest and fee-shifting language was clear, it was enforceable – but only against the defendant that signed the contract.  The homeowner that didn’t sign the contract wasn’t responsible for the over $26,000 in interest and nearly $40,000 in attorneys’ fees awarded to the plaintiff contractor.  (¶ 38).

Aftermath:

Definitely a pro-contractor and anti-persnickety homeowner case.  I suppose perfectionism, as character trait and life ethos, has its merits.  But the law doesn’t require it; at least not in the construction setting.   This case illustrates in lurid detail the perils of a property owner having unrealistic and too-exacting expectations of his contractor.  Blemish-free work is not required under the law.  As this case amply shows, if a contractor substantially performs or is prevented from remedying or completing performance by a recalcitrant homeowner, the contractor will win.  Wolfe Construction also seems to set a fairly lenient benchmark for a contractor to establish substantial performance.  This case should and will likely give property owners pause before they declare a default and fail to pay a contractor.

 

 

 

Non-Shareholder of ‘Belly Up’ Bakery Can Be Personally Liable on Piercing Claim – IL Court Rules

I’ve seen no hard data to support this but it seems that piercing the corporate veil – as a concept – has seeped into the cultural lexicon and consciousness.  I say this because many people – lawyers and nonlawyers alike – appear to have at least a nodding acquaintance with piercing.  Over and over I hear some variation of:  “Oh, that company’s out of business you say?  Just do that piercing thing.”  (Sigh) If only it were that easy.

Yet, for its perceived prominence in legal and business circles, veil-piercing’s mechanics and elements remain largely shrouded in mystery.  Piercing breeds misinformation and a flurry of questions: is piercing a remedy or a cause of action?  Whom should you sue? Do you sue the officers, directors, employees, shareholders? All of them?  Can you pierce in post-judgment enforcement proceedings?  Or do you have to file a new lawsuit once you find out a company is out of business?  The cases are inconsistent and unclear on these important veil-piercing questions.  See http://paulporvaznik.com/piercing-the-corporate-veil-in-illinois/71 (discussion of piercing generally).

The First District recently answered some of these questions in Buckley v. Abuzir, 2014 IL App (1st) 130469, a trade secrets-cum-veil-piercing case involving rival Chicago-land bakeries.  The plaintiff sued a corporate defendant (a competing bakery) alleging it hired away plaintiff’s top employee and stole plaintiff’s customers and secret recipes.  The court entered a default judgment of over $400,000 against the corporate defendant on the plaintiff’s trade secrets claim.  When collection efforts failed because the corporation was defunct, plaintiff filed a piercing claim against the individual that funded and controlled the judgment corporate debtor.

The trial court granted defendant’s motion to dismiss under Code Section 2-615 on the basis that plaintiff failed to allege sufficient facts to make out a piercing case and because the individual defendant wasn’t a shareholder, director or officer of the corporate debtor.  Plaintiff appealed.

Held: Reversed.  Plaintiff sufficiently pled grounds for piercing under fact-pleading rules and a veil-piercing claim can be brought against a nonshareholder.

Rules/Reasoning:

In reversing the trial court’s dismissal order, the First District aligned itself with multiple jurisdictions which allow a piercing remedy against nonshareholders of a defunct corporation.  The Court’s analysis was informed by the salient piercing principles:

Corporate Formation and The Basic Nature of Veil-Piercing

A corporation is a separate entity from its constituent shareholders, directors and officers and the whole purpose of incorporating is to shield shareholders from unlimited personal liability;

– Veil-piercing applies where a corporation is dominated by an individual or entity to such an extent that the “separate identity” doesn’t exist and it’s a sham to continue to recognize a separation between company and the controlling agent;

– piercing the corporate veil is not a cause of action; instead, it is a means of imposing liability on an underlying cause of action (here, the underlying cause of action was the trade secrets claim plaintiff initially filed against the competing bakery concern);

– BUT, a plaintiff may bring a separate piercing action to pierce the corporate veil for a judgment previously entered against a corporation;

– Veil-piercing applies almost exclusively in disputes involving close corporations (think Mom and Pop businesses) or one-man corporations.

Buckley, ¶¶ 7-9, 12.

Veil-Piercing’s Elements

The Court also stated and applied Illinois’ familiar veil-piercing elements:

Illinois courts will pierce the corporate veil where (1) there is such a unity of interest and ownership that the separate personalities of the corporation and the component dominant parties doesn’t exist and (2) adhering to the concept of separation between corporate entity and dominant agent would promote injustice or inequitable circumstances;

-the unity of interest element (number (1) above)) alone involves a multi-factored analysis of whether there is evidence of (i) inadequate capitalization; (ii, iii) a failure to issue stock, failure to observe corporate formalities; (iv)-(vi) nonpayment of dividends, insolvency of the corporate debtor, non-functioning corporate officers, (vii)-(xi), absence of corporate records, commingling of funds, diversion of corporate assets to shareholders instead of creditor’s, no arm’s-length dealings with related entities; and whether the corporation is a façade or front from the dominant shareholders.

Application:

The Complaint, while sparse and conclusory, alleged enough facts to satisfy the two overarching piercing elements.  On the unity of interest piercing element, the First District exhaustively (an understatement) canvassed over 20 states’ piercing decisions that permit a piercing plaintiff to bind a nonshareholder to a failed corporation’s judgment debt.  The First District aligned itself with those jurisdiction that allow piercing against individuals who aren’t officers, directors, shareholder or employees of a corporation.  All that’s required is that the defendant be an “equitable” or de facto owner.  If the individual controls a company “behind the scenes” and makes the key funding, hiring and firing decisions, then that individual’s personal assets can be reached via a piercing claim.

The plaintiff’s complaint allegations met the main unity of interest criteria: he hired, fired, funded and managed the corporation that plaintiff sued in the underlying trade secrets case.  The “officers” of that corporation had little or nothing to do with the day-to-day operations of the corporation.  The plaintiff also alleged that the corporation issued no stock and had no shareholders.  If this was true, then defendant not being a shareholder is an illusory defense: there are no shareholders.  (¶¶ 15-33).

The Court also sustained plaintiff’s promotion-of-injustice element allegations.  While the plaintiff’s unadorned allegations were conclusory, they still contained just enough facts to state a piercing claim under Illinois pleading rules.  Plaintiff alleged that the defendant hired away plaintiff’s key employee to gain access to secret recipes and data to unfairly compete with and siphon business from the plaintiff.  These allegations were enough (but not by much) to plead that refusing to pierce would result in unfairness to the plaintiff.  (¶¶ 34-41).

Take-aways: Even though the ultimate ruling is simply a reversal of a Section 2-615 pleadings motion to dismiss, the case’s importance lies in its endorsement of using piercing to reach assets of individuals who aren’t corporate officers, shareholders or employees yet in reality, control and fund the corporate entity.  It’s important to recognize though that the Court didn’t rule on the merits of the plaintiff’s claim.  All that is settled is that a plaintiff can allege facts against an “equitable owner”/nonshareholder of a corporation that can lead to personal liability for that nonshareholder.

Mechanics Lien Trumps Prior Mortgage in ‘Lien Strip’ Bankruptcy Dispute Involving Residential Property

Priority disputes happen a lot in mechanics’ lien litigation.  Typically, a mortgage lender claims that its first-filed mortgage trumps a later-filed mechanics lien.  The “trumps” part is activated if and when the property is sold and there aren’t enough proceeds to pay both the lender and contractor.  If the lender’s mortgage has priority, it gets first dibs on the sale proceeds, leaving the contractor with little or nothing.

Section 16 of the Mechanics’ Lien Act (770 ILCS 60/16) governs the lien priority issue.  This section provides that (i) prior lien claimants have lien priority up to the value of the land at the time of making of the construction contract; and (ii) mechanics’ lien claimants have a paramount lien to the value of all improvements made to the property after the construction contract is signed.

In re Thigpen, 2014 WL 1246116 examines the mortgage lender-versus-contractor priority question through the lens of a bankruptcy adversary case where the debtors attempt to strip away a mechanics’ lien recorded against their homeresidence.

The debtors filed for Chapter 13 bankruptcy protection and later filed an adversary proceeding to extinguish the lien a contractor recorded against the home. 

The debtors claimed that since there was a prior mortgage on the home and the home’s value had dropped to a sum less than the lien amount, the lien should be removed.

In bankruptcy parlance, this is called “lien stripping” and applies where a mechanics lien lacks collateral; usually because of plummeting property values. 

The contractor argued that its lien took priority to the value of the improvements/enhancements and moved for summary judgment.

Held: Contractor’s summary judgment motion granted.

Q: Why?

A: Applying Section 16 of the Act, the Court held that where proceeds of a property sale are insufficient to pay competing lienholders, a mechanics’ lien claimant takes priority over a lender up to the value the contractor added to the property.

The Court wrote: “the Illinois Supreme Court has expressly recognized that Section 16 of the Act confers first priority, not something less, on mechanic’s lien holders, and that they trump pre-existing mortgages to the extent of the value of the improvements.”  (*2).

While the court found that the contractor’s lien trumped the prior mortgage, the Court did not decide the specific monetary amount of the improvements relative to the home’s value. 

The holding is still significant because now the contractor has a secured claim (as opposed to an unsecured one) against the debtors’ estate which must be paid over the life of the Chapter 13 plan. 

If the debtors default, the contractor can liquidate the collateral –  by forcing a sale of the home – and get paid via the proceeds.  An unsecured creditor, by contrast, has no assets securing its claim.  It must hope that the debtors have unattached assets (e.g. paycheck, bank accounts, accounts receivable) with which to pay the debt.  (Good luck with that!)

Take-away: A big win for the contractor.  Instead of having an unsecured claim (with no collateral tied to the claim), its mechanics’ lien claim is secured.  This means the contractor’s lien attaches to the debtors’ house. 

If the debtor defaults under the plan, the contractor can foreclose its lien and force a sale of the home and take priority to the sale proceeds up to the amount of the improvements (here, about $200,000).  

The case’s unanswered question is how does the contractor prove the dollar amount of his improvements?  The contractor will likely have to produce expert witness testimony or documents to establish the dollar value of the contractor’s time, labor and materials  furnished to the debtors’ home.