Illinois ‘Reverse Piercing’ Law: Can You or Can’t You?

image“Reverse piercing” involves the creditor of an individual shareholder attempting to reach assets of a corporation operated by that shareholder.  Illinois reverse-piercing law is unsettled.  Some cases allow  the remedy; others don’t.  When it is allowed, it usually involves a one-person corporation.

In Fish v. Hennessy, 2013 WL 577012 (N.D.Ill 2013), the Northern District rejected a creditor’s attempt to reverse-pierce in supplementary proceedings. The plaintiff obtained a nearly $1 million judgment against the defendant in Ohio Federal court and registered the judgment in the Illinois Northern District.  The plaintiff then filed a motion to reverse-pierce the corporate veil in order to reach the assets of two companies controlled by the debtor.  The debtor argued that the Court lacked jurisdiction to reverse-pierce the debtor.

Result: The Court dismissed the plaintiff’s reverse-piercing motion for lack of jurisdiction.  Plaintiff is given leave to file separate reverse-piercing action.

Rules/reasoning:

Illinois law (735 ILCS 5/2-1402, SCR 277) governs supplementary proceedings in Northern District cases.  FRCP 69(a).  Because Illinois supplementary proceedings are limited to finding assets of a debtor – either in his possession or in the hands of a third party -creditor piercing efforts are usually beyond the scope of supplementary proceedings.  Because of this, Illinois law requires the creditor to sue separately to pierce the corporate veil; naming the shareholder as a defendant in the underlying claims that would normally lie against a corporation.

The Court held that while some Illinois courts permit reverse-piercing, the creditor must file a  stand-alone action against the shareholder. Fish, *2.  Here, since the creditor tried to reverse-pierce in post-judgment proceedings, the motion was improper and the Court dismissed it for lack of jurisdiction.  Id.

The plaintiff creditor argued that after its 2008 amendment, Code Section 2-1402(c)(3) allows a creditor can bring a (straight) piercing motion in supplementary proceedings against a corporate debtor.  However, since defendant was an individual, not a corporate debtor, this section didn’t apply.  In addition, the Court found no Illinois case reading amended Section 2-1402(c)(3) to allow reverse-piercing in post-judgment proceedings.  Id., *2.

Take-aways: A creditor of an individual can’t reverse-pierce (to attach corporate assets of companies run by the debtor) in judgment enforcement proceedings.  Instead, the creditor must file a separate lawsuit against the corporate entity controlled by the shareholder.  Fish‘s discussion of Code Section 2-1402(c)(3) suggests that a judgment creditor may now be able to bring a piercing-type claim against a corporate debtor in supplementary proceedings.  While this is welcome news to creditors’ counsel (since they won’t have to file entire new piercing suits), it still runs counter to “good” Illinois caselaw (see Pyshos (above), Conserv v. Von Bergen Trucking, 2011 IL App (2d) 101225U (2011)), that clearly disallow piercing claims in supplementary proceedings.  Even so, the Fish Court didn’t have to categorically rule on this issue since the defendant was an individual and not a corporate debtor.  As a result, amended Section 2-1402(c)(3) didn’t apply to the case’s facts.

 

Defendant Bank Not Liable for Permitting Judgment Debtor to Transfer Over $700,000 from Accounts

The Citation to Discover Assets to a Third Party or “third-party citation”  allows a judgment creditor to serve a citation on a third-party –  a bank, for instance – who holds property of the judgment debtor and attach that property until the court orders the property released.  See 735 ILCS 5/2-1402(f)(1). 

The third-party citation prohibits the citation respondent from allowing any transfer or other disposition of debtor’s property pending further order of court or termination of the citation. 

When a bank is the third-party citation respondent, the creditor serves the citation upon the bank (either by personal service or certified mail) and upon receipt of the citation, the bank must freeze the debtor’s account until the court enters an order dismissing the citation or releasing the account. 

What’s simultaneously enticing (to a creditor) and sinister (to a debtor) about third-party citation practice is that the creditor doesn’t have to notify the debtor of the third-party citation until 3 business days have passed. 735 ILCS 5/2-1402(b).  This makes it next to impossible for a debtor to deplete his bank account(s) and hide funds – something which could easily happen if he caught wind of a creditor’s attempts to seize his accounts. 

Mendez v. Republic Bank, 2013 WL 3821532 (7th Cir. 2013), examines whether a bank that unfreezes the wrong bank accounts (and allows a judgment debtor to transfer hundreds of thousands of dollars in the process) can be liable to the judgment creditor for violating a citation’s restraining provisions. 

The Court affirmed the trial court’s finding that the bank was not liable to the plaintiff.

The plaintiff won a judgment and froze some 22 separate accounts of the corporate judgment debtor.  After several of the banks moved to quash various citations, the district court judge entered an order requiring that all bank accounts except for three (3) specified accounts be unfrozen. 

The defendant bank released from the citation two of the debtors’ accounts which totalled over $700,000 – all of  which of course was dissipated by the debtors within a few months. 

Plaintiff then moved to refreeze the accounts and to hold the bank liable for violating the citation restraining provision.

The District Judge, while originally siding with plaintiff, reversed herself and found the bank not liable.  The reason: the prior judge’s order requiring the bank to unfreeze accounts was ambiguous “at best” and the bank’s actions were a reasonable response to and interpretation of that order.  *4.

The Seventh Circuit affirmed, noting that the prior judge’s order unfreezing certain accounts was poorly drafted and the defendant bank followed the most reasonable interpretation of the order. 

Acknowledging that under Illinois law, a citation respondent can be liable for any transfer that violates a citation’s restraining provisions (regardless of whether there is intent or contempt), the bank’s actions were reasonable in light of the order’s text.* 11. 

Take-away: In my experience, from a creditor’s standpoint, attaching a corporate debtor’s bank account via a third-party citation is often my only real chance of collecting anything on a judgment.  Any real estate is usually mortgaged to the hilt, and the corporate debtor often lacks sufficient accounts receivable, inventory or personal property to meaningfully make a dent in the judgment amount.  

This case shows why hyper-precision in drafting citation orders is critical in post-judgment enforcement proceedings.  If the order is not drafted by the parties (i.e. it’s prepared by the court) and it’s text is unclear, it is incumbent on a party to file a motion seeking clarification of the order. 

 

Collecting Your Illinois Judgment Part II: the Citation Order

Per my earlier post – neophyte collection lawyers often wonder what they should put in the order once the citation examination concludes.  Section 2-1402(c) sets forth several possible orders that can enter.

The Citation Respondent Appeared and Answered

Broadly, if the debtor appears and you conduct the examination, you can either dismiss or discharge the citation, continue it, or order a turnover of funds or property.  I enter a dismissal if the debtor fully complied and has no assets, I continue the proceedings if the debtor does not produce the requested documents, and I enter a turnover order if the debtor or a third-party answers that there are funds or property that can be applied towards the judgment.

For a third-party citation, typically issued to the debtor’s bank, I enter a dismissal order which provides that the bank turnover the non-exempt funds within 7 days.  If the bank fails to pay, I move for a Rule to Show Cause and entry of conditional judgment.  This gets the bank’s attention.

Another possible order on the citation return date is an installment payment order which I file with the court.  An example of this is found at: http://12.218.239.52/Forms/pdf_files/CCG0105.pdf.

Citation Fails to Appear

Surprisingly, debtors often fail to appear on the Citation return date.  When this happens, you ask for a “Rule” – shorthand nomenclature for Rule to Show Cause.  That’s also a pre-printed form found in the courtroom.  You fill out the required information and have it served personally on the debtor.  If the debtor fails to respond to the served Rule, you request a body attachment or “writ of attachment”.  That order will contain a $1,000 bond amount (usually), and should be placed with the Sheriff, who – at some point – will contact the debtor and physically bring him/her to the courtroom.

Collection counsel should familiarize themselves with House Bill 5434 – eff. July, 2012 (http://www.ilga.gov/legislation/BillStatus.asp?DocNum=5434&GAID=11&DocTypeID=HB&LegId=65695&SessionID=84)

which added requirements specifically concerning body attachments.  Basically, no body attachment will issue until creditor obtains personal or abode service of a Rule to Show Cause on the debtor, there is a maximum $1,000 bond amount, and the body attachment expires after 1 year.