Property Subject to Turnover Order Where Buyer Is ‘Continuation’ of Twice-Removed Seller – Corporate Successor Liability in Illinois

Advocate Financial Group, LLC v. 5434 North Winthrop, 2015 IL App (2d) 150144 focuses on the “mere continuation” and fraud exceptions to the general rule of no successor liability – a successor corporation isn’t responsible for debts of predecessor – in a creditor’s efforts to collect a judgment from a business entity that is twice removed from the original judgment debtor.

The plaintiff obtained a breach of contract judgment against the developer defendant (Company 1) who transferred the building twice after the judgment date. The second building transfer was to a third-party (Company 3) who ostensibly had no relation to Company 1. The sale from Company 1 went through another entity – Company 2 – that was unrelated to Company 1.

Plaintiff alleged that Company 1 and Company 3 combined to thwart plaintiff’s collection efforts and sought the turnover of the building so plaintiff could sell it and use the proceeds to pay down the judgment. The trial court granted the turnover motion on the basis that Company 3 was the “continuation” of Company 1 in light of the common personnel between the companies.  The appeals court reversed though.  It found that further evidence was needed on the continuation exception but hinted that the fraud exception might apply instead to wipe out the Company 1-to Company 2- to Company 3 property transfer.

On remand, the trial court found that the fraud exception (successor can be liable for predecessor debts where they fraudulently collude to avoid predecessor’s debts) indeed applied and found the transfer of the building to Company 3 was a sham transfer and again ordered Company 3 to turn the building over to the plaintiff. Company 3 appealed.

The appeals court affirmed the trial court’s judgment and in doing so, provided a useful summary of the principles that govern when one business entity can be held responsible for another entity’s debts.

In Illinois, a corporation that purchases the assets of another corporation is generally not liable for the debts or liabilities of the transferor corporation. The rule’s purpose is to protect good faith purchasers from unassumed liability and seeks to foster the fluidity of corporate assets.

The “fraudulent purpose” exception to the rule of no successor liability applies where a transaction is consummated for the fraudulent purpose of escaping liability for the seller’s obligations.

The “mere continuation” exception to the nonsuccessor liability rule requires a showing that the successor entity “maintains the same or similar management and ownership, but merely wears different clothes.”  The test is not whether the seller’s business operation continues in the purchaser, but whether the seller’s corporate entity continues in the purchaser.

The key continuation question is always identity of ownership: does the “before” company and “after” company have the same officers, directors, and stockholders?

In Advocate Financial, the factual oddity here concerned Company 2 – the intermediary.  It was unclear whether Company 2 abetted Company 1 in its efforts to shake the plaintiff creditor.  The court affirmed the trial court’s factual finding that Company 2 was a straw purchaser from Company 1.

The court focused on the abbreviated time span between the two transfers – Company 2 sold to Company 3 within days of buying the building from Company 1 – in finding that Company 2 was a straw purchaser. The court also pointed to evidence at trial that Company 1 was negotiating the ultimate transfer to Company 3 before the sale to Company 2 was even complete.

Taken together, the court agreed with the trial court that the two transfers (Company 1 to Company 2; Company 2 to Company 3) constituted an integrated, “pre-arranged” attempt to wipe out Company 1’s judgment debt to plaintiff.

Afterwords:  This case illustrates that a court will scrutinize property transfers that utilize middle-men that only hold the property for a short period of times (read: for only a few days).

Where successive property transfers occur within a compressed time window and the ultimate corporate buyer has substantial overlap (in terms of management personnel) with the first corporate seller, a court can void the transaction and deem it as part of a fraudulent effort to evade one of the first seller’s creditors.

The Illinois Fraudulent Transfer Act – An Illinois Case Note

Heartland Bank v. Goers, 2013 IL App (3d) 12084-U illustrates the procedural and substantive hurdles a creditor’s counsel must clear to enforce a judgment against a guarantor who transfers his personal assets into a trust.

The plaintiff bank in sued the defendant for breach of a commercial guarantee after defendant’s company defaulted on a $650,000 loan.  The bank obtained a money judgment against the defendant and issued citation proceedings against him.  During post-judgment proceedings, the bank learned that before the money judgment entered against the defendant, he transferred all  his assets, including a house, cars and bank accounts into a family trust (the Trust).

The trial court ordered the defendant to relinquish one-half of his bank and stock accounts, two cars, and 50% of the sale proceeds of his residence. Defendant appealed.

Result and Reasons:

The Court first held that the trial court wrongly ordered the sale and turnover of 50% of the house sale proceeds under the Uniform Fraudulent Transfer Act, 740 ILCS 160/1 et seq. (the UFTA).

The UFTA deems a transfer fraudulent against a creditor where (1) for claims arising before or after the transfer, the debtor transfers property with the actual intent to impede the creditor; or (2) for claims arising before the transfer, the debtor was insolvent or became insolvent as a result of the transfer.  740 ILCS 160/5, 6; ¶ 16.

A “transfer” means the disposal of an “asset” – defined by the UFTA as property of the debtor that is not held in tenancy by entirety. ¶ 16

It’s difficult to prove a debtor’s subjective intent to impede a creditor (a UFTA Section 5 claim) so most UFTA claims are brought under UFTA Section 6: that the debtor’s transfer caused its insolvency.

The court found the defendant and his wife owned the home in tenancy by entirety at the time they transferred the home to the trust.  Because of this, the UFTA didn’t apply to the transfer.

An interest in tenant-by-the-entirety property cannot be fraudulently transferred against a creditor of only one of the tenants. (¶ 18).

Reversing the turnover and sale of the house, the Court cited Illinois’ post-judgment statute which dictates that real property held in tenancy by the entirety is not liable to be sold upon judgment entered against only one of the tenants.  (¶ 18,) 735 ILCS 5/12-112.

The Court did uphold the trial court’s turnover order involving the defendant’s investment account funds.

Under UFTA Section 6 – which governs pre-transfer claims – a creditor must show by a preponderance of the evidence (it’s “more likely than not”) that:

  • its claim arose before the transfer,
  • the debtor made the transfer without receiving a reasonably equivalent value in exchange for the transferred property; and
  • the debtor was insolvent at the time of the transfer or was rendered insolvent as a result of the transfer.

Here, the corporate borrower’s default in July 2009 immediately triggered defendant’s obligations under the guarantee.  And since the corporation’s default predated defendant’s transferring his bank account to the trust by two months, plaintiff’s claim against defendant arose before he transferred the investment account to the Trust. ( ¶¶ 31-33)

The court also found that at the time defendant transferred the account, he was insolvent within the meaning of the UFTA.  The defendant’s financial statements revealed that the guaranteed loan amount far exceeded defendant’s total assets.  As a result, plaintiff established all required elements of a UFTA Section 6 constructive fraud claim. ( ¶ 35)

Take-aways:

1/ A judgment creditor can’t force the sale of debtor’s real estate that’s held in tenancy by entirety property;

2/ A UFTA claim applies to any right to payment; regardless of whether or not the claim is liquidated (reduced to a fixed numerical amount);

3/ The Court’s UFTA  insolvency calculus takes into account a debtor’s contingent liabilities; not just its current ones.