Plaintiff Shows Actual and Constructive Fraud in Fraudulent Transfer Suit – IL Court

The plaintiff mortgage lender in Summitbridge Credit Investments II, LLC v. Ahn, 2017 IL App (1st) 162480-U sued the husband and wife borrower defendants for breach of a mortgage loan on two commercial properties in Chicago

Two days after the plaintiff obtained a $360K-plus default judgment, the defendants deeded a third commercial property they owned to their adult children.

The plaintiff caught wind of the post-judgment transfer during citation proceedings and in 2015 filed a fraudulent transfer suit to undo the property transfer.  The trial court granted summary judgment for the lender and voided the defendants’ transfer of property. The defendants appealed.

Affirming, the First District recited and applied the governing standards for actual fraud (“fraud in fact”) and constructive fraud (“fraud in law”) under Illinois’s fraudulent transfer act, 740 ILCS 160/1 et seq. (the “Act”)

The Act allows claims for two species of fraud under the Act – actual fraud and constructive fraud, premised on Act Sections 5(a)(1) and 5(a)(2) and 6(a), respectively.  (Also, see http://paulporvaznik.com/uniform-fraudulent-transfer-act-actual-fraud-constructive-fraud-transfers-insufficient-value-il-law-basics/5646)

Actual Fraud and ‘Badges’ of Fraud

Actual fraud that impels a court to unwind a transfer of property requires clear and convincing evidence that a debtor made a transfer with actual intent to hinder, delay or defraud creditors.

Eleven badges or indicators of fraud are set forth in Section 5(b) of the Act.  The factor the Summitbridge Court particularly homed in on was whether there was an exchange of reasonably equivalent value.  That is, whether the defendants’ children gave anything in exchange for the transferred commercial property.

In analyzing this factor, courts consider four sub-factors including (1) whether the value of what was transferred is equal to the value of what was received, (2) the fair market value of what was transferred and what was received, (3) whether it was an arm’s length transaction, and (4) good faith of the transferee/recipient.  Reasonably equivalent value is measured at the time of transfer.

In opposing the plaintiff’s summary judgment motion, the defendants made only conclusory assertions they lacked fraudulent intent.  Moreover, they failed to come forward with any evidence showing they received consideration for the transfer.

In summary, because there were so many badges of actual fraud present, and the debtors offered no proof of consideration flowing to them in exchange for quitclaiming the property, the appeals court affirmed the trial court’s actual fraud finding.

Constructive Fraud

Unlike actual fraud, constructive fraud (i.e., fraud in law) does not require proof of an intent to defraud.  A transfer made for less than reasonably equivalent value of the thing transferred that leaves a debtor unable to meet its obligations are presumed fraudulent.  A fraudulent transfer plaintiff alleging constructive fraud must prove it by a preponderance of evidence – a lesser burden that the clear and convincing one governing an actual fraud or fraud in fact claim.

Constructive fraud under Act Section 5(a)(2) is shown where a debtor did not receive a reasonably equivalent value for the transfer and the debtor (a) was engaged or was about to engage in a business or transactions for which the debtor’s remaining assets were unreasonably small in relation to the business or transaction, or (b) intended to incur, or believed or reasonably should have believed he would incur, debts beyond his ability to pay as they came due.

Section 6(a) constructive fraud applies specifically to claims arising before a transfer where a debtor doesn’t receive reasonably equivalent value and was insolvent at the time of or resulting from a transfer.

The First District agreed with the lower court that the plaintiff sufficiently proved defendants’ constructive fraud.  It noted that the plaintiff’s money judgment pre-dated the transfer of the property to defendant’s children and there was no record evidence of the debtors receiving anything in exchange for the transfer.

Take-aways:

Summitbridge provides a useful summary of fraud in fact and fraud in law fraudulent transfer factors in the context of a dispositive motion.

Once again, summary judgment is the ultimate put-up-or-shut-up litigation moment: a party opposing summary judgment must do more than make conclusory assertions in an affidavit.  Instead, he/she must produce specific evidence that reveals a genuine factual dispute.

The defendants’ affidavit testimony that they lacked fraudulent intent and transferred property to their family members for value rang hollow in the face of a lack of tangible evidence in the record to support those statements.

 

 

 

Corporate Officer Can Owe Fiduciary Duty to Company Creditors – IL Court in ‘Deep Cut’* Case

Five years in, Workforce Solutions v. Urban Services of America, Inc., 2012 IL App (1st) 111410 is still a go-to authority for its penetrating analysis of the scope of post-judgment proceedings, the nature of fraudulent transfer claims and the legal relationship between corporate officers and creditors.

Here are some key questions and answers from the case:

Q1: Is a judgment creditor seeking a turnover order from a third party on theory of fraudulent transfer (from debtor to third party) entitled to an evidentiary hearing?

A1: YES

Q2: Does the denial of a turnover motion preclude that creditor from filing a direct action against the same turnover defendants?

A2: NO.

Q3: Can officer of a debtor corporation owe fiduciary duty to creditor of that corporation?

Q3: YES.

The plaintiff supplier of contract employees sued the defendant in 2006 for breach of contract.  After securing a $1M default judgment in 2008, the plaintiff instituted supplementary proceedings to collect on the judgment.  Through post-judgment discovery, plaintiff learned that the defendant and its officers were operating through a labyrinthine network of related business entities.  In 2010, plaintiff sought a turnover order from several third parties based on a 2008 transfer of assets and a 2005 loan from the debtor to third parties.

That same year (2010), plaintiff filed a new lawsuit against some of the entities that were targets of the motion for turnover order in the 2006 case.

In the 2006 case, the court denied the turnover motion on the basis that the plaintiff failed to establish that the turnover defendants received fraudulent transfers from the judgment debtor and that the fraudulent transfer claims were time-barred.  740 ILCS 160/10 (UFTA claims are subject to four-year limitations period.)

The court in the 2010 case dismissed plaintiff’s claims based on the denial of plaintiff’s turnover motion in the 2006 case.  Plaintiff appealed from both lawsuits.

Section 2-1402 of the Code permits a judgment creditor to initiate supplementary proceedings against a judgment debtor to discover assets of the debtor and apply those assets to satisfy an unpaid judgment

A court has broad powers to compel the application of discovered assets to satisfy a judgment and it can compel a third party to turn over assets belonging to the judgment debtor.

The only relevant inquiries in a supplementary proceeding are (1) whether the judgment debtor is holding assets that should be applied to the judgment; and (2) whether a third-party citation respondent is holding assets of the judgment debtor that should be applied to the judgment. .  If the facts are right, an UFTA claim can be brought in supplementary proceedings

But where there are competing claimants to the same asset pool, they are entitled to a trial on the merits (e.g. an evidentiary hearing) unless they waive the trial and stipulate to have the turnover motion decided on the written papers.

Here, the court disposed of the turnover motion on the bare arguments of counsel.  It didn’t conduct the necessary evidentiary hearing and therefore committed reversible error when it denied the motion.

The defendants moved to dismiss the 2010 case – which alleged breach of fiduciary duty, among other things – on the basis of collateral estoppel.  They argued that the denial of the plaintiff’s motion for turnover order in the 2006 precluded them from pursuing the same claims in the 2010 case.  Collateral estoppel or “issue preclusion” applies where: (1) an issue previously adjudicated is identical to the one in a pending action; (2) a final judgment on the merits exists in the prior case; and (3) the prior action involved the same parties or their privies.

The appeals court found that there was no final judgment on the merits in the 2006 case.  Since the trial court failed to conduct an evidentiary hearing, the denial of the turnover order wasn’t final.  Since there was no final judgment in the 2006 suit, the plaintiff was not barred from filing its breach of fiduciary duty and alter ego claims in 2010.

The Court also reversed the trial court’s dismissal of the plaintiff’s breach of fiduciary duty claims against the corporate debtor’s promoters.  To state a claim for breach of fiduciary duty, a plaintiff must allege that the defendant owes him a fiduciary duty; that the defendant breached that duty; and that he was injured as a proximate result of that breach.

The promoter defendants argued plaintiff lacked standing to sue since Illinois doesn’t saddle corporate officers with fiduciary duties to a corporation’s creditors. The Court allowed that as a general rule, corporate officers only owe fiduciary duties to the corporation and shareholders.  “However, under certain circumstances, an officer may owe a fiduciary duty to the corporation’s creditors….specifically, once a corporation becomes insolvent, an officer’s fiduciary duty extends to the creditors of the corporation because, from the moment insolvency arises, the corporation’s assets are deemed to be held in trust for the benefit of its creditors.

Since plaintiff alleged the corporate defendant was insolvent, that the individual defendants owed plaintiff a duty to manage the corporate assets, and a breach of that duty by making fraudulent transfers to various third parties, this was enough to sustain its breach of fiduciary duty claim against defendants’ motion to dismiss. (¶¶ 83-84).

Afterwords:

1/ A motion for turnover order, if contested, merits a full trial with live witnesses and exhibits.

2/ A denial of a motion for a turnover order won’t have preclusive collateral estoppel effect on a later fraudulent transfer action where there was no evidentiary hearing to decide the turnover motion

3/ Once a corporation becomes insolvent, an officer’s fiduciary duty extends to creditors of the corporation.  This is because once insolvency occurs, corporate assets are deemed held in trust for the benefit of creditors.


* In the rock radio realm, a deep cut denotes an obscure song – a “B-side” – from a popular recording artist or album.  Examples: “Walter’s Walk” (Zeppelin); “Children of the Sea” (Sabbath); “By-Tor And the Snow Dog” (Rush).

LLC That Pays Itself and Insiders to Exclusion of Creditor Plaintiff Violates Fraudulent Transfer Statute – Illinois Court

Applying Delaware corporate law, an Illinois appeals court in A.G. Cullen Construction, Inc. v. Burnham Partners, LLC, 2015 IL App (1st) 122538, reversed the dismissal of a contractor’s claim against a LLC and its sole member to enforce an out-of-state arbitration award.  In finding for the plaintiff contractor, the court considered some important and recurring questions concerning the level of protection LLCs provide a lone member and the reach of the Uniform Fraudulent Transfer Act, 740 ILCS 160/1 et seq. (“UFTA”), as it applies to commercial disputes.

The plaintiff sued  a Delaware LLC and its principal member, an Illinois LLC, to enforce a $450K Pennsylvania arbitration award against the Delaware LLC.  The plaintiff added UFTA and breach of fiduciary duty claims against the Delaware and Illinois LLCs based on pre-arbitration transfers made by the Delaware LLC of over $3M.

After a bench trial, the trial court ruled in favor of the LLC defendants and plaintiff appealed.

Reversing, the appeals court noted that the thrust of the UFTA claim was that the Delaware LLC enriched itself and its constituents when it wound down the company and paid itself and its member (the Illinois LLC) to the exclusion of plaintiff.

The UFTA was enacted to allow a creditor to defeat a debtor’s transfer of assets to which the creditor was entitled.  The UFTA has two separate schemes of liability: (1) actual fraud, a/k/a “fraud in fact” and (2) constructive fraud or “fraud in law” claims.  To prevail on an actual fraud claim, the plaintiff must prove a defendant’s intent to defraud, hinder or delay creditors.

By contrast, a constructive fraud UFTA claim doesn’t require proof of an intent to defraud.  Instead, the court looks to whether a transfer was made by a debtor for less than reasonably equivalent value leaving the debtor unable to pay any of its debts. (¶¶ 26-27); 740 ILCS 160/5(a)(1)(actual fraud), 160/5(a)(2)(constructive fraud).

When determining whether a debtor had an actual intent to defraud a creditor, a court considers up to eleven (11) “badges”of fraud which, in the aggregate, hone in on when a transfer was made, to whom, and what consideration flowed to the debtor in exchange for the transfer.

The court found that the Delaware LLC’s transfers of over $3M before the arbitration hearing had several attributes of actual fraud. Chief among them were that (i) the transfer was to an “insider” (i.e. a corporate officer and his relative), (ii) the Delaware LLC transferred assets without telling the plaintiff knowing that the plaintiff had a claim against it; (iii) the Delaware LLC received no consideration a $400K “management fee” paid to the Illinois LLC (the Delaware LLC’s sole member); and (iv) the Delaware LLC was insolvent after the  transfers.

Aside from reversing the UFTA judgment, the court also found the plaintiff should have won on its piercing the corporate veil and breach of fiduciary duty claims.  On the former, piercing claim, the court held that the evidence of fraudulent transfers by the Delaware LLC to the Illinois LLC presented a strong presumption of unjust circumstances that would merit piercing.  Under Delaware law (Delaware law governed since the defendant was based there), a court will pierce the corporate veil of limited liability where there is fraud or where a subsidiary is an alter ego of its corporate parent.  (¶ 41)

On the fiduciary duty count, the court held that once the Delaware LLC became insolvent, the Illinois LLC’s manager owed a fiduciary duty to creditors like the plaintiff to manage the Delaware LLC’s assets in the best interest of creditors. (¶¶ 45-46)

Afterwords:

A pro-creditor case in that it cements proposition that a UFTA plaintiff can prevail where he shows the convergence of several suspicious circumstances or “fraud badges” (i.e., transfer to insider, for little or no consideration, hiding the transfer from the creditor, etc.).  The case illustrates a court closely scrutinizing the timing and content of transfers that resulted in a company have no assets left to pay creditors.

Another important take-away lies in the court’s pronouncement that a corporate officer owes a fiduciary duty to corporate creditors upon the company’s dissolution.

Finally, the case shows the analytical overlap between UFTA claims and piercing claims.  It’s clear here at least, that where a plaintiff can show grounds for UFTA liability based on fraudulent transfers, this will also establish a basis to pierce the corporate veil.