Category: Post-judgment – Collections

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/)]

 

Turnover Order Against Debtor’s Wife’s Company Upheld – IL First District

While the amount of the turnover order – less than $6,000 – challenged in Xcel Supply, LLC v. Horowitz, 2018 IL App (1st) 162986 was but a fraction of the underlying judgment – over $600,000 – the case provides a useful discussion of the interplay between Section 2-1402 and Rule 277 – Illinois’s twin supplementary (post-judgment) proceedings authorities – and when a third-party citation respondent is entitled to an evidentiary hearing.

About a month after a trial court entered a money judgment against defendant, his wife – through her company – wrote six checks to the defendant/ judgment debtor over a three-month span totaling $5,220.

On the creditor’s turnover motion, the trial court ordered the debtor’s wife and third-party citation respondent (the Respondent) to turn over $5,220 to plaintiff’s counsel (defendant’s wife’s company). The Respondent appealed.

Affirming, the Court examined Code Section 2-1402 and Rule 277 to assess whether the turnover order was supported by competent proof.

Code Section 2-1402(a) permits a judgment creditor to prosecute supplementary proceedings to discover assets or income of the debtor and apply assets or income discovered toward the payment of the judgment.

The creditor can initiate post-judgment proceedings against the debtor or any other third party who may have information concerning income or assets belonging to the judgment debtor.

Code Section 2-1402 vests the Court with broad powers to compel any person to deliver assets to be applied towards satisfaction of the judgment in situations where the judgment debtor can recover those assets. An order compelling a third-party to deliver assets in full or partial satisfaction of the judgment is called a turnover order. A court can enter judgement against someone who violates a citation’s restraining provision in the amount of the property transferred or up to the judgment amount. 2-1402(f)(1); ⁋⁋ 40-41.

Rule 277 works in tandem with Section 2-1402 and specifies how supplementary proceedings are conducted. Among other things, the Rule allows “any interested party” to subpoena witnesses and adduce evidence in the same manner it could at a civil trial.

Where a judgment creditor and third-party citation respondent each claim superior rights to the same debtor assets, the trial court should conduct an evidentiary hearing. However, where only the judgment creditor is claiming rights in the debtor’s assets, the trial court can decide the post-judgment proceeding without an evidentiary hearing.

Here, because the Respondent was the debtor’s wife – the Court viewed her as an illusory citation respondent. That is, the debtor and Respondent acted as a united front. Because this was not the prototypical “tug-of-war” between a judgment creditor and third-party citation respondent, the trial court was able to rule on the respondent’s argument without an evidentiary hearing.

The Court also rejected the respondent’s argument that the turnover order lacked an evidentiary basis. The Court noted that the judgment debtor admitted in his affidavit to cashing all six checks from the Respondent’s company and that Respondent did nothing to stop him from cashing the checks.

Since the Respondent never challenged the debtor’s right to cash the checks, the Court viewed it as strong proof that the checks were the debtor’s property to spend as he pleased.

Finally, the Court rejected Respondent’s argument that the money sent to the debtor wasn’t really his money as the funds were earmarked for their children’s expenses. According to the court, since both the debtor and Respondent had equal parental obligations to pay their children’s expenses, whether or not the money was for child expenses didn’t negate the trial court’s finding that the checks were defendant’s property and Respondent violated the citation by transferring the checks to the defendant after the date of the money judgment.

Afterwords: This case shows that citation restraining provisions which bar a third-party citation respondent from transferring money or property belonging to or to become due a judgment debtor have teeth.

While an evidentiary hearing is normally required where there are competing claimants to the same pool of assets, this rule is relaxed where the citation respondent is aligned (here, through marriage) with the debtor. In such a case, the court will look beyond the legal nomenclature and assess the reality of the parties’ relationship. Where the third-party citation respondent doesn’t have a meaningful claim to transferred debtor assets, the Court can decide a turnover motion without hearing live witness testimony.

Fraudulent Transfer Action Can Be Brought In Post-Judgment Proceedings – No Separate Lawsuit Required – IL Court

Despite its vintage (over two decades), Kennedy v. Four Boys Labor Service, 664 N.E.2d 1088 (2nd Dist.  1996), is still relevant and instructional for its detailed discussion of Illinois’ fraudulent transfer statute and what post-judgment claims do and don’t fall within a supplementary proceeding to collect a judgment in Illinois.

The plaintiff won a $70K breach of contract judgment against his former employer and issued citations to discover assets to collect the judgment.

While plaintiff’s lawsuit was pending, the employer transferred its assets to another entity that had some of the same shareholders as the employer.  The “new” entity did business under the same name (Four Boys Labor Service) as the predecessor.

Plaintiff obtained an $82K judgment against the corporate officer who engineered the employer’s asset sale and the officer appealed.

Held: Judgment for plaintiff affirmed

Rules/reasons:

The Court applied several principles in rejecting the corporate officer’s main argument that a fraudulent transfer suit had to be filed in a separate action and couldn’t be brought within the context of the post-judgment proceeding.  Chief among them:

– Supplementary proceedings can only be initiated after a judgment has entered;

– The purpose of supplementary proceedings is to assist a creditor in discovering assets of the judgment debtor to apply to the judgment;

– Once a creditor discovers assets belonging to a judgment debtor in the hands of a third party, the court can order that third party to deliver up those assets to    satisfy the judgment;

– A court can authorize a creditor to maintain an action against any person or corporation that owes money to the judgment debtor, for recovery of the debt (See 735 ILCS 5/2-1402(c)(6);

– A corporate director who dissolves a company without providing proper notice to known creditors can be held personally liable for corporate debts (805 ILCS 5/8.65, 12.75);

– An action to impose personal liability on a corporate director who fails to give notice of dissolution must be filed as a separate lawsuit and cannot be brought in a post-judgment/supplementary proceeding;

– Where a third party transfers assets of a corporate debtor for consideration and with full knowledge of a creditor’s claim, the creditor may treat the proceeds from the sale of the assets as debtor’s property and recover them under Code Section 2-1402;

– A transfer of assets from one entity to another generally does not make the transferee liable for the transferor’s debts;

– But where the transferee company is a “mere continuation” of the selling entity, the transferee can be held responsible for the seller’s debt.  The key inquiry in determining successor liability under the mere continuation framework is whether there is continuity of shareholder or directors from the first entity to the second one;

– An action brought under the Uniform Fraudulent Transfer Act (FTA), 740 ILCS 160/1, is considered one that directly concerns the assets of the judgment debtor and imposes liability on the recipient/transferee based on the value of the transferred assets;

– A transfer is not voidable against one who takes in good faith and provides reasonably equivalent value.  740 ILCS 160/9;

– A court has discretion to sanction a party that disobeys a court order including by entering a money judgment against the offending party;

(664 N.E.2d at 1091-1093)

Applying these rules, the Court found that plaintiff could properly pursue its FTA claim within the supplementary proceeding and didn’t have to file a separate lawsuit.  This is because an FTA claim does not affix personal liability for a corporate debt (like in a corporate veil piercing or alter ego setting) but instead tries to avoid or undo a transfer and claw back the assets actually transferred.

FTA Section 160/5 sets forth eleven (11) factors that can point to a debtor’s actual intent to hinder, delay or defraud a creditor.   Some of the factors or “badges” of fraud that applied here included the transfer was made to corporate insiders, the failure to inform the plaintiff creditor of the transfer of the defendant’s assets, the transfer occurred after plaintiff filed suit, the transfer rendered defendant insolvent, and all of the defendant’s assets were transferred.  Taken together, this was enough evidence to support the trial court’s summary judgment for the plaintiff on his FTA count.

Take-away: Kennedy’s value lies in its stark lesson that commercial litigators should leave no financial stones unturned when trying to collect judgments.  Kennedy also clarifies that fraudulent transfer actions – where the creditor is trying to undo a transfer to a third party and not hold an individual liable for a corporate debt can be brought within the confines of a supplementary proceeding.