Doctor’s Oral Promise to Retire in Future Not Enough To Sustain Healthcare Plaintiff’s Fraud Claims

In Heartland Women’s Healthcare, Ltd. v. Simonton-Smith, 2021 IL App (5th) 200135-U, the appeals court affirmed summary judgment for an obstetrician sued for fraud based on her alleged verbal promise to retire from her practice at the end of a three-year employment term.

The plaintiff claimed the defendant tricked it into buying her practice by promising to retire. The written agreement resulting from the parties’ negotiations contained neither a non-compete term nor a recital that defendant intended to retire at the agreement’s conclusion.

The trial court granted summary judgment for the defendant on plaintiff’s fraud and negligent misrepresentation claims.  Plaintiff appealed.

Affirming, the Fifth District found that the plaintiff failed to produce evidence to support its misrepresentation claims and specifically, to show defendant hatched a “scheme to defraud” the plaintiff.

In Illinois, to state a colorable fraudulent misrepresentation claim, a plaintiff must allege: (1) a false statement of material facts, (2) known or believed to be false by the person making it, (3) an intent to induce a plaintiff to act, (4) action by the plaintiff in justifiable reliance on the truth of the statement, and (5) damage to the plaintiff resulting from the reliance.

A negligent misrepresentation plaintiff must also establish these elements but instead of showing a knowingly false statement, must prove the defendant (i) was careless or negligent in ascertaining the truth of the statement and (ii) owed a duty to the plaintiff to impart accurate information.

In both a fraudulent and negligent misrepresentation claim, the statement must be of an existing or past fact and not merely a promise to do something in the future.  The alleged fraud must also be complete at the time of the challenged statement as opposed to an intention to commit a future fraud.

The ‘Scheme to Defraud’ Exception

Where the false representation of future conduct is the scheme or device employed to accomplish the fraud, a court can restore the parties to the positions they occupied before the fraud was committed.  And while courts make clear that something beyond a lone broken promise is usually required to trigger the scheme exception, that “plus-factor” is still elusive.

Some courts require a plaintiff to allege a sustained pattern of repeated false representations [see HPI Health Care Services, Inc. v. Mt. Vernon Hospital, Inc., 131 Ill.2d 145 (1989)] while others [Roda v. Berko (401 Ill.335 (1948), Vance Pearson, Inc. v. Alexander, 86 Ill.App.3d 1105 (1980)] have held that a single promise can trigger the scheme exception.

In cases that have recognized the exception in the single broken promise setting, the plaintiff must generally produce evidence of a  defendant’s contemporaneous intention not to follow through on the promise.   The cases also make clear that whether a plaintiff is proceeding on a course of conduct scheme theory or one that involves only one promise, it must show the defendant’s fraudulent intent existed at or before the time of the promise. [25]

Here, the plaintiff could not prove the defendant promised to retire while, at the same time, never intending to fulfill that promise at the outset.  For support, the Court quoted both plaintiff’s agent’s and defendant’s deposition testimony.  Both testified that while the defendant’s future retirement was discussed prior to inking the three-year pact, it was never reduced to writing.  The plaintiff also could not pinpoint a definite promise by the defendant to retire when the employment contract lapsed.

As further proof that the defendant never unequivocally promised to retire, the plaintiff’s agent testified he even asked the defendant not to retire and that defendant stay beyondthe employment contract’s end date.  In the end, Plaintiff’s evidence did not go far enough to establish either an oral promise to retire at the agreement’s conclusion or the defendant’s intention not to fulfill that promise.

Afterwords:

In finding for the doctor defendant, the Heartland Women’s Healthcare Court was careful to respect the boundary between contract and tort law damages – a delineation that, in theory at least, prevents every broken promise from undergirding a fraud claim.

And while the content and outer reaches of the scheme to defraud exception [to the rule that a false promise is not actionable fraud] is still murky, it seems that something beyond a one-off broken promise is generally required.  A plaintiff invoking the scheme exception has a better chance of surviving a pleadings motion or summary judgment where it can show a defendant’s pattern of repeated broken promises.

Here, the plaintiff alleged only a single misstatement – defendant’s supposed oral promise to retire at the conclusion of the employment contract.  Without evidence of defendant’s contemporaneous intent not to uphold her promise, there wasn’t enough evidence of a scheme to defraud to survive summary judgment.

In hindsight, the Plaintiff should have negotiated and codified both a non-compete provision and defendant’s imminent retirement as material terms of the contract.

 

 

Lumber Exec’s Diversion of Profits to Company Owned by Son Supports Minority Shareholders’ Breach of Fiduciary Duty and Shareholder Oppression Claims – IL 2nd Dist.

Roberts v. Zimmerman, et al., 2021 IL App (2d) 191088-U provides a useful primer on the pleadings and evidence required to sustain a breach of fiduciary duty and shareholder oppression claim against a corporate officer and the contours of the business judgment rule defense to those claims.

The case involved three separate but related lumber buying companies:  Outstanding, Our Wood Loft, Inc. (“OWL”), and Lake City Hardwood (“Lake City”).  OWL is owned 1/3 by the two plaintiffs and 2/3 by the defendant majority shareholder.  Lake City is owned by the majority shareholder’s son.

Plaintiffs’ salient claim was that OWL’s majority shareholder breached his fiduciary duties to the company and minority shareholders by buying lumber from Lake City at a higher price than he could have paid other vendors.  According to the plaintiffs, the net result of the majority shareholder’s actions was a depletion in OWL profits over a multi-year span.  The fact that the director was paying the increased lumber prices to his son’s company created additional bad optics and provided more ammunition for the plaintiffs’ lawsuit.

Plaintiffs’ alleged breach of fiduciary duty and shareholder oppression under Sections 12.56(a)(3)(oppressive conduct) and 12.56(a)(4)(misapplication of corporate funds and/or waste) of the BCA.  Plaintiffs also joined an aiding-and – abetting claims against the majority shareholder’s son and wife.  Plaintiffs alleged these latter defendants were complicit in the majority shareholder’s scheme to enrich his son’s Lake City business to the detriment of OWL.

The trial court dismissed all claims except for the breach of duty claim premised on diversion of profits. After a bench trial, the trial court found in favor of the majority shareholder on this surviving claim on the basis that Plaintiffs failed to prove compensable damages.  Plaintiffs appealed.

Reversing, the appeals court first examined Illinois breach of fiduciary principles in the context of a close corporation shareholder dispute.

Breach of Fiduciary Duty

Corporate officers owe a fiduciary duty of loyalty to the corporation and are precluded from actively exploiting their positions within the corporation for their own personal benefit or impeding the corporation’s ability to conduct the business for which it was formed.

Here, the Court found the majority shareholder owed a fiduciary duty of loyalty to act in OWL’s best interest, to deal on behalf of OWL fairly and honestly, and seek to maximize OWL’s profits.  This duty included ensuring that OWL got the best price for lumber it bought from third parties.

The Court held that the majority shareholder breached his fiduciary duty by paying inflated lumber prices to his son’s company – Lake City.

The Court rejected Defendant’s business judgment rule (BJR) defense.  Under the BJR, courts will not interfere with business decisions of a corporate officer even if it seems that a more prudent decision could have been made.  However, a corporate officer cannot use the rule as a shield for conduct that does not rise to the level of due care.

Here, the court gave the BJR a cramped construction: it found that the rule only applies to honest mistakes in judgment and activities over which a corporate officer has discretion – such as whether an officer spent too much or too little on advertising, salaries, and the like.  The Rule does not apply to situations where challenged conduct subverts the rights of a corporation.  A corporate officer does not have discretion to divert profits from a corporation.

According to the Court, with minimal investigation, the majority shareholder would have discovered that Lake City was profiting at the expense of OWL by selling lumber at inflated prices to OWL.  [¶ 71]

Shareholder Oppression and Aiding-and-Abetting Claims

Reversing the Section 2-615 dismissal of the Plaintiffs’ shareholder oppression and aiding-and-abetting claims, the Court noted that shareholder oppression is not limited to acts that are illegal, fraudulent, or that involve mismanaged funds.  Instead, shareholder oppression applies to a wide gamut of conduct including a course of heavy-handed and exclusionary conduct and self-dealing.

To state a colorable aiding-and-abetting claim in Illinois, a plaintiff must allege (1) the party whom the defendant aids performed a wrongful act that caused an injury, (2) the defendant is generally aware in his or her role as part of the overall or tortious activity at the time or she provides assistance; and (3) defendant must knowingly and substantially assist the principal violation.

Here, Plaintiffs sufficiently alleged enough facts to sustain both claims. The allegations that the majority shareholder overpaid for lumber at OWL’s expense and to his son’s/Lake City’s benefit sufficiently pled an actionable oppression claim.

The Court similarly held that the Plaintiffs adequately pled Lake City’s active participation in the underlying lumber purchasing scheme in the aiding-and-abetting Complaint count.

Afterwords:

Roberts cements the proposition that a majority shareholder’s diversion of corporate profits to another entity can support both a breach of fiduciary duty claim and a statutory shareholder oppression action.

The case also makes clear that shareholder oppression is not limited to acts that are illegal, fraudulent, or that involve mismanaged funds.  Here, Plaintiffs allegation that the majority shareholder used an unnecessary middleman – Lake City – to which the company overpaid for lumber and lost resultant profits – was enough to make out a colorable oppression claim.

Finally, Roberts clarifies that a successful aiding-and-abetting a breach of fiduciary duty claim requires allegations of a defendant’s active participation and knowledge in/of  underlying wrongful conduct.  Constructive knowledge is not enough.

 

 

 

Transferee Corporation Is Judgment Debtor’s Alter Ego – Illinois Court (Deep Cut Case)

Dated but relevant for its discussion of some signature commercial litigation issues , Dougherty v. Tsai, 2017 IL App (1st) 161949, addresses, among other things, corporate alter ego liability, fraudulent transfers, and the admissibility of expert witness testimony.

In 2011, the plaintiff lessor obtained a default judgment against a corporate tenant (Tenant) in a 2009 commercial lease dispute case.

Through post-judgment discovery, the landlord learned that the Tenant and its owner (the Owner) secretly transferred money and assets from the Tenant to a related company (Transferee) that had the same employees and general line of business.  The landlord filed a new action in 2013 to hold the Transferee and Owner jointly responsible for the underlying judgment against the Tenant.

After a bench trial, the circuit court found that  the Transferee was the Tenant’s alter ego and entered judgment against the Transferee and Owner.  They appealed.

Defendants argued that the trial judge improperly entered judgment on a nonexistent cause of action – alter ego.  In Illinois, a corporation is a legal entity separate and distinct from its shareholders, directors and officers.  Corporate shareholders, officers and directors are generally not responsible for corporate debts.  But a court will disregard a corporate form and pierce its veil of limited liability where the corporation is merely an alter ego or business conduit of another person or entity.

The alter ego doctrine imputes liability to an individual or entity that uses the corporation as a vehicle to conduct the person’s or entity’s business.  However, neither piercing the corporate veil nor alter ego are separate, “stand-alone” causes of action.  Instead, they are means of imposing liability in an underlying claim.

To pierce the corporate veil, a plaintiff must demonstrate (1) unity of interest and ownership between the corporation and the person to be held liable such that separate personalities of the corporation and parties who compose it no longer exist and (2) circumstances are such that adherence to the fiction of a separate corporate existence would promote injustice or inequitable circumstances.

Here, the Court found that the trial court properly pierced the Tenant’s corporate veil of limited liability.  The similarities between the Tenant and Transferee (same business, ownership and employees, transfer of accounts from one company to the other, etc.) were so glaring that the Transferee was the Tenant’s alter ego.  Since the Tenant and Transferee were essentially one-and-the-same, the Court held that recognizing a separation between them reeked of unfairness to the plaintiff lessor.

The Court also rejected Defendants’ argument that piercing was improper since the underlying case sounded in breach of contract. In a breach of contract case, it’s more difficult to pierce the corporate veil than in tort causes of action.  This is because parties are presumed to enter into contracts voluntarily and assume the risks of the breaching party’s insolvency or protection from liability.

Here, however, the Court noted the 2013 case was not a breach of contract suit; it instead was an attempt to enforce the earlier judgment entered against the tenant.  Because the 2013 case wasn’t viewed as a breach of contract suit, the high hurdle to establish piercing in contract cases didn’t apply. [¶29]

The Court then addressed defendants’ argument that the trial court improperly allowed plaintiffs’ accounting expert to offer undisclosed damages opinions at trial.

The purpose of pretrial discovery in Illinois is to encourage timely disclosure of witnesses and opinions and discourage gamesmanship and surprise testimony.

Rule 213(g) limits expert testimony at trial to matters disclosed in answer to a Rule 213(f) interrogatory or in a discovery deposition.  An expert witness can elaborate on a disclosed opinion so long as the augmented testimony states “logical corollaries” to an opinion instead of new reasons for it.

The Court held that the trial court properly allowed the accountant’s testimony that the Tenant did not receive equivalent value in exchange for nearly $100,000 in rental payments it made to a company controlled by the Owner after the Tenant had supposedly gone out of business and decamped the leased premises.

The Court noted that the accountant had authored a pre-trial report that covered his damage opinions at trial, the report was disclosed to the Defendants and the Defendants deposed the accountant twice before trial. [¶ 43]

Afterwords

The case illustrates how important it is for judgment creditors to be tenacious in their collection efforts.  The Tenant’s Owner operated a complicated web of related business entities and freely transacted business among them.  This made it challenging for the plaintiff to unspool the various layers of corporate liability protection.  However, through its determined efforts and aggressive use of Illinois’ post-judgment enforcement rules, the plaintiff won a substantial money judgment against both individual and corporate defendants.

The case also reaffirms that alter ego and piercing the corporate veil are not  standalone causes of action but are instead a means of attaching liability on an underlying cause of action

Dougherty also makes clear that under Illinois pre-trial discovery rules, an expert witness at trial can amplify previously disclosed opinions as long as the expanded trial testimony has a factual nexus to earlier opinion.