Fee Shifting – Is ‘Prevailing Party’ Language Required?

I see this often: plaintiff sues a defendant for breach of contract.  The defendant has more financial resources than the plaintiff and the contract doesn’t have an attorneys’ fees provision.  Meaning, each side is responsible for its own fees. 

After several months, the plaintiff gets financially (and mentally) worn down by the richer defendant – who by now has filed numerous counterclaims and scheduled a flurry of witness depositions. 

The plaintiff says “uncle” and the parties enter the dreaded Mutual Walk-Away.  The plaintiff gets nothing, is annoyed at her lawyer (whom she has been paying hourly) and loses confidence in the litigation system. 

Once again, the deeper-pocketed defendant gets its way and the plaintiff, whose claim had merit, never gets her day in court.

One way to protect against this  common occurrence is to insert an attorneys’ fees or “fee-shifting” provision in the contract. 

Fee language can at least make a defendant think twice about trying to break a plaintiff’s will through protracted litigation.  It also encourages the plaintiff to not give up so easily when there is a potential fees and costs recovery at the end of the lawsuit. 

In Bank of America v. Oberman, Tivoli & Pickert, Inc., 2014 WL 293662,  an accounting firm sued a commercial lender for breach of a commercial loan agreement.  The agreement contained fee-shifting language applicable to the “collection, enforcement, administration, or protection” of the loan agreement. 

After plaintiff’s Illinois suit was dismissed for the fourth time and the dismissal was affirmed on appeal, the lender filed a separate action to recover its defense fees.

The accounting firm moved to dismiss the lender’s claim on the basis that the loan documents  didn’t specify that the prevailing party could recover attorneys’ fees.  The Northern District denied the motion.

Reasoning:

– The general rule in Illinois is that the lawsuit winner isn’t entitled to recover its attorneys’ fees unless there is a contractual provision that says so;

– Allowing a losing party to collect attorneys’ fees from the successful party violates Illinois public policy;

– A fee provision doesn’t have to contain the magic words “prevailing party” to be enforceable.

*4-5.

The Northern District found the fee-shifting language applied to the lender’s defense of the accounting firm’s various lawsuits.  The loan contract specifically said that fees incurred in the “protection” of the loan agreement were recoverable. 

The Court applied the Black’s Law Dictionary definition of protection (“to defend from danger or injury”) in ruling that defending a lawsuit equated to protecting the lender’s contract rights.  

Afterword:

To avoid the negative aftershocks of the above walk-away scenario, I always stress to clients that their contracts should contain attorneys’ fees language.  I also caution them that when signing another party’s contract, to be alert for attorneys’ fees language slanted in the other side’s favor. 

This case illustrates that while “prevailing party” terminology isn’t required to enforce a fee-shifting clause; the clearer and broader the clause, the better. 

 

 

7th Circuit Affirms Fraudulent Transfer and Alter Ego Judgment Against Corporate Officers

The Seventh Circuit affirmed an almost $3M judgment against the defendants under fraudulent transfer, successor liability and alter ego rules in Center Point v. Halim, 2014 WL 697501.

The plaintiff energy company entered into a written contract to supply natural gas to defendants’ 41 Chicago area rental properties.  The individual defendants – a husband and wife – managed the properties through a management company (Company 1).

Over a two-year period, defendants used over $1.2M worth of plaintiff’s gas and didn’t pay for it.  Plaintiff sued Company 1 in state court and got a $1.7M judgment.  When plaintiff discovered that defendants transferred all of Company 1’s assets to Company 2, plaintiff sued Company 2 and the husband and wife in Federal court alleging a fraudulent transfer and successor liability.  The Northern District entered summary judgment for plaintiff in the amount of $2.7M on all claims and defendants appealed.

Affirming, the Seventh Circuit first found that the defendants’ conduct violated the Illinois Fraudulent Transfer Act, 740 ILCS 160/1 (the “Act”).  The Act punishes debtor attempts to avoid creditors through actual fraud or constructive fraud.

Constructive fraud applies where (1) a debtor transfers assets without receiving a reasonably equivalent value in exchange for the transfer and (2) the debtor intends to incur or reasonably should believe he will incur debts beyond his ability to pay them as they become due.  Halim, *2, 740 ILCS 160/5.

The Court found that the defendants’ actions were constructively fraudulent. First, the Court noted that during a three-year time span, Company 1 (the state court judgment debtor) transferred almost $11M to the individual defendants; ostensibly to repay loans.

But the Court found it odd there was no documentation of loans or a paper trail showing where the millions of dollars went.  The suspicious timing of defendants’ creation of a new company – Company 2 – coupled with the defendants’ inability to account for the millions’ whereabouts, bolstered the Court’s constructive fraud finding.

Since the individual defendants’ depletion of Company 1’s assets made it impossible for it to pay the state court judgment, the defendants’ actions were constructively fraudulent under the Act. *3.

The Court also affirmed summary judgment for the plaintiff under successor liability and alter ego theories.  In Illinois, the general rule is that a company that purchases assets of another company does not assume the liabilities of the purchased company.

A common exception to this rule is where there is an express assumption (of liability) by the purchasing company.  Here, the record showed that Company 2 assumed all rights, obligations, contracts and employees of Company 1.  As a result, the unsatisfied state court judgment attached to Company 2 under successor liability rules.

The Court also affirmed the judgment under the alter ego doctrine.  Alter ego applies where there is virtually no difference between the business entity and that entity’s controlling shareholders.  That is, the dominant shareholders don’t treat the corporation as a separate entity and fail to follow basic corporate formalities (e.g. minutes, stock issuance, incorporation papers, etc.).

The individual defendants treated Company 1 as their personal piggy bank by commingling their personal assets with the corporate assets.  There were no earmarks of “separateness” between the individual defendants’ assets and Company 1’s corporate assets.  *3-4.

Because of this, the husband and wife defendants were responsible (in the Federal suit) for the unsatisfied state court judgment entered against the defunct Company 1.

Take-away: Halim illustrates that where a judgment debtor corporation or controlling shareholders of that corporation transfer all corporate assets to a new, similarly named (or not) entity shortly after a lawsuit is filed, it will likely look suspicious and can lead to a constructive fraud finding.

The case also underscores the importance of following corporate formalities and keeping corporate assets separate from individual/personal assets – especially where the corporation is controlled by only two individuals.  A failure to treat the corporation as distinct from the dominant individuals, can lead to alter ego liability for those individuals.

Craigslist Ad = Improper Hearsay Evidence at Bike Theft Trial

bikeIn re Jovan A, 2014 IL App (1st) 103835, poses the question of whether the content of a craiglist.org advertisement (the “craiglist Ad” or “Ad”) is admissible under the hearsay exception for showing what steps police took in the course of investigating a crime.  The First District answered “no”; it’s not admissible.

The State charged the defendant with stealing a bike off the back of a parked car in Chicago’s Bucktown neighborhood.  The bike belonged to the car owner’s friend.  Later that same night, the car owner visited the craigslist.org site and saw a bike for sale that looked just like her friend’s stolen bike.  The Ad also directed the viewer to call a phone number if interested in buying the bike.  The car owner printed the Ad, cross-referenced it to find an address associated with the phone number and gave it to her detective friend, who then started an investigation.

The detective eventually located a person he believed to be defendant (based on car registration data), called the number on the Ad, and the defendant’s cell phone rang.  Defendant was arrested and charged with theft of property over $300. 720 ILCS 5/16-1(a)(1) (criminal theft statute).  At trial, the detective, the car owner (off whose car the bike was stolen) and two other witnesses testified against the defendant.  The detective and car owner both testified as to the contents of the craiglist Ad over defendant’s hearsay objection.  After a bench trial, the defendant was sentenced to 18 months probation for stealing the bike.  Defendant appealed.

Held: Trial court reversed.  The craiglist Ad is inadmissible hearsay.

Reasoning:

The craigslist Ad was the key piece of evidence relied on by the trial court when it found defendant guilty of stealing the triathlon bike.  The First District reversed the trial court because the Ad was hearsay evidence and didn’t satisfy any exceptions.

Hearsay is an out-of-court statement offered in court to prove the truth of the matter asserted. IRE 801-807.  Hearsay is generally disallowed because it is “no better than rumor or gossip” and can’t be tested by cross-examination.  U.S. v. Boyce, No. 13-1087 (7th Cir. 2014). 

Hearsay includes both oral and written statements (and sometimes non-verbal conduct) and encompasses matters directly asserted as well as matters implied by the declarant (the person making the out-of-court statement). 

Hearsay is inadmissible unless it falls within an exception to the rule.  In the criminal context, a hearsay exception exists where a law enforcement member testifies concerning out-of-court information he read, heard, or saw during the course of an investigation to explain why he arrested a defendant or took other action.  

This testimony is not hearsay because it is offered to show the steps the officer took in his criminal investigation; not for the truth of the matter asserted. Id.   Under the course-of-investigation exception to the hearsay rule, an officer’s testimony is limited to what is necessary to explain his actions.  Beyond that, he can’t testify to the content of any statements he received in the course of the investigation.  Jovan, ¶¶ 23-28.

The challenged hearsay statements allowed in at trial were (1) the car owner’s and (2) detective’s description of the craiglist Ad’s written text and (3) their separate recitation of the Ad’s phone number and how that number led to defendant’s apprehension.  The trial court admitted this testimony not for its truth, but to show the course of the bike theft investigation and the steps taken to arrest the defendant.

The First District held that the trial court improperly allowed the testimony concerning the Ad’s content in evidence.   Ruling that the in-the-course-of-investigation exception didn’t apply, the Court pointed out that the car owner was not a member of law enforcement but was instead a lay person.  As a result, her trial testimony about what the Ad said exceeded the limits of the exception.

The Court also found the detective’s testimony exceeded the scope of the course of investigation hearsay rule.  He testified that he relied on the Ad to locate the subject bike and used the Ad’s phone number to connect that number to the defendant.  The detective should have stopped there (since that testimony satisfied the exception).

But he went further: he also testified that his friend (the car owner) told him that the bike was being sold on craiglist, that he called the number on the Ad and that defendant’s cell phone rang when he called.  The detective violated the hearsay rule by relying on the out-of-court statements – namely, the car owner’s description of the Ad and the phone number and picture featured on the Ad.  The Court found that the Ad’s specifics were improper hearsay and should have been excluded by the trial court.

Afterword:

Jovan is interesting for its discussion of an atypical hearsay exception (at least in the civil litigation context).  The  course-of-investigation hearsay exception is broad but not without limits. Curiously, the State didn’t use the actual craiglist Ad at trial.

I was left wondering why it didn’t try to get the Ad into evidence under IRE 902’s self-authenticating rules for newspapers and periodicals.  I would think craiglist is enough of a ‘Net household name – and similar enough to a generally circulated “newspaper” – that a print-out from the site would be  sufficiently trustworthy to be utilized at trial.  Jovan is also unique in the sense that the First District acknowledges that there was enough circumstantial evidence – aside from  the craiglist Ad – to convict the defendant.

Even so, since the trial court relied so heavily on out-of-court evidence (the Ad), the conviction was reversed.