Piercing the Corporate Veil Not a Standalone Cause of Action: It’s A Remedy – IL Court Rules

Gajda v. Steel Solutions Firm, Inc., 2015 IL App (1st) 142219, stands as a recent discussion of the standards governing section 2-619 motions, successor liability and whether piercing the corporate veil is a cause of action or only a remedy for a different underlying legal claim.

The plaintiffs alleged they were misclassified as independent contractors instead of employees under the Illinois Employee Classification Act (820 ILCS 185/60) by their employer and one of its principals.  The plaintiffs sued under piercing the corporate veil and successor liability theories.  The trial court dismissed all of the plaintiffs’ claims and they appealed.

Reversing the trial court and sustaining the bulk of plaintiffs’ claims, the First District stressed some important recurring procedural and substantive rules in corporate litigation.

Piercing the corporate veil – Standalone cause of action or remedy?

Answer: remedy.  In Illinois, piercing the corporate veil is not a cause of action but is instead a “means of imposing liability in an underlying cause of action.”  In the usual piercing setting, once a party obtains a judgment against a corporation, the party can then “pierce” the corporate veil of liability protection and hold the dominant shareholder(s) responsible for the corporate obligation.  Piercing can also be used to reach the assets of an affiliated or “sister” corporation.

Here, since the plaintiff captioned their first count as one for piercing the corporate veil, the trial court properly dismissed the claim on defendant’s Section 2-615 motion since piercing isn’t a recognized cause of action in Illinois.  (¶¶ 19-24).  However, the court did find that the plaintiff’s factual allegations that the defunct predecessor and its successor were alter-egos of each other, that they commingled one another’s funds and made improper loans to each other were sufficient to state a claim for piercing the corporation veil as a remedy (not a separate cause of action).  (¶ 25).

Successor Liability

The court then applied Illinois’ established successor liability rules to both the defunct and current employers.  A company that purchases another company’s assets normally isn’t responsible for the purchased company’s debt.  Exceptions to this rule against corporate successor non-liability include (1) where there is an express or implied agreement or assumption of liability; (2) where a transaction amounts to a consolidation or merger of the buyer and seller companies; (3) where the buying entity is a “mere continuation” of the selling predecessor entity; and (4) where the transaction is fraudulent in that it is done so that the selling entity can evade liability for its financial obligations. (¶ 26).

Here, the plaintiff’s allegations that showed an overlap in the buying and selling entities’ management and employees as well as the complaint’s assertions that the predecessor and successor companies were commingling funds were sufficient to make out a case of mere continuation successor liability. (¶ 26).

Afterwords:

This case cements proposition that piercing isn’t a standalone cause of action – but is instead a remedy where there is an underlying failure to follow corporate formalities.  The case is also useful for its providing some clues as to what facts a plaintiff must allege to state a colorable successor liability claim under Illinois law.

Economic Loss Rule Requires Reversal of $2.7M Damage Verdict In Furniture Maker’s Lawsuit- 7th Circuit

In a case that invokes Hadley v. Baxendale** – the storied British Court of Exchequer case published just three years after Moby-Dick (“Call me ‘Wikipedia’ guy?”) and is a stalwart of all first year Contracts courses across the land – the Seventh Circuit reversed a multi-million dollar judgment for a furniture maker.

The plaintiff in JMB Manufacturing, Inc. v. Child Craft, LLC, sued the defendant furniture manufacturer for failing to pay for about $90,000 worth of wood products it ordered.  The furniture maker in turn countersued for breach of contract and negligent misrepresentation versus the wood supplier and its President alleging that the defective wood products caused the furniture maker to go out of business – resulting in millions of dollars in damages.

The trial court entered a $2.7M money judgment for the furniture maker on its counterclaims after a bench trial.

The Seventh Circuit reversed the judgment for the counter-plaintiff based on Indiana’s economic loss rule.  

Indiana follows the economic loss doctrine which posits that “there is no liability in tort for pure economic loss caused unintentionally.”  Pure economic loss means monetary loss that is not accompanied with any property damage (to other property) or personal injury.  The rule is based on the principal that contract law is better suited than tort law to handle economic loss lawsuits.  The economic loss rule prevents a commercial party from recovering losses under a tort theory where the party could have protected itself from those losses by negotiating a contractual warranty or indemnification term.

Recognized exceptions to the economic loss rule in Indiana include claims for negligent misrepresentation, where there is no privity of contract between a plaintiff and defendant and where there is a special or fiduciary relationship between a plaintiff and defendant. 

The court focused on the negligent misrepresentation exception – which is bottomed on the principle that a plaintiff should be protected where it reasonably relies on advice provided by a defendant who is in the business of supplying information. (p. 17).

The furniture maker counter-plaintiff’s negligent misrepresentation claim versus the corporate president defendant failed based on the agent of a disclosed principal rule.  Since all statements concerning the moisture content of the wood imputed to the counter-defendant’s president were made in his capacity as an agent of the corporate plaintiff/counter-defendant, the negligent misrepresentation claim failed.

The court also declined to find that there was a special relationship between the parties that took this case outside the scope of the economic loss rule.  Under Indiana law, a garden-variety contractual relationship cannot be bootstrapped into a special relationship just because one side to the agreement has more formal training than the other in the contract’s subject matter.

Lastly, the court declined to find that the corporate officer defendant was in the business of providing information.  Any information supplied to the counter-plaintiff was ancillary to the main purpose of the contract – the supply of wood products.

In the end, the court found that the counter-plaintiff negotiated for protection against defective wood products by inserting a contract term entitling it to $30/hour in labor costs for re-working deficient products.  The court found that the counter-plaintiff’s damages should have been capped at the amount representing man hours expended in reconfiguring the damaged wood times $30/hour – an amount that totaled $11,000. (pp. 9-17, 24).

Take-aways:

1/ This case provides a good statement of the economic loss rule as well as its philosophical underpinnings.  It’s clear that where two commercially sophisticated parties are involved, the court will require them to bargain for advantageous contract terms that protect them from defective goods or other contingencies;

2/ Where a corporate officer acts unintentionally (i.e. is negligent only), his actions will not bind his corporate employer under the agent of a disclosed principal rule;

3/ A basic contractual relationship between two merchants won’t qualify as a “special relationship” that will take the contract outside the limits of Indiana’s economic loss rule.

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** Hadley v. Baxendale is the seminal breach of contract case that involves consequential damages.  The case stands for the proposition that the non-breaching party’s recoverable damages must be foreseeable (ex: if X fails to deliver widgets to Y and Y loses a $1M account as a result, X normally wouldn’t be responsible for the $1M loss (unless Y made it clear to X that if X breached, Y would lose the account, e.g.) [https://en.wikipedia.org/wiki/Hadley_v_Baxendale]

Michael Keaton Defeats Production Company’s “Merry Gentleman” Breach of Contract Suit – ‘Reliance’ Damages Summary

“The ultimate badass introduction. Say this upon meeting someone tough and they’ll never mess with you.”

That’s how no less an authority than Urban Dictionary (who said I wasn’t high-brow?!!) describes “I’m Batman!” – a film-defining movie line that seems to have been catapulted into cultural idiom status. (http://www.urbandictionary.com/define.php?term=I’m+Batman)

Not sure if Michael Keaton unveiled this quiver-inducing Statement as a breach of contract defense but the Seventh Circuit did recently rule in the actor’s favor in a multi-million dollar contract dispute that’s the genesis of Merry Gentleman, LLC v. George and Leona Productions, Inc. (http://caselaw.findlaw.com/us-7th-circuit/1711569.html)

There, the plaintiff production company sued the famed actor and one of his companies for damages, alleging Keaton failed to deliver timely versions or “cuts” of a film, failed to cooperate in the distribution and marketing of the film and was derelict in his film post-production obligations.

The suit concerns 2009’s The Merry Gentleman, a motion picture directed by and acted in by Keaton that was a box office bust but was lauded by some critics, including the late Roger Ebert.  The plaintiff claimed Keaton breached his director duties at the movie’s pre-production, distribution and post-production phases and sought a cool $5.5M in damages – the amount plaintiff claimed it spent producing and marketing the film.  Keaton won summary judgment on the basis that plaintiff couldn’t prove a causal link between Keaton’s’ breach and the plaintiff’s claimed damages.  Plaintiff appealed.

The Seventh Circuit affirmed and in doing so, espoused some key contract damages guideposts.

The two entrenched contract damage schemes are expectation damages and the more remote reliance damages.  Expectation damages apply where a party seeks the “benefit of his bargain”; what he would have received had the breaching party performed.  Reliance damages, by contrast, involve a plaintiff getting reimbursed for loss caused by his reliance on the contract.

Classic reliance damages include preparatory costs: those expenses incurred by a plaintiff in preparing for performance of a contract minus any loss he would have suffered had the contract been performed.  Restatement (Second) of Contracts, § 349.

Reliance damages are designed to compensate a plaintiff who is unable to demonstrate expectation damages.  Reliance damages involve a burden-shifting analysis where a plaintiff must first prove his expense outlay in preparing for performance.  The burden then shifts to the defendant to prove what damages the plaintiff would have sustained if the contract was performed.

While reliance damages present a lower proof hurdle than do expectation damages, the breach of contract plaintiff must still produce evidence that the claimed losses were both caused by the breach and foreseeable.

Typically, reliance damages apply where one party to a contract has walked away without performing.  The plaintiff then recovers the expenses it incurred in its own preparation for performance.  Here, though, the court emphasized, Keaton did perform: he made and acted in the movie.  He also presented Merry Gentleman at the vaunted Sundance Film Festival.

The court said that if Keaton had failed to act in or direct the movie, then maybe the plaintiff could have recovered its reliance expenses.  However, since Keaton substantially performed his contractual obligations (acting and directing), plaintiff failed to prove how the actor’s claimed breaches caused over $5M in damages.  To allow plaintiff’s damages in this case meant that Keaton’s performance as director and actor was completely worthless – that plaintiff lost its entire multi-million dollar investment in the film based on Keaton’s breach.  The court refused to find that the actor’s services entirely lacked value.

Based on the plaintiff’s failure to establish proximate cause (that Keaton’s breach resulted in $5.5M in damages), the Seventh Circuit upheld summary judgment for defendants.

Afterwords:

This case provides a good summary of expectation and reliance contract law damages including when one damage scheme applies versus the other.

Merry Gentleman also illustrates in sharp relief how difficult it is for a plaintiff to recover reliance damages where the defendant substantially performs a contract.  This is especially so in a case like this where the claimed breach is subjective – involving the quality of performance – rather than a more readily measurable breach like a complete failure to perform.