Tag: actual fraud

Plaintiffs’ Are ‘SOL’ Based on IFTA’s SOLs

The First District recently considered when the discovery rule can mitigate the harshness of a statute of limitations [the SOL] in a fraudulent transfer case.

The plaintiffs in Andersen Law LLC v. 3 Build Construction, LLC, 2019 IL App (1st) 181575-U, a judgment creditor’s former counsel and her new law firm who secured a $200K judgment against two limited liability companies, sued under the Illinois Fraudulent Transfer Act, 740 ILCS 160/1 et seq. [the “IFTA”] alleging two members of the debtor LLCs pilfered corporate bank accounts and formed a corporation to avoid the judgment.

The judgment debtors and third party defendants moved to dismiss the IFTA claims on statute of limitation grounds and for failure to state a cause of action. The trial court granted the motion to dismiss and the plaintiff appealed.

Affirming the lower court’s dismissal, the First District noted that while an SOL motion to dismiss is normally brought under Code Section 2-619 [which involves affirmative matter], the SOL issue can be disposed of on a Code Section 2-615 [which looks at the four-corners of a pleading] motion where the complaint’s allegations make clear that claim(s) is time-barred.

An IFTA actual fraud [a/k/a fraud-in-fact] claim is subject to a four year limitations period, measured from the date of transfer. [740 ILCS 160/10(a)]. This section has a built-in discovery rule:  where the fraud could not have reasonably been discovered within the 4-year post-transfer period, the fraud-in-fact claim must be brought within one year after the transfer was or could have reasonably been discovered. [¶42]

To determine whether the discovery rule preserves a too-late claim, the court considers whether an injured party has (1) sufficient knowledge that its injury was caused by actions of another, and (2) sufficient information to ‘spark inquiry in a reasonable person’ as to whether the conduct of the party causing an injury is actionable. [¶51]

Constructive fraud [a/k/a fraud-in-law] claims, by contrast, must be brought within 4 years of the transfer.  There is no discovery rule that extends the limitations term.

Looking to the plain text of IFTA Section 10, the First District affirmed the trial court’s dismissal of the plaintiffs’ constructive fraud claims.  It held that the IFTA statute of limitations runs from the date of transfer, not, as plaintiffs argued, from the judgment. [¶48]

The Court then rejected plaintiffs’ assertion that IFTA’s discovery rule saved the otherwise time-barred actual fraud claims.  It found the plaintiffs failed to allege specific facts or a chronology as to when they reasonably learned the defendants’ diverting funds from the corporate debtors’ accounts.  As a result, the Court affirmed trial court’s dismissal of plaintiffs’ actual fraud claim.

The Court also nixed the plaintiffs’ related argument that the discovery rule applied based on the obstructionist actions of their former client [from whom the IFTA claim was assigned].  It made clear that the fraudulent concealment of a cause of action must be based on the conduct of thedefendant, not a third-party. The lone exception is where the person concealing a claim is in privity with or an agent of the defendant.  In such a case, the statute of limitations period can be tolled. [¶59]

Here, the plaintiffs failed to plead facts that the former client/underlying creditor acted in concert with the judgment debtor or the transferees.

Take-aways:

Some key take-aways from the Anderson Law LLCcase include that in a fraudulent transfer case, the four-year limitations period runs from the date of transfer, not from the date of the underlying judgment.

The case also makes clear that it is the plaintiff’s burden to successfully invoke the discovery rule to breathe life into a stale IFTA fraud-in-fact claim. [The one-year discovery extension period doesn’t apply to fraud-in-law claims.]  If a plaintiff fails to plead specific facts to carry its burden of demonstrating that its time-barred claim should be saved by the discovery rule, its claim is subject to Code Section 2-615 dismissal.

 

 

Non-Shareholder Can Be Liable On Alter-Ego and Veil Piercing Theory – IL Bankruptcy Court

Buckley v. Abuzir  will likely be viewed as a watershed in piercing the corporate veil litigation because of its exhaustive analysis of when a non-shareholder can be personally liable for corporate debts.  In that case, the court provides an extensive survey of how nearly every jurisdiction in the country has decided the non-shareholder piercing question.

In re Tolomeo, 2015 WL 5444129 (N.D.Ill. 2015) considers the related question of whether a creditor can pierce the corporate veil of entities controlled by a debtor non-shareholder so that those entities’ assets become part of the debtors’ bankruptcy estate.

The answer: “yes.”  In their complaint, the creditors sought a determination that three companies owned by the debtor’s wife but controlled by the debtor were the debtors’ alter-egos.  The creditors of the debtor also sought to pierce the companies’ corporate veils so that the companies’ assets would be considered part of the debtor’s bankruptcy estate.  This would have the salutary effect of providing more funds for distribution to the various creditors.  After striking the debtor’s defenses to the complaint, the court granted the creditors motion for judgment on the pleadings. In doing so, the bankruptcy court applied some fundamental piercing principles to the situation where an individual debtor controls several companies even though he is not a nominal shareholder of the companies.

In Illinois, a corporation is a legal entity separate and distinct from its shareholders. However, this separateness will be disregarded where limited liability would defeat a strong equitable claim of a corporate creditor.

A party who seeks to set aside corporate liability protection on an alter-ego basis must make the two-part showing that (1) the company was so controlled and manipulated that it was a mere instrumentality of another entity or individual; and (2) misuse of the corporate form would promote fraud or injustice.

The mere instrumentality factors include (a) inadequate capitalization, (b) a failure to issue stock, (c) failure to observe corporate formalities, (d) nonpayment of dividends, (e) insolvency of the debtor corporation, (f) nonfunctioning officers or directors, (g) lack of corporate records, (h) commingling of funds, (i) diversion of assets from the corporation by or to a shareholder, (j) failure to maintain arm’s length relationships among related entities; and (k) the corporation being a mere façade for the dominant shareholders.

Promotion of injustice (factor (2) above)), in the veil piercing context, requires less than a showing of fraud but something more than the prospect of an unsatisfied judgment.

The court echoed Buckley and found that the corporate veil can be pierced to reach the assets of an individual even where he is not a shareholder, officer, director or employee.

The key question is whether a person exercises “equitable ownership and control” over a corporation to such an extent that there’s no demarcation between the corporation and the individual.  According to the court, making shareholder status a prerequisite for piercing liability elevates form over substance.

Applying these standards, the court found the circumstances ripe for piercing. The debtor controlled the three entities as he handled the day-to-day operations of the companies. He also freely shifted money between the entities and regularly paid his personal bills from company bank accounts. Finally, the court noted an utter lack of corporate records and threadbare compliance with rudimentary formalities. Taken together, the court found that the factors weighed in favor of finding that the three companies were the debtor’s alter-egos and the three entities should be considered part of the debtor’s bankruptcy estate.

Take-aways:

1/ A defendant’s status as a corporate shareholder will not dictate whether or not his assets can be reached in an alter-ego or veil piercing setting.

2/ If non-shareholder sufficiently controls a corporate entity, he can be responsible for the corporate debts assuming other piercing factors are present.

3/ Veil piercing can occur absent actual fraud by a controlling shareholder.  The creditor plaintiff must show more than a mere unpaid debt or unsatisfied judgment, though.  Instead, there must be some element of unfairness present for a court to set aside corporate protection and fasten liability to the individual.

 

 

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.