Tag: alter ego

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.

 

Judgment Creditor Can Recover Attorneys’ Fees Spent Pursuing Successful Veil Piercing Suit Versus Corporate Officers

Q:           Can a judgment creditor recover attorneys’ fees incurred in both its post-judgment discovery efforts after a default judgment against a defunct corporation and a subsequent piercing the corporate veil action to enforce the prior judgment where the contract with the defunct entity contains an attorneys’ fees provision?

A:            Yes.

That’s the salient and nuanced holding from Steiner Electric Company v. Maniscalco, 2016 IL App (1st) 132023, a case that’s a boon to creditor’s rights attorneys and corporate litigators.

There, the First District held in a matter of first impression that a plaintiff could recover fees in a later piercing the corporate veil suit where the underlying contract litigated to judgment in an earlier case against a corporation has an attorneys’ fees provision.

The plaintiff supplied electrical and generator components on credit over several years to a company owned by the defendant.  The governing document between the parties was a credit agreement that had a broad attorneys’ fees provision.

When the company defaulted by failing to pay for ordered and delivered equipment, the plaintiff sued and won a default judgment against the company for about $230K. After its post-judgment efforts came up empty, the plaintiff filed a new action to pierce the corporate veil hold the company president responsible for the earlier money judgment.

The trial court pierced the corporate veil and found the company president responsible for the money judgment against his company but declined to award plaintiff its attorneys’ fees generated in litigating the piercing action.

The First District affirmed the piercing judgment and reversed the trial court’s refusal to assess attorneys’ fees against the company President.

The Court first affirmed the piercing judgment on the basis that the company was inadequately capitalized (the company had a consistent negative balance), commingled funds with a related entity and the individual defendant and failed to follow basic corporate formalities (it failed to appoint any officers or document significant financial transactions).

In finding the plaintiff could recover its attorneys’ fees – both in the underlying suit and in the second piercing suit to enforce the prior judgment – the court stressed that piercing is an equitable remedy and not a standalone cause of action.  The court further refined its description of the piercing remedy by casting it as a means of enforcing liability on an underlying claim – such as the prior breach of contract action against the defendant’s judgment-proof company.

While a prevailing party in Illinois must normally pay its own attorneys’ fees, the fees can be shifted to the losing party where a statute or contract says so.  And there must be clear language in a contract for a court to award attorneys’ fees to a prevailing litigant.

Looking to Illinois (Fontana v. TLD Builders, Inc.), Seventh Circuit (Centerpoint v. Halim) (see write-up here and Colorado (Swinerton Builders v. Nassi) case precedent for guidance, the Court found that since the underlying contract – the Credit Agreement – contained expansive fee-shifting language, the plaintiff could recoup from the defendant the fees expended in both the first breach of contract suit against the company and the second, piercing case against the company president.  The Court echoed the Colorado appeals court’s (in Swinerton) depiction of piercing the corporate veil as a “procedural mechanism” to enforce an underlying judgment.

The combination of broad contractual fees language in the credit application and case law from different jurisdictions that fastened fee awards to company officers on similar facts led the First District to reverse the trial court and tax fees against the company president. (¶¶ 74-90)

Afterwords:

An important case and one that fee-seeking commercial litigators should look to for support of their recovery efforts.  A key lesson of Steiner is that broad, unequivocal attorneys’ fees language in a contract not only applies to an initial breach of contract suit against a dissolved company but also to a second, piercing lawsuit to enforce the earlier judgment against a company officer or controlling shareholder.

For the dominant shareholders of dissolved corporations, the case spells possible trouble since it upends the firmly entrenched principle that fee-shifting language in a contract only binds parties to the contract (not third parties).

7th Circuit Provides Primer on Fraudulent Transfer and Alter Ego Doctrine In Contract Dispute

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.