Tag: asset purchase

Substantial Performance of Asset Purchase Agreement Wins the Day in Pancake House Spat

pancakes-155793_960_720The Second District affirmed summary judgment for the plaintiff pancake house (“Restaurant”) seller in a breach of contract action against the Restaurant’s buyer and current operator.  Siding with the seller, the court discussed the contours of the substantial performance doctrine and what kind of evidence a plaintiff must supply to win summary judgment in a contract dispute.

The plaintiff in El and Be, Inc. v. Husain, 2016 IL App (2d) 150011-U, sold the Restaurant for about $500K pursuant to an Asset Purchase Agreement (APA).   The defendant failed to pay the agreed purchase price when it learned the plaintiff had several unpaid vendor bills, utility debts and a lien lawsuit was filed in Texas against Restaurant equipment by a secured creditor of the plaintiff.  The plaintiff sued for breach of contract to recover the APA purchase price and the defendant counterclaimed for fraud and breach of the APA.  The trial court entered summary judgment for the plaintiff on its claims as well as defendants’ counterclaims.

Affirming summary judgment for the plaintiff, the Second District framed the salient issue as whether the plaintiff substantially performed its APA obligations.

Perfect performance isn’t required to enforce a contract.  Instead, a plaintiff must show he substantially performed.  Substantial performance is hard to define and is a fact-based inquiry.  In deciding whether substantial performance has occurred, a court considers whether a defendant received and enjoyed the benefits of the plaintiff’s performance.  Substantial performance allows a plaintiff to win a breach of contract suit; especially where his performance is done in reliance on the parties’ contract.

The court found that the defendant Restaurant buyer clearly benefitted from the plaintiff’s performance.  The buyer gained the Restaurant assets and goodwill and operated the Restaurant continuously for over a year before plaintiff sued to enforce the APA.  The defendant’s operation of the Restaurant during this pre-suit period was a tangible benefit flowing to the defendant from the plaintiff’s APA performance.  (¶¶ 25-27).

Next, the Court rejected the defendant’s fraud counterclaim – premised on plaintiff’s failure to disclose outstanding debts prior to the Restaurant sale.  The defendant claimed this omission exposed the defendant to a future lien foreclosure action and a possible money judgment by plaintiff’s creditors.

In Illinois, a fraud plaintiff must establish (1) a false statement of material fact, (2) the statement maker’s knowledge or belief that the statement was false; (3) an intention to induce the plaintiff to act based on the statement, (4) reasonable reliance on the truth of the statement by the plaintiff, and (5) damage to the plaintiff resulting from the reliance.  A fraud claimant must also prove damages (monetary loss, e.g.) with reasonable certainty.  While mathematical precision isn’t required, fraud damages that are speculative or hypothetical won’t support a fraud suit.

Here, since the defendant made only generalized allegations of possible damages and could not point to actual damages evidence – such as having to defend a lien foreclosure suit or a money judgment – the fraud claim failed.  On summary judgment, a litigant must offer evidence to support its claims.  The defendant’s failure to produce measurable damages evidence stemming from plaintiff’s pre-sale omissions doomed the fraud claim.  (¶¶ 33-36)

Afterwords:

El and Be, Inc. cements the proposition that perfect performance isn’t required to enforce a contract.  Instead, a breach of contract plaintiff must show substantial performance – that he performed to such a level that the defendant enjoyed tangible benefits from the performance.  Where a contract defendant clearly reaps monetary awards from a plaintiff’s contractual duties, the substantial performance standard is met.

The case also makes clear that fraud must be pled and proven with acute specificity and that vague assertions of damages without factual back-up won’t survive summary judgment.

 

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.