Tag: Davis mcgrath

Debtor’s Refusal to Return Electronic Data = Embezzlement – No Bankruptcy Discharge – IL ND

FNA Group, Inc. v. Arvanitis, 2015 WL 5202990 (Bankr. N.D. Ill. 2015) examines the tension between the bankruptcy code’s aim of giving a financial fresh start to a debtor and the Law’s attempt to protect creditors from underhanded debtor conduct to avoid his debts.

After a 15-year employment relationship went sour, the plaintiff power washing company sued a former management-level employee when he failed to turn over confidential company property (the “Data”) he had access to during his employment.

After refusing a state court judge’s order to turn over the Data and an ensuing civil contempt finding, the defendant filed bankruptcy.

The plaintiff filed an adversary complaint in the bankruptcy case alleging the defendant’s (now the debtor) embezzlement and wilfull injury to company Data.

The plaintiff asked the bankruptcy court to find that the debtor’s obligations to the plaintiff were not dischargeable (i.e. could not be wiped out).

Siding with the plaintiff, the Court provides a useful discussion of the embezzlement and the wilfull and malicious injury bankruptcy discharge exceptions.

The bankruptcy code’s discharge mechanism aims to give a debtor a fresh start by relieving him of pre-petition debts. Exceptions to the general discharge rule are construed strictly against the creditor and liberally in favor of the debtor.

Embezzlement under the bankruptcy code means the “fraudulent appropriation of property” by a person to whom the property was entrusted or to whom the property was lawfully transferred at some point.

A creditor who seeks to invoke the embezzlement discharge exception must show: (1) the debtor appropriated property or funds for his/her benefit, and (2) the debtor did so with fraudulent intent.

Fraudulent intent in the embezzlement context means “without authorization.” 11 U.S.C. s. 523(a)(4).

The Court found the creditor established all embezzlement elements. First, the debtor was clearly entrusted with the Data during his lengthy employment tenure. The debtor also appropriated the Data for his own use – as was evident by his emails where he threatened to destroy the Data or divulge its contents to plaintiff’s competitors.

Finally, the debtor lacked authorization to hold the Data after his resignation based on a non-disclosure agreement he signed where he acknowledged all things provided to him remained company property and had to be returned when he left the company.

By holding the Data hostage to extract a better severance package, the debtor exhibited a fraudulent intent.

The court also refused to allow a debtor discharge based on the bankruptcy code’s exception for willful and malicious injury. 11 U.S.C. s. 523(a)(6).

An “injury” under this section equates to the violation of another’s personal or property rights. “Wilfull” means an intent to injure the person’s property while “malicious” signals a conscious disregard for another’s rights without cause.

Here, the debtor injured the plaintiff by refusing to release the Data despite a (state) court order requiring him to do so. Plaintiff spent nearly $200,000 reconstructing the stolen property and retaining forensic experts and lawyers to negotiate the Data’s return.

Lastly, the debtor’s threatening e-mails to plaintiff in efforts to coerce the plaintiff to up its severance payment was malicious under Section 523 since the e-mails exhibited a disregard for the importance of the Data and its integrity.

Take-aways:

The bankruptcy law goal of giving a debtor fiscal breathing room has limits. If the debtor engages in intentional conduct aimed at evading creditors or furthers a scheme of lying to the bankruptcy court, his pre-petition debts won’t be discharged.

This case is post-worthy as it gives content to the embezzlement and wilfull and malicious property damage discharge exceptions.

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]

Fire Alarm Contract Doesn’t Create Implied Warranty Claim – IL ND

Two titans of their respective industries went head-to-head in Allstate Indemnity Company v. ADT, LLC, 2015 WL 3798715 (N.D.Ill. 2015), a dispute over an alarm company’s responsibility for fire damage to its homeowner customer.

After a 2013 house fire decimated its insured’s home to the tune of about $1.4M in damages, the plaintiff home insurer (Allstate) sued ADT, the home smoke and fire alarm installer, for negligence, breach of contract and consumer fraud for failing to complete smoke detector repairs it was hired to complete about 7 months before the fire.

The Northern District, in Allstate Indemnity Company v. ADT LLC, 2015 WL 3798715, *2 (N.D.Ill. June 17, 2015), granted ADT’s motion to dismiss the complaint with prejudice and in doing so, addressed some important issues involving contract interpretation, exculpatory provisions and damage limitations in home security contracts.

The 2007 alarm contract (the “Alarm Contract”) was for an initial three-year term and was automatically renewed for 30-day increments unless terminated in writing. The Alarm Contract contained a limited warranty and a waiver clause that provided that the alarm company was not an insurer against damage to the insured home.

Other than some basic warranties, ADT’s contract disclaimed consequential or incidental damages.

The court rejected the insurer’s argument that the contract’s damage waiver was unenforceable. In Illinois, an exculpatory clause or damage waiver is enforceable unless it is unconscionable or violates public policy. Since there were no public policy concerns implicated, the alarm contract damage waiver was upheld and defeated Allstate’s claims.

Allstate also lost its breach of implied warranty claim.  Illinois doesn’t recognize an implied warranty in service contracts. The only settings where a court recognizes an implied warranty is in (1) contracts involving the sale of goods, (2) contracts involving residential property construction (where the implied warranty of habitability attaches) and (3) construction contracts – where Illinois recognizes an implied warranty of performance in a good, workmanlike manner.

Since the Alarm Contract didn’t involve the sale of goods and wasn’t a construction contract, Allstate’s implied warranty claim failed.

Lastly, the court discarded Allstate’s consumer fraud claim.  The Illinois Consumer Fraud and Deceptive Business Practices Act (ICFA), 815 ILCS 505/2 broadly prohibits unfair methods of competition and unfair or deceptive acts.  But where a consumer fraud claim simply duplicates a breach of contract claim, the consumer fraud count is redundant and should be stricken.

A plaintiff can’t “dress up” a garden-variety contract claim as one sounding in fraud.  Here, since Allstate repackaged its breach of contract suit and labeled it as a consumer fraud claim, the court dismissed Allstate’s ICFA claim.

Key take-aways:

1/ A clear waiver provision in a service contract will be enforced as written; even if it puts some financially harsh consequences on the plaintiff;

2/ Service contracts won’t give rise to an implied warranty claim in Illinois;

3/ A breach of contract does not equate to consumer fraud.  A repackaged breach of contract claim that is appended with a consumer fraud label will be dismissed as redundant (to the parallel breach of contract claim).

Reference: http://law.justia.com/cases/federal/district-courts/illinois/ilndce/1:2014cv09494/303656/21/