Tag: piercing

Pleading Fraud ‘On Information And Belief’ Fails Rule 9 Specificity Test

In Deschepper v. Midwest Wine and Spirits,2015 WL 1433230, the Northern District considered the necessary pleading allegations for claims based on the Illinois Wage Payment and Collection Act (“IWPCA”), common law fraud and successor liability in an employment dispute involving former salespersons of a liquor wholesaler.  The employer (and their principals) defendants moved to dismiss under FRCP 12(b)(6).  The court granted in part and denied in part the motion.

The Illinois Wage Payment and Collection Act Claim

Upholding the IWPCA claim, the Court held that to state a claim under the IWPCA, a plaintiff “must plead that wages or final compensation is due to him or her as an employee from an employer under an employment contract or agreement.” 820 ILCS § 115/5.  An employment contract or agreement under the IWPCA doesn’t have to be formal or even written.  Instead, employers and employees can manifest their assent to employment terms by conduct alone.

Here, while there wasn’t a formal written employment contract, the Court still sustained the IWPCA count since the plaintiffs alleged that they had a hybrid salary-plus-commissions arrangement.  This was enough to survive dismissal of the IWPCA claim.

Successor Liability

A plaintiff suing under a Federal statute (like the Fair Labor Standards Act here) can sue on a successor liability theory where (1) the successor had notice of the plaintiff’s claim prior to the acquisition; and (2) there was substantial continuity in the operation of the business before and after the sale/acquisition.

The plaintiffs stated sufficient factual allegations to support a successor liability claim against a corporate entity plaintiff said was formed for the purpose of continuing the employer defendant’s business while avoiding that first employer’s Federal overtime payments to employees obligations.

Fraud

Plaintiffs fraud claims failed because they pled the facts “on information and belief.”  Alleging fraud on information and belief is insufficient to state a fraud claim unless (1) the facts constituting the fraud are not accessible to the plaintiff and (2) the plaintiff provides the grounds for his suspicions.

The court found that the plaintiffs’ shotgun pleading, and generalized assertions of fraud weren’t specific enough to place the court and the defendants on notice of the alleged factual basis for the claimed fraud. As a result, the Complaint didn’t satisfy FRCP 9(b)’s  particularity requirement for alleging fraud.

The fraud claim was also deficient since plaintiffs didn’t allege that the underlying fraud facts weren’t accessible to them and also failed to plead the factual bases for their suspicions that defendants were setting up various business entities to evade paying overtime to the plaintiffs.

Afterwords:

– An actionable IWPCA claim doesn’t require a formal written agreement.  All that’s required is the employer and employee manifest assent to payment terms through their conduct;

– Fraud pleading must rise above notice pleading under FRCP 9(b).  Absent specific factual assertions to support the fraud, the claim will likely be dismissed;

– Successor liability applies where defendant forms an entity that is arguably set up to avoid predecessor corporate obligations.

Corporate Successor Liability in Illinois: the Rule and Exceptions

Corporate successor liability’s focal point is whether a purchasing corporation (Company 2) is responsible for the purchased corporation’s (Company 1) pre-sale contract obligations. 

It’s an important question because the Company 1 will usually have no assets after the purchase.  Creditors of Company 1 will then try to pin liability on Company 2.

The general rule in Illinois is that a corporation that purchases the assets of another corporation is not responsible for the debts or liabilities of a transferor corporation.  

The rule is designed to protect good faith purchasers from unassumed liability and to maximize the fluidity of corporate assets.  

The four exceptions to this rule are: (1) where there is an express or implied agreement of assumption; (2) where the transaction amounts to a consolidation or merger of the purchaser or seller corporation; (3) where the purchaser is merely a continuation of the seller; and (4) where the transaction is fraudulent – done for the purpose of escaping the seller’s obligations.

The express assumption exception only applies if the plaintiff can produce an agreement where the purchasing corporation agrees to assume the selling corporation’s obligations.

If the agreement is silent, there is no express assumption.  Implied assumption is trickier and requires an examination of the selling and buying corporations’ conduct.  

The merger or consolidation exception applies where the plaintiff demonstrates: (a) continuity of management, personnel, physical location, assets, and business operations; (b) continuity of shareholders; (c) that the seller ceases its business operations quickly after the sale; and (d) the buyer assumes the seller’s liabilities and obligations that are necessary for seamless perpetuation of the seller’s business operations. 

In examining the continuation exception, the court’s focus is whether the purchasing corporation is a reincarnation of the seller corporation and has same or similar management but merely “wears different clothes”. 

The continuity calculus includes whether there is a common identity of officers, directors and shareholders between the selling and purchasing corporations.    

Exact commonality between the selling and purchasing corporations’ management isn’t required for the court to find a continuation.

In assessing whether the fraud exception applies to the general rule of no corporate successor liability, the court looks at multiple factors set forth in the Illinois Fraudulent Transfer Act. 740 ILCS 160/5(b)(1)-(11) including the timing of the transfer from seller to purchaser, whether the seller paid and whether purchaser received adequate consideration, whether the seller became insolvent at or shortly after the transfer, whether the transfer was to an insider (officer, director shareholder of the selling corporation), etc.

Conclusion

To temper the possible harsh results of a corporate transfer wiping out any chance of creditor recovery, I try to put language in a contract saying that if there is a transfer from defendant to another entity during the term of the contract, the defendant promises to both promptly notify my client in writing and make the new, purchasing company aware of the contract and its obligations under it.

Piercing the Corporate Veil in Illinois

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In Illinois, a corporation is a legal entity that exists separate and apart from its shareholders, officers and directors.  In fact, a major purpose of incorporating is to insulate yourself from personal liability.  This liability-reducing function of corporations does have its limits though.  If someone is abusing the corporate form, a court can disregard the corporation and “pierce the corporate veil.”

For instance, if I incorporate Paul, Ltd. and you enter a contract with Paul, Ltd. to sell widgets and Paul, Ltd. breaches, generally, you will not be able to sue me personally for Paul, Ltd.’s debts.  Because, the law views me as a separate “person” from Paul, Ltd.  However, if Paul, Ltd. is simply my alter-ego, or a pass-through entity – then the court can pierce Paul, Ltd.’s veil of limited liability and hold me responsible for Paul, Ltd.’s debts!

Illinois courts apply a two-prong test to determine whether to pierce the  corporate veil: (1) unity of interest and ownership is such that separate personalities of the corporation and the other person no longer exist; and (2) adherence to the fiction of separate corporate existence would sanction fraud or promote injustice.  Fontana v. TLD Builders, 362 Ill.App.3d 491 (2005).

Within this two-part framework, courts analyze the following factors: (1) inadequate capitalization (opening a corporate bank account with minimal $); (2) failure to issue stock; (3) nonpayment of dividends; (4) nonfunctioning officers or directors; (5) absence of corporate records (Articles of Incorporation?  What’s that?!!); (6) insolvency of debtor corporation; (8) commingling of funds; (9) diversion of corporate assets to a dominant shareholder, among others.

Afterword: It’s difficult to demonstrate grounds for piercing.  A creditor seeking to pierce has a very heavy burden.  For this reason, when dealing with a corporation with whom you don’t have a prior relationship or that doesn’t have a track record, doing pre-contract due diligence (running credit reports, checking trade references, etc.) is critical.

In addition, getting a personal guaranty from a corporate officer is helpful. This assures that a real live person actually has some skin in the game.  Otherwise, you run the risk of getting an uncollectable judgment.