Tag: Rocco

Non-Shareholder of ‘Belly Up’ Bakery Can Be Personally Liable on Piercing Claim – IL Court Rules

I’ve seen no hard data to support this but it seems that piercing the corporate veil – as a concept – has seeped into the cultural lexicon and consciousness.  I say this because many people – lawyers and nonlawyers alike – appear to have at least a nodding acquaintance with piercing.  Over and over I hear some variation of:  “Oh, that company’s out of business you say?  Just do that piercing thing.”  (Sigh) If only it were that easy.

Yet, for its perceived prominence in legal and business circles, veil-piercing’s mechanics and elements remain largely shrouded in mystery.  Piercing breeds misinformation and a flurry of questions: is piercing a remedy or a cause of action?  Whom should you sue? Do you sue the officers, directors, employees, shareholders? All of them?  Can you pierce in post-judgment enforcement proceedings?  Or do you have to file a new lawsuit once you find out a company is out of business?  The cases are inconsistent and unclear on these important veil-piercing questions.  See http://paulporvaznik.com/piercing-the-corporate-veil-in-illinois/71 (discussion of piercing generally).

The First District recently answered some of these questions in Buckley v. Abuzir, 2014 IL App (1st) 130469, a trade secrets-cum-veil-piercing case involving rival Chicago-land bakeries.  The plaintiff sued a corporate defendant (a competing bakery) alleging it hired away plaintiff’s top employee and stole plaintiff’s customers and secret recipes.  The court entered a default judgment of over $400,000 against the corporate defendant on the plaintiff’s trade secrets claim.  When collection efforts failed because the corporation was defunct, plaintiff filed a piercing claim against the individual that funded and controlled the judgment corporate debtor.

The trial court granted defendant’s motion to dismiss under Code Section 2-615 on the basis that plaintiff failed to allege sufficient facts to make out a piercing case and because the individual defendant wasn’t a shareholder, director or officer of the corporate debtor.  Plaintiff appealed.

Held: Reversed.  Plaintiff sufficiently pled grounds for piercing under fact-pleading rules and a veil-piercing claim can be brought against a nonshareholder.

Rules/Reasoning:

In reversing the trial court’s dismissal order, the First District aligned itself with multiple jurisdictions which allow a piercing remedy against nonshareholders of a defunct corporation.  The Court’s analysis was informed by the salient piercing principles:

Corporate Formation and The Basic Nature of Veil-Piercing

– A corporation is a separate entity from its constituent shareholders, directors and officers and the whole purpose of incorporating is to shield shareholders from unlimited personal liability;

– Veil-piercing applies where a corporation is dominated by an individual or entity to such an extent that the “separate identity” doesn’t exist and it’s a sham to continue to recognize a separation between company and the controlling agent;

– piercing the corporate veil is not a cause of action; instead, it is a means of imposing liability on an underlying cause of action (here, the underlying cause of action was the trade secrets claim plaintiff initially filed against the competing bakery concern);

– BUT, a plaintiff may bring a separate piercing action to pierce the corporate veil for a judgment previously entered against a corporation;

– Veil-piercing applies almost exclusively in disputes involving close corporations (think Mom and Pop businesses) or one-man corporations.

Buckley, ¶¶ 7-9, 12.

Veil-Piercing’s Elements

The Court also stated and applied Illinois’ familiar veil-piercing elements:

– Illinois courts will pierce the corporate veil where (1) there is such a unity of interest and ownership that the separate personalities of the corporation and the component dominant parties doesn’t exist and (2) adhering to the concept of separation between corporate entity and dominant agent would promote injustice or inequitable circumstances;

-the unity of interest element (number (1) above)) alone involves a multi-factored analysis of whether there is evidence of (i) inadequate capitalization; (ii, iii) a failure to issue stock, failure to observe corporate formalities; (iv)-(vi) nonpayment of dividends, insolvency of the corporate debtor, non-functioning corporate officers, (vii)-(xi), absence of corporate records, commingling of funds, diversion of corporate assets to shareholders instead of creditor’s, no arm’s-length dealings with related entities; and whether the corporation is a façade or front from the dominant shareholders.

Application:

The Complaint, while sparse and conclusory, alleged enough facts to satisfy the two overarching piercing elements.  On the unity of interest piercing element, the First District exhaustively (an understatement) canvassed over 20 states’ piercing decisions that permit a piercing plaintiff to bind a nonshareholder to a failed corporation’s judgment debt.  The First District aligned itself with those jurisdiction that allow piercing against individuals who aren’t officers, directors, shareholder or employees of a corporation.  All that’s required is that the defendant be an “equitable” or de facto owner.  If the individual controls a company “behind the scenes” and makes the key funding, hiring and firing decisions, then that individual’s personal assets can be reached via a piercing claim.

The plaintiff’s complaint allegations met the main unity of interest criteria: he hired, fired, funded and managed the corporation that plaintiff sued in the underlying trade secrets case.  The “officers” of that corporation had little or nothing to do with the day-to-day operations of the corporation.  The plaintiff also alleged that the corporation issued no stock and had no shareholders.  If this was true, then defendant not being a shareholder is an illusory defense: there are no shareholders.  (¶¶ 15-33).

The Court also sustained plaintiff’s promotion-of-injustice element allegations.  While the plaintiff’s unadorned allegations were conclusory, they still contained just enough facts to state a piercing claim under Illinois pleading rules.  Plaintiff alleged that the defendant hired away plaintiff’s key employee to gain access to secret recipes and data to unfairly compete with and siphon business from the plaintiff.  These allegations were enough (but not by much) to plead that refusing to pierce would result in unfairness to the plaintiff.  (¶¶ 34-41).

Take-aways: Even though the ultimate ruling is simply a reversal of a Section 2-615 pleadings motion to dismiss, the case’s importance lies in its endorsement of using piercing to reach assets of individuals who aren’t corporate officers, shareholders or employees yet in reality, control and fund the corporate entity.  It’s important to recognize though that the Court didn’t rule on the merits of the plaintiff’s claim.  All that is settled is that a plaintiff can allege facts against an “equitable owner”/nonshareholder of a corporation that can lead to personal liability for that nonshareholder.

Mechanics Lien Trumps Prior Mortgage in ‘Lien Strip’ Bankruptcy Dispute Involving Residential Property

Priority disputes happen a lot in mechanics’ lien litigation.  Typically, a mortgage lender claims that its first-filed mortgage trumps a later-filed mechanics lien.  The “trumps” part is activated if and when the property is sold and there aren’t enough proceeds to pay both the lender and contractor.  If the lender’s mortgage has priority, it gets first dibs on the sale proceeds, leaving the contractor with little or nothing.

Section 16 of the Mechanics’ Lien Act (770 ILCS 60/16) governs the lien priority issue.  This section provides that (i) prior lien claimants have lien priority up to the value of the land at the time of making of the construction contract; and (ii) mechanics’ lien claimants have a paramount lien to the value of all improvements made to the property after the construction contract is signed.

In re Thigpen, 2014 WL 1246116 examines the mortgage lender-versus-contractor priority question through the lens of a bankruptcy adversary case where the debtors attempt to strip away a mechanics’ lien recorded against their homeresidence.

The debtors filed for Chapter 13 bankruptcy protection and later filed an adversary proceeding to extinguish the lien a contractor recorded against the home. 

The debtors claimed that since there was a prior mortgage on the home and the home’s value had dropped to a sum less than the lien amount, the lien should be removed.

In bankruptcy parlance, this is called “lien stripping” and applies where a mechanics lien lacks collateral; usually because of plummeting property values. 

The contractor argued that its lien took priority to the value of the improvements/enhancements and moved for summary judgment.

Held: Contractor’s summary judgment motion granted.

Q: Why?

A: Applying Section 16 of the Act, the Court held that where proceeds of a property sale are insufficient to pay competing lienholders, a mechanics’ lien claimant takes priority over a lender up to the value the contractor added to the property.

The Court wrote: “the Illinois Supreme Court has expressly recognized that Section 16 of the Act confers first priority, not something less, on mechanic’s lien holders, and that they trump pre-existing mortgages to the extent of the value of the improvements.”  (*2).

While the court found that the contractor’s lien trumped the prior mortgage, the Court did not decide the specific monetary amount of the improvements relative to the home’s value. 

The holding is still significant because now the contractor has a secured claim (as opposed to an unsecured one) against the debtors’ estate which must be paid over the life of the Chapter 13 plan. 

If the debtors default, the contractor can liquidate the collateral –  by forcing a sale of the home – and get paid via the proceeds.  An unsecured creditor, by contrast, has no assets securing its claim.  It must hope that the debtors have unattached assets (e.g. paycheck, bank accounts, accounts receivable) with which to pay the debt.  (Good luck with that!)

Take-away: A big win for the contractor.  Instead of having an unsecured claim (with no collateral tied to the claim), its mechanics’ lien claim is secured.  This means the contractor’s lien attaches to the debtors’ house. 

If the debtor defaults under the plan, the contractor can foreclose its lien and force a sale of the home and take priority to the sale proceeds up to the amount of the improvements (here, about $200,000).  

The case’s unanswered question is how does the contractor prove the dollar amount of his improvements?  The contractor will likely have to produce expert witness testimony or documents to establish the dollar value of the contractor’s time, labor and materials  furnished to the debtors’ home.

Condo Association Sues Developer Based on False Statements In Sales Brochure and For Anemic Repair Reserves

In Henderson Square Condominium Association v. LAB Townhomes, LLC, 2014 IL App (1st) 130764, a condominium association sued the developer and contractor after unit owners discovered wide-ranging property defects in their units. (For Chicago readers: the project is near that nightmarish, multi-cornered Belmont-Lincoln-Ashland intersection on the North side).

The property’s construction was completed in 1996, the unit owners discovered the property defects in 2007-2008 and filed suit in 2011 – nearly 15 years after construction was finished and about 4 years after discovery of the defects.  The extent of the unit damage wasn’t revealed until a consultant hired by the association opened up the unit walls and ceilings. 

The association sued for breach of implied warranty of habitability, fraud, negligence, for violating the Chicago Municipal Code section (Section 13-72-030) governing real estate marketing misrepresentations.  The trial court dismissed all the claims as time-barred.  The association appealed.

Result: Trial court reversed.  Association’s claims reinstated

Rules/reasoning:

The basis for the reversal was the defendants’ possible fraudulent concealment of the association’s causes of action.  Code Section 13-214(a)and (b) provide a four-year limitations and 10-year repose period for construction-related claims, respectively.  The construction repose period can have harsh results: it means that no matter when a plaintiff discovers an injury, if more than 10 years have elapsed since construction was complete, the plaintiff’s claim is barred.

But Code section 13-214(e) provides that the repose period doesn’t apply where a defendant makes fraudulent misrepresentations or fraudulently conceals a plaintiff’s claim.  735 ILCS 5/13-214(e); ¶ 28.  When fraud is involved, the five-year limitations period set forth in Code Section 13-205 (735 ILCS 5/13-205) applies.  To demonstrate fraudulent concealment, a plaintiff must show silence coupled with deceptive conduct or the suppression of material facts.  ¶¶ 95-96. 

The Court found a question of fact as to whether there was active concealment based on (1) defendants’ marketing documents: a sales brochure that made specific statements concerning unit insulation; and (2) the anemic repair reserves earmarked by the developer for repairs.  The Court held that if the defendants didn’t inform the plaintiff that the units lacked insulation – as the plaintiff’s consultant found and noted in its report – and if the reserve levels weren’t large enough to meet anticipated future repairs, this could show fraudulent concealment sufficient to beat the repose period argument.  (¶¶ 98- 102).

The Court also sustained the association’s claims that were premised on Municipal Code.  Sections 13-72-030 and 13-72-100 of the Code provide a real estate buyer both with a private cause of action and damages remedy (including attorneys’ fees) where a seller makes misrepresentations in the course of marketing the sale of real estate; including condominiums.  The First District found that the association stated a cause of action under the Ordinance and rejected the defendants’ argument that the Ordinance claims were duplicative of the association’s fraud claims.  The Court found the Ordinance gave rise to a private right of action and provided an additional remedy to a common law fraud claim.  (¶¶112-113).

Validating the plaintiff’s breach of fiduciary duty claim, the Court looked to the Illinois Condominium Act (“Act”). Section 9.2 of the Act imposes a duty on a developer to adequately fund a reserve account for future improvements and repairs.  765 ILCS  605/9(c)(1), (2).  A “reasonable reserve” amount is a fact-based inquiry determined by (1) repair and replacement costs, and the (2) estimated remaining useful life of the property’s various structural, mechanical and energy components and its common elements.  (¶¶ 122-123, 129). 

The Court held that the question of whether the developer adequately funded the repairs reserve account wasn’t properly decided on a Section 2-615 motion.  And since the association properly pled that the developer breached fiduciary duties by failing to disclose known, latent defects in the property, the association stated a valid claim for breach of fiduciary duty (or at least one that survives a motion to dismiss).

Take-aways:

The Court found that a breach of fiduciary duty claim against a developer can survive almost 15 years after the developer’s last involvement with the property (the property was completed in 1996 and suit wasn’t filed until 2011).  The case also underscores the importance of adequately funding reserve accounts and demonstrates that claims premised on the City Ordinance sections governing false statements in real estate sales literature can be brought independently of common law fraud claims.  Henderson Square also illustrates the evidentiary showing a plaintiff must make to trigger the fraudulent concealment exception to the 10-year repose period applicable to construction claims.