Tag: seventh circuit

No Fiduciary Duty Owed Lender By Closing Agent in Botched Real Estate Deal

In Edelman v. Belco Title & Escrow, LLC (http://law.justia.com/cases/federal/appellate-courts/ca7/13-2363/13-2363-2014-04-25.html) the plaintiffs sued an escrow agent after investing $3M in a failed real estate deal.

The plaintiffs invested the monies directly with the developers of a mixed-use project.  The plaintiff never met with nor spoke to the defendant escrow agent and there was no document that formalized the relationship between plaintiffs and defendant other than some boilerplate closing forms.

Plaintiffs sued when they lost their entire investment after a prior mortgage lender foreclosed on the subject development, wiping out plaintiffs’ entire investment.

Affirming summary judgment for the escrow agent, the court first addressed a procedural pleading issue.  FRCP 8(b)(6) provides that a complaint allegation is admitted if that allegation isn’t denied.  The purpose of a responsive pleading is to put everyone on notice of what a defendant admits and what it intends to contest.

Here, since defendant answered plaintiff’s earlier versions of the complaint which contained identical allegations to the current version, plaintiffs were on notice of what allegations were admitted and which ones were not.

On the merits, the Court found that the defendant escrow agent didn’t owe a fiduciary duty beyond its specific instructions from the plaintiffs.

In Illinois, a principal and agent stand in a fiduciary relationship as a matter of law.  The agent occupies a position of trust towards the principal and he (the agent) must act in the utmost good faith and apprise his principal of all key facts within the agent’s knowledge that could affect the principal’s legal relationships.

Illinois law is clear that an escrowee, like a trustee, owes a fiduciary duty to act only according to the specific escrow instructions.  No Illinois court has held that an escrowee in defendant’s position is tasked with an obligation to seek additional instructions from parties to a real estate deal.

Here, the plaintiffs and defendant never met nor communicated.  The defendant wasn’t party to the underlying loan agreement that documented plaintiffs’ $3M investment.  The loan agreement parties were the plaintiffs and the developers (who weren’t named as defendants).

Also, the disbursement agreement wasn’t signed and offered no details of the plaintiff-defendant relationship.  The Court also pointed out that the plaintiffs never deposited any funds with the defendant: plaintiffs paid the $3M directly to the developers.

The Seventh Circuit bolstered its no fiduciary duty finding with a policy argument.  It held that escrow transactions would be “destabilized” if an escrow agent like defendant could be legally liable in circumstances like here, where it didn’t know what responsibilities it owed and to whom.

Take-aways:

– an escrowee or closing agent only owe duties spelled out in instructions given him by his lender-principal;

– it will be difficult for a real estate lender to prove a fiduciary duty claim where there is no physical or paper connection between the lender and escrow agent and where the lender doesn’t fund a loan through the escrow agent.

 

Student Loan Discharge In Bankruptcy: How Hard Is It?

In Steven Harper’s The Lawyer Bubble: A Profession In Crisis, the author (quoting a newspaper article) describes Federally guaranteed student loans as the closest thing to a debtor prison in existence.  Lawyer Bubble, p. 11.  This statement, while jarring, has some empirical support.  In the book, Harper cites bankruptcy code changes that have made it virtually impossible to get student loan debt relief in all but the most extreme (and trying) circumstances.  He also provides anecdotes, documented examples and profuse research to back up his arguments.

Hard data aside, the “knowledge” that student loans can’t be discharged in bankruptcy has permeated the collective consciousness.  Indeed, the difficulties a bankrupt debtor must surmount to get a discharge from student loan debt have assumed near-mythic proportions.  The popular narrative is that student loan relief is given in only the most severe (think physical and mental infirmities coupled with fiscal calamity) circumstances and that it’s basically not even worth trying to get a discharge.  And in many cases, the belief is accurate: it is nearly impossible to convince a bankruptcy judge to grant a student loan discharge.  

This extreme difficulty in securing a discharge is graphically illustrated by the depressing fact patterns that underlie many student loan discharge cases where relief is granted only under the sadness-tinged “certainty of hopelessness” standard.  In many of these cases – in which the court does grant discharge relief – the court chronicles the lives of borrowers who live in abject poverty and in desperate conditions, all the while trying to support themselves and their dependents.  Yet, for other student borrowers whose circumstances aren’t as severe, the courts often refuse their discharge requests.  

But in the Seventh Circuit, as shown by a recent decision, getting a discharge may not be as difficult as previously understood.  In Krieger v. Educational Credit Management Corp., 213 F.3d 882 (7th Cir. 2013), the Court seems to relax the austere requirements for a borrower who seeks to discharge student loan debt.  In that case, the Court discharged nearly $25,000 in student loans where the borrower was in good health, educated and had solid academic credentials.

Like other cases in the student loan discharge milieu, Krieger’s underlying facts aren’t sunny.  The debtor was in her fifties and lived with her elderly mother.  She was divorced and lived in a rural area where jobs are scarce.  She hadn’t worked in over twenty years, lacked income, assets and reliable transportation.  The debtor filed an adversary proceeding to discharge student loan debt which she acquired to attend paralegal school.  The lender objected and after a trial, the bankruptcy judge sided with the debtor and discharged the loans.  The lender appealed and the District Court (bankruptcy  orders are appealed to District court) reversed on the grounds that the debtor didn’t show undue hardship.  The Seventh Circuit reversed and found that the debtor was entitled to a discharge.

 Rules/Reasoning:

Section 523(a)(8) of the Bankruptcy Code provides that student loans are generally excepted from discharge unless “excepting such debt from discharge….would impose an undue hardship on the debtor.”  11 U.S.C. 523(a)(8).  Undue hardship isn’t defined in the Code but the standard’s content is instead established by the caselaw from various jurisdictions.

To analyze undue hardship (whether the borrower demonstrates undue hardship) 7th Circuit applies the three-part test espoused by the Second Circuit in In re Brunner (831 F.2d 395 (2nd Cir. 1987) – a seminal Second Circuit case from the late 1980s.  To establish undue hardship, the borrower must show, by a preponderance of the evidence that (1)  the debtor can’t maintain a “minimal standard of living” based on current income and expenses; (2) “additional circumstances” exist that show that the state of affairs is likely to persist for a significant portion of the repayment period of the loans (the so-called “persistence” element); and (3) that the debtor-borrower has made good faith efforts to repay the loans.

The Seventh Circuit found that all three undue hardship factors were met.  The debtor showed that she was destitute, lived in a remote area that was “out of the money economy”, and hadn’t worked in over two decades.  The Court also found that the debtor’s circumstances were likely to persist and unlikely to financially improve in the future.  On this second factor – the “persistence” factor – the court rejected other courts’ requirement of the debtor showing “certainty of hopelessness”, finding that the undue hardship standard is a more flexible test.

Noticeably absent from the analysis though, is any discussion of the debtor’s “good faith.”  Other cases look to whether the debtor took advantage of reduced-payment options as well as the debtor’s past payment efforts.  Here, though, the Court simply held that the good faith element of the undue hardship test involves a fact-specific analysis that requires “clear error” for reversal.  The Court also held that a debtor is not required to exhaust all reduced-payment options as a predicate for showing good faith.  In finding good faith, the Seventh Circuit found that the bankruptcy judge’s good faith determination based on the debtor’s 200 unsuccessful job applications over the years wasn’t clearly erroneous and should have been upheld.

Manion’s cautionary concurrence:

In his concurrence, Judge Manion notes that the debtor is physically healthy, intelligent and graduated from paralegal school with a high GPA.  Judge Manion didn’t think the debtor’s circumstances were egregious enough to merit a discharge and even wondered whether other student borrowers will use this case as an “excuse to avoid their own student loan obligations?”  He pointed out that debtor’s applying for 200 jobs over a 10-year period amounted to less than two applications per month.  Hardly a Herculean job search effort.

Take-aways: Compared to other student discharge decisions – where the debtor is either physically or mentally impaired or is responsible for  sick parents or children – Krieger arguably establishes a more lenient discharge standard.  Clearly, the debtor was insolvent, destitute and hadn’t worked in decades.  But she was also physically healthy and educated.  The debtor’s circumstances seem to be missing an element of “certainty of hopelessness” – the standard that governed Seventh Circuit  discharge cases before Krieger.  At any rate, it’s too early to tell if this case represents a sea-change in student loan discharge cases.  It’s also unclear whether this case will result in an uptick in student discharge attempts.  Still, the case is worth reading for its topical relevance as well as its statistical description of the Federal loan-student borrower bankruptcy crisis.

 

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.