Saying “I Wasn’t Served” Not Enough to Challenge Service Return On Corp. Registered Agent – IL Law

In Charles Austin, Ltd. v. A-1 Food Services, Inc., 2014 IL App (1st) 132384, the First District affirmed the denial of a corporate defendant’s Section 2-1401 motion to vacate a judgment.

About three months after judgment, the defendant sought to vacate the judgment claiming it was never served with the lawsuit.  The trial court denied the motion leaving the judgment intact.

Q: Why?

A:  

1/ A party can serve a private corporation by leaving the complaint and summons with the registered agent or any officer or agent of the corporation found anywhere in the State. 735 ILCS 5/2-204;

2/ An affidavit of service is prima facie proof of proper service and the court will indulge every presumption in favor of finding that service was proper;

3/ To attack service, the moving party must produce evidence that casts doubt on the return of service by clear and convincing evidence;

4/ A conclusory affidavit that merely says “I was never served” isn’t sufficient to refute a return of service.  ¶ 16.

Here, the defendant’s affidavit saying he didn’t recall receiving the plaintiff’s complaint wasn’t enough to contest service on the corporation.  A defendant’s bare assertion that it doesn’t remember receiving a summons and complaint is not the kind of evidence required to impeach a facially valid service return. ¶ 19.

In Illinois, to vacate a judgment more than 30 days old,  a petitioner must show (1) the existence of a meritorious defense, (2) due diligence in presenting the defense in the underlying claim, and due diligence in filing the 2-1401 petition.

The defendant failed to show a meritorious defense.  The plaintiff alleged the predecessor corporation secretly sold its assets to the defendant – the acquiring entity – while the litigation was pending and did so to elude the debt to the plaintiff.  A well-known exception to the general rule that a successor corporation doesn’t assume the debts of a corporate predecessor is where the seller engages in a fraudulent transaction to avoid the seller’s contract obligations.

Here, the court found that the fraud exception to the rule against successor liability applied.

The court found that plaintiff sufficiently pled under Illinois fact-pleading rules that the sale of the predecessor’s assets to the defendant was fraudulent and done for the purpose of evading the plaintiff’s contract rights.  As a result, the meritorious defense argument failed.  ¶¶ 28-37.

The defendant also failed to establish due diligence in raising its defenses to the underlying breach of contract suit.  The court noted the defendant’s registered agent was served with process in October 2012, the judgment entered in January 2013, the defendant’s bank account was liened in May 2013 and it didn’t file its 2-1401 motion until June 2013.

The eight month delay in responding to the lawsuit signaled its lack of diligence in defending the suit.

Take-aways:

– To challenge service, a defendant must do more than blanketly allege that he doesn’t recall receiving a pleading;

– If a plaintiff alleges factual basis for his claim, the defendant trying to vacate a default judgment will have difficulty meeting 2-1401’s meritorious defense element.

Corporate Successor Liability: Continuation and Fraud Exceptions (IL Law)

Advocate Financial Group, LLC v. 5434 North Winthrop, 2015 IL App (2d) 150144 spotlights the “mere continuation” and fraud exceptions to the general rule of no successor liability – a successor corporation isn’t responsible for debts of predecessor – in a creditor’s efforts to collect a judgment from a business entity that is twice removed from the original judgment debtor.

The plaintiff obtained a breach of contract judgment against the developer defendant (Company 1) who transferred the building twice after the judgment date. The second building transfer was to a third-party (Company 3) who ostensibly had no relation to Company 1. The sale from Company 1 went through another entity – Company 2 – that was unrelated to Company 1.

Plaintiff alleged that Company 1 and Company 3 combined to thwart plaintiff’s collection efforts and sought the turnover of the building so plaintiff could sell it and use the proceeds to pay down the judgment. The trial court granted the turnover motion on the basis that Company 3 was the “continuation” of Company 1 in light of the common personnel between the companies. The appeals court reversed though. It found that further evidence was needed on the continuation exception but hinted that the fraud exception might apply instead to wipe out the Company 1-to Company 2- to Company 3 property transfer.

On remand, the trial court found that the fraud exception (successor can be liable for predecessor debts where they fraudulently collude to avoid predecessor’s debts) indeed applied and found the transfer of the building to Company 3 was a sham transfer and again ordered Company 3 to turn the building over to the plaintiff. Company 3 appealed.

The appeals court affirmed the trial court’s judgment and in doing so, provided a useful summary of the principles that govern when one business entity can be held responsible for another entity’s debts.

In Illinois, a corporation that purchases the assets of another corporation is generally not liable for the debts or liabilities of the transferor corporation. The rule’s purpose is to protect good faith purchasers from unassumed liability and seeks to foster the fluidity of corporate assets.

The “fraudulent purpose” exception to the rule of no successor liability applies where a transaction is consummated for the fraudulent purpose of escaping liability for the seller’s obligations.

The “mere continuation” exception to the nonsuccessor liability rule requires a showing that the successor entity “maintains the same or similar management and ownership, but merely wears different clothes.” The test is not whether the seller’s business operation continues in the purchaser, but whether the seller’s corporate entity continues in the purchaser.

The key continuation question is always identity of ownership: does the “before” company and “after” company have the same officers, directors, and stockholders?

In Advocate Financial, the factual oddity here concerned Company 2 – the intermediary. It was unclear whether Company 2 abetted Company 1 in its efforts to shake the plaintiff creditor. The court affirmed the trial court’s factual finding that Company 2 was a straw purchaser from Company 1.

The court focused on the abbreviated time span between the two transfers – Company 2 sold to Company 3 within days of buying the building from Company 1 – in finding that Company 2 was a straw purchaser. The court also pointed to evidence at trial that Company 1 was negotiating the ultimate transfer to Company 3 before the sale to Company 2 was even complete.

Taken together, the court agreed with the trial court that the two transfers (Company 1 to Company 2; Company 2 to Company 3) constituted an integrated, “pre-arranged” attempt to wipe out Company 1’s judgment debt to plaintiff.

Afterwords: This case illustrates that a court will scrutinize property transfers that utilize middle-men that only hold the property for a short period of times (read: for only a few days).

Where successive property transfers occur within a compressed time window and the ultimate corporate buyer has substantial overlap (in terms of management personnel) with the first corporate seller, a court can void the transaction and deem it as part of a fraudulent effort to evade one of the first seller’s creditors.


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.