Supreme Court Rule 277 – Paul Porvaznik

The Third-Party Citation: How Long Does It Last?

Shipley v. Hoke, 2014 IL App (4th) 130810 provides an exhaustive discussion of Illinois’ post-judgment enforcement rules in the context of a judgment creditor trying to reach debtor assets held by third parties.

It’s key points concerning a citation’s life span include:

– Code Section 2-1402 allows a judgment creditor to prosecute supplementary proceedings for the purposes of examining a judgment debtor and to compel the application of non-exempt assets or income discovered toward the payment of a judgment;

– Section 2-1402(f)(1) contains a “restraining provision” that prohibits any person served with a citation from allowing a transfer of property belonging to a judgment debtor that may be applied to the outstanding judgment amount;

– If someone violates the restraining provision, the Court can punish the violator by holding him in contempt or entering a money judgment against him in the amount of the property he transferred;

– A third-party citation must be served in the same manner a (“first party”) citation is served (e.g. either by personal service or certified mail);

– Supreme Court Rule 277(f) provides that a citation proceeding automatically terminates six months from the date of the respondent’s first personal appearance unless the court grants an extension of the citation;

– This six-month rule is an affirmative defense that must be raised by a citation respondent or else it’s waived;

-Rule 277(f)’s purpose is to prevent a creditor from harassing a judgment debtor or a third party subject to a citation proceeding and is designed to provide an incentive for creditor’s to diligently work to discover debtor assets;

– While a court can retain jurisdiction over a turnover order entered before but not complied with until after the expiration of the six-months, the court does not maintain jurisdiction to enforce any restraining provision violations past that six-month mark.

– Rule 277 does permit a creditor to request an extension of the six-month limitation period indefinitely to fit the needs of a given case.

(¶¶ 78-81, 92-93).

Take-away: While I often serve bank respondents with third-party citations by certified mail (since banks usually aren’t motivated to evade service), a judgment creditor should serve any non-bank respondent by personal service; either via county sheriff or a special process server.

In addition, the creditor should keep track of when a judgment debtor first appears in response to a citation. If it looks like the creditor’s post-judgment case isn’t going to be finished at the six-month mark, he should move to extend the citation for as long as necessary to complete his examination of the debtor and any third-party(ies).

Priority Dispute Central: When a Bank and Creditor Both Vie for the Same Account Holder Funds

Banks and their commercial customers often enter loan agreements which give the bank the right to set-off or “swipe” the customer’s account if the customer defaults on a loan. The boilerplate loan documents will typically list as a default event, a judgment creditor of the customer attempting to attach the account funds.

The loan and security agreement will also give the bank “first dibs” on those funds: the bank can liquidate the account and apply the funds to the customer’s outstanding loan balance. This creates a classic priority dispute: the judgment creditor wants the customer’s account (because that is likely the only hope for recovering any monies) while the bank wants the same funds so it can salvage its loan rights.

One CW, LLC v. Cartridge World, 661 F.Supp.2d 931 (N.D.Ill. 2009) involves a priority dispute in a franchise suit. The plaintiff, a prospective franchisee, sued and obtained an arbitration award against the seller and entered the judgment (about $360K) in Federal court. The plaintiff then issued a third-party citation against the defendant/seller’s bank and sought turnover of over $81K held in the defendant’s bank account. The bank claimed priority to the entire funds pursuant to both a UCC filing against the defendant’s assets and under Code Section 12-708 which governs a third party citation respondent’s set-off rights. 735 ILCS 5/12-708.

In finding for the plaintiff creditor, the Court harmonized the various Illinois Code sections and some cases that govern post-judgment or supplementary proceedings. See 735 ILCS 5/2-1402 (governs citation proceedings); SCR 277 (same). The key rules:

– a judgment lien is created in a judgment debtor’s nonexempt assets upon proper service of a citation. Section 2-1402(m);

– citations may be served upon the judgment debtor or a third party (usually a bank) that has personal property of the debtor in its possession. 2-1402(m)(2);

– the citation lien that’s created upon service of a citation doesn’t affect the rights of citation respondents in property prior to service of the citation. 2-1402(m);

– a third party who violates the citation restraining provision (by not freezing the account, e.g.), can have judgment entered against it for – lesser of – unpaid judgment amount or in the amount of any property transferred. 2-1402(f)(1);

– a third-party citation respondent has a right to clam all set-offs against the judgment creditor that it could assert against the debtor and must hold, subject to court order, any non-exempt property of the debtor in the respondent’s possession. 12-707(a);

– the third-party respondent must also file a written answer (to the garnishment interrogatories) under oath, that states any property or indebtedness due or to become due the debtor in the third party’s possession or control. 12-707(b);

– a third-party respondent can exercise its set-off rights and deduct from a debtor’s deposit account amounts owing on a note even if the note is not yet due;

– the bank does not have to first proceed against an account holder’s collateral securing the loan before exercising its set-off rights.

pp. 934-936.

Applying these rules, the Court found that the third-party respondent bank failed to properly assert its prior security interest rights by unfreezing the debtor’s assets without court approval and by taking no action to foreclose on its security interest in the debtor’s bank account.

The Court also held that the bank lost its set-off rights by failing to comply with the third-party citation. The Court pointed out that the bank failed to take any steps to exercise its set-off rights such as accelerating the debtor’s defaulted loan and also failed to properly freeze the debtor’s account as required by the text of the third-party citation order and Section 2-1402(f)(1) and 2-1402(m).

Take-aways:

Creditor’s counsel should be leery of Section 12-708’s set-off provision and the caselaw’s expansive application of a third-party’s set-off rights. If a bank has a prior loan to an account holder/debtor, it can likely claim a set-off in the amount in default. It seems the best you can do as a creditor attorney in this situation is to have the bank prove that it is swiping the debtor’s funds and actually crediting the funds against the loan balance.

From the third-party respondent/bank’s vantage point – it should exercise all security interest rights by taking possession of a debtor’s collateral and applying the account funds to the outstanding loan balance. The responding bank should also timely and properly answer a creditor’s garnishment interrogatories and immediately assert its set-off rights in the debtor’s account funds.

Defendant Bank Not Liable for Permitting Judgment Debtor to Transfer Over $700,000 from Accounts

The Citation to Discover Assets to a Third Party or “third-party citation” allows a judgment creditor to serve a citation on a third-party – a bank, for instance – who holds property of the judgment debtor and attach that property until the court orders the property released. See 735 ILCS 5/2-1402(f)(1).

The third-party citation prohibits the citation respondent from allowing any transfer or other disposition of debtor’s property pending further order of court or termination of the citation.

When a bank is the third-party citation respondent, the creditor serves the citation upon the bank (either by personal service or certified mail) and upon receipt of the citation, the bank must freeze the debtor’s account until the court enters an order dismissing the citation or releasing the account.

What’s simultaneously enticing (to a creditor) and sinister (to a debtor) about third-party citation practice is that the creditor doesn’t have to notify the debtor of the third-party citation until 3 business days have passed. 735 ILCS 5/2-1402(b). This makes it next to impossible for a debtor to deplete his bank account(s) and hide funds – something which could easily happen if he caught wind of a creditor’s attempts to seize his accounts.

Mendez v. Republic Bank, 2013 WL 3821532 (7th Cir. 2013), examines whether a bank that unfreezes the wrong bank accounts (and allows a judgment debtor to transfer hundreds of thousands of dollars in the process) can be liable to the judgment creditor for violating a citation’s restraining provisions.

The Court affirmed the trial court’s finding that the bank was not liable to the plaintiff.

The plaintiff won a judgment and froze some 22 separate accounts of the corporate judgment debtor. After several of the banks moved to quash various citations, the district court judge entered an order requiring that all bank accounts except for three (3) specified accounts be unfrozen.

The defendant bank released from the citation two of the debtors’ accounts which totalled over $700,000 – all of which of course was dissipated by the debtors within a few months.

Plaintiff then moved to refreeze the accounts and to hold the bank liable for violating the citation restraining provision.

The District Judge, while originally siding with plaintiff, reversed herself and found the bank not liable. The reason: the prior judge’s order requiring the bank to unfreeze accounts was ambiguous “at best” and the bank’s actions were a reasonable response to and interpretation of that order. *4.

The Seventh Circuit affirmed, noting that the prior judge’s order unfreezing certain accounts was poorly drafted and the defendant bank followed the most reasonable interpretation of the order.

Acknowledging that under Illinois law, a citation respondent can be liable for any transfer that violates a citation’s restraining provisions (regardless of whether there is intent or contempt), the bank’s actions were reasonable in light of the order’s text.* 11.

Take-away: In my experience, from a creditor’s standpoint, attaching a corporate debtor’s bank account via a third-party citation is often my only real chance of collecting anything on a judgment. Any real estate is usually mortgaged to the hilt, and the corporate debtor often lacks sufficient accounts receivable, inventory or personal property to meaningfully make a dent in the judgment amount.

This case shows why hyper-precision in drafting citation orders is critical in post-judgment enforcement proceedings. If the order is not drafted by the parties (i.e. it’s prepared by the court) and it’s text is unclear, it is incumbent on a party to file a motion seeking clarification of the order.

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