Fraudulent conveyance and piercing the corporate veil causes of action, if employed wisely, can enhance the likelihood of successfully collecting a claim against individuals and entities who are not primarily or directly liable for plaintiff’s claims. Call these individuals and entities, “Second Tier Defendants,” since the defendants directly liable for claims in litigation are in concept the “Primary Defendants.”
Thus, for example, if plaintiff, ABC Company, had a breach of contract claim against defendant, XYZ Company, then defendant XYZ Company would be the Primary Defendant, and its shareholder, Bob Smith, could be a Second Tier Defendant for a cause of action for fraudulent conveyance or piercing the corporate veil, if the facts, and critically, the economics, merit pursuit of these causes of action against Bob Smith.
With this line-up in mind, the central questions for a plaintiff to ask are: (a) does the plaintiff have the facts to support the causes of action for either a fraudulent conveyance or piercing the veil; (b) what are the costs of pursuing either of these causes of action against Second Tier Defendants; and (c) what is the likelihood of success in pursuing either of these causes of action?
While a thoughtful attorney must due diligently answer these questions, the good and thoughtful attorney knows that these questions are sometimes more theoretical than practical. Certainly, no pursuit of meritless claims is being advocated; but when a plaintiff is faced with questionable transfers of assets and corporations that are operated as “mere facades” of their shareholders–aggressive litigation against Second Tier Defendants to enhance the plaintiff’s ability to obtain a collectible judgment is the primary consideration. Central to the litigator’s inquiry is collectability because achieving an uncollectible judgment is a failure: symbolic victories in litigation, rarely are acceptable in the real world where the small business model dictates.
Today, litigators have numerous sources of information in the public domain through the internet, as well as traditional means to evaluate potential fraudulent conveyance and piercing the corporate veil causes of action against Second Tier Defendants. “Timing is everything” in litigation, and the plaintiff must use all of the tools at his/her disposal to evaluate the timing for asserting these claims against Second Tier Defendants, especially in light of time-sensitive statutes of limitation (discussed infra). A more conservative approach to due diligence on these claims is through traditional discovery, including the designation of Second Tier Defendants as Respondents in Discovery (see 735 ILCS 5/2-402). But, if time is of the essence, or if the naming of Second Tier Defendants in the original Complaint is key to “sending a clear message,” necessary to gain immediate ascendancy in litigation, the litigator is tasked with the urgent need to correctly evaluate the strategy and tactics in pursuing the Second Tier Defendants. Clearly, the thoughtful litigator will aggressively pursue Second Tier Defendants if it is cost-efficient and the claims have merit, principally to enhance the possibility of successful collection of a claim.
The “starting points” for the plaintiff’s analysis is, of course, the law pertaining to fraudulent conveyances and piercing the corporate veil. This article will discuss the law in Illinois, but due to a limitation of space this article will not discuss the actual pursuit of these claims in bankruptcy–although that is an important discussion, indeed. Thus, Section 548 of the Bankruptcy Code will not be specifically discussed, but the claims available in bankruptcy under the Uniform Fraudulent Transfer Act (UFTA) will be discussed. Also, to assist the practioner, in addition to the discussion of the law, the authors have included an appendix of important cases on these causes of action decided in the Seventh Judicial Circuit, the United States District Court for the Northern District of Illinois (“Northern District of Illinois”), the Illinois Supreme Court, and the First, Second and Third Illinois Appellate Court Districts.
The next point of inquiry for the pursuit of a fraudulent conveyance claim is to determine whether a “transfer” of any assets of the Primary Defendant occurred that can be avoided as a fraudulent conveyance. If so, the UFTA provides for a remedy of avoiding the transfer, itself (i.e., reversing the transfer), or obtaining a judgment against the transferee-defendant (i.e., the Second Tier Defendant). Practioners should avoid the mistake of avoiding the transfer as the sole remedy at all costs. It is imperative that both remedies should be property pleaded, but certainly, if given a choice, a plaintiff should plead the remedy under the UFTA for damages in an amount to be determined by the court, but in the minimum, equal to the value of the asset transferred.
The definition of “transfer” in the UFTA is very broad, and includes the traditional concept of the Primary Defendant transferring title in an asset(s) to a Second Tier Defendant; but also, this definition includes pledges of collateral belonging to the Primary Defendant and other direct and indirect acts in diminution of the creditor’s rights. While there is no case law on point, an interesting discussion is whether a dilution of a Primary Defendant’s equity securities in a business organization (stock or membership interests in a corporation or limited liability company, respectively) is a “transfer” under the UFTA.
Cost-efficiency is a critical factor in the pursuit of all litigation. This factor is especially important when considering the pursuit of piercing the corporate veil litigation against a Second Tier Defendant. As the discussion in this article will show, the pursuit of this cause of action is typically fact-intensive (the same is usually true for fraudulent conveyance litigation), and fact-intensive litigation is expensive, especially if the proof requires a review of the Primary Defendant corporation’s financial and business affairs and practices. Unfortunately, this particular, fact-intensive analysis is the central focus of achieving a judgment against Second Tier Defendant shareholders, and it adds substantial costs to litigation. As such, plaintiff’s commitment to a “piercing” cause of action requires an up-front commitment of time and resources to complete the initial analysis of the claim, let alone success on the merits. In addition, the pursuit of a “piercing” claim will often add substantial time to achieving a final judgment in litigation since the fact-intensity favors the defendant on a Motion for Summary Judgment. Thus, this is often “long haul” litigation with resolution only through settlement or trial—both only achieved after substantial resources are expended.
This article is meant to assist the practioner in the achieving success in evaluating and litigating the causes of action against Second Tier Defendants in fraudulent conveyance and piercing the corporate veil litigation. The best approach to litigating these causes of action, besides an aggressive, yet thoughtful attitude, is to analyze and evaluate the case as a dynamic, where change and the possibility for change is a constant. Remember, “what you don’t know” is what will bring harm to the case, and surprises in this type of litigation must be avoided at all costs if success is to be achieved.