Articles Posted in Appellate Court

Cashmere

Kashwere, LLC vs. Kashwere USAJPN, LLC
Before the U.S. Court of Appeals 7th Circuit
Docket No. 13-3730 Decided November 13

The Facts

Diversity jurisdiction brought this complex commercial case before the 7th Circuit, which applied Illinois law to a series of trademark and business questions. At issue was whether the developer of chenille fabric under the tradename “Kashwere” (Selzer) could prevent a series of transactions via a non-compete agreement (“NCA”) and, conversely, whether the buyer of the Kashwere trademark (Kashwere LLC) could prevent Selzer from using a conduit company and distributors (Kashwere USAJPN) to get around that same NCA.

The Issues

The background in the case makes the opinion lengthy and complex: in fact, the Court goes out of its way to mention the convoluted facts and blames the litigants’ Attorneys for failing to keep it simple. But the issues are actually limited and familiar. In a nutshell, they are:

1) Can Kashwere LLC, as licensee of the Kashwere trademark, prevent Selzer from using USAJPN to market overseas via distributors; and
2) Can Kashwere USAJPN prevent Kashwere from allegedly violating the same NCA by attempting to sell directly into the Japanese market.

Put another way, the issues were:

(A) Does the NCA prevent distributors – not the signatories themselves but their distributors – from selling Kashwere?
(B) If not, do the equitable obligations of good faith and fair dealing implied in Illinois contracts prevent the same?

The Decision

The Appellate Court concluded that the facts indicated Selzer was not playing fair (so licensee Kashwere LLC has a cause of action) but it is dubious whether the NCA would affect the right of distributors of USAJPN to sell the product once they bought it. In other words, the NCA could only bind the signatories, not prevent the distributors from selling the product.

The Upshot

The Opinion basically favors free commerce and reads the NCA – a document the parties hoped would prevent future litigation – narrowly. That narrow reading means that there is only the slightest wiggle room for Selzer, so licensee, Kashwere LLC, ought to obtain relief on remand (although not the draconian relief that it was seeking initially). As for Selzer and his would-be Japanese conduit USAJPN, they do not fair well in this opinion at all.

Your Turn

Want to share your thoughts on this post? Need to discuss your own situation? Call us in confidence at 630-378-2200 or reach us via e-mail at mhedayat[at]mha-law.com.

When Lien Strips Attack

As a Bankruptcy lawyer I can’t count how many times people have asked why Courts won’t reduce their mortgage debt to match the deflated value of their home, or why they should pay anything on that second mortgage, line of credit, or HELOC, when they’re underwater. I even discussed these questions and the state of the law concerning lien strips in this post. Now, the very cases referred to in that post have made it to the U.S. Supreme Court and the stage is set for the battle of the lien strip cases.

Of course this all started with the Supreme Court’s 1992 Opinion in Dewsnup v. Timm that the Bankruptcy Code does not permit the cramdown of a partially secured mortgage. Some Courts took this to mean that lien-strips are a no-no. Others interpreted it to mean that lien-strips were permissible under the right circumstances. So in some parts of the country a completely unsecured second mortgage can be stripped, but only in a Chapter 13 reorganization; while in other parts it can be stripped in a Chapter 7 liquidation, too.

So, with Courts in disagreement, what’s a home-owner to do? Remember, in Dewsnup the Court ruled the Bankruptcy Code doesn’t permit mortgages to be written down to the value of the home – even though that practice, known as the cram down,  is acceptable as to vehicles. Ironically, one of the Court’s primary concerns in Dewsnup was to prevent windfall gains to home-owners who strip away their loans, then enjoy the profits as their homes rise in value.

But that didn’t exactly happen, did it? These days, most people’s homes are more a burden than a boon. Luckily the Supreme Court has agreed to take another look at the question. And just in time: being underwater with your 1st mortgage while having an unsecured 2nd is the new normal. And nowhere is that more true than in Florida where both cases to be consolidated and heard by the Court, Bank of America v. Caulkett and Bank of America v. Toledo-Cardona, started off as Chapter 7 Bankruptcies.

In a nutshell, the issue to be decided is whether, in a Chapter 7, partially secured mortgages can be written down and unsecured ones written off, despite the Supreme Court’s Dewsnup decision. Here, Florida home-owners filed Chapter 7 and were allowed to strip their unsecured second mortgages. That decision by the Bankruptcy Court was affirmed by the Federal District Court as well as the 11th Circuit Court of Appeals. Bank of American now wants the Supreme Court to outlaw Chapter 7 lien strips once and for all.

Stay tuned to this station as the case goes up for argument and decision. We’ll bring you the opinion as soon as it’s available.

Your Turn

Want to share your thoughts on the largest municipal Bankruptcy in U.S. history? Need to discuss your own situation? Call us in confidence at 630-378-2200 or reach us via e-mail at mhedayat[at]mha-law.com.

Franchise Business

Many small business owners find comfort and success capitalizing on a franchise. Franchisors use Non-Compete (“NCA”) and Non-Disclosure (“NDA”) clauses as well as mandatory arbitration provisions to protect themselves. But should such a provision be effective against a non-signing spouse? That was the question before the Appellate Court in the recent 7th Circuit case of Everett vs. Paul Davis Restoration. The short answer? Yes, it is.

The Family Business

Davis Restoration entered into a Franchise Agreement with Matthew Everett, husband of Plaintiff Renee, as the “principal owner” of Franchisee EA Green Bay. Sometime after signing as the sole owner of EA, Matthew transferred 50% of the company to his wife despite not securing permission from the Franchisor beforehand. Eventually, the Franchise Agreement was terminated and the 2-year non-compete provision took effect. Matthew then transferred the remaining 45% of EA to his wife, who continued to operate it under the name “Building Werks” from the same location with the same customers and employees. Moreover, the Franchisor contended, Building Werks continued to capitalize on its good will and reputation.

Reversal of Fortune

The Franchisor reacted to the breach of its NCA by initiating arbitration with Mrs. Everett, who sought a declaratory judgment in District Court to the effect that she should not be bound by the Arbitration Clause because the Franchise Agreement was signed by her husband. The District Court, however, found “abundant evidence” that she had benefited from the Franchise Agreement and therefore could be compelled to arbitrate according its terms. This was the so-called Direct Benefits Doctrine.

Following arbitration, the Franchisor went back to Court to confirm the unanimous finding in its favor. To its great surprise, this time the District Court denied confirmation and declared that its earlier ruling had been in error. Now, the Court felt, the benefit to Renee from the Franchise Agreement had not been “direct” but “indirect” through her ownership interest in EA and relationship to her husband. As a result, she could not be compelled to accept the arbitration award.

The Doctrine of Direct Benefits Estoppel

The Franchisor appealed to the 7th Circuit, which set about deciding whether the obligation to arbitrate in such a document was limited to those who had personally signed it or could include non-signatories benefited by it. Ultimately the Appellate Court reached same basic conclusion drawn by the District Court the first time around: that the non-signing, benefited party could not escape her obligation to arbitrate because she was estopped from doing so by the Doctrine of Direct Benefits.

As the Court observed, a direct benefit is derived the subject agreement itself. An indirect benefit by contrast would be one derived from exploitation of the contractual relationship of the parties. The 7th Circuit found that Mrs. Everett received the same benefits as her husband, including the ability to trade on the name, goodwill, and reputation of the Franchisor. In fact, Mrs. Everett’s ownership in EA had only arisen because EA had been formed to satisfy the requirements of the Franchisor. In every sense, Renee had benefitted from Matthew’s relationship with the Franchisor.

The Upshot

Perhaps the primary message of this case was that those who live by the Franchise Agreement, die by the Franchise Agreement…. So to speak. If a party directly benefits from a deal, they should be made to comply with its less glorious features as well. After all, any other conclusion would end up handing franchisees a giant loophole.

Questions about your own situation? Business owner looking for answers? Call us in confidence at 630-378-2200 or reach out to us by e-mail at mhedayat[at]mha-law.com.

House of Dollars

In LaSalle Bank N.A. vs. Cypress Creek 1, LP (Edon Construction et al.), 950 N.E.2d 1109 (2011), 242 Ill.2d 231 (Feb. 25, 2011), the Illinois Supreme Court ruled on the thorny problem of how to apportion proceeds from a foreclosure sale between the mortgagee bank and mechanics lien claimants when there weren’t enough proceeds arising from the foreclosure sale to pay both in full. In other words, who gets paid and who gets the shaft according to Sec. 16 of the Illinois Mechanics Lien Act?

Holdings

Here’s what the Court decided:

#1 Sec.16 of the Mechanics Lien Act gives lien claimants priority only as to the value of work in place (materials and labor).

#2 The Illinois S. Ct. case of Clark v. Moore, 64 Ill. 273 (1872) indicates that while the contractor is entitled to the value of unpaid work and materials used to improve the property (which would be in its Mechanics Lien), the value of paid-for work and materials should benefit the mortgage lender (mortgagee), not title holder (mortgagor) or the contractor.

#3 In dividing sale proceeds between the mortgagee and the lien claimant, Illinois Courts have used one of two analyses:

(a) Market Value approach;

(b) The Contract approach.

Courts have also used subordination rules to supplement their analysis.

Conclusion

Under the facts of this case the Court determined that the value of unpaid work in place (the liened sum) should be tendered to the Contractor, except for those improvements paid for with mortgage funds or construction loan funds, which should inure to the Mortgagee. All other sums should go to the Mortgagee as well.

Mechanics Lien or construction law question of your own? See our Construction Primer and feel free to contact us for a confidential consultation.

By Guest Blogger: Paul B. Porvaznik, Esq.

When you file for bankruptcy, you sign sworn schedules that itemize your assets.  If you fail to fully disclose or update your asset summary, you risk a creditor objecting to your discharge on the basis of fraud.  Another peril of nondisclosure concerns claims that arise after the bankruptcy filing; like future lawsuits.   So, what happens if a claim develops after you file your bankruptcy petition but before you are granted a discharge and you don’t inform the bankruptcy court of this claim?  That’s the question examined in Schoup v. Gore, 2014 IL App (4th) 130911 (4 Dist. 2014), a case that will doubtless serve as a cautionary tale for future bankruptcy petitioners.

 In Schoup the debtor filed in 2010 and obtained a discharge in 2012.  Several months into the case the debtor was injured on private property, giving rise to a premises liability claim.  The debtor didn’t tell the bankruptcy court or trustee of the premises suit until after his bankruptcy case was discharged. Indeed, after obtaining his discharge the debtor filed that claim. The property owners moved for summary judgment on the basis of judicial estoppel, arguing that the plaintiff’s failure to disclose the suit as an asset in his bankruptcy barred the post-discharge action entirely.  The trial court agreed and the plaintiff/debtor appealed.

Ruling: Summary judgment affirmed. Why? Because the judicial estoppel doctrine barred the plaintiff’s premises liability suit.  Judicial estoppel prevents a litigant from taking a position in one case and then, in a later case, taking the opposite position (i.e., you can’t claim that you’re an independent contractor in one case and then in a second case, claim that you’re an employee).  Judicial estoppel’s purpose is to protect the integrity of the court system and to prevent a party from making a mockery of court proceedings by conveniently taking whatever position happens to serve that party at a given moment.  (¶ 9).  The five elements of judicial estoppel: (1) two positions are taken by the same party; (2) the positions must be taken in judicial proceedings; (3) the positions must be taken under oath; (4) the party must have successfully maintained the first position and received a benefit from it; and (5) the two positions must be “totally inconsistent.” (¶ 10).  Illinois courts have consistently held that a debtor who fails to disclose an asset – including an unliquidated lawsuit – can’t later realize a benefit from the concealed asset after discharge.  (¶ 14).

The Court agreed with the trial court that all five elements were met.  First, the plaintiff took two positions: he impliedly represented to the bankruptcy court that he had no pending lawsuits and then filed a personal injury suit in state court after discharge.  The two positions were taken in judicial proceedings (Federal bankruptcy court and Illinois state court) and under oath (the plaintiff signed sworn disclosures in the bankruptcy court and filed a sworn complaint in state court).  The plaintiff also obtained a benefit from concealing the premises liability case as he received a discharge without any creditor knowing about the state court claim.  Finally, plaintiff’s positions were “totally inconsistent”: he omitted his personal injury case from his bankruptcy schedules and then filed a state court personal injury suit after he got his discharge. (¶¶ 17-18).

In conclusion, a party that had absolutely nothing to do with the plaintiff’s prior bankruptcy was able to get a case dismissed because the plaintiff didn’t update his asset schedules to account for an inchoate lawsuit.  The case is a great reminder to always check on-line bankruptcy records to see if a plaintiff suing your client has any prior bankruptcies.  More than once I’ve found that a plaintiff recently received a discharge before filing suit and never disclosed the lawsuit as an asset in the bankruptcy case.  In those situations, the plaintiff, not wanting to deal with a judicial estoppel motion (like the one filed by the defendants in this case), is usually motivated to settle for a reduced amount and in one case, even non-suited the case.  Viewed from the debtor’s lens, I counsel clients to fully disclose all assets – even lawsuits that haven’t materialized on the bankruptcy filing date.  Otherwise, they run the risk of having a creditor challenge the discharge or even having a future lawsuit dismissed; like the plaintiff in this case.

My other observation concerns the “sworn statement” judicial estoppel element.  What if the state court complaint wasn’t verified under oath?  Would that still meet the sworn statement criterion?  It’s unclear from the text of the opinion.  If the complaint wasn’t verified, I think I’d argue that the plaintiff didn’t take two sworn contradictory positions.

Paul Porvaznik Photo

About the Author: Paul B. Porvaznik, Esq. is a business litigation attorney practicing in Chicago at the firm of Molzahn, Rocco, Reed & Rouse, LLC, a full-service litigation firm.  He has practiced for 17 years primarily in the areas of general civil litigation, mechanics liens, landlord-tenant law, collections, post-judgment enforcement and general business disputes.

In re MS Valley Livestock

As a rule, debtors ask the Bankruptcy Court to protect them. In return for its iron-clad protection the Bankruptcy Court demands that all rules be obeyed and debtors refrain from hiding or giving away assets that could be used to satisfy creditors.

To ensure that nothing slips through the cracks Bankruptcy law empowers the case Trustee to claw back anything paid or given away by a debtor within 90 days of filing. In essence, Bankruptcy law treats all such transfers as attempts to shed assets. So payments in that period automatically constitute preferential transfers (“preferences”). Preferences can be sucked back into the Bankruptcy Estate by the Trustee; so unsuspecting vendors can be ambushed and forced to give back money they actually earned!

Finally, to make things even more confusing there are exceptions to the preference rule such as payments in the ordinary course of business, a contemporaneous exchange for value, and receiving new value for the payment.

In re Mississippi Value Livestock

In re Mississippi Valley Livestock, decided recently by the 7th Circuit Court of Appeals, involved payments made by the debtor within 90 days of an involuntary bankruptcy filing. But since the debtor had not planned on filing, it would be hard to say that it was purposely trying to get rid of property or playing hide-and-seek with assets. So this was not exactly the kind of case the law was meant to prevent. No, this was one of those cases that pushed the Bankruptcy law to its limits.

The Facts

Mississippi Valley Livestock (“Debtor) was in the business of buying and selling cattle for slaughter. J&R Farms (“J&R”) hired the Debtor to sell its cattle and remit the proceeds – essentially a consignment arrangement. The two entities enjoyed a long, prosperous commercial relationship until the Debtor started to fall behind in payments: first to J&R, then to all its other creditors.

While J&R was prepared to wait for things to turn around, a group of creditors got together and petitioned the Debtor into involuntary bankruptcy; but not before it paid around $900,000 to J&R. The Trustee in the Debtor’s case objected that the constituted a “transfer” of “property of the estate” on account of an existing (i.e. “antecedent”) debt: the dictionary definition of a preference.

Finally, no exception applied because this was not an “ordinary” payment – it represented an extraordinary payment to a particular creditor while the other creditors were poised to get nothing at all. The upshot, said the Trustee, was that the Debtor had chosen to pay J&R with money that should have been used to pay all creditors pro rata.

The Issues

The first issue in the case was whether or not the money paid by the Debtor was really its property, and therefore property of the Bankruptcy Estate. If this was the Debtor’s money, then paying it all to J&R – even though it was owed – was a derogation of the pro rata payment obligation of the Trustee: a Bankruptcy no-no.

But J&R argued that the Debtor was really just giving it back its own property (or at least the proceeds from the sale of that property). So if the sold cattle had never belonged to the Debtor, the proceeds from the sale of those cattle didn’t belong to the Debtor either.  And when the Debtor paid J&R, it was just returning what it didn’t own: certainly, that did not constitute a preference, right?

As usual however, there was a fly in the ointment. The Debtor had placed the proceeds from the sale of J&R’s cattle into the same account it used for other monies. The result was comingling of funds, making them indistinguishable when paid out.

So the second issue in the case was whether the Debtor paying J&R back with the proceeds from the cattle sale (J&R’s own money) or with its operating funds and savings (which should have gone to the Trustee and been distributed to other creditors)?

Bankruptcy Court and District Court Agree: The Proceeds Were Not the Debtor’s Property

 The Bankruptcy Court and District Court agreed with J&R that the Debtor was merely holding the proceeds of the cattle sale as a bailee and did not have a legal or equitable interest in them.  This was especially true because property interests in Bankruptcy are created and defined by State law – not Bankruptcy law. In its evaluation of the case, the 7th circuit does a very thorough analysis of the law on this subject, focusing on the distinction between bailor/bailee relationships and conditional sales in Illinois.  The Court concludes that a bailor/bailee relationship existed here.

Time For A Constructive Trust

While that conclusion could have been the end of the story, in this case it was not. Had the Debtor returned the consigned cattle, there would be no dispute. But here the proceeds were returned to J&R, not the cattle.  The Court concluded that a link had to be found between those cattle and the money returned, or the Debtor would be back in preference territory.

The method used to create that link was the constructive trust – an equitable device in Illinois law that is used when one party has money to which it is not entitled. A constructive trust prevents unjust enrichment of that party. Here, if a constructive trust were construed then the funds in question would never have been part of the Debtor’s Bankruptcy Estate.

Of course a constructive trust actually circumvents the Bankruptcy Code since it prioritizes some creditors over others (which is why it is used so sparingly in Bankruptcy Court). Here however, it was the perfect vehicle because it permitted the Debtors payments to J&R to be characterized as a kind of restitution claim.  The Court noted that in order for a restitution claim to lie, the funds had to be traced to the creditor’s specific interest; which is just what happened here.

But since the funds in this case were comingled, there were insufficient findings at the Trial Court level to support the necessary tracing. As a result the case was remanded for further findings.

The Upshot

The moral of the story here is 2-fold:

First, comingling proceeds or fungible items of personal property is a danger to all parties – Debtors, Creditors, and everyone involved.

Second, even where the parties maintain solid practices, proceeds should be remitted in the ordinary course of business and not permitted to pile up.

Got a thorny issue yourself? Give us a call and find out how we can help you!

Chapter 13 Bankruptcy

[T]here are known knowns… known unknowns … and unknown unknowns… things we do not know we don’t know.—US Secretary of Defense Donald Rumsfeld

When it comes to Bankruptcy, many Debtors don’t know what they don’t know about real estate taxes. Confused? So were the District Courts until the 7th Circuit Court of Appeals addressed the issue in the case of In re LaMont, Opinion 13-1187 (January 7, 2014).

The 7th Circuit began its analysis in LaMont by acknowledging the 2 kinds of real estate taxes with which Debtors must deal:

(a) Sold; and (b) Unsold.

The 2 are treated differently under State law and receive distinct treatment in a Plan of Reorganization as well:

Unsold taxes can be paid through the Plan in the same way that a Debtor would pay arrears to a secured creditor like a mortgage company. The rationale for such treatment is that the taxing body – the County – is presumed to have a secured lien in the subject property for its taxes. Moreover, those axes cannot be sold once a Bankruptcy Petition is filed. Such taxes generally get paid directly to the County Treasurer via the Plan.

Sold taxes are trickier. They can be paid through the Plan like unsolid taxes, but only so long as the “redemption period” has not expired. Even if the redemption period expires during the Plan, sold taxes can still be paid over the rest of the Plan period. And while that is taking place, the Automatic Stay will remain in effect to prevent Tax Buyers from redeeming the sold taxes or forcing a sale of the underlying property (the typical State law remedy).

In LaMont the issue was sold taxes. The LaMont Debtors owed real property in Minooka, Illinois on which the Village had levied a special assessment that they hadn’t paid. The Court noted that in this context a special assessment was deemed a property tax. Thus, the unpaid assessments were disposed of at a tax sale. Shortly afterwards the Debtors filed Chapter 13 and their Plan provided for payment of the assessment directly to the Village. However, the Plan did not identify. nor did notice go out to, the tax buyer. Nonetheless, the Plan was confirmed and the Debtors made payments to the Trustee who distributed them to the creditors including the Village.

But was the tax buyer bound by the terms of the confirmed Plan even though he had not been notified? In answering the questions the Court conducted a thorough analysis of the Illinois property tax system including tax sales and redemption periods – treating the sold special assessments the way they would sold property taxes.

The upshot of the analysis was that for the entirety of the redemption period – usually 2 to 2 ½ years, – a property owner could redeem his or her sold taxes by paying the County Clerk the past due amount, plus penalties and interest. Between 3 and 6 months before the expiration of the redemption period, a tax buyer had to file a Petition for Tax Deed with the Circuit Court, then take the resulting Order to the County Clerk to secure a Tax Deed, which then had to be recorded within a year. If those steps were not followed the tax buyer would lose his interest in the subject property. That is time enough for the property owners to act, but here the time period was tolled because of the Bankruptcy. Still, the Debtors neither identified the proper party to pay nor made adjustments to their Plan of Reorganization.

The LaMont the tax buyer filed his Petition for Tax Deed with the Circuit Court 3 years after the Debtors filed Bankruptcy and the Circuit Court denied it. The tax buyer then filed a Lift Stay Motion in the Bankruptcy Court, which denied the Motion because he was ostensibly being taken care of in the Plan. The tax buyer appealed, arguing that the Stay should not apply since he was not given notice of the case. But the District Court affirmed the Bankruptcy Court.

The tax buyer had also argued that his interest was in the real property, so it was not an interest against the Debtors. In other words he argued that his interest automatically divested the Debtors of their interest in the property after the redemption period expired. In response the 7th Circuit first examined whether or not the tax buyer had a claim, concluding that he did even though there wasn’t a traditional creditor-debtor relationship present. Nonetheless, the Court found that the tax buyer did not have an executory interest in the property itself: he merely had a tax lien on the property.

In reaching its decision the LaMont Court reviewed Illinois case law in concluding that, while there were differences, precedent favored the treatment of sold taxes as a lien. Since the tax buyer’s claim was deemed to be a lien, it could be modified under Section 1322(b)(2) of the Bankruptcy Code and the Debtors could force him to take payments even past the redemption date as long as the Plan was in effect.

In short, sold taxes can be addressed in a Plan of Reorganization but notice should be given to the payee or the Debtors risk paying into their Plan for 5 years only to end up with no credit towards their sold property taxes – and in the end stand to lose their home. Sad but true.

Business Opportunity Doctrine.jpgLet’s face it. Things are tough economically. Most talking heads agree the economy is undergoing a structural change that will affect everybody. Sadly it looks like not everyone is sharing the pain of the Great Recession, however. The rich are getting richer, while the rest of the population keeps on

sliding,

At a time like this who wouldn’t want to get everything they can? What if you were part of a company that wasn’t doing well and decided to make the best of it by jumping on opportunities unearthed by the company?

This is where the Corporate Opportunity or “Business Opportunity” Doctrine comes in. This equitable principal is employed by Illinois Courts and holds that:

a company fiduciary such as a director, officer. or majority shareholder may not develop an opportunity using company resources, or acquire an interest adverse to the company, or acquire property related to current or future company business, until they present that opportunity to the company and allow it to choose or decline the opportunity.

The hallmark of the Doctrine is the use of company assets to benefit the fiduciary. For instance, if a Director or Officer profited personally by acquiring property they have reason to know the company will need or intends to acquire, the Doctrine is violated. In other words, fiduciaries should not step in to grab things that the company could use.

The Doctrine itself is derived from the duty of undivided loyalty that comes with being a fiduciary. So while it goes without saying a fiduciary must act in the best interests of the company; Directors and Officers must do more: they must deal openly and honestly and exercise the utmost good faith. Levy v. Markal Sales Corp., 268 Ill. App. 3d 355, 364, 205 Ill. Dec. 599, 643 N.E.2d 1206 (1994).

While not codified by statute, the recognized elements of the Doctrine are:

a) The opportunity could benefit the company or benefit its future business;
b) The opportunity fits into the business model established by the company;
c) The company has an actual or in expectancy interest in the opportunity; and
d) The fiduciary has not presented the opportunity to the company yet; or
e) The fiduciary presented it, company chose it, but the fiduciary took it.

Using this analysis the Illinois Appellate Court pronounced in Graham v. Mimms, 111 Ill. App. 3d 751, 761, 67 Ill. Dec. 313, 444 N.E.2d 549 (1982) that the core principle of the Doctrine is that a fiduciary may not usurp a business opportunity developed through the use of corporate assets.

If corporate assets are used to develop an opportunity, the fiduciary cannot deny that the resulting benefit belongs to the company – even if the company couldn’t have pursued the opportunity itself or had no expectation interest. In Preferred Meal Systems v. Guse, 557 N.E.2d 506 (Ill. App. 1 Dist. 1990), the Court held that an officer was liable for breach of his fiduciary duty because, while still employed by the company, he failed to inform his employer that other employees were forming a rival company and soliciting customers and fellow employees to join that rival business.

The touchstone case regarding disclosure of corporate opportunities is Dremco v. South Chapel Hill Gardens, in which the Court enunciated the core principle that a fiduciary may not usurp an opportunity developed through the use of the company assets unless he first discloses and tenders the opportunity to the company – even if he believed that the company would not have been able to take advantage of the opportunity anyway. SEE ALSO Graham v. Mimms; Levy v. Markal.

Factors considered in this context include:

a) The manner in which the offer was communicated to the Corporation;
b) The good faith of the disclosing fiduciary;
c) The use of corporate assets to acquire the opportunity;
d) The degree of disclosure made to the Corporation;
e) Action taken by the Corporation with reference to that opportunity; and
f) The need or interest of the Corporation in the opportunity.

Lindenhurst Drugs, Inc. v. Becker, 154 Ill. App. 3d 61, 68, 506 N.E.2d 645, 650, 106 Ill. Dec. 845, 850 (Ill. App. 2 Dist. 1987).

So the basic tenet of the Corporate Opportunity Doctrine is that fiduciaries cannot compete with the company because they owe duties of loyalty, good faith, transparency, and fair dealing. The original conception of the Doctrine restricted fiduciaries from taking any opportunity that the company could have pursued: but more recent decisions have held that disclosure to the company and its decision not to pursue the opportunity relieves the fiduciary of further obligation. Still,  failure to disclose and tender the opportunity results in the fiduciary being prevented from exploiting the opportunity at all.

If you believe that you have experienced a violation of the Corporate Opportunity Doctrine, or that fiduciaries at your company may be violating their obligations, contact us in confidence to find out what you can do about it.

Thumbnail image for Breaking the (Piggy) Bank.png

In Illinois, as in most jurisdictions, retirement funds like 

  • Pension proceeds
  • 401(k) accounts
  • 403(b) accounts
  • IRA’s and Roth IRA’s 

constitute exempt assets that cannot be taken away in Bankruptcy. 

But what if a Debtor were to inherit an IRA? Would the inheritance still be “exempt?”

This was the issue before the Bankruptcy Court for the Western District of Wisconsin in the case of In re Clark. The Clark Court found that the retirement funds did not retain their exempt character. 

The 7th Circuit Court of Appeals agreed; noting that  11 USC 522(b)(3)(C) and (d)(12) only makes an IRA exempt if it is part of a tax exempt fund  Thus a spouse that inherits or rolls over a retirement fund can take advantage of the exemption because they are bound by the same IRS rules that bound the deceased – that money could not be withdrawn (without penalty) until the inheritor reached age 59 1/2. But if the inheriting spouse wanted to take a distribution before then, the transfer or rollover would be retroactively treated as a taxable event.

Rules applicable to a non-spouse inheritor are even more strict, and those differences played a large role in the decision of the 7th Circuit. As noted by the Court for instance, the Debtor in Clark inherited an IRA from her mother since she was the beneficiary. But an inherited IRA cannot be rolled over into another IRA, and additional funds could be be added to the inheritor’s IRA per 26 USC 408(d)(3)(C)); and since all distributions from the inherited IRA would have to commence within a year according to 26 USC 402(c)(11)(A), the Court refused to treat those funds as exempt because doing so would be the equivalent of form over substance.

Unfortunately, resolving this issue isn’t that easy. The 7th Circuit isn’t the only Federal Appeals Court that has considered this issue: and wouldn’t you know it, there’s a circuit split. 

The 5th and 8th Federal Circuits treat inherited retirement funds as exempt. See In re Nessa, 426 BR 312 (BAP 8th Cir. 2010), In re Chilton, 674 F.3d 486 (5th Cir. 2012). The rationale is that 522(b)(3)(C) of the Bankruptcy Code specifies that retirement funds in the Debtor’s possession are exempt.

The 7th Circuit on the other hand examined the nature of the inherited funds following their distribution. Since such funds could not be held until Debtor’s retirement, to simply treat them as retirement funds would exalt form over substance. Put another way, the 7th Circuit believed inherited IRA funds were an “opportunity for current consumption, not a fund for retirement savings.”

Since there is a Circuit split on this issue, it is important to determine which way the wind blows where you are; and if the Debtor has a choice as to where to file, it would be a wise to keep these factors in mind. An interesting issue not addressed by the Clark opinion is this: 

What if the Debtor in that case had actually within a year of retirement (i.e. 59 1/2 years old)? 

In that instance, an inherited IRA could be held until the Debtor’s retirement. Ultimately that is a case for another day. 

But if Clark is the law of the land then another question comes to mind: 

Is there a way around the harsh results of the 7th Circuit’s Clark decision? 

Well, other than filing in the 5th or 8th Circuits, the answer seems to be that in order to avoid such a problem, estates would have to roll their IRA’s into Trusts having a valid discretionary or spendthrift provision. Under those circumstances the money in the Trust would still be exempt from Bankruptcy execution (albeit not because it was in an IRA but because it was in a spendthrift trust).

As usual, no perfect solution, but it pays to plan. Thinking of your estate or planning for the future? Contact us for a free consultation to find out how to deliver more to your heirs and less to Uncle Sam.

The Race to File Before The Lien Kicks In.png

Q: Can a Citation to Discover Assets filed prior to  a Bankruptcy

case have an affect on the resulting Bankruptcy estate?

A: You Bet It Can …

The Facts


In the 7th Circuit Case of In re Porayko, appealed from the Bankruptcy Court for the Northern District of Illinois, a Citation to Discover Assets was served on a year before the Debtor filed bankruptcy, while a 3rd Party Citation was served on his bank the month he filed. The creditor moved for relief from the Automatic Stay to seize the $10,000 in the Debtor’s bank account and the Trustee objected on the basis that the initial citation had not created a lien, while the 3rd Party Citation was avoidable pursuant to 11 USC 547.

The Law
Citations to Discover Assets are addressed in Illinois Statutes, Section 5/2-1402. According to Sec. 1402(m) a Citation to Discover Assets creates a lien on all

“nonexempt personal property including money, choses in action and effects of judgment debtor” as well as “personal property belonging to the judgment debtor in the possession or control of the judgment debtor or which may thereafter be acquired or come due…”

Illinois cases support the concept that a checking account is personal property to which a lien may attach. See Chicago v. Air Auto Leasing Co., 297 Ill. App. 3d 873, 878 (1st Dist. 1998), a problem for the Trustee.

The Argument
The Trustee in Porayko tried to distinguish Air Auto Leasing by pointing out that other Illinois Courts treated bank accounts as mere promises to pay rather than items of personal property that could be subject to a lien. The leading case of its kind, Citizens Bank of Maryland v. Strumpf, 515 US 16 (1995), dealt with whether a bank could offset a payment while the Debtor was in Bankruptcy. But the Porayko Court found the situation before it to be quite different, and concluded that the creditor’s citation had created a secured interest in the checking account, so the relief from the Automatic Stay granted by the Bankruptcy Court was proper. 

Surprisingly, this meant that under the proper circumstances the lien of a pre-filing creditor could trump the interest of a Bankruptcy Trustee: a notion that would appear to stand the law of insolvency on its head.

The Takeaway
The takeaway from the Porayko case is that Debtors are wise to address debts before their creditors secure judgments that turn into liens. At a minimum, a Debtors ought to file soon enough so that creditors cannot perfect their judgment liens and trump the case Trustee.

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