Category: Commercial Collection Law

Understand whether it’s fraud in fact or fraud in law

In Illinois, the Uniform Fraudulent Transfer Act, 740 ILCS 160/1 (the “UFTA”), permits creditors to reach fraudulent transfers and conveyances made by a debtor with intent to defraud, hinder, or delay a creditor, or place property out of a creditors reach.  A violation of the UFTA requires either ‘fraud in fact’ or ‘fraud in law.’

Fraud in Fact: Fraud in Fact occurs when “the debtor made the transfer or incurred the obligation…with (1) actual intent to hinder, delay, or defraud any creditor of the debtor.”  It’s unlikely a debtor would ever admit actual intent, so circumstantial evidence is necessary to demonstrate actual intent (or fraud in fact).  The UFTA provides (11) factors which may be given consideration in determining whether actual intent is established.  These factors include:

  • Whether the transfer or obligation was to an insider:An insider can be broadly defined as someone with a close relationship (personal or professional) or control over the debtor.  A full list of “insiders” is set forth in 740 ILCS 160/2(g).
  • Whether the debtor retained possession or control of the property transferred after the transfer:  For example, a debtor might have transferred title to his automobile to a friend, but he is still driving it, parking it in his garage, and treating it as his own vehicle.
  • Whether the transfer or obligation was disclosed or concealed: If the transfer was concealed from the creditor, this factor weighs in favor of fraud in fact.   If the transfer was disclosed to the creditor, however, this factor weighs in favor of no fraud in fact.
  • Whether before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit: If the debtor makes the transfer after a lawsuit was filed against the debtor, this suggests that the transfer was made with actual intent to commit fraud.
  • Whether the transfer was of substantially all the debtor’s assets: A debtor knowing it has substantial liabilities to a creditor or creditors may try to transfer everything of value, knowing that it would likely be obtained or liquidated to satisfy debts if it remained in the debtor’s possession.
  • Whether the debtor absconded: The debtor leaves hurriedly and secretively.
  • Whether the debtor removed or concealed assets.
  • Whether the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred: If the value received for the assets was reasonable, this would weigh in favor of no actual intent to commit fraud.  
  • Whether the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred: A debtor is considered insolvent when the sum of the debtor’s debts is greater than all of the debtor’s assets at a fair valuation.
  • Whether the transfer occurred shortly before or shortly after a substantial debt was incurred: This factor considers both the timing of the transfer, how close it was to incurring the debt, and the substance of the transfer.
  • Whether the debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.

Fraud in Law: If Fraud in Fact cannot be established, the UFTA provides a creditor with an avenue for recovery if it can establish “Fraud in Law.” 740 ILCS 160/5(a)(2).  Fraud in Law occurs when an asset is transferred, or an obligation is incurred, and the debtor does not receive a reasonably equivalent value in exchange, and:

  • The debtor was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or
  • The debtor intended to incur, or believed or reasonably should have believed that he would incur, debts beyond his ability to pay as they became due. 

Determining the “Reasonably Equivalent Value” is a fact specific inquiry, and courts will compare the value of what was transferred to what was received in exchange, whether the asset was transferred or the obligation was incurred for fair market value, and whether the transaction was at arm’s length between a willing buyer and a willing seller. See Barber v. Golden Seed Company, Inc.)

In People ex rel. Hartigan v. Anderson,the defendant transferred a beneficial interest in his marital residence to his wife less than one month prior to being indicted by a grand jury but many months after receiving a subpoena to appear before a grand jury and produce tax documents.  Eventually, the criminal charges were dropped and the state brought a civil suit against the defendant.  A civil judgment was entered, and the state filed an action to set aside the real estate transfer, alleging that is was a fraudulent conveyance.  The Court applied a three pronged tests to determine if the conveyance was fraudulent in law: (1) there must be a transfer made for no or inadequate consideration; (2) there must be existing or contemplated indebtedness against the transferor; and (3) it must appear that the transferor did not retain sufficient property to pay his indebtedness.

The defendant and his wife argued: (1) the wife’s decision not to divorce the defendant, after discovering he had an affair which produced children, was adequate consideration for the transfer, and (2) the defendant did not contemplate a civil judgment at the time of the transfer.  The court conducted a hearing on the matter and found the transfer to be fraudulent.

Bankruptcy Code and Fraudulent Transfers: Debtors who fraudulently transfer assets to avoid turning them over to creditors may be tempted to use bankruptcy as a shield by discharging the debt owed to those creditors. The Bankruptcy Code, however, provides creditors with protection against dishonest debtors. Bankruptcy trustees have the power to avoid fraudulent transfers made within two years before the bankruptcy filing. The standard for proving a fraudulent transfer under that section is the same in many respects as the standard for proving fraud under the UFTA. If a transfer is avoided, then trustees have the power to recover the property or its value and then distribute the recovery to creditors. The trustee’s “look back period” may often exceed two years depending on several factors, including the method and recipient of the transfer and the applicable state law.

This blog and any materials available at this web site are for informational purposes and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Use of and access to this Web site or any of the e-mail links contained within the site do not create an attorney-client relationship between the Law Office Of Christian Blume, LLC or Christian Blume and the user or browser.

Illinois Creditor Law: Can you pierce the corporate veil after a final judgment?

As I discussed in a previous blog-post (DON’T PIERCE THE CORPORATE VEIL – 11 mistakes to avoid for small-businesses), piercing the corporate veil is an equitable remedy and a means to impose liability from an underlying claim. It is not a stand-alone cause of action; it must be merged with an underlying claim/cause of action.

A party can pierce the corporate veil as part of the underlying case, allege facts to support an alter-ego theory, and impose liability on the individual or entity attempting to be shielded by the corporate liability limits. However, in some cases a litigant may not have the facts necessary to allege an alter-ego theory until after final judgment before learning that the judgment debtor is unable to satisfy the judgement.

So, how can a creditor pierce the corporate veil after a final judgment against a debtor corporation?

In many cases, after a judgement is entered, supplementary proceedings may be commenced to collect on the judgment, including the filing of a citation to discover assets. (735 ILCS 5/2-1402). Language in 1402(c)(3), permits a judgement creditor to:

“Compel any person cited, other than the judgment debtor, to deliver up any assets so discovered, to be applied in satisfaction of the judgment, in whole or in part, when those assets are held under such circumstances that in an action by the judgment debtor he or she could recover them in specie or obtain a judgment for the proceeds or value thereof as for conversion or embezzlement. A judgment creditor may recover a corporate judgment debtor’s property on behalf of the judgment debtor for use of the judgment creditor by filing an appropriate petition within the citation proceedings.”

This section permits a judgment creditor to determine whether a third-party is holding assets of the judgment debtor, BUT cannot be used to pierce the corporate veil and find the third-party personally liable. Psyhos v. Heart-Land Development Co.

In Pyshos, the creditor secured a judgment in the underlying case and attempted to pierce the corporate veil in a supplementary proceeding. The appellate court found this improper. The court reasoned that the allegations in a supplementary proceeding are limited to considering the allegation that the third-party is holding assets of the judgment debtor, but a supplementary proceeding may not determine personal liability against those shareholder and directors. The Pyshos court outlined two approaches a judgment creditor may take to recovery against a third-party: (1) supplementary proceedings, alleging the third-party is in possession of assets of the judgment debtor, or (2) initiating a new proceeding to pierce the corporate veil.

(1) Supplementary Proceedings – to obtain assets of the judgment debtor, held by a third-party. A supplementary proceeding, can determine whether a third-party is in possession of assets of the judgment debtor. Those assets may be used to satisfy the judgment.
A supplementary proceeding can determine whether a judgment debtor transferred assets to a third-party in violation of the Illinois Uniform Fraudulent Transfer Act (UFTA). (740 ILCS 160), which conforms with Pyshos and precedential interpretation of 1402(c)(3). If the UFTA has been violated, the judgment creditor may be able to avoid the transfer to satisfy the underlying debt, or seek an attachment or other provisional remedy against the transferred asset or other property of the transferee. (740 ILCS 160/8).

While a violation of the UFTA permits some relief pertaining to the assets held by a third-party, it does not provide for personal liability against that third-party.

(2) Initiating a new proceeding to pierce the corporate veil. “A new proceeding is proper because, where a party obtains a judgment against another party, the underlying claim merges with the judgment and the judgment becomes a new and distinct obligation of the [judgment debtor] which differs in nature and essence from the original claim.” Pyshos.

We can look at the case of Buckley v. Abuzir. The Plaintiffs in Buckley obtained a default judgment against a corporation, for violation of the Illinois Trade Secrets Act. Unable to recover from the corporation, the Plaintiffs sought to recover from an individual, in a separate chancery action, under a alter-ego theory. The Plaintiffs incorporated the underlying judgement as part-of the suit to pierce the corporate veil and alleged facts to support an alter-ego theory; thereby merging the judgement with a separate suit. The relief sought was equitable, the legal relief had already been obtained in the underlying case. The filing of the second case was a means to attach liability to the individual for the underlying debt of the corporation.

*Starting a business or running a closely held business in Illinois? Contact Attorney Christian Blume at 773-706-7514 or christian@attorneyblume.com.

This blog and any materials available at this web site are for informational purposes and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem.  The information in this article is current as of the date indicated, and may not be updated to reflect future changes/developments.  Use of and access to this Web site or any of the e-mail links contained within the site do not create an attorney-client relationship between the Law Office Of Christian Blume, LLC or Christian Blume and the user or browser.