Tag:badges of fraud

By Jesse G. Shallcross, K&L Gates, Chicago

In a recent decision from the 1st District Appellate Court of Illinois, A.G. Cullen Constr., Inc. v. Burnham Partners, LLC, defendants husband and wife were held personally liable for roughly $450,000 due to unpaid construction work performed under contract with the limited liability company controlled by the couple.

Robert Halpin owned defendant Burnham Partners, LLC (“Burnham”), a real estate development company with a 90 percent stake in defendant Westgate Ventures, LLC (“Westgate”), and Halpin’s wife, Lori, ran the bookkeeping for both companies.  Westgate engaged plaintiff A.G. Cullen Construction, Inc. (“Cullen”) to build a warehouse and distribution facility in Big Beaver, Pennsylvania.

During the course of construction, Westgate refused to approve one of Cullen’s payment requests for work performed, and Cullen took the dispute to arbitration.  The arbitrator awarded Cullen $448,406.87 for the unpaid work and associated expenses and penalties, and the award was reduced to a judgment in Allegheny County, Pennsylvania.

Shortly before the arbitration hearing, Westgate sold the project and Halpin began winding up Westgate’s affairs and liquidating its assets, using the proceeds of the sale to pay other creditors.  He also paid a $400,000 developer’s fee to Burnham and transferred roughly $97,500 to himself and his wife, leaving a zero balance in the operating account of Westgate and no means with which to pay the Pennsylvania judgment.

Cullen filed suit in Cook County, Illinois against Westgate, Burnham and the Halpins to recover the amount owed by Westgate on the Pennsylvania judgment.  In attempting to hold Burnham and the Halpins liable for Westgate’s debts, Cullen argued that Burnham, through Halpin, perpetrated a fraud by transferring all of Westgate’s assets to themselves and other creditors.  The trial court ruled in favor of the defendants, however, finding that Cullen failed to present “undisputed evidence” of fraud.

The appellate court reversed the trial court’s decision and ruled in favor of Cullen, finding that the activity of the defendants presented nine of the 11 factors or “badges of fraud” set forth in the Illinois Uniform Fraudulent Transfer Act (UFTA) (740 ILCS 160/5) which give rise to an inference or presumption of fraud:

1. There was a transfer of funds to a company “insider”, which term includes individuals who control the company and the relatives of such individuals, such as Robert and Lori Halpin.
2. The action of transferring assets out of Westgate was concealed from Cullen.
3. The transfer of Westgate’s assets to Burnham served to remove or conceal the assets themselves from Cullen.
4. Before any of the transfers occurred, Cullen’s demand for arbitration had put the defendants on notice of a threatened lawsuit.
5. Substantially all of Westgate’s assets were transferred.
6. Westgate did not receive “reasonably equivalent value” in exchange for (a) its payment of a $400,000 development fee to Burnham or (b) its repayment of a $120,000 “loan” from the Halpins, the original payment of which, the court found, should have been a capital contribution from Burnham to Westgate under the terms of the company operating agreement.
7. Westgate became insolvent after the transfers.
8. The transfers occurred just 10 months after Cullen’s demand for arbitration and two months before the arbitration award was entered.
9. Westgate had transferred assets to Burnham, a lienor, and Burnham then transferred those assets to the Halpins, who were insiders.

The court found that the defendants’ transfers of Westgate’s assets to themselves and other unsecured creditors when they knew about Westgate’s potential liability to Cullen amounted to fraud in violation of the UFTA.

While this finding of fraudulent activity of the defendants was a victory for Cullen, it did not necessarily follow that each of the defendants would be held personally liable for the obligations of Westgate to pay Cullen.  This is because a company is ordinarily treated as a separate legal entity, the debts and liabilities of which its shareholders or principals are not responsible for.

However, the common law system has developed a legal doctrine by which the principal of a company may be held liable for the debts and obligations of the company.  Where the principal has, for example, treated the company as a mere “alter ego”, failed to obey corporate formalities, or engaged in fraudulent activity, courts may “pierce” or “lift” the corporate veil to hold the principals liable for the actions of the company.

Under Illinois law, efforts to pierce the corporate veil of a company are governed by the law of its state of incorporation.  As Westgate was a Delaware limited liability company, the court applied Delaware law, which states that the corporate veil may be pierced where there is fraud.  The presence of nine of the 11 “badges of fraud” was enough to convince the court that the defendants had engaged in fraud.  As a result, the court ruled that Cullen may pursue each of Burnham and the Halpins for the $457,416.37 Pennsylvania judgment against Westgate.