The Illinois Credit Agreements Act: A Lender’s Best Defense, A Debtor’s Greatest Obstacle

In Illinois, if any aspect of an agreement is deemed to be a “credit agreement” under the Illinois Credit Agreements Act, 815 ILCS 160/1 et seq. , and if the credit agreement is not a writing signed by both parties, then debtors may be barred from asserting certain claims, counterclaims, and defenses against the lender.  Klem v. First National Bank of Chicago, 275 Ill. App.3d 64 (1995).  A credit agreement is defined as any agreement by a creditor to lend money, extend credit, or forbear repayment for commercial purposes.  Under the Act, credit agreements, or amendments thereof, are unenforceable  unless both parties sign the agreement or amendment.  In this regard, the Act has a particularly harsh effect on debtors trying to sue lenders for deceptive  statements or conduct made in relation to a credit agreement.  The Act expressly precludes debtors from asserting claims/defenses like fraud, part performance, and equitable estoppel based on a lender’s oral statements or conduct.

When Does the Act Apply?

The Act applies to any commercial credit agreement or other non-credit agreement that is an integral part of a commercial credit agreement, e.g., a guaranty.  The Act’s requirements can be characterized as a much stricter incarnation of the common law statute of frauds, as the Act requires a writing signed by both parties in order for a credit agreement to be  enforceable.  This requirement not only applies to the initial credit agreement but also extends to any modifications and amendments of such agreement.  Even if only a portion of an agreement involves a credit agreement, the Act still applies.   The application of this Act by Illinois courts provide commercial lenders with significant protection, while leaving debtors vulnerable to unscrupulous lender conduct.  So what does this mean?

Scenario 1: Oral Statements

Let’s assume there is an existing loan agreement between a lender and a debtor, and before the agreement matures, the lender orally agrees to extend it for another two years over the phone.  The lender even sends the debtor an email summarizing the terms of the oral promise.  As a debtor, should you rely on this oral promise?  The answer is no.  The promise has to be in writing and signed by both lender and debtor to be enforceable.   Otherwise, the lender can change its mind and demand that the debtor pay the full amount on the original maturity date.  In this scenario, the debtor would have no recourse against the lender because of the Act.

Scenario 2: Reliance on Oral Statements

Now let’s assume that a lender induces a debtor to execute a $1 million promissory note, payable to the lender.  The lender orally promises that the debtor’s liability on the note will be extinguished upon the lender’s investment in the debtor’s company, which the lender promises it will make.  Relying on this promise, the debtor also invests his own $1 million in the company.  The lender later decides not to invest in the company and demands payment on the promissory note.  Can the debtor claim fraud by the lender?  Breach of contract?  Promissory estoppel?  No, no and no.  Fortunately for the lender, and unfortunately for the debtor, all of these claims/defenses are barred because they relate to a un-memorialized and un-signed credit  agreement, leaving the debtor personally liable to the lender for $1 million.

In Conclusion

If you are a debtor, before entering into any commercial loan or credit agreement, ensure that the agreement is in writing and signed by both you and the lender.  Any amendments or modifications to the agreement — however minor — also must be in writing and signed by both parties.  If in doubt as to whether the agreement is a “credit agreement” under the Act, put it in writing and have both parties sign it.  If you don’t, you risk being denied certain legal protections against the lender.

Conversely, if you are  a lender, ensure that your credit agreements contain a choice of law and venue selection provision mandating that disputes be litigated under Illinois law  in Illinois courts.  Lenders should take advantage of the broad protections afforded under the Act.

If you have any questions regarding commercial loans or credit agreements, please call one of our experienced attorneys at Acumen Law Group.

Authored by Bardia Fard, Esq. and Shoko Asaka, Law Clerk

Illinois Home Repair and Remodeling Act: A Cautionary Tale for Contractors

The Illinois Home Repair and Remodeling Act, 815 ILCS 513, is a statute obligating residential contractors to (i) have a written contract, (ii) include certain terms in the contract, such as price, insurance, and dispute resolution, (iii) provide the homeowner with a brochure informing them of certain rights, and (iv) obtain a receipt for giving the brochure.   Recent appellate court decisions involving the Act reveal an inconsistent landscape with respect to a contractor’s ability to recover monies owed where the Contractor fails to comply with the Act’s strictures.  Ultimately, the issue of whether a contractor can recover its fees from a homeowner  may depend on  which judicial district the issue is litigated in.  A map of the various judicial districts may be viewed here.

Fourth District

In 2007, the fourth district in Smith v. Bogard held that a contractor’s failure to comply with the Act is an absolute bar from recovery, i.e., prevents him from recovering any payment including mechanics liens, breach of contract claims, unjust enrichment claims and the like.

First District

In the first district, the court in K. Miller Construction Company, Inc. v. McGinnis provided that a contractor’s failure to comply with the Act still prevents the payment recovery based on a mechanic’s lien claim and breach of contract claim; however, the contractor may recover payment based on a claim for quantum meruit (unjust enrichment, which provides that even if there wasn’t a contract, the owner benefited from the work and should have to pay for that work).

Second District

In a decision subsequent to K. Miller Construction, the second district held in Artisan Design Build, Inc. v. Bilstrom that a contractor’s failure to provide the homeowner with the brochure required under the Act does not remove the contractor’s right to recover in either equity (quantum meruit) or law (breach of contract, mechanic’s lien, etc.).  So what do these decisions mean for residential contractors and homeowners?

Scenario

Consider the following scenario: a contractor finishes his work under a home-repair contract with a homeowner, and is owed $10,000 for the job by the homeowner, but fails to provide a copy of the brochure, or fails to comply with other provisions of the Act.  In the fourth district, the homeowner will not have to pay the $10,000 even if his house is completely repaired according to the contract.  In the first district, the contractor may recover the payment because the homeowner in fact benefited from the contractor’s work, but the recovery amount may be less than $10,000.  Finally, in the second district, the contractor can recover the payment, either in law or in equity.

Conclusion

Although the judicial decisions in the first and second districts are more favorable to contractors, they are only controlling over law suits filed within these districts.  Given the inconsistency of rulings between the various appellate districts, it is likely that the Illinois Supreme Court will intervene and issue an opinion on the matter.  Until that time, however, contractors  should strictly comply with the Act.

The best way to ensure that you are in compliance is to consult with an Illinois attorney who is familiar with the Home Repair and Remodeling Act.   If you have any questions regarding the Act or construction law generally, please call one of our experienced attorneys at Acumen Law Group.

Authored by Bardia Fard, Esq. and Shoko Asaka, Law Clerk

Employers’ Liability For The Misconduct Of Their Notary Public Employees

Many business owners are unaware of their exposure to liability for the misconduct of their notary-employees.  This legal principle recently cost one Illinois employer $233,000 in damages, and likely a comparable amount in legal fees.

In Vancura v. Katris, the Illinois Appellate Court held that a Kinkos copy shop was liable for the damages resulting from its employee’s notarization of a forged mortgage assignment.  While the facts of the Vancura case make for an interesting read, the court’s explanation of how an employer may be held liable for an employee-notary’s misconduct is particularly instructive for business owners.

In Illinois, employers may be liable for the misconduct of an employee-notary either under (i) the Notary Public Act or (ii) common law.  A notary-employee’s “misconduct” generally includes the wrongful or unlawful exercise of the notary’s power to notarize documents, e.g., notarizing a document where it has not been executed before the notary. 

Liability Under the Notary Public Act
Under the Notary Public Act, employers are liable for a notary-employee’s misconduct where:

• the notary-employee is acting within the scope of his employment when the official misconduct occurred; and
• the employer consented to the notary-employee’s official misconduct.

While the above conditions seem simple enough, the dispositive issue in the Vancura case was whether the employer “consented” to its notary-employees misconduct.  The court identified two forms of consent: “active consent” and “implied consent.”  Active consent may be satisfied where the employer directs, encourages, or tolerates the notary-employee’s misconduct.  Meanwhile, implied consent exists where the employer knows of prior infractions but fails to address them.  Although the Vancura court held Kinkos not liable under the Notary Public Act due to its lack of “consent,” employers will be liable where the requirements of the statute are satisfied.

Liability Under the Common Law
Likewise, an employer may be liable for its notary-employee’s misconduct under the common law theories of negligent training and supervision.  Negligence is generally defined as the failure to do something which a reasonably careful person would do under the circumstances.  An employer may be liable under the theories of negligent training and supervision where it knew or should have known that its employee behaved in an incompetent or dangerous manner, and where despite this knowledge the employer failed to supervise the employee or implement preventative measures.

In Vancura, the court held that the Kinkos owed a duty to the general public to train, supervise, and control its notary-employees.  In affirming the trial court’s $233,000 judgment against Kinkos, the appellate court held that the evidence supported a finding that Kinkos failed to properly train and supervise its notary-employees.

Lessons
The lesson of the Vancura case should be painfully clear to business owners – you should have an internal policy that trains, supervises, and monitors the conduct of your notary-employees, or otherwise face potential liability under the Notary Public Act or common law.  If you have any questions regarding your company’s liability exposure for its notary-employees’ conduct, please call one of our experienced attorneys at Acumen Law Group.

Authored by Bardia Fard, Esq.

Purchasing A Business: How To Avoid Successor Liability

In purchasing a business, buyers typically have 2 options: either a stock or asset purchase agreement. Under a stock purchase transaction, the buyer acquires a majority of the seller’s shares or, if an LLC, membership units in the business. The business’s underlying assets — e.g., equipment, furniture, real estate, inventory, etc. — continue to be owned by the entity, and the entity owned by the buyer. Conversely, under an asset purchase deal, only the business’s assets are purchased, with the seller retaining ownership of the entity. Most business owners and attorneys alike are familiar with the maxim that when a business sells its assets, those assets are transferred to the buyer free and clear of all liabilities. This general rule, however, is not without exceptions like the successor liability doctrine.

What Is Successor Liability?
Under the successor liability doctrine, a buyer who purchases the assets of a business may be held accountable for the seller’s debts and liabilities where:

(i) there is an express or implied agreement of assumption;

(ii) the transaction amounts to a de facto consolidation or merger of the buyer or seller corporation;

(iii) the purchaser is merely a continuation of the seller; or

(iv) the transaction is for the fraudulent purpose of escaping liability for the seller’s obligations.

Of the foregoing bases for successor liability, the 1st and 4th predicates are the easiest to understand, and therefore the easiest to avoid. With respect to express or implied assumption of liabilities, careful drafting of the asset purchase agreement should ensure that unwanted liabilities are not transferred to the buyer. Similarly, transactions satisfying the fraud standard are avoidable, especially where the assets are purchased for adequate consideration, and where there are no interested (or related) parties to the transaction.

The remaining two predicates for successor liability — de facto merger and mere continuation — require a more nuanced analysis of the circumstances surrounding the asset purchase. The de facto merger doctrine is usually implicated where (i) the buyer retains the same management, employees, location, and general business operations as the seller; (ii) the seller becomes a shareholder of the buyer; and (iii) the seller dissolves its operations shortly after the sale. Illinois courts have opined that the continuity of shareholder element is the most important, as it would appear unjust to force a buyer to assume the liabilities of the seller when a substantial price has already been paid for the seller’s assets.

The mere continuation predicate for successor liability, unlike de facto merger, applies where a corporate reorganization has taken place such that the corporation has simply put on a “new coat”; thus, there is no combination of two existing entities into a single successor entity. Illinois courts will invoke the mere continuation doctrine where there is continuity of same management, corporate organization, and ownership.

How To Avoiding Successor Liability?
Buyers and their counsel should consider the following measures before, during, and after the consummation of an asset purchase agreement:

Request insurance. Buyers should request sellers to maintain their corporate existence post-closing, or to retain insurance policies covering pre-closing liabilities, like product defects. These issues should be negotiated while drafting the asset purchase agreement, and any associated costs can be easily built into the purchase price.

Due diligence. And more due diligence! Buyers should conduct a thorough review of sellers business to identify practices or products that may give rise to post-closing liability. Particular attention should be paid to the sellers’ industry, as some industries have higher occurrences of certain types of claims, e.g., car dealerships frequently deal with state/federal lemon laws.

Separate good assets from bad assets. Buyers should consider establishing a separate entity to hold any problematic asset they deems risky or susceptible to legal claims. This way, the entire investment is not lost if a bad apple gives rise to successor liability.

Draft a clear purchase agreement. The asset purchase agreement should expressly state that buyer is not assuming any of seller’s debts or liabilities. Additionally, the agreement should contain a comprehensive indemnification provision, obligating seller to defend and hold buyer harmless should a post-closing liability arise. Holding a portion of the purchase price in escrow – for a set time – is an effective way of buttressing an indemnification provision.

Structure a deal that contemplates Illinois successor liability precedent. To the extent possible, buyers and sellers should ensure that there is no continuity of management, employees, and especially shareholders post-closing. Buyers would also be well advised to obligate sellers to maintain their corporate existence for a period of time post-closing. Implementing these measures will appreciably reduce the risk of a court invoking the successor liability doctrine to the buyer’s detriment.

Prudent buyers to asset purchase agreements should heed the old adage that “an ounce of prevention is worth a pound of cure.” The involvement of competent counsel in the negotiating and drafting of an asset purchase agreement can significantly reduce the risk of post-closing litigation, and the implication of the successor liability doctrine. Indeed, buying a business through an asset purchase is no longer a sure way of acquiring the business free and clear of all debts and liabilities. In the vast majority of cases, the financial cost of litigating an asset purchase agreement post-closing will dwarf the costs that should have been incurred initially to draft a comprehensive asset purchase agreement.

If you are interested in learning more about successor liability or more generally about asset purchase agreements, please feel free to contact Acumen Law Group to discuss what types of contractual provisions will best protect you when purchasing a business.

Authored By Bardia Fard, Esq. & Brian Afshar (Law Clerk)

Square Peg, Round Hole: Preventing the “Tortification” of a Contract Claim

The vast majority of legal practitioners are familiar with the parol evidence rule, which prevents a party to a written contract from contradicting, or supplementing, the terms of a contract by introduction of evidence outside the four-corners of the document. An example of this extrinsic (or outside) evidence is found in oral or written representations made before the final contract is executed. To prevent the introduction of extrinsic evidence, parties frequently negotiate “integration” clauses into a contract; that is, a clause which defines the written contract as the entire agreement between the parties, superseding all prior negotiations and agreements. Thus, where a contract contains an integration clause, the parol evidence rule may be successfully invoked, and the party challenging the contract barred from introducing extrinsic evidence.

But, what happens when the party challenging the contract boot-straps a fraud claim to a breach of contract claim? Does the parol evidence rule apply to bar extrinsic evidence? The answer is “NO,” as the parol evidence rule is a principle of contract law, with no application to tort based claims. Indeed, many perceptive attorneys have recognized this loop-hole, and have circumvented the parol evidence rule by crafting fraud based claims out of facts that support nothing more than a garden variety breach of contract claim.  These attorneys are the flag bearers of what Judge Kozinski so eloquently called the “tortification of contract law” in Oki America, Inc. v. Microtech Int’l, Inc., 872 F.2d 312 (9th Cir.1989).

So, is the sanctity of a contract lost, and extrinsic evidence introduced, whenever the party challenging the contract alleges a fraud occurred in the negotiations leading up to the contract? Not necessarily, according to Judge Richard Posner in a recent Seventh Circuit Court of Appeals decision in Extra Equipamentos E Exportacao Ltda. v. Case Corp., 541 F.3d 719 (7th Cir. 2008). In Equipamentos, the court addressed the enforceability of a “big boy” clause, which in legal parlance is referred to as a “no-reliance clause.” A typical no-reliance clause states that the parties have not relied upon any oral representations leading up to the execution of the contract. Reliance is, of course, a critical element of any fraud claim, so the inclusion of a no-reliance clause may defeat such a claim. The plaintiff in Equipamentos sued the defendant for fraud, maintaining that he signed a release based on false statements and promises made by the defendant. In response, the defendant argued that the no-reliance clause precluded any such fraud claim. In holding that the no-reliance clause defeated the plaintiff’s fraud claim, the court cautioned that big boy clauses may not be enforceable if one of the contracting parties is not actually a “big boy,” like an unsophisticated person or a party not represented by counsel. In such a scenario, a court will conduct an inquiry into the circumstances surrounding the negotiations to ensure that the unsophisticated party understood what  rights he or she was waiving in the no-reliance clause.

The lesson of Equipamentos is clear: it behooves legal practitioners – and business owners – to consider “big boy” clauses in their contracts to head off fraud claims where the actual dispute involves nothing more than a breach of contract. If you are a business owner interested in learning more about no-reliance clauses, in the transactional or litigation realm, please feel free to contact us to speak with one of our attorneys at Acumen Law Group.

Authored by Bardia Fard, Esq.