Every so often, a debtor tries to evade creditors simply by transferring assets to another entity owned or controlled by the same principals. The Seventh Circuit, applying Illinois law, recently handed down an opinion dealing with this exact scenario in the case of Centerpoint Energy Services, Inc. v. Halim, Nos. 13–1797, 13–1807, (7th Circuit, February 18, 2014). The defendant debtor and its principals owned numerous rental properties in the Chicago area and contracted with plaintiff, a natural gas supplier, to buy natural gas for those properties. Defendant stopped paying plaintiff and racked up $1.2 million in unpaid gas bills. 

Plaintiff sued defendant in Illinois state court for breach of contract and obtained a judgment for $1.7 million, including interest and collection costs allowed under the parties’ contract. See Centerpoint Energy Services, Inc. v. Wilmette Real Estate & Management Co., 2010 WL 9922947 (Ill. Ct. App. Sept. 14, 2010)(affirming judgment). Not surprisingly, defendant did not pay the judgment. Plaintiff subsequently discovered that three weeks after the original lawsuit was filed, the debtor company’s owners had transferred all of the defendant’s assets to a newly formed entity, owned by the same principals, which continued to own and manage the same rental properties. 

Armed with this knowledge, Plaintiff filed a second suit against the individual owners and the new successor company in federal court, alleging violations of the Illinois Fraudulent Transfer Act and various common law claims. The federal district court entered summary judgment in favor of plaintiff and the defendants’ appealed to the Seventh Circuit. As the Seventh Circuit explained, the Illinois Fraudulent Transfer Act punishes two types of fraud on a creditor. The first (“actual fraud”) is a transfer of assets “with actual intent to hinder, delay, or defraud any creditor.” 740 ILCS 160/5(a)(1). The second (“constructive fraud”) is a transfer of assets “without receiving a reasonably equivalent value in exchange for the transfer or obligation, and 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.” 740 ILCS 160/5(a)(2)(B). The Court explained that the subjective element (“actual intent”) makes the first type of fraudulent conveyance more difficult to prove. 

The various defendant parties argued that the asset transfers were not fraudulent, but rather were repayments of loans made by both the newly formed entity and the common owners. The Seventh Circuit was not persuaded by defendants’ argument in large part because defendants could produce no documentation for the alleged loans. The Court ultimately affirmed the judgment entered by the district court in favor of plaintiff, finding the transfers were indeed fraudulent and holding the new company and the owners personally liable for the debts. The Seventh Circuit was clearly not amused with the defendants’ conduct, warning them to heed the old adage: “when you’re in a hole, stop digging.” That’s probably excellent advice, as the defendants are now $2.7 million in the hole, not counting their own litigation costs.