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ELDER LAW UPDATE – March 14, 2018

TIP OF THE WEEK: Suffice it to say that they are awful diseases. They change your life and your relations with your loved one.

Your loved one can lose their memory and ability and you lose your peace of mind.

But there are some bright spots on the horizon. With planning you can learn how to deal with these diseases and regain your peace of mind.

There are number of steps that many family and professional caregivers use to forge ahead.

When someone enters a nursing home, they often spend thousands of
dollars paying for care. Sometimes they even spend down to just $2,000 before they can qualify for Medicaid to pay their bills.

Fortunately, over the years we have developed strategies to help keep some of your life’s earnings from being totally spent on long-term care.

Yes, the best solution would be to have long-term care insurance. Unfortunately, very few of our clients have it. We recommend it to all of our clients, but very few will end up qualifying for it and eventually purchasing it.

Therefore it’s up to you to discover the different ways to preserve some of your assets. The best way to do this is to discuss this with your trusted advisors. Start with an experienced practitioner. At our office, we will do a free 15 minute consultation over the telephone with you so you can begin to discover your options.

Here is how we explain the 2 different sets of steps we take in the process:

For all Cases:
1. Revise Power of Attorney documents – not all the POA’s we observe are adequate

2. Inventory of Assets – not that easy as individuals forget what they own and how they own it

3. Correct your Estate Documents – at 55 years of age your estate documents may need to change substantially

4. Create a Blueprint of Options, Design & Sign Trusts – gives clarity

For Crisis Cases Only:
5. Review Nursing Home or Other Facility Contract – often these contracts are not resident friendly

6. Set up 60 month history – this takes gathering and sorting

7. Work Your Strategy to Protect Assets– it is worth the effort, but you need an experienced practitioner

8. Apply for Medicaid Coverage – can be a complicated sequence of tasks

9. Post-Application Audit – these are comprehensive audits

10. Appeal, if needed – must be done in short time period

11. Annual Redetermination – must be done

Most people are interested in learning the correct legal methods that can be used to protect at least a portion of your lifelong savings. What if you still have a healthy spouse who will live on for many years? What if you have a needy child?

Perhaps there’s nothing for you to do at this point. But at least you should be sure that you’ve covered the ground necessary to be smart about handling this awful disease.

If you call our office for a free 15 minute telephone consultation we will talk to talk to you about your personal situation and generally discuss the steps you need to take right now to build a protective wall around your loved ones and your savings. We will also talk about governmental benefits that may be available to you from either Medicaid, Medicare, Social Security and the VA.

Ask us about legal steps that we have taken with other clients to make sure that they are never totally impoverished.

NEWS OF THE WEEK:
Recent News on Proposed Observation Status Regulations.

On February 2, 2018 The Department of Public Health of the state of Illinois has proposed amendments to Hospital Licensing Requirements. The rule that is proposed requires that patients be given written notice within 24 hours when they are placed under observation status rather than being admitted . The notice must state that the observation status may affect private insurance, Medicare or Medicaid coverage for any other services or medication they receive while in the hospital as well as coverage of any subsequent discharge to a nursing home or to home or community based care.

When is the Employer’s Action Adverse Enough to Be Illegal “Retaliation?”

Most employment discrimination statutes contain “anti-retaliation” provisions.  Generally, the elements of retaliation claims are the same.  The employee must produce enough evidence for a reasonable jury to conclude that (1) she engaged in a statutorily protected activity; (2) the employer took a materially adverse action against her; and (3) there existed a but-for causal connection between the two.  See Burton v. Bd. of Regents of the Univ. of Wis. System, No. 16-2982 (7th Cir. March 17, 2017).

 Not every action is an “adverse action.” Not everything that makes an employee unhappy is an actionable adverse action.  Petty slights or minor annoyances that take place at work and that all employees experience are not actionable.  Rather, “an adverse action is one that a reasonable employee would find to be materially adverse such that the employee would be dissuaded from engaging in the protected activity.” Burton, supra.  For example, written reprimands without changes in the terms of conditions of the employee’s employment are not adverse employment actions.  For similar reasons, unfulfilled threats of discipline are not materially adverse actions.

The Burton Case.  In Burton, the plaintiff was hired as a tenure-track professor. In October 2012, a student reported to Burton that another professor had sexually harassed her.  Burton reported the incident to her department head and chair. The department chair then instituted a new policy altering the procedure for reporting student complaints, stated at a department meeting that the policy change was necessary because someone had overreacted by bringing a student complaint, and became less collegial towards Burton. He and the department head then objected to wording in a draft press release prepared by a funder of Burton’s proposed cybersecurity curriculum at the University, and they confronted  Burton about inaccuracies in materials she created for the proposed curriculum.  Regardless, Burton subsequently received the grant. In January 2013, Burton submitted her tenure application and it was granted. In August 2013, Burton filed a charge of sex discrimination and retaliation against the University claiming two adverse actions – that her reporting of the student’s complaint resulted in the department  (1) reprimanding her, and (2) withdrawing its support of the curriculum she was developing.  After Burton filed the charge, she was told that she might have been considered for the dean or department chair positions, but that she could not expect to advance if she continued to engage in litigious behavior.  Ultimately, Burton filed a lawsuit.

Like the district court, the 7th Circuit Court of Appeals found that neither of Burton’s professed adverse actions rose to the level of materiality necessary to form the basis of a retaliation claim.  The court found that even if the chair’s actions could be characterized as a reprimand, this would not be sufficient to be a materially adverse action.   The court also observed that the “reprimand” caused no consequences for Burton’s employment, noting that she received tenure just months after the incident.  The court found the same to be true about the disagreement related to the cybersecurity curriculum – no material adverse consequences followed.

But what about the University’s repeated pressuring of Burton to drop the discrimination charges and the statement that she could not advance if she was litigious?  The court found that since the pressure to drop the litigation resulted in no adverse action, the conduct ipso facto was not materially adverse.  Likewise, since Burton never applied for the positions of dean or department head, the court ruled that the statements caused her no injury.

Why train with Di Monte & Lizak?

In today’s diverse workplace, employers and employees are faced with the challenge of creating and maintaining environments free of discrimination and harassment.  Training with Di Monte & Lizak will help you become better equipped to establish a more respectful and lawful work environment and help limit legal exposure.  Government agencies such as the EEOC and Office of Federal Contract Compliance make training a priority. And, the EEOC’s Strategic Enforcement Plan for Fiscal Years 2017 – 2021 has identified “preventing systemic harassment” as a focus of attention.  We provide on-site, off-site, group, and one-on-one training to private, public, and non-for-profit employers, including law firms.  Let me know how we may help you.

When Workplace Bullying Rises to Actionable Title VII Harassment

December 5, 2017

Yesterday, I heard author and journalist Suki Kim describe unwanted sexual attention she received from former public radio Takeaway host, John Hockenberry (White, male).  She also described Hockenberry’s abuse and bullying of numerous Takeaway female co-hosts, producers, and interns (women of color).  Kim was being interviewed by interim host Todd Zwillich (White, male), who a few days earlier tweeted that he was “angry” and saddened to learn” of the allegations against Hockenberry.   (Hockenberry has not denied the allegations and he and the show parted ways in the summer.  Zwillich has worked for the show for years.)  Zwillich stated that he was aware of Hockenberry’s bullying, that Hockenberry never “trained his ire” on him, and that while he did not know why he was “spared,” he was thankful Hockenberry never abused him.  Kim called Zwillich out on his tweet, asking “how could you not have seen” Hockenberry’s abuse and inquiring how Zwillich could not have asked himself why he, a White male, remained employed by the radio show while the women failed.   All good questions!

Generic bullying

The courts and the Equal Employment Opportunity Commission maintain that if you eliminate the racial, sexual, age, disability, or other protected class aspect of workplace harassment and hostile work environment, you get, simply, bullying.   Neither Illinois nor federal civil rights laws cover bullying, because, as Justice Antonin Scalia said in the 1998 Oncale v. Sundowner case, Title VII of the Civil Rights Act of 1964 is “not a general civility code for the American workplace.”  Nonetheless, generic bullying merits management attention and proper remedial action.  Left unmanaged, bullying negatively impacts productivity, profits, and morale.  It also can lead to common law actions for intentional infliction of emotional distress and, in severe cases, worker compensation claims.

But what if the supervisor bullies women only?   

If women only are subjected to the bullying, the employer may have Title VII exposure. Suppose George Supervisor shouts at Martha, his subordinate female employee, frequently, profanely, and often in public.  There is little or no provocation for George’s conduct. He screams at Martha for not reading her work emails when taking time off to visit her dying sister.  George sometimes approaches Martha silently as she is working, stands behind her, and watches her for no apparent reason.  He shakes his fist and lunges at her across a table during her performance evaluation when accusing her of taking breaks with other employees in order to talk behind his back.  George conducts himself similarly with other female subordinates.  Martha continues to work for the company but two females resign due to George’s conduct.  All three sue the company for Title VII sex-based hostile work environment.  The discovery record suggests that women only are subjected to George’s behavior, at least in its most severe form.

Did these plaintiffs experience sexual harassment?

The above facts were present in EEOC v. National Education Association.  The district court dismissed the women’s claims, concluding they failed to meet the harassment “because of sex” requirement of Title VII.  After all, none of the women claimed, and no evidence existed, that George’s behavior was lewd, sexual, or that the content was gender-specific.  There was no evidence that George harbored animus towards women –  whether generally or at work  –  or had a specific motive to make women’s lives miserable.

The 9th Circuit Court of Appeals disagreed.  It found that the “because of sex” requirement was satisfied by the women’s alleged experiences.  After all, the bulk of the evidence showed that George directed his brutish behavior only at women.

The “takeaway”

Sexual harassment law is not limited to sexual advances or coerced sexual submission.  The goal of Title VII is workplace equality, not a workplace free of sexual advances.  When George victimized only women with his hostile conduct, his behavior affected women more adversely than it affected men.

Why train with Di Monte & Lizak?

In today’s diverse workplace, employers and employees are faced with the challenge of creating and maintaining environments free of discrimination and harassment.  Training with Di Monte & Lizak will help you become better equipped to establish a more respectful and lawful work environment and help limit legal exposure.  Government agencies such as the EEOC and Office of Federal Contract Compliance Programs make training a priority.  And, the EEOC’s Strategic Enforcement Plan for Fiscal Years 2017 – 2021 identifies “preventing systemic harassment” as a focus of attention.  We provide on-site, off-site, group, and one-on-one training to private, public, and not-for-profit employers, including law firms.  Let me know how we may help you.

Client Cannot Enforce Against Employee Her Arbitration Agreement with Staffing Agency

EMPLOYMENT AND BUSINESS LAW ALERTS AND UPDATES

 

Employee Anne filed a Title VII sexual harassment and retaliation suit against Fromm Family Foods, where she had been placed by a staffing agency. She did not sue the staffing agency. During the discovery process, Fromm learned that Anne’s contract with the staffing agency included an arbitration clause. Fromm moved to compel arbitration, but the district court denied the motion. Scheurer v. Fromm Family Foods LLC, No. 163327 (7 th Cir. July 17, 2017).

The 7 th Circuit Court of Appeals (which covers Illinois, Indiana, Wisconsin, and Michigan) agreed with the lower court. The arbitration agreement Anne signed with the staffing agency stated: “In the event there is any dispute between Employer and I relating to my employment or the termination of my employment, which Employer and I are unable to resolve informally through direct discussion, regardless of the kind or type of dispute, Employer and I agree to submit all such claims or disputes to be resolved by final and binding arbitration in accordance with the National Rules for the Resolution of Employment Disputes of the AAA within the state of employment.” The arbitration clause identified Title VII claims in the list of claims covered by arbitration.

The court began its analysis noting that arbitration is contractual and that a party “cannot be required to submit to arbitration any dispute which he has not agreed so to submit.” Fromm argued that even though it was not a party to the arbitration agreement, “equitable estoppel” should compel arbitration. Equitable estoppel is a legal principle that stops someone from taking a position that conflicts with his previous claims or behaviors. The party arguing estoppel must show that it relied upon the other’s claims or behaviors to its detriment. Fromm argued that since Anne signed a contract with the staffing agency to arbitrate her Title VII claims, she could not refuse to arbitrate her claims against Fromm. The court found that Fromm could not prove that it relied upon Anne’s contract to arbitrate Title VII claims since Fromm admitted that it did not learn of the contract until after Anne filed suit.

What This Means for Employers

Employers often look to temporary staffing agencies to fill pressing employment needs. The case underscores the significance of understanding whether the staffing agency has adequate measures in place to protect your business. If your business uses temporary staffing agencies, scrutinize their employment policies and contracts with employees. If arbitration of employment disputes is important to you, consider having temporary workers sign arbitration agreements, even if you and the staffing agency agree that the worker is solely an employee of the staffing agency.

According to EEOC guidance and applicable case law, staffing agencies are responsible for discrimination, retaliation, and harassment that their employees confront at clients’ work sites. Further, to the extent that the working conditions of staffing firms’ employees are controlled in whole or in part by the clients to whom the employees are assigned, clients are responsible, too. As the EEOC guidance makes clear, staffing firms must hire and make job assignments in a nondiscriminatory manner and client companies must treat staffing firm workers assigned to them in a nondiscriminatory manner. Further, a staffing firm must take immediate and appropriate corrective action if it learns that a client has discriminated against one of its workers.

The nature of the staffing firm/client company relationship makes dealing with EEO issues and employment laws even more difficult than is typically the case. When in doubt about how to handle a particular situation, call me.

Noncompete Agreement Interpretation and Enforceability

Seventh Circuit Court of Appeals (Illinois, Indiana, Wisconsin) Rules that Company’s Distributor Is Not its “Competitor” in E.T. Products, LLC v. D.E. Miller Holdings, Inc., No. 16-1204 (Sept. 20, 2017)

November 1, 2017

What is a business “competitor”?  What does “indirectly” mean?  Is the difference between “and” and “or” a big deal?  Are you competing with the buyer of your business by leasing operation space to its competitor?  In E.T. Products, the Indiana trial court and the 7th Circuit weighed in on all these issues.

Background:

Doug Miller and his son Tracy owned two Indiana-based companies, E.T. Products and Petroleum Solutions.  The former blended and sold fuel additives.  The latter blended and sold lubricants.  The latter also had a few customers to whom it sold fuel additives supplied by E.T. Products, making Petroleum Solutions E.T.’s distributor.  After 13 or so years in operation, Miller put both companies up for sale.  In January 2011, Miller sold E.T. to an investment group for $5 million.  Ancillary to the sale contract, Doug and Tracy signed 5-year noncompete agreements covering the continent of North America that prohibited them from “directly or indirectly, as agent, employee, consultant, distributor, representative, equity holder, manager, partner, or in any other capacity, … assist[ing] any Person, … that engages in or owns, … any venture that directly or indirectly engages in the Business.”  The “Business” was defined in the sales contract as “the business of blending, packaging, marketing and selling chemical fuel additive products, with its primary focus on diesel fuel additives.”

In January 2012, Miller sold Petroleum Solutions to an individual named Kuhns.  Doug was generous to Kuhns.  He provided low-interest financing for the purchase; a lease for the land on which the business was operated; training in lubricant blending and consulting help as Kuhns learned the business; and Tracy helped by training Kuhns on the company’s computer programs for a few months after the sale.  Throughout most of 2012, Petroleum Solutions continued to be a customer and distributor of E.T. fuel additive products.   In late 2012, E.T. presented Kuhns with a non-compete agreement which Kuhns refused to sign. Presumably, E.T. wanted Kuhns to distribute only E.T. products. In December 2012, E.T. stopped supplying fuel additives to Petroleum Solutions.  Petroleum Solutions found a new supplier. When Doug learned that E.T. severed its relationship with Petroleum Solutions, Kuhns and the Millers parted ways.

E.T. sued, alleging that the generous financing and lease terms, and the Millers’ assistance to Kuhns during 2012, breached the noncompete agreement.  Miller, in turn, argued that the noncompete agreements were overly broad and unenforceable.  On motions for summary judgment, the Indiana trial court (applying Indiana law) ruled that the agreements were enforceable but that the Millers had not breached them.  The court found that all of the complained-of conduct occurred while Petroleum Solutions sold only E.T. fuel additive products and that acting as E.T.’s distributor did not violate the agreements.  The court also strictly construed the “in the Business” term in the noncompete agreements against E.T., finding that by the use of “and” in the definition, unless Petroleum Solutions engaged in all of the same aspects of the additive business as E.T. Products, it was not competing with E.T.

The 7th Circuit affirmed the decision, holding that “a firm whose sole conduct in the relevant market consists of distributing one manufacturer’s product plainly isn’t that manufacturer’s competitor.  The 7th Circuit called E.T.’s argument that the Millers’ assistance to Petroleum Solutions was a form of “indirect” involvement in the industry “a bit much.”

The 7th Circuit went on to discuss whether Petroleum Solutions became E.T.’s competitor once it began blending its own fuel additives and distributing additives from other suppliers:

The [trial court] thought that the noncompete wasn’t triggered unless Petroleum Solutions engaged in all the same aspects of the additive business as E.T. Products:  blending, packaging, marketing, and selling.  That’s not correct.  Two companies need not perfectly mirror each other before they are considered competitors, and the inclusion of the phrase “directly or indirectly” in the noncompete was designed to preclude precisely this kind of narrow construction.  That language means, if nothing else, that complete overlap isn’t required.

The 7th Circuit also found that Miller did not breach the noncompete by failing to revoke the property lease:

Taking affirmative steps to lease to a competitor is quite different from what Doug Miller did here.  Recall that Kuhns and Doug entered into the lease agreements in January 2012.  At that point Petroleum Solutions and E.T. Products were business partners.  …  On E.T. Products’s reading of the noncompete, Doug was required to break the existing lease with Kuhns – itself a breach of contract – once Petroleum Solutions became E.T. Products’s competitor.  That’s an overbroad and unreasonable reading of the agreement.

Takeaways:

  • This noncompete agreement arose in the context of the sale of a business, but the analysis of who is a “competitor” applies in the context of employment agreements, as well.
  • Be mindful of how you define the “business” you seek to protect from competition, especially when the noncompete agreement is in the context of an employment contract.  Courts dislike these agreements and will look for reasons to find the noncompete agreement overly broad and unenforceable. But even in the context of a sale of a business, Illinois courts are loathe to enforce an overly broad covenant.
  • Be mindful of the use of the word “and,” and “or.”  Consider using “and/or.”
  • In many jurisdictions (including Indiana), the law requires covenants, even in the sale of business context, to be “strictly construed against the covenantee” or the preparing party. Consider stating that the language in the noncompete agreement is chosen by the parties to express their mutual intent and that no rule of strict construction will be applied against either party.

“Limited Guardianship: A Customized Approach to Substitute Decision Making”

IICLE Special Needs Conference
Lisle, IL – September 23, 2016

“Substitute Decision Making – Limited Guardianship”

IICLE Special Needs Conference
Lisle, IL – September 26, 2017

A WIN FOR THE LITTLE GUY

Introduction:
This month’s edition of my newsletter provides a “war story” of a zoning matter with a successful result at the trial court level. It’s been awhile since I’ve sent out this newsletter. I’ll try to be more diligent in 2017 and trust you’ll find my articles of interest and of use. Remember I am here to provide the best legal advice and service that I can. If I can be of assistance I am only a phone call or email away. Also if you know of anyone who can use my services or those of our law firm I’d appreciate the referral.

A WIN FOR THE LITTLE GUY

My client is a hard working and honest man. He’s Mexican-American and English is not his first language. In 1982 he and his wife bought a parcel of property in unincorporated Cook County with a small house on it. My client and his wife took up residence on the property and he began his landscape business. Over the next three years my client acquired three adjacent properties; two of which had small houses on them. Eventually his sons moved into the houses and worked with their father and helped him make the business a success.

In 1988 an adjacent municipality approached my client and asked him to voluntarily annex two of his properties. This municipality was in a boundary war with another Village and wanted my client’s property so they could control the area. My client asked what was he going to get in return and was told he could “keep staying there and working there.” My client trusted the municipal officials who approached him and he and his wife signed a voluntary petition to annex two of their properties. Once these properties were annexed the other properties were surrounded and were forced annexed. Upon annexation as is customary the properties were zoned residential.

For the next twenty-seven years my client and his sons continued to reside on the properties and operated their landscape business. During this period numerous building permits were issued for improvements and one was for an eight foot fence along the west boundary of the properties that needed an exception because the height limit was six feet. Also during this twenty-seven year period violation notices were issued from time to time. Each time a violation was brought to my client’s attention he and his sons promptly corrected the problem.

In May of 2015 the Village issued a complaint for operating a landscape business in a residential district and operating a contractor’s yard without a special use permit. Obviously my client was surprised and shocked at the Village’s actions. He felt they had gone back on their promise that he would be able to stay at his property and continue to work there. Once I was retained I endeavored to settle the matter but the Village Board had directed staff to “shut down” any businesses that were operating in residential zoning districts regardless of the circumstances.

A zoning complaint such as the one issued to my client is first heard by an Administrative Hearing Officer. They are referred to as Administrative Law Judges. Generally they are attorneys hired by the municipality to conduct hearings and issue decisions. Their decisions are subject to what is called “Administrative Review” by the circuit court.

An administrative hearing was held in May of 2016. The Village put on its evidence and in defense I had my client testify as well as one of his sons. In addition I had a well regarded land planner testify. My client testified through an interpreter as to how he acquired the properties and started his landscape business. He testified as to how the Village asked him to annex and what they told him about being able to continue to operate. My client’s son testified as to how the business operates with trucks going out early in the morning and coming back late afternoon or early evening. There’s little activity during the day. Landscape materials are stored on the property but there are no high stockpiles and landscape waste is removed every few days. I had my client’s son go through each of the building permits that were issued and how one of the violation notices was because they were expanding the business from what it was when the property was annexed. My client’s son testified that the Village did not require him to remove the additional storage containers that had been brought onto the property but told him “just to keep it as it was.” A new house is being built just a lot or two away to the north and my client’s son estimated its cost of construction at five hundred to six hundred thousand dollars. Our expert in land planning testified that in his opinion there has been no adverse impact from the landscape business on the normal and orderly development of the area.

When I cross examined the Village’s Director of Community Development he admitted that he had been employed by the Village for twelve years and he always knew how my client’s property was being used. I got him to admit that he granted the exception that allowed the eight foot high fence because the Village wanted my client’s trucks and landscape operation screened from the adjoining residential street.

In closing argument I argued my client’s use of the property was a legal non-conforming use and that he had acquired a vested right to continue to operate as he had been for twenty-seven years. I also argued the legal theories of equitable estoppel and laches. Equitable estoppel can be applied to a municipality when a person’s action was induced by the conduct of municipal officers and where in the absence of relief the property owner will suffer a substantial loss and “the municipality would be permitted to stultify itself by retracting what its agents have done”. Laches is a doctrine that bars a plaintiff relief where because of the delay in the plaintiff asserting a right the defendant is misled or prejudiced.

I had warned my client that most likely we would lose before the Administrative Law Judge. Not because our case was weak or my legal arguments were not well founded. It’s just how the system works. Sure enough I was right and the Administrative Hearing Officer ruled against my client and found that his business was not a permitted “home occupation” and there was no basis to find a vested right had been acquired or that the doctrines of equitable estoppel or laches should apply. In addition he found my client’s use of the property was not a legal non-conforming use. My client authorized filing a lawsuit in the Circuit Court of Cook County for Administrative Review.

When a complaint for Administrative Review is filed the municipality is required to answer by filing the record that was made at the administrative hearing. This includes the transcript of the testimony and any exhibits that were introduced into evidence. On Administrative Review the trial court is not allowed to consider any additional evidence. The Judge is limited to reviewing the record that was made at the administrative hearing. This is why it is critical to get into the record anything you think is needed to succeed. You do not have an opportunity to add anything before the trial court.

Fortunately the trial judge was a former City of Chicago alderman and very familiar with zoning and its legal nuances. Once the Village filed the record I made a Motion for Judgment on the Pleadings. The Village filed a response and I filed a reply.

At the hearing the Judge directed his questions mainly to the Village attorney. The Judge started with questions regarding why my client’s business should not be considered a legal non-conforming use. It appeared the Judge was leaning in my client’s favor. I have done this long enough to know that when this occurs the best thing to do is say as little as possible. That’s what I did and before I knew it the Judge shifted gears and focused on our legal defense of “laches”. The Judge went through each and every time the Village issued a permit or inspected the property. He found especially compelling the inspection where the inspector noted on his report that my client was expanding the non-conforming use from what it had been at the time of annexation. The Judge also noted how the Village had issued an exception for the height limit of the fence because it wanted the commercial vehicles and landscape operation screened from the adjacent residential street.

The Judge stated that my client’s case was the “poster child” for the equitable defense of laches. I knew this was our strongest defense and emphasized the doctrine of laches in my initial brief and the reply I filed. Also I concentrated on this defense in the oral argument I made and specifically referred to the Illinois Appellate Court decision in Du Page County vs K-Five Construction. In K-Five, Du Page County was prevented from enforcing its zoning ordinance against a concrete batching plant that was an illegal use because the County waited five years from the time it knew of the illegal use. Obviously I argued that if five years was enough in K-Five then waiting twenty-seven years was far more egregious. Also in K-Five the Appellate Court noted that the County had failed to prove harm to the general public if its zoning ordinance was not enforced. I argued the same situation existed in my client’s case and this was borne out by the fact a house worth half a million dollars was being built two lots away.

The Judge ruled in my client’s favor and held that the Village cannot enforce its zoning ordinance against my client’s property and business. He’s allowed to continue to operate as he has been all these years. The Judge ruled that my client can’t expand his use but that’s fine and as it should be.

My client will have to wait and see if the Village appeals the trial court’s ruling. If it does I think we have a good chance of success at the Appellate Court level due to the manner in which the trial court went through each and every time a building permit was issued or a violation notice issued and nothing was done for over twenty-seven years to stop my client from doing what he had been told from the beginning he’d be allowed to do if he cooperated with the Village and annexed his property. My client always acted in good faith.

In my opinion justice has prevailed and a win obtained for the “little guy.” Hopefully the Village will see fit to leave my client and his business alone. If not we’ll move up to the Appellate Court and I trust the Appeals Court will agree with the trial court. In the meantime my client can continue to cut grass, prune bushes and plant flowers. However, this time of the year its snow plowing.

New Illinois Freedom to Work Act Bans Non-Competes for Low Wage Earners

Spurred in part by sandwich shop Jimmy John’s requirement that sandwich-makers and delivery drivers sign over-reaching non-compete agreements, the Act prohibits private sector employers from entering into non-compete restrictions with “low-wage employees” and renders such agreements “illegal and void.” The Act applies to non-compete agreements entered into on or after the Act’s effective date of January 1, 2017.

A “low-wage employee” is someone who earns the greater of (1) the hourly minimum wage under federal (currently, $7.25 per hour), state (currently, $8.25 per hour), or local law (currently, $10.50 per hour in Chicago) or (2) $13.00 per hour. Therefore, the Act initially will apply to agreements with employees earning $13.00 per hour or less.

The Act defines “covenant not to compete” broadly to mean an agreement between an employer and a low-wage employee that restricts the employee from performing:

(1) Any work for another employer for a specified period of time;
(2) Any work in a specified geographic area;
(3) Work for another employer that is similar to the low-wage employee’s work for the employer in question.

Understanding the Illinois Exemption Statute

Most people are aware that retirement benefits are exempt assets protected from the claims of creditors of the plan’s beneficiaries. Jordan Finfer and I have been recently working on a case in which we had to dive deeper into the scope of the Illinois law provides for retirement plans. In doing so, we learned some of interesting facts on how courts apply the Illinois exemption statue (Section 12-1006 of the Illinois Code of Civil Procedure (735 ILCS 5/12-1006)) in complex or unusual situations.

First, let’s review some basics. Retirement plans are fully exempt, with no ceiling or cap, if the plan falls within the statute’s definition of a “retirement plan.” So, the definition is the key. Fortunately, the Illinois statute broadly defines the term “retirement plan”, and courts have construed the statue in manner that will further the clear legislative policy of protecting retirement plans from creditor claims. The Illinois statute is significantly broader than analogous federal statutes which are limited to protecting social security benefits and pension plans that are governed by ERISA. The Illinois exemption protects every type of pension, profit sharing, or retirement account recognized under the Internal Revenue Code (“IRC”); IRA accounts; stock bonus plans; pension plans created under the Illinois Pension Code, which include virtually pension plans established for public employees by Illinois municipalities or units of local government; and plans crated by the government or a church. The exemption statute’s definition of a retirement plan does not create an exhaustive list of protected plans. It permits a court to find that any retirement vehicle created by statute or contract falls within the definition of an exempt “retirement plan” if the plan is intended in good faith to qualify as a retirement plan under the Internal Revenue Code or if it was created under the Illinois Pension Code. All pension plans established by municipalities and units of local government fall within the scope of the exemption.

The exemption protects both the beneficiary’s interest in the plan’s assets and the right to receive distributions from the plan, including returns or refunds of contributions a plan. The protection for returns or refunds is particularly important for plan participants who have the right to withdraw contributions when the beneficiary terminates his employment or participation in the plan, or when the plan is terminated.

The exemption statute does not specifically state whether or not distributions or refunds from a retirement plan remain exempt after the plan participant receives distributions or other withdrawals. Typically, the funds from a distribution or withdrawal are initially deposited into a plan participant’s bank account. Illinois courts and bankruptcy courts applying Illinois law have consistently found that in order to implement the purposes and policies of the exemption statute governing retirement plan, the exemption must extend to funds received by the plan beneficiary, provided that certain basic rules are followed. After a retirement plan beneficiary receives a distribution or refund, the funds remain exempt if they remain in an account that can be traced to the retirement plan and if that account is used for the ongoing support or living expenses of the plan beneficiary. If those conditions are satisfied, the funds remain exempt from creditor claims. The courts reach this result because they have found that the exemption for retirement plans would be seriously eroded if creditors could reach the plan distributions in the hands of the plan beneficiary. However, if the plan beneficiary used distributions or refunds from the plan to capitalize a new business venture, or as a fund for making investments, courts applying Illinois law will probably find that the exemption is terminated. For example, if the plan beneficiary started a business with a $100,000.00 distribution from a retirement plan, the beneficiary’s equity interest in his new business will not be an exempt asset.
The protection the Illinois statute provides to the beneficiary of a retirement plan creates an impenetrable barrier against creditor claims as long as the plan is intended in good faith to qualify under the Internal Revenue Code or is a plan created under the Illinois Pension Code. If the plan can satisfy either of those criteria, then the exemption statute provides a conclusive presumption that the debtors interest in the plan and any distributions from or traceable to the plan is a valid spendthrift trust for the plan beneficiary. Clearly, participants in a pension created pursuant to the Illinois Pension Code have total protection from creditor claims. For everyone else, the hard cases arise from situations where there is some flaw in the creation or funding of a retirement plan recognized under the Internal Revenue Code. This happens in two ways. There can be violations of the contribution limits or a flaw in the creation of the plan. Either form of noncompliance can result in a loss of the exemption, either entirely or partially.

Some retirement plans are self-managed vehicles created by the sole owner of the plan sponsor. These include IRAs, Keoghs, SEP IRAs, SEP 401ks, and pension plans set up and administered by a business in which the owner may be the sole plan participant. What happens if the plan’s owner contributes more than the amount permitted under the applicable provisions of the IRC? This can arise innocently, such as when the plan sponsor or owner makes an honest mistake concerning contribution limits. It can also occur as part of a strategy to take advantage of the unlimited exemption for retirement plans by intentionally making excess contribution, without regard to the IRC limits. In the later situation, the judgment debtor is typically hoping that the judgment creditor will not perceive that the judgment debtor has contributed more than the IRS contribution limits. The majority trend of cases that have looked at a situation where a judgment debtor has contributed more than the IRC contribution limits to a plan have found that plan assets are exempt only up to the point of the IRS contribution limits. Any excess contributions are not exempt. A judgment creditor has recourse against the excess contributions and the proportionate share of the plan’s earnings from the excess contributions to satisfy its judgment.

As already noted, a retirement plan will be immune from creditor claims if it is intended in good faith to qualify under the IRC. Courts have had to set standards to define the point at which non-compliance with the IRC will result in a finding that the retirement plan was not intended to in good faith qualify with the IRC. There are only a few reported decisions on how to determine whether a plan was intended in good faith to qualify. Courts put the burden of persuasion on the debtor (i.e. plan beneficiary) to provide evidence of conduct or action to support a claim that there was a good faith attempt to comply with the IRC. If the judgment debtor is successful, the plan remains fully exempt, notwithstanding technical noncompliance. A judgment debtor could meet this burden by demonstrating that he retained an accountant or pension consultant to set up a valid plan which, through no fault of the judgment debtor contained provisions which did not fully comply with the IRC.

Participants in defined benefit pension and profit sharing plans or 401(k) plans must be particularly vigilant in order to retain the full benefit of the Illinois exemption statue. Pension plans and 401(k) plans will accumulate significantly more value than IRA accounts because of the higher contribution limits. When an employee leaves the sponsor’s employment or when the sponsor terminates a plan, the affected employee has the right to withdraw or rollover the vested plan benefits, which is often a substantial amount of money. If the beneficiary takes a withdrawal, the withdrawn funds should be put into one or more accounts that are traceable to the former retirement plan, and those funds should be used only for living expenses, and not for investment purposes. If the affected employee is going to use the funds in the first plan to fund a new retirement plan such as a rollover IRA (which is another type of fully protected “retirement plan” within the meaning of the exemption statute), the safest course of action is to arrange for a direct trustee-to-trustee rollover from the prior employer’s plan to the new rollover IRA. That will ensure that the full exemption remains intact. Alternatively, the money can be first withdrawn by the employee and then transferred to the new rollover IRA, provided that the rollover IRA is funded within 60 days after the withdrawal from the prior retirement plan. If the plan beneficiary does not setup the rollover within the 60 day safe harbor, the rollover IRA will not qualify under the applicable provisions of the IRC. Therefore, the rollover IRA will be subject to creditor claims unless the plan beneficiary can meet the high burden of establishing that the rollover IRA was intended to qualify, which means being able to convince a court that steps were taken to effectuate the rollover within 60 days and through no fault of the plan beneficiary, the deadline could not be met.
The Illinois exemption statute for retirement plans is perhaps the most significant of all Illinois exemption statutes because there is no ceiling or cap on the amount of the exemption, and because compliance with the statute is relatively easy. There are 3 steps that should be taken to preserve the full extent of the exemption. When funds are withdrawn from a retirement plan they should be put in an account that can be traced to the retirement plan. The withdrawn funds should be used for living expenses. When creating a self-managed pension vehicle such a Keogh, SEP IRA, SEP 401k or rollover IRA, start working with a qualified professional as soon as possible in order to ensure that the retirement plan will qualify under provisions of the IRC. By retaining a certified or licensed professional, you will bolster your chances of convincing a judge that the plan was intended in good faith to qualify with the IRC, thus preserving the exempt status of a flawed retirement plan.

Can I Recover My Attorneys Fees? Maybe. It Depends.

When I first meet with a client on a new litigation matter, one of their first questions is how much is this going to cost. The second question is “whether the party will be responsible to pay my attorneys fees”. My answer to that question is always “It depends.”

These are legitimate questions. We all know that litigation is expensive. When clients come to us and want to sue somebody, it’s because they believe that they have been wronged . If they have been wronged, they believe that they should not be responsible for the fees to bring the lawsuit.

Whether or not the defendant will be responsible for attorneys fees depends on whether: a) there is a contract which provides for attorney fee recovery; or b) there is a statute which provides recovery of attorneys fees as part of the damages. Let’s walk through both instances.

You may come to us because your employer owes you wages and is refusing to pay you what you are owed. You want to sue for the wages. Can you recover your attorneys fees if you win in court? The answer is yes, because under the Illinois Wage Payment and Collection Act, in the case an employer is found to have wrongfully withheld wages to an employee, the employee may recover not only wages, but attorneys fees and costs in bringing the action. The law encourages attorneys to file suit against employers, and encourages employers to pay their employees, to avoid being sued for wages. Several other city, state and federal statutes, like discrimination statutes, landlord tenant statutes and employment statutes allow for the plaintiff to recover attorneys’ fees as a way to balance power.

Examples of contractual provisions for recovery of legal fees follow:

You may be a contractor. You are hired by a homeowner to work on her house. You have her sign a contract that provides that you are entitled to recover your attorneys fees and costs if you need to sue to enforce payment. The homeowner fails to pay you at the end of the project because she doesn’t like the color of the paint. You do sue her for the balance due because your contract allows for recovery of your attorneys’ fees and costs, you can recover them if you win at trial.

You may be a contractor who performed work on a building for a general contractor. The contractor did not pay you, and you are out several thousand dollars. You have an oral contract with the general contractor (not in writing.) You did not record a lien on the property. (If you had a lien, you may be entitled to recover fees because of the statute.) You can sue the general contractor and recover the contract amount, but you will not recover any of your attorneys fees. There is no statute contract provision that provides for recovery your attorneys’ fees.

You may be a homeowner who hired a painter to paint your house. You have paid the down payment, but the painter does a bad job painting your house. You refused to pay the painter at the end, showing him the issues you have with the work. You have a contract with the painter. It provides that if there is a lawsuit with regards to the contract that “the prevailing party shall recover its reasonable attorneys fees”. Can the painter recover its fees? The answer is yes if he wins at trial. But so can the homeowner if the court finds in his favor. The contract allows for the winner at trial to be awarded his fees.

So the point is that if you are in a position to have a written contract, make sure it has language in it that allows you as the prevailing party to recover your reasonable attorneys fees and costs. Look at your contract today to see if that language is contained in the contract. If it is not, call us, and we will help you draft that language. In particular, the term “prevailing party” should be defined in the contract.

Window Closing On Discounted Family Gifts

Making gifts of partial interests in family-controlled business entities in order to reduce transfer taxes is likely to become much more challenging in 2017. Using family-owned limited partnerships and limited liability companies to make children partners has been an effective way to transfer wealth out of a parent’s generation at a discounted value for transfer tax (estate, gift and generation-skipping taxes) purposes. When such gifts are made, gift tax returns for each gift must be filed demonstrating the value of property that has been gifted.

The logic of the technique is quite simple: say a couple owns development real estate with a value of $1,500,000 and wants their children to participate in the development of the land and to not have to pay estate taxes to inherit it. The owners would first deed the land into a newly-organized LLC of which one or both of them is the member (owner). If the owners had 3 children, they then could transfer, say, 30% membership interests in the LLC to each of the children, making each a 30% owner of the land development.

But ownership of a membership interest in an LLC is subject to the terms of the LLC’s partnership agreement also known as an operating agreement. Those terms include lack of marketability limitations (right of first refusal for other members) on selling the membership interest as well as lack of voting control over the investment for minority (say 30%) interests. So even though a 30% interest in the land should be worth an asset value of about $450,000, it is unlikely any unrelated buyer would pay that amount because of the partnership limitations.

When we counsel clients regarding making such discounted wealth-transfer gifts, we always have an appraisal prepared which indicates the appraiser’s evaluation of just how much the value of the LLC membership interest is diminished by these two factors and therefore what is the actual value of the gift. Over the years, while much more aggressive discounts are sometimes sought, we have typically seen discounts of 20-30%. Thus, a gift of $450,000 in value of real estate would only be assessed for gift and estate tax purposes for $337,500, which is 75% of its true asset value. Multiplied by three, the couple could transfer 90% of $1.5 Million real estate to their children for a value of just over $1 Million. In addition, the post-gift appreciation of the land would also be out of the parents’ estates, amplifying the estate tax avoidance benefits.

It should come as no surprise that the IRS has been very unhappy with this concept through the years, as the family is able to keep their property into the next generation with a nice estate tax discount. But while they have consistently fought court challenges to the amount of claimed discounts, the IRS has been unable to provide a legal objection to the discount concept. The IRS on August 2 finally issued long-anticipated proposed regulations which will be the subject of public hearings, after which final regulations will be issued which will be binding upon taxpayers. The proposed regulations, as expected, effectively eliminate discounts for transfers to family-controlled entities. The hearings will commence soon, and it is expected the regs will become enforceable sometime near the beginning of 2017.

If gifting makes sense for your plan, please call your DiMonte & Lizak estate planning attorney to evaluate whether it will be possible to make discounted gifts prior to the new law’s effective date. Until then, the technique will be legal. Even after the law takes effect, it may make sense to gift certain assets to children if the gifted assets are likely to appreciate over the years. Every family’s estate planning needs are unique, so allow us to be of assistance.

Please Comply with the Illinois Mechanic’s Lien Act When Performing Home Repairs

We are in the tail end of summer with the kids going back to school. As you contemplate those home repair projects you procrastinated having done, be sure to protect yourself as an owner when having contractors perform work on your home. Whether you are having an addition put on to your house all the way down to small projects such as replacing a broken fence, the Illinois Mechanic’s Lien Act (“Mechanic’s Lien Act”) applies to your project. The Illinois Home Repair and Remodeling Act also applies to your project. However, this is a subject of separate newsletter articles that can be found on DiMonte and Lizak’s website at www.dimontelaw.com.

It has been said that the Mechanic’s Lien Act is a powerful tool for a contractor, subcontractor, or material supplier to force payment from an owner when the general contractor or subcontractor fails to pay. In certain instances, even if you have paid the general contractor, a subcontractor or material supplier can force you to pay its balance due if the general contractor failed to pay it. In order to avoid this apparent unjust result, the Mechanic’s Lien Act has a provision to safeguard you. However, if you don’t comply with the Act’s requirements, you can not rely on the Act’s protections.

Very few people and sometimes few contractors consider the requirements of the Mechanic’s Lien Act when performing home repair and remodeling work. I will give you this hypothetical in order to illustrate the problems that can occur. All winter you have stared out the window at the section of your fence which blew down during the winter storm. Now that summer is here, you are eager to get a new fence installed. You contract with Woody’s Wooden Fences for $3,000.00 to have your old fence removed and a new fence installed. Burch Woody of Woody’s Wooden Fences presents a proposal to you that identifies the project, has a brief description of the work to be performed, a proposal price of $3,000.00, a line for you to sign and a line for someone to sign on behalf of Woody’s Wooden Fences. Once signed, the proposal becomes a binding written contract between the parties. This contract does not specifically reference the Mechanic’s Lien Act. However, the Mechanic’s Lien Act is read into every construction contract in Illinois regardless if it is specifically identified.

Burch Woody and his crew do a fantastic job, and in less than a week your old fence is torn down, hauled away and a new fence erected. Happy as a nine year old in line at the ice cream truck after baseball practice, you pay Woody’s Wooden Fences in full and receive a receipt in return. You do not ask Mr. Woody for a contractor’s sworn statement or waivers of lien required under the Mechanic’s Lien Act and he doesn’t offer them to you. Everyone is happily oblivious, that is until one month later when you receive a notice from Stiffed Lumber Company serving you with a Subcontractor’s Claim for Lien providing that it sold $2,000.00 worth of lumber to Woody’s Wooden Fences and delivered this material to your home for the construction of your new fence. It also provides that Woody’s Wooden Fences failed to pay any money to Stiffed Lumber Company in return.

Of course, you have recourse directly against Woody’s Wooden Fences and so does Stiffed Lumber Company. In the ensuing investigation, you both come to realize that Burch Woody and his company are in financial ruin and Mr. Woody has left the country to live as a nomadic bush man in the northern Canadian wilderness. He closed Woody’s Wooden Fences for good with no assets to cover this debt.

The Mechanic’s Lien Act requires the owner to ask for, and requires the contractor to supply, a contractor’s affidavit and sworn statement and Lien Waivers from the general contractor and all subcontractors and material suppliers. Stated differently, if the owner doesn’t ask for these documents, he or she is not afforded the protection of the Mechanic’s Lien Act. If the owner asks for these documents and the contractor doesn’t provide them, the contractor is not entitled to get paid.

So lets review what documents we are talking about. The contractors sworn statement and affidavit which should accompany every request for payment identifies that contract price, any extras or credits, the revised contract price, payments made to date, the amount of the current payment or draw request, and the remaining balance due. It also identifies the same information for each subcontractor or material supplier working on your project. Also accompanying each payment should be either a partial or a final waiver of lien from all subcontractors or material suppliers which identifies the amount being paid and the amount due on its contract.

If you obtain these documents with each draw payment you have a defense to any Mechanic’s Lien Claim by the general contractor, subcontractor or material supplier to the extent of the lien waivers received. In addition, if the general contractor fails to identify a subcontractor or material supplier on the contractor sworn statement and affidavit and you did not have prior knowledge of the subcontractor or material supplier working on your project, you can only be compelled to pay that subcontractor or material supplier any balance due from you to the general contractor remaining on the contract. As such, you can not be forced to pay more for your project than your contract price. The unpaid subcontractor or material supplier’s only recourse is against the insolvent general contractor.

As a homeowner, you need to protect yourself from claims of an unpaid subcontractor or material supplier whether you knew they were working on your project or not. The Mechanic’s Lien Act provides a statutory remedy to these unpaid subcontractors or material suppliers which could ultimately result in the sale of your home to satisfy the debt even if you have already paid the general contractor the full contract price. The only way to avoid this problem is to be aware of and force the general contractor’s compliance with the Mechanic’s Lien Act requirements whether you’re project is $2,000.00 or $2 million dollars.

Of course, everybody wants to be frugal and save money. However, if you do not understand the obligations and requirements of the Mechanic’s Lien Act, it may save you a lot of headaches and money in the future to retain an attorney to advise you in advance in negotiating a contract and requiring performance under the Mechanic’s Lien Act throughout the project. Please give me a call if I can assist you, your family or friends in this process. I hope you are having a wonderful summer.

Margherita Albarello Publishes in ISBA

Margherita Albarello has recently published an article called “Assistance and Service Animals In the Housing Context” The article is featured in the May, 2016 Animal Law Section of the Illinois State Bar Association.

https://www.isba.org/sections/animallaw/newsletter/2016/05/assistanceandserviceanimalsinthehou

401(K) Fiduciary Compliance Review

Recently I had a breakfast meeting with a friend and in the course of the meeting he brought up the fact that there is personal liability in the event that a retirement plan administrator, or plan trustee, does not comply with certain standards. This conversation caught my attention because I believe that most plan administrators of small retirement plans are the owners of the company or members of upper management in larger companies.
Well, what does it mean to be in compliance? After all, the client generally works with an advisor for an investment company (such as Voya, Fidelity, Merrill Lynch and many others) and at least annually, and in many cases more frequently, the employees of the company meet with the investment counselor. The employees are given a list of investments and told what the risk element is for various investments being offered. Isn’t this enough to be compliant? And the answer is a resounding NO!
Plan sponsors are required to regularly and continuously monitor investments offered under the plan to plan participants. The plan sponsors are responsible to be knowledgeable with respect to the fees charged and use appropriate benchmarks to evaluate the performance of the investments. This process needs to be documented. So if Plan fiduciaries (those making decisions about what investments are being offered to participants) should adopt and then review their Investment Policy Statement (IPS) to ensure that it contains clear guidelines as to how investments should be monitored and how often the reviews will take place. Best practices indicate that the investments being offered should be reviewed at least annually or more frequently if the fiduciary determines that doing so would be prudent under ERISA’s fiduciary standards. Once it is confirmed that the IPS contains language that periodic monitoring will take place, it is crucial that the monitoring process actually take place and is documented.
In a recent case (Tibble vs. Edison International) the Supreme Court stated a “fiduciary must discharge his responsibility with the care, skill, prudence, and diligence that a prudent person acting in like capacity and familiar with such matters would use.” The plan sponsors are fiduciaries. The ruling in that case emphasizes the need for plan sponsors to regularly and continuously monitor investments and fees, use appropriate benchmarks and document the process. Additionally, the plan sponsor will need to monitor the costs of administering the plan, not just the investment expense. This becomes extremely important if the plan participants are bearing the cost of the administration and recordkeeping for the plan.
Okay, I’m a busy executive and I don’t have time to do all of the things that appear to be necessary in order to be compliant with the regulations for managing a 401(k) program. What should I do?
First, if you have a plan advisor, find out if you have an IPS currently in place. If so, are you meeting regularly to review the criteria set forth in the policy? If not, you will want to work with an advisor to create an IPS for your plan. The criteria should be broadly drafted to provide for both quantitative and qualitative analysis of the investments offered, but not too stringent so as to require a specific action if the fund’s performance lags the appropriate benchmarks for a short period of time. Remember, you don’t have to be the investment expert here, you, as a plan fiduciary, just need to make reasonable and prudent decisions based on the information provided to you.
Also, keep minutes of these investment meetings along with any reports provided by your Advisor. This will provide defensible documentation of your periodic and formal monitoring process.
Lastly, you may want to consider fiduciary liability insurance coverage to help protect personal assets against claims by participants and beneficiaries as related to investment decisions made for the retirement plan. You may want to consider hiring an independent advisor who specializes in retirement plans.

Fraudulent Transfers: A lesson in persistence and asset recovery

Litigation is like a maze; there are twists, turns and uncertainties. To successfully navigate the maze of litigation you need to utilize many different skill sets and resources: preparedness, collaboration and organization are major components of any successful litigation. But in some matters, persistence is the litigator’s chief asset. This was so in our recent representation of a bank whose bankrupt borrowers secretly transferred their sole unencumbered asset to a family member.
We assisted the client in successfully foreclosing on one of the Bank’s customers who had defaulted on a commercial loan. The Bank was the successful bidder at the judicial sale and became the record title holder of the property. However, the Bank was not made whole as the value of the real estate was substantially less than the amount due it under the note. As such, the Bank obtained a deficiency judgment against the borrower.
The Bank believed that the borrower had other real property that could be used to satisfy the deficiency judgment. One of those properties was no longer owned by the borrower, having been transferred to a third party (“transferee”). The Bank believed that the transferee was related to the borrower. Based on the information provided to us by the Bank, we filed suit against the transferee, invoking sections 740 ILCS 160/5(a) and 740 ILCS 160/6(a) of the Illinois Uniform Fraudulent Transfer Act (“UFTA”). Unbeknownst to the Bank, the transferee was the borrower’s brother with a different surname.
The UFTA is a wonderful tool in asset recovery matters that permits a party to recover assets that were transferred from a judgment debtor to a third party. For the UFTA to apply there must be either (under section 5 – Fraud in Fact) the presence of statutorily defined 11 “badges of fraud” or (under section 6 – Fraud in Law) a transfer made after a claim arose and the transfer results in the transferor becoming insolvent. We pursued both claims, uncertain at the outset whether the proofs would support a Fraud in Fact or Fraud in Law claim. What unfolded over the next two years was one of the most trying and rewarding cases I have been involved in.
After initiating discovery we learned that the transferee was in fact a close relative of the borrower (one of the badges of fraud). Thereafter, we focused on learning who was actually in control of the real estate (another badge of fraud). After months of discovery disputes we were able to obtain both the borrower’s and transferee’s bank statements. However, the statements only told us that other bank accounts existed that had been withheld from production in discovery by both the borrower and the transferee. As a result, we issued additional subpoenas to the new bank accounts, engaged in additional discovery disputes and another three months later, obtained the additional bank account records. The results provided us with the proverbial smoking gun: evidence that the borrower had paid back the transferee for the purchase price of the real estate and that the transferee was signing over rent checks paid to it from the real estate to the borrower. Despite the avalanche of evidence we had, the case did not settle until the day of trial, when the transferee and his attorney could no longer ignore the magnitude of the evidence we had gathered.
The lesson from this case was persistence, because early on in the case it appeared the transaction was at arm’s length. But through hours of researching public records, obtaining and reviewing the financial records of the borrower and transferee, we were able to piece together a clear line of proofs to support both our fraud in fact and fraud in law claims. By staying true to the planned course of action and leaving no stone unturned, the maze became a path, clear and straight to a successful conclusion.

Updating Your Estate Plan

Many people are inclined to forget about their estate plans once they’ve signed the documents and filed them away. However, once you have an estate plan in place, it’s important to keep it up to date. You should review your estate plan every few years and any time there is a major event in your life, such as a divorce or a significant change in health.

Evaluating your estate plan every few years ensures that it will be updated when there are changes in the law. This includes your powers of attorney, which allow someone you elect to act as your agent if you are incapacitated or disabled and unable to make certain financial or health care decisions. A properly executed power of attorney can ensure that your wishes are followed and may help avoid conflict between family members. In Illinois, the statutory forms for both the health care power of attorney and property power of attorney have recently been modified. Even if you have existing powers of attorney, you should consider executing new documents using the most recent language. The property power of attorney was updated in 2011 to raise the standard of care for an agent, and effective January 1, 2015, the Illinois Power of Attorney Act also modified the power of attorney for health care. The amendments to the act included changes to the language describing the duties and responsibilities of the agent, as well as the descriptions for life-sustaining treatment options. The new form also indicates that the agent will act as the principal’s personal representative as defined under HIPAA, giving the agent access to medical records governed by HIPAA. Outdated powers of attorney that do not specifically include a reference to HIPAA may not allow the agent to have access to these records.

Estate planning strategies have also evolved in recent years in light of the greatly increased estate tax exemptions. The federal estate tax exemption is currently $5.45 million, while the Illinois estate tax exemption remains at $4 million. With the exemptions being so high, income tax planning has in some ways become more important than planning to avoid estate taxes. For example, incorporating a disclaimer trust is a tax efficient way to give a surviving spouse flexibility in determining which assets he or she would like to receive from the decedent. Additionally, before the exemptions were significantly increased, clients with large estates may have been advised to make gifts during their lifetimes to reduce their taxable estates. Now, the focus has shifted to taking advantage of the step-up in basis at death. For the majority of estates, paying estate taxes is no longer a concern and a more appropriate strategy is to maximize asset values at death.

We encourage you to reexamine your estate plan to be certain that it accurately represents your intentions and that it takes advantage of the recent changes in the law. An up-to-date estate plan will not only ensure that your wishes are respected, but will also lessen the burden on your surviving family.

Business Divorce – What Is It and How Do I Get One?

All businesses have owners. Without owners, a business would not exist. The owner starts the business. The owner has success. The owner makes mistakes. The mistakes cost money. The owner learns from her mistakes. So long as a single business owner remains single, she can make any business decision she wants without consulting anyone. She, alone, will enjoy the benefits or suffer the consequences of her business decisions.

Compare the sole owner to the joint business enterprise. For strategic reasons (additional capital, talent, or both), the single owner joins forces with one or more co-owners. They may decide to operate as a partnership, a corporation, or a limited liability company. Once the sole owner joins forces with a co-owner, business decisions must be made jointly. And the types of business decisions that may cause controversy within the organization are many. For example: (a) Should we perform (or decline) this project? (b) Should we hire (or fire) this employee? (c) Should we buy (or sell) this equipment? (d) Should we distribute (or retain) these profits? (e) Should we raise or contribute capital to cover losses? (f) Should we incur (or defer) these expenses? etc., etc., etc.

Every business owner knows there are many business decisions to make every day, every week, every month, and every year. Each owner has passionate feelings and philosophies which may support a particular position or decision. And, each owner’s decision making ability and style may make the decision-making process easier or more difficult. As we all know, there are both advantages and disadvantages to co-ownership of a business.

Many co-owners divide responsibilities. For example, one partner takes Athe office and the other takes the Ashop. One does the bidding and the other supervises the projects. One performs a sales function and the other performs a service function. Some owners delegate their decision making power to the other partners. Other owners want to be involved in every decision, no matter how small or petty. (My favorite example is the argument about the type of soda pop in the company vending machine). In short, there are many and varied things upon which business owners may disagree.

As you can imagine, the number of owners, the size of the business, and the legal entity used, can multiply the complexity of the organizational structure. The more complex the organizational structure, the more difficult it becomes to navigate and untangle once disputes develop. As an example, the simplest business organization is the two-owner partnership. At common law, one partner could dissolve the partnership by simply declaring it to be ended. The dissolution would automatically follow and both partners were free to settle the joint affairs of the business and go their separate ways to pursue their own separate and independent businesses. Upon dissolution of the partnership, the fiduciary duty owed to one another and the partnership would evaporate and the only lasting legal obligation was to wind up the financial and business affairs of the partnership. After dissolution, each partner was free to go their separate ways and pursue the same or a different line of business.

Compare the simple common law partnership with the modern day corporation or limited liability company-multiple owners, sometimes thousands of shareholders, eternal life, limited liability, by-laws, operating agreements, resolutions, annual shareholders and directors’ meetings, fiduciary duties and director and officer liability-it hardly compares! But modern day business requires a modern day business organization. And, when owners disagree on how to stay in business together, the modern business organization needs to be sold, dissolved, reorganized or sometimes simply liquidated.

The Business Divorce

Whether owners have used a partnership, limited partnership, corporation, or limited liability company to operate the business, the term Abusiness divorce generally means serious disagreement between owners about the way to run the business. In other words, is the disagreement so fundamental that the parties should split up and go their separate ways or would one or more like to buyout the other(s)?

Our business divorce cases take many forms. We have partnership dissolution and accounting, corporate dissolution and shareholder derivative actions, and limited liability company lawsuits. In each of these situations, the owners cannot agree on terms of separation, resolving the disagreement, or mutual buy/sell terms. We encourage negotiation before litigation. Negotiation can be difficult in business divorce situations especially since the personalities of the individuals involved may be difficult, stubborn, or eccentric. Like the dissolution of a marriage, many of these owners have been together for 10, 25, or even 50 years! They involve families, spouses, children, grandchildren, uncles, nephews and cousins. Some family businesses pick and choose between which children can be involved. Others mistakenly include all children much to the detriment of company management. I often observe companies that are Astarted by the father, grown by his son, and squandered by the grandson. Sharing a surname is not necessarily a recipe for success.

Moreover, each case is different and carries its own unique set of circumstances. Getting prompt, practical business and legal advice is essential. Unfortunately, many business divorce cases result in the unnecessary expenditure of corporate assets to fund the litigation between owners in disagreement. As they say, an ounce of prevention is worth a pound of cure. Once disagreements between co-owners reach the level of Airreconcilable differences, good practical, legal advice can prevent financial ruin caused by ego-driven litigation.

In a perfect world, business owners would resolve their problems internally, without lawyers or litigation. However, if that becomes impossible, prompt and practical legal consulting, with the creation of an exit strategy and dispute resolution plan, may prevent years of time-consuming and expensive litigation.

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Transfer on Death Instrument: Requirements, Amendments & Considerations

Jeffery Ramirez

On January 1st, 2012, the Illinois Legislature passed the Illinois Residential Real Property Transfer on Death Instrument Act (“Act”). The purpose of the Act is to allow an owner of residential real estate to designate a beneficiary who would receive the residential real estate upon the owner’s death. This transfer was memorialized through a Transfer on Death Instrument (“TODI”). This article examines the statutory requirements for creating a TODI, analyzes notable amendments to the Act, and discusses key advantages to consider before using a TODI as part of your estate plan.

I. Statutory Requirements

There are four essential elements required to create a TODI. First, the TODI must contain the same elements and formalities as required to execute an inter vivos deed. In other words, the TODI must be done in writing, contain words of conveyance, and provide a legal description of the real estate. Second, the TODI must be signed by the owner and two witnesses who must attest to the fact they believe the owner is exercising a free and voluntary will and is of sound mind and memory and both the owner and witnesses signatures must be notarized. Third, the TODI must expressly designate a beneficiary and state the transfer to the designated beneficiary is contingent upon the owner’s death. Fourth, the TODI must be recorded in the county where the residential real estate is located in prior to the owner’s death.

II. Notable Amendments

On January 1st, 2015, the Illinois Legislation amended the Act in two notable ways. The first notable amendment limited the class of individuals who have the right to create or revoke a TODI. In the original text of the Act, there were two individuals who had the power to create or revoke a TODI. First, the owner of real estate has the power to create or revoke a TODI. Second, the owner could previously vest their right to create or revoke a TODI in a third party by expressly granting that third party the power to create or revoke a TODI through a power of attorney for property. Under the amended Act, an owner no longer had the ability to vest their right to create or revoke a TODI in a third person. The amendment limited that right strictly in the owner of the real estate. However, the amended Act does not restrict an agent, pursuant to a power of attorney for property, to sell, transfer, or encumber the residential real estate; which ultimately has the same effect of revoking the TODI.

The second notable amendment eliminated a requirement placed on a beneficiary receiving real estate through a TODI. In the original text of the Act, a beneficiary receiving real estate under a TODI had to file a notice of death affidavit within 30 days of the owner’s death to make the transfer. Otherwise, the beneficiary would be liable to the personal representative of the owner’s estate for the expenses incurred in the management and care of the property subject to the TODI. The original text also contained a 2 year statute of limitations period by which a beneficiary was required to file a notice of death affidavit. Otherwise, the TODI in its entirety would be null and void to transfer the real estate to the designated beneficiary. Fundamentally, the amendment to the Act eliminated the burden on a beneficiary and it no longer made the filing of a notice of death a condition to the transfer of the real estate.

III. Considerations

Further, there are some considerations to keep in mind when determining whether a TODI is an appropriate estate planning tool for your estate plan. First, the creation of a TODI does not affect an owner’s right to sell, encumber, mortgage, refinance, receive public assistance, grant a legal interest to a designated beneficiary, or subject the owner’s real estate to a beneficiary’s creditors. Much like transferring a piece of real estate to a self-declaration life time trust and re-titling the real estate in the name of the trust; the owner does not lose any ownership rights or control with respect to that real estate. Likewise, the mere creation of a TODI does not affect an owner’s present ownership interest, right, and control with respect to the real estate subject to the TODI because the TODI does not become effective until the owners death.

Second, the Act defines a TODI as a non-testamentary instrument. To keep it simple, a non-testamentary instrument generally passes outside of probate. Much like contracts, life insurance policies, and promissory notes, those instruments are considered non-testamentary and are generally excluded from a decedent’s probate estate. In effect, property passing outside of a probate estate is not subject to decedent’s probate creditors or claimants. Therefore, a TODI can be used as way to transfer a residential real estate to a beneficiary and may provide a level of protection against a decedent’s creditors.

Lastly, using a TODI to transfer residential real estate to a designated beneficiary can make it simpler, less costly, and more efficient to refinance instead of using a Land Trust. In most cases, lenders require real estate held in a Land Trust be deeded out of the Land Trust to refinance the real estate. Consequently, the owner must deed the property back into his or her name to proceed with the refinance. Then after the refinance is completed, the owner has to remember to deed the property back into the Land Trust. This process is repeated every time an owner applies for a refinance. Alternatively, if the owner used a TODI instead of a Land Trust to hold the residential real estate, the owner would not have to go through the same process of deeding the real estate back into their name and then deed it back afterwards. This is because the TODI does not become effective until the owner of the real estate passes away. Thus, using a TODI instead of a Land Trust to hold residential real estate makes the refinance process much simpler, less costly, and more efficient.

Always consult your estate planning attorney, financial advisor, and tax specialist to determine whether a TODI is an appropriate estate planning strategy for your estate plan.

Aunt Rena and Julia, the “Service Dog,” in Commercial Establishments

Aunt Rena Albarello was born in 1925 in the Town of Pullman. She lost her sight at age 4 from spinal meningitis. In her late teens, she attended a residential guide dog school in Michigan where she was paired with Julia, a beautiful black Doberman Pinscher. Julia was taught by skilled instructors to safely guide her ward through the complexities of pedestrian travel. Julia provided Rena with increased independence and they loved each other very much.

Shop owners in Pullman and Roseland, like Fattori’s Square Deal and Frigo Bros. Foods, freely allowed Julia to accompany Rena into their establishments. Julia was harnessed. She had impeccable manners. She was not a “pet.” These business owners accommodated Rena long before the passage of the Illinois White Cane Law, the Service Animal Access Act, and the Americans with Disabilities Act of 1990 (ADA).

Title III (public accommodations and commercial facilities) of the ADA makes it illegal for places like restaurants, theaters, schools, and hospitals to interfere with the ability of people with disabilities to come onto the premises and access services. Today, Julia would be deemed a “service animal” under the ADA. The ADA defines a “service animal” narrowly as any dog that is individually trained to do work or perform tasks for the benefit of a person with a disability, including a physical, sensory, psychiatric, intellectual, or other mental disability. In certain circumstances, businesses also must permit the use of a miniature horse. Notably, the ADA regulations specify that the provision of emotional support, well-being, comfort, or companionship do not constitute work or tasks.

If Rena entered the Italian Village today for a meal of polenta and roast chicken, she could not be turned away. The restaurant legally could not ask her about the nature or extent of her disability because her blindness is open and obvious and the work performed by Julia for Rena’s disability is readily apparent. The restaurant legally could not ask Rena for proof that Julia has been certified or trained as a service animal. Special identification and certification are not required by the ADA. Neither a deposit nor a surcharge may be required as a condition of allowing the service animal to accompany the individual.

However, if Rena’s disability was a non-apparent seizure condition and Julia’s work or task relative to the condition was not readily apparent, the restaurant legally could make two inquiries to determine whether Julia qualified as a service animal: 1) Is this a service animal that is required because of a disability? and 2) What work or tasks has the animal been trained to perform? If the answer to the first question is yes, and the second question is answered, further inquiries are impermissible, and the restaurant cannot ask that Julia demonstrate her ability to perform the work or task for which she is trained.

The restaurant has some protection. If Julia is out of control and Rena does not take effective action to control her, or Julia does not control her waste or acts in a manner that poses a direct threat to the health or safety of others, the Italian Village legally could deny Julia access to the restaurant. However, a determination that a service animal poses a direct threat must be based on an individualized assessment based on the animal’s actual conduct. The restaurant legally cannot deny Julia access because of a stereotype that Doberman Pinschers are dangerous.

The law concerning “assistance animals” in the housing context differs from the above. I address the topic in this article.

© Margherita M. Albarello, Esq., 01-31-16

Assistance and Service Animals in the Housing Context (When must a housing provider allow a tenant to have an animal?)

Both the federal Fair Housing Act (FHA) and Title II of the Americans with Disabilities Act (ADA) require that certain housing providers reasonably accommodate people with disabilities who require animals to assist them in some manner related to their disability. While the FHA and the ADA have many similarities, the acts differ in significant ways and housing providers need to know the differences in order to comply with the law.

What is “housing”? The FHA covers nearly all types of housing, including privately-owned housing and federally assisted housing. Title II of the ADA applies to public entities that provide housing, like housing at state universities and other places of education. Sometimes the FHA and the ADA overlap (e.g., a public housing agency, sales or leasing offices, or housing associated with a university or other place of education), in which case the housing provider must meet its obligations under the reasonable accommodation standard of the FHA and the service animal provisions of the ADA.

What type of animal is covered by the acts? The FHA and HUD often use the term “assistance animal.” An assistance animal is an animal that works, provides assistance, or performs tasks for the benefit of a person with a disability, or provides emotional support that alleviates one or more identified symptoms or effects of a person’s disability. Courts are divided on the issue of whether an animal must be specially trained in order to qualify as a reasonable accommodation under the FHA. The better view appears to be that the FHA does not require that the assistance animal be individually trained or certified. An assistance animal is not limited to a particular type or breed of animal. The ADA uses the term “service animal.” In contrast to the FHA, the term is limited to a dog or a miniature horse, the animal has to be individually trained to do work or perform tasks for the benefit of the individual with the disability, and emotional support animals are not service animals.

What type of discrimination occurs? HUD reports that the most common disability-related complaint it receives involves assistance animals – the applicant or tenant asks that the landlord accommodate her disability by allowing her to have an assistance animal despite the landlord’s “no pet” policy, charges the lessee a fee for the ability to have the animal in the housing unit, or requires special identification or a certificate that the animal is an assistance animal. “No pet” policies cannot be used to deny or limit housing to people with disabilities who require the use of an assistance animal or a service animal because of the disability. The request for a reasonable accommodation may not be unreasonably denied, conditioned on payment of a fee or deposit or other terms and conditions applied to applicants or residents with pets, and a response to an accommodation request may not be unreasonably delayed.

When is an accommodation in order? In order for a requested accommodation to qualify as a reasonable accommodation, the requester must 1) have a disability and 2) the accommodation must be necessary to afford a person with the disability an equal opportunity to use and enjoy the dwelling. Under the FHA and the ADA, housing providers are to evaluate the request to possess the animal in a dwelling using the general principles applicable to all reasonable accommodation requests.

What may the landlord ask when a reasonable accommodation is requested? Under the FHA, the housing provider may ask individuals whose disabilities are not readily apparent or known to the provider to submit reliable documentation of a disability and their disability-related need for the assistance animal. There must be an identifiable relationship, or nexus, between the function the assistance animal provides and the disability. The landlord cannot ask an obviously blind person who uses a harnessed guide dog if she is disabled and why she needs the dog. In contrast, if the person has a psychiatric condition and seeks the accommodation for an assistance animal that provides him with emotional support, the landlord can ask the person to provide documentation from a physician, psychiatrist, social worker, or other mental health professional that the animal provides emotional support that alleviates at least one of the identified symptoms or effects of the existing disability. A housing provider may not ask an applicant or tenant to provide access to medical records or medical providers and may not ask for detailed or extensive information or documentation of a person’s physical or mental impairment. Questions a housing provider can ask under the ADA are more limited. The housing provider may only ask 1) Is this a service animal that is required because of a disability? and 2) What work or tasks has the animal been trained to perform? Here, too, if the disability and the work of the service animal is obvious, these questions may not be asked.

In cases where the FHA and the ADA apply, the housing provider should apply the ADA service animal test first in order to avoid possible ADA violations. This is because the permitted inquiries under the ADA are narrower than those allowed under the FHA. If the animal meets the test for a “service animal” (a dog or miniature horse) but the animal is, for example, a cat, the provider should allow the animal to live in the housing unit and accompany the individual with a disability to all areas of the facility where persons normally are allowed to go, unless 1) the animal is out of control and the handler does not take effective action to control it, 2) the animal is not housebroken, or 3) the animal poses a direct threat to the health or safety of others that cannot be eliminated or reduced to an acceptable level by a reasonable modification to other policies. If the animal does not meet the ADA service animal test, the provider should apply the FHA test.

What protections does the housing provider have? A request for accommodation may be denied if allowing the animal access to the property would impose an undue financial and administrative burden on, or fundamentally would alter the nature of, the housing provider’s services. The request also may be denied if the specific assistance animal poses a direct threat to the health or safety of others that cannot be reduced by another reasonable accommodation, or the animal would cause substantial physical damage to the property of others that cannot be reduced or eliminated by another reasonable accommodation.

What about breed, size, and weight restrictions? These restrictions are not allowed. Breed restrictions, for example, no pit bulls, generally may not be applied. A determination that the animal poses a direct threat of harm or substantial physical damage must be based on an individualized assessment, not on mere speculation. In his June 12, 2006 HUD memorandum, regarding “Insurance Policy Restrictions as a Defense for Refusals to Make a Reasonable Accommodation,” Deputy Assistant Secretary for Enforcement and Programs Bryan Greene stated that if a housing provider’s insurance carrier would cancel, substantially increase the costs of the policy, or adversely change the policy terms because of the presence of a certain breed of dog or a certain animal, HUD will find that this imposes an undue financial and administrative burden on the provider. However, the defense likely will fail unless the provider can substantiate the defense and show that it tried to find comparable insurance without the restriction.

Beware of companies that offer certifications and registrations of animals. There is no federal agency that regulates assistance or service animal certification. As stated above, certification that the animal mitigates the symptoms of a person’s disability is not required. There are several businesses selling certifications, registrations, and IDs over the Internet. All you need to do to receive these products is pay a fee. The dog never is tested and the disability never is verified. In contrast, legitimate training entities exist which issue certifications and IDs upon completion of the animal’s disability-related training. Know the difference.

Whose Ring Is It Anyway?

By Julia Smolka

Love is in the air. Between Christmas and Valentine’s Day, there is a surge of wedding proposals. There is also a surge in the purchase of expensive diamond engagement rings. Usually, those engagements end in wedding bells and nuptials. However, sometimes they do not. Current statistics show twenty percent of engaged couples break off engagements before weddings take place.

When the engagement ends, who ends up with the ring?

An engagement ring, given as part of a proposal, has been found to be a conditional gift. It is a gift, given by one party to another in contemplation of marriage between the parties. The proposal itself is a contract between two people – it’s a promise to marry. Once the parties are married, the condition for the gift is met, making the party who received the engagement ring the owner of the ring. The ring is a gift and it cannot be taken back by the giver.

Illinois courts have typically required the return of an engagement ring if the parties fail to marry. The courts found that an engagement ring is a gift given in contemplation of a marriage and is a conditional gift, meaning if the marriage does not happen, the ring should be returned to the proposing party.

But what happens if the party proposed to breaks off the engagement? What if the party in possession of the ring acts in such a way which makes going forward with the marriage impossible? What if the proposing party commits adultery during the engagement? What if there exists other abuse, addiction or other faults committed by the proposing party, making calling off the wedding a valid choice by the party in possession of the engagement ring? What if the proposing party is at fault for the breakup? The cases as they are now being decided find that fault does not matter. The ring must be returned if the marriage does not go forward.

The underlying law used as basis for the lawsuit is called a replevin action, and under Illinois replevin laws, there is no mention of assessing or considering “fault” when determining who is entitled to keep the ring. It matters who purchases the ring, why it was purchased, and why the party has the ring in his or her possession. The judges do not look at the party who was “bad.” The judge must decide which party has the right to possess and keep the ring.

I recently represented a woman who was given a very expensive diamond cocktail ring by her boyfriend. They broke up and she kept the ring. Six years after the breakup, the former boyfriend filed suit for return of the ring, claiming it was an engagement ring and my client had wrongfully kept it. My client maintained the position that it was just a gift, no proposal was made, no acceptance given and no engagement, meaning no conditional gift was made and the ring belonged to my client. The judge dismissed the action, without having to decide whether the ring was an engagement ring because the former boyfriend brought the lawsuit six years after the breakup. There is a five-year statute of limitations from the time of a breakup to bring an action to recover an engagement ring. My client’s former boyfriend was a year too late.

This was an interesting case, and I enjoyed working on it. If you have any interesting litigation cases, call me. I would love to discuss them with you.

Subcontractor Contract Review; Subcontractor Pre-Qualification Requests; Developers Beware-You May Have to Live with What You Agree To

Subcontractor Contract Review

I am often asked to review subcontract agreements between those of you who are subcontractors and the general contractor you are going to work for. In a project like this I advise my clients that I will take a practical approach to the contract review. I don’t nitpick the contract. If I did the process of obtaining work would be severely hampered. This is not what my clients need or want. I focus on what I view as the most important issues from a legal standpoint and business perspective. On business issues I point them out and ask that the client make a sound business decision as to how to approach the issue. On legal issues I may suggest modifications to the contract language or in certain instances suggest an entirely revised provision. The following are the usual issues that arise and the advice I give.

Notice provisions. A 24 hour time limit is too short and I recommend at least 72 hours. If there is a breach of contract on your part are you liable for consequential damages? Does anyone else besides the contractor you are working for have the right to reject your work? Permits: who is responsible for obtaining and who pays for them. If hazardous materials are encountered whose responsibility is it and are you compensated for demobilization and remobilization if the job is shut down. When does the warranty period for your work begin, one year from the time your work is completed or completion of the entire project. This can make a difference.

The indemnity provisions are a significant issue. Generally they are too broad and need modification. Under Illinois law you cannot indemnify another party for that person’s negligence.
What are the limitations on making claims for additional expenses, time limit and method for making the claim. Are there provisions for dispute resolution by mediation and arbitration? If so what is your position on this process and do you have to keep working while the mediation and arbitration takes place. If dispute resolution is by litigation are there any restrictions such as where a lawsuit has to be filed and/or waiver of the right to a jury trial.

Does the contract have a pay if paid clause. Most general contractor form contracts provide for this. Under Illinois law this provision is enforceable and you need to be aware of the risk it poses. What are the rights and responsibilities of each party under the termination for cause and termination for convenience provisions? If there is a suspension of work are you compensated for increased costs and demobilization and remobilization.

Retainage: What is the amount held back and when is it to be released. Is there a provision for reduction when the job reaches a certain level of completion? What are the insurance requirements? With regard to insurance I advise that you consult your broker as to what is being required and can you comply. Does the contract call for payment and/or performance bonds. If so, can you obtain them and who pays for them.

If your work is dependent on the work of others, what does the contract provide for detecting deficiencies. Generally the contract provides for you to report them otherwise you are deemed to have accepted the work and are responsible for how it affects your work. If payments to you are overdue is there an interest provision and when does it kick in? If you have a dispute with a sub-subcontractor or material supplier and they assert a lien on the project what are your responsibilities to resolve the issue, for example bond over.

Another issue of concern is what documents are incorporated by reference into the subcontract and what impact they have on the subcontract provisions. For example is the Owner-General Contractor contract made a part of your agreement. Are the Owner-General Contractor general conditions of the contract made a part of the subcontract. If there is a default or dispute on this job does the contract allow the general contractor to withhold payments from other jobs you are doing for him. Does the agreement prohibit subcontracting out portions of it or does it only allow you to do so with the general contractor’s permission?

These are the usual types of issues that arise in reviewing a subcontract agreement. I recommend to my clients who have me do this type of contract review that they maintain a library of these reviews. In this way if they work for the same general contractor on subsequent occasions they can use the prior review as a reference. In addition since most of these issues reoccur they can use a prior review to go over a new contract that they are asked to sign. This can make the process run more smoothly and contain legal expense.

Subcontractor Pre-Qualification Requests

Many general contractors have started to request that potential subcontractors submit pre-qualification statements before they are allowed to bid on projects or before a subcontract is awarded. Obviously the general contractors are trying to determine the financial strength and integrity of a subcontractor to avoid potential problems. I have seen a few of these forms and while for the most part they ask legitimate questions and want a subcontractor to submit basic operating information there are a few issues of concern. While asking about the structure of your company i.e. are you a corporation, partnership or limited liability company is proper, I see no reason to disclose who the shareholders or members are and their percentage ownership interest. Also these pre-qualification requests want your financial statements and information usually for the past three years. This is confidential information and I would advise furnishing this information only if the request provides at the very least that this information will be held in confidence. To be safe I would submit financial statements only if a confidentiality agreement is executed by the general contractor that gives you some relief should the sensitivity of this information be compromised. If you want a short and basic agreement for the general to sign please contact me and I can furnish one for you. Also perhaps you as a subcontractor should ask the general contractor for the same type of financial information especially in these difficult economic times. One form I have seen requires the subcontractor to sign the pre-qualification statement under oath and affirmatively state that none of the information provided is misleading. Obviously you should never provide inaccurate information but signing under oath raises significant issues not the least of which is liability for any misstatement even should it be non-intentional.

Developers Beware-You May Have to Live with What You Agree To

In a recent Illinois Appellate Court opinion a developer’s predecessor in interest sought and was granted a special use permit for a residential development that required 96 acres of the property be maintained as a golf course or other open space. The ordinance granting the zoning required execution of a restrictive covenant that required maintenance of the open space for 35 years unless the covenant was released by vote of five of the seven members of the Village’s board of trustees. Several years later the developer’s successor in interest approached the Village and requested that it be allowed to amend the zoning to permit the closing of the golf course, reduction of the open space from 96 acres to 51 acres and construction of approximately 350 new residential units on the once golf course land. The Village declined to release the covenant and refused to refer the rezoning request to its planning and zoning commission.

The developer’s successor in interest brought a lawsuit seeking to void the restrictive covenant and disconnect the property from the Village or in the alternative to force the Village to allow it to apply for the rezoning. The trial court held the restrictive covenant was valid but allowed the request for disconnection.

On appeal the Appellate Court upheld the trial court’s decision. The Appellate Court reasoned that one cannot agree to conditions in order to obtain a special use permit, take advantage of the special use in developing a portion of the land and then dispute the validity of the conditions. According to the Appellate Court, development of the land by the successor in interest’s predecessor was an acceptance of the benefits of the covenant along with the agreement to be bound for 35 years unless five of the Village’s trustees voted to release the covenant. The Appellate Court held that the trial court was correct in holding that acceptance of the covenant’s benefits prevents the successor in interest from seeking a release from the burdens of the covenant more that a decade later.

While the covenant regarding the open space was upheld, the Appellate Court also affirmed the trial court’s decision that the covenant did not prohibit the disconnection of the property from the Village. The covenant made no reference to any obligation to keep the property within the Village’s jurisdiction. Since the statutory conditions for disconnection were proven, disconnection of the property from the Village was allowed.

In this case, it appears that the original developer’s successor in interest may have won the battle but lost the war One has to wonder what good disconnection from the Village has if the covenant has to be followed in any future development of the land. Further development of the land as unincorporated property will still have to comply with the restrictive covenant and may not be as advantageous without certain municipal services. I wonder if a changed conditions argument may have helped the successor’s cause since it does not appear from the Appellate Court decision that this argument was made. The morale of the story is be careful as to what you agree to since you and your successors in interest may be bound to your agreement for some time to come.

General Contractor Contract Review; Amendment to Mechanic’s Lien Act; Zoning in a Home Rule Municipality – Rules and Procedures Need Not be Followed

General Contractor Contract Review

In the last issue of this newsletter I provided comments concerning issues that arise when I am asked to review for subcontractor clients a general contractor’s form contract. When doing this work for a general contractor in regard to an owner agreement many of the same issues arise. Provisions that deal with notice, consequential damages for breach, permits, hazardous materials, retainage (amount and reduction), indemnity and insurance are for the most part the same. However, there are certain issues that those of you who are general contractors confront when negotiating a contract with an owner that are different from those a sub encounters when dealing with you. The following are some of the owner/contractor issues I have seen and the advice I give when reviewing a contract or rider to a contract between the owner and general contractor

  • What is the effective date of the contract and how does this effect commencement of performance? Beginning construction should be related to when the building permit is issued and not just the signing of the contract.
  • When is substantial completion accomplished? It should not be dependent upon a final certificate of occupancy?. A temporary occupancy certificate should be sufficient along with minor punchlist items to complete. Also important is how long do you have to obtain substantial completion. This should be so many days from the effective date of the contract which again should be related to when the building permit is issued.
  • Is there a liquidated damages provision for not achieving substantial completion by the required date? If the owner wants this he should agree that if the project is completed early a bonus of a set amount per day is paid to you. A cap on these sums is something that is usually requested and is subject to negotiation.
  • Is there a limitation on the amount you are entitled to recover should you default on the contract? Are there any special requirements to obtain payment based upon the owner’s agreement with his lender? If the owner terminates the contract for no reason what are you entitled to recover? Payment only for work done and retention or also for loss of profit on the remainder of the work.
  • If a default occurs either by you or the owner is mediation and arbitration the required means of dispute resolution or is litigation permitted? In any event is the prevailing party entitled to recover attorney fees and costs. Any such provisions should be reciprocal.
  • Is there any special representations or warranty required regarding the work complying with local laws and ordinances? I have seen very broad provisions to this effect which need to be curtailed.
  • How are your subcontractors to be paid? Some contract provisions provide for direct payment by the owner which limits your control of the subcontractors.
  • Is there a provision that defines abandonment of the project on your part? I have encountered a provision that if work was not performed for ten consecutive days this constituted abandonment. In my opinion this was too short a period and I recommended it be changed to thirty days.
  • Is there a limitation on the amount you can charge for overhead and profit on extras? If so make sure the amount is sufficient to justify doing the work. Is there a provision for the owner’s architect to review and provide comments/approval of product data, samples and shop drawings within a reasonable time i.e. five to seven days from receipt.

These are some of the issues I have encountered in reviewing an owner/general contractor agreement. Resolving these types of issues at the beginning is important to a successful project. As I mentioned in last month’s issue when I review contracts for both subcontractor’s and general contractor’s I do not nitpick the contract or rider. I address the significant issues that can affect job performance and try to recommend language that is fair to both sides. If you encounter a particular problem I suggest that having me review the contract or particular provision at issue may be worth the cost to avoid future conflict.

Amendment to Mechanic’s Lien Act

Effective as of January 1, 2010 an amendment to the Illinois Mechanic’s Lien Act went into effect that pertains to an original contractor who works on an owner occupied single family residence. You are an original contractor if you contract with the owner of the property or one who the owner has authorized or knowingly permitted to contract for the improvement of the property. If you are going to work on an owner occupied single family residence then if you lien the property you now have to give written notice of the lien to the owner within 10 days after recording of the lien claim. If you do not give notice and as a result the owner is damaged before notice is given your lien is extinguished to the extent of the damages. This new provision now requires a second step that you did not have to do before if you fall into the category of an original contractor working on an owner occupied single family residence. The amendment does not apply to subcontractors and only applies to contracts that are made on or after its effective date, January 1, 2010.

Zoning in a Home Rule Municipality-Rules and Procedures Need Not Be Followed

A line of cases has developed that gives me concern as an attorney who does zoning and land development work. When I am representing a developer who seeks a zoning approval or someone who wants to challenge a municipal zoning decision, I look to the City’s or Village’s zoning ordinance to see what rules and provisions apply and what they state. However, if the City or Village is a home rule municipality, Illinois Supreme Court and Appellate Court decisions have held that a failure of the home rule City or Village to comply with its own self imposed regulations is insufficient to challenge the municipality’s zoning decision. A home rule municipality is any City or Village with a population over 25,000 or one that by referendum has chosen to be home rule. A County is home rule if its chief executive officer is elected by the electors of the County. The reason these decisions raise concern for me is if I am dealing with a home rule municipality what are the rules that apply?

In making these decisions the Illinois Supreme Court and Appellate Courts have emphasized that a municipal zoning decision is a legislative function. As such a home rule municipality has broad powers under the home rule provisions of the Illinois Constitution. Only when the zoning decision of a home rule municipality violates a provision of the Federal or State constitutions or violates the mandates of an applicable Federal or State statute will the courts intervene.

These decisions emanate from what I believe is a somewhat circumspect decision from a case that challenged a City of Chicago fuel tax ordinance. In that case the fuel tax ordinance was challenged on the grounds that it had been improperly removed from committee and therefore improperly adopted. The Appellate Court declined to review this assertion since there was no claim that the failure of the City Council to follow one of its own rules amounted to a violation of any constitutional or statutory provision. In my opinion this is far different than a home rule City or Village failing to follow the criteria or standards set forth in its own zoning ordinance.

The difficulty with these cases is clearly shown in an Appellate Court decision that dealt with the grant of a variance by the Village of Schaumburg for a room addition that was beyond the applicable rear yard setback. An abutting property owner challenged the grant of the variance. As is the case with almost all municipalities the Village’s ordinance set forth criteria for granting a variance. The Village’s zoning code provided that an applicant had to show there are practical difficulties or particular hardship in the way of carrying out the strict letter of the regulations of the ordinance. The Appellate Court held that since the granting of a variance was a legislative decision the Village did not have to follow its own standards as set forth in its zoning code and as long as the ordinance granting the variance was a rational means to accomplish a legitimate purpose it would be upheld. Failure to show what the Village’s zoning code provided as required for obtaining a variance was of no consequence.

Based on this line of cases, what they mean to me as a zoning attorney is that when dealing with a home rule municipality I do not need to be concerned with what the municipal zoning code provides with regard to standards for zoning relief. The mere failure of a home rule municipality to follow its own self imposed regulations in making a zoning decision is not in and of itself a constitutional violation. In order to challenge a home rule municipality’s zoning decision you need to make an independent claim of a constitutional violation such as procedural or substantive due process.

Procedural would be lack of notice or an opportunity to be heard. In order to claim a substantive due process violation it needs to be shown that the ordinance fails to pass a rational basis review under which legislative action will be upheld as long as it bears a rational relationship to a legitimate legislative purpose and is not arbitrary or unreasonable.

Dealing with a home rule municipality versus a non-home rule city or village with regard to zoning issues is different. The same rules do not apply.

Good Corporate Governance; Liability to your Surety – How Long?

Good Corporate Governance

If you are in business either as a Contractor, Subcontractor or Developer you most likely do so as a Corporation or more recently a Limited Liability Company. The reason for doing so is to insulate yourself from personal liability for the acts and/or omissions of the business. However, merely forming the business entity is not enough. You need to make sure that you are following legal formalities to maintain the protection the law provides for corporations and limited liability companies.

Many times a creditor of a business entity will try and pierce the corporate veil in order to impose personal liability on the shareholders and directors. This can be done if the corporation fails to hold appropriate annual meetings and keep minutes of them, commingles corporate and personal funds, fails to properly document transactions between shareholders and the corporation i.e. loans or does not issue proper stock certificates.

As business owners you are busy running your day to day operations and in the current economy just surviving is a major challenge. However, this seemingly mundane issue of keeping good corporate records is important. It can become even more so if your business encounters problems and you need to deal with creditors who will be looking to pierce the corporate veil and impose personal liability if they can. Some questions to ask and be prepared for are the following:

  1. Are you keeping minutes of meetings and properly documenting transactions that are not routine?
  2. Have you issued proper stock certificates and any new ones if the need arises, i.e. a new shareholder buys in or you gift stock to a child?
  3. Has the company been properly capitalized?
  4. Do not commingle personal and corporate funds. if shareholders make loans properly document them.
  5. Are all directors and officers taking an active part in the business operations?
  6. If transactions occur between the business and its owners i.e. you lease property to the business is it at market rates and properly papered with a lease that has all the usual terms and provisions?

The above list is not exhaustive but should give you an idea as to the types of issues that need to be addressed. Those of you who consult with me know that I strongly recommend that you let us provide corporate/limited liability company maintenance for you on an annual basis. You are busy with other business issues and usually don’t have time for this and may not think it important. However, this is what we do as lawyers and advisers to you. We charge a nominal fee for this service but I believe it is well worth the cost to make sure the insulation from personal liability is maintained. Those of you who have asked me about this issue know that I advise the nominal fee you pay us is “cheap insurance” to maintain proper corporate governance that can protect your personal assets should a business calamity occur. If we are not already doing this for you give me a call and I can give you more information about this service we provide.

Liability To Your Surety—How Long?

General Contractors that do public work are familiar with having to post payment and/or performance bonds. Sometimes the obligation for doing so is also placed on subcontractors for their part of the work. There are also private jobs where an owner will require a bond. In any event when you have to post a surety bond. the bonding company is going to require your personal guaranty to indemnify against any loss it sustains. When you give the guaranty and the indemnification your personal assets are liable to satisfy any judgment that is obtained against you. If your company defaults on the underlying construction contract and the surety has to come in and complete performance or pay creditors it will make a demand against you to indemnify for the losses it sustained. In a recent Illinois Supreme Court case the issue was how long does the bonding company have to file a lawsuit against you after it makes a demand and you fail to pay. Is the statute of limitations the four year statute that applies to construction improvements to real estate or is it the ten year statute of limitations that applies to written contracts?

In Travelers Casualty & Surety Company v Bowman the Illinois Supreme Court stated that in order to answer this question you have to look at the nature of the liability and not the nature of the relief that is sought. The four year statute of limitations applicable to construction improvements applies to the design, planning, supervision, observation or management of construction or construction of an improvement to real property. In order for this statute of limitations to apply, liability must rest on construction related activity. The Supreme Court held that this was not the basis upon which Travelers was seeking to impose liability on the individuals involved. Rather the liability at issue arose from a breach of the contractual duty to indemnify.

The construction company’s breach of the underlying construction contract resulted in the bonding company having to pay claims. Payment of these claims then triggered the individuals obligation to perform under the indemnity provisions of the bond. The individuals liability arose from their breach of their duty to indemnify and not from the construction company’s breach of the construction contract. Accordingly, the Illinois Supreme Court ruled that the bonding company had ten years from the date of the demand to bring an action against the individuals who had given their personal guarantees and agreed to indemnify the bonding company from its losses.

In these difficult economic times the possibility of defaulting on a contract is a real possibility. Things can just happen no matter how hard you try. The Travelers case lets us know how long the bonding company has to come after you. Its ten years which is a long period to have to have potential liability hanging over your head. While posting these bonds is something you cannot avoid if you are doing public work the Travelers decision lets you know for how long your personal assets are at risk should something go wrong.

Dispute Resolution – Litigation v. Mediation/Arbitration

When a construction dispute arises, it becomes necessary to decide whether litigation will be pursued or some other alternative dispute resolution mechanism. In some situations this decision was already made at the time the parties entered their contract. If the ALA form documents were used then a mediation/arbitration procedure will most likely have to be followed. However, even when the AIA documents have been used I will confer with my client and discuss the pros and cons of mediation/arbitration and determine if my client would prefer to litigate the matter or if circumstances exist such as the need to conduct discovery that we should still try to litigate.

It is well settled law that a contractual right to arbitrate can be waived like any other contractual right. Waiver will be deemed to have occurred when a party’s conduct has been inconsistent with the arbitration clause so as to indicate an abandonment of the right to arbitrate. Once a lawsuit has been filed you can claim that you no longer have the right to demand arbitration as you have waived that right and it is up to the other side to demand arbitration if they want it.

In determining whether to pursue alternative dispute resolution procedures it is generally thought they are more expeditious and less costly. My experience with the mediation/arbitration process leads me to advise that while the process is more expeditious, it is not less costly. The filing fees for mediation/arbitration are much more than to file a lawsuit. In addition the mediators/arbitrators charge significant hourly fees generally ranging from $400 to $600 or more. This can add up fast. There are no such hourly fees for a judge or jury in a lawsuit. Also you need to consider if more than one arbitrator is required by contract provision or by the rules of the agency administering the arbitration. Unless a case involves hundreds of thousands of dollars I personally see no reason for more than one arbitrator. I have been confronted with situations where a contract requires arbitration and the clause in the contract calls for multiple arbitrators and the amount in controversy is not that large. In these instances I have approached counsel for the other side and suggested that we agree to use only one arbitrator. In most cases the other side agrees since they realize that the expense of multiple arbitrators is not necessary.

Another possible disadvantage in arbitration is that discovery is not allowed or limited to a great extent. This may not be that much of a problem if the issues are straight forward and based primarily on documents. Also if the dispute has been going on for some time and the parties have been trying to settle then you have a good idea of what the other side is going to say. You also need to consider what agency is administering the arbitration. If it’s the ALA then the rules only allow for exchange of documents before the arbitration hearing. Some other agency’s rules allow for limited depositions. In most cases one for each side. Again the whole concept of mediation/arbitration is to streamline the process so extensive discovery is not going to bemediation/arbitration is to streamline the process so extensive discovery is not going to be allowed. In my experience limiting discovery does not hurt either side and does serve to expedite the process.

In determining whether to mediate and arbitrate a construction dispute I need to consider who the client is and what setting is best for that person. Mediation/arbitration provides for a more informal dispute resolution process. In one case I was involved in which required arbitration it would have been a disaster to litigate the case. My client was very knowledgeable about his construction business but he could not testify without using his hands to gesture and draw. While this was allowed in the arbitration it would not have been in a courtroom. I have had other clients who were extremely good witnesses in a courtroom and did quite well. The bottom line is I need to consider if my client is going to be more comfortable in an informal setting as opposed to a courtroom. In an arbitration proceeding, the rules of evidence are relaxed and the proceeding is private. No public record is made of the dispute nor the award that is made. However, another important consideration is the finality of the award. It is extremely difficult to vacate an arbitration award. Also there is no appeal from an arbitrator’s decision.

If mediation is required before arbitration, my experience is that mediation only has a chance to succeed if the process is treated seriously. It is necessary to be throughly prepared even though the mediation process is informal. Mediation gives an opportunity to determine how a neutral third party will react to the claim you have and the reasonableness of the settlement position you take. If a mediation is going to have a chance of success a well prepared presentation is needed that is well formulated and presented concisely. In a mediation it is necessary for me as the lawyer to not let the adversarial nature of good lawyering overtake the mediation process. The more conciliatory and cooperative the parties and their attorneys are the more likely an amicable resolution will be achieved.

If litigation is possible and determined to be the preferred means of resolving the dispute a determination needs to be made whether to request a jury trial or bench trial. I always confer with my client before making this decision. Some people distrust judges and would rather place their fate in a jury of their peers. In addition a trial by jury is a constitutional right. However, 1 always caution my construction clients regarding the complexities of construction litigation and what the public’s attitude is toward contractors. This is especially true when I represent homebuilders. I would almost never advise a homebuilder to demand a jury trial. ‘[‘his is not so because homebuilders don’t do good work but because the jury pool is most likely going to consist of at least some people who have had a problem with a builder. In such situations it is much better to take your chances with a judge and a bench trial than a jury.

A trial before a judge is much like a proceeding before an arbitrator. Even though the rules of evidence govern, in my experience in most bench trials almost all evidence is admitted. There is one important difference between a bench trial and an arbitration. You can appeal from a judge’s decision.

Regardless of which dispute resolution mechanism is chosen it is important to properly determine the facts and present them clearly and concisely. I always advise my contractor clients that just as they use an architect’s plans for construction of the building the complaint I prepare or the demand for arbitration that I submit is the blueprint for resolution of the dispute. To the greatest extent possible we need to get it right and do so the first time it is submitted so that amendments are not needed.

Regardless of whether the dispute is being litigated or arbitrated it is important to properly frame the claim and present it in the best manner possible. t advise my clients that it is extremely important that we know the facts, marshal the evidence such as job logs, time records etc., to support the claim. We need to present the case clearly, succinctly and be consistent. To the extent this is done and done well the more likely success will be achieved whether it’s in litigation or arbitration.

Lienable Services – Architects and Engineers Dilemma

If you are an architect or engineer and do work for a construction or land development project that does not go forward and your client fails to pay, do you have a mechanics lien that can be enforced to secure payment? In my opinion, the answer is yes but some Illinois Appellate Courts have a different view. I think they are wrong.

The Illinois Mechanics Lien Act (Act) provides that if you “perform any services or incur any expense as an architect, structural engineer, professional engineer…in, for or on a lot or tract of land for any such purpose” you have a lien. The phrase “for any such purpose” refers back to constructing improvements on the property. The Act does not say that if you are an architect or engineer there has to be an actual improvement of the property. However, some Illinois Appellate Court decisions have imposed this requirement.

A recent Appellate Court decision involved a situation where Power Holdings of Illinois LLC was a contract purchaser of property and intended to construct a coal gasification plant on the land it was acquiring. It contracted with an environmental firm to provide “air quality construction permitting and dispersion modeling services.” The environmental firm was to focus its permitting application process and efforts on securing construction permit approval for the property. The environmental firm did its work and was not paid. It recorded a mechanics lien and filed a lawsuit to enforce the lien. A motion to dismiss was filed and granted by the trial court. The environmental firm appealed.

The motion to dismiss argued that the environmental consulting services were performed to aid Power Holdings in determining if the land would meet the requirements of the Illinois Environmental Protection Agency for a coal gasification facility and that the services did not benefit the land directly or indirectly. The motion to dismiss further argued that the environmental firm did not provide any design or construction work. The Illinois Appellate Court upheld the dismissal of the complaint and stated in its decision that “the proper focus in determining the validity of a mechanic’s lien is whether the work actually enhanced the value of the land.” The Appellate Court went on to state in what I would characterize as a play on words “that the services rendered by the plaintiff were not for the purpose of improving the land but were for the purpose of determining whether Power Holdings should exercise its option to purchase the land and thereafter build a coal gasification facility thereon.” The Appellate court held these were not the type of services for which a lien can be filed and enforced under the Act.

In my opinion decisions such as the Appellate Court made in the environmental firm’s case are wrong for several reasons. First the courts are not distinguishing between an architect’s or engineer’s lien and that of a contractor, subcontractor or material supplier. The Act very clearly states that if you perform ANY services or incur ANY expense as an architect or engineer for the purpose of constructing improvements on the lot or tract of land you have a lien. The Act does not state that the improvements actually have to be constructed. In my over 30 years of experience architects and engineers usually have mechanic’s lien problems when the project does not go forward. It’s when the developer doesn’t succeed that he feels no one should get paid if he has not made a profit. This is not the risk that the architect or engineer has agreed to take.

An Appellate Court decision such as in the environmental firm case imposes a judicial requirement of adding value to the property for an architect or engineer to have a mechanics lien. This is improper and in my opinion not the law.
I also think the Appellate Court is wrong when it states the focus should be on whether the work actually enhanced the value of the land. Enhancement is only an issue in a mechanics lien case when a mechanics lien competes for priority with a prior recorded mortgage. As between the owner and mechanics lien claimant there is no issue of enhancement.

By their very nature, architectural and engineering plans and studies do not constitute a physical improvement to real estate. However, the Act recognizes this and states explicitly that all that is required for an architect or engineer to have a lien is that he provide services or incur expenses for the purpose of improving the real estate. A trial court’s ruling requiring that the services furnished “add value” will mean that in most situations an architect or engineer will be precluded from asserting a mechanic’s lien claim. As mentioned above most architect or engineer lien claims arise when a proposed development does not proceed. The Act takes this into account and explicitly provides that all that is required is that the services be rendered for the purpose of improving the property and not that an actual physical improvement be made.

A few years ago I encountered the same type of situation for a civil engineering firm that I represent. Civil engineering was done for a proposed development for the contract purchaser. The development did not proceed and my client was not paid for its work. We recorded a lien and filed suit to enforce it. A motion to dismiss was granted by Judge Clifford Meacham of the Circuit Court of Cook County. He made a ruling that the work had to “add value” to the land. I took his ruling up on appeal.

While the appeal was pending we settled the case and did not get an Appellate Court decision on my argument that an architect’s or engineer’s lien is different from that of a contractor. Judge Meacham retired about a year ago. I had many cases before him during the years he served as a judge. On the day he retired I went to his court room to say good bye and wish him the best in retirement. He saw me sitting in the back of his court room waiting for his call to conclude. He stopped what he was doing and called me up to the bench. He had surmised why I was there.

We exchanged best wishes and as I was ready to leave he said you remember that engineer’s case you took me up on, I’ve been thinking about it for a long time and on that one I got it wrong. He said “Al you were right.” While that is not much consolation for my client it made me feel good and convinced that my analysis is correct. Hopefully I will have another similar case and if I get an adverse trial court ruling I can take the issue up again and this time get an Appellate Court decision upholding my position. Stay tuned.

Interest and Attorneys Fees – Settlement Leverage

Those of you who have had me work with you to review and revise your form contracts whether you are a general or sub know that I recommend you include a provision for recovery of interest and attorney’s fees if there is a dispute with your customer. You can have a contract clause that provides for this that is one sided, namely you get interest on any unpaid balance and you recover your attorney fees if there is a dispute and an award is made in your favor. Some of you agree with this but some of you express you do not want the contract to be too harsh so that prospective customers are scared away. When I hear this, I suggest the provision for recovery of attorney’s fees be made reciprocal. I then draft a provision that states if there is a dispute that results in either a lawsuit or arbitration the prevailing party is to recover interest on the award and reasonable attorney’s fees. I can also include language about recovering costs if that is desirable. The interest rate should be set at a rate that makes a difference. Currently the Illinois Mechanic’s Lien Act provides for interest at ten percent so I would not set the rate any lower.

You may be wondering, do provisions for interest and attorney’s fees make any difference and are they of any real value? In my opinion they are. Let me provide an example.

I am in the process of settling a matter for a client where the claim is approximately $257,000. The client is a luxury home builder and was going to build a house that was estimated to cost approximately 12.5 million. The client’s architectural group designed the house but with a project of this magnitude as is usual the customer was working with an interior designer to select finishes, colors etc. The interior design project was dragging on so the client and its customer decided to proceed to start demolition of the existing structures on the property, do the site grading and construct the foundation and swimming pool. A separate contract for this construction was entered. Unfortunately when the work was finished and the third and final draw was to be paid the homeowner refused to pay. This particular homeowner builds a number of clinics throughout the country and has a commercial architect who began to critique the client’s work on the house and interfered to the point that the homeowner lost confidence in the work our client did. Allegations were made that the soils compaction was not proper, the foundation was not reinforced properly, the steel framework was not structurally sound and more.

Per the terms of the contract I filed a demand for arbitration for the money that was owed, $257,000 plus interest and attorney’s fees. The foundation contract provided for the prevailing party to recover not only the amount found due but also attorney’s fees and the costs of the arbitration and any other related expenses. In addition interest at the statutory rate set forth in the Illinois Mechanics Lien Act is to be given on the money awarded which as noted above is currently ten percent.

Within a short period of time after the arbitration demand was made, the homeowner’s attorney contacted me and made an offer of settlement in the amount of $150,000. I inquired why a deduct of over $100,000 should be considered and the response was that there were numerous defects in our client’s work that needed to be corrected. While our client had no intention of considering this offer, I used it to learn what their defense to the claim would be. I contacted the homeowner’s attorney and asked to see any reports they had, test results regarding soils and proposals and paid bills for corrective work. What I received convinced me and our client that the homeowner’s claims were not well founded. Soils analysis was done when the soils were wet which resulted in a few areas where the psi did not conform to contract requirements. My client knew that if they waited for the soil to dry out its strength would come back and once the drainage system was operational there would be no problems. A report that the steel had not been erected properly was also bogus because after the report had been done our steel subcontractor corrected any deficiencies. My client dug in and directed me to reject the settlement proposal which I did without making any counterproposal for settlement.

A few weeks went by and without any contact on my part the homeowner’s attorney made another offer of settlement increasing the offer by $75,000. My client and I found it strange that another offer to settle would be made without us having made any counterproposal. However, this confirmed in our minds that the homeowner’s claims that the work was defective were not well founded. My client and I discussed the matter and decided that we would hold firm with our position that nothing was wrong with the work and full payment of the balance due had to be made. I agreed with the client that if he felt strongly that the work was done properly he should remain steadfast that the full amount due had to be paid. However, I knew that in settlement everyone has to “get something” so I suggested making a counterproposal where the client would waive the claim for attorney’s fees and interest if the full amount due was paid. I calculated the interest that had accrued which at the time was over $13,000 and made a proposal in writing to the homeowner’s attorney that if they agreed to pay the $257,000 our client would waive interest and attorney’s fees. The counterproposal has been accepted, a settlement agreement agreed to and right now we are working with the escrow agent to process payment of the settlement funds to our client and the subcontractors that worked on the project. Everyone is being paid in full.

As you can see, the provision for recovery of attorney’s fees and interest at a significant rate helped make this settlement. This provision in the contract gave us negotiating leverage where we could be adamant on recovery of one hundred percent of the claim and yet give the other side something. I reminded the homeowner’s attorney that if they did not settle now the homeowner would be paying a significantly greater amount if we went through full arbitration with an award being made in our client’s favor. The homeowner would then be subject to paying interest on the award from the last day worked and my attorney’s fees and the expenses of the arbitration.

I think you can see the advantage of having an attorney’s fees and interest provision in your form contracts. This type of provision gives you leverage in settlement. If you do not have this type of provision in your form agreements you can contact me and I can draft provisions that will give you this advantage should a dispute arise on one of your projects. The cost incurred to do so is minimal compared to the long range benefit and leverage obtained. I would be happy to work with any of you to review and revise your form agreements.

The Home Repair and Remodeling Act

Those of you who are engaged in home repair and remodeling have had to contend with the Illinois Home Repair and Remodeling Act (Act) since it went into effect on January 1st, 2000.  As you know the Act requires that before starting home repair or remodeling work for over $1,000 you have to provide the customer for signature a written contract or work order.  Also before the customer signs the contract you have to provide a pamphlet “Home Repair: Know Your Consumer Rights.”  The customer has to sign an acknowledgment form that this has been done.

As we all know “things happen” in life as well as in business.  Even the most organized business may run into a situation where although unintentional an oversight occurs and one of the requirements of the Act is not followed.  Initially the Illinois Appellate Courts took a very rigid stand on violations of the Act.  Basically the Courts position was if there was a failure to comply with the Act a contractor could not recover even under equitable principles such as unjust enrichment or quantum meruit.  For example, in the Appellate Court decision in Smith v Bogard a contractor made a contract with a customer for a room addition to their house but failed to commit the contract to writing and did not give the homeowners the consumer rights brochure. When the work was finished the homeowners refused to pay the balance owed and the contractor sued.  The homeowners raised the contractors violations of the Act as a defense.  The Appellate Court upheld the trial court’s dismissal of the contractor’s lawsuit.  The contractor argued that even if the Act precluded recovery he should still be allowed to recover under equitable principles of law otherwise the homeowners would receive a windfall.  The Appellate Court disagreed and stated, “Allowing a contractor a method of recovery when he has breached certain provisions of the Act would run afoul of the legislature’s intent of protecting consumers, would reward deceptive practices, and would be violative of public policy.”  A pretty harsh result without considering how the violations of the Act may have affected the work done or the fact that the homeowners were getting something for nothing.

Fortunately the Illinois Supreme Court has addressed the issue of violations of the Act in its recent decision in K. Miller Construction v McGinnis.  At issue in McGinnis was whether a home remodeling contractor who violates the Act and enters an oral contract for home remodeling work over $1000 can enforce the oral contract or seek recovery in quantum meruit against the homeowners who refuse to pay for a completed home remodeling project.

The facts showed that the contractor had done work for these homeowners previously and before the litigation the owner of K. Miller Construction and Mr. McGinnis were friends.  The McGinnis’s bought a three flat apartment and wanted to convert the building into a single family residence.  Initially the project was to cost $187,000.  After work began the McGinnis’s informed Miller that they wanted to significantly increase the work and had new plans drawn for the larger project.  The modifications increased the total cost of the project to approximately $500,000.  The homeowners paid the first $65,000 of invoices but after that told Miller they did not want to make further payments until the end of the project.  Miller could not self-finance the work and therefore obtained a bank line of credit.  The homeowners regularly visited the construction project and approved all of the work except certain flooring which was estimated to cost about $300 to repair.  At the close of the project there was a balance due of over $300,000 which the homeowners refused to pay.

The contractor filed a lawsuit seeking in Count I to foreclose a mechanic’s lien, Count II was for breach of contract and Count III sought recovery in quantum meruit.  The homeowners filed a motion to dismiss and raised the violation of the Act, no written contract, as a defense and also the decision in Smith v Bogard as to the contractor’s claim to recover in quantum meruit.  The trial court granted the homeowner’s motion. The Illinois Appellate Court affirmed in part and reversed in part.  The Appellate Court agreed that because there was no written contract recovery on the oral contract and for a mechanic’s lien could not be had.  The Appellate Court reversed on the issue of quantum meruit recovery since there was no clear and plain intent in the Act to do away with this equitable remedy.

The Illinois Supreme Court approached the issue as determining whether or not Illinois public policy precludes recovery under an oral contract that is violative of the provisions of the Act.  In doing so the Court commented that a statutory violation does not automatically render a contract unenforceable if not seriously injurious to the public order.  The Supreme Court also commented that the Illinois legislature is capable of stating when a contract that violates the statute is unenforceable.  No such provision is made in the Home Repair Act.  The Illinois Supreme Court never really addressed the public policy issue because on July 12, 2010 the Act was amended and the provision that previously provided that oral contracts in violation of the Act were unlawful was changed in its entirety to now provide that any person who suffers actual damages as a result of a violation of the Act can bring an action under the Consumer Fraud and Deceptive Business Practices Act.  The Illinois Supreme Court held that this amendment was not a change in Illinois law but a clarification of existing law and made clear that a violation of the Act does not render oral contracts unenforceable or relief in quantum meruit unavailable.  The Supreme Court concluded that there is no public policy requiring oral contracts over $1,000 be held unenforceable or that relief in quantum meruit be denied.

I represent many of you who are home remodeling contractors or do home repair work.  The Illinois Supreme Court’s decision in McGinnis is important for you and a practical approach to what I think was getting out of hand with certain Appellate Court decisions.  In the McGinnis case the contractor and homeowner had done work together before and were friends.  Why wouldn’t the contractor think a written contract was not necessary?  It’s easy in hindsight to criticize but in the real world it’s easy to see how this could happen.  As a result should the McGinnis’s get a windfall and be able to use over $500,000 worth of work without having to pay for it.  Also in this case all of the work was done properly with only a small portion needing to be corrected.  It would be an extreme injustice in a case such as this to say that the contractor loses and the homeowner wins just because of violations of a statute.

I have not had a case yet where home remodeling or repair was done under an oral contract.  However, I have had a case where a claim was made by the homeowners that the required brochure was not timely given.  After the contract was entered the contractor and homeowners communicated regularly and the real issue was timely commencement of the work.  In this case just as McGinnis the homeowners would have been hard pressed to show any actual damages as a result of not getting the “Home Repair: Know Your Consumer Rights” pamphlet even if that allegation had been true. The amendment that was recently made to the Act by our legislature and the Illinois Supreme Court’s decision in McGinnis are important for the home remodeling industry and bring some practicality to situations that could otherwise lead to unjust results.

Home Repair Act-Follow Up

In the October issue I addressed the Illinois Supreme Court’s latest decision on the Illinois Home Repair and Remodeling Act.  I received a very good question from a client who is an architect but also does general contracting and construction management work.  The question was does the Act apply to construction managers as advisors to homeowners?  The Home Repair Act defines home repair and remodeling as “the fixing, replacing, converting, modernizing, improving or making an addition to any real property primarily designated or used as a residence.”  The requirement of a written contract or work order applies to any person engaged in home repair or remodeling.  In my opinion this language is broad enough to encompass a construction manager.  The better practice would always be to have your contract in writing.  As far as the requirement to give the brochure Home Repair Know Your Consumer Rights, I do not think a failure to give this is going to cause a problem in most instances.  The reason for my belief on this point is the amendment to the Act which I referenced in my article which now requires the homeowner to show actual damages as a result of a breach of the Act.  I think a failure to give the brochure is not going to cause actual damages in almost all cases.  One Appellate Court has called this brochure merely a “tip sheet.”  Again the better practice is to comply with the Act.  However, as the Illinois Supreme Court held in McGinnis, all is not lost if a failure to comply occurs.

Vested Rights – A New Test Applies

If you are a developer can you rely upon a zoning classification from a change in zoning by a municipality after you have purchased the property or entered into a contract to purchase.  Under Illinois law a property owner may obtain rights to develop property based upon a prior zoning classification if you in good faith rely upon the probability of a building permit being issued and you sustain a significant change in position based upon making substantial expenditures or incurring substantial obligations.  In a recent Illinois Appellate Court decision the Court clarified the nature of the vested rights doctrine.  In 1350 Lake Shore Associates v Randall the Court applied a totality of the circumstances test to determine whether or not a municipality is estopped from enforcing a zoning change against a developer based upon a vested rights argument.

In Randall the Court held that expenditure of $272,000 were not sufficiently significant to trigger a vesting of development rights.  The Randall Court held that a proportionality test is to be used to determine substantiality.  You are to compare the expenditures made to the total project costs.  In Randall the $272,000 of expenditures amounted to less than one-half of one percent of the total proposed development cost of $72 million.  This was considered insufficient.

The Appellate Court in Randall did not establish any bright-line test for determining substantiality of expenditures.  The Court held that in determining substantiality you are to consider the totality of the circumstances.  One of the factors to consider is the purchase price of the land.  You also make a comparison of the expenditures incurred to the total projected cost of the development.  You also consider the nature or character of the person or entity seeking to develop the property and any other factors that are deemed relevant.  No single factor is controlling and each case presents a different factual setting that has to be assessed base upon its own facts to determine whether substantial expenditures have been made.

The Randall decision may make it more difficult for a developer to succeed on a vested rights claim.  The developer’s expenditures will no longer be considered in a vacuum.  An analysis must now be made of all of the relevant factors to determine if expenditures are substantial.  It does seem appropriate to examine the totality of the circumstances in determining if it is unfair for a municipality to be allowed to change a zoning classification and make it apply to a particular development proposal.  It will be interesting to see how the courts apply this “new test” to various factual situations as they arise.

Bankruptcy Notice – Now What Do You Do

Those of you engaged in construction whether as a general contractor, subcontractor or material supplier know that you have mechanic’s lien rights to secure payment from the owner or contractor for whom you have worked.  On a private job the property stands as security for what is owed.  On a public job the money owed to the general contractor by the governmental entity provides the security for what is owed.  In these difficult economic times questions often arise as to what you should and can do if you receive the dreaded notice that the owner, general contractor or subcontractor with whom you have contracted has filed for bankruptcy.

Once a petition in bankruptcy has been filed an “automatic stay” order is issued by the Bankruptcy Court.  The “automatic stay” is an injunction-like prohibition.  It prohibits a creditor during the pendency of the bankruptcy case from instituting any action against the debtor or against its property on account of a pre-petition debt.  However, the “automatic stay” does not prohibit perfection of your mechanic’s lien rights.  Whether it’s the owner, general contractor or subcontractor that has filed for bankruptcy you can and should proceed to perfect your mechanic’s lien.  If you are a general contractor record your lien within four months of your last day worked.  If you are a subcontractor or material supplier send out the ninety day notice within ninety days of your last date worked or last delivery of material and then proceed to record your lien claim within the four month requirement.

Once your lien claim is recorded you are protected as far as security for the money that is owed.  However, you still need to enforce your lien in order to recover the amount due.  This is done by filing a mechanic’s lien lawsuit.  Under the Illinois Mechanic’s Lien Act a lawsuit to enforce a lien has to be filed within two years from your last date worked.  However, when an owner or general contractor or sub has filed bankruptcy, you cannot file a foreclosure lawsuit without approval of the bankruptcy court.  This is commonly referred to as lifting the stay order.  When the owner is in bankruptcy lifting the stay order can be more difficult than when it’s the general contractor that has filed for bankruptcy protection.  Usually if the owner is in bankruptcy the stay is not going to be lifted unless there is no equity in the property.  If it’s the general contractor or a subcontractor that has filed for bankruptcy you can usually get the stay order lifted so long as you agree not to seek any direct relief against the general or sub.  The reason the Court usually allows the stay to be lifted against the general contractor is because the general is required to be a named defendant in a mechanic’s lien lawsuit and so long as you are not seeking direct relief against the general contractor the bankruptcy proceeding is not affected.

What happens with regard to the two year time limit to file the mechanic’s lien lawsuit when a bankruptcy petition is filed.  The Illinois Supreme Court took care of that issue in its decision in Garbe Iron Works Inc. v Priester and held that the two year limitation is tolled during the pendency of the bankruptcy.  The two year limitation is tolled until the automatic stay order is modified.  The same tolling takes place if an owner serves a Section 34 notice to commence a lawsuit and a bankruptcy occurs.  In Chicago Whirley v Amp Rite Electric a subcontractor perfected a lien. The owner served notice to commence a lawsuit which meant the subcontractor had thirty days to do so.  However, the general contractor filed for bankruptcy.  The Appellate Court held the thirty day requirement was tolled until the stay order was lifted.  You can also encounter bankruptcy issues after the mechanic’s lien lawsuit has been commenced.  If a general contractor or subcontractor files for bankruptcy during the foreclosure proceeding the lawsuit is stayed until either the general or sub is discharged or the stay order is lifted.

As you can see all is not lost if you receive a notice of bankruptcy.  While you cannot proceed on a breach of contract claim, you can perfect and enforce your mechanic’s lien rights.  It is always important to act within the required time limits for sending notice and recording the lien.  It is even more important to do so when an owner, general contractor or subcontractor has filed a bankruptcy petition.  Once you perfect your mechanic’s lien claim you then have plenty of time to try and reach a settlement before having to file a lawsuit to enforce the lien.

What You Sign Does Matter

Over the past two years the construction industry has been hit hard by the downturn in the economy. When I talk with my construction clients, I hear the same complaint. Either there is no work and if there is work it is going so “cheap” many of you do not believe it is worth pursuing. Also there are more companies bidding the same work and driving the price down. In the last year I have lost one client to a bankruptcy, one has decided to shut down completely and liquidate its assets and another closed temporarily waiting for things to get better. These have been difficult situations since the client that was forced out of business I represented for over twenty years and the one that decided to voluntarily shut down I have represented for over thirty years. The ownership of both companies are good upstanding people but the significant downturn in the economy and its dire effects on construction just could not be overcome.

In these difficult times getting paid and managing your cash flow becomes even more difficult and important. Recently, I was asked by a subcontractor client who is owed several hundred thousands of dollars on four or five projects, “Do I have to go back and complete the work on a project when I have not been paid on past draw requests.” Unfortunately, my response had to be “It depends.” The “It depends” refers to what does your contract say. I asked the client to send me the subcontract and I would review its provisions and give an answer.

In reviewing the subcontract I found that while it had provisions for what the general contractor’s rights were for a breach by the sub, it did not provide for similar or any rights of the subcontractor for non-payment or any other breach by the general. Upon seeing that the contract was the general’s form and very one sided, I thought about the concept of an anticipatory breach i.e. the general not paying. However, as is typical the contract provided that the general contractor did not have to pay the subcontractor until the general received payment from the owner. I also looked at the provision of the subcontract dealing with change orders and found that it required a written change order issued by the general contractor and signed by the officer that signed the subcontract or his successor. I knew that my client did not want to go back and finish what was left unless past draws were paid and was looking for me to find some leverage to assert. I asked my client if there was any indication the general had gotten paid from the owner and in turn not paid him. The answer was “no”. I then asked about the change orders and were there any requests for extras that had been made but no change order issued by the necessary officer from the general. My thinking was that if the general contractor had not followed his own procedure my client could use this as the reason for not returning to the job and hopefully buy time that would result in a partial payment that would help his cash flow and prevent him from having to expend more money before receiving a payment. Unfortunately the answer was again “no”. All the required change orders had been issued and executed as necessary. Upon hearing this I had to advise my client that there was no basisfor not returning to the job and finishing what had to be done. Not the answer the client wanted but the correct answer. Otherwise my client would be in breach of contract. The general contractor could then take action against my client and declare a default.

The lesson to be learned is what you sign does matter. If the AIA General Contractor-Subcontractor agreement had been used it provides that the subcontractor can terminate the agreement if nonpayment continues for 60 days or longer. There is no pay if paid clause in the AIA subcontractor form agreement. While it is difficult to avoid using a general’s form agreement, if you are a subcontractor you need to know what it says and try to negotiate some rights for yourself if you can. If not at least you will know what situation you are in and govern your activities and cash flow accordingly. If you are a general contractor you need to be aware of what your rights are if the owner does not make timely progress payments. The same situation could apply to you.

The tough economic climate for the construction industry appears to be continuing for the foreseeable future. As such be careful of what you are signing and know that consequences do exist if the agreement does not protect you. In general the contract’s provisions are going to control your rights and duties. Accordingly, remember WHAT YOU SIGN DOES MATTER.

Shortening a Contract’s Limitations Period A New Concept for Insurance

Shortening a Contract’s Limitations Period

If you have entered into a contract with an owner or a subcontractor for construction work there is usually a provision that states the general contractor or subcontractor warrants its work for one year from the time the job is complete. However, in Illinois the statute of limitations for bringing an action for breach of contract is ten years. Therefore, although the job may be out of warranty a lawsuit can be brought up to ten years from the time there is a breach of contract.

Recently an Illinois Appellate Court issued an opinion that upheld a contract provision that shortened the time for bringing suit to two years. The case arose in the context of a homeowner suing a building inspector who had done a home inspection and failed to note certain defects in the house. The contract provision stated “Any legal action must be brought withing two years from the date of the inspection.” The Appellate Court held that parties to a contract can agree to a shortened contract limitations period to replace a longer statute of limitations so long as the shortened period is reasonable. The homeowners argued that they did not know of the two year limitations period or that it was negotiable. The Appellate Court was not persuaded by this argument. The Court stated that the homeowners argument had to fail because parties to a contract can contract for any lawful purpose on any terms agreeable to them and it is not the duty of one party to a contract to inform another of the duties or obligations assumed under the contract.

I am of the opinion that this decision can be useful to those of you in the construction industry. We need to note the Appellate Court said its alright to shorten a limitations period so long as the shortened period is reasonable. If you are warranting the work for one year from the time of its completion or one year from the time the entire job is complete, I see nothing to prohibit you from then providing that any legal action regarding a breach of contract has to be brought within two years of when your work is complete or when the entire job has been finished.

Based upon this Appellate Court decision, I am going to start recommending that a shortened limitations period be set forth in the form contracts I draft for those of you who have me do this work for you. If you would like me to review your form contract and recommend this and other possible changes or provide you with a paragraph that provides for a shortened limitations period please give me a call or send me an email request.

A New Concept for Insurance

If you are a small to medium sized business owner you know that if you borrow money for working capital or other business needs, your bank is going to want you to sign a personal guarantee. Once you sign a personal guarantee not only are your business’s assets collateral for the loan but your personal assets are now subject to seizure if a business failure occurs.

A new concept for insurance is now being offered called Personal Guarantee Insurance. This insurance is available for loans of $500,000 to $5,000,000. There is a 50% limitation on the amount of the risk. The 50% limit is imposed because these policies are not meant to eliminate an insured’s risk but to share it. If this limit did not exist then upon a default the borrower, guarantor and lender would have no incentive to address the issues that exist and try to come to a resolution. Personal guarantee insurance is intended to provide a safety net without eliminating the motivation to overcome the difficulties that exist and attempt to correct the business’s faults.

These types of policies are annual policies with premiums based upon the size of the loan and the risks characteristic of the underlying business. Not all businesses qualify for coverage by a personal guarantee policy. There are eligibility criteria that have to be met and reviewed by the underwriter.

If a business calamity occurs and you have personally guaranteed your business loan, your personal assets will be on the line and a personal bankruptcy might have to be considered. If your business loans are up for renewal and you are being asked to sign a personal guarantee either for the first time or again in order to renew the loan, this type of insurance may be something to consider. If you are faced with this type of situation, give me a call and we can look into personal guarantee insurance to see if it might be a reasonable solution to a common business problem.

What Is Your Liability If You Follow the Plans and Specs but the Installation Fails?

If you are engaged in construction either as a general contractor or subcontractor and enter a contract to do work, the contract is going to provide that certain plans and specifications are to be followed. These plans and specifications are usually referred to as the “Contract Documents” along with other documents such as general conditions, supplementary general conditions, addenda etc. The plans and specifications are usually prepared by a design professional such as an architect or engineer.

Let’s assume you proceed to do your work and follow the plans and specifications but the installation fails. The owner asserts a claim against you as the general contractor or if you are a subcontractor you are brought into the dispute by the general after he is sued by the owner. What is your liability?

As a contractor you have two obligations under your contract. First you have to follow the plans and specifications and perform your work in strict accordance with them. In addition you have an obligation to perform the work you do in a good and workmanlike manner. If you breach either of these two duties doing so can give rise to a cause of action against you. In addition you have no right to deviate from the plans and specifications unless a deviation was mutually agreed upon.

In an Appellate Court decision in Georgetown High School District No 218 v Hardy certain allegations of a complaint were held not to state a cause of action and others were held to properly assert liability. The School District alleged that the general contractor did not build an addition to withstand certain wind pressures and also that the roof could not withstand outward pressure of 15 lbs. per square foot. The Appellate Court held that there was nothing in the plans and specifications to require the general to build the addition to withstand any given wind pressures. Accordingly these allegations did not state a cause of action.

The School District also alleged that the roof had not been built correctly because certain specified steel or iron bolts were not used to resist the vertical uplift of the roof and the roof anchorage provided on the roof trusses was not of sufficient strength nor properly fastened. These allegations were held to state a cause of action because they indicated the plans and specifications were not followed and the work was not done in a good and workmanlike manner.

The above addresses a contractor’s or subcontractor’s liability to the party with whom you contract. What about a situation where a third party is injured and a cause of action is brought for what is alleged to be faulty construction. Let me give you an example of a case in which I am currently involved.

I represent a contractor that did a road improvement project for a municipality which included new sidewalks in a portion of a residential subdivision.  My client subcontracted out the sidewalk phase of the job. The entire project was completed in December of 2001. No punchlists were issued regarding the sidewalks and the sidewalk subs retention was released by the Village one year after the work was completed. In addition final payment to my client was not made until October of 2003. No complaints were ever received regarding the sidewalks.

At an unknown date but certainly at least after December of 2002 and most likely after October of 2003 when my client received final payment a portion of a sidewalk in front of a house settled and a deviation between the sidewalk and an existing driveway occurred. In July of 2008 almost seven years after the job was completed a bicyclist ran over the deviation, fell off his bicycle and was injured. A lawsuit was filed naming the municipality, the design engineer, my client and the sidewalk subcontractor as defendants.

I have taken the position that my client is not liable because the plans and specifications for the job were followed and the work was done in a good and workmanlike manner. The facts that I am relying upon to support this position are that no punchlists were issued regarding the sidewalks, the subs retention was paid out a year after the job was completed without asking for any repairs and my client’s final payment was not made until almost two years after the job was completed, again without any complaints regarding any of the sidewalks that were installed. I have taken the position that my client is not a guarantor of the sidewalk at issue nor did it have an obligation to maintain the sidewalk once it was constructed in accordance with the plans and specifications for the job.

The law in Illinois supports the position I am taking. A contractor in the position of my client owes no duty to third persons i.e. the bicyclist to judge the adequacy of the plans and specifications which the contractor has merely contracted to follow. Accordingly, if the contractor does the work in accordance with the plans and specifications, the contractor is justified in relying upon their adequacy. The only exception to this rule of law is where the plans and specifications are so obviously dangerous that no competent contractor would follow them. Therefore, unless the plans and specifications are obviously dangerous a contractor cannot be held liable for following them as he has contracted to do.

In the case that I am involved with the injured bicyclist is not making any claim that the plans and specifications were so obviously dangerous that neither my client nor its subcontractor should have followed them. Both myself and the attorney for the subcontractor have filed motions for summary judgment requesting that our clients be held not liable for the plaintiff’s injuries. I’ll let you know how it turns out.

Change Orders – What You Need To Know!

Extras are one of the biggest issues that cause problems in the owner/general contractor relationship or between a contractor and subcontractor. Sometimes an owner gets caught up in the construction process and orders or consents to extras without realizing the ultimate impact on the cost of the project. As a contractor you are not bidding on this work and therefore may charge more than normal for extras. In the contractor/subcontractor relationship the issue is usually whether a particular item is an extra and were the contract requirements for an extra followed.

Almost every construction contract or subcontract that I have reviewed or been at issue in litigation that I have handled has a provision requiring that extra work only be performed if authorized by a written authorization, change order. Many times the contract clause dealing with extras will even state that the authorization has to be signed by a particular individual i.e. the president of the general contractor or perhaps the project manager. When I review an agreement for a client, I always point out such provisions and warn the client that they follow the procedure set forth in the contract for change orders.

While the contract may require set procedures for authorization of extras, we know the real world and especially the world of construction does not always work the way a contract says it should. Construction work moves quickly and many times things come up in the field that are not expected. You are trying to get the work done and don’t always have time to document the request for an extra or a situation just arises that has to be dealt with then and there. You are trying to accommodate your customer be it the owner or general contractor. You go ahead and do the extra work and when it comes time for payment you are then confronted with the contract language that says you were suppose to get a written change order BEFORE doing the work. What are you do?

Fortunately for those in the construction industry and me as your lawyer, the Courts recognize that the real world is different then what parties may state in their contracts. Accordingly, an owner or a general contractor can waive the requirement for a written change order by their words or conduct. The rationale for the Courts taking this position is that the requirement for a written change order is in a contract for the protection of the owner or in the contractor/subcontractor relationship for the gc’s benefit. The owner or general may waive the protection afforded by the requirement of a written change order and become liable for extras ordered verbally or by consenting to the work being done and knowing that it is outside the contracted for work.

While the requirement for a written change order can be waived, you are going to be put to a test when you are claiming an extra was authorized either verbally or by conduct. Illinois Courts consistently hold that a contractor seeking to recover for extras must establish by clear and convincing evidence each of the following:

  1. The extras were outside the scope of your original contract promises.
  2. The owner or general contractor requested the extra.
  3. The owner or general contractor by words or conduct agreed to pay extra.
  4. The contractor or subcontractor did not voluntarily proceed with the extra work.
  5. The extras were not necessitated by reason of some default by the contractor or subcontractor.

While it is always best to follow the contract requirements when dealing with extras (get a written change order signed by the owner or appropriate representative of the general contractor), as you can see all is not lost if you fail to do so. However, the burden of proof is high, clear and convincing evidence. Accordingly, when you do have extras and the required procedures as set forth in your contract were not followed, be prepared to present the requisite evidence on each of the above points. If you do you will recover. If not you have given your customer a gift.

Change Orders – Real Life

In the April issue of this newsletter I addressed the issue of change orders and how extras are one of the biggest problems in the owner/general contractor relationship or between a contractor and subcontractor. I am now involved in a matter for a general contractor client that brings to light that what I addressed in my April newsletter does happen in the real world.

My client is doing a commercial remodeling project that includes floor leveling work. The floor preparation subcontractor submitted a proposal to do the work for $8646 for 2200 square feet or $3.93 psf more or less area. My client was not comfortable with the proposal as it seemed ambiguous and open ended and did not want to take the chance that the “more or less” would occur. Accordingly, my client requested the sub come to the job site and in the presence of our project manager take measurements with a laser of the areas of the floor that needed leveling. The subs project manager did so and confirmed that the work could be done for the lump sum price of $8646.00. My client prepared a subcontract agreement for this price and it was executed by the subcontractor’s owner.

At the end of the subs work a bill was sent for not only the lump sum price but also an extra in the amount of $9169.69 for additional floor leveling. Needless to say my client was shocked. Exactly the problem that had been anticipated might occur unless the sub measured the job in my client’s presence had arisen.

During performance of the job the subcontractor never brought to my client’s attention that additional areas were being leveled and for which extra compensation would be sought. My client’s form subcontractor agreement which I helped draft does provide that before any extra work is done a change order must be approved in writing “by the General Contractor’s accredited representative before proceeding with the work.” In addition the subcontract also provides that if any legal proceedings are instituted and an award is made in favor of my client, regardless of any setoffs to the subcontractor my client as the general contractor will be awarded its reasonable attorney fees and costs of litigation.

If you recall my April newsletter article, you know that in this “real life” situation the sub is going to have a hard time prevailing. First there is no indication my client waived the requirement of a written change order. Also as I discussed in my April article even if the written extra requirement could be considered as waived, the subcontractor in this case is going to have a hard time proving that the extra was outside the scope of its original contract agreement. Further there is no evidence that my client requested the extra or by words or conduct agreed to pay extra. Also remember that the standard of proof in a situation like this is “clear and convincing evidence.”

The general contractor I represent is a very reputable company and treats its subs extremely well. However, in this situation the feeling is that the sub is trying to take advantage of my client which does not sit well with upper management. While the amount in controversy is relatively small my client feels the subcontract was entered into fairly and they insisted on laser measurements being taken so that this type of situation would not occur. While my client is going to try and resolve this matter with the subcontractor’s owner, if litigation does ensue we have a very good position given the contract language and especially the provision that if we prevail the subcontractor is going to have to pay our attorneys fees.

As you can see in “real life” the situation I described in my April newsletter can occur. It is better for you if you have a good contract agreement to rely upon. In this instance my client had me review and update its form contracts a few years ago and this work is helping them with this current situation. If you would like me to review and revise your agreements either as a general or subcontractor I would be happy to work with you. I’ll let you know how this situation works out.

Up Front Waivers – Know The Consequences

If you are asked to give a waiver either by an owner or a general contractor before payment is received there are consequences that you need to be aware of. Most likely the form waiver will state the amount you are receiving and recite that you acknowledge receipt of the same. This is true for either a partial or final waiver. If you are giving the waiver up front you are acknowledging receipt of payment even though you have not received the funds. If the check is received then “no foul, no harm.” But what if you don’t receive payment?

While you can attempt to condition the waiver i.e. state that the waiver is not good unless payment is received, most title companies look for this type of language and will not accept a conditional waiver. If you give the waiver and the owner relies upon it in paying the general contractor and the general does not pay, you have waived out your mechanic’s lien rights. If you are a material supplier and the general pays the subcontractor to whom you have issued the waiver and the sub fails to pay you then your lien rights are waived. In these situations you have no recourse as against the owner or if you are a material supplier as against the general contractor I am told it is becoming commonplace to be required to furnish these up front waivers. If you do and are not paid what do you do?

The Illinois mechanic’s lien act has two provisions that address obtaining a waiver and then not paying. One provision provides that if a general contractor or if the gc is a corporation any officer or employee who with intent to defraud induces a subcontractor to execute and deliver a waiver of lien for the purpose of allowing the general contractor to obtain payment and upon the representation that the gc will from such payment pay the sub the amount owed and who willfully fails to pay the subcontractor in full within 30 days after such payment is received is guilty of a Class A misdemeanor.

In Illinois a Class A misdemeanor can be punishable by a prison sentence of less than one year and a fine not to exceed $2500. While this provision of the Act may sound onerous note what has to exist. There has to be “intent to defraud” and a “representation” of payment and then a “wilful” failure to pay. An action to enforce this provision of the Act would have to be brought by the State’s Attorney of the County where the situation arose. My experience is that State’s Attorneys offices are not inclined to become involved in this type of situation. My opinion is that if all of these elements are present and can be proven you would have a common law action for fraud. Note that if a corporation is involved it is the individual who is liable and the corporate shield from personal liability does not apply. Given that many companies now do business as LLC’s I think the form of that type of entity would also be disregarded by the courts. In addition to the actual damages sustained if you can prove the elements listed in the Act I believe a claim could be made for punitive damages. To date there are no reported cases dealing with this provision of the Act.

Another provision of the Act provides that if a waiver is requested and delivered and used to obtain payment then the moneys that are received are held in trust for the benefit of the entity that gave up the waiver. Commingling of the funds is not a violation of the Act. However, if the moneys are not paid over then any owner, contractor, subcontractor or material supplier who knowingly retains or used the money held in trust for any purpose other than paying is liable for all damages sustained.

There is one reported case out of the Bankruptcy Court that has dealt with this provision of the Act. Let’s say a general contractor requires a waiver from a sub and receives payment. The general puts the money in its bank account but does not pay the sub. The general files bankruptcy. If the sub can trace the funds based upon this case an argument can be made and would most likely succeed that those funds are not the general contractor’s but held in trust for the subcontractor and are not subject to being used to pay other creditors of the general.

While the Act provides for remedies where an up front waiver is given and payment not received as can be seen the road to a recovery is not going to be easy. The better practice is to not provide a waiver until payment has been received or simultaneously for payment. As we all know the “real world” does not operate this way. You are going to encounter situations where you have to give a wavier “up front”. In doing so now you know the consequences.

Mechanic’s Liens: Illinois Supreme Court Cypress Creek Decision

Last year the Illinois Supreme Court issued a decision that is causing a great deal of discussion in the construction industry and legislation has now been introduced to overturn the Court’s decision. The Supreme Court’s opinion was issued in the case of LaSalle Bank, N.A. vs Cypress Creek 1, LP. What was at issue was the competing interests of a prior mortgage and mechanic’s lien claimants when a development project went bust and the mortgage foreclosed.

In situations where you have the competing interests of a prior recorded mortgage and mechanic’s lien claimants you have to deal with the concept of enhancement, the increased value of the property due to the improvements that were made. The value of the land before the improvements were constructed is subtracted from the value as improved. The result is the enhanced value. Section 16 of the Mechanic’s Lien Act provides that prior encumbrancers (the mortgage holder) are preferred to the value of the land at the time of making the contract and the lien creditor (those providing the labor and materials) are preferred to the value of the improvements erected on the property. However, this is not how the Illinois Supreme Court interpreted Section 16 of the Act.

In Cypress Creek, LaSalle Bank paid certain of the contractors that performed work and argued that it should be subrogated to their position and given equal priority to mechanic’s lien claimants asserting their liens for work done and claiming the benefit of the enhanced value of the property. The majority opinion in Cypress Creek sided with the Bank and held that if construction disbursements are used to pay for lienable work the lender is subrogated and has equal priority to an enhancement claim under section 16. The effect of the Court’s decision is that now when you have an enhancement situation the mechanic’s lien claimant’s percentage of any sale proceeds is diluted.

There were two Supreme Court Judges that dissented and stated that the majority of the Court was not following the provisions of Section 16 of the Act and were impermissibly expanding the definition of the word “contractor” to include construction lenders. I happen to agree with the dissenting judges. Having litigated many cases that involved enhancement issues if the decision in Cypress Creek is left intact it will seriously hamper a contractor’s ability to be paid anything but a fraction of the claim. If a project has gone bust and a lender is given equal priority with mechanic’s lien claimants as to the enhanced value of the property the result is a serious dilution of the proceeds of a sale that would otherwise go to the contractors that constructed the improvements.

There is legislation pending in the Illinois legislature to in effect overrule the Illinois Supreme Court’s decision in Cypress Creek. The proposed legislation amends section 16 of the Act to make it clear that a mortgage holder is only preferred as to the value of the land at the time the contract is made and “shall not be preferred to the value of any subsequent improvements.” The proposed amendment further provides that each mechanic’s lien claimant is to be preferred to the value of “all subsequent improvements” whether or not they were provided by the lien claimant. If this legislation is passed, the adverse consequences of the Cypress Creek decision will be avoided.

I will keep you updated on whether this amendment to the Act is passed. I would suggest you may want to contact your State Senator and Representative and urge that they vote in favor of the proposed amendment. Also it would be a good idea to get your trade association behind this legislation. I know the Chicago Plumbing Contractor’s Association and the Illinois Mechanical and Specialty Contractors Association are actively pursuing passage of the proposed amendment to Section 16 of the Act. If you have any questions let me know.

Extras Revisited: Bizarre Trial Court Decision

In the April and June 2011 editions of this newsletter I addressed the issue of extras and provided the rules the Court’s apply in determining a claim for extra compensation. A recent Illinois Appellate Court decision addressed what I think was a bizarre ruling by a trial court on a claim for extras and overturned the trial court’s ruling.

A general contractor was going to expand the warehouse of a Menard’s store. A concrete subcontractor submitted a bid that did not include “winter protection of concrete or subgrade” nor “winter heat.” The project got delayed and revised bids were requested. This time the concrete sub included an up-charge for winter heat but again did not include winter protection. A contract was entered which had the usual provision that no extra work would be paid for unless there was a written change order signed by the gc that specified the amount of additional compensation.

The job got further delayed and in December the concrete sub wrote the general contractor a letter expressing concern regarding the necessity of performing winter protection work. The sub stated that it would move forward with its work to maintain the project schedule and document its additional costs and that upon completion of the disputed work it would resolve its claim under the terms of the contract agreement. The general contractor’s position was that winter protection was included in the agreement and advised the sub that if it did not quickly complete it’s work the sub would be removed from the job. The concrete sub completed it’s work with winter protection which increased it’s cost by $171,262.

When the general contractor refused payment for the winter protection, a lawsuit was instituted. The trial court granted partial summary judgment to the gc on the issue of payment of the extra for winter protection. While the trial court held that winter protection was clearly outside the scope of the contract, it found there was nothing to show the general contractor ordered the work to be done nor did it agree to pay extra for the work. As you will recall from my April 2011 issue of this newsletter, there are five factors the courts look to when considering a claim for extra compensation:

  1. The extras were outside the scope of the contract
  2. The owner or general contractor requested the extra
  3. The owner or general contractor by words or conduct agreed to pay extra
  4. The extra work was not done voluntarily
  5. The extras were not necessitated by reason of some default of the gc or subcontractor

The trial court stated that the subcontractor should have done the work per the terms of the contract even though it knew that in doing so the work would not have been done in a good and workmanlike manner because it was being performed in the winter months and there would be no winter protection. I think the trial court’s ruling is bizarre because it put the subcontractor in an untenable position. If the work was done without the winter protection there are going to be all kinds of claims for defective performance. If the sub goes ahead and does the work with winter protection then the trial court is saying you are doing so for free and in this case the sub would lose $171,000. Certainly not a good position to be put in.

Fortunately, the Appellate Court came to the subcontractor’s rescue and overruled the trial court. The Appellate Court held that the sub could not do it’s work knowing that it would be done in an unworkmanlike manner. The Appellate Court stated, “One who contracts to perform construction work impliedly warrants to do the work in a reasonably workmanlike manner.” In addition the Appellate Court held that the trial court was also wrong that the sub could do the work in an unworkmanlike manner because the Menard’s building is open to the public and to allow work to be done in an unworkmanlike manner would be unrealistic and contrary to public policy. The Appellate Court ordered the case back to the trial court because it could be found that the general contractor impliedly ordered the sub to perform the winter protection work if in fact doing so was necessary to do the work in a workmanlike fashion. The Appellate Court also noted that the general contractor was informed by the concrete subcontractor that it was going to perform the winter protection work and did not tell the sub to stop.

The lesson to be learned is that if you are placed in a position of being forced to do your work in an unworkmanlike manner do not do it. Do what is necessary to perform the work properly. Inform the owner or general contractor you are doing so and properly document the claim you will be making and the additional costs incurred. You simply should not do the work in an improper fashion as the consequences of doing so are too grave.

Pay If Paid Clause – Alive and Well

In the first issue of this newsletter, April 2010, I wrote about subcontractor contracts and provisions that you need to be concerned about. One of those is the pay when paid provision. Most general contractor form contracts have such a provision and under Illinois law it is enforceable.

In essence this provision shifts the risk of an owner’s insolvency to the subcontractor since it provides that the gc only has to pay you if he receives payment from the owner. A recent Seventh Circuit US Court of Appeals decision reaffirms that such a provision is enforceable and can have severe consequences to a subcontractor or material supplier.

The general contractor was under contract with the owner to construct a manufacturing plant near Indianapolis, Indiana. After about a year of construction the owner went bankrupt. There was significant money owed. $40 million to the gc, $11 million to a subcontractor and $1.5 million to a sub-subcontractor. The sub-subcontractor’s contract had a pay if paid clause. The sub-subcontractor perfected it’s mechanic’s lien rights and recovered about half of its money in the owner’s bankruptcy proceedings when the property was sold. A lawsuit was filed by the sub-subcontractor on the payment bond that had been provided by the subcontractor to the general.

The dispute in the lawsuit was whether the clause at issue was a true pay if paid clause or a pay when paid provision. Also at issue was whether the bonding company could assert the pay if paid clause as a defense to the action on the payment bond.

There was little question by the US Court of Appeals that the provision at issue was a pay if paid clause. It provided as follows:

“IT IS EXPRESSLY AGREED THAT OWNER’S ACCEPTANCE OF SUBCONTRACTOR’S WORK AND PAYMENT TO THE CONTRACTOR FOR THE SUBCONTRACTOR’S WORK ARE CONDITIONS PRECEDENT TO THE SUBCONTRACTOR’S RIGHT TO PAYMENTS BY THE CONTRACTOR.”

The Appellate Court held this language was clearly a pay if paid provision and that by agreeing to it the sub-subcontractor assumed the risk of the owner’s insolvency.

The sub-subcontractor argued that because the payment bond did not expressly incorporate the terms of the sub-subcontract that had the pay if paid provision the bonding company could be held liable even though the subcontractor could not be under the contract. The Appellate Court rejected this argument as it contradicts basic principles of surety law. The bonding company is only liable to answer for the debts of its principal and if the principal is not liable then neither is the bonding company. Accordingly, the sub-subcontractor could not recover the balance of its money from either the subcontractor with whom it contracted nor the bonding company.

The decision in this case highlights the importance of perfecting your mechanic’s lien rights. While this case involved Indiana law the law in Illinois is the same. A pay if paid clause in a contract is not a defense to a mechanic’s lien claim. It is a defense to a contract claim. Had the sub-subcontractor not perfected its lien rights that allowed it to recover half of its money in the owner’s bankruptcy it would have lost the entire $1.5 million it was owed. Don’t think that just because a payment bond is in place you are safe. The bonding company has all the defenses that it’s principal has under the contract at issue. Make sure you understand the consequences of a pay if paid clause and always take action soon enough to perfect your lien rights.

An Unsigned Contract – Is It Binding?

If you do not sign a contract but do the work do you have a binding written agreement? As with so many situations in the law, it depends. What it depends on, are the facts.

Our personal and business lives are busy and hectic. We now have voicemail, email, text messages and tweets. It is easy to overlook the details and forget to dot the i’s and cross the t’s. However, failure to do so can have consequences.

Let’s suppose you are a subcontractor and you give a bid to a general contractor who is from out of state for a job here in Illinois. The bid is verbally accepted and the job needs to start right away so you commence work. After the work is started you receive a seven page Purchase Order and then a few days latter you receive a document titled Construction General Notes and Conditions. The Purchase Order contains a description of the work to be done, a schedule for performance, the contract price and payment terms. The General Notes and Conditions document contains provisions regarding risk of loss, change orders, indemnification and insurance, Acts of God, and liens. It also has a jurisdiction provision that says that any disputes will be governed and construed according to the laws of the State where the general is located which is not Illinois and the courts of that State will have exclusive jurisdiction to decide all disputes. You don’t sign any of these documents but continue performance of the work.

As the work progresses you are delayed by causes you believe are not your fault. You give written notice to the general contractor consistent with the provisions in the Purchase Order and General Notes and Conditions that you will not be responsible for these delays or any damages caused by them. You also follow the payment procedures and requirements as set out in the Purchase Order and General Notes and Conditions. You provide the insurance called for under the written documents and tender the required certificate of insurance.

After you complete the work the general files a lawsuit in its home state and maintains you are liable for delay damages. Do you have to defend in the court’s in the general’s home state? An Appellate Court ruled that the subcontractor had consented to the forum selection clause by its conduct in following the terms and provisions of the written contract documents and was bound by all the terms and provisions even though the Purchase Order and General Notes and Conditions were never signed. What the Appellate Court looked to was the subs course of conduct which showed it was aware of the written contract documents and was following them. The Court did not agree with the sub that all it had was an oral contract by virtue of the verbal acceptance of its bid.

What should you do if confronted with this situation? If you are pressed to begin performance before receiving any written contract documents send a letter saying you will do so subject to agreeing in the future to the provisions of the written documents and if not agreed upon then you are entitled to stop work and receive payment for what is done to date. When the documents are received review them and if not acceptable suspend performance until you negotiate and agree upon all terms and provisions. Remember, no matter how busy you are or how much you want to cooperate to get the job started you need to dot the i’s and cross the t’s otherwise you may encounter unintended consequences.

Let’s look at this issue from a general contractor’s perspective. You send your standard subcontract form out to a sub for signature after verbally accepting the sub’s bid and agreeing on the basic terms, regarding scope of work and price. The sub sends the contract back but makes changes. One of those changes is that the subs warranty will apply and the subs warranty provides that if there is a claim for damages the general can only sue for direct damages which would be capped at the greater of $5000 or the contract amount. You don’t respond to these changes. At the end of the job the owner sues the general for delays and you blame the sub and sue to recover these costs. An Appeals Court ruled the general couldn’t sue to recover these costs because by its conduct i.e. letting the sub proceed with the work, it had consented and accepted the counteroffer that the sub made in sending the subcontract back with changes.

How does a general protect himself from this situation? Again, send a letter out with your form subcontract that says any changes have to be accepted in writing. Also provide in the letter that if the subcontractor begins work without a fully signed agreement in final form it has unconditionally accepted your standard form agreement without any changes.

Remember, no matter how many voicemails, emails, text messages or tweets you receive the details of a contract must be followed up on or you could find yourself in an unexpected and unintended situation.

Unions – Contributions for Non-Bargaining Unit Work

While I am not a labor lawyer per se, since I represent general contractors and subcontractors I sometimes get involved with a union issue. With the downturn in the economy and its devastating effect on the construction and development industries causing many contractors to fail, unions are hurting and their pension and health and welfare funds are taking a hit. One of my clients was recently sued by a union trying to collect contributions owed by another company that had gone out of business and was owned and operated by relatives of some of the existing company owners. The union claimed the existing company was a successor in interest of the company that had gone out of business. I had represented the former company and knew its ownership structure and also that of the existing company and how the existing company came to be organized. Fortunately, I was able to put together in a letter an explanation of how the existing company was distinct and separate and not a related or successor entity to the company that had failed. I showed the union’s attorney the lawsuit was without merit and baseless and let it be known albeit politely that if the lawsuit was not dropped we would seek to have the Court impose sanctions for the filing of a frivolous lawsuit. The union’s attorney agreed to dismiss the suit.

Since I do get involved occasionally with a labor issue, a recent United States Court of Appeals decision caught my eye. It involved a union cement mason worker doing non-bargaining unit work and whether the employer had to make contributions for the non-bargaining unit hours worked. The district court said yes and the Appellate Court affirmed.

The employer had entered a Memorandum of Joint Working Agreement with the local of the Cement Masons Union. This MOA adopted by reference all the Collective Bargaining Agreements between the Union and various employer associations in the geographical jurisdiction of the Union. One of the employers union workers had done non-bargaining unit work such as painting, installing hardwood floors and demolition. The employer did not make contributions based on these hours worked. The Union did an audit and then brought suit to collect contributions for the non-bargaining unit work performed.

There were two Collective Bargaining Agreements at issue and both stated that contributions had to be made for “each hour worked by employees covered by the CBA’s.” The employer tried to argue that certain language in the MOA limited the required contributions to only bargaining unit work. The employer pointed to language that stated the MOA only applied to employees doing bargaining unit work. The US Court of Appeals did not agree that this language placed a limitation on the work for which contributions had to be made. The Appellate Court ruled that all this language in the MOA did was establish that for an employee to be covered under the CBA he or she had to be an employee who does bargaining unit work. The MOA’s language did not limit the CBA’s coverage to employees doing only bargaining unit work. The employer was ordered to make contributions for the non-bargaining unit hours worked.

If you have a MOA with a local of a union that adopts a collective bargaining agreement, make sure you have a copy of the CBA and that you understand its provisions. You can rest assured the union will know what it provides and in this economy the unions are going to take action to enforce these agreements and get every dollar they can for their pension and health and welfare funds. There is nothing wrong with this so long as both parties know the rules and play by them.

Perfecting Your Mechanic’s Lien Rights – It’s Important

I recently settled a matter for a client about two weeks before a trial was to begin. The case involved construction work at a northwest suburban shopping center. The settlement I obtained was very good. I negotiated a settlement for 100% of the amount owed plus $50,000 of accrued interest. The situation that existed shows why it’s so important to perfect your mechanic’s lien rights within the time limits provided by Illinois law.

The client is an out of state general contractor. There were two contracts involved. One to build a store in the shopping center and the other for outside work.(sidewalks, landscaping etc.) Both of the contracts were with the owner of the shopping center. As is usual the owner was a limited liability company formed for the purpose of developing the property. In other words a shell entity with no assets other than the shopping center being constructed. A money judgment against an entity such as this is usually uncollectible.

After my client finished building the store the owner did not make the final payment and strung my client along with continued promises of payment. This went on for several months. Unknown to my client, the owner was in financial trouble with its bank and needed to sell the center in order to pay off the construction loan and reduce the loan that had been obtained to purchase the land. While my client was trying to get paid for the work it did to build the store, it began the outside work. Without my client knowing about it the owner sold the shopping center to an investment group who obtained a new mortgage to purchase the property. After months of trying to get paid this general contractor contacted me having gotten my name from one of its subcontractors who I represent.

By the time I got the case work on the store had been completed more than four months before. The last day worked on the outside contract before the contractor pulled off the job was still within the four month period. I took action to prepare and record two mechanic’s liens. One for the work done to build the store and the other for the outside work. The liens were for over two hundred thousand dollars each.

The Illinois Mechanic’s Lien Act provides that in order to perfect a lien as to all parties it has to be recorded within four months of your last day worked. In this case one lien was within the four months and one was outside four months. Unfortunately for my client there is a quirk in the Appellate Court decisions that interpret the mechanic’s lien act that allows a third party to purchase property and ignore a lien if it is recorded outside the four month period. This is the situation my client was in.

I filed a lawsuit and so did a number of other contractors who did other work for the owner at this shopping center. All the cases were consolidated before one Judge. Not long after the lawsuit was filed the owner and its lender brought a motion to dismiss that part of the lawsuit involving the lien claim recorded outside the four month period. They also tried to dismiss the claim in the lawsuit for the amount owed for the outside work.

While I made a sound argument why the lien claim for the work done to build the store which was the lien recorded beyond the four month period should not be dismissed the trial court did not accept the argument and this lien claim was dismissed. The trial court rejected the argument to dismiss the claim for lien involving the outside work. The lien for this work was recorded within four months of the last day worked.

With regard to the lien for the outside work my client was in an excellent position. Since the lien was timely recorded it had an absolute priority over the ownership interest of the new owner and also its lender. A title company had insured the owner’s interest and the first position of its mortgage lender. How the original owner ever got the sale closed without obtaining final waivers from my client and all the other contractors remains a mystery. However, I knew that if I could prove my client’s claim the title company would have no choice but to pay since it had issued a policy of title insurance guaranteeing to the new owner its title and the first position of its mortgage lender. Fortunately my client kept good records on this part of the job and I felt confident that we could prevail. The mechanic’s lien act does provide that interest accrues on the amount owed at ten percent per annum from the last date worked. As I said above this aspect of the case was settled right before trial for the entire amount owed and a significant amount of the interest that had accrued.

The lesson to be learned is how important it is to timely perfect your lien rights. In this case not doing so with regard to the amount owed to build the store was very costly. The contractor failed to timely perfect a $200,000 claim.. While I understand the conflict between sales/customer relations and collections, you need to be aware of what it might cost if you don’t act to perfect your lien rights. In this case with regard to the work done to build the store the client lost over two hundred thousand dollars. On the other hand you can see what leverage we had for the lien claim regarding the outside work. The title company was on the hook and I knew it. The fact the lien had been properly perfected gave me great leverage in negotiating an excellent settlement.. The title company was in a bad situation and I capitalized upon it to the benefit of my client. Remember once you properly perfect your lien rights you don’t have to rush into a lawsuit and have time to negotiate a compromise. However, once you fail to perfect your lien rights you are going to be at the mercy of a third party purchaser and its lender. I think you know what is the better position.

Implied Warranty of Habitability – Expanded Again!

I know there is not much residential development occurring these days. However, this segment of the construction industry will come back (HOPEFULLY). There have been some recent developments with the legal concept of the Implied Warranty of Habitability that those of you who do residential work or are developers need to know since it can affect your exposure to liability.

Two decisions have been rendered by the Illinois Appellate Court First District arising out of one condominium development that expand the Implied Warranty of Habitability and affect a disclaimer of the warranty.

Every sale contract for the construction and conveyance of a single family residence including condominiums includes the implied warranty of habitability. This warranty is well known to builders-vendors or in other words contractors who build and sell houses. The core principle of the implied warranty of habitability is to protect purchasers of residences and hold builders accountable for latent defects in the residences they construct. However, what if your not the seller of the residence but a general contractor who builds for the developer of a project? In the first Appellate Court decision that arose out of this condominium development this issue was addressed.

After the project was completed, the developer of an eight unit condominium went out of business. The developer didn’t do the construction work but hired a general contractor. Serious defects arose and the homeowners association sued the general contractor and several of the subcontractors. The general contractor brought a motion to dismiss and argued that there was no liability since the general was not the seller of the residences and the implied warranty of habitability did not apply since the general was not the builder-vendor. The Trial Court agreed and dismissed the case. The Appellate Court reversed and ruled that although prior cases referred to builder-vendors it would defeat the policy goal of the implied warranty of habitability to hold builders accountable for latent defects to limit the warranty’s application to builders who are also vendors. What this decision means is that if you are a general contractor and enter a contract with a developer for construction of a residential project you and your subcontractors are going to be subject to liability under the implied warranty of habitability. This is so even though you have no connection with the buyers contracts.

The implied warranty of habitability can be disclaimed in the contract of sale. If the disclaimer language is specific, conspicuous and fully discloses the consequences of its inclusion and truly reflects the agreement between the parties, it will be upheld. In this condominium project the developer’s contracts with the purchasers had language disclaiming the implied warranty of habitability. When the case was returned to the trial court, the general contractor and one of the subs made another motion to dismiss, this time based on the disclaimer in the sale contracts. The general contractor argued that since the implied warranty was waived as to the developer it was also waived as to the general and its subcontractors. The Trial Court agreed and dismissed the case again. The condominium association appealed again and the Appellate Court reversed again. The Appellate Court referred to a prior Illinois Supreme Court decision that held the burden to establish a knowing waiver of the implied warranty is on the builder and that disclaimer language will be strictly construed against the builder. Remember as noted above, the language of a disclaimer has to be not only conspicuous and fully disclose the consequences of its inclusion it also has to be specific. The Appellate Court held that while the disclaimer clearly mentioned the developer it said nothing about the general contractor or its subcontractors. In determining the disclaimer was not applicable the Appellate Court noted there was nothing in the sale contracts to indicate that the individual unit owners agreed to disclaim the warranty as to the general contractor or its subs or that they were aware of the possible consequences of disclaiming the warranty as to them.

These two Appellate Court decisions have definite consequences for those of you engaged in residential construction. If you’re a general contractor working for a developer you had better make sure the developer’s disclaimer of the implied warranty of habitability includes you and your subcontractors. If you’re a sub you should also check the developer’s disclaimer language. If you’re not included then you need to make sure your contract with the developer or your contract with the general has indemnity language to protect you if a lawsuit on the implied warranty of habitability is filed. If you don’t protect yourself you may find yourself on the wrong end of an implied warranty of habitability claim that could be avoided. If you need assistance drafting appropriate language to protect yourself give me a call.

Spoilation of Evidence – What Is Your Responsibility

Let’s assume you are running a job and an I-beam you are installing fails and falls to the ground and several of your men are injured. You are informed of the accident and immediately go out to the jobsite to inspect. You take pictures of the site and the I-beam. The public agency that has jurisdiction as well as OHSA come out and make an inspection. The next day you destroy the I-beam. One of the reasons you do so is to salvage the embeds because the manufacturer informs you that a replacement can be made more quickly if the embeds are retrieved and sent back as soon as possible. Another reason you destroy the I-beam is because the public agency involved advised that you could not leave it where it fell. However, you acknowledge the beam could have been preserved by bringing in equipment to lift the beam and remove it from the jobsite.

Your employees file a lawsuit against the manufacturer of the I-beam and the designer of the bearing assembly and you. The employees lawsuit against you is based upon spoilation of evidence. The employees contend you had a duty to retain the beam as potential evidence; you breached that duty by destroying the beam and that as result they are not able to prove their claims against the manufacturer and designer. Are you liable?

The Illinois Supreme Court recently held a contractor in this situation was not liable to his employees for negligent spoilation of evidence. Spoilation of evidence is a form of negligence and in order to recover there first has to be a duty owed to preserve the evidence. As a general rule the law in Illinois is that there is no duty to preserve evidence. However, as you know there are exceptions to every general rule. There is a two prong test that a plaintiff must meet in order to establish an exception to the general “no-duty rule.” Under what is call the “relationship” prong of the test there needs to be shown an agreement, contract, statute, special circumstance or voluntary undertaking that gives rise to a duty to preserve the evidence. The second prong of the test is known as the “foreseeability” prong and here it needs to be shown that the duty extends to the specific evidence at issue and that a reasonable person in the circumstances that exist should have foreseen that the evidence was material to a potential civil action. If a plaintiff does not meet both prongs of the test there is no duty to preserve the evidence at issue.

The Illinois Supreme Court held that a voluntary undertaking requires a showing of affirmative conduct that reveals an intent to voluntarily assume a duty to preserve evidence. The Supreme Court found that the contractor’s conduct fell short of a voluntary undertaking to preserve evidence. The Court focused on the fact that the I-beam was not moved from where it fell. Also the fact the contractor, the public agency having jurisdiction and OSHA inspected the beam was not enough to constitute “affirmative steps to preserve the I-beam as evidence.”

The contractor’s employees also argued that “special circumstances” existed. They pointed to the contractor’s exclusive possession of the I-beam; his status as their employer; and his status as a potential litigant. The Supreme Court did not agree. As far as possession is concerned the Court held that more than possession is required such as a request by the plaintiff to preserve the evidence and/or segregation of the evidence for the plaintiff’s benefit. The Court also held that the employer-employee relationship in itself is not a “special circumstance” giving rise to the duty to preserve evidence. In rendering its decision the majority opinion glossed over the contractor’s position as a potential litigant. There was a dissenting judge who found that “special circumstances” did exist because the contractor admitted the accident would be the basis for future litigation and the fact that the plaintiff’s did not request that he preserve the I-beam was due to the fact they were hospitalized and could not act on their own.

If you have a job and an accident occurs what should you do? Although the general rule is you have no duty to preserve evidence I would counsel that you take a more conservative approach than what the contractor did in this case. Today’s society is prone to litigation and everyone knows that lawsuits are commonly filed. In my opinion it was a “stretch” to find that “special circumstances” did not exist. If the I-beam had been preserved and tested it may very well have been found a defect existed in its manufacture or that the bearing assembly was defective. If you are faced with a similar situation be cautious in what you do.

An Unsigned Contract with a Twist

In the January issue of this newsletter my article dealt with a trial I won that involved an unsigned contract. The trial court found in my client’s favor based upon the facts. Currently I have another situation involving an unsigned contract but this time there’s a twist.

My client gave a proposal based upon a bid set of drawings. The proposal was accepted via an email “intent to award contract.” The general contractor is a design build firm and proceeded to send my client its form subcontract agreement. The subcontract listed the plans and specifications on three pages referring to the bid set of drawings all of which were dated in May and June, 2013. My client never signed the subcontract nor did the gc.

About a month after receiving the subcontract a scope review meeting was held in the field and certain items were pointed out that were not on the drawings. It was agreed this work would be done and a price given and accepted. My client then proceeded to do certain of the preliminary work. At this point if the story ended you might think my client is bound by the subcontract even though not signed. Remember from the January article, the parties conduct can show that an unsigned contract is binding. But wait, there’s more.

In December of last year my client and all the other subs received an email from the gc advising that the “construction” drawings are now on line and that from that point forward they are to be used. The “construction” drawings are dated October 30, 2013. As I said the gc is design build and its architectural division prepared the “construction” drawings. Contrary to industry standard the changes to the “construction” drawings were not clouded so picking up where these plans differed from those listed in the subcontract and upon which my client’s bid was based was not easy.

My client’s estimator made a detailed review of the new drawings and found they required additional work that would cost $36,000 more. The gc was notified of the price increase and because the work was now to be done per different plans my client requested a new contract. The gc responded by asking my client to give a breakdown of the additional cost. This was done and again a request was made for a new contract. This second request was ignored and the gc responded to my client’s breakdown by saying the request for additional compensation would be considered. In addition many items were just referred to as being on hold. My client became suspicious and decided to walk off the job and ceased performance. This action was not met favorably by the gc.

Once my client refused to return to work the gc’s project manager threatened to replace my client and hold my client responsible for the additional costs incurred. After a few telephone conversations and email exchanges the gc issued a formal letter of termination and advised my client that it would be held responsible for the additional costs being incurred plus liquidated damages for project delay. At this point my client asked me to get involved and respond to the gc’s threats.

Based upon these facts I have taken the position that no contract exists. The difference in this situation and the one I wrote about in my January article is this time a basic element of contract law is missing, “a meeting of the minds.” How can there be a contract if the gc changes the plans?

I advised the gc the termination notice is meaningless since no contract exists. Also I advised them it didn’t take a genius to figure out what they were trying to do by issuing a “construction” set of drawings after my client began performance which were not clouded and then insisting that they continue performance under a new set of plans while the issue of what would be paid for was worked out. Not surprisingly the form subcontract agreement provides that if the sub does extra work without a signed change order it won’t be paid for.

I also advised the gc if a lawsuit is filed it will be vigorously defended and a counterclaim asserted for lost profits, fraud, misrepresentation and punitive damages. As you can see whether an unsigned contract is binding depends on the facts. In this case there is no contract because how the work was to be done and what it consisted of was not agreed upon. As of the writing of this article no response has been received from the gc or its legal counsel. Stay tuned.

Public Work – No Bond Doesn’t Mean No Pay

On public jobs the government entity i.e. IDOT, Village, School District, or Park District is required by law to obtain from the general contractor not only a performance bond but also a payment bond. These requirements are set forth in the Illinois Bond Act. The performance bond protects the government entity and the payment bond protects both the government entity as well as subcontractors providing materials and labor. The Bond Act does require a claimant to file a verified notice of its claim within 180 days after the date of the last item of work or the furnishing of the last item of materials.

What happens if the government obtains a performance bond but fails to get a payment bond, the general contractor goes bankrupt and the subcontractor does not give the required notice within 180 days of the last date worked? Is the subcontractor out in the cold? A recent Illinois Appellate Court decision out of the 2nd District Appellate Court addressed this situation.

The facts showed a Village did not require a house builder who was developing two subdivisions to provide payment bonds. The Village obtained performance bonds but not payment bonds. A subcontractor who did work did not file a claim within 180 days of its last date worked. Its excuse was that it wanted to maintain its relationship with the builder and not risk the loss of future work. As a result of the downturn in the economy the builder/developer filed bankruptcy. The subcontractor filed a lawsuit against the Village and maintained it was what the law calls a third-party beneficiary of the contract between the Village and the builder and could hold the Village liable for the amount due the subcontractor. The Appellate Court agreed. It found that the provisions of Section 1 of the Bond Act that require the furnishing of a payment bond are read into the provisions of every construction contract for public work. In order to be a third-party beneficiary of a contract you have to show that the contract at issue was entered into for your direct benefit. The Appellate Court held this requirement was satisfied since Section 1 of the Bond Act was incorporated into the contract at issue. The contract also had a provision in which the Village acknowledged that in constructing the public improvements the general contractor would be using subs and material suppliers. The Second District Appellate Court held that the 180 day requirement to file a claim did not apply since no bond had been obtained. A similar case out of the First District Appellate Court (Cook County) holds just the opposite.

The subcontractor’s decision not to timely perfect its claim was a risky decision. I fully understand the “business decision”. It’s the usual sales vs collections dichotomy. The situation would have been different had the job occurred in Cook County since an Appellate Court decision already existed finding that even though a payment bond had not been posted it was still necessary to give the required notice in order to make a third-party beneficiary claim. The moral of the story is that it’s always better to follow the requirements of the law regarding perfecting a claim. But if you don’t all may not be lost except in Cook County.

Architectural Copyright Infringement – Successful Result

Our client entered into an agreement to design a multi-million dollar luxury house. The design process took over two years and designs were made for several different sites. Finally, husband and wife decided upon a site but after construction began terminated my client. The design agreement had a provision that the plans could be purchased for a certain percentage of the estimated cost of construction. The homeowners didn’t want to pay for the design so they retained another architect who “supposedly” created an entirely independent design. The new architect allegedly created this independent design in just two months.

My client obtained a copy of the “new” plans and there was no doubt they were not independently created. This particular client has built a business based upon one of a kind designs and is committed to protecting the company’s design work. There was no good reason for the client being terminated except interference from outside sources. My client was not about to let two years of work be taken and not recover for the many hours of work involved in creating a truly unique luxury house that incorporated the stunning creativity of his design team.

Architectural plans have copyright protection. If there is infringement by unauthorized copying a lawsuit can be instituted in Federal court to recover damages. The damages recoverable are the reasonable value of the plans, the profit that would have been made if the builder had built the house and depending on when infringement occurs attorneys fees and costs. I filed a lawsuit to recover all of these damages.

Since I’ve had experience with this type of matter before (not only filing suit but going all the way through trial and judgement) I knew the best way to proceed was to have the two sets of plans compared. I had this done not only by my client’s chief in house architect but also by an independent architect retained as an expert witness. Both architects concluded that the infringing plans were almost an exact duplicate of my client’s plans. Room sizes were the same, as were room locations, niches, wall thickness and other interior details. Our expert concluded this could only have occurred if there were tracing, scanning or use of computer disk. The exterior design was modified slightly but not to any great extent.

Once we filed suit the homeowners countered with eighteen affirmative defenses, a counterclaim and a third party complaint. In addition they tried to bury us with discovery requests. Since most records are now kept on computer there are issues that arise concerning how computer records are maintained and what information is within a record kept by computer. ESI issues(electronically stored information) are the new hot topic in litigation. I had to overcome a twenty-seven page letter from my opponents addressing what were alleged as discovery response deficiencies. I learned a great deal about ESI but overcame their objections.

Once my opponents realized my client was not going to cave in and that I knew what I was doing in an architectural copyright infringement lawsuit (my opponents were the Intellectual Property practice group of a large law firm) they requested that a mediation/settlement conference be held. My client and I set certain parameters that the homeowners had to consent to before agreeing that we would participate in settlement discussions. The parameters concerned a certain dollar amount the homeowners had to be willing to offer in settlement before we would lower our settlement demand.

Before participating in the mediation/settlement conference I submitted a detailed “Pre-Settlement Conference Letter” setting forth my client’s position and the strengths of our case. I emphasized the substantial similarity of the infringing plans to my clients drawings and that the test to determine copyright infringement of architectural drawings is the ordinary observer test. “Two works are substantially similar if the ordinary observer, unless he sets out to detect the disparities would be disposed to overlook them and regard their aesthetic appeal as the same.” In Federal Court settlement conferences are usually conducted not by the trial judge but a magistrate judge. Fortunately we were before a magistrate who was experienced, took the matter seriously and reviewed all of the material before we got to court. My client explained in detail the similarities in the plans and how certain unique things his company does in their drawings were copied in the infringing plans. It didn’t take the magistrate long to see through the homeowners defenses and conclude they were weak at best. One of these defenses was that the homeowners contributed so many ideas for the design that they were co-authors of the plans. This contention was not only refuted by a provision in the design agreement but also not supported by case law. “This is because the drawing is not created until it is fixed in copy and the ideas and sketches contributed by the homeowner do not sufficiently constitute fixed expressions of ideas(that is, copyrightable work) to make the buyer a co-creator.”

Before beginning the settlement conference my client told me the bottom line number he would take in settlement. We never had to consider that number because a significantly higher amount was negotiated and obtained. I think the reason this came about was because I had put together a very sound case that was supported factually and in the law. Also of great importance was the other side realized my client was steadfast in his conviction that his company’s unique design work was not going to be taken and he was going to protect the foundation upon which he built his company’s reputation. If that meant going all the way through trial then so be it. Fortunately a very good settlement was obtained and the inconvenience, time and expense a trial takes was avoided.

Architectural copyright infringement cases are intricate and somewhat complex. However, I know how to prepare a case like this and for me as a lawyer they are challenging and present issues where my lawyering skills can be used. This type of case doesn’t come along too often but when it does I am well equipped to handle the matter and welcome the opportunity.

Good Corporate Governance – Revisited

In the June 2010 issue of this newsletter I wrote about corporate governance and how important it is to maintain corporate formalities. The reason for doing so is to avoid a claim of “piercing the corporate veil” should your business run into difficulties. The reason you do business as a corporation or limited liability company is to protect your personal assets from creditors of the business. If you think you can outsmart everyone by forming a company and having others be the shareholders, directors and officers and avoid creditors claims think again. A recent Illinois Appellate Court opinion expanded the ability to pierce the corporate veil and hold an individual responsible.

A creditor of a corporation obtained a judgment against the corporation. It turned out to be non-collectible against the corporation so a new action was instituted to pierce the corporate veil and hold an individual responsible. However, this individual was not a shareholder, director, officer nor employee of the corporation. Upon being served with a summons he made a motion to dismiss and the trial court granted it. The Appellate Court reversed. The facts showed that the defendant’s sister owned all the stock in the corporation and she and her husband were the directors and officers and registered agent for the corporation. However, the defendant provided the funds to start up the business, negotiated the corporations lease and arranged sales agreements. It was alleged that no corporate formalities were followed such as issuing stock, holding meetings of stockholders and directors nor were dividends ever paid. The creditor claimed that the named individual exercised control over the corporation to such a degree that separate personalities of the corporation and individual did not exist.

The Appellate Court in finding that a valid claim for piercing the corporate veil was stated focused on the individual’s domination of the corporation. The Appellate Court stated “it would elevate form over substance to allow the defendant to avoid personal liability merely because he has avoided owning stock in his own name and assuming a corporate title such as officer or director.” What counts is if you are the “principal figure” in the corporations dealings with others. Accordingly, lack of status as a shareholder, director, officer or employee is not going to preclude piercing the corporate veil if you are in fact the person “in charge” and calling the shots even though you do so behind the scenes.

As I advised in my June 2010 article good corporate governance is of critical importance and should be strictly followed. You don’t want your personal assets subject to a “veil piercing” claim. It’s never advisable to think you can outsmart everyone. As this Appellate Court decision shows being the power behind the scenes is not going to shield you from personal liability. For a nominal yearly fee we maintain our clients corporations and LLC’s. If we are not already providing this service for you, I suggest you consider having us do so.

Di Monte & Lizak Welcomes Maria Laftchiyska to Firm

Maria Laftchiyska graduated from Carlson School of Management at the University of Minnesota in 2009. She received her J.D. in 2013 from Loyola University Chicago School of Law. While at Loyola University, Maria was a member of the ABA National Appellate Advocacy Competition team and National Moot Court team.

Maria focuses her practice on estate planning, asset protection, and taxation. She assists business owners and families to create individualized estate plans, including preparation of wills and trust. She works closely with clients to restructure personal and professional assets to maximize wealth preservation and minimize gift and estate taxation. Maria also has experience in general business and taxation matters for corporations, limited liability companies, and partnerships.

Another Appellate Court Smack Down for Architects and Engineers

The Illinois Mechanic’s Lien Act clearly provides that architects, structural engineers, professional engineers (i.e. civil engineers) and surveyors have a lien if they provide “any services or incur any expense” in, for or on a lot or tract of land for the purpose of improving the property. For some reason the Illinois Appellate Courts don’t want to recognize this language of the Act and continue to hold that these professionals have to show their services improved the property before they can have a lien. I addressed this issue in the August, 2010 issue of this newsletter. Just recently a majority opinion of the Illinois Appellate Court, Third District, got it wrong again.

In this most recent smack down for architects and engineers, a civil engineering firm did preliminary engineering and performed land surveying services for a preliminary and final plat. The development did not proceed. The civil engineering firm claimed a lien for its services and filed a lawsuit to foreclose its lien. The Bank holding a mortgage on the property sought dismissal of the engineer’s lien. A motion for summary judgment was granted in the Bank’s favor on the ground the civil engineering and land surveying services provided did not constitute an improvement to the property. The civil engineering firm appealed.

The majority of the Appellate Court upheld the trial court and again relied upon a line of decisions that hold the purpose of a mechanic’s lien is to permit a lien where a benefit has been received by the owner and where the value or condition of the property has been increased or improved by reason of the furnishing of labor and materials. The Court’s reasoning is wrong. What the Appellate Court failed to realize is that the line of decisions relied upon are the typical situation where a contractor or subcontractor furnishes labor and materials to a job. Architects and engineers don’t furnish the usual type of materials and labor. They provide designs and drawings but they do so for the purpose of improving land and the Act specifically states they have a lien for the type of services they provide. The fact that a development doesn’t go forward doesn’t mean the services were not provided for the purpose of improving the property.

One Judge dissented and this judge got it right. The dissent stated the appropriate inquiry is whether the services were provided “for the purpose of improving the subject property.” This Judge referenced the specific language of the Act and stated the Act allows architects and engineers to have a lien regardless of whether the services actually improve the property. The dissent referred to the fact the engineering services were used to obtain financing and municipal approval for the development. As this Judge stated, “Professionals who design buildings and developments should not be penalized for an owner’s choice not to proceed with a construction project.”

In my opinion this Appellate Court decision is flat out wrong since it ignores the explicit language of the Illinois Mechanic’s Lien Act. Hopefully this engineering firm will petition the Illinois Supreme Court to allow a further appeal to our State’s highest Appellate Court. This is a significant issue and should be addressed by our Supreme Court. Hopefully they will read the Act and enforce the Act’s explicit provisions in favor of design professionals.

Builders Beware

Alan L. Stefaniak

Alan L. Stefaniak

We have all heard the phrase “Buyer Beware”. A recent Illinois Appellate Court decision turns the table on residential homebuilders and those of you who build houses now “need to be aware.” Illinois has long recognized the Implied Warranty of Habitability in residential construction. The purpose of the implied warranty is to protect home buyers from latent defects and place the responsibility for the costs of repair on the builder-vendor who created the latent defect.

Over the years the implied warranty of habitability has been expanded to apply to subsequent purchasers if there is a short intervening ownership between that of the first purchaser. The warranty has also been held to apply not only to builders but developers and in some cases to subcontractors if the original builder is no longer in business. The implied warranty of habitability not only applies to new construction but also remodeling. While Illinois Courts have expanded the warranty from what was first announced, the implied warranty can be disclaimed if there is a knowing disclaimer that is conspicuous, fully discloses its consequences and clearly sets forth that the disclaimer is the agreement of the parties.

The Illinois Appellate Court, First District, recently extended the implied warranty of habitability to a subsequent purchaser who bought the house three years after it was first built; the defect didn’t arise until a year after the second sale which means four years after construction; the subsequent purchaser bought the house Aas is@ and what’s even more disturbing is that in the initial sale there was a disclaimer of the implied warranty that met all the criteria for a valid waiver.

The Appellate Court ruled that since the implied warranty of habitability does not depend upon privity of contract and since the second purchaser did not have notice that the implied warranty had been waived, the subsequent purchaser could bring a claim against the builder for breach of the implied warranty.In my opinion this decision makes residential home builders virtually guarantors of the house.The only salvation in the Court’s decision is that it held the subsequent purchaser still has to prove that there are in fact latent defects in the house; those defects interfere with the reasonably intended use of the house; and that the latent defects arose within a reasonable time after the house was purchased. The case was sent back to the trial court for determination of these issues. It remains to be seen if a reasonable time means from initial construction or after the second purchaser buys the residence.

Almost all residential builders include a disclaimer of the implied warranty of habitability in their contracts. However, this decision means that is no longer protection against the claim of a second purchaser. How can a builder protect itself? I suggest if you are building on your own lot you have the waiver of the implied warranty on a separate document and record it. If you’re building on your customer’s property include in the contract a provision that gives you the right to record the disclaimer of the implied warranty of habitability. If this is done at least an argument can be made that the subsequent purchaser had constructive notice that the implied warranty was waived. If you would like assistance in preparing such a document contact me.

Construction Contractor Employment Classifications

In the construction industry, contractors commonly use tradesman as independent contractors for a specific construction project. With the recent passage of the Employee Classification Act, any contractor that utilizes a subcontractor must be certain that the subcontractor is truly an “independent contractor” and not an employee. The law became effective January 1, 2008, and seriously punishes private sector general and subcontractors that misclassify any worker as an “independent contractor” on construction related projects. Construction work is broadly defined and includes, for example, remodeling, landscaping, decorating, and painting.

According to the Act, an individual performing services for a contractor is deemed an employee of the contractor unless the contractor can prove: (1) that the work performed by the individual is different from the work the contractor performs; (2) that the subcontractor is engaged in an independently established business; (3) that the individual is a legitimate sole proprietor, or a member of a partnership, or an employee of a corporation established for the purpose of furnishing subcontractor services; and (4) that the contractor has no control or direction over the performance of the independent contractor’s services.

The Illinois Department of Labor can enforce this law by means of an investigational audit. A $1,500 penalty can be assessed for the first violation and $2,500 penalties for subsequent violations within a 5-year period. Each person misclassified and each day the misclassification takes place is a separate violation. These penalties are doubled in the case of willful violations. The misclassified individual or other interested party can file a private action against the contractor and seek damages and injunctive relief. A successful employee can recover any unpaid wages, overtime, employment benefits, liquidated damages equal to any compensatory losses, $500 per day for each violation, and attorney’s fees and costs.

How many times have we heard about construction industry employees being willing to work more than 40 hours per week for “straight” time and “waive” their right to time and a half pay for overtime, in violation of the law? This usually comes about because of the present apparent good relationship between the employer and employee and their willingness to cooperate in such an arrangement.

However, when the employer-employee relationship ends, whether on an amicable or hostile note, and regardless of whether the employee previously knew or subsequently learns his rights (often while having a beer with his friends and telling them his story), the employee can assert his right to overtime pay. These claims are often very costly to the employer as they usually result in an audit of the employer’s payroll records and the government’s assertion of additional claims for present or past employees who are not pursuing a claim.

This example involving extra pay for overtime is not covered by the Employee Classification Act, but is analogous of situations that will occur where a person who is hired as an “independent contractor” later decides he wants more money and brings a claim for additional wages and other benefits of employment.

There will be many lawyers out there “chomping at the bit” to file these cases. If you employ individuals as independent contractors, you must become familiar with this law and modify your practices as necessary.

Unless the subcontractor comes within the exceptions of the Act, the consequences can be very serious for you.

Mechanics Lien Act From An Owner’s Perspective

Our last issue explained how the Illinois Mechanics Lien Act provides a powerful collection tool to general contractors, subcontractors and material suppliers who provide labor or materials for the construction of improvements on private projects. The Act allows a contractor or material supplier to force the sale of an owner’s property to pay the contractor’s claim with the sale proceeds. However, the Act also provides the owner with a method to protect his interest in the property.

An owner who has a written contract with the general contractor, documents all change orders in writing, obtains a contractor’s sworn statement and waivers of lien prior to making a payout and has documentation of all payouts, can defend against a contractor’s claim for lien and protect the property.

One scenario where an innocent owner may have problems with mechanics lien claims of a subcontractor or material supplier is the bankruptcy of a general contractor. Consider: The general contractor performs under its contract with the owner by employing subcontractors to perform the work. The general contractor submits a pay request to the owner in the amount of $50,000, $30,000 of which is to be disbursed among the subcontractors. After receiving payment from the owner, but before disbursing funds to the subcontractors, the general contractor declares bankruptcy. The unpaid subcontractors perfect their lien rights and ultimately file suit to foreclose on their mechanics lien claims. Unless the owner has complied with the Mechanics Lien Act, he may be forced to pay the $30,000 due the subcontractors twice in order to avoid the sale of the property to satisfy the lien claims.

The Act affords protection to an owner who complies exactly with the Act’s requirements. First, an owner should have a written contract with the general contractor that clearly defines the scope of work to be per formed and the amount the owner will pay for the work. Any changes in the scope of the contract work or the contract price should be memorialized in a written change order. Second, before making payments to the general contractor, the owner should demand the general contractor’s sworn statement which identifies all of the subcontractors the general contractor employed to perform the contract work, each subcontractor’s total contract price, changes to the contract price, amounts previously paid, amount to be paid under the current draw request, and the balance due. At the time of making payment on a draw request, the owner should obtain lien waivers from the general contractor and subcontractors which correspond to the values on the contractor’s sworn statement.

Under the Act, an owner is only required to pay for the work performed, the amount due under the contract, and change orders. This includes the cost to retain a replacement contractor to complete a defaulting general contractor’s work. In addition, the Act provides that the owner may rely on a contractor’s sworn statement in making payouts. This means that if a subcontractor’s contract price is identified as $50,000 on the contractor’s sworn statement, the owner is only obligated to pay a total of $50,000 on that subcontractor’s claim even if the general contractor had promised funds in addition to $50,000 to that subcontractor. Finally, an owner who complies with the Act and who receives lien waivers from the general contractor and subcontractors protects the property from claims for funds which were previously disbursed.

Every participant in a private construction project should have a fundamental understanding of the mechanics lien process. An owner who complies with the Act’s requirements can protect his property from the auction block. Lawyers of Di Monte & Lizak have been practicing in the area of construction law for over 44 years and regularly counsel parties in the construction industry, including general contractors and subcontractors, home owners and condominium associations, owners and developers, financial institutions and material suppliers.

Mechanic’s Lien Act – Amendments

Alan L. Stefaniak

Alan L. Stefaniak

In the March 2012 issue of this newsletter I addressed the Illinois Supreme Court’s decision in the case known as Cypress Creek. This is the decision that stood on its head the concept of enhancement when there are competing liens of a prior mortgage and mechanics lien claimants. In Cypress Creek the majority of the Court held that if construction disbursements are used to pay for lienable work the lender is subrogated and has equal priority to an enhancement claim under section 16 of the Mechanic’s Lien Act. As I advised in the March issue this decision adversely affected a mechanic’s lien claimant faced with an enhancement situation since it would dilute the lien claimants percentage of any sale proceeds.

Legislation was introduced to overturn the Cypress Creek decision. I am pleased to report that this legislation was passed and signed into law by our Governor on February 11, 2013. The law takes effect immediately. The bill passed with the minimum number of votes for passage, 60. There were 44 votes against and 9 present votes.

The passage of this legislation and enactment into law is important because it restores the concept of enhancement as set forth in Section 16 of the mechanic’s lien act. Section 16 as amended now clearly provides that a prior mortgage holder is only preferred as to the value of the land at the time the contract is made and shall not be preferred to the value of any subsequent improvements. Further Section 16 as amended provides that each mechanic’s lien claimant is to be preferred to the value of all subsequent improvements whether or not they were provided by the lien claimant.

In my opinion these amendments regarding enhancement were essential to level the playing field once again. I doubt if restoring the concept of enhancement is going to stop construction lending as some in the banking industry have predicted. While it may cause lenders to more carefully scrutinize their risk and take precautions to better protect their interests, that is a good thing. Certainly a lender is in a much better position to protect itself then those in the construction industry such as subcontractors, material suppliers, architects and engineers who are most times removed from the credit risk analysis process. After the Supreme Court’s decision in Cypress Creek I read in several trade articles about dire situations where contractors lost several hundreds of thousands of dollars in enhancement situations and several were forced into bankruptcy. These unfortunate situations should no longer occur and those who have provided value to the property will now be better able to recover for their work when a project runs into financial difficulty or goes bust.

The bill that dealt with enhancement also made another amendment to the Act. Section 34 allows an owner to serve on a mechanic’s lien claimant a notice to proceed to file suit and if not done in thirty days the lien is lost. The notice that is given must now provide a warning. It has to contain the following language in at least 10 point bold face type: Failure to respond to this notice within 30 days after receipt, as required by Section 34 of the Mechanic’s Lien Act, shall result in the forfeiture of the referenced lien.

Another amendment to the Mechanic’s Lien Act took effect on January 1, 2013. In response to the slowdown in our economy especially with regard to commercial projects which are often started but then stopped and put on hold Section 6 of the Act has been amended to state that a claimant can still have a lien so long as the work is done or material furnished within 3 years from the time it is commenced as to owner-occupied residential property and within 5 years as to any other type of property.

While the amendment to Section 6 is not as dramatic as the amendment overturning the Cypress Creek decision it is still important and a benefit to those of you in the construction industry. If you have any questions as to how these amendments might affect any situations you are confronting give me a call or send me an email and I will be happy to respond.

How Do I Change My Construction Contract?

It’s common for projects to expand in scope, and this generally requires modifying the construction contracts using a change order. By being careful and documenting any changes to the contract with change orders, you limit the disputes that can occur, and you protect yourself from having to litigate issues. In this video, David Arena discusses how this is done.

How Do I Dispute a Lien Against My Property?

If a lien is placed on a homeowner’s property, the homeowner can bond over the lien. This protects title to the property. Without a bond, the homeowner would not be able to sell his or her property or refinance the property without paying the lien claim. In this video, David Arena explains this and other options available to homeowners to dispute a lien on their property.

How Does a Homeowner Protect Against a Mechanic’s Lien?

The Mechanic’s Lien Act provides a powerful tool for contractors, subcontractors and materials suppliers get paid. It also provides protection for homeowners, but they have to exercise those rights in order to benefit from those protections. In this video, David Arena reviews those rights and how homeowners use them to protect against mechanic’s liens.

What Is the Illinois Mechanic’s Lien Act?

The Illinois Mechanic’s Lien Act gives contractor and material suppliers the ability to place a lien against title of a homeowner’s property and foreclose on that lien in the event the homewoner doesn’t pay the general contractor or the general contractor doesn’t pay the material suppliers for subcontractors. In this video David Arena details the act and how affects homeowners, contractors and material suppliers.

What Should Be Included in a Construction Contract?

David T. Arena

Homeowners often enter into relationships with contractors without a written contract. There is an oral contract, which is enforceable, but unclear as to what the terms are. That’s usually where the dispute happens. In this video, David Arena discusses the importance of a construction contact and what it should include.

Comments on the Preliminary Report of the ABA Task Force on Corporate Responsibility

Let him who stole steal no longer, but rather let him labor,
working with his hands what is good
that he may have something to give him who has need.
Eph 4-28

 

And the thief, male and female: cut off the hands of both.
Qur’an 5:42

 

I am determined not to steal
and not to possess anything that should belong to others
Bhagavad Gita

 

By “thefts” are meant thefts that are manifest and those not manifest,
which are effected by fraud and craft
under various pretenses to make them appear lawful,
or so done clandestinely as not to appear at all.
Apocalypse Explained 967

1.         Introduction

Ladies and Gentlemen, on behalf of Jesse White, Illinois’ Secretary of State and the people of Illinois, home to 321,754 corporations and 63,145 Limited Liability Companies, welcome to Illinois. Thank you for permitting me to share my thoughts on your preliminary report with you. I commend you for your motivation and effort in preparing this report at this difficult time for our country and its business community.

a.         Jesse White is the Secretary of State of Illinois, and the ConstitutionalOfficer charged with administration of Illinois’ business laws. He has chosen, as had his predecessors back to Jim Edgar, to appoint a “Corporation Acts Advisory Committee” consisting of volunteer business lawyers from every part of our State, who meet monthly with the Secretary’s staff to discuss the corporate and other business laws of our jurisdiction, and their continual improvement.

Since 1981, this Committee has rewritten our various corporation laws, our limited and general partnership acts, and has written and re-written our limited liability company act. We did not participate in the preparation of the Illinois Registered Limited Liability Partnership Act under which the accounting firm of Arthur Andersen and Company was organized..

b.         Lin Hanson is my name. I am a partner in the Park Ridge, Illinois law firm of DiMonte and Lizak. I have been a member of the Secretary of State’s Corporation Acts Advisory Committee since its formation in 1981, and I am its current serving Chair. My practice is transactional, with an emphasis on business. Inspired by your task force member, Roberta Cooper Ramo, I wrote The Illinois Corporation System for IICLE, as well as The Illinois LLC System. With my partner, Jeff McDonald and I own a controlling interest in ILForms, Inc. and we are suppliers of corporate and LLC software to the legal profession.

My great grandfather, grandfather and father were all lawyers. Two of my daughters are married to lawyers, and one is a lawyer also. I have been practicing law for 41 years. I feel I have a strong and personal interest in our shared profession.

My views expressed herein have not been approved by either The Secretary or the Committee which I chair, and should not be considered as representing the views of Secretary of State Jesse White or the Corporation Acts Advisory Committee.

2.         Legislating Morality.

a.         Your Report. We often say, or think “You can’t legislate morality.” You said it in your report, § I.B., p. 10, “No set of legal rules or guidelines can guarantee that such active care will be achieved in practice.” In your footnote you cite The Business Roundtables’ May, 2002 Principles of Corporate Governance to the same effect.

Congress has now enacted, and President Bush has signed into law the Sarbanes-Oxley Act of 2002, so there is no point discussing whether or not to adopt a legislative “fix.” It has been done. We can go on to look at what additional fixes ought or ought not be adopted, and I take it that is the direction in which your report directs us.

All of us who serve on committees know how they work. We recognize and chuckle at the statement that “A camel is a horse designed by a committee.” So I understand how you can start out recognizing that it is impossible to legislate morality, and then proceed for 50 pages to discuss how to go about doing it.

b.         Professor Ribstein’s Critique. One of our committee members, Larry E. Ribstein, aprofessor of law at the University of Illinois Urbana-Champaign, has written a scholarly critique of the new legislation, “Market -vs- Regulatory Responses to Corporate Fraud: A Critique of the Sarbanes-Oxley Act of 2002″ which you may care to examine in detail. You may read it in full at http://luna.law.uiuc.edu/~ribstein/enron.doc. Professor Ribstein has summarized his critique by saying:

The crashes of Enron and WorldCom and frauds or irregularities at many other companies have reinvigorated the debate over regulating corporate governance. Numerous pundits called for corporate regulation to restore confidence in the securities markets. These recommendations appear to be supported by the fact that neither the contracting devices that were supposed to control managers, nor efficient securities markets, worked to prevent or spot the problems. Congress responded with the Sarbanes-Oxley Act of 2002. But this article shows that, given the limited effectiveness of new regulation, its potential costs, and the power of markets to self-correct, new regulation of fraud in general, and Sarbanes-Oxley in particular, is unlikely to do a better job than markets.”

c.         Other Critical Comments. In the Sunday, September 15th, 2002, edition of The New York Times, there was an article entitled “Reining In the Imperial C.E.O.” The article addresses the effects of the Sarbanes-Oxley Act, and mentions “The recent corporate responsibility bill signed by President Bush does not specifically address severance packages….” Still looking for a legislative fix. The same edition of the paper also contained an article “From Investor Fury, a Legal Bandwagon” which portrays our profession in a less than favorable light, as birds of prey circling over the remains of these fallen corporate giants. The August 29 issue of The New York Times suggests that “split dollar” insurance may be an unintended victim of the new law. See “Insurance Plans of Top Executives May Violate Law.” On the other hand, loan transactions commenced prior to the effective date of the new law continue.

d.         Costs and Complications of the Legislature Approach. One by-product of the “new”legislative fix as well as the other economic conditions arising out of the September 11th attack have been and will continue to be increased insurance costs for Director and Officer liability insurance. This will result in a reduction in such coverage provided by some companies, and thereby reduce the number of eligible candidates for board positions. Additionally, the possibility of adverse press coverage itself may have a chilling effect on candidates for board positions.

e.         Public Opinion. Particularly at this time, public opinion may be a more effective tool in securing corporate responsibility.

3.         Internal Corporate Governance. Of the two action recommendations contained in your report, the first deals with several aspects of corporate governance.

a.         Public/Non-Public Companies. You have (correctly, I feel) made a distinction between the publicly traded corporation and the thousands of more closely held corporations, and chosen to apply your suggested actions only to the public corporations. Illinois has made a similar distinction in the treatment of its domestic corporations. See the Illinois Business Corporation Act, §12.55:

In an action by a shareholder of a corporation that has shares listed on a national securities exchange or regularly traded in a market maintained by one or more members of a national or affiliated securities association….”

and §12.56:

In an action by a shareholder in a corporation that has no shares listed on a national securities exchange or regularly traded in a market maintained by one or more members of a national or affiliated securities association…..”

For ease of reference, a copy of our act is available on the Internet, through the offices of Secretary White, at: http://www.legis.state.il.us/ilcs/ch805/ch805actstoc.htm.

b.         Independent Directors. The six specific actions you have recommended in the area of corporate governance all hinge in one way or another on the concept of independent directors. You are recommending creation of Board Committees either entirely populated with independent directors, or with a majority of such directors, and that they function in an environment isolated from inside director/officers. Governance, Audit and Compensation committees are discussed in your report in detail.

i.         Illinois Experience. Our Business Corporation Act §8.60, has dealt with the concept of Independent Directors, calling them “Interested Directors” and “Disinterested Directors.”

“For purposes of this Section, a director is “indirectly” a party to a transaction if the other party to the transaction is an entity in which the director has a material financial interest or of which the director is an officer, director or general partner.

The presence or absence of a majority of Disinterested Directors voting to approve a transaction shifts the burden of proof in determining fairness under our law. Very careful drafting is urged in this area. Too stringent a requirement of Independent Directors can cause corporate paralysis, as Illinois has learned.

ii.        State Corporation Law. Your report indicates you are “not at this time addressing possible changes in state corporation law. You make reference to the activity of the ABA Business Law Section, and its Model Business Corporation Act. It seems to me that your suggestions lack any method of practical application without adoption by the states, or by the agencies and exchanges that regulate trading of securities..,

iii.       Guarding the Guards. Even if adoption of the rules and procedures your report suggests were accomplished, any attempt to “cure” through the mere requirement of Independent Directors without more should give little assurance of success. 2000 years ago Cicero inquired “But who will guard the guards?” No satisfactory answer has yet emerged. Your report’s recommendation of Director training courses, with emphasis on fiduciary duties and compliance programs is an excellent suggestion, but of course, no guarantee.

4.         Judicial Intervention. Your report (p. 16) also addresses the role of the judiciary. It is submitted that the ability of the judiciary is a major component in dealing with the problem of Corporate Responsibility. One longs for a judiciary reminiscent of Mr. Justice Benjamin N. Cardozo. It is not difficult to imagine his angry countenance as he pronounced his opinion in Meinhard v. Salmon (1928), 249 N.Y. 458, 463-64, 164 N.E. 545, 546:

Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the ‘disintegrating erosion’ of particular exceptions. Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. It will not consciously be lowered by any judgment of this court.”

The language quoted was adopted verbatim by the Illinois court in Labovitz V. Dolan et al., 189 Ill. App. 3d 403; 545 N.E.2d 304 September 26, 1989.

5.         The Conduct of Lawyers.

a.         Rule 1.13. You have recommend expansion of the Model Rules of Professional Conduct to make it clear, under Rule 1.13, that the obligation of the lawyer who becomes aware of misconduct by a corporate officer, where the misconduct involves crime or fraud, including violation of federal securities laws and regulations, is to go to higher authority in the organization, or in an extreme case, where higher authority fails to act, resigning from the representation, or disclosing confidential client information to a third party. Clarifying and emphasizing the obligation of counsel to “do the right thing” is an important statement which might make a critical difference in a particular circumstance.

b.         Rule 1.6. You have recommended expansion of the rule on permitting (even mandating) disclosure in order to prevent client conduct known to involve a crime, including securities laws violations. This is a bold proposal which departs from traditional “confidentiality at all costs” doctrine. Tradition has always been that the confidential relationship encourages disclosure by the client, affording the attorney an opportunity to counsel against proposed improper conduct.

c.         Communication with Independent Directors/Independent Counsel. Your report has recommendations regarding tailoring the terms of engagement to facilitate communication by in-house counsel with the independent directors and with independent counsel. Both commendable ideas which I would endorse.

6.         Points for Further Study. In general, I think your focus should be on recommendations which can be accomplished by the ABA itself to the greatest extent possible. If changes need to be made in existing corporation law, what the ABA can do is act on its own Model Corporation Act. If we require changes in the rules governing professional conduct, what the ABA can do is amend its model rules. I have a few other suggestions for consideration, as to things the ABA can do itself.x

a.         Law Schools. The American Bar Association should use every persuasive poweravailable to influence additional study of ethics at the law school level. Over 40 years ago when I was a second year student at Michigan law school, we studied Chapter 20 of the Book of Exodus as being a fundamental foundation of all our law. On the other hand, our entire study of legal ethics consisted of two-two hour lectures in the evening. In my view, legal ethics, as distinguished from merely the law of the legal profession, ought to be taught as a classroom class, but also taught as a part of every class throughout the law school experience. Our graduating lawyers ought to emerge from school with a fundamental sense that there is a special version of right and wrong which applies to the members of our profession from the day of admission until the day they die. Ethical considerations should be a knee jerk reaction to every new engagement or employment. Of course ethical training should start long before law school.x

b.         CLE Programs. ALI/ABA programs and ABA programs should make ethical considerations a mandatory part of every speaker’s material. Reviewers of content of written materials should be alert for inclusion/omission of this topic. We need to constantly remind our members of their ethical obligations as we hone their practice skills. Ethical considerations should not be a stumbling block to creative practice. Instead they should always be a selling point for the employment of counsel.

<            c.         Study Groups. I belong to a men’s Bible Study Group which meets weekly. It is an important part of my life, not only in a religious sense, but in an ethical one. We constantly refer to Proverbs 27:17 “As iron sharpens iron, So a man sharpens the countenance of his friend.” when we try to explain the benefit of our group membership.

The American Bar Association ought to encourage the formation of small study groups of members who can meet regularly to discuss various aspects of practice and problems. Where does an attorney go to test his ideas, his objectives, his practice style? To his partners? Perhaps. To his church? Sometimes. My point here is to say that is would be a good thing to provide an outlet, a place where attorneys with issues can come to discuss these issues with others whose opinion is regarded as sound and informed. I was fortunate to be born into a family of lawyers. I am indeed very fortunate to have joined a firm of competent and caring partners to whom I can speak with candor, and listen with respect. Not everyone has this luxury, and for those who lack it, I recommend you consider the creation of discussion groups. Perhaps in person, but also perhaps on the Internet for the benefit of counsel who are geographically or temporally so separate as to make attending in-person meetings impractical or impossible.

d.         Hot Line. Consider the creation of an e-mail hotline. This could be like a support staff on ethical considerations, staffed 24 hours a day, 7 days a week. Attorneys seeking ethical guidance could submit their issues for quick response, perhaps with followup later. Think about it. There is a point of no return where one must either disclose, participate or quit. At that critical point, there ought to be someone, somewhere to whom the troubled attorney can submit his concern, and get a response. If a month has gone by, or longer, the time for decision/action may well have passed. It is within the possible actions of the American Bar Association, through the use of the Internet, and, yes the telephone, to provide a voice of detached reason at a time when one is needed.

7.         Conclusion. In conclusion let me once again state the obvious: You can’t legislatemorality. If public opinion and pressure makes you try, no one should be too critical. But I hope you will consider other alternatives to elevate the level of our profession. To provide the kind of mentoring that can be a real force for good in the legal profession and the world. It is good to recommend procedural safeguards in the area of corporate governance, and to encourage open and independent consultation between counsel and the directors and outside counsel.

What the American Bar Association should be about, however, is lawyers. Lawyers helping lawyers. Lawyers supporting each other in times of doubt, stress and crisis. Lawyers reminding each other of their obligations to the client, the public and the profession. Truly there is strength in numbers. Not the strength of a mob, but also the strength of conviction, reinforced by the conviction of others, to Do the Right Thing.

 

Thank you.

Directors’ Duty to Creditors

Directors and officers obviously owe a duty to the corporation and its shareholders. But if the corporation becomes insolvent, directors owe a duty to creditors as well.

Regrettably, the current economic climate suggests that more and more clients will face financial difficulty.

It is well recognized that corporate directors and officers owe a fiduciary duty to corporations they serve, and to the shareholders of those corporations. But if the corporations become insolvent, do directors have a collateral obligation to corporate creditors? That duty has been recognized by Delaware courts, as well as courts in Illinois. Schwendener, Inc v Jupiter Electric Co Inc, 358 Ill App 3d 65, 829 NE2d 818 (1st D 2005).

The BCA

The Illinois Business Corporation Act itself suggests directors’ and officers’ duty to suppliers and customers:

>805 ILCS 5/8.85 In discharging the duties of their respective positions, the board of directors, committees of the board, individual directors and individual officers may, in considering the best long term and short term interests of the corporation, consider the effects of any action (including without limitation, action which may involve or relate to a change or potential change in control of the corporation) upon employees, suppliers and customers of the corporation or its subsidiaries, communities in which offices or other establishments of the corporation or its subsidiaries are located, and all other pertinent factors.

(Emphasis added.)

The underlying theory of officer and director liability to creditors in the case of insolvency is based on the assumption that once the corporation is insolvent, the shareholders no longer have anything of value. Their interest has been wiped out. Then the officers’ and directors’ duty shifts to protecting the creditors of the corporation.

Courts, particularly in Delaware, but now in other states as well, have begun to discuss directors’ possible fiduciary duties to creditors when the corporation is operating in the “zone of insolvency.”

Consequently, attorneys advising corporate officers and directors need to know when the corporation is insolvent. Although not directly on point, the Illinois Business Corporation Act (BCA) sheds some light on the subject.

The duty of directors to avoid authorizing distributions to shareholders when the corporation is insolvent was recognized before the BCA of 1983. The 1983 act, at 805 ILCS 5/9.10 (c) and (d), sought to give directors some guidance as to when and how they might determine the solvency of the corporation in making their decisions.

(c) No distribution may be made if, after giving it effect:

(1) the corporation would be insolvent; or
(2) the net assets of the corporation would be less than zero or less than the maximum amount payable at the time of distribution to shareholders having preferential rights in liquidation if the corporation were then to be liquidated.

(d) The board of directors may base a determination that a distribution may be made under subsection (c) either on financial statements prepared on the basis of accounting practices and principles that are reasonable in the circumstances or on a fair valuation or other method that is reasonable in the circumstances.

(Emphasis added.)

This language takes the determination of solvency out of a strict GAAP standard, replacing it with a standard of accounting practices and fair valuation that are reasonable in the circumstances.

The “Zone of Insolvency”

So corporate officers and directors of insolvent corporations have a fiduciary duty to the creditors. But what’s their obligation if the corporation is operating in the “zone of insolvency”? From this point on, imagine eerie music in the background. We’re approaching that ill-defined area where unintended consequences might occur.

Some argue that the shift in fiduciary obligations occurs not at the moment of insolvency but rather when, and only when, an insolvency proceeding is instituted. This gives the directors, officers, courts and third parties a bright-line standard.

The Delaware courts, however, have rejected this concept. See Geyer v Ingersoll Publications Co, 621 A2d 784 (Del Ch 1992), where the court said “insolvency means insolvency in fact rather than insolvency due to a statutory filing in defining insolvency for purposes of determining when a fiduciary duty to creditors arises.”

In Geyer, the Delaware chancery court wrote as follows:

An entity is insolvent when it is unable to pay its debts as they fall due in the usual course of business….That is, an entity is insolvent when it has liabilities in excess of a reasonable market value of assets held….Although there may be other definitions of insolvency that are slightly different, I am not aware of any authority which indicates that the ordinary meaning of the word insolvency means the institution of statutory proceedings.

This and other rulings gave rise to a theory that there must be a prefiling state called the “zone of insolvency,” or sometimes the “vicinity of insolvency,” where the fiduciary obligation to creditors springs into being. In Illinois, we have a federal district court opinion in Seidel vByron, 2008 WL 4411541 (ND Ill 2008) where the court wrote as follows:

Under Delaware law, corporate officers and directors owe creditors no extra contractual duties unless there are special circumstances, including operating in insolvency or in the zone of insolvency [citing Geyer]. The duties owed to creditors may arise before the filing of the bankruptcy petition because a corporation is insolvent when it is in fact insolvent, not when insolvency arises due to a statutory filing like bankruptcy.

A corporation is insolvent when its liabilities far exceed its assets, or when it is unable to pay its debts. Production Resources Group, LLC v NCT Group, Inc, 863 A2d 772, 775-776 (Del Ch 2004). The Delaware Supreme Court has not yet defined “zone of insolvency” precisely. North American Catholic Educ Programming Fund, Inc v Gheewalla, 930 A2d 92, 98 n 20 (Del 2007) (“NACEPF”). In NAECPF, however, the plaintiffs complaint was found to allege that the debtor operated in the zone of insolvency where it stated, among other things, that the debtor could not raise sufficient funds to pay its debts; that it was unable to borrow money from any source other than from one investor; and that it had a certain specific amount of cash on hand that was being spent at a specific rate each month.

The NAECPF case gives us a very clear statement regarding operating in the “zone of insolvency”:

In this case, the need for providing directors with definitive guidance compels us to hold that no direct claim for breach of fiduciary duties may be asserted by the creditors of a solvent corporation that is operating in the zone of insolvency. When a solvent corporation is navigating in the zone of insolvency, the focus for Delaware directors does not change: directors must continue to discharge their fiduciary duties to the corporation and its shareholders by exercising their business judgment in the best interests of the corporation for the benefit of its shareholder owners. Therefore, we hold the Court of Chancery properly concluded that Count II of the NACEPF Complaint fails to state a claim, as a matter of Delaware law, to the extent that it attempts to assert a direct claim for breach of fiduciary duty to a creditor while Clearwire was operating in the zone of insolvency.

(Emphasis added.)

The Safest Assumption

We have no direct guidance from Illinois courts yet on the zone of insolvency. Delaware suggests that until a corporation is actually insolvent – where its debts far exceed its assets or it is unable to pay debts as they mature – directors and officers owe their duty strictly to the corporation and the shareholders.

The safest assumption is that once a corporation is insolvent, whether or not a formal insolvency filing has occurred, the directors’ duty to creditors arises. We should counsel our director and officer clients accordingly.

Family Limited Liability Entities

Increasingly, the family limited partnership, or a family owned limited liability company, which could perhaps be collectively referred to as family limited liability entity or FLLE is being employed in planning larger estates. When coupled with the concept of a “minority discount” it contains many attractive features for a family gifting program.

A FLLE typically will have “active” and “passive” participants. These would be called the “general” and “limited” partners or the “manager” and “members” depending on which entity is selected. The general or manager will control the entity. He or she is the decision maker, and the limiteds or members will merely participate in profits and losses, without a say in management.

An owner of a substantial estate can transfer assets, whether stock, bonds, cash, real estate or other interests to a FLLE. This transfer is tax free. The owner, at this phase, will own both the general and limited partnership interests in the entity.

Next, the owner will transfer limited partnership interests or membership interests to his family members. Since he retains total control of the enterprise, the financial responsibility of the recipients is not as large an issue as it would be if the gifts were “outright”. Additionally, the gifts can qualify for a minority discount (see attached).

Example: Father places $1,000,000 in the FLLE. Each child is given a 10% interest. A 35% “minority” discount is taken. The value of the gift to each child is $65,000 for gift tax purposes. Father totally controls the portfolio … all buy, sell etc. decisions are made by him alone. He decides whether the income is to be distributed at year end or not. (Whether it is or not, though, each child will be taxed on 10% of the income, or have a deduction for 10% of the losses). If father chooses to do so, he can pay himself a fee for managing the partnership, thus, in effect, retaining the income from the assets. The children are only taxed on the “net” income, so dad’s fees are deducted before their income is computed.

Upon the death of the owner, only the value of his retained ownership in the partnership is taxed in his estate. If he has transferred 99% of the ownership during his life (and lived the required three years), only 1% of the assets are taxed when he dies.

Minority Discounts

It makes sense, doesn’t it, that a controlling interest in a company is worth more than a minority interest? Of course it does – the minority can’t run the business, help itself to corporate profits, put kids on the payroll, etc. like the majority can. While there might be a market for a majority interest, it would be hard even to sell a minority interest in most small companies. Nonetheless, the IRS ruled for many years, that for purposes of the estate and gift tax, no discount would be allowed for a minority interest, where the family, combined, owned a majority interest. Since 1993 however, in Revenue Ruling 93-12, IRB 1993-7, the Treasury backed off this position, in recognition of a number of Court losses. Henceforth, the family ownership of a majority position will not, by itself, deny a minority discount in valuing stock for estate and gift tax purposes. Discounts of as much as 35% are now being claimed routinely on gift tax returns. Qualified expert opinion on both the value and the discount are necessary, however.

In a 1996 ruling, the United States tax court recognized a 50% interest as a “minority”. It was noted that although a 50% shareholder can block action by other shareholders, this percentage cannot by itself control the corporation.

For LLC Minority Owners, “Fair Value” Often Isn’t

The Illinois Business Corporation Act (BCA) and the Illinois Limited Liability Company Act (LLC) contain references to the term “fair value.” In the BCA, we find this term in the context of dissenter’s rights (805 ILCS 5/11.60-70) and in the minority shareholders’ rights section (805 ILCS 5/12.56). In the LLC act, the term occurs in the provision giving members the right to dissociate and receive payment for their interest in the company (805 ILCS 180/35-60).

Lack of Control Leads to Lack of Marketability

The Illinois courts have looked at the issue of fair value on a number of occasions, and the Journal published a very good article a couple of years ago. John T. Shriver and Paul J. Much, Determining Fair Value for Minority Shareholders Who Sue for Corporate Wrongdoing, 91 Ill B J 199 (April 2003). Discounts for lack of control and lack of marketability are one aspect of fair value, and they are the focus of this column.

An illustration is helpful. Assume we have a company with two shareholders, one called “Boss” having 70 percent of the stock and another called “Worker” with the remaining 30 percent. Assume for simplicity’s sake that we know that the company is worth exactly $100,000.

Worker comes to Boss and says, “Hey, Boss, I’ve got an idea! We’re making decent money here, we’ve both got kids about to go to college; let’s put the kids on the payroll and let them earn some money for college. Boss responds, “Good idea! We’ll put my kid to work next week. We don’t have an opening for yours. The minority shareholder is thus made painfully aware of his lack of control.

Come year’s end, Worker stops by again, with another idea: “We’ve had a good year; let’s reduce our corporate profit by paying ourselves each a bonus.” To which Boss responds, “Good idea! I’ll take that bonus, but you haven’t impressed me that much, so you won’t be getting one.” (See a pattern here?)

So Worker tries to sell his shares for the $33,000. The response is “Are you nuts? I can’t put my kid on the payroll, I can’t get a bonus. Why should I pay $33,000 for your shares? On the off chance that the whole place may get sold someday, I’ll pay you $20,000.” Thus we have lack of marketability and a corresponding discount.

But It Ain’t Fair, Judge…

In Hickory Creek Nursery, Inc v Johnston, 167 Ill App 3d 449, 455, 521 NE2d 236, 239-40 (3rd D 1988), the court held that a minority discount should not be applied. But in Independence Tube Corp v Levine, 179 Ill App 3d 911, 917, 535 NE2d 927, 931 (1st D 1988), the court held that “[t]here may be situations in which the minority or illiquid nature of the stock diminishes its value. In such instances, these factors should be considered in determining fair value.”

In Institutional Equipment & Interiors, Inc v Hughes, 204 Ill App 3d 922, 562 NE2d 662 (2nd D 1990), the court sustained the trial court’s action rejecting both premium and discount. However, in Stanton v Republic Bank of South Chicago, 144 Ill 2d 472, 581, 581 NE2d 678 (1991), the court upheld discounts for minority interest.

In Weigel Broadcasting Co v Smith, 289 Ill App 3d 602, 682 NE2d 745 (1st D 1996), the court discussed valuation methodology in detail: “The fact that the statute requires dissenting shareholders to be given ‘fair value,’ without specifically defining the term, we think, evidences a legislative intent to allow courts the freedom to fashion a remedy without limiting them to any single form of valuation. It is a legislative grant of broad discretion.” Id at 607, 682 NE2d at 749. The court then went on to uphold the trial court’s valuation, relying on the testimony of an expert who applied discounts for illiquidity and minority.

It would seem the rationale in valuing a minority interest in an LLC would be the same. Note that the LLC Act calls for a withdrawing (dissociating) member to receive the “fair value” of his interest. Like the Business Corporation Act, the Limited Liability Company Act does not define “fair value.”

These discounts are not inventions. They reflect market reality. The question is, in the context of a merger, a reverse stock split, or section 12.56 litigation, is it fair to impose the discount?

The Wisconsin appellate court put it rather well in HMO-W, Inc v SSM Health Care System, 228 Wis 2d 815, 598 NW2d 577 (1999):

We conclude that minority discounts are inappropriate under dissenters’ rights statutes. These statutes were intended to be a trade-off. Majority shareholders were given the power to make fundamental corporate decisions free from minority-shareholder interference and, in exchange, minority shareholders were given the opportunity to receive the appraised fair value of their shares. That appraised fair value should be equal to the shareholder’s share of the corporation. It would not be a fair trade-off to require minority shareholders to surrender their veto power in exchange for a discounted return on their investment, while allowing majority shareholders to obtain control over the corporation as well as a premium on their investment. Such a relationship favors one side at the expense of the other, which we conclude is inconsistent with the purpose of the statute. In short, we conclude that each dissenting shareholder should be assigned his or her pro rata share of the corporation’s net assets, undiscounted for minority status.

Id at 827, 598 NW2d at 582-83.

Secretary of State Jesse White’s Business Laws Advisory Committee is studying amendments to both the BCA and the LLC Act. One could add dissenters’ rights to the LLC Act and another might exclude these discounts from the statutory definition of fair value. Whether this study will result in a proposal for legislative change is uncertain.

Practice Pointers

Meanwhile, prudent practice when representing a minority shareholder or minority owner in an LLC is to negotiate for agreements protecting the minority from a forced buy-out including discount(s). Obviously, a buy/sell agreement with either a fixed price or an appropriate valuation formula would be a first objective.

Other provisions for the protection of the minority owner would be a contractual veto power. The business corporation act permits either increasing or decreasing the minimum vote requirement(s) in the case of organic acts (merger, sale of assets in bulk, charter amendment or dissolution). If your client holds 20 percent, negotiate for an 85 percent vote requirement, giving your client a veto.

Chapter 2A of the Business Corporation Act (Close Corporations) is little used, but it contains a provision allowing a shareholder (even a minority shareholder) to elect to liquidate the corporation, a powerful negotiating position. The LLC act permits any number of such protections to be included in the Operating Agreement. The only things you can’t do in the operating agreement are listed in section 805 ILCS 180/15-5(b).

If you represent a minority owner, you and your client cannot afford to rely on the statute for protection. You need to negotiate and draft aggressively to protect the interests of your client.

Linscott R. “Lin” Hanson is a member of Di Monte & Lizak, LLC in Park Ridge and is past chair of the Secretary of State’s Business Laws Advisory Committee.

 

The Joy of Being Disregarded

Many of your Mom-and-Pop business clients will prefer the simplicity and cost savings of being a “disregarded entity” for tax purposes, which lets them file using Schedule C of their 1040 rather than a separate form for the business. How do you help them do it? Read on.

Drafters of Illinois’s limited liability company law sought to create a flexible and relatively informal system with low administrative costs. Nearly 20 years after Illinois adopted its first LLC act, it seems they met those objectives to the benefit of the business community.

An LLC is an entity created by state statute. The IRS uses tax-entity classification, which allows an LLC to be taxed as a corporation, partnership, or sole proprietor, depending on elections made by the LLC and the number of members. An LLC is always classified under federal law as one of these types of taxable entities.

Becoming a “disregarded entity”

A single-member LLC (SMLLC) can be either a corporation or a “disregarded entity,” which is taxed as a sole proprietor on Schedule C of the owner’s personal Form 1040. To be treated under federal law as a corporation, the SMLLC has to file Form 8832 and elect the “corporation” classification. An SMLLC that does not elect to be a corporation will be classified as a disregarded entity.

For the Mom-and-Pop business, simplicity and cost saving are typically important. By choosing an LLC over a corporation as their entity they eliminate the need for annual meetings, minutes recording action at those meetings, and the attendant legal fees. The cost saving (or time saving for do-it-yourself clients) is significant. If their business can also achieve disregarded-entity status, they won’t need to have state and federal income tax returns prepared for the company. The saving in accounting fees or time is significant.

Does a company owned by a husband and wife constitute a SMLLC? The answer is not necessarily intuitive. The Internal Revenue Service has ruled (Rev. Proc. 2002-69) that the entity is disregarded if (1) it is wholly owned by a husband and wife as community property under the laws of a state, a foreign country, or a possession of the United States; (2) no person other than one or both spouses would be considered an owner for federal tax purposes; and (3) it is not treated as a corporation under section 301.7701-2.

Thus, if the husband and wife are residents of a community property state like Wisconsin or California, the LLC can be considered a SMLLC and disregarded. No similar ruling has been made with regard to residents of common law states like Illinois. The Internal Revenue Service has given every indication, however, that a husband and wife residing in a common law state and owning 100 percent of an LLC will not automatically produce a disregarded entity.
Thus, common law state residents will be forced to file a partnership return for such an LLC. If a federal partnership return is filed, the state of Illinois requires one as well.

The Uniform TOD Security Registration Act

So what do you advise your husband and wife Illinois resident clients who seek the benefit of the disregarded-entity rule? You tell them to move to Wisconsin, but then they would have to endure those cold north-of-the-border winters.

There may be another way. The Uniform TOD Security Registration Act (815 ILCS 10/0.01 et seq.) permits an owner to register real or personal property, or any interest therein, in beneficiary form. “Property” is defined in the Act as “both real and personal property or any interest therein” and means anything that may be the subject of “ownership.” “Beneficiary form” is defined as “a registration of a security which indicates the present owner of the security and the intention of the owner regarding the person who will become the owner of the security upon the death of the owner.”

“Security” is defined as “a share, participation, or other interest in property, in a business, or in an obligation of an enterprise or other issuer, and includes a certificated security, an uncertificated security, and a security account.” Hence, either spouse could be the sole owner of the entire membership interest in an LLC, registering it in beneficiary form to transfer on the death of that spouse to the other spouse. The form of registration is set out in the act as follows: “Registration in beneficiary form may be shown by the words ‘transfer on death’ or the abbreviation ‘TOD’, or by the words ‘pay on death’ or the abbreviation ‘POD’, after the name of the registered owner and before the name of a beneficiary.”

Additionally, the spouses could, either by separate written agreement or in a provision in the LLC’s operating agreement, explain what they are doing and why and require the owner spouse to transfer half of his or her membership interest to the other spouse if 1) the LLC ever ceases to be a disregarded entity or 2) their marriage ends.

If the provisions are included in the operating agreement, the non-member spouse should be specifically identified as a third-party beneficiary of the provision(s) regarding the disregarded status and membership. Consideration for the agreement could be the non-member spouse’s waiver of the right to be a member to qualify the company as a disregarded entity.
The language of the operating agreement might be as follows:

*****

DISREGARDED ENTITY

a. Member’s Marital Status. [Mary Smith] is married to [Harry Smith]. They reside in Illinois, which is not a community property state. They desire to own [Company Name LLC] in joint tenancy, but they also desire that [Company Name LLC] be treated for tax purposes as a disregarded entity.

b. Single Member. [Harry Smith] has agreed with [Mary Smith] that [Mary Smith] shall be the sole (single) member of [Company Name LLC] in order that [Company Name LLC] may obtain disregarded entity status for tax purposes. [Mary Smith] has agreed that the membership shall be registered “TOD [Harry Smith]” in order that [Harry Smith] may have assurance that the membership shall belong solely to [Harry Smith] in the event of [Mary Smith]’s death.

c. Loss of Disregarded Status. In the event [Company Name LLC] shall ever cease to be a disregarded entity, or in the event that [Mary Smith] and [Harry Smith] shall no longer be husband and wife, [Mary Smith] agrees to transfer a 50% membership interest to [Harry Smith] without any further consideration.

d. Third Party Beneficiary. [Mary Smith] and [Company Name LLC] agree that [Harry Smith] is an intended third party beneficiary of this Article and of this Agreement.

e. Spouse’s Signature. The non-member spouse’s signature is attached to this Agreement, to indicate an assent to be bound by all the terms and conditions of this Agreement so that if any portion of the membership interest is ever transferred to the non-member spouse by virtue of the terms of this article or otherwise, such spouse shall become a member immediately and automatically, without further action of any person.

Reprinted with permission of the Illinois Bar Journal, Vol. 100 No. 9, September, 2012. Copyright by the Illinois State Bar Association www.isba.org.

Single Member LLC Better Than Unincorporated Business

Illinois’ amended Limited Liability Company Act permits single member LLCs. This feature offers some unique opportunities to the sole proprietor.

The big difference is, the LLC is a recognized legal entity for purposes of state law. It provides a liability shield like a corporation, but with far less formality. There is no requirement for the election of Directors and Officers. No annual meetings need be held and no minutes need be prepared. In fact, the LLC act says, in so many words, “The failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business is not a ground for imposing personal liability on the members or managers for liabilities of the company.”

A single member LLC is what the Internal Revenue Service calls a “disregarded entity.” This means that for purposes of the IRS, the company is totally transparent. Not only does it pay no tax, but the company need not even file an income tax return. Although S Corporations “pass through” their income, they still have to file a tax return. Single member LLCs instead report profit or loss on their owners’ tax return. An individual will report his business on Schedule C of his personal return just as any sole proprietor does.

The State of Illinois Department The State of Illinois Department of Revenue follows the lead of the IRS, so no Illinois corporate or partnership return is required for single member LLCs, either.

Sole proprietorships cause problems at the owners death. Ordinarily a probate court supervised proceeding is involved to wind up the business, pay bills, close out bank accounts and so forth. On the other hand, the ownership of a single member LLC can be placed in a living trust, totally avoiding probate, and permitting the trustee to continue or wind down the business after the owner’s death, without involvement of the probate court. Alternatively, the membership interest can be issued “t.o.d.” to someone else under Illinois’ Uniform Transfer on Death Act, also avoiding probate.

Although the cost of creating a single member LLC is higher, its lack of formality makes it far less expensive to keep up, annually, than a corporation.

The graphic is a portion of the walled city of Carcassonne in the South of France. Its significance for this article is the enormous wealth which it both represented and contained within its walls, and the superb job of asset protection it did, when the Cathars, under the leadership of Raymond-Roger Trencavel, withstood a five year siege laid by Northern crusaders under the leadership of Simon de Montfort, in the early 13th century AD. It is submitted that if modern-day asset protection counselors can construct a plan of asset protection that can sustain a five-year siege, they will have succeeded as well as can be hoped for. In view of a Colorado Bankruptcy opinion issued in 2003, In re Ashley Albright, 2003 Bankr. LEXIS 291 (Bankr. D. Colo. April 4, 2003), it would seem prudent, however, to use a multi-member, rather than a single member LLC if asset protection is a principal purpose.

Beneficial Changes to Bankruptcy Preference Defenses

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“Act”) was signed into law by President Bush on April 20, 2005. Subject to some exceptions, the Act will take effect in bankruptcy cases filed on or after October 17, 2005. The Act contains many changes to the Bankruptcy Code (“Code”). One change, which will be beneficial to parties conducting business with companies that may be heading into bankruptcy, is broadened defenses to preference actions.

A preference action is one in which a Trustee or bankrupt seeks to avoid and recover certain transfers made to a non‑insider within 90 days of the filing or to an insider within a year of the filing. The Act broadens the defenses available to vendors who have done business with a company which becomes a debtor in a bankruptcy case.

The typical preference is a payment received by a vendor within 90 days of the filing of a bankruptcy petition on an outstanding and overdue invoice (arguably an expedited payment can also be preferential). The debtor or its bankruptcy Trustee can avoid certain of these payments. The preference recovery provisions of the Code are designed to achieve fairness. The law presumes that the debtor is insolvent. It is deemed unfair that certain vendors are lucky enough to be preferred and receive a payment on an overdue invoice while there are other creditors who do not receive any payment whatsoever in the 90 days prior to bankruptcy. Therefore, preference payments can be recovered and returned to the bankruptcy estate for redistribution to the entire creditor body.

In theory, the preference provision of the Code is fair. However, in practice, every person who receives a dreaded Trustee letter seeking the return of monies paid within the 90 days prior to a bankruptcy case feels victimized. However, the Trustee’s letter is not the end of the story. When you receive such a letter, you should explore available defenses, not write a check. The initial demand for a return of a preference is the beginning of a process and the commencement of a negotiation. The Code provides several defenses to those who regularly transact business with a debtor company. In the majority of situations which we encounter, we are able to achieve for our clients significant reductions, if not total defenses, to the supposedly avoidable preference asserted by the Trustee.

One of the most common Code defenses is the “ordinary course of business” defense. Under the amendments to the law which go into effect on October 17, 2005, the ordinary course of business defense will be much easier to establish. The crux of the broadened preference defenses is that the prior law required that payments be made in the ordinary course of business of both the transferee and the debtor and in addition that the transfer be made according to ordinary business terms (i.e. ordinary terms according to the relevant industry standard). Under the prior law, you had to meet both a “subjective” (business practices of the parties) and an “objective” (business practices of the industry) test. The Act makes these tests an either/or proposition. Under the old law preference defendants often had trouble meeting the objective industry standard. In order to prove the industry standard, courts frequently required them to present testimony from an industry expert or a competitor. This burden was not only difficult, but also costly or impractical. The ordinary course of business may be established by proof of an established business relationship (several years or many transactions) together with a showing that normal payment terms were followed as to the alleged preferential transfers at issue. For example, regardless of the fact that invoices provide that payments are due in 30 days, if it is the parties’ routine custom, over a relatively long period of time, to have payments made within 60 to 90 days of invoice, this should establish the ordinary course of business. Therefore, in circumstances where there is an established history between the parties and the payments are made within those terms it would be easier to defend a preference action. When the relationship is a first‑time one, or it has not been very long, some proof that industry standards were followed will be required. Other common defenses are: a) providing subsequent new value to a debtor after the receipt of the alleged preferential transfer, b) exchanges that are intended to be and in fact are substantially contemporaneous, and c) the fact that pre‑payments are not preferential since an antecedent debt is not being paid.

For cases involving primarily commercial debt (not consumer debt) the Act precludes avoidence if the aggregate value of the property that constitutes or is affected by such transfer is less than $5,000.00. However, it is possible that a Trustee might still sue (forcing this defense to be raised as an “affirmative defense”) or still send a demand letter for a sum under $5,000.00. For cases involving primarily consumer debt, the threshold is $600.00.

If you receive a Trustee demand letter, you should consult with bankruptcy counsel rather than issuing a check. In most circumstances you can settle (but only with court approval) for a percentage of your exposure. Please contact us about any questions you may have concerning this or other provisions of the Act.

Employment Covenants – Need to Update

Recently one of my clients had an estimator jump ship and go to work for a competitor. As is usually the case the employee was just coming into his own after several years of training and was becoming an asset to the company. When he announced his departure, he was reminded that he had signed a Covenant Not to Compete which included non-solicitation and non-disclosure covenants. The employee firmly stated he was not joining a competitor and would not be working in the same field. This employee lied. Within weeks emails surfaced from the ex-employee to several of my client’s customers advising of his new employment and that he was ready, willing and able to do business with them for his new employer.

My client dug out the Employment Covenant that had been signed. Unfortunately it had been entered several years ago and not updated to take into account a recent Illinois Supreme Court decision on Restrictive Covenants and more importantly an Illinois Appellate Court decision issued in June of 2013.

My client’s agreement was the usual Employee Confidentiality, Non-Disclosure, Non-Competition and Non-Solicitation Agreement. It was for four years from termination of employment and prohibited the employee from working for any company in the same industry within the counties of Cook, DuPage and Lake. It also prohibited the employee from soliciting customers for the same amount of time. Under current Illinois law as announced by a recent Illinois Supreme Court decision a restrictive covenant will be enforced if it contains a reasonable restraint and the agreement is supported by adequate consideration. In determining reasonableness the court applies a three prong test. The covenant can be no greater than required for protection of a legitimate business interest of the employer. The covenant cannot impose an undue hardship on the employee and the covenant cannot be injurious to the public.

Where the covenant at issue failed was that it was too long i.e. four years. In addition it prohibited the employee from working in the same industry when really all that matters is that customers and legitimate prospects not be solicited. Further it was too broad covering multiple counties when the client’s business is primarily centered in one.

A recent Illinois Appellate Court decision elaborated on the issue of adequate consideration for employment covenants. The Appellate Court held that for adequate consideration to exist there has to be two years of continued employment. This is true even if the employee resigns instead of being terminated.

If you have existing employment covenants you should have us review and update them. Also the form you are using should be updated for new hires. In order to meet the new adequate consideration criteria you will most likely have to pay a signing bonus to both current employees and new hires. However, the expense of doing so is outweighed by having an enforceable agreement. You spend a great deal of time and money training people and that benefit should not go to a competitor if you can prevent it.

The law is not static and continues to evolve. You need to keep agreements current and up to date with changes in the law.

Immigration Status Not a Bar To Illegal Aliens Suing Employers For Civil Rights Actions

In our July 2007 newsletter, I wrote about the government’s increased crack-down on illegal aliens and the employers who employ them. You may think that employers of illegals are immune from lawsuits filed by illegals for race, national origin, or any other kind of workplace discrimination. Wrong. As a recent Title VII sex harassment case illustrates, undocumented workers are covered by the federal employment discrimination statutes and it is as illegal for employers to discriminate against them as it is to discriminate against individuals authorized to work in the United States.

The Torres Case Against Perkins Restaurant – Food For Thought

In a recent United States District Court case in Minnesota, Maria Torres and the U.S. Equal Employment Opportunity Commission sued Perkins Restaurants for sexual harassment and retaliatory discharge. Torres, a cook, claimed that kitchen manager Centano made sexual comments to her, rubbed up against her, and came to her house uninvited. She claimed that when she refused Centano’s advances, he began treating her less favorably than other workers and threatened to report her to the immigration authorities for being an undocumented alien. Torres eventually complained to senior management about the harassment and explained that Centano threatened to have her deported.

Perkins investigated Torres’ complaints. Perkins decided that Centano should get a written warning. It also decided to call the Social Security Administration, which reported that Torres’ name did not match her social security number. Perkins told Torres it no longer could employ her and that she could come back to work when she had proper documentation. Torres sued Perkins for sexual harassment and for retaliatory discharge. In its defense, Perkins argued that because the Immigration Reform and Control Act compels an employer to discharge employees upon discovery of their undocumented status, Torres was not an “employee” protected under Title VII. Perkins also argued that even if Torres is protected, she can’t be awarded lost wages because she was not entitled to them anyway (remember, she was here illegally). The court rejected Perkins’ position, stating that its argument would incentivize employers to hire undocumented workers because of their inability to enforce workplace rights available to documented workers.

Worker’s Compensation Cases

What about worker’s compensation benefits? The Illinois Workers’ Compensation Act provides that “aliens” are covered employees, but does not address whether or not illegal status exempts the “alien” from coverage. However, the Workers’ Compensation Commission deems undocumented aliens to be covered by the Act and able to collect worker’s compensation benefits.

NLRB Postpones Deadline for Displaying New Union-Rights Poster to Jan. 31, 2012

The National Labor Relations Board (NLRB) has postponed until Jan. 31, 2012, the implementation date for a new poster describing employee rights to join a union. The NLRB had originally required employers to display the poster in their workplaces by Nov. 14, 2011. In a statement, the NLRB said the two-and-a-half-month delay was a response to “queries from businesses and trade organizations indicating uncertainty about which businesses fall under the Board’s jurisdiction.” An NLRB representative told the Wall Street Journal that “many private-sector employers mistakenly think they are excluded “because they don’t have a unionized work force.”

Estate Planning

When we speak of estate planning, we think first and foremost about planning for disposition of assets at death. One focus of estate planning is tax planning. We should also keep in mind, however, asset protection and asset management for individuals unable to manage for themselves including clients who become disabled.

A principal objective of estate planning clients, particularly in the last decade, has been avoiding probate. Probate may be avoided in a number of ways. Joint ownership of property avoids probate until the death of the last surviving owner. Beneficiary designations, such as those used with life insurance contracts and pension and profit-sharing plans avoid probate if the beneficiary designated survives the insured or owner. Certain forms of bank accounts called “Totten trusts” permit the owner of the account to designate a beneficiary or payee on death. In recent years, the Illinois legislature has enacted the “Uniform Transfers on Death Act” which permits registration of stocks, bonds, memberships in LLC’s and the like in one name with a beneficiary at death.

An alternative means of avoiding probate is the living trust. Many of our clients are creating trusts, acting as their own trustees, and naming someone else to act as trustee at the time of their death or disability. Such trusts often deal with three consecutive time periods: the time during the client’s own life, the time after the client’s death while the client’s spouse is alive, and the time after both spouses are gone. These trusts are known as “self-declared living trusts”. Self-declared because the client declares himself or herself to be the trustee of the trust. Living trusts because they come into existence during the clients lifetime. Since property is placed in the living trust during the clients lifetime, and the trust has beneficiaries named to receive the property after the client’s death, these trusts avoid probate.

VERY Important Note: trust. In the case of real estate, this means a deed to the land must be prepared, and recorded with a Recorder of Deeds, transferring title from the client or clients to the trust. In the case of stocks, bonds, mutual funds, and bank accounts, the institution involved should be contacted and requested to re-register in the name of the trust. In the case of tangible personal property such as jewelry, gem stones, works of art, silver and crystal, precious metals, stamp and coin collections, recreational vehicles, and the like, a bill of sale should be prepared documenting the transfer of ownership from the client to the trust. In the case of automobiles, trucks, boats and aircraft, where certificates of title issued by the state exist, the appropriate state agency should be contacted, and a new title certificate issued in the name of the trust.

Special Note: Under the Illinois “Small Estate Act” a person may have up to $50,000 in his or her name alone and still avoid probate. Thus many clients choose not to register their automobiles and family bank accounts in the name of their living trust.

The principal benefit of the living trusts, during the clients life, is that it acts as a vehicle for asset management in the event the client becomes disabled. Without a living trust, in the event of disability, ordinarily it will be necessary to have a guardian appointed by the probate court to manage the client’s affairs. The guardianship is somewhat inflexible and expensive. Many decisions made by a guardian need to be reviewed by the appointing probate court meaning an attorney must prepare a petition, present it to the judge, produce what ever evidenced the judge feels is necessary in support of the petition, and secure a court order. Often the court order must be certified by the clerk and delivered to a third party before action can be taken. This is both time-consuming and costly. The guardian needs to post a bond with the probate court, which means the payment of an annual premium for the bond so long as the estate remains open. The living trust, on the other hand, does not have court supervision and the trustee need not post a bond. Of course, the trustee needs to conduct himself or herself in a careful manner in the management of the client’s estate, and is subject to court review in the event the client or another interested party files a suit questioning the administration in the trust.

Under current Internal Revenue Service regulations, a self-declared living trust is the “alter ego” of the client. It does not need a separate taxpayer identification number, and it is not required to file an annual income tax return. All the income and expenses of the trust are reflected on the personal income tax return of the client. The State of Illinois, Department of Revenue follows the lead of the Internal Revenue Service, and also does not require self-declared living trusts to file a separate income tax return.

At the clients death, the nominated successor trustee of the trust takes over the office. Provisions of the trust are carried out by the successor trustee. Sometimes the trust terminates at the client’s death, and the successor trustee distributes the trust assets to whomever is designated. On the other hand, sometimes the trust goes on for many years after the client’s death with the successor trustee, or perhaps even a succession of successor trustees administering the assets for the benefit of the beneficiaries according to the terms of the trust. Choice of trustee is more critical in the case of the trust which will be ongoing for a period of time than one where the trust distributes immediately. In either case the loyalty and honesty of the trustee must be unquestioned. In the case of an ongoing trust, the ability of the trustee to manage money (invest wisely) must also be considered.

Sometimes a co-trustee relationship is best. A family member can be chosen as trustee because of his or her knowledge of the family, and the wishes of the client. A corporate fiduciary (usually a bank) can be chosen as co-trustee for its money management ability, administrative and bookkeeping skills, and the fact that, unlike an individual, the bank will not die, go on vacation, or be distracted by its other activities. Often the corporate fiduciary can earn enough through its additional management skills to pay the extra costs of its fees.

In the case of larger taxable estates ($1 million and more) tax planning features can be built right into the living trust. Each individual spouse in a marriage relationship has a separate exemption from the estate tax. Currently the exemption amount is $1,000,000. Through careful drafting of the living trust, the children or other beneficiaries of a married couple can enjoy not one but two exemptions of $1,000,000 each ($2,000,000).

A carefully drafted trust will contain a “spendthrift clause”. An example of the spendthrift clause is as follows:

All payments may be made to the respective beneficiaries or, at their direction, may be deposited in any bank in any account carried in his or her name alone or with others. Such payments shall not be transferable by the voluntary or involuntary acts of any beneficiaries or by operation of law and shall not be subject to any obligation of any beneficiary.

The effect of the spendthrift clause is to prevent the creditors of a beneficiary of the trust from levying on the beneficiary’s share, or filing a garnishment against the trust. Under current Illinois law, a client is not able to protect his own assets from the claims of his own creditors through the use of the spendthrift clause. Some states, including Alaska and Delaware, have amended their statutory law to permit clients to create trusts for their own benefit and secure the asset protection benefit of the spendthrift clause. Clients who wish this additional degree of protection should discuss the creation of an Alaska trust, or some other alternative asset protection vehicle with us.

CONCLUSION. Living Trusts can benefit almost everyone. Both large and small estates can benefit. Young and old alike will find benefits to fit their particular needs. As much flexibility as can be desired can be built into the individual documents. Tax planning, asset protection and probate avoidance are all available through the Living Trust.

Pet Trusts in Illnois

Recent news accounts have informed us that Leona Helmsley, “the Queen of Mean,” died as she lived. She left a $12,000,000 trust for her pet dog, “Trouble,” while disinheriting at least two of her grandchildren. Ms. Helmsley was, fortunately for Trouble, not an Illinois resident.

While Illinois has a “Pet Trust Act” which I drafted, and which was passed in 2004, the act contains a section seeking to rein in the excesses of pet owners by providing, “The court may reduce the amount of the property transferred if it determines that the amount substantially exceeds the amount required for the intended use. The amount of the reduction, if any, passes as unexpended trust property….” I believe it would be difficult indeed for an Illinois judge to hold that $12,000,000 is “required” for the intended use – caring for Trouble for the remainder of his life, even with the best of care.

So what would happen to the excess funds left in trust for Trouble under Illinois law? There are three possible answers: (1) If the trust instrument itself provides for what happens to excess funds, that provision would control or (2) if it does not, the excess funds would pass to the “residuary” or ultimate taker under Ms. Helmsley’s will or (c) if there is no ultimate taker eligible under her will, the excess funds would pass to her heirs at law, possibly even the two grandchildren she has chosen to disinherit.

If you would like to discuss a possible trust for a companion animal under Illinois law, please feel free to email me, or contact your Di Monte & Lizak, LLC attorney.

Benefits of LLCs over Restrictive Trusts for Vacation Home and Second Home Ownership

An LLC can offer new flexibility in managing your summer home or vacation property for the benefit of future generations of your family. This short slide presentation seeks to discuss some of the ways this can be done.

Illinois Supreme Court Gets It Right – Finally

In the February issue of this newsletter I wrote about an Illinois Appellate Court decision that dealt with the lien rights of design professionals. The article was Another Appellate Court Smack Down for Architects and Engineers.” The Appellate Court held that design professionals can only have a lien if their services increase the value of the property or the property has actually been improved by reason of their services. I stated this decision was “flat out wrong” since it was contrary to the explicit language of the Illinois Mechanic’s Lien Act. As I previously informed you this case was further appealed to the Illinois Supreme Court. I am pleased to advise you our Supreme Court reversed the Appellate Court. This is a major victory for architects, structural engineers, professional engineers and surveyors.

As you will recall this case involved a civil engineering firm who did preliminary engineering and performed land surveying services for a preliminary and final plat. The development did not proceed. In a contest between the mortgage lender and the engineering firm both the trial court and the Appellate Court ruled that since the development did not proceed there was no increase in the value of the property and no physical improvement was made. Accordingly the engineer had no lien. The trial and Appellate Court ignored the explicit language of the Act that provides design professionals have a lien if they provide “any services or incur any expense” if it is for the purpose of improving a lot or tract of land. Fortunately, the Illinois Supreme Court did not ignore the language of the Mechanic’s Lien Statute and specifically referred to it in reversing the Appellate Court decision on this issue.

The Illinois Supreme Court stated, “If a physical improvement is required for an engineer to secure a lien for their work, then these professionals would be subject to the whims of the parties with whom they contract, who may decide to complete the project or not. Such an outcome is contrary to the protective purpose of the Act.” In rendering its decision the Illinois Supreme Court seemed a little taken aback by the Appellate Court’s position that a physical improvement or increase in property value had to exist before a design professional had a lien. The Supreme Court cited to a decision it rendered way back in 1900, Freeman v Rinaker and another it rendered in 1930 Crowen v Meyer and said both decisions stand for the proposition that a design professional is entitled to a lien if the services provided are rendered for the purpose of improving property. The Illinois Supreme Court stated it saw no reason to depart from this rule.

I have represented several architects and engineers and have confronted this same issue. In most cases a design professional’s need to assert a lien arises when the project doesn’t proceed. In these situations there is no physical improvement to the property and while there may be an increase in the property’s value it can be difficult to quantify and prove. I have advocated for the position that the Illinois Supreme Court has now ruled is the law under the Illinois Mechanic’s Lien Act. I am very pleased that the Illinois Supreme Court got it right. There is now an Illinois Supreme Court decision that upholds the specific language of the Act in favor of design professionals – FINALLY!

The Pitfalls of Zoning

As many of you know in addition to concentrating my practice on Construction law and litigation I do a great deal of zoning work. Once the “Great Recession” hit this area of my practice dropped off considerably. Now that the economy has picked up, I find this area is getting busier and I have several current matters that I am handling. Not like the “Old Days” with large scale residential and commercial projects but smaller projects are being undertaken that need municipal entitlements.

Zoning and land development law is an interesting area but a minefield. Each municipality has its own Zoning Ordinance and Subdivision regulations. These need to be reviewed and understood with every case since each City or Village has its own rules and procedures. You need to not only know them but make sure you adhere to the required rules and procedures. A recent Illinois Appellate Court decision brought home that Zoning lawyers need to know and follow the rules precisely or suffer the consequences.

A developer’s large high rise project (13 stories, 155 feet tall) was approved by the City of Chicago and the neighboring property owners were not pleased. They filed a lawsuit and contended the project was oversized and out of character with the neighborhood. They also complained there was inadequate off street parking. The lawsuit requested that the rezoning be declared invalid because it would cause changes to their neighborhood that would diminish property values and was arbitrary and capricious and violated their right to substantive due process of law. Unfortunately for the neighbors none of these arguments were reached by the trial court.

There is a State Statute that requires when you are challenging a rezoning in municipalities of 500,000 or more in population that you give notice of your lawsuit to all property owners within 250 feet of the property that was rezoned. The Statue provides that a property owner who is entitled to notice who shows that his property will be substantially affected by the lawsuit can enter an appearance and if he does so he’ll have the same rights as a party to the suit.

Unfortunately for the neighbors their attorney did not precisely follow the notice requirements. When a zoning search was done several parcels were listed as “tax exempt” and no notice to these owners was given. In addition the common address of the property was used in determining owners within 250 feet. However, the common address only included two of three parcels. Accordingly, not all properties within 250 feet were picked up and several were not given the requisite notice of the lawsuit’s filing.

The Developer and City of Chicago sought dismissal of the lawsuit and the trial court granted their motion to dismiss. The dismissal was upheld on appeal. The neighbors argued that they had made a bona fide effort to comply with the Statute and that substantial compliance was achieved. The Appellate Court did not agree and held that strict compliance with the Statue was required. The neighbors also argued that proper notice had been given with regard to two out of the three parcels and their lawsuit should be allowed to proceed with regard to those parcels. Again the Appellate Court did not agree and held that the Statute does not refer to the common address of the property. The Statute refers to the location of the property involved and its property index number. In ruling against these neighbors the Appellate Court emphasized that substantial compliance is not enough since every property owner within 250 feet may either want to defend the zoning or assist the plaintiff in challenging it. The Appellate Court ruled that the purpose of the Statute cannot be met unless all property owners entitled to notice are given the required notice.

The moral of this story is to know the rules and precisely follow them. If a property is listed as tax exempt more has to be done to determine who the owner is and provide the requisite notice. In addition don’t rely on the common address but use the legal description. Unfortunately for the zoning lawyer involved in this case a lesson was learned but the hard way.

Seniority Has Its Privileges

During the recent residential real estate development boom, our client, a real estate broker, and his partners successfully negotiated for a large national builder, the acquisition of two farms. The first farm, consisting of 300 acres, sold for $16 million. The second farm, consisting of 450 acres, sold for $30 million. At a 5% commission rate, our clients had $2.3 million in commissions at stake! While the market was hot, the national builders were gobbling up the countryside at record prices. However, things changed once the market got cold.

After placing the farms under contract for acquisition, the builder “land banked” the farms. This consists of finding a nominee to acquire the farm at the existing contract price, and the land banker “sells” the property back to the builder at a higher, enhanced sales price.

This is also called “off-balance sheet financing.” In our case, the national builder denied that it incurred liability to our client for the 5% commission because, it claimed, it had not acquired the property, the land banker had.

Of course, that argument ignored the fact that the builder and the land banker were under a separate contract to sell and purchase the property in the future. With more than $2 million at stake, the real estate brokers were vitally interested in getting the case concluded pronto.

However, our court system moves slowly. We had two national corporate defendants with large treasuries devoted to paying attorneys; a crowded court system; and judges with too many cases. Luckily, one of the brokers was over 70 years old, 85 to be exact, and subject to preferential treatment according to Section 2-1007.1 of the Code of Civil Procedure. The law provides that individuals who have reached the age of 70 years be entitled to preference in setting for trial. Of course, using our client’s age as an advantage, we filed suit and immediately requested the court to set the case for trial in a few months.

Our strategy worked. The court learned the plaintiff was 85 years old. The court set the case for trial nine months later (that is pretty fast for Cook County, Illinois). The lawyers had a compressed schedule for taking depositions, producing documents and exchanging pre-trial information. This caused the lawyers to put pressure on the clients to settle the case and the elderly client received a very favorable award. Of course, the other brokers under the age of 70 received the same benefit as the one over 70. They had the good luck of partnering-up with someone who received a preference for trial. As we have heard in the past, seniority should have its privileges!

Understanding the Illinois Commercial Real Estate Broker Lien Act

This fall, Julia Jensen Smolka had an article published with the Illinois State Bar Association Real Estate Section. The article is a summary of the Illinois Commercial Real Estate Broker’s Lien Act. Ms. Smolka won a ruling on appeal with the First District Appellate Court on the validity of a commercial real estate lien on a property when the owner of a six flat attempted to close a sale without paying her realtor.

You can read the article here

Lawyer as Detective – Sexual Harassment Investigations

It was a hot humid afternoon, the kind when the Cubs blow a 5 to 2 lead in the top of the ninth. I was wearing my light-blue double-worsted French-cuff blouse, black pumps, and black pencil skirt with back-slit detail. Perfect for court or taking in a set at Buddy Guy’s. The Blue Line was rumbling past my law office and I was wondering whether the horse fly on my window was going to sit still long enough for me to swat it to kingdom-come with the Daily Law Bulletin my partner just dropped off. I could hardly hear the phone ringing over the racket, but I knew it meant trouble.

I’ve represented employees and employers in and outside the courtroom for over 20 years. Because of my experience in workplace discrimination, I also am hired by employers and their attorneys as an independent investigator of workplace harassment. In other words, I get to play detective (hence, my salute to Raymond Chandler). Our Supreme Court has made abundantly clear that when faced with a sexual harassment complaint, an employer must conduct a prompt, thorough investigation and take appropriate remedial action based upon the results of that investigation. When properly conducted, the investigation can protect employers from liability. The same rules apply to other types of workplace harassment.

Employers or attorneys for employers often retain a qualified outside investigator with no ties to the employer in order to avoid claims by the defense that the investigator was biased and the investigation a sham. The employer’s internal human resources professional may be accused of bias and may not have the legal knowledge necessary to ask the right questions and develop the information necessary to afford maximum protection to the employer. Her concern for her own future with the company may cloud her findings or stifle her candid interview of an organization’s power player. An attorney of the law firm that represents the employer also may have his neutrality challenged. Messy issues of attorney-client privilege also can arise, and the law firm’s ability to represent the employer if litigation ensues may be challenged.

The object of the employer’s workplace investigation is to find out what really happened. The employer must procure reliable facts so that it can make an informed decision about what remedial steps, if any, need to be taken. The investigator may conclude that sexual harassment occurred, that it did not occur, or that it is impossible to tell what really happened. The adequacy and fairness of the employer’s remedial action depends on the investigator’s ability to expose the truth. Only then can employer’s counsel make proper recommendations to the employer concerning the form of disciplinary actions to be taken. Remember, the investigation must be unbiased and thorough in order to cloak the employer with protection. Does the investigator have the legal knowledge and skills to identify and ask key questions of the witnesses? Is the investigator a good listener, courteous, non-threatening, but able to ask the tough questions and stand up to bullies? Does the investigator have the ability to gain the confidence of the witnesses? To challenge them in a respectful manner and treat them in a non-judgmental way, but with a firm hand?

The following investigation guidelines are written from the viewpoint of the retained investigator, after the employer or its attorney has determined the need for an investigation.

Preparation

  • Establish the scope of your investigation. Prepare and obtain a signed engagement letter.
  • Establish the attorney-client privilege at the outset of the investigation. Agree upon the procedures to be used during the investigation to protect the confidentiality of communications. Note that recent cases suggest that an employer’s ability to protect the notes and reports of a workplace investigator is very limited, especially if the employer’s response to the harassment complaint is part of its legal defense.
  • Establish protocol regarding communications with the employer or witnesses employed by the employer. Consider prohibiting all e-mail communications between you and the company and its employee in order to reduce E-discovery nightmares in litigation.
  • Investigate before you meet with witnesses. Before interviewing any witnesses, understand everything you can about the alleged conduct, the people involved, and the culture of the employer. Review available evidence. Obtain the employer’s harassment policy (hopefully, it has one) and determine how it has been published in the workplace (the policy is worthless if it is not made known to those it is designed to protect).
  • Identify witnesses based upon present understanding of facts and determine the order in which to conduct interviews. In most cases, interview the alleged harasser last. Determine whether interpreters or other aids are necessary to conduct effective interviews of witnesses.
  • Contact witnesses, introduce yourself, describe the nature of your assignment, explain that you are an independent investigator who has been retained by the company, that you are not representing the witness, and ask the witness to sit for an in-person interview at a firm date and time. If the witness refuses to be interviewed, document the refusal and the reason. Arrange for the interview to take place in a private setting where the witness feels comfortable, and where you feel safe.

During the Interviews

  • Interview each witness separately.
  • Look and act professional. Do not show any leanings toward any side. Remember, you are a neutral and your job is to learn the truth.
  • Give the witness your business card and ask her to call you if after the interview she remembers additional information, needs to clarify or recant anything, or has any questions.
  • Present the witness with a statement disclosing your role and his acknowledgment that he is submitting voluntarily to the interview. This can avoid claims of false imprisonment, duress, etc. Explain the purpose of the interview and your role as an independent fact-finder. Emphasize that the company takes complaints seriously and is investigating the charges, including interviewing all potential witnesses in compliance with policy. Reaffirm that you are not representing the witness and that the statements made by the witness to you are not protected by an attorney-client privilege, an “Upjohn warning”
  • Address issues of confidentiality, consistent with the matter at hand. For example, you may tell the witness that, to the extent possible, the matters disclosed in the interview will be disclosed only to those with a “need-to-know”within the company or, perhaps will be disclosed only to the company attorney with whom you are dealing.
  • Advise the witness not to discuss the content of the interview with anyone else. Explain that your goal is to ascertain what happened, and that by talking to other potential witnesses, the witness may unwittingly influence the recollections of other witnesses.
  • Explain that retaliation will not be tolerated and that the witness should contact you immediately if retaliation is suspected.
  • Ask open-ended questions and listen, listen, listen. Use silence to your advantage.
  • Take very good notes; write down key phrases verbatim using quotation marks.
  • Gets dates, times, places, and the names and contact information of other witnesses.
  • Dig deep for fine details. Don’t be embarrassed to ask about where, how many times, the degree and nature of the contact. Allow the witness to take her time.
  • Explore the effect of the alleged harassment (psychological, emotional, financial).
  • Establish whether the witness has any physical or other evidence of the incidents (e.g., diaried notes, e-mails, text messages, etc.); collect documents from witness.
  • Determine whether the witness is aware of company anti-harassment and reporting policy.
  • Ask the complainant if s/he can continue to work with the alleged harasser
  • Ask the complainant what s/he would like the company to do.
  • Do not give your opinion about the credibility of other witnesses, whether or not you think the conduct in question amounts to harassment, etc.; reaffirm, as necessary, that you are a fact-finder and a reporter of findings to the employer, not someone who decides outcomes.
  • Tell the witness that you will prepare a summary of the interview, provide the witness with a copy, and allow the witness to correct any statements and add additional information.
  • Establish that you can contact the witness after the interview if you have further questions.

Interview Results

  • Cross-reference interview results with information developed from other interviews, verifying and confirming results where possible.
  • Circle back to witnesses, and conduct second interviews with the complainant or others if other interviews or evidence raise new questions.
  • Prepare detailed summaries of interviews, including evidence provided by witnesses.
  • Provide witness with a summary of the interview and evidence provided, and confirmation that they have the right to make corrections to the summary, etc.
  • Make witness credibility determinations. Factors include bias, internal consistency, nonverbal cues, details, plausibility of accounts, prior misconduct, corroboration by others.

Report of Findings

  • Prepare formal report to employer or counsel for employer, including the timeline of material events in the investigation (hopefully, this will show that the employer moved with due speed and conducted a thorough investigation after becoming aware of the harassment complaint), summary of allegations, investigator’s findings and credibility determinations, interview summaries, credibility reports, and physical evidence.
  • Consistent with scope of engagement, follow up with relevant witnesses to determine whether harassment has stopped or retaliation is occurring.

Margherita Albarello has represented employees and employers in Title VII and similar anti-discrimination laws since 1987. Her representation of employees and management maximizes her effectiveness as a neutral and objective investigator of allegations of sexual and other forms of workplace harassment or discriminatory misconduct.

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Section 38.1: A New Era on Illinois Mechanics Lien Law

On January 1, 2016, the Illinois Mechanics Lien Act (the “Act”) will be amended to include section 38.1, which will permit a lien claimant, housing association, owner, or any person or entity that may be liable for a lien claim, to file a petition to substitute a surety bond for the lien claim. In other jurisdictions the substitution is known as “bonding over”. The following will explain how to initiate and effectuate the bonding over process.

How to Initiate the Substitution of the Bond Claim

The surety bond may be obtained after a lien claim is initiated. The substitution of a surety bond for a lien claim will act as security for the claim, not result in its release. A petition may be filed within the two year time limit to file suit under the Act or within 5 months from the date of filing the complaint. However, before a petition can be filed the lien claim has to be properly perfected, i.e. a subcontractor’s 90 day notice issued, and recording of the lien within 4 months of the last day worked. A failure to properly perfect the lien will also bar the filing of a petition to substitute the bond claim.

A petition may be filed pre-suit. Under that scenario the petition should be filed with the clerk of the county where the property subject to a lien claim is located.

Section 38.1 spells out specifically what the petition must include. Chief among the requirements of the petition is that the surety bond has a financial strength rating of an ‘A’ or greater, that it be in the amount of 175% of the lien claim, and that the principal and surety be jointly and severally liable for the amount due the lien claimant.

The person filing the petition shall personally serve or send via certified mail, return receipt requested, to each person whose name or address is stated in the petition and his or her attorney of record in a pending action on the lien claim. The notice to each interested party should also contain language specifically set forth in Section 38.1.

Proceeding on the Petition.

Each party receiving notice of the petition has 30 days after receipt of the notice or 33 days after the notice is mailed to object to the petition. A failure to object will be deemed a waiver. If there are no objections to the petition, then the court upon an ex parte motion of the petitioner shall substitute the eligible surety bond for the property securing the lien claim, and the lien claimant’s right to recover under section 9, 27, or 28 of the Act. If there is an objection to the petition, a hearing will be set to determine whether the proposed surety bond is an eligible surety bond.

If no action has been commenced at the time the bond has been substituted in, the principal and surety of the bond will become parties to the action in equity. If an action has already been commenced at the time the bond has been substituted in, the principal and surety of the bond will become parties to the action without the need to intervene and all other parties to the action may be dismissed.

Prevailing Party

A unique characteristic of Section 38.1 is that it permits the prevailing party of the claim to recover its attorney fees. However, the attorney fees for the lien claimant will be limited to the amount remaining under the surety bond after satisfaction of the judgment, and the principal will not be able to recover its attorney fees in excess of 50% of the lien claim. The prevailing party means a lean claimant awarded at least 75% of its lien claim or a principal awarded a judgment equal to less than 25% of the amount of lien claimant’s claim. For purposes of determining the prevailing party, the amount of the lien claim shall be reduced by any payments received by the lien claimant before the entry of judgment.

The amendment should help streamline the process of proceeding on a mechanics lien; making the procedure simpler and involving fewer parties. And with the addition of the attorney fee provision, may assist in mechanics lien matters being resolved pre-suit or pre-petition.

Doing Business on the Internet

More and more businesses are opting for an online presence in hopes of reaping the commercial benefits of increased national and global exposure. The benefits of an online presence are numerous, including increased brand awareness, a more expansive market to sell goods and improve customer interaction and response.
However, many businesses may not understand or be prepared to face the potential legal risks of an e-commerce venture. For example, an online business could unknowingly subject itself to lawsuits in foreign jurisdictions, violate intellectual property laws or encroach on the privacy of its customer base.
The following legal problems that arise from an online presence can stem from any number of issues, including:

  • Copyrights and Trademarks
  • Advertising
  • Privacy and Protection of Consumer Data
  • Online Contracts – Delivery of Products
  • Internet Sales Taxes
  • Online Speech
  • Commercial E-mail Regulations

A misstep in anyone of these areas could subject your business to a State or Federal investigation, litigation and potential liability. In the next several of our firm’s newsletters, I will review the legal hurdles commonly faced by online businesses and the best practices for successfully surviving these challenges. In the meantime, should any of these issues arise, please do not hesitate to contact our firm.

…And You Think Your Case Is Taking a Long Time?

Riccardo A. DiMonteLitigants bemoan the time and expense consumed by lawsuits. Whether you are the proponent or the respondent, our clients find that the quest for justice is not easy nor convenient. The discovery, the depositions, the court appearances, the motions, the hearings, trials and appeals – it’s all extremely time-consuming and expensive. Even a case that is resolved “quickly” – say less than a year – is something most people would rather not endure. Like a surgical procedure, a lawsuit is a legal procedure that most people would prefer to avoid, especially after having experienced one themselves. However, lawsuits, like surgery, are inevitable and neither surgery nor litigation is a pleasant experience for the parties involved. Given the annoyance of devoting your time and your treasure to the legal system in order to resolve a dispute, YOU WANT IT OVER NOW!

Clients often ask us, “How long will this take? How long could this take? What is the longest and oldest case you have handled?” Well, this one could take the cake!

During 1996, our client decided to build an ice arena facility in Lincolnwood. In order to design the building, the owner hired an architect who agreed to design the building and function as construction manager. The owner and architect agreed on a warehouse type masonry and steel building containing ice rinks, concession stands, locker rooms, and other amenities. The architect estimated the construction cost to be $1,800,000, exclusive of ice-making equipment. In July of 1996, the parties started construction with an anticipated completion date of December, 1996.

In his role as architect and construction manager, the architect was the owner’s agent for the purpose of construction. However, the owner later learned that the architect abused his authority by approving cost increases for the project without obtaining the consent of the owner. Without the owner’s knowledge or consent, the architect had approved extras with 40 subcontractors and material suppliers totaling approximately $1,000,000! The unauthorized cost increases came to the owner’s attention in December 1996 and the owner was forced to borrow extra money to settle with all of the subcontractors. This cost the owner an additional $900,000.

During 1997, various subcontractors and material suppliers filed mechanics lien foreclosure lawsuits and the owner settled and resolved all of them between 1997 and 2001. However, the dispute between the owner and the architect remained undetermined and we had a trial that took approximately 2.5 months between June 11th and August 31, 2001. 14 witnesses testified and the judge ruled in favor of the owner finding the architect liable for approximately $1,000,000 in unauthorized extras and attorney’s fees as a result of the architect’s failure to obtain the owner’s consent to order extras not authorized by the owner. The court’s decision was filed in May, 2002, six years after the construction project was finished. Six years is a long time. But the story goes on…

By 2002, the architect was broke and unable to pay a $1,000,000 judgment. However, he did have an architectural malpractice insurance policy that covered the architect and the owner for this type of loss. We should have received immediate payment in full. End of story? Nope – the story goes on…

In 2003, we pursued the insurance company to pay the architect’s covered claim. However, the New York insurance company was insolvent. After the judgment was entered against the architect and we demanded payment under the policy, the New York insurance company was placed into receivership by the New York Department of Insurance. After much investigation, we learned the New York insurance company was a subsidiary of a parent insurance company located in California. Although the New York insurance company was technically insolvent, its parent company in California was not. During 2003 and 2004, the claims we asserted against the New York and California insurance companies caused the California parent insurance company to be placed into receivership in California as well. We pursued the California Department of Insurance to get our client paid. After eight more years of delay, our client finally received its first distribution from the California Department of Insurance in March of 2012, ten years after the judgment was entered. In July of 2015, the owner received its final distribution, 18 years after the case was originally filed!

Lawyers and judges say, “The wheels of justice grind slowly, but always forward.” This case was a prime example. It took six years to resolve the original lawsuit and 12 more years of additional litigation against insurance companies to finally get paid. Thankfully, the client had the patience and the perseverance to hang on for 18 years. During this 18 year period, some of our children were born and others graduated from high school and college. So, next time you ask your lawyer how long your case might take, rest assured it will probably not take 18 years. But it will always take longer than you hoped!

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Reorganizing the Balance Sheet: How Millennial Professionals Can Take Advantage of Government Tax Breaks

Many millennials carry heavy student debt burdens, but there are tax-advantaged strategies that some may employ to better take advantage of the Internal Revenue Code. The term “millennial” has become almost a bad word among generation-xers and their baby boomer parents, used to describe the generation born between 1980 and the mid-2000s. Sometimes characterized as entitled, self-centered and needy, the millennial generation now makes up over one-third of the population of the United States; the largest generation. The generation provides the U.S. labor market with 53.5 million workers, also the largest in the nation. Yet, nearly half of all millennials entering the work force, and nearly 70% of those with college degrees, are burdened with heavy debt loads – the average student debt burden is ~$29,000 per person.

Millennials are the most educated generation in United States history, with at least 61% having attended college, compared to only 46% of their parents. Many in the maligned generation entered the labor force in the midst of one of the worst recessions in United States history and unemployment among the generation remains high. The result is a highly educated, yet underemployed generation grappling with financing their education. To illustrate, according to the USA Today total student loan debt in the U.S. now exceeds $1.2 trillion. Of course, the debt burden has manifested itself in the housing market as home ownership among the generation has fallen to 36.2%, the lowest level among their cohorts since the United States Census Bureau began the survey in 1982. Though, for those professionals that have moved out of mom and dad’s basement and into their own home, there are some important strategies that can be utilized to save on student loan spending.

Student loan interest, especially among graduate students, is expensive. Since 2006, and despite historically low federal funds rates, graduate loans have averaged between 6.8%-8.5%. Importantly, these rates are fixed and cannot be refinanced through the world’s largest student lender, the United States government. A married couple, each with a graduate degree, is likely to start out with $105,000 of student loan debt (2014 average). That couple is likely paying at least $7,140 in interest per year, without any payment towards principle. Unfortunately for that couple, they are limited to a total tax deduction of only $2,500. Had they not gotten married, they would each have been able to deduct $2,500, for a total of $5,000; but because they got married – only $2,500. It gets worse. As soon as that married couple exceeds $130,000 in joint income, the deduction begins being phased out, with a total phase out at $160,000 of income.

Importantly, the tax code provides big benefits for home ownership. A couple can deduct home mortgage interest on a home worth up to $1 million, and can deduct interest on home equity lines of credit up to $100,000. Home mortgage debt is much cheaper than student loan debt; currently around 4.0% or lower for a 30-year fixed mortgage. Therefore, a $100,000 home equity line of credit costs $4,000 per year, nearly $3,000 less than the student loan. Additionally, for households earning less than $309,900 per year (or $258,250 for single individuals) all of that interest is deductible. Take for example, a married couple consisting of a dentist and an accountant carrying $240,000 of student loan debt (average dental student loan debt in 2013 was $241,000), and a joint adjusted gross income of $300,000. That family would be squarely in the 33% tax bracket, meaning that the interest on a $100,000 home equity line of credit would provide them with a $4,000 tax deduction, or a reduction of their total tax liability of $1,320 per year ($4,000*33% tax bracket). Therefore, if that family is able, they should strongly consider “refinancing” existing loan debt through equity in their home. The savings would total over $4,000 per year ($2,800 in interest plus a reduced tax liability of $1,320).

Of course, this plan is not without pitfalls; the most glaring being that the couple has $100,000 of equity in their home. However, young owners may be surprised to learn how much equity that they have built in the last 5+ years, especially in urban areas. Additionally, married couples need to closely analyze their student debt situation. For those couples where only one borrowed and accumulated the student debt before marriage, careful consideration and planning must take place. Should that couple own the home jointly, the non-borrowing spouse would effectively be accepting personal responsibility for the debt. However, there may be estate planning techniques to avoid this pitfall. Additionally, for those on income based repayment or “pay as you earn” plans, the lower monthly payment and potential loan forgiveness would be forfeited. Note, however, that in the long run, these repayment options can be extremely expensive as any amount forgiven by the government is taxable as income ($100,000 of loan forgiveness would likely trigger a tax due of $28,000-$33,000). This plan is best for those with stable careers and measured income growth. It is also likely inappropriate for those over the age of 60 (the fastest growing student-borrower population as a result of co-signer requirements).

There are some slight tangential advantages to stripping equity from the home to pay off student loan debt. Student loan debt is not dischargeable in bankruptcy, but home equity lines are. Certainly, one should not take advantage of this strategy with the plan to declare bankruptcy, as it is likely fraudulent and would not benefit the borrower. However, if unforeseen circumstances arise in the future, such as the incapacity or disability of a high-earning spouse, the debt may now be discharged where before it could not. Again, this cannot be the sole purpose for “refinancing” with home equity debt, but the added creditor protection is beneficial.

Ultimately, this is a niche plan best suited for young professionals with stable careers. There are other options out there for refinancing graduate student loans. Some private lenders have begun to identify high-quality credits, such as physicians, and are attracting borrowers looking to refinance at rates up to half of what the federal government is charging. The end result will be net negative for the taxpayer and average student borrower as the government’s portfolio will continue to be stripped of the higher quality credits, requiring the administration to charge higher rates to offset defaults. However, refinancing through such a lender would not provide for the same tax benefit as using home equity as only a fraction of the interest would be deductible, and would subject the borrower to income phase out restrictions. Further, the total debt load would be unchanged (mortgage plus student loan debt vs. mortgage plus home equity line), and a large portion would remain undischargeable in bankruptcy.

Before engaging in any strategy, the borrower and their family should assess their current and future financial situation, their lending status, and their risk tolerance. This plan provides real benefits for the right borrowers, and vastly increases the return on educational investment. Any individual considering such a strategy should consult their financial advisor and tax professional.

Jeffery Ramirez Joins DiMonte & Lizak

Di Monte & Lizak is proud to announce the hiring of Jeffery Ramirez. Jeff joined Di Monte & Lizak’s transactional department in June of 2015. Jeff devotes his practice to real estate and business transactions, estate planning and taxation. Jeff earned his B.S with honors from DePaul University in Accounting with a minor in Economics in 2011. Jeff earned his juris doctorate degree from DePaul University College of Law in 2014. He lives in Des Plaines with his wife and daughter.

How to Deal With a Preference

In a bankruptcy proceeding, preference law is the means by which the debtor or a trustee, can recover a payment or other transfer which was made by the debtor within 90 days of the debtor’s bankruptcy filing or alternatively within one year in the case of a transfer to an insider. An insider is generally a person or entity that bears a close relationship to the debtor.

The preference law is designed to treat all creditors equally. The main purpose of the law is to clawback transfers and eventually make them available for redistribution among the creditors of the estate. This purpose, however, does not always work perfectly and certainly does not provide much solace to a creditor who is being sued for such a recovery. After all, the creditor was simply paid a debt owed to it for services or products it actually provided. The creditor may also still have an unpaid balance with the debtor. Therefore being sued for a preference, from the creditor’s viewpoint, is simply rubbing salt in the wounds.

If you operate a business you may run into a preference payment situation. DiMonte & Lizak is well versed in this area of law and may assist in softening the blow or minimizing the risk when you suspect that someone you are dealing with may be heading towards bankruptcy. This article is only intended to give you a primer on how to deal with such situations.

The basic elements of a preference are as follows:

  1. A transfer of an interest of the debtor in property;
  2. To or for the benefit of a creditor;
  3. For or on account of an antecedent debt owed by the debtor before such transfer was made;
  4. Made while the debtor was insolvent;
  5. Made on or within 90 days of the date the bankruptcy was filed (or within 1 year if the creditor was an insider); and
  6. That enables the creditor receive more than it would have received in a Chapter 7 liquidation.

There are various defenses to a preference. The most common are as follows:

  1. The parties intended the transaction to be a contemporaneous exchange for new value and it actually was one;
  2. The ordinary course of business, generally either based upon the parties history of dealings or of the norms of the industry;
  3. Perfection of a lien for which a relevant statute provides for relation back if compliance is within a statutorily specified time period;
  4. Subsequent new value. The delivery of goods or services after the alleged preference; and 5) Solvency. Insolvency, however, is presumed within 90 days of the filing.

There are also various business practices, when dealing with a person or entity that is likely to wind up in a bankruptcy, that may insulate you or provide some protection. One simple method is to receive prepayment or simultaneous payment (Cash on Delivery). Prepayment results in the transfer not being made on the account of an antecedent debt. You must take care to document/evidence that the parties agree to, intend to, and have actually consummated the desired business practice. Generally, under the preference law, unless otherwise specified by the parties (best practice in writing), payments are applied to the oldest invoices. Therefore if you did not document a prepayment or contemporaneous payment, as being the intent between both you and the debtor, the payment will most likely be allocated to the earliest invoice, which very well might result in preference exposure.

The adherence to a prior consistent course of conduct between the parties may also provide some protection. For instance, if there is a history under which the debtor always paid your business within 30 days of invoice, and assuming invoices are promptly issued and not backdated, the adherence to that practice will strengthen an ordinary course defense. A separate defense would be adherence to the ordinary terms of payment of the industry that is involved. Regardless of the forgoing it almost always is best to accept payment without concern of a clawback. The person or entity may never file for bankruptcy or the filing, as relevant to you, could be outside the clawback period. Preferences can also be settled. We can assist you if such litigation is threatened or filed.

In the event you suspect someone who you are dealing with is unfortunately heading towards a potential bankruptcy, it is prudent to contact a lawyer specializing in bankruptcy law. At DiMonte & Lizak we have several attorneys with that specialization.

UCC Financing Statements Are Not Impenetrable Shields

By Derek D Samz

Collecting on judgments or other accounts receivable can often be a daunting and murky endeavor, especially without the assistance of an attorney. Oftentimes debtors will go to great lengths to avoid payment of your debt. A common tactic that debtors will employ is to assert that they owe money to a lender whose loan is secured by a UCC Financing Statement. UCC Financing Statements are security instruments typically used to secure loans where the collateral for the loan are not real property, but consist of vehicles, tools, cash, accounts receivable and other forms of personal property. However, this form of security instrument is not as ironclad as the debtor, and its secured lender, would hope you believe.

I represented a subcontractor that had obtained a judgment against the general contractor (“Debtor”) for breach of contract. After issuing a citation to discover assets to the Debtor, I discovered that the Debtor was due to receive a payment of $80,000 on a different project. However, upon the filing of the request that these funds be turned over to my client, the Debtor’s primary lender stepped in and asserted that it possessed a higher priority security interest in the Debtor’s collateral, and that my client would not use the Debtor’s assets to satisfy its judgment. However, the Debtor was still operating its business as a going concern. Indeed, documents produced by the Debtor pursuant to the citation to discover assets revealed that its lender had made similar statements to other creditors, but at the same time had allowed the Debtor to continue operating instead of liquidating the Debtor’s assets to satisfy the loan. In fact, documents produced revealed that the lender had made additional loan advances to the Debtor after the date the Lender had supposedly declared the Debtor to be in default under the loan.

After submitting briefs to the Court detailing these facts, the Judge held that the Lender could not assert a higher priority under the UCC Financing Statement until it had declared the Debtor to be in default. The Judge determined that based upon the facts before him, most notably that the Lender had allowed the Debtor to continue operating and access to additional funding, that the Lender had not declared a default, or was actively assisting the Debtor in shielding its assets from creditors. The Judge went on to rule in my client’s favor, and ordered that the $80,000 receivable be turned over to my client to satisfy its judgment.

The moral of the story is that the simple existence of a UCC Financing Statement, or other security instrument, is not the end of the inquiry in collection proceedings. A diligent and savvy creditor may be able to obtain superior rights over a lender that has not declared a default and taken action to enforce its secured lien. If you have any questions regarding your collection issues, please give DiMonte & Lizak, LLC a call.

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Prevailing Wage Act It’s That Time of Year Again! Fringe and Overtime

As another bleak, cold and snowy Chicago winter melts into an all too brief Spring, it is time to get outside and start those “Public Works Projects” again. Therefore, a brief refresher regarding the applications of the Illinois Prevailing Wage Act (“Act”) seems particularly appropriate. This article will focus on paying of wages, fringe and overtime.

Before discussing the wages, fringe benefits and overtime required by the Act, it is important to understand which projects are covered under the Act. The Act applies only to “Public Works Projects” that improve, build, demolish or alter property or equipment owned or operated by the government. In other words, any contract for public works that involves work for the State of Illinois or any governmental subdivision such as the Illinois Depart of Transportation, municipalities or school districts is covered under the Act. The Act does not cover employers who are engaged in private sector work or even that work performed for the federal government.

Wages and Fringe

After determining whether your current project is a Public Works job, the next step is to determine what wages the Act requires. The current Prevailing Wage Act rates can be found at http://www.illinois.gov/idol/Laws-Rules/CONMED/Rates). It is important to note that each county has a separate wage scale. The Act requires employers to pay all covered employees the statutorily required wages and the associated fringe benefits regardless whether the employees are members of a particular union. Perhaps the most common mistake non-union contractors make is that they pay the base rate but do not add the fringe to the hourly rate normally paid by union contractors to union trust funds as required by the respective CBAs. The Act requires that both union and non-union contractors make contributions to Health and Welfare, Insurance, Pension, Vacation and Training that are either paid to employees through employer-offered benefits, or paid directly to the employees as hourly wages. For example, if Employee A is a Laborer working in Cook County and not covered under a CBA and does not receive benefits from his or her employer, Employee A is to be paid $62.40 per hour for all straight time hours worked covered under the Act ($38.00 for straight time wages plus $24.40 for fringe).

Overtime

Another common mistake employers make relates to the payment of overtime. The Act requires the payment of overtime, time-and-a-half or double time under three distinct circumstances:

  1. When an employee works more than 8 hours on a given day. The mistake many employers make is that they believe overtime is based on the number of hours an employee works during a week. That is incorrect. Overtime is applied on a daily basis. http://www.illinois.gov/For example, if Employee A works 9 hours on Monday, 8 hours on Tuesday, does not work Wednesday or Thursday and works 10 hours on Friday, Employee A is owed 3 hours of overtime. One for Monday and two for Friday even though s/he did not work on Wednesday or Thursday.
    ***Please note that while the majority of the labor classifications defined by the Act require time and a half for daily overtime, a significant number require double time for daily overtime. Please consult the prevailing wage scale for your county to determine the proper overtime scale.
  2. When the employee works on a Saturday. If an employee works on a Saturday, even if s/he has not worked a full 40 hour week, overtime must be paid, either time-and-a-half or double time (depending on the labor classification). Taking the example from Paragraph A, if Employee A also worked 8 hours on Saturday, Employee A’s employer is required to pay for 8 hours of overtime (time-and-a-half) even though Employee A worked only 27 hours Monday through Friday.
  3. When an employee works on a Sunday or Holiday (or the Monday following a Sunday holiday). All labor classifications, except for painters and painters of signs, require double time for Holiday or Sunday work. Once again, how many hours an employee worked in the days leading up to the Holiday or Sunday has no impact on whether overtime is paid. Using our example from Paragraph A, Employee A works the same hours as detailed above plus 8 hours on Saturday and 5 hours on Sunday, that employee is to be paid 11 hours of time-and-a-half (3 hours of daily overtime and 8 Saturday hours) plus 5 hours of double time for Sunday.
    Note: If Employee A works on the Monday following a recognized Holiday that falls on a Sunday, such as Christmas, Employee A would be entitled to double time for the hours worked.

Penalties

It is extremely important that employers do their absolute best to ensure compliance with the Act because the penalties for a violation are severe. First, employers who violate the Act are required to pay back wages to affected employees for the difference between the wages paid and the wages earned under the Act plus the applicable fringe benefits. Second, the Act allows for a 20% penalty to be paid by the employer to the Illinois Department of Labor of all wages, including fringe and overtime, owed to employees, plus an additional 2% payment of that 20% penalty is paid to the employees in addition to the back wages owed. Third, and perhaps of greater importance, contractors who incur two violations within a five-year period can be barred from performing any Public Works Projects in Illinois for a period of four years. For employers who rely on work in the public sector, this ban could sound a death knell for their businesses.

If you receive a notice of investigation from the Illinois Department of Labor, feel free to contact Paul A. Greco or Peter M. Follenweider of Di Monte & Lizak (847-698-9600).

A second, and much less obvious, potential violation occurs during the hauling of material and debris, including rocks, concrete and blacktop, either to or from a jobsite. It is important to note that not all drivers who deliver materials to a job site are covered under the Act. The Act carves out an exemption for material sellers and suppliers. If a contractor or subcontractor has its own employees deliver materials to a jobsite and engage in actual construction, those employees are covered under the Act. An additional and often overlooked aspect of the Act is the hauling of material and debris, including rocks and blacktop, to and from jobsites. If contractors or subcontractors contract to have debris brought to or taken away from jobsites, the Act applies. If sellers of materials direct their own employees or hire a third party to bring materials to the jobsite, the Act will not apply. If contractors or subcontractors hire third parties to remove debris from jobsites, the Act applies and the drivers must be paid according to mandates of the Act. It is important to remember that the courts narrowly construe the extremely limited delivery and hauling exemptions to the Act. In most cases, it is more likely than not the Act will apply to material delivery to the jobsite and debris hauling from the jobsite.

The important factor in determining if the Act applies to hauling debris from a jobsite is not whether the debris will be recycled or who now owns the debris. The important factor is who is doing the hauling and with whom the hauler contracted to haul the debris. If you have any questions as to whether the Act applies, please contact Paul Greco or Peter Follenweider at Di Monte and Lizak, LLC before creating a potential Act violation. This is truly a case in which an ounce of prevention is not worth the pound of cure which will most definitely be dispensed by the Illinois Department of Labor.

Turned Down For What? Settlement Offer Rejected By Plaintiff Leads to Poor Trial Result

As a case gets closer to a scheduled trial date, the parties frequently engage in eleventh hour settlement discussions. The uncertainty of a trial result often influences all parties to settle a pending dispute with a certain result via settlement. The party who had more success during the discovery phase of the litigation may have more leverage in the settlement negotiations. However, more often than not, the terms of a settlement agreement leave both sides with a feeling of discontent. The plaintiff often feels as though he or she should have received more and the defendant often feels as though he or she should have paid less. The settlement negotiation process requires the parties to exercise reason over emotion. When a plaintiff turns down a substantial cash offer during settlement negotiations, he or she has to be prepared for a result at trial that could be worse. I recently experienced such an occasion while defending a general construction client.

This case involved the build out of a commercial space. The owner had a cost-plus agreement with the general contractor, which required our client to pass through his actual costs for materials and labor to receive an agreed upon percentage mark-up for overhead and profit. At the conclusion of the project, the owner accused our client of intentionally inflating the invoices from his laborers and material suppliers to receive a much larger profit than our client was entitled to. Our client disputed these allegations, but had discarded much of the documentation regarding the project. Accordingly, the owner filed a lawsuit against the general contractor in his individual and corporate capacities alleging claims for both breach of contract and fraud.

After five painstaking years of discovery and pretrial motion practice, the case was finally set for trial. After the trial date was set, the parties focused on settlement negotiations. At first, it appeared as though the parties were too far apart. Initially, the plaintiff demanded in excess of $1,000,000, which was quickly reduced to a mid-six figure demand. The defendant’s offer slowly crept up from $0 to $50,000 to $100,000. At the final pretrial conference, the judge persuaded both parties to move even further. The plaintiff’s final settlement demand was $160,000. At that point, the defendant would not agree to come up with more than $120,000 paid over several years. The general construction company had stopped doing business and our client was going to have to make these payments personally. Therefore, the defendant was hesitant to commit to more than he thought he could pay.

In the week before trial, the parties agreed that the financial amount for the settlement would be $160,000 with monthly payment over several years. However, the plaintiff then demanded that the defendant must stipulate to specific facts concerning fraudulent conduct. The defendant absolutely refused to stipulate to fraudulent conduct, because he had not inflated the invoices he passed through to the owner. Rather, he was agreeing to settle the dispute to avoid the uncertain result of the trial and the expense of attorney’s fees associated with the trial. On the first day of trial, the judge cautioned the plaintiff of two things: 1.) Be careful when pointing fingers, because three fingers may be pointed back at you; and 2.) Reconsider the proposed settlement offer, because not all breaches of contract amount to fraud. However, based on the defendant’s refusal to stipulate to fraudulent conduct, the plaintiff rejected the settlement offer and the case proceeded to trial with the plaintiff claiming that it was entitled to approximately $1,300,000 in damages.

At the beginning of trial, the plaintiff was very confident. The plaintiff believed that most of the evidence produced in discovery supported his position. However, the evidence did not come in at trial in plaintiff’s favor. Rather, the plaintiff was impeached multiple times during cross-examination and one of his witnesses was nearly found in contempt for refusing to directly answer questions that were asked on cross-examination.

After calling six fact witnesses and an expert witness over nearly two full weeks of trial, the plaintiff rested its case. At the conclusion of the plaintiff’s case, the defendant moved for a directed finding. When moving for a directed finding in a bench (non-jury) trial, the defendant asks the court to weigh the evidence and rule in defendant’s favor on the plaintiff’s claims without requiring the defendants to put on a defense at trial. After a lengthy oral argument, the judge ruled in favor of the defendants on the fraud and breach of contract claims against the general contractor in his individual capacity and on the fraud claim against the general contractor in its corporate capacity. This ruling left the plaintiff in a very poor position. The only claim that survived the motion for a directed finding was the breach of contract claim against the corporate defendant, and the corporate defendant had no assets because it had stopped doing business several years prior.

Since all of the fraud claims were denied and there was no longer the potential for personal liability, the defendants did not put on a defense case. After closing arguments, the judge entered a small judgment against the corporate defendant, which was less than 10% of the damages initially sought by the plaintiff. Regardless, the judgment resulted in little comfort to the plaintiff, because the corporate defendant had no assets to satisfy the judgment. Accordingly, instead of accepting the $160,000 settlement offer, the plaintiff incurred the substantial expense of having two attorneys prepare for and conduct trial for nearly two weeks and the additional expense of its expert witness preparing and testifying at trial.

While our client received a very successful result at trial, this story should serve as a cautionary tale to those who are currently involved in litigation and those who may experience litigation in the future. Always give careful consideration to settlement offers in the days before trial and even settlement offers that may arise during or after trial. There is an inherent value to a certain result, plus you save the cost of trial. Always be aware that the result at trial could be less than the amount offered in settlement; it could even result in no recovery at all. Even the strongest cases have potential flaws, and it is impossible to predict with 100% accuracy how a judge or jury will interpret the evidence presented at trial. It has been said that there are only two certainties in life: death and taxes. Well there is only one certainty in trial: additional litigation expense. Accordingly, the prudent litigant should always assign value to the certainty of settlement, because the uncertainty of trial may prove to be the greatest expense of all.

Business Owners Beware: Advertising Via Prerecorded Phone Messages, Mass Unsolicited Faxes or Mass Text Messages May Cost More Than Its Worth

A common problem for business owners experiencing a loss of customers based on the current economy is how to market your services and products to potential new customers. Advertising on billboards, television and radio is expensive and may not reach your intended market. Therefore, you may consider hiring a company that sends out phone calls with prerecorded messages, mass faxes and/or mass text messages. These companies have the ability to send out thousands of advertisements to thousands of customers in a matter of minutes using automatic dialing system equipment. Even more enticing is the fact that these companies perform this service for a relatively low fee in comparison to the other available forms of advertising. While this method may appear to be attractive because it is extremely economical on the front end, the fact that it is now prohibited by federal law makes it incredibly expensive on the back end.

The Telephone Consumer Protection Act

In response to consumer complaints regarding the receipt of unsolicited phone calls, which requires the use of the consumer’s cell phone minutes, and unsolicited faxes, which uses the consumer’s paper, toner and ink, the federal government enacted the Telephone Consumer Protection Act, 47 U.S.C. §227 (“TCPA”). The TCPA prohibits: 1.) using automatic dialing machines to make calls to emergency telephone lines, health service providers’ lines and cellular phones; 2.) calling residential telephone lines using a prerecorded voice to deliver a message without the prior consent of the recipient; and 3.) using fax machines or computers to send unsolicited advertisements to fax machines. Furthermore, courts interpreting the TCPA have found that sending unsolicited text messages is also prohibited by this statute.

Civil Liability for Violations of the TCPA

Not only does the TCPA prohibit the use of prerecorded messages, unsolicited faxes and unsolicited text messages for commercial advertisement purposes, but it also creates a civil cause of action for individuals harmed by the receipt of these advertisements. One would think the damages for receiving an unsolicited fax would be relatively low. A few minutes on the phone or the cost of a piece of paper, a small amount of ink and toner cannot amount to much, right? Wrong. The TCPA creates a statutory fine in the amount of $500 per violation. Further, the court can triple the amount to $1500 per violation in the event there is a finding that the party violated the TCPA willfully or knowingly. Therefore, if a company sends out 1,000 faxes, then it could be liable for $500,000 (1,000 faxes x $500 per violation) in liability, or up to $1,500,000 in liability if the court finds that the violation was committed willfully or knowingly.

Perhaps the most damaging aspect of this statute is that courts have been imposing personal liability on the agent of the corporation who directed the advertisements to be sent out, rather than simply imposing liability on the corporation. Imagine this scenario- a business owner goes to a store that performs these mass faxing services. His business is decreasing, it does not have fixed assets and he needs to do something to generate more customers. He sends out 1,000 faxes and hopes the business will come pouring in. A few months later he receives a summons and complaint, which states that he is being sued for violating the TCPA. To his surprise, the plaintiff is not only seeking to recover from his company, but also from him personally. Therefore, business owners need to be careful to comply with this statute because not only are your business assets at stake, but so are your personal assets.

These types of cases have become a hot commodity for plaintiff’s class action attorneys. Once they find a potential plaintiff who has received a single fax, they will file suit and use discovery procedures to attempt to find out how many faxes have been sent and to whom they were sent. They will use this information to create a class of plaintiffs who all have the same TCPA violation claim against the party who sent the prerecorded messages, unsolicited faxes or text messages. In the scenario discussed above, the business owner who sent out 1,000 faxes could now be facing between $500,000 and $1,500,000 of personal liability. The potential for liability and litigation are simply not worth the use of advertising via prerecorded messages, mass faxes or mass text messages.

We have successfully defended multiple companies and individuals who have been sued for alleged TCPA violations. If you are faced with litigation regarding violation of the TCPA or are considering advertising for your company using prerecorded messages, faxes or text messages, please contact us to discuss your legal rights before proceeding.

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A Recent Decision in Mechanic’s Lien Law Affecting Public Works

The Illinois Supreme Court in an opinion filed October 17, 2014, in the case of Lake Country Grading Company, LLC v. The Village of Antioch clarified the law requiring completion and payment bonds for public works projects. A grading company sued the Village alleging that the Village failed to obtain a payment bond as required by the Construction Bond Act; 30 ILCS 550/1 (The Bond Act). Both the trial and appellate courts ruled in favor of the grading company.

The Bond Act requires public bodies, when contracting for public works costing more than $50,000, to obtain from the contractor a payment bond guaranteeing that all contractors who perform construction services, including labor and materials, be paid for their services and materials.

The Bond Act also requires a public body to obtain a performance bond (a completion bond) guaranteeing that all work contracted for by the contractor be completed by the bond company if the contractor fails to do so. In the case mentioned herein the bond contained language guaranteeing completion of the project. However, it did not include language guaranteeing payment.

The Bond Act also requires a claimant to serve a notice of claim against the bond upon the public body, within 180 days after claimant’s last day worked on the project.

In the subject case the Plaintiff did not serve the 180 day notice on the Village instead, it filed suit against the Village for failure to obtain a payment bond.

The Supreme Court ruled that although no payment guarantee language was included in the bond in question, the bond is presumed to include a payment guarantee. This is because of the language in Section 1 of the Bond Act that each bond is deemed to contain provisions ensuring payment to all persons who perform labor or provide materials and guaranteeing completion “whether such provisions are inserted in such bond or not.”

The Supreme Court ruled that the above language from the Bond Act unambiguously provided that both payment and completion provisions are deemed to be included in the bond as a matter of law. Therefore only the one bond was necessary as it was deemed to include both provisions. Separate bond or expense language for each provision were not necessary. Thus the Village acted in compliance with the Bond Act.

The Supreme Court overruled both the trial and appellate court and held in favor of the Village, determining that it had in fact obtained a bond which included both payment and completion provisions in accordance with the Bond Act.

New Year Resolution: Review Your Employment Agreements and Behave Accordingly

The courts continue to look past the language of confidentiality and non-solicitation and non-competition agreements and to focus on whether the employer has a “thing” worthy of protection and whether the employer has given the employee adequate, independent consideration to support the restrictive covenant.

In nClosures, Inc. v. Block and Company, Inc., October 2014, the 7th Circuit Court of Appeals (covering Illinois, Indiana, and Wisconsin) reminded businesses that their confidentiality agreements will not be enforceable unless the business takes reasonable steps to protect the alleged confidential information.  nClosures was an industrial design firm.  It hired an independent contractor to design metal enclosures for items like the iPad.  Block and Company manufactured the enclosures for nClosures.  Before the parties began doing business with each other, they signed a confidentiality agreement in anticipation of the potential business relationship.  The agreement stated that nClosures’ confidential information would be used solely for the purpose of engaging in discussions and evaluating a potential business relationship regarding Block’s manufacture of the enclosures.  Block subsequently started manufacturing the enclosures.  Shortly after nClosures’ product entered the market for sale, Block developed a competing design for its own tablet enclosure.  nClosures sued Block for breach of the confidentiality agreement.

The court granted Block’s motion for summary judgment, finding that nClosures did not take reasonable steps to keep its proprietary information confidential.  The court acknowledged the elements a party must show to bring a successful breach of contract claim, but stated that when assessing the enforceability of a confidentiality agreement, the agreement will be enforced only when the Ainformation sought to be protected is actually confidential and reasonable efforts were made [by the owner] to keep it confidential.@  The court noted the following concerning nClosures’ conduct:

  1. nClosures did not enter into a confidentiality agreement with the independent contractor who designed the enclosure.
  2. nClosures did not require Block’s engineers or other employees to sign confidentiality agreements before accessing the design information.
  3. The design drawings were not marked “confidential” or “contain proprietary information.”
  4. The design drawings were not kept under lock and key.
  5. The design drawings were not stored on a computer with limited access.

Takeaway: Companies should review all confidentiality agreements for content, should identify gaps in coverage, and should conduct themselves in accordance with the non-disclosure clause.

Client Prevails Against Insurer on Denial of Insurance Coverage

Recently, one of our clients who owns a number of apartment buildings was sued by a tenant for personal injury. Our client had purchased insurance for the building, and had paid the premium, so he tendered the claim to his insurance company. He was confident the insurance company would take care of the claim. After all, that is why he had purchased insurance. He was in for a shock.

It turned out, there was a mix up when he purchased the insurance, and the insurance company failed to name our client as the insured on the policy. Our client was not covered for this injury, and he was worried about what to do next. Faced with the possibility of having a judgment against him, he came to see us.

We were hired to persuade the insurance company to do the right thing – to cover our client for this injury which should have been covered but for the clerical mix up. I contacted the insurance company to suggest settling the claim. The tenant did not suffer a major injury. It would be cheaper to settle than to fight with us in court on whether there was coverage. The insurance company ignored my suggestion. So we fought back.

We filed an answer to the personal injury claim of the tenant, a counterclaim lawsuit against the insurance company, and a third party lawsuit against the insurance broker for charging our client the insurance premium, but failing to provide coverage for our client. We initiated discovery and noticed up depositions of the parties. Suddenly, all of the parties realized that this matter should be resolved.

The insurance company settled the claim with the injured tenant. It then amended the insurance policy to name our client as the insured. The insurance company agreed to pay our client’s attorneys fees in full, including paying the retainer our client paid us.

Most denials of insurance claims do not involve facts as clear as in the above case. Insurance companies usually deny claims based upon language provisions in the policy, and the failure of the insured to comply with such policy language. Among the reasons set forth for denial of coverage is the failure to timely renew the policy, failure to pay the premium, a claim that another insurance company is primarily responsible, or a claim that the insurance company is not responsible for intentional conduct or claims for punitive damages. Quite often the basis for the denial of the claim is found under the AExclusions@ listed in the policy.

In some cases the reason for the denial involves a mistake as to the facts. The insured can deliver a copy of a canceled check that proves that the insurer received the check on or before the grace period had expired. Where the facts are clear, the insured need only contact his insurance agent to clear up the mistake.

However, most denials of claims involve interpretation of the terms of the insurance contract, application of the insurance law of the state, issues of public policy, and other related questions.

If you receive a denial of claim, assemble the denial letter, declaration page, and the insurance policy, then come see us. Your insurance coverage attorney will examine the foregoing documents, and be able to give you an opinion as to the merits of the insurance company’s denial. If the matter is not resolved expeditiously, it is highly likely that you will be able to recover the attorneys fees that you expended if the insurance company has wrongfully denied your claim.

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Jonathan Morton Appointed to New Positions

Jonathan D. Morton was appointed to the Illinois State Bar Association Federal Tax Section Council. The Council’s purpose is to inform and advise members of the bar on current developments in federal taxation, to review and comment on pending tax laws, regulations, and court decisions, and to make proposals on additions or changes to existing tax laws and regulations. Jonathan was also appointed to the Young Leaders Board of the Lakeview Food Pantry. The Lakeview Food Pantry is one of the largest and longest-lived food pantries in Chicago, providing on-site food distribution, food delivery to home-bound clients, and helping clients with other services they need to address causes of food insecurity.

D&L Recovers Large Settlement on Eve of Trial

DiMonte & Lizak, LLC’s litigation team of Riccardo DiMonte, David Arena, Margherita Albarello and Ryan Van Osdol recently obtained a favorable settlement for their client and against the Village of Mount Prospect. In the lawsuit, various Village employees and the Village of Mount Prospect were alleged to have violated the civil RICO statute and plaintiff’s civil rights in an effort to force plaintiff to sell his property for less than fair market value. On the eve of trial, we successfully recovered a $6,500,000 settlement for our client and resolved a dispute that had been pending for approximately six years. We will publish a full article regarding this case in the next edition of the firm newsletter, but until then, see:

  1. The Daily Herald article and;
  2. The Chicago Tribune article.

Illinois Enacts Law Impacting Criminal Background Inquiries

The Job Opportunities for Qualified Applicants Act is effective January 1, 2015, and applies to Illinois private employers and employment agencies with 15 or more employees. It restricts the timing of pre-employment inquiries by employers about an applicant’s criminal past. Employers still can conduct background checks or inquire about criminal convictions; the law only affects when they do so.

The law is called a “ban the box” law because it removes the “box” asking about criminal history information from a job application. The public policy behind the law is the belief that employers should judge applicants on their qualifications first, without the stigma of a record, and that putting people back to work is good for the economy and reduces recidivism. The most effective policies don’t just remove the “box” – they ensure that background checks are used fairly, that the employer makes individualized assessments instead of blanket exclusions, and that the employer considers the age of the offence and its relevance to the job.

The employer can inquire about, consider, and require disclosure of the applicant’s criminal record or history after he has been deemed qualified for the position and notified that he has been selected for an interview. If the employer does not conduct interviews, the inquiry cannot take place until after a conditional offer of employment has been made to the applicant

The law exempts certain positions from coverage, including where a federal or state law excludes applicants with certain criminal convictions from working in the position sought; the position requires a standard fidelity bond or equivalent and the conviction would preclude the applicant from obtaining the bond; or the employer employs individuals licensed under the Emergency Medical Services Systems Act. Employers may provide applicants advance notice of specific offenses that would disqualify the applicant under state or federal law.

The Illinois Department of Labor is empowered to investigate violations and impose civil penalties for violations of the law. Multiple violations and failures to remedy violations can lead to heightened or additional penalties.