SharpThinking

No. 190  Perspectives on Developments in the Law from Sharp-Hundley, P.C.  November 2020

High Court Reaffirms Successor Liability Rule

By John T. Hundley, Sharp Thinking Editor

Illinois’ traditional doctrine on corporate successor liability – not the federal doctrine on that subject – applies to claims arising under the Illinois Human Rights Act (775 ILCS 5), the Illinois Supreme Court held recently.

Ruling in People ex rel. Dep’t of Human Rights v. Oakridge Healthcare Center, 2020 IL 124753, the high court reaffirmed the state’s “common law” doctrine and rejected an appeal to engraft onto that doctrine a fifth exception for employment discrimination cases.

The court also interpreted the doctrine’s “fraudulent purpose” exception to avoid liability for an entity that purchased the assets of the discriminator after the discrimination claim had been asserted.

In Oakridge, an employee of a nursing home and rehabilitation center filed a charge of discrimination against her employer with the Illinois Department of Human Rights.  However, before the claim could be adjudicated, the employer entered into an “Operations Transfer Agreement” and went out of business, transferring substantially all its assets to a new entity organized by persons associated with the landlord on the property where the center operated.  Eventually the agency awarded the claimant some $30,880, by which time the employer had been involuntarily dissolved.  The state sued the new entity on the claimant’s behalf.

The state argued that the federal doctrine on successor liability should apply, pointing to Illinois’ frequent following of federal law in civil rights cases.  That doctrine, as applied in the Seventh Circuit, looks at whether (1) the transferee had notice of the legal challenge, (2) the transferor could have given the requested relief before the sale or dissolution, (3) the transferor could have given the requested relief after the sale or dissolution, (4) the transferee can give the requested relief, and (5) a continuity of operations and work force existed between the transferor and the transferee.

The trial court rejected that argument, but an appellate panel reversed and found enough of the federal factors present to impose liability on the new entity.

In the Supreme Court, the state pressed its request for Illinois to apply the federal doctrine.  In a 6-0 decision, the high court rejected that request.

“Illinois, along with the majority of American jurisdictions, has long applied the common-law rule that a corporate successor is not subject to any debts or obligations incurred by the entity that previously operated the business,” the high court noted.  Under the doctrine of stare decisis, to overturn that rule “requires a clear showing of good cause or some other compelling rationale,” it said.  In light of the reliance which corporate buyers have placed on Illinois’ traditional doctrine, the court found the state had not carried its burden.

The state pointed out that if Illinois did not follow the federal rule, results could vary depending on whether the civil rights claim was filed in state or federal court.  “The mere possibility that a particular employment discrimination case could have a different outcome if brought in federal court is not sufficiently compelling to overturn our decades-old common-law rule,” the court said.

The court noted that the appellate panel had not rejected the Illinois doctrine in toto so much as created a fifth exception to it.  (Under established law, four exceptions to the rule of successor non-liability apply: (1) where the parties had an express or implied agreement that the transferee would assume the transferor’s liabilities; (2) where the transaction amounts to a merger or consolidation or a de facto merger of the transferor and the transferee; (3) where the transferee is a mere continuation or reincarnation of the transferor; and (4) where the transaction was entered into for the fraudulent purpose of avoiding liability for the transferor’s obligations.)

Noting that creation of a fifth exception for employment discrimination matters “constitutes a significant modification” of Supreme Court precedent on successor liability, the court said the “appellate court may not overrule or change our holdings.”

The state alternatively argued that the appellate court’s judgment should be sustained under the “fraudulent purpose” exception to Illinois’ traditional rule.  Analyzing §§ 5 and 6 of the Uniform Fraudulent Transfer Act (740 ILCS 160/5, 6), the high court rejected that request.  It said it was “difficult to imagine when the mere transfer of substantially all corporate assets, standing alone, would be sufficient to justify an inference of fraud in fact.”   Moreover, it noted that in Oakridge “transferring those assets allowed for the continuous care of the residents and is not, by itself, sufficient justification to infer fraud in fact. . . . [T]he transfer allowed [seller] to stop the bleeding that was rapidly draining the company’s financial lifeblood.”

But, the state argued, the parties had not received an appraisal of the transferred assets, so the amount of consideration given therefor was suspect.  “We cannot say that the lack of an appraisal creates a reasonable inference of an intent to defraud creditors in light of the serious financial stress and limited sale opportunities for [seller]”, the court said.

Applying the so-called “badges of fraud” approach, the court found only two applicable.  “We cannot say that the presence of only two indicators of potential fraud . . . is sufficient to preclude the entry of summary judgment” for seller, the court said.  “Even if all 11 factors are present, they may be insufficient to create an inference or presumption of fraud in fact. . . .  One of the touchstones of the Fraud Act is whether the transfer was made with ‘actual intent to hinder, delay or defraud’ a creditor . . . .  If the circumstances surrounding a transfer do not establish it was made with actual intent to avoid a creditor, the evidence is insufficient to prove the fraud.”