Ohio Practical Business Lawyer & Attorney : Teri Rasmussen : Lane Alton & Horst Law Firm : Commercial Law, Creditors, Business Formation : Columbus, Central Ohio

If you've been in business long at all, somewhere along the line there may well have been some sort of dispute about the amount a customer owes.  And if you've had any contact at all with an attorney, you have undoubtedly been told to watch out for "payment in full"  situations in which you receive checks purporting to be "in full satisfaction" or containing some similar endorsement indicating that the customer intends this payment to be it.  In fact, if you're in Ohio, you have probably been admonished (and maybe even established as policy) that any check accompanied by a such a restrictive endorsement, or any cover correspondence using this language, MUST be returned to the customer. 

Simple enough.  But suppose you receive a cover letter enclosing a check for less than the amount owed which doesn't use these "magic" terms of art?  What if the letter specifically states that it is not placing any restrictive endorsement on the check to you, but hastens to add something to the effect that this is all the money we believe is owed to you?

In Ohio, the answer has changed over the years.   Prior to the 1989 Ohio Supreme Court case of AFC Interiors v. DiCello, 46 Ohio St.3d 1, 544 N.E.2d 869 (1989), creditors faced the dilemma of having to choose between  accepting the lesser amount offered and writing off the balance or rejecting the partial payment being offered in favor of pursuing the debtor for the entire amount due.  If a check offered "in full payment" or "in full satisfaction" was cashed by the creditor, the remaining amount owed simply could not be recovered.

From 1989 through 1994, there followed a glorious period for creditors in which they could rely upon Ohio Rev. Code 1301.13 to take the partial payment AND still pursue the debtor for the balance if they did so while make a "reservation of rights".  Thus if the creditor endorsed the check by writing words such as "under protest" or "without prejudice" just above their endorsement before cashing the check, the creditor had managed to have its cake and eat it too.  In this way, creditors accepted the partial payment, applied it against the balance owing and then were permittred to continue further collection efforts.  

All this changed in 1994 when Ohio adopted the revised version of Uniform Commercial Code Articles 3 and 4.  As a result of the change in the law, making a reservation of rights was no longer possible.  In addition, if the partical payment was accompanied by correspondence indicating that the payment was ended to satisfy the obligation in full. cashing the check meant that the creditor could not pursue the trmaining ballance.  New Ohio Rev. Code 1303.40 (A), which remains in effect today, provided that

the claim is discharged if the person against whom the claim is asserted proves that the instrument or an accompanying written communication contained a conspicuous statement to the effect that the instrument was tendered as full satisfaction of the claim.

 This had the effect of returning Ohio to the pre-1989 common law era.

So, today, do not be fooled if receiving a partial payment check.  In addition to the obvious situation in which it is clearly marked as "payment in full", you must also pay attention to the correspondence accompanying the payment.  If that correspondence indicates that the sender does not intend to pay the balance, then you are cashing the check at your own risk, even if there is no restrictive endorsement placed  on the check.  

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From the comfort and convenience of my office computer this morning, I watched the oral argument before the Ohio Supreme Court in Dombroski v. Wellpoint, Case No. 2007-2162.  In this case. the Court was asked to answer the question "when may a tort plaintiff pierce the corporate veil to pursue recovery from a "parent" corporation".  The Court allowed both sides substantially more than the allotted 15 minutes each, asking both attorneys numerous questions. 

• As an aside I want to mention how wonderful it is to be able to see Ohio Supreme Court oral argument without the hassles of parking and transportation. The Ohio Supreme Court has been doing this since early 2004. but this was my first experience utilizing the option. Not only did I save the time coming and going (in pouring rain today I might add), I tuned in a little early and was able to work on other matters right up to the minute oral argument began. The picture is clear and shows close-ups of the attorneys and Justices as they speak. The sound quality is terrific. In many respects, this was actually better than going in person.  You can still see the oral argument by going to the video archives.
• I have a case coming up shortly before the Ohio Supreme Court which does involve the corporate veil piercing issue. So I suppose I'm just a little more interested than I otherwise would be, even though at the moment we're only up on a preliminary procedural issue. (If I don't win on that, we'll be back on the corporate veil piercing issue later.)

Suzanne Richards of Vorys, Sater, Seymore & Pease argued on behalf of the defendant-appellant "parent" company shareholder against which plaintiff-appellee Dombroski seeks recovery.  Robert Palmer appeared on behalf of Ms. Dombroski.  Both attorneys were extremely well prepared.  Although the Ohio Council of Retail Merchants, Ohio Chamber of Commerce,  the Ohio Chapter of the National Federation of Independent Business, and the Ohio Farm Bureau Federation jointly submitted an amici curaie brief in support of the defendant parent company, they did not participate in the oral argument.

Factual and Procedural Background.  In a nutshell, the most salient facts are that Ms. Dombroski was denied insurance coverage for a procedure deemed "experimental".    Ms. Dombroski had a health insurance policy issued by defendant Community Insurance Company ("CIC") which utilized Anthem  UM Services, Inc. ("AUMS") to administer its policies and process claims.  Still another company, Anthem Insurance Companies, Inc.  ("AICI") defined the scope of the coverages under CIC policies.  CIC, AUMS, and AICI were all subsidiaries of  defendant Wellpoint, Inc. ("Wellpoint").  Coverage was apparently denied as a result of a blanket policy by defendant AICI.  Dombroski sued everyone for bad faith denial of her claim.  Counsel for Ms. Dombroski conceded that undercapitalization was not an issue.

AICI and Wellpoint filed motions to dismiss each of them as a party defendant on the grounds that the contract was with CIC and not with them and there was no grounds for bypassing the corporate entities.  The trial court agreed, but the Seventh Appellate District Court of Appeals reversed, holding that the second prong of the Belvedere test could be satisfied through the showing of an "unjust" or "inequitable" act even if it did not rise to level of fraud or illegality  On appeal, the proper interpretation of Belvedere for determining when it is appropriate to pierce the corporate veil was certified because of a conflict among the Courts of Appeal.

Oral Argument Synopsis.  All of this is a very long introduction to the oral argument itself.  Counsel for Wellpoint emphasized that the second prong of  Belvedere required the parent company/shareholder to have "perpetrated a second wrong" by deliberately destroying the ability of the defendant subsidiary to satisfy any judgment against it.  Counsel for Ms. Dombroski emphasized that "piercing the corporate veil" is an "equitable argument" and that insurance bad faith claims are "fairness torts".  He also emphasized thhat Wellpoint set corporate policy for the subsidiaries.  Several of the Justices seemed to have difficulty understanding the complete corporate structure and a couple asked if perhaps the case was not yet ripe for determination.

Justice Pfeifer suggested that perhaps the Court didn't think all that carefully about  the test formulated in Belvedere because the veil piercing was a relatively small part of that case and that the whole test should be re-evaluated.  Later in the oral argument, he posed the question of what would happen if and when the plaintiff tried to depose the nonparty parent regarding the establishment of the policy leading to the denial of coverage.

Chief Justice Moyer suggested that, although the question certified was the proper interpretation of Belvedere, the case could actually be decided on much narrower grounds.  He posited that if a medical insurance company sets up a subsidiary with the purpose of hindering recovery by plaintiffs, that would be "illegal" and easily fall within all interpretations of Belvedere's second prong.  Justice Lanzinger later asked a similar question.

Justice Stratton seemed to think (and I tend to agree) that Dombroski should have an adequate direct claim against CIC and consequently no veil piercing argument was necessary.  Justice O'Connor was concerned that focusing on whether an "unjust" or "inequitable" act might "open the floodgates" for litigation in this area; she indicated that she felt that there had to be "some level of dishonesty"  before recovery could be had.      

My Thoughts.  I tend to agree that more must be proven than just that there was an "unjust" or "inequitable" act perpetrated on the plaintiff to justify piercing the corporate value.  Otherwise the three prong test of Belvedere is really collapsed into a single inquiry.  I also think that sometimes the world is not fair and people who really don't deserve it suffer misfortune; I don't think that someone else should be held responsible for this occurrence in every case.

At the same time, I am not altogether sure that the more stringent test really helps the defendant "parent" company in this particular instance.  It does seem to me that the multiplicity of subsidiaries may well have been set up to thwart policyholders seeking to challenge denial of coverage.  To the extent that is true, I think the parent company may have abused the underlying  conceptual policies of limited liability and should be denied the benefits of that legal doctrine as a consequence.

I am also concerned, however, as to what effect a more "flexible" standard for determining when piercing the corporate veil is permissible would have on closely held companies with a limited number of individuals as equity owners.  Here, especially, something more sinister than suffering by the plaintiff ought to be required.  If that is all that is necessary, then every complaint should include a count seeking the piercing of the corporate veil.  Almost by definition, if there is any actionable claim at all, it is because something "unjust" or "inequitable" happened to the plaintiff.

Perhaps the answer is to introduce further confusion by bifurcating the standards for piercing the corporate veil, having one applicable only to closely held entities, or at least to imposing personal liability against individuals, while the other is applicable only to more sophisticated transactions.

Oh yeah - how do I want it to come out to help my case?  I like the Belvedere standard just as it is, thank you, and wouldn't mind if you made it even more restrictive.

For more on the piercing the corporate veil concept and Belvedere, read my previous post on Piercing the Corporate Veil- What It Means and How to Avoid It. 

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Your business supplies a service or product to a customer and then bills the customer.  One month goes by, then two, and you hear nothing from the customer - no payment, no complaint, no explanation.  By the third month, you are probably becoming rather irritated at the very least and depending on how things are going financially, may be getting a bit concerned.  Or perhaps you've called the customer only to receive a series of excuses and promises that payment will soon be forthcoming.  What do you do?

Chris Moander of the Wisconsin Business Law and Litigation blog has been making a series of posts about how and when to make the decision to go to court to collect these sort of delinquent accounts.  My favorite, with the attention-getting title of "Would lower legal bills motivate you to organize your files?", explains what sort of information and records are helpful to your attorney when you turn the account over ro him or her for collection.  

What to Give Your Attorney.  I agree with everything on Chris' list and with his general point that the more organized information you can give your attorney about a delinquent account, the more quickly -- and inexpensively -- things can move forward.  While all of the items mentioned by Chris are certainly helpful, here's my list of what I find especially useful when I am asked to file a lawsuit against a customer who hasn't paid as agreed:

• Basic contact information (i.e.name, address, phone) of customer
• Credit application, purchase order, or contract documenting the purchase
• Invoice
• Ledger or account history for at least the last 3-4 months
• Copy of any checks previously sent by the customer (or information about the bank used by the customer)
• Any correspondence (including e-mails) exchanged (i.e. sent to, or received from) the customer relevant to the outstanding debt
• Any pertinent information about general nature or length of the relationship with the customer, i.e. was it generally good before this or has this customer always been difficult, is this a huge part of your revenues

With this information, I can get a fairly good idea of what the best approach might be and have what I need to file a lawsuit.  Getting it on the front end saves both time and money.

Why Collect?  Chris also addresses the question "Why collect?", and in another post entitled "Time to call Mr. Wolf", provides some guidelines concerning when it might be time to turn the matter over to your lawyer.  Again I agree wholeheartedly with Chris, but let me add some additional thoughts.  As far as the "why", that much seems rather self-evident.  Unfortunately, the world is not a perfect place and not everyone voluntarily does what they should.  If you're not willing to force the issue of payment when appropriate from time to time, it won't be long before you find you're not making any money and may have to go out of business altogether.

Deciding When to Pursue Legal Action.  Knowing "when" to pursue payment through legal channels and "when" it might be helpful to turn the matter over to your attorney is more complicated.  As Chris suggests, if any of the following are true, it probably is time to "go legal":

• The account is 90 days past due, and in some cases, even sooner.  If you wait too long to pursue legal action, events and circumstances may have occurred in the interim which make the legal option less effective
• Suddenly there's a "problem" with the product or service sold or the customer now has some other dispute with you and the customer wants some or all of their money back.  Of course in many cases, it makes good business sense to just go along with the customer and give a discount.  However, make sure you are doing that in appropriate cases.
• You've endured a series of excuses and broken promises that payment is right around the corner.

There are also times when it probably doesn't make sense to play the "legal" card:

• If there really was a problem or defect in the service or product, even if it wasn't near as big a deal as the customer is now making it
• The amount at stake is relatively small (or relatively small in comparison to the complexity of the situation resulting in nonpayment - read, lots of legal fees to sort through the facts and counter-allegations)  
• You have very important noneconomic reasons for wanting to avoid a dispute - perhaps it's your wife's brother's business
• Someone in your company engaged in some sort of objectionable behavior or made what could be characterized as misleading statements to the customer about any aspect of the business relationship between you (e.g. one of your sales people said somethingto the customer about waiting for the customer to get back on their feet before pressing for payment)
• There's virtually no chance the customer has any money or assets available to pay any judgment obtained

Thus knowing "when" it's time to pursue legal action is a case by case decision.  Often the choice will not be clear-cut. 

Once you've made the decision to pursue legal action, if the debt is small, you may still be able to handle it without the intervention of a lawyer if you really want to do so.  In Columbus where I live and practice law, and elsewhere throughout Ohio (and probably in other states as well), there are "Small Claims Courts".  In Ohio, these courts only have jurisdiction to hear matters involving $3,000 or less.  In addition, while it is possible for an officer or employee of the company to handle the case on behalf of the company without an attorney, he or she may only present documents such as invoices and testify only about facts of his or her own personal knowledge; no questioning or cross-examination of the customer's witnesses is permitted.  The Small Claims Division of the Franklin County, Ohio Municipal Court has prepared a very useful synopsis of how this court works.

If you decide to consult an attorney, that does not necessarily mean there has to be a lawsuit.  Often a letter from your attorney can prompt a response from the customer and it will be possible to work out a payment plan or other resolution of the matter.  An attorney can also help you make the determination whether pursuing collection makes sense in a particular case.

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In connection with the downfall of the C.V. Perry homebuilder entities, I have previously posted on the increasing use of receivership in place of bankruptcy. It's been a few months since then and perhaps time for an update, as well as some commentary.

This is the first of a two-part series concerning events in the case itself and some reflections on what it all means. In this post, I want to provide some more detailed information about the case, some of its players, and the context in which it is happening. In Part II, I will explore the influence of federal bankruptcy law in the case.

Parties. First, more info on the basics. The C.V. Perry receivership actually involves multiple related entities, consisting of limited liability companies in which C.V. Perry & Co. was the sole member. In addition to C.V. Perry & Co., the receivership case also includes the judicial administration and winding up of the following entities (collectively, along with C.V. Perry & Co., I'll refer to as "Perry Entities"):

• C.V. Perry Builders, LLC
• C.V. Builders II, LLC
• Manors at Homestead, LLC
• Pointe at Blacklick, LLC
• Manors at CrossCreeks, LLC
• C.V. Land II, LLC
• Arlington Remodeling, LLC

Martin Management Services, Inc., through its principal Reg Martin is the court appointed "Receiver and Liquidating Trustee" (more on what this means below) and is represented by the law firm of Strip, Hoppers, Leithart, McGrath & Terlecky Co., LPA. Judge John F. Bender is presiding.

Following Case Progress. Anyone wanting to follow this case closely can visit the Franklin County Clerk of Court's website and enter Case No. 07MS-11-454 (you don't actually have to enter the "11" as that is simply a notation indicating the case was filed in November) to see the docket showing the pleadings which have been filed. To see copies of pleadings, you can make a personal visit to the Franklin County Clerk of Courts and view them on computer terminals provided there.

Original Complaint. According to the Perry Entities' receivership Complaint, filed November 7, 2007, the impetus for seeking appointment of a receiver/liquidating trustee resulted from such problems as (1) numerous cognovit judgments having been taken against the Perry Entities by The Home Savings and Loan Company of Youngstown; (2) dozens of mechanics' liens filed against Perry Entities; and (3) numerous other lawsuits filed against the Perry Entities. The Complaint for Judicial Administration of Winding Up of Affairs of Voluntarily Dissolved Corporation and Limited Liability Companies has eight counts which are:

• Appointment of Receiver for C.V. Perry; R.C. 1701.89(A)(8)
• Appointment of Liquidating Trustee for the Limited Liability Companies; R.C. 1705.44
• Establishment of Proof of Claims Procedure; R.C. 1701.89(A)(1), 1705.45 and 1705.46
• Settlement or Determination of Claims; R.C. 1701.89(A)(3), 1705.45 and 1705.46
• Determination of Rights of Holders of Shares; 1701.89(A)(4), 1705.45 and 1705.46
• Presentation and Filing of Receiver's and Liquidations Trustee's Account; R.C. 1701.89(A)(5) and 1705.44
• Injuctive Relief; R.C. 1701.89(A)(9) and 1705.44
• Allowance and Payment of Compensation to Receiver, Liquidating Trustee, Attorneys, Accountants, and other Persons; R.C. 1701.89(A)(10) and 1705.44

Order Appointing Receiver and Liquidating Trustee. An initial Order appointing the receiver/liquidating trustee was entered the same day as the Complaint was filed, but an Amended Order Appointing Receiver and Liquidating Trustee was entered on December 5, 2007. The Amended Order granted the relief sought in the Complaint and required the newly appointed Receiver and Liquidating Trustee to post a bond of $100.00 with the Franklin County Clerk of Court.

So why the appointment as Receiver and Liquidating Trustee? Simply put, what statutory authority Ohio has concerning the liquidation and winding up of the affairs of business entities are slightly different with respect to corporations and limited liability companies. Ohio Rev. Code 1701.89, applying to corporations, references appointment of a receiver. Ohio Rev. Code 1705.44, the analogous statute for LLCs, refers to a "liquidating trustee".

Local Rule 93. In addition to these statutes, Franklin County Court of Pleas Common Pleas Court Local Rule 93 (courts elsewhere in Ohio will have their own rules which may differ in important respects from this rule) will govern procedures and events in this case. Among other provisions, Local Rule 93 requires the filing of an initial inventory and appraisal of the assets of the entity placed in receivership by the court appointed receiver within two months of his or her appointment, together with receipts and disbursements received and made to that point. It also restricts a receiver's fees to no more than $75 an hour and caps fees for counsel for a receiver at $150,000 (which may seem like a lot, but in this case may pose a problem for the receiver's counsel).

Events. What's happened so far has mainly been authorization to sell certain properties, establishment of a "proof of claim" procedure, and a fair amount of sparring about "administrative priority". I'll talk about the latter two of these in my next post.

So that's the lay of the land. In Part II, I will focus on the influence of federal bankruptcy law on these receivership proceedings.

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You probably have some regular customers who order items from you from time to time.  Maybe there's a purchase order involved, but for whatever reason, there's never been any actual written contract between the two of you regarding the relationship as a whole.  Now suppose some of these customers start stretching out payment on you after you invoice them for their purchases.  What can you do?

What about adding a notation to the invoices indicating that interest will be charged on any amounts not paid in 30 days?  That's exactly what a farm cooperative did (to the tune of 24% per annum) in a case decided last week by the Ohio Supreme Court.  (The creditor said it also sent a letter about the new finance charge, but there was some dispute whether the customer ever received the letter.)  The customers continued to purchase items after the invoices indicated interest would be charged on unpaid amounts, but eventually ran up a balance which they failed to pay.  The farm cooperative then sued. 

Holding.  Result?  In a unanimous decision (which includes one Justice concurring in the judgment only) in Minster Farmers Coop. Exchange Co., Inc. v. Meyer, 2008 Ohio 1259, the Ohio Supreme Court held that those notations were not enough to constitute a "written contract".  Therefore, according to the Court, the farm cooperative could not collect interest on the unpaid amounts in excess of the statutory amount permitted under Ohio law pursuant to Ohio Rev. Code 5703.47 (in this case 10%).  As usual, the Ohio Supreme Court's Office of Public Information has prepared a useful and informative summary of the case.   

Ohio Supreme Court's Reasoning.  As the Ohio Supreme Court saw it, under Ohio Rev. Code 1343.03(A)(3), a creditor is not permitted to charge more than the applicable statutory rate on a book account "unless a written contract provides a different rate of interest".  Thus the question was whether the notations on the invoice constituted a "written contract."

To answer this question, the Court had to consider one of my favorite  issues of contract law: the infamous "battle of the forms".  The creditor asserted that Ohio Rev. Code 1302.10 rather than Ohio Rev. Code 1343.03(A)(3) should control the result.  Ohio Rev. Code 1302.10 provides that a written confirmation of a commercial agreement sent within a reasonable time operates as an acceptance in most cases even though it has "additional" or "different" terms.  According to the creditor, the provisions concerning interest were "additional" terms that, absent any objection by the customer within a reasonable time, became an enforceable part of the contract between the creditor and the customer.

The Supreme Court rejected the argument that there was even a "written contract", holding that the more specific statutory provisions of Ohio Rev. Code 1343.03 applied.  For "additional" terms to come into a contract, first there has to be a written contract.  According to the Court, the weight of authority in Ohio had concluded that invoices did not constitute "written contracts" for purposes of Ohio Rev. Code 1302.10.  The Court agreed with the determination by these courts that the customer needed to sign indicating his agreement to the new interest rate and opined:

By stating interest terms on invoices or account statements, [creditor] Minster Farmers made no attempt to condition the acceptance of orders on [customers] Meyer's or Due's agreement to Minster Farmers' interest rate terms; instead it tried to unilaterally impose those terms after the fact....  Minster Farmer's placement of an interest rate on invoices contained no promise by Meyer or Dues and demonstrated no meeting of the minds between the parties.

Prospective Application Only.  Thankfully, the Ohio Supreme Court limited application of this new rule to transactions occurring in the future.  As it explained: " We do not intend for this decision to create shock waves throughout the many sectors of Ohio's economy that rely on book accounts to do business, nor do we wish to encourage a propagation of pleadings regarding past practices."   

What It Means.  If you want to charge interest on unpaid accounts or purchase orders, make sure that it says that on the very first correspondence or documentation you send the customer. 

• Even then, unless you also add language indicating that you are unwilling to do business unless the customer agrees to this, don't expect to be able to enforce your chosen interest rate if the customer objects. 
• With this sort of language, you have a better chance of having your interest rate enforced, but it would be best to have the customer actually sign off in writing on the interest rate. 
•  If that first time payment of interest is mentioned is on an invoice sent along with the item purchased (or delivered later) which is not signed by the customer, you may have difficulty enforcing the interest provisions in any event.  
• And of course every case is slightly different and will turn on its specific facts.

Maximum Interest Rate.  One other thing you should be aware of is that for trade accounts and other business loans and indebtedness less than $100,000.00 and not secured by real estate, Ohio Rev. Code 1343.01 caps the permissible interest rate at 8% per annum.  (There are some other exceptions in Ohio Rev Code 1343.01(B), but this is the gist of it.) 

Yes I know the banks and credit card companies charge waaay more than that.  So why can't you?  Well, because you are not a federally chartered financial institution, that's why.  Federal law "preempts" state law and allows banks and credit card companies to charge more; there's also some other laws applicable only to banks and credit card companies and not to you.  

So, let's be careful out there about slapping interest rates of 18% plus on those slow paying accounts....

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As a bankruptcy attorney who mostly represents creditors, I am not infrequently asked to assist companies who have recently received correspondence demanding that they repay thousands of dollars of payments received from a now bankrupt customer because it's a "preference". Often this happens well into the bankruptcy proceeding and long after the creditor has closed its books on the account, perhaps even writing off a remaining balance as uncollectible. If you have been unfortunate enough to be tagged for a "preference", the most important thing to remember is that you still have options and it is not always necessary to just write a check for the amount demanded.

Bizpointer>>> As a practical matter, it is NEVER wrong for a creditor to accept a payment even if the creditor thinks it might be a "preference". For one thing, the failing company may last longer than you think and may not file until after the payment to you is outside the ninety day preference period. In addition, to recover, it is the debtor which must demonstrate its "insolvency" at the time the payment was made. Furthermore, there are a number of defenses which can be asserted which can wind up justifying the creditor's receipt of the payment. Finally, preference actions are typically matters especially susceptible to neogtiation and settlement which may allow creditors to keep a portion of the prefernce payment.

Bankruptcy Preference Defined. So what, exactly, is a "preference" and what should you do if you get one of these letters, or worse, actually get sued? Basically, a "preference" is a payment that allows the recipient to receive more than their fair share of the now bankrupt customer's available cash and assets. The Bankruptcy Code says that a "preference" must be repaid because it frustrates the underlying policy of federal bankruptcy law that similar creditors should be treated in a similar fashion. This policy is intended to discourage a mad grab by creditors that might accelerate a financially ailing company's slide into bankruptcy.

On a more technical level, section 547 of the Bankruptcy Code defines a "preference" as a payment

• On an antecedent (i.e. past due) debt owed to a creditor;
• Made while the now bankrupt customer was "insolvent";
• Within 90 days (or a year, if the creditor is an "insider" such as a shareholder, officer, or director of the bankrupt debtor, or another affiliated company) before the date the bankruptcy proceeding was filed; AND
• That allowed the creditor to receive more on its claim than it would have had the payment not been made and the claim paid through the bankruptcy proceeding.

Banks and other creditors holding collateral for a debt can wind up receiving a preference payment if they are owed more than the collateral is worth. However, it is unsecured creditors such as the ordinary trade creditor in the form of suppliers, product inventors, and service providers that are the most vulnerable. In addition, it is important to understand that a preference claim can be asserted against a creditor even if the debtor still owes money to the creditor after the payment.

How to Respond. The records of a company in bankruptcy are, not surprisingly, often disorganized and sometimes incomplete. As a result, the net for possible preference payments is usually cast far wider than the true universe of actual preference payments. Thus, once fingered as a possible preference payment defendant, it is crucial to do a thorough "preference analysis" to determine whether there is really any actual liability.

A bankruptcy and creditors' rights attorney has the skills and experience to assist with this crucial task of evaluating what the likely liability exposure is. Martindale-Hubbell's Counsel to Counsel magazine offers this helpful, but very brief, overview of action steps and conceptual considerations that should be undertaken by any company being confronted with preference allegations.

• The CMA Daily News offers several suggestions about how to avoid being in a preference payment situation by taking certain preventive action such as requiring payment in advance of supplying goods or services.

• Thomas Onder of the New Jersey Law Blog recommends that, before contacting your attorney, you should try to gather a full payment history for the period of at least the year before the payment was made. A copy of all invoices showing both sales and payments received during this period is essential to a good defense. In addition, copies of any correspondence (including e-mail), contracts, checks, or other evidence of payments received can be extremely helpful. If you can determine the number of days which generally elapsed between presentation of the invoices and receipt of payment and detect any patterns, that can also be useful.

• Why is this information useful? Well, the two leading defenses to a preference action rely upon what this information can show. The "contemporaneous exchange" defense found in section 547(c)(1) excepts payments where the debtor receives something of value at the same time the payment is made. A related defense depends upon the amount of "subsequent new value" extended to the debtor by the creditor. Alternatively, the "ordinary course" argument based on section 547(c)(2) rests upon a demonstration that a payment comported with a reasonable course of dealing between the creditor and the debtor.

How This Helps in the Defense of a Preference Action. A preference analysis can utilize this information and preventive action to determine whether there is in fact a defense to the demand for repayment of the alleged preference payment. Three of the most common defenses are:

Contemporaneous Exchange. In many cases, as the now bankrupt customer begins to have more and more severe financial problems, there will be times in which the need for a particular shipment of goods or services is so great, that there will be payment for that particular shipment. When the shipment of goods or services and receipt of payment for those goods and services happen more or less at the same time, there is said to be a "contemporaneous exchange", constituting an exception within the meaning of section 547(c)(1) of the Bankruptcy Code.

Ordinary Course of Business. Section 547(c)(2) of the Bankruptcy Code offers another defense if the payment was made in the "ordinary course of business or financial affairs" of the creditor and bankrupt customer in payment of a debt "incurred in the ordinary course of business or financial affairs" of the parties. Payment made "according to ordinary business terms" are also excepted. Thus, both the course of dealing between the parties as well as customs in the relevant industry can be important. Changes in the Bamkruptcy Code in the last few years has made it somewhat easier to rely upon this defense.

Subsequent New Value. Sometimes, even as a financially distressed company struggles for survival, it is able to induce creditors to continue doing business with it, perhaps on the strength of a promise to get everything caught up in the near future or a partial payment of the past due amount. If there are both payments and supplying of goods and/or services within the ninety day "preference period", it is likely that the "subsequent new value" defense found in section 547(c)(4) will be applicable at least to some extent. If applicable, the amount of "subsequent new value" extended will be subtracted from the amount of payments received.

All of these defenses depend greatly on the timing of invoices and payments and require a careful legal analysis of the creditor's documentation. Once a preference analysis has been completed by a bankruptcy attorney, you will have a much better idea of the strength of your case. This will then allow you to make a legally informed decision whether to fight or negotiate your best settlement quickly, thus minimizing the cost both in the amount paid back and attorneys' fees.

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The other day, one of my attorney friends called to see if I could "sign a cog" for him, by which he meant confess judgment for the defendants by signing an Answer to the Complaint on their behalf.  Since this function is considered merely a ministerial act in Ohio and gives rise to no actual attorney-client relationship with the unfortunate defendants, I said sure and we made a date for lunch when I'll sign the pleadings. 

I've previously posted on the enforceability of cognovit promisory notes, but I thought it might be useful to step back for a moment and explain in more detail what they really are.  Ohio is one of only a handful of states that still allow the enforcement of cognovits in commercial transactions.  To the best of my knowledge, it has been decades since any jursidiction permitted cognovit provisions to be enforced in consumer transactions.  While cognovit provisions are most commonly used in promissory notes, they can also be used in guaranties, litigation settlement agreements and even contracts involving the payment of money.   

As long as the debtor does not default, there is really no practical difference between a cognovit promissory note and any other promissory note.  However, when  things go bad, they head south much faster for the borrower who signed a cognovit note.   

Language.  Cognovit notes are simply a special kind of promissory note -- with the addition of certain statutorily required language.  That extra verbage gives creditors an unusually rapid path to judgment and collection activities in the event of a default by the borrower.  In Ohio, cognovit provisions are effective ONLY if they have the language required by Ohio Rev. Code 2323.13.  Thus, the following warning - IN EXACTLY THIS LANGUAGE - must appear "in such type size or distinctive marking that it appears more clearly and conspicuously than anything else in the document" immediately above or below (customarily it will be just above) the signature of the debtor:

WARNING

BY SIGNING THIS PAPER, YOU GIVE UP YOUR RIGHT TO NOTICE AND COURT TRIAL.  IF YOU DO NOT PAY ON TIME, A COURT JUDGMENT MAY BE TAKEN AGAINST YOU WITHOUT YOUR PRIOR KNOWLEDGE, AND THE POWERS OF A COURT CAN BE USED TO COLLECT FROM YOU REGARDLESS OF ANY CLAIMS YOU MAY HAVE AGAINST THE CREDITOR WHETHER FOR RETURNED GOODS, FAULTY GOODS, FAILURE ON HIS PART TO COMPLY WITH THE AGREEMENT, OR ANY OTHER CAUSE.

To ensure compliance with the statute, this language is typically in a larger boldfaced typeface and often boxed.

In addition, an authorization to take a cognovit judgment must be contained somewhere in the body of the promissory note or other instrument of indebtedness,   Thus, generally near the end of the document, the following language (or something fairly similar) must appear:

WARRANT OF ATTORNEY

Each of the undersigned authorize any attorney at law to appear in any Court of Record in the State of Ohio or in any other state or territory of the United States after the above indebtedness becomes due, whether by acceleration or otherwise, to waive the issuing and service of process, and to confess judgment against any one or more of the undersigned in favor of the Bank for the amount then appearing due together with costs of suit, and thereupon to waive all errors and all rights of appeal and stays of execution.  No such judgment or judgments against less than all of the undersigned shall be a bar to a subsequent judgment or judgments against any one or more of the undersigned against whom judgment has not been obtained hereon; this being a joint and several warrant of attorney to confess judgment.

Execution.  To be valid, a cognovit promissory note must either be signed in Ohio or the borrower executing the cognovit must reside in Ohio at the time judgment is taken.  To ensure enforceability, virtually all creditors will require execution in Ohio, even if that means the borrower must make a plane trip.

Enforcement.  The primary value of cognovit provisions is that they provide a shortcut to judgment for the creditor.  If the debtor defaults, the creditor can file a complaint, as well as an answer on behalf of the delinquent debtor, and obtain judgment within minutes of filing the action rather than having to wait a month or more to obtain a default judgment.  Within minutes after that, bank account or wage garnishments or other post judgment action can be instituted against the now judgment debtor.  Thus it is entirely possible that the defaulting borrower's bank account will be cleaned out by the creditor before the debtor even knows judgment has been taken.  The only requirement is that the ORIGINAL of the note or other document with cognovit provisions must be produced and shown to the judge before judgment is entered. 

Traditionally, the job of taking cognovit judgments falls to the youngest lawyer in the office.  In urban populated areas like Columbus and Franklin County where I practice, taking a cog is really no big deal from the standpoint of difficulty.  You simply call one of your attorney friends and take them to lunch in exchange for their signature on the purported answer of the debtor and then head down to court with the pleadings and the original note.  Once there, you file the Complaint and then find your way to the "Duty Judge" who checks to make sure you have the original promissory note or other instrument with the cognovit provision, signs the judgment entry, and gives it back to you to be filed downstairs with the Clerk.  If you want to hit some bank accounts belonging to the defendant, you can then do that too, although I usually let the court runner take care of that in his next run because there's lots of copies involved and it takes too long.  The whole thing takes maybe an hour at most, but it does have to be a real lawyer who does the deed - no paralegals or laypeople allowed.

In more rural counties, taking a cog can sometimes be an adventure.  Often there is only one judge for the county and if he or she is in trial, well then you just have to wait for a break in the action.  In addition, I have strong and not so pleasant  memories of one judge in particular cross-examing me at length about whether our "Warning" was distinctive enough.  For a while, I was seriously concerned that he would refuse to sign my judgment entry and began wondering just how I was going to be able to spin this one and explain coming home without the judgment.  Fortunately for me, the judge did eventually sign the entry and my membership in the mythical American College of Cognovit Lawyers remained secure.         

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OK, so I thought the dismissals of foreclosures without prejudice by three federal judges a couple of months back were not that big a deal by themselves. Click here and here for my earlier postings on the decisions by Judge Boyko, Judge O'Malley, and Judge Rose. However, the recent "public nuisance" and "predatory lending" lawsuits by the City of Cleveland and the City of Baltimore, respectively - coupled with a number of other events I'll describe below - HAS gotten my attention.

I stand by my earlier postings about the importance of those particular decisions on their own, but the march of events since then clearly indicates that foreclosures - regardless of whether they are connected to the subprime mortgage business - and mortgage lending in general are destined for the national stage. For a quick round-up on what's been happening here in Ohio click here. For those wanting the most succinct description of recent legal filings in Cleveland and Baltimore, click here for the Wall Street Journal Law Blog's posting.

As might be expected, according to the Cleveland Plain Dealer, the rulings did affect the actual number of filings in federal court in Cleveland, resulting in drastically fewer filings. Click here for the Christmas Day story in the Cleveland Plain Dealer. However, the impact has been far more widespread. Like a lit match dropped on dry wood, these rulings have ignited a veritable forest fire not easily extinguished.

Summary of Recent Events. A brief review of some recent events is in order. This is by no means complete, even with respect to Ohio, but should give an idea of the burgeoning issue.

• In early December, Hamilton County Common Pleas Judge Steven E. Martin dismissed a Wells Fargo foreclosure with facts very similar to those in the federal cases. Although the bank was ultimately able after the case had been filed to demonstrate that it was the owner of the mortgage, Judge Martin nevertheless dismissed the action. In addition, the law firm handling the foreclosure was told that it could not file any more foreclosures unless it provided proof of the client's ownership of the mortgage at the time of the initial filing. Click here for news coverage on this by Cincinnati Enquirer.

• According to several news reports (including various ones I've linked to elsewhere in this post), the Consumer Protection Section of the Office of Ohio Attorney General Marc Dann is apparently waging a stealth campaign by filing motions in Hamilton County and elsewhere challenging whether the named plaintiff is the proper "party in interest". Interestingly, while some reports state that as many as 30 such motions have been filed, there is no press release on the Attorney General's website concerning these actions.

• On the Friday before Christmas, Ohio State Bar Association President Rob Ware sent an e-mail to OSBA members seeking volunteers to help assist people facing foreclosure and according to this story in the Cincinnati Enquirer, by the day after Christmas more than 200 attorneys had volunteered.

• In Clermont County, Common Pleas Judge Robert P. Ringland has sent a letter to local law firms asking that they participate in mediation in foreclosure cases. Click here for coverage by the Cincinnati Enquirer.

• Following on the heels of the recently released University of Iowa study Misbehavior and Mistake in Bankruptcy Mortgage Claims detailing widespread "shortcuts" and other less than stellar loan collection practices in Chapter 13 bankruptcies, came a New York Times article about how Countrywide Home Loan, Inc. was forced to admit it "recreated" certain letters used as evidence in a bankruptcy proceeding. Read the Countrywide Transcipt of the Status Conference in which this came out.

Enter City of Baltimore and City of Cleveland. Then, last week came the attention-commanding lawsuits by the City of Baltimore and the City of Cleveland:

• Last Tuesday, the City of Baltimore filed a Complaint infederal district court, Case No. L 08 CV 062,against Wells Fargo Bank, NA alleging that the bank engaged in a"reverse redlining"predatory lendingpractice by charging higher fees and interest rates in Baltimore's poorest neigborhoods, resulting in foreclosure rates twice the citywide average. Click here for the press release issued by the City of Baltimore about the lawsuit. Click here for news coverage by the New York Times. Click here and here for news coverage by the Baltimore Sun-Times and here for Baltimore Sun-Times coverage of reaction.

• A couple of days later on January 10, 2008, the City of Cleveland filed a "public nuisance" action in state court against Deutsche Bank Trust Company and twenty other lenders (including Wells Fargo & Company, but not including any Ohio home grown institutions such as National City Bank, KeyBank, Fifth Third Bank or the Huntington National Bank) in a suit on the docket of Cuyahoga Common Pleas Court captioned City of Cleveland v. Deutsche Bank Trust Company, Case No. CV 08 646970, Judge Corrigan presiding, Here is a copy of the filed Cleveland Complaint and a graphic showing the named defendants and their foreclosure activity in the Cleveland area. Click here for the City of Cleveland press release on the case.
  • For news coverage from Cleveland including a video of Cleveland Law Director Robert Triozzi discussing the lawsuit, click here and here. In the "notable quote" department, Cleveland Mayor Jackson told the Cleveland Plain Dealer reporters, "To me, this is no different than organized crime or drugs."
  • For Cleveland Plain Dealer coverage of reaction to the suit, click here
  • For the Cleveland Plain Dealer's Sunday editorial praising the filing of the lawsuit click here.
  • UPDATE: On January 16, 2008, defendant Lehman Brothers Holdings, Inc. got the case removed to federal court in the U.S. District Court for the Northern District of Ohio, Case No. 08-CV-00139-DCN, Judge Donald C. Nugent presiding. As might be expected, the City of Cleveland has responded by filing a Motion to Remand.

What the Boyko, O'Malley, and Rose decisions did was legitimize lingering questions and uncork pent-up forces long looking for an angle of attack. To some extent, an old problem has simply gotten new visibility. Click here for an ABC News story on a New Hampshire man engaged in a six year "predatory lending" battle and click here for a Wall Street Journal Law Blog posting about a Cleveland man ahead of the curve who made the "not the owner" argument years ago and is now appealing on that basis to the United States Sixth Circuit. Read his arguments in Davet Motion.

So, basically there's a lot to take in at this point. For one academic perspective on whether municipalities even have standing to file actions like the City of Baltimore action, see Cleveland State University Assistant Professor Kathleen Engel's 2005 paper, "Do Cities Have Standing? Redressing the Externalites of Predatory Lending", which discusses "public nuisance" as a possible basis for city claims against predatory lenders.

What's It All Mean? Anyone who reading the papers over the last month or so can see that the politicians from the federal government on down have recognized that foreclosures have started to be a enough of a real risk for a substantial enough Americans that they need to take notice. And there will undoubtedly be various plans offering "assistance" of one kind or another to "deserving" homeowners. It's still too early to know the form these will take or whether they will really help any significant number of people.

From a legal standpoint, residential foreclosures in Ohio may become more costly for lenders (and less easy for lenders' counsel to do on a "flat rate" per case basis as is often done) in the short run. Logically, the stricter standards may also carry over into commericial foreclosures although probably with less impact since commericial mortgages are less often commoditized into securitization vehicles.

Documenting Ownership. In the end, however, the "not the real owner" argument will merely force lenders to take more care in documenting transfers of mortgage loans. While this is certainly not a bad thing from an objective standpoint - although it may add to transaction costs ( which may ultimately be passed on to consumers), especially in the beginning as lenders retool - it is also not some sort of fatal blow to the mortgage lending industry or even to securitization. In addition, not every mortgage loan has been assigned away. This theory may buy some borrowers some time (and sometimes that IS very important), but with some exceptions, it's probably not going to change the outcome for most borrowers in default.

Public Nuisance. Although the "public nuisance" theory advanced by the City of Cleveland is certainly innovative and I'd be remiss if I didn't give kudos to a superfically appealing argument, I just don't see it as a winning argument ultimately. I haven't fully digested the lengthy Complaint yet and perhaps once I do, I'll have a better understanding. It strikes me as just another reincarnation of the "lender liability" arguments in vogue when I began practicing law - "you shouldn't have lent me the money because you knew I couldn't pay it back". At some point, there has to be some assumption of responsibility by borrowers for taking the loans in the first place. From my cursory review of the City of Cleveland Complaint, it seems to contend that lenders "should have known" about all sorts of trends and economic factors more easily understood by everyone in hindsight. While "lender liability" lawsuits did get some borrowers out of some loans and did complicate lenders' lives for a while, eventually the novelty wore off. I think the same thing may happen here.

Predatory Lending. Now this one MIGHT amount to something. If lenders did mislead borrowers about the terms of their loan, then they should have to reap the consequences. Perhaps due to all my years as bank counsel, however, I'm a bit skeptical here too. The truth of the matter is that NONE of us really listen to all of the terms of the loan; we just want the house and are happy we found a bank willing to give us the money we need to make it happen. So who's job is it to police the terms offered? Again I haven't fully analyzed the allegations of the City of Baltimore Complaint either so I'm not sure how strong that case is. So I will be interested to see how this one develops, both in Baltimore and elsewhere.

Why It Matters. Aside from the obvious reasons why we should all care about this issue both personally in terms of our own ability to access mortgage loans and more generally in terms of the plight of our fellow citizen, its effect on the credit markets is likely to extend beyond residential mortgages. Business owners may find that their ability and cost to obtain credit have changed.

It's hard to know for sure how the foreclosure "crisis" will play out over the next few months in Ohio and elsewhere. In the short run, however, "business as usual" for the foreclosing lender is over for a while.

UPDATE: What Might Be Next. For an interesting peek at what might be next in Cleveland and Baltimore, click here for the recent cover story in Business Week about "Bank Day" in a Buffalo courtroom in which lenders are being held accountable for various housing code violations on properties being foreclosed upon.

This post was accidentally deleted for a time, but fortunately I had kept a copy and was able to put the original post back up once I realized the problem.

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If your business receives a "bad check" from a customer, there may be a solution you haven't considered.  Under Ohio law, in certain circumstances you may be entitled to "treble damages" equal to three times the amount of the check, plus your attorneys' fees.

Here is the way it works.  Under Ohio Rev. Code §2913.01 and §2913.11, if someone gives you a check and there is not enough money in the account to pay the check, a criminal theft offense has been committed.  Ohio Rev. Code §2307.60 allows a person injured by a criminal act such as a theft offense to bring a civil action to recover damages, plus attorneys' fees.  Ohio Rev. Code §2307.61 speaks to the amount of those damages.

Pursuant to Ohio Rev. Code §2307.61, the recipient of a bad check is entitled to receive, at its choice, either compensatory or liquidated damages.  Compensatory damages are awarded as follows:

•     $50 if the loss was $50 or less

•     $100 if the loss was more than $50 but no more than $100

•     $150 if the loss was more than $100

Liquidated damages is the greater of either $200 or three (3) times the amount of the check, plus any charges imposed by the recipient's financial institution as a result of there being insufficient funds in the issuer's account, "irrespective of whether the property is recovered by way of replevin or otherwise, is destroyed or otherwise damaged, is modified or otherwise altered, or is resalable at its full market price."  In plain English this means that you can get treble damages (i.e. three times the amount of the check) even if you get the goods back that the "bad check" was used to purchase.  

If the original amount involved is less than $5000, the recipient of the bad check can also recover "reasonable administrative expenses" if a written demand for payment of the treble damages is made by certified mail, receipt requested, in accordance with the requirements set out in the statute.  Ohio Rev. Code §2307.61(A)(2).  "Administrative expenses" includes "the costs of written demands for payment and associated postage."  Ohio Rev. Code §2307.61(H)(1).  The notice must be sent at least thirty days prior to filing any lawsuit.

While the statute does not seem to require it, caselaw has imposed the same notice requirement on parties seeking treble damages because not requiring it "would defeat the public policy of encouraging parties to settle their disputes outside the judicial system."  Buckeye Check Cashing Inc. v. Proctor, 199 Ohio App. LEXIS 2678 (Franklin County)

Thus, the key thing to remember is that a notice must be given the perpetrator who issued the check at least thrity days before initiating a lawsuit.  To be efective, that notice must contain certain specific information pursuant to §2307.61(C):

• The specific property damage or theft offense committed

• The amount of damages for which recovery is sought

• Notice that if payment of the specified demand amount is made within thirty days thereafter or an agreement for payment is made within that time and kept, no lawsuit will be filed

• Notice that if either payment of the damages demand is not made within thirty days or there is a default on any agreement made within that thirty days, a lawsuit may be filed

• The fact that any recovery in the lawsuit may also include attorneys' fees, reasonable administrative costs, court costs, and any compensatory damages provable

To be sure you have sent an effective notice, be sure to read the satute carefully or consult an attorney before sending it out.  In addition, sending the notice by both regular and certified mail is a good idea.

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What could be worse than having a judgment taken against your business?  Having the holder of that judgment going after your home and other personal assets.  If they are not careful, business owners can unexpectantly and unpleasantly discover that they are being held personally liable and responsible for what they thought were obligations of the company only.  This can happen when, in the press of everyday busy-ness, shortcuts are taken and the distinction between the company itself and its owner(s) becomes blurred.  Lawyers call this "piercing the corporate veil" and it can have disastrous effects.

Everybody understands the basic rule that generally speaking, the most important reason for setting a business up as a corporation or limited liability company in the first place is to protect its owners, shareholders, members, officers and directors (and their respective assets) from the consequences of any financial or legal misfortune of the business.  The corollary to this principle -- that individuals will remain liable for their own wrongful acts done as individuals even if a business is also involved -- is also an accepted tenet of everyday life.  Conceptually, the idea of "piercing the corporate veil" grew out of the desire to prevent individuals from escaping the consequences of their individually wrongful acts by using a corporate entity for criminal or fraudulent purposes.

Historical Background.  Historically, the limited liability now taken for granted, which use of a corporate or limited liability company business structure allows, is a relatively recent development.  In the early 1800's, there were very strict limits on the ability of a business owner to obtain limited liability; incorporation of a particular business typically required a special act of the state legislature.  To the extent general incorporation statutes existed, they usually imposed substantial limitations on their use by emphasizing significant minimum paid-in capital requirements, limited permissible purposes and limited duration.

In time, and especially following the Industrial Revolution in the last century, more businesses began to require substantial expenditures and infusions of capital well beyond the means of the typical entrepreneur.  Investors willing to provide these sums of money were, in the absence of limited liability, far less anxious to invest in businesses they neither operated nor were in a position to monitor closely.  As a result, state legislatures eventually removed virtually all of the restrictive limitations on the ability of corporations to organize and operate and the ability to avoid personal liability for debts of one's company became an accepted economic tenet of business life. 

By allowing people to participate in the ownership of businesses without risking their entire personal net worth, granting limited liability encouraged investment and the growth of businesses.  Thus, traditionally, the benefit of limited liability has been linked with the passive involvement by those granted the benefit.  The idea was that people could trade involvement in the management of the business for the security of having no personal liability for the obligations of the business beyond their investment. 

The Problem and Its Consequences.  Today, with the possible exception of businesses fortunate enough to have attracted venture capital, the distinction between passive investors and operating managment is often far less clear.  Typically, in a small or medium privately held owner-operated business, most or all of the owners are likely to have active roles in the day to day management of the company.  Unfortunately, this trend can be a trap for the harried unwary business owner who assumes that observing formalities imposed by Ohio law for operating his or her business is merely optional or "just not that big a deal".

Does this ever really happen?  Yes.  In a surprising number of cases, people suing a business have argued, and the court has agreed, that business owners displaying carelessness in following proper corporate procedures, or lax practices in separating the financial affairs of the business from their own, are personally liable for everything from environmental claims to breach of contract.

Consider the situation of a general building contractor, known as Bachinski Builders, Inc. whose sole shareholder was the president's wife.  Barbee Concrete Construction was a subcontractor hired by Bachinski Builders, Inc. to do concrete work for a residential subdivision being built by Bachinski Builders.  Upon completion of the residential development, Barbee Construction was not paid for all of its work.  After filing suit for breach of contract to recover the unpaid amounts, Barbee Construction amended its Complaint to include a claim seeking to recover against the president of the general contractor personally.  (Barbee Concrete Construction v. Bachinski Builders, et al.).  Among the transgressions important to the Court in deciding to impose personal liability on the president were:

• President testified that he alone made all decisions, including how corporate monies were to be spent and distributed

• President was unable to name any members of the company's board or say whether it had ever even met

• No corporate records could be produced

• A series of payments totaling more than $32,500.00 were made to one of the president's son, allegedly as compensation for work as a construction supervisor, but when questioned about specific payments, the president was unable to explain the amounts or what work was done to earn specific payments

• Payments totaling more than $56,000.00 were made to two other sons supposedly as repayment of loans made, but there was no documentation supporting the existence of the loans.

In still another case, a nursery rewholesaling business owner ran afoul of the "piercing the corporate veil" doctrine when sued by a nursery supplier in a breach of contract action.  (Willoway Nurseries v. Curdes).  Thomas and Rosemary Curdes had taken appropriate legal steps to set up their business, but later became thoroughly undisciplined in maintaining any separate existence for their company. 

Initially, appropriate incorporation documents were filed with the Ohio Secretary of State, shares were issued and paid for, Mr. and Mrs. Curdes were designated as the company's shareholders, officers and directors, and the first shareholders' and first directors' meeting were held.  Unfortunately, the Curdes' business began experiencing difficulties almost immediately.  Plans to make their existing lawn care and landscaping sole proprietorship a subsidiary of the newly formed corporation were never completed.  Instead the Curdes continued to use the sole proprietorship's checking account for both businesses.  In addition, in imposing personal liability on the Curdes, the Court found that:

• although salaries had  been paid to the Curdes, records and accounts for the new company were inaccurate and badly in arrears

• plants in the new company's inventory were used for the old landscaping business without any corresponding record of payment

• revenues generated by the new company were used to buy equipment for the old landscaping business and pay its employees

• no corporate formalities had been observed since the initial incorporation activities

• no corporate or state tax returns had been filed

• when the new company eventually ceased operations, the Curdes simply took the company's assets to their own home, viewing them as their own property

Belvedere Sets Ohio Standard.  In Ohio, the leading case describing the circumstances in which "piercing the corporate veil" is appropriate is Belvedere Condominium Unit Owners' Association v. R.E. Roark Companies, Inc., 67 Ohio St.3d 274 (1993).  This case involved a dispute between a Cincinnati condominium unit owner's association and a Columbus real estate developer (and its majority shareholder).  The association (whose board was controlled by employees of companies owned by the real estate developer's shareholders) and the real estate developer had entered into a lease with provisions highly favorable to the real estate developer as lessee and at an allegedly under-market rent.

After finding no fiduciary duty existed between the developer and the condo association, the Ohio Supreme Court nevertheless held the developer liable under a strict liability statute for failure to disclose to prospective purchasers relevant financial information concerning the condominium development.  The question then was whether the majority shareholder of the developer could be held individually liable for this violation by the developer.  In answering this question, the Ohio Supreme Court indicated that it intended to strike "the correct balance between the principle of limited shareholder liability and the reality that the corporate fiction is sometimes used by shareholders to protect themselves from liability for their own misdeeds." 

The Ohio Supreme Court set out the following guidelines for when individual shareholders could be held liable notwithstanding the corporate form of their business:

1. control over the corporation by those to be held liable was so complete that the corporation has no separate mind, will or existence of its own, i.e. there was no separation between the business affairs of the company and the personal affairs of the owner

2. control over the corporation by those to be held liable was exercised in such a way as to commit fraud or an illegal act against the person seeking to disregard the corporate entity, and

3. injury or unjust loss resulted to the plaintiff from such control and wrong.

The Court also hastened to add that "mere control over a corporation is not in itself a sufficient basis for shareholder liability."  In analyzing the situation before it, the Ohio Supreme Court found it persuasive that the individual shareholder did not use his influence and control to injure or defraud the association.  Accordingly, it concluded that it was not appropriate to hold the shareholder individually liable.

Practical Applications.  What does this mean on a practical level?  The most important prong of the standard is the first which tests whether the owner and the corporation or LLC are distinguishable from one another.  Among the telltale factors considered by Ohio courts are 

• grossly inadequate capitalization

• failure to observe corporate formalities

• insolvency of the business entity at the time the debt was incurred

• owner acting in ways holding himself out as personally responsible for the company's obligations

• diversion of company funds or property for personal use

• company used as a mere façade for other operations of the owner

Thus, in the recent case of Kelley v. McComas, 2007 U.S. Dist. LEXIS (S.D. Ohio 2007), while the Court felt it was a "close question" whether the corporate veil should be pierced, the Court refused to impose personal liability on the company's owners based upon the fact that corporate meetings were held and that the company was the holder of the liquor permit, filed corporate tax returns, had employees, and was no more insolvent now than when the incident in question occurred. 

So what's the best way to avoid accidental personal liability?

1. Keep good corporate records.  If there is more than one shareholder or owner, have corporate meetings on a regular basis (monthly or quarterly) and keep minutes of those meetings

2. Make sure you keep some sort of record of revenue coming in, and expenses being paid by, the company.  If you bill clients or customers, make sure they make their check payable to the company, rather than you personally. 

3. Don't pay company bills from personal funds.  If the business is running short of money, deposit a personal check in the company banking account instead of paying even such essentials as employee paychecks or utilities from your own funds.  Make sure to have your bookeeper or accountant keep track of these "loans" to the company.  And while it probably goes without saying, make sure you DO have separate personal and company accounts. 

4. Don't pay personal bills from company funds.  Be sensible about which expenses the business is paying for you.  Car payments may (or may not, depending on the circumstances) be appropriate, but expensive vacation trips to the Carribean even if you did have that one business meeting, are likely to be pushing it.

5. Make sure you've completed ALL of the legal steps in Ohio for proper legal formation of the business.  For example, if a corporation, simply filing Articles of Incorporation with the Secretary of State without also attending to electing directors and officers and issuing shares of stock is not sufficient.

6. Use signage, business order forms, invoices, and business stationary with the company's name and address prominently featured when doing business with customers and clients.

While these guidelines are relevant to all privately held companies, individuals who are the sole owner of thier business should pay particular attention to adhering to them.

In general, the best way to stay out of trouble is to simply remember that the company IS NOT you, but has its own distinct identity and needs to be treated as a separate independent entity. 

• To learn how courts in another state look at the issue, read John Waller's post from earlier this year on "More on Piercing the Corporate Veil in Indiana and the UFTA" in his Indiana Commercial Foreclosure Law blog.

UPDATE: The Ohio Supreme Court heard oral argument in Dombroski v. Wellpoint, Inc., Case No. 2007-2162, on June 4, 2008 in which the certifed question related to the proper interpretation of Belevedere's second prong in a case involving a tort plaintiff and the parent corporation against whom veil piercing was sought.  For more on this, read my posts here and here.  In these posts, I also include links to the Ohio Supreme Court website where you can see the streaming video of the oral argument.

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Over the last couple of weeks, Judge Boyko and Judge O'Malley in Cleveland, as well as Judge Rose in Dayton, have dismissed numerous residential foreclosures brought by the trustees of mortgage-backed securitizations on the grounds that the financial institutions have failed to demonstrate adequately their ownership of the mortgages being foreclosed. Because of all the hype these federal court dismissals without prejudice seem to be getting, especially in the blogosphere (visit Iamfacingforeclosure.com if you don't know what I'm talking about), I thought it would be helpful to post some basic source documents in one place so that everyone could see what this is all about.

1. Judges' Opinions - there are three so far that I know about:

• Judge Boyko's decision, handed down October 31, 2007, dismissed 14 cases and has the most colorful language and juicy footnotes - click JudgeBoykoOrder to read.

• Judge O'Malley's decision, handed down November 14, 2007, dismissed 32 cases and is the most matter-of-fact decision - click Judge O'Malley Order to read.

• Judge Rose's decision, handed down November 15, 2007, dismissed 20 cases and chooses to focus on a perception that mortgage lenders are generally scofflaws by referencing a study by University of Iowa Associate Professor Katherine Porter (more about this below) - click JudgeRoseOrder to read.

2. Misbehavior and Mistake in Bankruptcy Mortgage Claims, a recently released study by University of Iowa Associate Professor Katherine Porter of 1700 Chapter 13 bankruptcy cases filed in April 2006 across 24 states which was quoted by Judge Rose as follows:

("[H]ome mortgage lenders often disobey the law and overreach in calculating the mortgage obligations of consumers.... Many of the overcharges and unreliable calculations... raise the spector of poor recordkeeping, failure to comply with consumer protection laws, and massive, consistent overcharging.")

I have not yet read this study with any thoroughness so I can't comment on it other than to say its conclusion certainly is that mortgage lenders have been permitted to be rather lax in providing appropriate documentation in at least consumer bankruptcy proceedings. From the limited vantage point of my own legal practice, I will say that I disagree with the conclusion as a sweeping generalization.

3. The Affidavits - Just so everyone understands what these Judges were looking at, I thought I would post examples from each Judge of an Affidavit being put forth. In most state courts in Ohio, no such affidavit is needed at the inception of the case. Yes, they are fairly conclusory.

• Affidavit in Boyko Case
• Affidavit in O'Malley Case
• Affidavit in Rose Case

4. The Complaints - again so we are all starting from the same information, here are examples of the Complaints that were filed in these cases, together with a notation of the named plaintiff and the named mortgagee in the document in each case:

• Complaint in Boyko case - Plaintiff is Deutsche Bank National Trust Company, as Trustee of Argent Mortgage Securties, Inc. Asset-Backed Pass-Through Certificates, Series 2006-W4 under the Pooling and Servicing Agreement dated April 1, 2006, assignee of Argent Mortgage Company, LLC. Mortgagee is Argent Mortgage Company, LLC
• Complaint in O'Malley case - Plaintiff is Deutsche Bank National Trust Company, as Trustee of Argent Mortgage Securties, Inc. Asset Backed Pass-Through Certificates, Series 2005-W5 under the Pooling and Servicing Agreement dated as of November 1, 2005 Without Recourse. Mortgagee is Argent Mortgage Company, LLC
• Complaint in Rose case - Plaintiff is Citibank, N.A., as trustee for First Franklin Mortgage Loan Trust, Mortgage Loan Asset-backed Certificates, Series 2005-FF12 c/o Home Loan Services, Inc. Mortgagee is First Franklin, a division on Nat. City Bank of In.

Rather than explaining the chain of title or alleging that the named plaintiff is an assignee of the original mortgagee, the Complaints simply allege that the named plaintiff is the "holder" of the mortgage, or perhaps the "owner and holder" of the mortgage. Had either the Complaint, or the Affidavit, in these cases added an extra sentence or two explaining the assignment, it would not have been nearly as easy a decision for the courts to dismiss these cases.

5. Securitization - What's it All About? - And finally for those who really are trying to understand the underlying factual and legal context in which these dismissals occurred, I offer the following links to resources explaining how securitization works. At some point soon, I hope to post on this as well [UPDATE-click here for post on this] , but for now visit either:

Chicago Federal Reserve November 2007 newsletter

Wikipedia's Securitization posting

In Ohio, foreclosures are most often brought in state, rather than federal, court. One reason these cases may have been filed in federal court was for the convenience of being able to assign a number of cases to a single attorney who would not have to travel from county to county. It will be interesting to see if Ohio state court judges (who are electe