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7th Cir. Affirms 'Substance Over Form' Doctrine in Fraud Case

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By Jonathan R. Tung, Esq. on April 05, 2016 1:58 PM

The Seventh Circuit recently affirmed a lower district court's decision to slap a defending company with liability arising out of a fraudulent transfer to insiders. A creditor, the Continental Casualty Company, who was owed a substantial sum of money in its accounts receivable sued a debtor, IGF Insurance, for siphoning off funds to friends and family, leaving the creditor holding the bag. IGF had argued that it's clever structuring of sales protected it from liability, but when it comes to fraudulent transfers, the Seventh Circuit declared, "substance trumps form."

Overall, the decision is a cautionary tale to those who seek to use the statutory language of the law to try and pull corporate shenanigans.

Continental's Facts Distilled

The dealings between IGF and Continental Casualty are complex, but we'll try to keep them simple.

In 1998, IGF insurance bought a crop insurance company from Continental Casualty Company for $25 million. IGF then sold the business for $40 million later on. During the bidding process, IGF heard many offers, but only accepted one from a company that agreed to pay the $40 million in a "circuitous" manner. The money was to be broken up in the following way: $16.5 million to IGF itself, and the remaining $25 million to insiders.

Meanwhile, CCC was still owed $24 million of the original purchase price. It sued IGF, the insiders and the brains of the IGF operation, Alan Symons under multiple theories alleging fraudulent transfer, violations of the Illinois Uniform Fraudulent Transfer Act, and alter ego theories. The key legal issue to be determined was whether or not the receipt of the monies during the sale of the business ($25 million to insiders) were fraudulent transfers made with the intent to defraud Continental.

Fraudulent Transfer

Everything about the facts smelled fishy. The company that eventually bought the crop insurance company paid only $16.5 million to IGF and paid the rest to insiders -- or in the words of plaintiffs and the court -- "siphoned off" that purchase money. In order to justify this weird payment scheme, Symons and company cooked up "sham noncompetes" and an "overpriced reinsurance treaty" that was pushed -- hard -- by the insiders.

It didn't help that Continental had also threatened to sue IGF if it didn't get its money. Chronologically, the payment for the resale of the company took place after this threat. Thus, even if Continental might have had issues proving actual intent, constructive fraudulent transfer elements were already met. There was a threat of legal action, a sub-value transfer of $16.5 million, moving around of monies and insolvency -- Symons was bankrupt. But even intent was easily supported by the mountain of circumstantial evidence. As the Seventh Circuit noted, almost all the insiders were members of the Symons family.

Alter-Ego Theory

The facts also clearly supported a finding of alter-ego theory violations. In traditional corporate law, shareholders own the company and the directors, board and officers cannot use a corporation to pursue personal interests. If they do so, the corporation is essentially an alter-ego to individuals which defeats the purpose of a corporation.

The facts clearly showed that the recipients of the lion's share "ignored, controlled, and manipulated the corporate forms" and essentially pulled the strings of multiple corporate subsidiaries, treating those companies as one with IGF. Insiders used a single address. They commingled funds. They made generous no-interest loans to friends and family. They basically didn't act like a corporation at all.

Substance Over Form

The Seventh Circuit didn't buy the defendants' claims that the UFTA or other laws did not apply to them because IGF never touched the later $25 million --- thus clearing them of "transferee" status. The circuit and the district agreed: courts must look "to the substance, rather than the form" of a business form, and strive to "protect creditors from any transaction ... that [has] the effect of impairing [creditors'] rights."

So, white-collar ne'er-do-wells, heed court's the warning: legal construction can go wrong and end up stabbing you back rather than acting as a shield.

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