Mother and Father Commit Fraud Against Everyone, Except the Jury

June 7, 2013 | Erika Eckley

In a confusing family financial saga, a husband and wife played fast and loose with loans, property transfers, and corporate entities. As a result, the court and jury were left to sort out the tangled web of deceit woven by the couple.

It all seemed to start when Land O’Lakes, in 1998, obtained a judgment against the plaintiffs in the amount of $127,125 for breach of four hedge-to-arrive contracts. The plaintiffs were advised by their attorney a few years later to move their non-exempt assets to a limited liability company to protect the assets from creditor claims. An LLC was created with the plaintiffs’ sons executing the operating agreement and designating the sons as the initial members and managers and the plaintiffs as managers. The LLC stated it was formed for the purchase, sale, and rental of real estate.

After the LLC was formed, the plaintiffs deeded several parcels to the LLC. The plaintiffs retained their homestead and farm. Land O’Lakes brought a claim in federal court claiming the transfers were fraudulent and meant to hinder and defraud the company. The plaintiffs settled with Land O’Lakes for $85,000.

Later, the plaintiffs and their sons met with a commercial loan officer for the defendant bank, which approved financing to the LLC based on conversations with the parties, financial statements, and organizational documents for the company. The sons personally guaranteed the loans on behalf of the LLC.

The LLC also made a personal loan to the plaintiffs in exchange for a mortgage on the plaintiffs’ homestead and farm. About six months later, the plaintiffs filed Chapter 7 bankruptcy. Their attorney estimated it would cost about $180,000 to settle the bankruptcy. The attorney offered to make a loan to the plaintiffs from an entity owned by the lawyer’s wife. The plaintiffs assigned the note given to the LLC for the homestead to a company owned by the lawyer’s wife. Additional notes were executed to the company to repay creditors. These notes were secured by property that had been transferred to the LLC.

The bankruptcy trustee challenged the real estate transfers to the LLC as fraudulent. The bankruptcy court held the transfers were void. (A later-decided Iowa case determined the LLC owned the real estate.) The trustee accepted a settlement from the plaintiffs, and the couple received a discharge from bankruptcy.

The LLC made payments on the loans to the bank following the bankruptcy until two years later. The bank declared a default on all seven notes when payments were no longer received.

In response to the defaults, the plaintiffs sued their attorney and his wife’s loan company claiming the attorney was negligent in advising them to form the LLC and the attorney breached his duty of loyalty to them. They also claimed the loan company was the attorney’s alter ego making him responsible for any liability of the company. The plaintiffs also alleged the notes executed by their sons on behalf of the LLC were invalid because the sons had no authority to bind the LLC.  Therefore, because the LLC was not responsible for the loans, the bank should refund all payments made by the LLC on the notes. The plaintiffs sued their sons claiming the sons intentionally interfered with the LLC’s contractual rights because neither son had any rights as a member of the LLC.

In response, all of the defendants filed counter-claims against the plaintiffs. The bank alleged fraudulent nondisclosure and sought punitive damages, the sons and the LLC sued for breach of contract, conversion, and breach of fiduciary duty. The attorney sued for unpaid attorney’s fees and the loan company sought foreclosure of its mortgages.

The claims went to a jury. The jury rejected all of the plaintiffs’ allegations and found for the defendants. At the conclusion of trial, the plaintiffs were responsible for: $12,200 in unpaid legal fees to their attorney; $200,000 in punitive damages to the bank for fraud; breach of contract, conversion, and breach of fiduciary duty in favor of the LLC in an amount of almost $950,000; and $58,360 in favor of the sons for breach of fiduciary duty.  The court held the bank was entitled to the secured real estate and entered judgment of the note against the LLC and the sons’ personal guarantees in the amount of $1.13 million. The court also awarded common law attorney fees to the sons in the amount of approximately $88,000.

The plaintiffs appealed the award to the bank to be paid by the LLC and the sons. The appellate court held that the plaintiffs could not appeal an award that did not involve their interests because they were not obligated to pay the judgments and dismissed that claim on appeal.

The plaintiffs also appealed submission of the bank’s fraudulent nondisclosure claim to the jury based on insufficient evidence. The court disagreed and held that the evidence showed that the plaintiffs knew that only they could bind the LLC to the loans, so the sons’ signatures on the notes were not valid. The plaintiffs, however, provided corporate documents and appeared at the meeting with the sons when the loans were discussed without disclosing that the sons could not bind the LLC. In fact, both sons testified that they believed they had authority to sign on behalf of the LLC. Because of this, the appellate court affirmed the trial court’s submission of the claim to the jury.

The appellate court also affirmed the trial court’s award of common law attorney fees to the sons. The court was appalled that the plaintiffs would allow the sons to sign personal guarantees for the loans that were to assist the plaintiffs in their financial condition at the same time the plaintiffs’ knew the sons’ signatures on behalf of the LLC were of no force and effect. The court likened this to the plaintiffs’ “ace in the hole” at the expense of their sons. The court agreed this showed a willful and wanton disregard for the sons’ rights, entitling the attorney fee award.

Ultimately, the sons were left holding the bag for their parents’ financial misdeeds. The only lesson that can really come from this case is that every party to a business transaction in which personal guarantees are being made on behalf of others should do their due diligence before signing on for the responsibility. This may include talking with an attorney about the entire deal. This case shows that, in financial transactions, even family members cannot always be trusted. It’s an expensive lesson these individuals learned the hard way.  Schaefer v. Putnam, No. 3-242/11-1437, 2013 Iowa App. LEXIS 581(Iowa Ct. App. May 30, 2013).