Wis. Supreme Court Narrows Fraudulent-Transfer Exception, Suggests Stringent Pleading Requirements

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Generally, companies purchasing the assets of another company are not responsible for the seller’s liabilities. One long-established, but poorly defined, exception applies when the assets are transferred fraudulently in an effort to evade liabilities. In Springer v. Nohl Electric Products Corp., the Wisconsin Supreme Court took a step towards clarifying (and perhaps limiting) this fraudulent-transfer exception, over the dissent of Justice Abrahamson.

While the majority opinion focused on the legal issue presented in the case—the proper legal standard for fraudulent transfer exception—Justice Abrahamson’s dissent was most concerned with the outcome of the litigation and its broader implications for due process.

In a 5-2 decision, the Court held that the Wisconsin Uniform Fraudulent Transfer Act (“WUFTA”), in chapter 242 of the Wisconsin Statutes, does not define the scope of the fraudulent-transfer exception to successor non-liability under common law. The Court additionally decided that summary judgment was appropriate because the plaintiff’s complaint did not clearly allege that the defendants were liable under a successor-liability theory. Justice Abrahamson dissented, briefly arguing that WUFTA should play a role in the fraudulent-transfer analysis, but focusing primarily on the Court’s decision to dismiss the case. She argued that even addressing an issue with the pleadings was inappropriate because the issue was not raised by the defendants and plaintiff had no opportunity to be heard on that issue.

Brief Background

Springer involved negligence and strict-liability claims against several companies for creating, distributing, and selling asbestos products. The complaint named Fire Brick Engineers Company, Inc. (“FBE2”) and its successor, Powers Holdings, Inc., as defendants. FBE2 was formed in the 1980s to purchase the assets of Fire Brick Engineers Company (“FBE1”), a company formed in the 1940s to manufacture and distribute asbestos products. FBE2 later merged with another company to form Powers.

After initially allowing the claims to continue to discovery, the trial court granted the defendants’ motion for summary judgment, holding that FBE2 (now Powers) could not be liable because it was formed more than a decade after the plaintiff’s husband was exposed to asbestos. In response, Springer argued that there was a factual dispute about whether FBE2 (and thus Powers) could be held liable under the fraudulent-transfer exception to successor non-liability because a number of circumstances surrounding the sale indicated a possible fraudulent intent. These included the fact that a FBE2 shareholder was aware of FBE1’s potential liabilities, several FBE2 shareholders acted as attorneys for FBE1, and FBE1’s assets were sold for inadequate consideration, without appraisal or negotiation.

Springer appealed to the Wisconsin Court of Appeals, which reversed, finding that WUFTA should govern the fraudulent-transfer exception and that the evidence showed there was a genuine issue of material fact as to whether the transfer from FBE1 to FBE2 triggered the fraudulent-transfer exception. Powers then successfully petitioned the Wisconsin Supreme Court for review.

Fraudulent Transfer Exception and WUFTA

The Wisconsin Supreme Court reversed, holding that WUFTA does not apply to the common law fraudulent-transfer exception. The Court pointed out that successor non-liability and its exceptions arose out of the American and English common law. On the other hand, WUFTA “exists independently from this common law history” and is focused not on holding successor entities responsible for their predecessors’ obligations, but on helping creditors collect claims which “may be frustrated by recent asset transfers.” 2018 WI 48, ¶27. After surveying a number of common law sources, the Court found WUFTA’s standard inapplicable to claims of fraudulent transfer regarding successor liability. Justice Abrahamson disagreed, stating that WUFTA should be a source of guidance for courts in identifying “indicia of fraud” for purposes of the fraudulent-transfer exception.

Summary Judgment and Justice Abrahamson’s Dissent

After determining that WUFTA does not govern the fraudulent transfer exception, the Court turned its attention to the procedural posture of the case. The Court noted that while Springer argued for successor liability in response to a motion for summary judgment, she never amended her complaint to allege successor liability. Evaluating the sufficiency of the pleadings, the majority found that Springer’s pleadings failed to “allege facts that plausibly suggest [she was] entitled to relief” against Powers and therefore affirmed the trial court’s order of summary judgment dismissing Powers.

Justice Abrahamson stridently disagreed with the Court’s decision to review the pleadings, noting that the defendants never challenged the sufficiency of the pleadings at any stage of litigation, including before the Wisconsin Supreme Court. Justice Abrahamson insisted that the issue of the sufficiency of the pleadings was not “properly before this court.” Id., ¶49 (Abrahamson, J., dissenting). She was particularly troubled by the fact that the parties were not given notice that the Court “[was] concerned about these issues” and were therefore given no opportunity to address them. Id. Pointing to two recent cases, Justice Abrahamson lamented what she described as “the court’s growing bad habit of addressing issues without giving parties notice and the opportunity to address the issue . . . .” Id., ¶52. She voiced a concern that this trend might violate due process, which “requires (at a minimum) notice and an opportunity to be heard.” Id., ¶51.

Take-Away

Springer makes clear that the fraudulent-transfer exception to successor non-liability is rather narrow. It is also serves as a startling reminder of increasingly demanding pleading standards. The long-established flexibility of notice pleading was somewhat curtailed by the U.S. Supreme Court’s Twombly and Iqbal decisions a decade ago, and the Wisconsin Supreme Court has largely followed suit. Springer reminds litigants to take care to amend or seek leave to amend pleadings as part of the defense of a summary judgment motion, even when that motion does not expressly attack the sufficiency of the initial pleading.

Law Clerk Collin Weyers assisted with researching and writing this post.

Court of Appeals Reverses Agency Prohibition on Strip Searches at Juvenile Residential Care Centers

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In Milwaukee Academy v. Department of Children and Families, 2016 AP 2377, the Wisconsin Court of Appeals faced the question of whether residential care centers for minors are prohibited from ever strip-searching residents. The Court concluded that state law does not contain a blanket prohibition against strip searches in all circumstances.

The specific strip search at issue before the court took place at Milwaukee Academy, a DCF-licensed residential care center for girls ages ten through seventeen. The children placed at Milwaukee Academy include victims of sexual abuse, subjects of CHIPS cases (where children and parents are subject to court supervision due to findings related to abuse or neglect), children experiencing emotional and behavioral disorders who need respite care, and children who have been adjudicated delinquent. 

The subject of the search is identified only as J. The record is silent regarding the nature of her placement at Milwaukee Academy. After she cut her arms with pieces of plastic, J had been taken to the Milwaukee Mental Health Center.  When J returned to Milwaukee Academy, she refused to cooperate or answer questions about whether she had any weapons. J was taken to the “time out room” with four female staff members present. After J kicked one staff member in the head, the staff took her to the floor using a “team lateral restraint.”

Milwaukee Academy acknowledged that J was forcibly searched and her clothing was cut off. According to an internal investigation , “[s]taff were able to complete the body search but due to J’s continued attempt to kick, bite, scratch and pinch, the nurse had to cut off her bras (she had two of them on) and shirt, and removed her pants.” After the search, Milwaukee Academy staff called for assistance from sheriff’s deputies, who took J to the hospital and then to jail.

Milwaukee Academy subsequently prepared and filed a “Serious Incident Report,” as required by DCF regulations. DCF then imposed a forfeiture on Milwaukee Academy, stating that the relevant statutes and code sections impose an absolute prohibition against strip searches in a residential care center for minors. Milwaukee Academy’s administrative challenge to the forfeiture failed, as the Division of Hearings and Appeals concluded that the strip search had violated J’s rights under state law.  

Milwaukee Academy petitioned for review in circuit court. The circuit court concluded that, under the relevant statutes, minors in residential care centers have right comparable to those granted to patients under state law. According to the circuit court, those rights do not include an absolute right to be free from strip searches. As the circuit court explained, “[d]epending on the security needs and other circumstances of each kind of facility, [an RCC] resident’s right to be free from strip searches might be as limited as an inpatient’s.”

On appeal, DCF argued that, as a matter of law, strip-searching an RCC resident is never permissible. DCF based its argument on Wis. Admin. Code § DCF 52.31(1)(a), which cross-references Wis. Admin. Code ch. DHS 94, and Wis. Stat. § 51.61. Because this was an appeal of an administrative decision, the Court of Appeals reviewed the agency action, not the circuit court’s analysis, and it afforded due-weight deference, under which the agency’s legal interpretation is sustained unless there is a more reasonable interpretation.

Ultimately, the Court of Appeals came reached the same result as the circuit court. It held that DCF’s interpretation—based on a distinction between a “patient” and an “inpatient”—lacked textual support in the statutes and regulations. Those sources, the Court determined, do not distinguish between “patient” and “inpatient” but use those terms interchangeably. As an example, the Court focused on the administrative code section that DCF cited, finding “no clear or meaningful distinction between the rights of a ‘patient’ and an ‘inpatient’ in § DHS 94.24(2)(d), contrary to DCF’s argument.” Slip op., ¶26.

The Court of Appeals held that the plain text of the relevant statutes and regulations led to a conclusion more reasonable than that reached by DCF: there is nothing in the DCF regulations that prohibits a strip search of an RCC resident in all circumstances. Instead, such searches are limited by the framework contained in § DHS 94.24(2)(d). Because the Courtdeemed the record insufficient to apply the governing regulations to this particular search,  it remanded the case to DCF for further proceedings.

While it is too early to know how Milwaukee Academy’s strip search of J will be adjudicated, this case may have a significant effect on juveniles’ out-of-home placements moving forward. It remains to be seen if courts will be more hesitant to place certain juveniles in RCCs, even when the juveniles need services that cannot be managed exclusively by the Department of Children and Families.

New Technologies Will Present New “Walking Quorum” Challenges for Governmental Bodies

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A “walking quorum” is a series of gatherings among separate groups of members of a governmental body, each less than quorum size, who agree, tacitly or explicitly, to act uniformly in sufficient number to reach a quorum. Recognizing that a walking quorum may produce a predetermined outcome and deprive the public the opportunity to observe the decision making process, Wisconsin courts have long warned public officials that any attempt to circumvent a public meeting through use of a walking quorum is subject to prosecution under the Open Meetings Act. See e.g., State ex rel. Newspapers v. Showers, 135 Wis.2d 77, 398 N.W. N.W.2d 154 (1987).

In State ex rel. Zecchino v. Dane County (February 27, 2018), the Court of Appeals (District IV) considered an Open Meetings Act claim based on a series of email messages between Dane County Board Supervisor Paul Rusk and no more than eight of his fellow supervisors prior to a controversial vote on the renewal of a billboard lease. The plaintiffs argued that the emails suggested the effort to assemble a walking quorum in violation of the Open Meetings Act, such that he should be allowed discovery to ascertain the full extent of informal communications.

The Court of Appeals dismissed the complaint for failure to state a claim. The Court first determined that the emails Zecchino already had did not indicate a “tacit agreement” between the defendants to vote against the lease. One of the emails dealt with a scheduling matter, while others asked supervisors for their opinion or expressed Rusk’s personal position. The Court also found that because the quorum of the Board on the day of the vote was eighteen, Rusk’s communications with eight supervisors could not establish a walking quorum. The court confronted the walking quorum prohibition in the context of email messages. Applying the walking quorum concept in light of newer technologies will raise new issues for Wisconsin governmental bodies. Today, members of governmental bodies can communicate using a wide variety of real-time communications platforms. Along with email, public officials can chat through tweets, Gchat, Yik Yak, Snapchat, Facebook, Instagram, Viber, Skype, HipChat, FireChat, Cryptocat, What’s App, and, of course, text messaging. Stafford Rosenbaum LLP’s Municipal Law team works with governmental bodies to navigate the challenges that new technologies present in complying with the Wisconsin Open Meetings Law.

Seventh Circuit Predicts That Wisconsin Will Adopt Learned Intermediary Doctrine

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The Seventh Circuit recently addressed an open issue under Wisconsin products liability law—do manufacturers of prescription drugs or medical devices satisfy their duty to warn of product risks by informing prescribing physicians (rather than the patients themselves) of those risks?  In In re: Zimmer, NextGen Knee Implant Products Liability Litigation, No. 16-3957 (7th Cir. Mar. 8, 2018), the federal appeals court predicted that the Wisconsin Supreme Court likely would answer “yes” to that question by adopting the “learned intermediary doctrine.”

At issue in this case was a knee implant manufactured by Zimmer NexGen Flex, an entity that has been subject to numerous complaints from patients alleging that their implants are subject to premature loosening.  The claimant in this particular case, Theodore Joas, is a patient who had knee-replacement surgery in Eau Claire in 2008 and filed suit against Zimmer after beginning to feel pain in his new knee in 2011.

Due to the number of similar claims against Zimmer, all litigation involving the Zimmer knee implants, including Mr. Joas’ lawsuit, were transferred to a multidistrict proceeding pending in the Northern District of Illinois.  The judge in the multidistrict proceeding subsequently selected Mr. Joas’ suit as a bellwether—a test case—and scheduled his claim to move forward.

Prior to trial, Zimmer moved for summary judgment on all of Mr. Joas’ claims.  Zimmer argued that the testimony of Joas’ only medical expert must be excluded as unreliable. The doctor’s report applied a differential etiology method that identified the most likely cause of Joas’ injury by eliminating other potential causes. But the medical expert could not affirmatively prove a specific cause for the loosening. The judge excluded the doctor’s opinion under the Daubert standard as lacking any discernable basis for concluding which potential causes were reasonable.  The judge then granted Zimmer’s summary judgment motion, holding that, absent expert medical testimony, the factual record did not support Joas’ causation theories.  Slip. op. at pp. 3-4.

Rather than challenge the Daubert ruling, Joas argued on appeal that, even without his own medical expert's testimony, he could win by proving that Zimmer failed to adequately warn both himself and his doctor of the risks associated with the knee implants. Joas supported his positions with testimony from one of Zimmer’s experts, who opined that it would take two bags of cement to properly bond the knee implant to a patient’s shinbone.  Because his doctor used only one bag, Joas theorized that Zimmer failed to satisfy its duty to warn that two bags of cement were needed to properly bond the implant.  Id. p. 4.

The Seventh Circuit rejected this argument on a number of grounds.  With respect to Zimmer’s duty to warn Joas directly, the Seventh Circuit noted that this was an issue of first impression under Wisconsin law.  The Court noted, however, that the overwhelming majority of courts from other jurisdictions facing this issue have adopted the “learned intermediary doctrine,” which states that medical device manufacturers satisfy their duty to warn of product risks by informing the prescribing physicians of those risks.  The Court predicted that Wisconsin would follow suit. It reasoned that the doctrine recognizes the practical reality that patients cannot obtain such devices without physician intervention and that patients reasonably rely on their physicians to warn them of the risks associated with medical procedures.  Id. pp. 5-8.

The Court also noted that Joas’ argument suffered from a lack of evidence to establish causation.  A warning directly to Joas would not have changed the outcome given that it was his physician (rather than Joas himself) who selected to use the Zimmer brand of knee implant for his procedure.  Any warning directed towards Joas’ surgeon similarly would have failed to make a difference, as the surgeon testified that he performed the surgical cementing technique based on his medical fellowship and residency training and that he did not review Zimmer’s device instructions.  While Joas argued for a “heeding presumption” that would allow for a factfinder to presume that a proper warning would have been read and followed by a medical professional, he cited no Wisconsin authority in support of this argument. The Court determined that such a presumption likely would not be adopted by Wisconsin courts.  Id. pp. 8-13.

While the Seventh Circuit’s decision is not a binding statement of Wisconsin law, Wisconsin courts will likely follow its well-reasoned analysis adopting and applying the “learned intermediary doctrine” to insulate medical device and pharmaceutical manufacturers from claims that they have a duty to warn patients directly.  Patients should also view In re: Zimmer, NextGen Knee Implant Products Liability Litigation as a warning that direct causal evidence likely will be needed to prevail on any liability claims against manufacturers of medical products

 

Court of Appeals Denies Nonprofit Medical Clinics from Claiming Property Tax Exemption

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The Wisconsin Court of Appeals recently held that a hospital owned by a non-profit entity failed to demonstrate that three medical clinics it also owns are not used as “doctor’s offices,” and therefore are not exempt under Wisconsin’s nonprofit hospital property tax exemption.  Mile Bluff Medical Center, Inc. v. Village of Necedah, City of New Lisbon and City of Elroy, No. No. 2017AP751, 2018 WL 1040203 (Wis. Ct. App. Feb. 22, 2018) (slip opinion) (unpublished.)  Mile Bluff is the most recent decision in a line of cases addressing whether medical clinics owned by a nonprofit hospitals qualify for the exemption.

Mile Bluff is a non-profit entity that owns a hospital in Mauston and the three medical clinics at issue in this case.  Mile Bluff sought an exemption from property taxation for the clinics under Wis. Stat. § 70.11(4m)(a).  Under § 70.11(4m)(a), real property owned and used exclusively for the purposes of a non-profit hospital of 10 beds or more devoted primarily to the diagnosis, treatment or care of the sick, injured or disabled is eligible for the exemption provided, among other things, that the property is not used as a doctor’s office. 

In concluding that the Mile Bluff medical clinics are used as doctor’s offices, and therefore not exempt from property taxation, the court considered seven factors previously articulated by other courts as relevant in determining whether a facility is a doctor’s office.  The seven factors the Court analyzed include whether the:

  1. physicians at the clinics owned or lease the facility or equipment;

  2. physicians at the clinics received “variable compensation,” that is, compensation based on their “productivity”;

  3. physicians at the clinics employed or supervised non-physician staff, or received extra compensation for such duties;

  4.  clinics and hospital generated separate billing statements or use separate billing software;

  5.  physicians at the clinics had office space in the clinics;

  6.  clinics provided services of the type that had been formerly performed inpatient at the hospital; and

  7. clinics were open during regular business hours during which time the physicians generally saw patients by appointment.

The Court sided with Mile Bluff on the first factor and assumed, without analysis, that the second factor also supported Mile Bluff’s position. The Court found that the fourth factor did not favor either of the parties.  The Court sided with the municipalities with respect to a majority of the factors—the third, fifth, sixth and seventh factors.  The Court further concluded that the clinics lacked typical hospital amenities, like a gift shop, and did not offer urgent care services, making the clinics more like doctor’s offices. 

The Court also rejected Mile Bluff’s argument that the fact that the clinics were “rural health clinics” and are required by federal and state law to have a certain level of integration with the non-profit hospital that owns them should be considered in determining whether the clinics were hospitals or doctor’s offices. The Court found that this status did not result in any significant change in the nature or manner of patient services, a critical element in determining whether a clinic is a doctor’s office, and therefore was not enough to tip the scales in favor of Mile Bluff’s argument.

Based on these findings, the Court held that the clinics were in fact doctor’s offices and therefore not exempt under the non-profit hospital exemption. 

The case makes clear that there is no bright line test for whether, on balance, property owned by a non-profit is a doctor’s office.  Assessors should carefully weigh the particular facts of each case against the guidelines relied upon by the Court. 

If you have questions on this case or on other property taxation related matters, contact Meg Vergeront at (608) 259-2663.

APPEALS COURT CLARIFIES APPLICABILITY OF WORKER’S COMPENSATION STATUTE TO TEMPORARY EMPLOYEE CLAIMS

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In a recent decision, the Wisconsin Court of Appeals addressed the insurance implications of a car accident made unusual because at least two of the deceased workers were employees of temporary help agencies. See Ehr et al. v. West Bend Mutual Insurance Co. et al., Case No. 2017AP142 (Wis. Ct. App. January 9, 2018) [decision].  In so doing, the Court clarified that worker’s compensation laws—and particularly the exclusive-remedy provision that prevents injured employees from bringing tort suits against their employers—apply differently to temporary workers than to permanent employees.

The accident involved a vehicle owned by the temporary employer and occurred during work-related activities, which unfortunately resulted in the death of three individuals, at least two of which were temporary employees.  It’s the last of these circumstances that complicated matters.

One of the temporary employee’s estate and two surviving minor children filed a wrongful death action in Milwaukee County Circuit Court against Alpine Insulation, the temporary employer, and Alpine’s automobile liability insurer, West Bend Mutual Insurance Company. That suit sought damages for pain and suffering as well as the minor children’s loss of society, companionship, and support.  Id., ¶¶ 3-5.

After answering the complaint, Alpine and West Bend moved for summary judgment on the ground that the plaintiffs’ claims were barred by Section 102.29(6)(b)1 of the Wisconsin Worker’s Compensation statute, which states:

“[n]o employee of a temporary help agency who makes a claim for compensation may make a claim or maintain an action in tort against . . . any employer that compensates the temporary help agency for the employee’s services.”

According to Alpine and West Bend, the plaintiffs’ wrongful death tort claim was barred under this statute because the deceased had been employed by a temporary help agency and Alpine had compensated that agency for the deceased’s services.  As a result, the defendants argued that under Section 102.29(6)(b)1 the plaintiffs could not bring tort claims against Alpine as the deceased’s temporary employer.  The circuit court agreed and therefore granted summary judgment in favor of the defendants. Ehr slip op. ¶ 6.

The Wisconsin Court of Appeals reversed.  The Court noted that, by holding that Wis. Stat. 102.29(6)(b)1 completely bars tort claims a temporary employee may otherwise bring against its temporary employer under all circumstances, the circuit court ignored the qualifying phrase “who makes a claim for compensation.”  The Court held that the plain meaning of the statute governs, such that a temporary employee injured during the scope of his or her temporary employment may seek relief in either of two ways: (1) by making a worker’s compensation claim against his or her permanent employer (the temporary help agency) and be subject to the exclusive remedy provision or, alternatively, (2) by pursuing a third-party claim against his or her temporary employer and foregoing any claim under the worker’s compensation statute.  Id. ¶¶ 14-18.

The Court further rejected Alpine and West Bend’s argument that such an interpretation would unfairly place temporary employees in a more advantageous position than permanent employees.  The Court explained that the exclusive-remedy provision only limits permanent employees’ claims against their employers, and that such employees are free to pursue tort claims against third parties.  The exclusive-remedy provision, the Court continued, places the same limitation on temporary employees vis a vis their permanent employers (the temporary help agency).  The legislature’s adoption of Wis. Stat. § 102.29(6)(b)1 was a reasonable recognition of a “middle ground” for claims by a temporary employee against his or her temporary employer; rather than treat such entities as a truly independent third party and allow a temporary employee to pursue those tort claims in addition to a worker’s compensation claim against the temporary help agency, the temporary employee may only choose one avenue of recovery.  Id. ¶¶ 21-25.

An interesting factual wrinkle that was not explored in this decision is that the driver of the Alpine-owned vehicle was also a temporary Alpine employee, but had been hired through a different temporary help agency than the employee whose estate brought this lawsuit.  One wonders if the plaintiffs could have avoided any potential worker’s compensation statutory complications altogether by filing a claim against only West Bend under the theory that, as the insurer of the Alpine vehicle, West Bend was obligated to provide coverage for any liability arising from the negligent operation of that vehicle.  Additionally, given that the temporary workers were employed by different temporary help agencies, the plaintiffs presumably could have brought suit directly against the driver and possibly his personal auto liability insurer without implicating any potential worker’s compensation statutory limitations.

In any event, in light of the Ehr decision, Wisconsin employers should factor in their increased liability exposure when deciding whether to seek help on a temporary basis.  While it may be cost-effective to avoid taking on additional permanent employees in other areas of their business, the Ehr decision makes clear that businesses employing temporary workers are exposing themselves to additional liability exposure should a temporary employee be injured on the job.  At a minimum, Wisconsin businesses should ensure that all of their liability insurance provides adequate coverage for any potential tort claims brought by a temporary employee.

Court Determines Defendant’s Breach of Contract Constituted a “Wrongful Act”

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The Wisconsin Court of Appeals issued a decision that clarifies an exception to the general rule that attorneys’ fees are not recoverable damages. Talmer Bank & Trust v. Jacobsen, No. 2017AP752-FT (Wis. Ct. App. Jan. 10, 2018). The court held that a litigant may recover attorneys’ fees if he or she is forced into litigation with a third party because of another party’s breach of contract.

Background

The Gomezes entered into a land contract with the Jacobsens. The underling land was owned by the Jacobsens, subject to a mortgage. Pursuant to the contract, the Gomezes made monthly payments to the Jacobsens, and in turn the Jacobsens were supposed to continue making mortgage payments. Unbeknownst to the Gomezes, the Jacobsens missed fifteen consecutive monthly mortgage payments. Eventually the mortgage holder initiated a foreclosure action against both the Gomezes and the Jacobsens. The Gomezes reached a settlement with the bank that allowed them to stay on the property. The Gomezes then filed a cross-claim arguing that the Jacobsens must pay their attorneys’ fees that they incurred in defending the foreclosure action.

Generally in the United States, litigants may not recover attorneys’ fees as damages, but there are exceptions to this rule. The Gomezes invoked the “third-party litigation exception,” which states that a party may recover attorneys’ fees if another party’s wrongful act forces the individual into litigation. It was uncontested that the Jacobsens’ breach of the land contract forced the Gomezes into litigation with the bank, therefore the sole question before the circuit court was whether the Jacobsens’ breach constituted a wrongful act. The circuit court held that a breach could not constitute a wrongful act, and therefore the Jacobsens were not required to pay the Gomezes’ attorneys’ fees.

Court of Appeals’ Decision

On appeal, the Jacobsens argued that their breach of contract did not constitute a wrongful act because a wrongful act is limited to fraud, breach of a fiduciary duty, or “something similar.” The court of appeals rejected this argument. “Our supreme court has unequivocally declared that ‘a breach of contract as well as tort may be a basis for allowing [a] plaintiff to recover reasonable third-party litigation expenses.” ¶ 10 (quoting City of Cedarburg Light & Water Comm’n  v. Glens Falls Ins. Co., 42 Wis.2d 120, 166 N.W.2d 165 (1969)). The court explained that attorneys’ fees are recoverable when such fees are rightly considered part of the damages flowing from the defendant’s breach of contract.

The court’s decision makes clear that when a party’s breach of contract forces someone else into litigation with a third party, such breach is a wrongful action, which permits the individual to recover his or her attorneys’ fees from the breaching party.

Appeals Court Limits Pro Rata Insurance Policy Distributions To Post-Trial Liability Determinations

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In Lovelien et al. v. Austin Mutual Insurance Company et al., No. 2016AP1679 (Wis. Ct. App. Dec. 27, 2017), the Wisconsin Court of Appeals addressed an issue that often arises when multiple claimants allege damages against an insured and the total damages claims exceed the coverage limits of the relevant insurance policy: does Wisconsin law impose any restrictions or other obligations on how an insurer elects to distribute the available funds among the claimants through pre-verdict settlements?

In Lovelien, Austin Mutual had issued a $500,000 liability policy to an insured who was facing claims from multiple parties in excess of that amount arising from a multi-fatality automobile accident.  After failing to reach a global settlement, Austin Mutual settled with all but two of the claimants for $245,000.  Austin Mutual then deposited the remaining $255,000 with the court clerk and the court distributed those limited funds equitably between the remaining two claimants.  Lovelien, slip op. at ¶¶ 5-6.  The two remaining claimants appealed, arguing that Austin Mutual’s settlement and release with the other claimants violated Wisconsin’s “direct action” statute.  Id. ¶ 12. 

Wisconsin’s direct action statute states the following:

Any bond or policy of insurance covering liability to others for negligence makes the insurer liable, up to the amounts stated in the bond or policy, to the persons entitled to recover against the insured for the death of any person or for injury to persons or property, irrespective of whether the liability is presently established or is contingent and to become fixed or certain by final judgment against the insured. 

Wis. Stat. § 632.24.

According to the appellants, Austin Mutual’s partial settlement and release violated the clear intent of this statute by making payments to certain claimants without a determination of each claimant’s equitable pro rata share of the $500,000 policy limit based on the amount of damages each claimant suffered.  Lovelien, slip. op. at ¶ 12.

Writing for a unanimous Court of Appeals, Judge Seidl rejected the appellants’ argument.  Noting that courts are bound by unambiguous statutory language, Judge Seidl explained that the direct action statute merely creates an avenue for a claimant to recover directly from an insurer without having to first establish an insured’s liability.  While the statute does limit an insurer’s exposure to the relevant policy limit, it otherwise is silent as to how an insurer must distribute those funds among the claimants.  To accept the appellants’ argument, the Court held, would be tantamount to impermissibly inserting additional requirements into the statute.  Id. ¶¶ 14-19.

The Court further held that the appellants’ position was unsupported by the Wisconsin case law they cited, as those cases all addressed factually distinguishable post-verdict pro rata distributions where the respective liability of the insured to each claimant had already been established.  Placing the same pro rata burden on an insurer prior to trial would curtail both the insurers’ and claimants’ rights to settle, reasoned the Court, as it arguably would require every multi-claimant dispute to proceed to trial.  Moreover, to the extent that allowing an insurer to enter into potentially inequitable (non pro rata) partial settlements prior to trial creates valid public policy concerns, the Court concluded that it is up to the legislature to determine what public policy best serves the people of Wisconsin.  Id. ¶¶ 20-22.

Having been recommended by the Court for publication as binding Wisconsin precedent, the Lovelien decision raises a number of questions and concerns for those injured by Wisconsin insureds.  Under circumstances where an insured’s policy limits are well below the total amount of damages incurred by multiple injured parties, is an insurer free to simply pick and choose which party or parties get rewarded with the available funds?  May an insurer pay the full policy amount to one claimant and leave the other victims wholly uncompensated?  May an insurer use the threat of paying the available policy limits to other claimants as a sword during settlement negotiations to create leverage? Under the rationale applied by the Court here, the answer to all of these questions now appears to be “yes” in Wisconsin.

In the wake of Lovelien, therefore, parties involved in multi-victim accidents in Wisconsin should attempt to identify as early as possible whether any potentially responsible party may be underinsured and, if discovered, alter their settlement negotiation strategy accordingly.  Under such circumstances, failing to engage in prompt settlement discussions with Wisconsin insurer(s) could result in the policy limits being distributed to other claimants, leaving a party to have to pursue an insured directly to seek redress.

WI COURT OF APPEALS CONFIRMS LIMITED LIABILITY EXPOSURE FOR BANKS UPON EMBEZZLEMENT BY EMPLOYEES

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On December 12, 2017, the Wisconsin Court of Appeals addressed a civil dispute arising from the high-profile criminal embezzlement scheme committed by Koss Corporation Vice President of Finance, Sujata (“Sue”) Sachdeva.  At issue were allegations Koss made against its bank seeking recovery on the theory that the bank committed bad faith in not detecting the embezzlement scheme. See Koss Corp. v. Park Bank, No. 2016AP636 (Wis. Ct. App. Dec. 12, 2017).

Koss’s complaint alleged that Park Bank of Milwaukee, Wisconsin, violated Wisconsin’s Uniform Fiduciaries Act (“UFA”) by allowing Ms. Sachdeva to embezzle about $34 million from Koss accounts for personal use. Ms. Sachdeva used a variety of ways to embezzle the $34 million, including requesting cashier’s checks and cashing checks made out to “petty cash,” as well executing wire transfers to pay personal credit card bills.  Koss alleged the bank’s failure to discern Ms. Sachdeva’s embezzlement scheme amounted to a violation of Wis. Stat. § 112.01(9), which exposes a bank to liability if it permits transactions “with knowledge of such facts that [the Bank’s] action in paying the check amounts to bad faith.”

The bank moved for summary judgment, asserting that no material facts established it had intentionally or deliberately allowed the transactions to occur in bad faith.  At the circuit court, the court held that Koss had failed to cite any evidence that the bank “intentionally ignored Sachdeva’s embezzlement,” without which there was no way to show the bank acted in bad faith.  The court further noted that the circumstances established only the bank may have been negligent in failing to uncover the fraudulent conduct, but that one of the purposes in adopting the UFA was to eliminate negligence claims against banks arising from transactions where employees or other persons acting as an agent of a depositor commit an act causing a loss to the depositor. 

On appeal, Koss took the position that, although the bank lacked actual knowledge of Ms. Sachdeva’s embezzlement scheme, the circumstances raised enough red flags that a factfinder could conclude that the bank’s failure to detect the fraudulent transactions amounted to bad faith under the UFA.  In support of its position, Koss cited to (1) the large volume of improper checks—adding up to millions of dollars—Sachdeva requested, (2) the bank allowing unauthorized Koss representatives to request, endorse, and pick up checks, (3) the bank’s acceptance of checks payable to companies with cryptic initials (e.g., “N.M., Inc.” for Neiman Marcus and “S.F.A., Inc.” for Saks Fifth Avenue), (4) after-the-fact deposition testimony from a bank employee that the large number of cashier’s checks requested were “strange,” (5) Ms. Sachdeva’s testimony that she chose the bank at issue because of the ease in which she could conduct her fraudulent transactions, and (6) the bank’s failure to implement and/or enforce proper fraud-detection policies and procedures.

Despite this evidence, the Court of Appeals affirmed the circuit court by dismissing Koss’ claim of bad-faith.  Consistent with cases from other jurisdictions interpreting the UFA, our Court of Appeals concluded that to effectively bring a claim of bad faith under the UFA a depositor needs “proof of two elements: (1) circumstances that are suspicious enough to place a bank on notice of improper conduct by the [employee embezzling the depositor’s money on deposit]; and (2) a deliberate failure [by the bank] to investigate the suspicious circumstances because of a belief or fear that such inquiry would disclose a defect in the transaction at issue.”  Id., ¶ 27.

While the Appeals Court acknowledged that Koss cited ample evidence to establish the bank’s negligent failure to investigate and discover Ms. Sachdeva’s embezzlement scheme, it concluded that Koss failed to adduce facts sufficient to allow a factfinder to determine that the elements of proof for bad faith under the UFA were satisfied:

Although the transactions Sachdeva engaged in may appear suspicious or odd in hindsight, Koss has not cited any evidence to indicate that, in the larger context of Koss’s banking practices and the banking practices of Park Bank’s other corporate clients, the transactions were suspicious enough to put Park Bank on notice of Sachdeva’s misconduct.  Koss also fails to cite any evidence indicating that Park Bank deliberately declined to investigate Sachdeva’s transactions due to a fear that further inquiry would disclose defects in them.

Id., ¶ 51.  The Appeals Court then concluded that allowing Koss’ claim to proceed would be contrary to the UFA’s purpose of insulating banks from the misconduct of a depositor’s employees.  Id., ¶ 52.

This decision highlights how important it is for businesses to adopt and enforce internal monitoring protocols for financial activities by their employees and agents.  By adopting the UFA, Wisconsin has allocated the risk of loss stemming from fraudulent financial transactions to businesses rather than banks in all but the most egregious circumstances.  Businesses failing to take notice of suspicious financial activities (1) not only expose themselves to the risk of severe financial losses, but also (2) if the business has publicly traded securities then they may expose themselves to possible violations of federal securities law for failing to properly ensure the accuracy of their financial reporting.  See id., ¶ 12 n.4 (noting an adverse judgment entered against Koss pursuant to SEC lawsuit).

Please feel free to contact Greg Jacobs or Rich Latta if you would like to discuss any of the matters discussed above.

While a law firm with which Mr. Latta was previously affiliated may have provided legal representation of a party mentioned in Koss Corporation v. Park Bank, Mr. Latta did not represent any party involved and the thoughts expressed herein are strictly his own.

Circuit Court Ordered to Enforce Option-to-Purchase Provision in Commercial Real Estate Lease

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District II of the Wisconsin Court of Appeals recently remanded a commercial lease dispute back to the Waukesha County Circuit Court, directing the court to enforce the parties’ agreed-upon option-to-purchase provision as written.  See Headstart Building, LLC v. National Centers for Learning Excellence, Inc., No. 2016AP434 (Wis. Ct. App. Nov. 8, 2017).

The dispute originated from a 2002 commercial lease in which Headstart Building, Inc. (“Headstart”) agreed to lease real estate property in Waukesha to National Centers for Learning Excellence, Inc. (“NCLE”).  Id. ¶ 5.  The lease included a provision allowing NCLE to invoke an option to purchase the property at any time.  The following language in the option-to-purchase provision is the focus of the parties’ dispute:

In the event Tenant shall elect to exercise Tenant’s option to purchase the Premises, Landlord and Tenant shall each choose an appraiser to appraise the Premises which appraisals must be completed within forty-five (45) days of the date Tenant notifies Landlord that it intends to exercise its option to purchase.  In the event the fair market value of the Premises in the two appraisals differs by no more than five percent (5%), the Appraised Value shall be the average of the two appraisals.  In the event the appraised value of the Premises in the two appraisals differs by more than five percent (5%), the two appraisers shall agree upon a third appraiser and the result of such third appraisal shall be the Appraised Value.

Id. ¶ 6.

In December 2012, NCLE invoked its right to purchase the property, and the two parties commissioned their respective appraisals.  Headstart’s appraiser valued the property at $6.88 million dollars while NCLE’s appraiser issued a $4.075 million valuation.  Upon comparing the two appraisals, it became clear that the cause of such a wide discrepancy was the differing methodologies employed by the appraisers.  Headstart’s appraiser determined the fair market value with consideration of the current NCLE lease encumbrance, while NCLE’s appraiser calculated the fair market value of the property free and clear of the current lease.  Id. ¶¶ 7-8.

Rather than following the terms of the option-to-purchase provision and have their respective appraisers seek a third party to resolve the conflict, the parties instead engaged in written correspondence disputing the proper methodology to calculate the fair market value of the property.  Once those communications broke down, Headstart filed suit in Waukesha County Circuit Court requesting specific performance of the option-to-purchase (at $6.88 million) and damages arising from NCLE’s bad faith breach of the lease.  NCLE filed a declaratory judgment counterclaim, requesting the court to declare the proper appraisal methodology.  Id. ¶ 9.

After a two-day bench trial, Judge Haughney issued an oral ruling rejecting Headstart’s breach of contract and bad faith claims, though it was unclear from the record whether the grounds for the dismissal was based on Headstart’s failure to follow the option’s procedure of seeking a third appraisal or because the court concluded that the parties’ differing appraisal methodology positions represented a failure to reach a meeting of the minds, rendering the entire provision unenforceable.  Judge Haughney requested supplemental briefing regarding the fate of NCLE’s declaratory judgment counterclaim, and ultimately dismissed that claim as moot on the ground that the option provision was unenforceable and must be stricken from the lease in its entirety.  Id. ¶¶ 10-11.

After NCLE filed an appeal seeking to revive its declaratory judgment counterclaim, the Wisconsin Court of Appeals overruled the Circuit Court’s order striking the option from the lease.  Writing for the Court, Judge Hagerdorn noted that, while essential contractual terms (such as the purchase price in a real estate transaction) must be definite in order to be enforceable, it is well-settled under Wisconsin law that the terms need not be 100% certain so long as they are “capable of being ascertained from the agreement itself.”  Id. ¶ 17.  The Court referenced a long line of Wisconsin precedent upholding real property contracts setting a “fair market value” price to be determined by appraisement, and concluded that the parties’ dispute was one of differing interpretations of agreed-upon contractual terms.  Id. ¶¶ 17-22.   In conclusion, the Court found that the provision provided a simple, straightforward and definite means of determining the purchase price: either the average of the parties’ respective appraisals or, if the difference between those values was too great, the third appraised value of the property.  Id. ¶ 22.

Despite this conclusion, however, the Court found that substantive questions regarding the meaning of the option-to-purchase provision were not before it on appeal and remanded the case to the Circuit Court to address NCLE’s declaratory judgment counterclaim regarding whether the parties must appraise the property with consideration of the NCLE lease encumbrance.  Id. ¶¶ 24-25.  In a concurring opinion, Presiding Judge Reilly disagreed with these remand instructions, concluding that the proper methodology for determining the fair market value of commercial real estate is not a question of law for the courts to decide and that the provision here provides a dispute resolution procedure (i.e., a third appraisal) that should be enforced.  Id. ¶¶ 26-29.

While exercising restraint in only addressing the narrow question presented to it on appeal (whether NCLE’s declaratory judgment claim was properly dismissed), the Court of Appeals’ analysis leaves little doubt in the enforceability of the entirety of the parties’ option-to-purchase provision, including their agreed-upon means of resolving any valuation disputes through the use of a third appraiser.  It will be interesting to see if the Circuit Court follows the Court of Appeals’ lead on remand or instead elects to resolve the substance of the parties’ “fair market value” appraisal methodology dispute, which is one of first impression in Wisconsin.  See id. ¶ 24 n.7

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