The Free Press - Volume 10, Fall 2011

REPORT FROM THE CHAIR

By Liviu Vogel

Since my last report, the CRS circulated a survey to our membership to explore the concept of Practice Groups within the League. The survey results are interesting and I want to share them with you. There are 2 striking results: 72% of you believe that participation in a Practice Group would benefit your law practice and 77% of you believe the CLLA should establish additional Practice Groups. Nevertheless, 71% of you do not currently participate in the new Practice Groups: Complex Litigation, Construction and Transactional. According to the survey, there are primarily 2 reasons for this. First, we have not done a good job of promoting the groups to you. And, second, the Practice Groups now offered are not relevant to your law practice. I will try to help remedy both of these problems in this short report.

First, a plug for our Practice Groups and their activities at the upcoming New York meeting next week:

The Complex Litigation Group is led by Walid Tamari, whose email is wtamari@tamblum.com. On Thursday, November 10, 2011, from 1:30 p.m. - 3:00 p.m. and 3:15 p.m. - 4:45 p.m., join them for an educational program on Using Technology to Obtain a Competitive Advantage in Commercial Litigation. Speakers, David Scott and Brian Shaw, will advise commercial litigators how to effectively and efficiently use technology to organize commercial cases from an initial case intake throughout the
litigation process, including using technology as an organizational and demonstrative tool for depositions, arbitration and trials. On Friday, November 11, 2011, join members of the group for a meeting between 5:00 and 6:00 P.M.

The Construction Group is led by Rick Johanson, whose email is rjohanson@ehjlaw.com. On Thursday, November 10, 2011, from 10:15 a.m. - 12:15 p.m., join them for an educational program on Arbitration of Construction Claims - Tips, Techniques, Troubles. Speakers, Hon. Richard D. Rosenbloom, Robert J. Miletsky and moderator, Rick Johanson, will talk about the intricacies of construction arbitration. On Friday, November 11, 2011 from 2:30 p.m. - 3:30 p.m., join the group again with Corey Collins and James J. Scott, in-house counsel, who will explain the ins-and-outs of construction contracts and how they protect companies from litigation. Immediately thereafter, at 3:30 p.m. - 4:30 p.m. join members of the group for a meeting.

The Transaction Group is led by Chris Considine, whose email is CConsidine@TamBlum.com. On Friday, November 11, 2011, between 1:30 p.m. and 2:30 p.m., join them for a presentation on Trends and Forecasts for the U.S. Economy. Chris Kuehl, whose company provides forecasts and strategic guidance for a wide variety of corporate clients around the world, will provide a current assessment of the U.S. economy and a forward looking analysis of trends to watch.

Let's not forget the balance of great educational programs in the CRS's traditional Practice Groups brought to you through the hard work of our education committee chaired by Ken Rozich and Richard Roosen.

Second, six people responded to our survey that they are willing to take the lead in establishing a new practice group! The survey was anonymous, so we don't know who these potential leaders are. If you are one of them, PLEASE email me at lvogel@salonmarrow.com for a no pressure, confidential conversation to explore your ideas about leading a new Practice Group.

I look forward to seeing you all in New York next week. Have a fun and profitable meeting!

Editor's Note: Liviu Vogel heads the Litigation and Alternative Dispute Resolution Department's commercial collection practice at Salon Marrow Dyckman Newman & Broudy LLP in New York, New York. His litigation expertise includes the representation of title insurance companies and their insureds in title insurance defense matters. He also has deep and extensive real estate and construction law experience representing owners, contractors, subcontractors, architects and engineers in all aspects of their business, including negotiating and drafting sale and lease agreements, executing transactions, advising on financing, filing mechanics liens and representing such clients in litigation. You can reach Mr. Vogel at lvogel@salonmarrow.com.

Financial Statements: A Map to Hidden Treasure

By David J. Cook

Reading the map to find the hidden treasures

New York City is great. You'll find Bernstein's practice piano on consignment along 56th; a missing Michelangelo in the French consulate: Mycenaean reliefs in the basement of an antiquity dealer, or a Blackbird on board USS Intrepid. Trawl the museums: You'll find Madam X, Perseus with Medusa's head in hand, Christina's World, or a Bell helicopter as art. You'll visit Sue, the T. Rex, at Christie's before she leaves for Chicago. You might find Nighthawks on loan. Don't forget the best chopped liver on Second Avenue or the 12th-century triptych at the Cloisters. Your treasure map is a city guide. You'll rival Heinrich Schliemann, who found Troy.

If a pirate's treasure map beckons you, browse through antiquarian bookshops along 57th between 5th and 7th. Captain Hook is your sales associate. ("May I help you, please?") Meet Bluebeard the doorman, Captain Kidd the cashier, and Long John Silver the inventory clerk. Vito Corleone is the buyer.

As a reader of the Commercial Law Bulletin, you are probably more interested in treasures buried in accounting records from bankruptcy courts, debtors' examinations (if not your clients' files - maybe even yours). Call your competition: Their files brim with financial data, even Exhibit "A." If sparkling treasures mesmerize shoppers in New York City, hidden wealth sparkles from financial statements.

Why look? Ever sue, serve, take judgment against a defunct corporation? Ever report: "We have obtained judgment. After a preliminary investigation, we advise recovery is slim, dim, remote and just god-awful. Close your file?" Never write this letter? How about: "Aside from your debtor winning the Lotto, try Lourdes: otherwise our file is sealed for eternity"? Too dour? Don't you suspect fraud, or did every debtor die a peaceful death at the hands of its corporate principals who dutifully went down with the ship? You believe this? The corporate principals, modern buccaneers, jumped ship and filched the remaining cargo. Like all good pirates, they buried their loot but left a treasure map as guide. You have this treasure map: It is called the accounting record, and this article provides tools and clues to find buried treasure, such as bank accounts, receivables, real property, equipment, business opportunities secreted away by the principals.

Girdled with tools, the treasure map of a financial statement invites the adventurer. Let's peruse the clues.

Note receivable. Generally Accepted Accounting Principals (GAAP) classifies a note receivable as a fixed asset if due more than one year. If the note is due within the year, GAAP classifies the note as a "short term asset." Either way, a note receivable may mask an insider loan to related company entities, such as officers, directors, shareholders, their spouses, and subsidiaries and affiliates ("insiders" or "principals"). This note receivable signifies the insider borrowed money or property from the company ("corporation" or "company" - your debtor) or the company gifted property away, and the accountant stylized the transaction as a note receivable to avoid a taxable event such as a dividend or salary.

Your job (inquire): What are the terms, and are they commercially sound? Is the note current? Have payments ever been made? What property (and its value) was given to the insider and compare to note amount? When is the note due? Is the note secured? What is the rate of interest? Is the company in the business of making loans, and why? Is the note payable interest only, or in periodic installments?

Next inquiry: Is the transaction a good deal for the company that made the loan? Dating from Blackstone, case law sets aside insider transactions, unless beneficial from the company's viewpoint, a harsh standard.

Find these additional treasure clues in the last five years of financial statements. Was the note ever reduced by the principal amount, if any? Check the income statement to seek, under "interest income," if any payments have been made. Look harder. If so, double-check the cash receipts journals, along with deposit slips to confirm receipt of any interest or principal payments. Any negative response to these questions leads to "X," marking the spot. Dig away. Unless the note is a superior investment (better than the Dow over the last 24 months), you can recover under the note or set it aside. You may have many remedies: Attach the note, and if default, sue the maker under its terms, or seek reformation under equitable grounds as straight, over due note. Set aside the note as a fraudulent conveyance and sue on the theory of money had and received. Sue under breach of trust theory and seek exemplary damages. Captain Kidd favors Accounts and Notes Receivable as a favorite spot for hidden loot, because of the tax laws. Taxing authorities treat insider payments as potential income: cloaking the payment as a loan might impede this treatment.

INSIDERS I: Accounts receivable due a related company and insiders straddling the fence. GAAP classifies intercompany transactions as related party transactions. Many related corporations legitimately exchange product at market prices between themselves, and an insider sits on both sides of the deal. Start looking: View this accounts receivable historically, such as examining the financial statement and the ledger account (you'll find one for "intercompany accounts") over five years to determine if the receivables are paid timely, or late, or not at all. Double-check: Even if products or services are paid timely, confirm the prices at market rates. Look again: Paying excessive prices for intercompany product is itself a fraudulent conveyance. Think: A company who defaults on an Intercompany Account received a gift, because the vendor (other half) will never sue. Selling product without collecting is a gift. Where is the fraudulent conveyance? You now have a fraudulent conveyance against the insiders whose company (the buyer) has been enriched. Charge this loss against the corporate insiders under a fraudulent conveyance theory and unlawful dividend. The seller sold its product without fair and equivalent consideration, consisting of viable creditworthy customer, and that the corporate insider is the beneficiary of product because the buyer received product without commensurate payment.

INSIDERS II: Insiders as landlord, merchants, and lenders; another remedy for the same problem: premium prices paid for junk? Self-dealing shines brighter than the giant screen TV in Times Square. Insiders lease buildings, sell products, and lend money to the corporation. Insiders straddle the corporation and its corporate marketing agents, suppliers, or subsidiaries. These transactions are again related party transactions on the balance sheets. Explore the market price of the goods or services: Excessive prices siphon off cash (unlawful dividends and so forth). These insider transactions spawn multiple claims: Fraudulent conveyances for expenses; goods and services rendered to the corporation at a premium; unlawful dividend for siphoning off cash through price gouging; under capitalization if the goods and services represent disguised capital; self-dealing for any transaction in which the insider bears the burden of an accounting. Think also equitable subordination of these payables due insiders because the goods and services, received by the corporation, are disguised and delayed capital, and seek to reclassify the corresponding receivable as capital and any repayment as an unlawful dividend or fraudulent conveyance.

INSIDERS III: Writing off the assets. The corporation may write off worthless assets, such as bank accounts, physical assets depreciated to salvage value, general intangibles depreciated to zero. This process removes the asset from the balance sheet, but what happens to the asset? Where do these assets go? Probably to the insider. To the insider, writing off the asset does not translate into wiping out the asset. These assets have real value, and insiders taking home these assets is a fraudulent conveyance. Examine the balance sheet for written-off assets and find their current home. Be vigilant to any written-off received owed by an insider, and if written off, you'll have the perfect corporate rip-off.

INSIDERS IV: Oldies and goodies write-off II. When credit initially was established, the customer provided a financial statement depicting substantial fixed assets, such as equipment and furnishings. The customer went broke, and you have the file. Your job: Locate a current financial statement, and at least the general ledger. Compare the major items. Find anything missing? Yes? If so, levy on every corporate insider under an attachment and seek return of these missing assets. Absent truly criminal fraud insiders "write off" assets in their favor to shrink the company. This is the classic case for a fraudulent conveyance in which a recipient takes possession of these assets and completes the sale.

INSIDERS V: CHECKS. Look for check books and copies of all canceled checks, both sides, in serial order. Checks payable to cash, checks payable to the insider, checks payable to a bank, checks payable to wives, mothers, husbands, children, or even blank checks, cashiers' checks are all hot. These checks evidence an insider diversion.

Read the checks carefully: Look for remittance advice, such as invoice number, statement "ending dates," account numbers: find none, find a fraud. Review the reverse side: Investigate the endorsement. If the check is payable to ABC, is the endorsement in favor of an account number only? Was the check cashed? Vendors normally do not cash checks. If the endorsement varies from the payee, probably the payee was fictitious, and check represents a diversion. Ask: Was the check written to cash, but converted to a cashier's check? Think about fictitious payees. Call directory assistance to confirm, superficially, the legitimacy of payees. Look for the payee whose address is a post office box, a private mail box service, or a residential address. This analysis working you too hard? A simpler approach is the journal. Under accounting principles, the check is credit to cash and debit to another ledger account. Compare the check with the cash journal. Trace the entry in the cash journal with the corresponding entry, for example, accounts payable, customer refunds, or notes payable. Find nothing? You might find gold in those checks. In one case, an insider brazenly wrote corporate checks in payment of his swimming pool cleaner, hedge trimmer, and gardener. The trial court took about two nanoseconds to pierce the corporate veil.

INSIDERS VI: Corporate subsidiary born from greed. GAAP divides assets into current and long-term. Current assets are cash, account receivable, and the current portion of any notes receivable, along with inventory. These items are virtual cash equivalents. Long-term assets are fixed assets, prepaid deposit, equipment, leaseholder improvements, real estate, and, occasionally, securities in a corporate subsidiary. This is a big-time clue. Subsidiaries are usually corporate entities whose shares of stock are owned by the parent. This parent completely capitalized the subsidiary with assets and received in exchange for shares of stock. The corporate parent transfers the shares of stock to the insider, or the subsidiary issues the shares of stock to the insider. You face a double fraudulent conveyance and unlawful dividend because the subsidiaries' shares are worth far less than the asset used for capital. The corporate subsidiary is therefore the fraudulent conveyee. Remember: The insider received the shares of stock. These shares of stock have virtually no market value (usually legend stock). However, the insider is a fraudulent conveyee if he or she is the recipient of these shares of stock. Furthermore, the insiders probably did not comply with the bulk sales act; and the insiders are probably the officers and directors of the subsidiary. Think ahead: To complete a fraud, the corporate parent causes the subsidiary to issue shares of stock in the insider's name to satisfy a long-term, unpaid loan, note, or unpaid wages. Neat. The corporation transfers its assets to a subsidiary who issues shares of stock to the parent's shareholders, and leave an empty shell. The unlawful dividend, along with any fraudulent conveyance claims, will unwind these transactions.

INSIDERS VII: Insider security interest and snap foreclosures: You levy on the company's bank account; the insider files a third-party claim and assets a blanket lien. From the third-party claim pops a financing statement and security agreement, which can transfer any assets, day or night. The Bulk Sales Act (Art. 6) doubly excludes a security interest: The granting and foreclosure are exempt from compliance. Are you in trouble? A security agreement looks genuine. Prolix detailed security agreements exudes legitimacy. Surely with all those recitals, real bucks went into the till? Want to unwind this security interest? Start with the presumptions:

1)  The insider deal is voidable by the corporation;

2)  The validity of the transaction is viewed in the best interests of the corporation.

3)  Insiders' loans mask disguised capital, or fabricated notes to transfer wholesale assets;

4)  The note represents an alleged wage claim, whose accrual suggests undercapitalization.

Are you moving forward with execution after discovering the insider security interests? Quickly enjoin foreclosure; otherwise, the insider will foreclose upon the security interest and establish a new business enterprise, all without change of possession or location and stall any further execution. Fearful of the change of name on the door? You bet, and the insider security interest shifts assets from the corporation to the insider, and again to a new corporation.

Deep rock. Sound familiar? Soft drink and rum at Rick's or equitable relief? Answer: This term means equitable subordination of insider loans, which converts debt to equity, and loan repayments to a recovery - assuming the trade creditor extends credit to a corporation that becomes insolvent. This corporation is a one-man (or -woman) show. The corporation collapses and the insider foreclosures on security interest that secures a long-term loan. The trade creditor cries foul partially because the insider promised payment. View the transaction laterally: The fact might not justify an alter-ego claim, but the court might subordinate the insider loan as capital and declare any loan repayments as an unlawful dividend. A levy on the corporate insider might force the insider to repay the unlawful dividend to the levying officer, and not to the corporation, which would lead to payment. Bring the forensic accountant to testify that the corporation was undercapitalized, and the insider loans are additional paid in capital.

Another, more detailed, look at loans. The C.P.A. might list an insider loan as a long-term loan payable on the financial statement. Many financial statements break this category into two sections: If the note payable is immediately due (or in some installments), this item is listed as current payables; the remaining portion (due later) is listed as long-term payables. Study each long-term liability and review the source documents, usually consisting of long-term note, agreement for the loan. If the loan is secured, expect a board of directors resolution, with shareholders' consent. If done professionally, expect an independent account's opinion, along with counsel's opinion, which justifies that the transaction serves the best interest of the corporation. Finish your search: The final test of a bona fide insider loan is double barreled: Could the corporation have borrowed the money from a bank? Why did the insider make the loan?

Let's break down this analysis further. Insiders characterize their capital contribution as long-term loans, and, upon insolvency, declare the loan due and collect. Two for me, and none for you. If you can recharacterize the loan as capital, all repayments are unlawful dividends, subject to recapture usually as fraudulent conveyances or illicit dividends. Therefore, to snare the repayment, paint the transaction as capital and not debt.

Let's return to the beginning: If the corporation would not qualify for the loan, and the corporation needed the loan due to inadequate capital, the loan is capital and not a loan. Your forensic accountant opines, "This corporation could not meet the basic lending requirement, and the initial lack of capital necessitated an infusion of capital. This insider loan is delayed capital to permit the corporation to meet its basic liabilities as they accrue."

You, the lawyer, argue that the loan transaction lacks the earmarks of regularity; and worse, the loan did not meet the corporation's best interest based on its terms, security, repayment, interest rate, and payment schedule. Presto-gizmo: The loan is capital, and dollars received by the insider are fraudulent.

Can we talk? Did we talk about capital? GAAP defines capital as the contribution of money or property to finance the activities of the corporation. Capital is at risk. Capital fuels the corporate enterprise. If an enterprise is successful, capital increases and multiplies by continuing retained earnings. If a failure, the deficit retailed earnings deplete available capital. In case you forgot, retained earnings is a historical snapshot of prior earnings. When the red ink of deficit retained earnings floods the business, insiders rewrite the books. Capital becomes secured long-term loans; long-term loans are paid; cash is returned on a short turnaround to fund day-to-day operations. Bedrock capital becomes a fluid number. Can you stop this? Sure enough. Besides an injunction preventing a fraudulent conveyance, seek a receiver to take charger of the corporation and stem the conversion of capital into loans. Fraudulent conveyances include habitual undercapitalization when the principal removes capital but incurs future debt. When thinking about receivers, think very big cases. Receivers are paid by the hour; they hire the lawyer; and, finally, don't forget about the bonds.

Accounts payable due related company. Insider transactions invite your inquiry. The corporate principals own the building in which the corporation is housed; the corporate principal runs a related business that provides goods or services - typically trucking, transportation, accounting, or even the product itself. Sometimes these companies feed each other, with captive customers or suppliers. Is anything wrong with this picture? The corporation needs to rent a premise, buy goods at market prices, and obtain supplies, labor, and loans. The answer is greed. Insiders habitually sell inflated goods, services, or fictitious product, tender vouchers and invoices for payment, and insure they are first for payment.

If the insider controls the buyer and seller, the price is neither competitive nor market based. Look for outright fraud, self-dealing, breach of fiduciary duty, along with alter ego. If a large balance accrues for accounts payable due related company, think deep rock if you can prove that the corporation was undercapitalized, and the liability to the insider masks disguised capital fueling the corporation's operation. Payment of trade debts due an insider resembles an unlawful dividend or fraudulent conveyance.

Drains, siphons, and wormholes. The financial bibliography provides voluminous reference materials depicting model balance sheets, profit and loss statement, capitalization requirements, key profit ratios, and so on. Skim the financial statement and compare. Look for disproportionate items. Take, for example, the restaurant business. Food costs average about 25%, and labor ranges anywhere around 30%. Are the numbers off the chart? They mask illicit expenditures. Look for "other," "miscellaneous," "other expenses," "direct operating," and "occupancy" or "marketing." These items suggest unvarnished fraud, because their general nature conceals the true nature of expenditures.

Look for excessive "G&A," which means general and administrative. If viewing a restaurant, retail business, basic manufacturing, or distributing, normal G&A is a fraction of operating expense. Ask: Big G&A numbers signify an insider exploiting the corporate cash flow to finance another parallel business, or lavish, ridiculous expenses, or - worse - a direct contribution from the corporation (the weak sister) to capitalize the corporate subsidiary. Watch for "headquarters offices," supported by G&A, which runs a restaurant chain, beauty salons, or copy shops. Look harder, and you'll find the corporate principals running a half dozen businesses from this corporate headquarters. These shared expenses might not blast your way to summary judgment, but excessive G&A, supporting unrelated operations is what dreams of fraudulent conveyances and unlawful dividends are made of.

Executive salaries. GAAP lists officers' salaries separately. These are big numbers, ranging between $4,000 and $10,000 a month. Is the corporate receiving real value in exchange? Obviously nobody works for free, and the corporation may pay executives a prevailing rate. What's wrong with this picture? Don't presume that the corporation is getting services in exchange. Contrary to the captain going down with the ship, capitalist captains are first off the ship and scourge for new opportunities. Find ex-employees who will tell if the insider invested 40-hour weeks. Even the client's own salesperson, driver, account manager, credit manager, or collector might opine that the insider played hooky rather than tend shop.

Unpaid subscription agreements, watered stock; stock for future services. "Water, water everywhere, and not a drop to drink." Wade through a financial statement, and you'll find a major oasis in the capital account. This is watered stock, which means the corporation issued stock in which the shareholder failed to exchange property or provided worthless property. Stock for future services; stock for unsecured notes; stock for worthless equipment or leasehold improvements; stock for insolvent business. Got a judgment, buddy? Levy on the shareholder and enforce the subscription agreement to force payment of the share's true value.

Plain old vanilla; undercapitalization. Anybody can incorporate. Send about $500, along with the articles to the Secretary of State, and Poop-be-doop: You're incorporated. Send $50 to the local government, and you've got a city business license; a fist of dollars more, and we can sell you a sales tax permit. Did we forget anything? How about real money to run the business? Examine the capital account. Even a one-eyed pirate will invest money in the ship, crew, cannons, muskets, swords, sails, hardtack, and rum. If the capital account shows $1,000 in capital stock, the corporation is undercapitalized. Don't look too hard for the $1,000; it is probably the precorporation lawyer's fees, along with franchise taxes.

The capital account itself and source entries. The opening capital account shows a humongous number; say, $100,000. Your forensic accountant suggests that $100,000 approximates adequate capital, given potential exposure for trade liabilities, and possible risk of financial collapse. The operation is broke, bust, and gone. Do you quit? No. Read on.

Find the original ledger for "capital." The initial entry is $100,000. Look for the corresponding journal entry, which refers you to the journal. The journal will show a credit and debit to another account. Ask: If the $100,000 was a cash contribution, you'll see $100,000 to the cash ledger account. If the contribution was inventory, likewise look for a debit to the inventory account. If none, you're found a clue - if not the treasure itself. Typically, insiders convert their sole proprietorship into a corporation, usually when they become concerned with expanding personal liability from trade debt. Under this hypothesis, you'll find the $100,000 capital account, but find corresponding entries to accounts such as cash, inventory, equipment, furniture, and goodwill. Is this capital sufficient, or are you looking for a hidden corporate dividend with fraudulent conveyance? Assuming the predecessor sole proprietor is losing money, and incorporating shifts a losing business into a corporate form to avoid accruing personal liability, the corporation is grossly undercapitalized.

Adequate capital means that the business entity has sufficient reserves to conduct its business by paying for obligations as they arise, acquire goods and services for resale, and liquidate long-term liabilities, and this capital remains permanently at risk to insure longevity. Conclude: If the corporation immediately loses money and falters on this trade bill, the corporation lacks adequate capital. If the journals and ledger accounts show a straight transfer from the prior business to the corporation, the records therefore will evidence classic undercapitalization.

From its inception, the corporation pays prior trade bills incurred by the insider when running predecessor sole proprietorship. The corporation pays past due, pre-incorporation bills, long-term liabilities, prior unpaid wages, and draws. These payments benefit the insider in discharging his or her pre-incorporation liability. These payments deprive the corporation of valuable working capital in paying bills for goods and services incurred by prior regime. These payments are therefore unlawful dividends because they return capital to pay a personal liability for an insider, or these payments are fraudulent conveyances because the corporation received nothing in return - not even a holiday card at years' end.

Correcting journal entries. Massive correcting or reversing entries favor only insiders. Pull the ledger; examine high-profile accounts such as insider accounts and note receivable; capital accounts; and current liabilities owed to shareholders. The financial statements show small balances. Is the insider honest, or did you chance upon a genuine Dali lithograph? Pull five years of financial statements, along with each ledger. Look for changes benefiting the insider, such as accounts receivable due from insiders declared worthless and "written off." Look for note payable to due insiders drastically reduced by asset transfers, such as cars, inventory, and equipment. Examine the ledger account for the debit to the accounts receivable due from insider account, but the corresponding item in notes payable to insiders.

These entries, all favoring the insider, suggests the insider avoiding liability for accounts and notes due the corporation (by writing down these receivables) masking the entries reducing the note payable to the corporation. This transaction is a fraud. First, the insider is not paying on the receivable, as any other debtor; and, second, the note payable due the insider is disguised capital. Any reduction is an unlawful dividend or fraudulent conveyance. Worse, examine the journal entries for the note payable to the insider.

a)  The corporation did not even issue a note:

b)  The note lacks any contemporaneous consideration, such as cash; and

c)  The note, as an insider transaction, might not even be due.

False accruing liabilities to insiders. Look for accrued current liabilities to insiders. The long-term note payable to the insider bears interest. If the interest is unpaid (which is a certainty), the corporation carries the unpaid interest as current liability, which is never paid. This accruing but unpaid liability, along with the underlying note (which the corporation could never pay), are disguised capital and hidden dividends and should be paid.

Accrued wage. Insolvency and horse racing are kissin' cousins: Everybody is at the gate. In the first lane is the IRS, in the second lane, the labor commissioner, in the third lane (and probable winner), the secured creditor, and in the fourth lane are individual wage claimants. Doesn't horse #4 look familiar? Why, that's horse is the insider who claims a six-figure accrued wage claim. That one claims months of unpaid wages, asserts statutory priority, and, worse, controls the company's checkbook. You can spot these wages under short-term liabilities as accrued wages, or from the cash disbursement journal, or canceled checks as large disbursement. Are the accrued wages recoverable as a fraudulent conveyance, unlawful dividend or improper payment? Maybe.

The basic tests to ferret the genuine from fraudulent wages claims follow: Do prior quarterly, or monthly, financial statements evidence a slow progression of a wage accrual? If the wages are taken, did the corporation deduct the taxes? Did the insider lack current payroll? And how did the insider make basic living expenses, such as payment on the mortgage? Look for notes from the corporation to the insider or employment contracts. However, if the corporation lacked money to pay basic wages, you have found the first clue to the alter ego. The corporation was so undercapitalized that the corporation could not make basic payroll when due. If the corporation couldn't make payroll, unpaid wages are equivalent to a continuing capital contribution, and any payment is an unlawful dividend, or fraudulent conveyance.

X marks the spot

Most insiders engage in petty theft. They borrow money and owe a receivable. They pay the receivable with accrued wages. Accrued wages are disguised capital. Capital is the prior failing business. The corporation pays the prior failing business bills. The corporation lacks sufficient capital to set sail, and quickly flounders. You'll find all these clues on the treasure map in your hand: the financial statement. "X" might mark the spot on your treasure map; but once found, the "X" becomes Exhibit "A" in your successful claim to recover the lost and stolen property. Yo, ho, ho, shiver me timbers, and have a good time.

Tools for your treasure map

Your personalized treasure tools: shovels, pick, axes, compass, telescope, and trowels.

This is a pirate story originating with such English heroes as Sir Francis Drake, who was sponsored by the Queen to plunder Spanish galleons. Private investors capitalized these risky ventures, whose pay-off easily exceeded 500%, if successful, which required both a successful venture and honesty of the ship's captain. Remember, the captain was a career pirate, whose purpose was to steal. Theft is democratic. Therefore, the captain could easily profit both from stealing from the enemy galleons along with his own investors, making this line of investment very speculative. In order to shore investor confidence in these ventures, the English Parliament passed 13 Elizabeth, which provided that all conveyances with the intent to defraud creditors was null and void. For the dilettante of the CLLA, the leading case is Twyne's Case, 3 Coke 80a, 76 E.R.C. 2, 1 Smith Lead Cas. 11. Am L. Reg., N.S. 137. The modern version is the Uniform Fraudulent Transfer Act. This is your first tool, a basic shovel. Long John Silver would find himself in a deposition.

Other tools abound to unearth these treasures. The state corporations code voids most conveyances by corporations to any officer, shareholders, and director, if the corporation was insolvent just by failing to pay bills when due and declares conveyances an unlawful dividend. Litigating an unlawful dividend requires proof of the debt owed by the corporation; the insolvency of the corporation; the fact of the transfer to the officer, director, and shareholder. Most states declare the conveyance avoidable (not void), or shroud the conveyance with the presumption of undue influence or fraud, and impose on the conveyance a burden of proof to demonstrate that the conveyance benefited the corporation from its own point of view. In habiting most creditors from this straightforward claim is standing. Many states limit an unlawful dividend claim to either the corporation, its other officers, directors, or shareholders, judgment creditors, and, in some instances, to a receiver. A judgment creditor might style the caption as "ABC, a judgment creditor, on behalf of XYZ Corporation." This remedy is a pick.

More elaborate tools hang on the shelf. Traditional common law equates officers, directors, and shareholders to trustees of trust in the setting of an insolvent corporation. Any transfer is probably recoverable as a breach of trust. Again the impediment is whether the individual creditor can maintain standing to bring the action; and, if successful, the recovery inures to the corporation for pro-rata distribution to all creditors. This remedy is a compass.

Under other trust theories, corporate properties held in the hands of officers, directors, and shareholders are presumptively held in trust for the benefit of the corporation. An attachment or execution levy upon the corporate principals would precipitate surrender of these assets to the levying officer on behalf of the executing creditors. In the event of refusal by the garnishees, the creditor would institute the traditional creditors suit to reach the debtor's assets held by a third party, or even a turnover order, if allowed, at the conclusion of a third-party examination. This remedy is like a crowbar.

Like more exotic claims as tools to reach the assets in the hands of third parties? If the shareholder failed to deliver on his or her capital investment, received watered stock, or failed on pay on the stock prescription agreement, collect the balance on a derivative claim or garnishee the amount due under attachment or execution. Find long-term loans by corporate principals that were repaid prior to your judgment, which emptied the corporate coffers. "Hey, the corporate liquidated its assets to repay its other creditors, holding long-term debt. Nothing is wrong with this. A debtor may prefer one creditor over another." Break this cycle by suing the other creditors, holding this long-term debt, on the theory that the long-term debt is disguised capital, and therefore repayment is an unlawful dividend. More esoteric is equitable subordination; equity will deep-rock an insider loan as capital, or defer payment, pending liquidation of creditor claims. These remedies are your axes - to grind.

Try, for fun, an action under the Unfair Business Practices Act, an amorphous statute that provides strong injunctive relief to remedy any wrong. Although lacking a clear remedy for monetary relief, such as damages, the Unfair Business Practices Act might reach the fraudulent conveyance because the corporate loot is an unlawful act per se and equitably order its return. Don't forget the old standby of "alter ego." Moving assets freely between insiders and their corporate charge is the sine qua non to most alter-ego actions. These remedies are a telescope.

Finally, don't forget fraud for false financial statements, reclamation actions, bankruptcy discharge actions to exempt the debt (Section 523(a)(2) and so forth), action to bar the discharge for non-existent records (Section 727). These remedies are your trowels.

David J. Cook Copyright 1995

Editor's Note: David J. Cook is the senior attorney of Cook Collection Attorneys PLC, San Francisco, California. He has practiced in the area of debt creditor and bankruptcy for the past 35 years. Mr. Cook is a regular contributor to business and legal journals, legal publications and periodicals. We welcome his participation and insights in this difficult and perplexing area of the law. You can reach Mr. Cook at: Cook@SqueezeBloodFromTurnip.Com.

Challenges of Proving Assigned and Purchased Debt Cases - Part I

by Stephen Niermann

I. Introduction

The Moral Basis for Contract

A failure to pay a debt is a betrayal of trust. All extensions of credit are predicated upon faith, trust and belief. Credit comes from the Latin word credo, which literally means "to believe" or "to trust". The lender loans on the good faith belief that the borrower will honorably repay the money loaned to him in the manner and at the time required. The borrower covenants with his word that he will be personally responsible to see that the borrowed money will be repaid. Most debtors, given the choice, want to repay the money that they borrowed and be released from their debt.

Necessity of Credit

In free industrial economies, households generally obtain credit, against individual guarantees. To do this, commercial sources reach lending decisions on the basis of readily available information about the credit risk of the borrower. Daniel Webster once said, "Credit has done a thousand times more to enrich mankind than all the gold mines in the world. It has exalted labor, stimulated manufacture and pushed commerce over every sea." Lack of access to credit, along with lack of financial literacy, are the leading causes of the inability of the poor to exit poverty. The World Bank, Social Development Department, Social Capital Working Paper Series.

Contracts are Sacred

Covenants are deeply rooted in the Judeo-Christian principles upon which this country was founded. "As a fundamental matter, Texas law recognizes and protects abroad freedom of contract. We have repeatedly said that if there is one thing which more than another public policy requires it is that men of full age and competent understanding shall have the utmost liberty of contracting, and that their contracts when entered into freely and voluntarily shall be held sacred and shall be enforced by courts of justice." NAFTA Traders, Inc. v. Quinn, 08-0613 (Tex. 5-13-2011).

Objective of this Article

This article will explore the challenges, real and perceived, of proving assigned and purchased debt cases. Most of the discussion will relate to unsecured lines of credit on credit card accounts, with an occasional reference to challenges on other forms of secured and unsecured debt.

Forms of Loans.

A loan may take the form of a series of distributions of money using a line of credit, or it may be a single, one time distribution. The issuance of a credit card is not the loan itself. A credit card is only the tangible evidence of the existence of a line of credit that backs the card each time the card is used. The line of credit may be issued by a bank and marketed with the Mastercard or Visa logo. Alternatively, the line of credit may be issued by the a particular merchant, like major department store, oil company or finance company, marketed with its own private label. Whichever, when trust is broken by nonpayment of the loans made on the line of credit, a lawsuit may be filed by the lender against the borrower.

Scope of the Issues.

Before determining how to try the case, the court must determine the scope of plaintiff's allegations and the nature of defendant's defenses. This determination will clarify which issues are actually contested between the parties. Once the issues are identified, the court will know the type of evidence it will expect to hear on those contested issues to arrive at its final judgment.

II. Plaintiffs pleadings - deciding the allegations

Plaintiff's Original Petition

In Texas, a lawsuit for unpaid debt is commenced with the filing of the plaintiffs complaint, entitled the Plaintiff's Original Petition. The petition need only contain a short plain statement of each of the plaintiff's grounds of complaint against the defendant. A ground of complaint, referred to as a cause of action, is the plaintiffs legal basis for recovery on the debt. A plaintiff may have more than one cause of action in the same lawsuit. Eaves v. Unifund CCR Partners, 301 S.W.3d 402 (Tex.App. [8th] 2009). The plaintiff may legally allege multiple causes of action as alternative grounds why plaintiff should win its case. Busch v. Hudson & Keyse, LLC, 312 S.W.3d 294 (Tex.App. [14th] 2010) (account stated, unpaid open account and breach of contract)

Causes of action are alleged in the alternative to increase the plaintiffs ability to prevail, so that if one cause of action is not applicable to the facts, then the alternative cause of action will be. Each cause of action will allege liability for nonpayment of the debt, but there will be alternate reasons that the plaintiff will argue that the court can use to arrive at the conclusion that the defendant is in fact liable for the unpaid debt. If any one of the plaintiffs causes of action is meritorious, the court must grant judgment to the plaintiff. Winchek v. Am. Exp. Travel Related Servs. Co., Inc., 232 S.W.3d 197, 202 (Tex.App.-Houston [1st Dist.] 2007, no pet.). This section reviews the most commonly used causes of action.

Causes of Action - Basis of Recovery

Account stated

An account stated has been defined as (1) transactions between the parties which give rise to indebtedness of one to the other; (2) an agreement, express or implied, between the parties fixes an amount due; and (3) the one to be charged makes a promise, express or implied, to pay such indebtedness. Damron v. Citibank, 03-09-00438-cv (Tex.App.-Austin 8-25-2010) McGrew v. Citibank (S.D.), 10-07-00343-CV (Tex.App.6-17-2009). Wynne v. Citibank, 07-06-0162-CV (Tex.App.-Amarillo [7th Dist.] 4-25-2008, no pet. h.) (The billing statements establish Wynne's acceptance and use of the Citibank credit card.). "[B]ased on appellants' usage of the credit card, we may reasonably infer that they impliedly agreed to pay a fixed amount equal to the purchases and cash advances they made, plus interest." McGrew v. Citibank (S.D.), 10-07-00343-CV (Tex.App.6-17-2009).

A claim for account stated "is a proper cause of action for a credit card collection suit because no title to personal property or services passes from the bank to the credit card holder." Budzyn v. Citibank, 01-08-00211-cv (Tex.App. [1st Dist.] 3-25-2010) Jaramillo v. Portfolio Acquisitions, LLC, No. 14-08-00939-CV, 2010 WL 1197669, at *7 (Tex.App.-Houston [14th Dist.] Mar. 30, 2010, no pet. h.) (mem. op.); Butler v. Hudson & Keyse, L.L.C., No. 14-07-00534--CV, 2009 WL 402329, at *3 (Tex.App.-Houston [14th Dist.] Feb. 19, 2009, no pet.) (mem. op.). ("[B] ased on appellants' usage of the credit card, we may reasonably infer that they impliedly agreed to pay a fixed amount equal to the purchases and cash advances they made, plus interest.") Opinions from other courts hold the same. McFarland v. Citibank (S.D.), N.A., 293 S.W.3d 759, 764 (Tex.App.-Waco 2009, no pet); Dulong v. Citibank (S.D.), N.A., 261 S.W.3d 890, 893 (Tex.App.-Dallas 2008, no pet.). ("Based on the series of transactions reflected on the account statements, it is reasonable to infer that Dulong agreed to the full amount shown on the statements and impliedly promised to pay the indebtedness.")

The advantage of the Account Stated cause of action is that it does not require existence of a contract. Budztyn v. Citibank, 01-08-0021 1-cv (Tex.App. [1st Dist.] 3-25-2010) held

"Even though Citibank produced a Cardholder Agreement dated 2003, which it contended applied to account 5153, Budzin argues that there was no proof of an agreement between the parties as to the 5153 account because Citibank did not produce the Cardholder Agreement originally issued by Associates National Bank before its merger with Citibank. Both the Waco and Dallas courts of appeals have considered and rejected this argument. In Dulong and McFarland, the cardholders argued that Citibank failed to prove the existence of an agreement because it did not include the cardholder agreements in its summary judgment proof. McFarland, 293 S.W.3d at 759, Dulong, 261 S.W.3d at 894. "Because an agreement on which an account stated claim is based can be express or implied, Citibank did not have to produce a written contract as long as it could produce other evidence of the agreement between the parties to meet its burden of proof." McFarland, 293 S.W.3d at 759, Dulong, 261 S.W.3d at 894. In both cases, the courts held that Citibank met its burden of proof by submitting billing statements showing the amounts due. McFarland, 293 S.W.3d at 759, Dulong, 261 S.W.3d at 894."

Damron v. Citibank, 03-09-00438-cv (Tex.App.-Austin 8-25-2010) held:

"Because the requisite agreement can be express or implied, the plaintiff need not adduce evidence of a written cardmember contract, but can instead present evidence of acts and conduct by the parties that give rise to an implied agreement fixing an amount due and that the defendant agreed to pay the indebtedness. See Busch, 312 S.W.3d at 299; Dulong, 261 S.W.3d at 894. Such acts and conduct may include the cardholder's use of the card to make purchases, the cardholder's making of payments on the account, and the cardholder's acquiescence in the card issuer's imposition of interest, fees, and charges. See Busch, 312 S.W.3d at 299-300; Dulong, 261 S.W.3d at 894." See also Singh v. Citibank, 03-10-00408-CV (Tex.App.-Austin 3-24-2011)

The Texas Supreme Court in Heidenheimer v. Ellis, 67 Tex. 426, 3 S.W. 666 (1887) a "stated account" is neither an "open account" nor a "written contract ascertaining the sum payable."
Unpaid open account

An action to collect a credit card debt may be brought as an action on an "open account." LTD Acquisitions, LLC v. Cook, No.04-10-00296-CV, 2011 WL 61634, at *2 (Tex. App.-San Antonio Jan. 5, 2011); Eaves v. Unifund CCR Partners, 301 S.W.3d 402, 408-09 (Tex. App.-El Paso 2009, no pet.). The elements of an open account are: (1) transactions between the parties, (2) creating a creditor-debtor relationship through the general course of dealing, (3) with the account still being open, and (4) with the expectation of further dealing. Eaves, 301 S.W.3d at 408. A credit card debt may be considered an open account because, under a credit card agreement, the terms of repayment remain subject to modification, and the parties exchange credits and debits until either party settles the balance and closes the account. See, Id. at 409.

Black's Law Dictionary defines an open account as "[a]n unpaid or unsettled account," or "[a]n account that is left open for ongoing debit and credit entries by two parties and that has a fluctuating balance until either party finds it convenient to settle and close, at which time there is a single liability." See Black's Law Dictionary 21 (9th Ed. 2009). Once a debtor defaults on his account, although the debtor may not be able to make further withdraws on the account, his obligation to pay still remains. The account is still open with the expectation of further dealings, that is, that the debtor would tender the amount owed. Eaves v. Unifund CCR Partners, 301 S.W.3d 402 (Tex.App. [8th] 2009, no pet.)

Credit card open line of credit contrasted with closed end loans.

Open end lines of credit are different from closed end loans. Credit card accounts are a type of an open end line of credit. A credit card account is said to be "open" because its contractual terms are variable or "open". The outstanding balance, minimum monthly payment, payment due date and sometimes the interest rate will vary from period to period. A closed end loan is usually created by a single borrowing transaction. A closed end loan, like a promissory note, car loan installment contract, or fixed rate mortgage each start with a fixed balance and the payments are static or determinable for the life of the loan.

Open End Line of Credit.

In the case of a credit card account, the terms of the use of the account are disclosed on each monthly statement. The cardholder has the option to either (1) pay all the charges by paying the balance in full or (2) make a minimum monthly payment and revolve the remainder owed until the next month and pay a finance charge. Open accounts are sometimes called revolving accounts.

The debt obligation and its terms of use for the credit card account are evidenced by the periodic statements of account sent from the issuer to the accountholder. The Truth in Lending Act, or Regulation Z, requires that the credit card issuer provide a statement of the account to the user each billing cycle. See 15 U.S.C. § 1637(b). The Regulation also requires that the account statements contain all the terms and disclosures required by law which give rise to the accountholder's debt. The terms include: the beginning balance, the use of the account for that period, the amount and date of each charge on the account; the amount and date of each credits applied, the amount of any finance charges, the rate(s) of interest used to calculate the finance charges; the annual percentage rate; the balance on which the finance charge is calculated; the closing balance; the payment due date to avoid additional accrual of finance charges. Id.Each account statement completely discloses the then current contractual relationship of the parties to the extent required by federal law. The debtor has knowledge each month of the complete terms of his borrowing set forth in each billing statement. This also allows a debtor to have fair notice so that he can dispute any inaccuracy within 60 days. By contrast, a closed end loan is often documented by a single contract signed by the borrower at the time the money is received by the borrower.

With a credit card account, neither an application for the line of credit, nor a cardholder agreement, would best document whether the debtor is current or is past due and owing. For this reason, Federal law does not require a card issuer to maintain the application for more than 25 months. See, 12 CFR § 202.12 entitled Record retention. At best, the cardholder agreement could only be some evidence of the existence of the financial accommodation (available line of credit), but it would not reflect the current status of the account relationship between the parties. For example, the application would not reflect the balance owed on the account at any given time. This is because the open account relationship between a credit card issuer and user is not static. As between the cardholder agreement and the account statements then, it is the latter that most accurately informs the parties and the court of any breach. In re Cleveland, 396 B.R. 83 (Bky.N.D.Okla. 2008) citing In re: Peck, 2008 WL 416927 (Bankr.E.D. Pa. 2008).

Breach of contract

Recovery under a breach-of-contract claim requires proof of four elements: (1) the existence of an valid agreement; (2) performance or tendered performance by the plaintiff; (3) nonperformance by the defendant; and (4) damages sustained by the plaintiff as a result of the defendant's nonperformance. Eaves v. Unifund CCR Partners, 301 S.W.3d 402, 407 (Tex.App. [8th] 2009 no pet.).

As to the first element, a valid contract exists when there is (1) an offer, (2) an acceptance in strict compliance with the terms of the offer, (3) meeting of the minds, (4) each party's consent to the terms, and (5) execution and delivery of the contract with the intent that it be mutual and binding concerning the existence of an valid agreement. Winchek v. Amn. Exp., 232 S.W.3d 197, 202 (Tex.App. [ 1st] 2007). "The issuance of a credit card constitutes a credit card offer and the use of the card constitutes acceptance." Hinojosa v. Citibank, 05-07-00059-CV (Tex. App.-Dallas [5th Dis.] 3-4-2008) citing Jones v. Citibank, 235 S.W.3d 333, 338 (Tex.App. [2nd] 2007). "[W]hen the parties manifest an intent through their actions and words that the contract become effective, delivery is shown." Winchek at 204.

Whether a defendant paid "the agreed prices" or "the reasonable market value" when making purchases with his credit card is not an element of plaintiffs claim for breach of contract because the credit card agreement does not require payments only for goods purchased at agreed prices or the reasonable market value. Simien v. Unifund CCR Partners, 321 S.W.3d 235, 248 (Tex.App [1st] 2010)

Contract does not need to be signed to be accepted. Under Texas law, if one party offers a contract, the other may accept by his acts, conduct, or acquiescence to the terms of the contract, making it a binding agreement on both parties. Jones v. Citibank, 235 S.W.3d 333 (Tex.App. [2nd] 2007) citing Benser v Citibank (South Dakota), N.A., No.08-99-00242-CV, 2000 WL 123186, at 5 (Tex. App. - El Paso Aug. 31, 2000, no pet.) (Mem. Op.) (concluding cardholder's use of credit card and payments to account showed he understood obligation to bank and contract had been formed.).

Sworn account

A cause of action based on an unpaid account can sometimes be alleged using the sworn account procedure. A sworn account is not a separate cause of action, rather it is an evidentiary procedure which streamlines the admission of evidence needed to establish plaintiff's right to recovery on the unpaid accounts.

Sworn accounts are governed by Rule 185 of the Texas Rules of Civil Procedure, which states:

Suit on Account When any action or defense is founded upon an open account or other claim for goods, wares and merchandise, including any claim for a liquidated money demand based upon written contract or founded on business dealings between the parties, or is for personal service rendered, or labor done or labor or materials furnished, on which a systematic record has been kept, and is supported by the affidavit of the party, his agent or attorney taken before some officer authorized to administer oaths, to the effect that such claim is, within the knowledge of affiant, just and true, that it is due, and that all just and lawful offsets, payments and credits have been allowed, the same shall be taken as prima facie evidence thereof, unless the party resisting such claim shall file a written denial, under oath. A party resisting such a sworn claim shall comply with the rules of pleading as are required in any other kind of suit, provided, however, that if he does not timely file a written denial, under oath, he shall not be permitted to deny the claim, or any item therein, as the case may be. No particularization or description of the nature of the component parts of the account or claim is necessary unless the trial court sustains special exceptions to the pleadings.

Rule 185 is a procedural tool that minimizes the evidence necessary to establish a prima facia right to recovery on certain types of accounts. Williams v. Unifund CCR Partners, 264 S.W.3d 231, 234 (Tex. App.-Houston [1st Dist.] 2008, no pet.). Under this expedited procedure, the creditor attaches an affidavit to its plaintiff's original petition swearing that a sum certain amount is owed on an account and that all just and lawful offsets, payments and credits have been allowed. The debtor must file a written denial, under oath, that the amount is not owed. See Tex.R.Civ.P. 93(10) and 185. If the debtor fails to file a sworn denial, then plaintiff has proven its case by its affidavit and the court will proceed to enter judgment for plaintiff upon the pleadings. If a sworn denial is filed, then plaintiff must prove its case the same way that plaintiff would prove a case that does not use the sworn account procedure. Powers v. Adams, 2 S.W.3d 496, 498 (Tex.App.-Houston [14th Dist.] 1999, no pet.)

Sworn account is appropriately used where credit is issued by the same entity that provided the goods or services. Where an account is financed by the same entity that sold the goods or services, like a department store, retail store, gas company underwriting its own private label credit cards, the sworn account is the most efficient cause of action to bring. McManus v. Sears, Roebuck & Co., No. 09-02-00472-CV, 2003 WL 22024238, at 2 (Tex. App.-Beaumont Aug. 28, 2003, no pet.) (mem. op.) (concluding that suit on sworn account was appropriate when Sears, Roebuck & Co. alleged in its motion for summary judgment that even though McManus entered into a credit agreement with Sears National Bank, he purchased goods and services from Sears, Roebuck & Co., which subsequently became the assignee of Sears National Bank's rights, and in McManus's responses to requests for admissions, he admitted that Sears, Roebuck & Co. was the proper party plaintiff and that the credit card issued to him was issued by Sears, Roebuck & Co.) Almost all and commercial open accounts are can be filed as sworn accounts.

Conversely, where the credit card's issuer loaning the purchase price is not same as the provider of the purchased goods or services, then a lawsuit using the sworn account procedure under Rule 185 is not appropriate. Williams, at 234-35. The Rule 185 procedure would not be appropriate for collecting debt on bankcards, like Mastercard and Visa, which are credit cards underwritten by banks, as the lender in the transaction. This is because bankcards involve a third party bank acting as a lender to a merchant's business where the consumer made a purchase on the bankcard. The relationship is indirect and cannot be sworn to by the bank in support of a sworn account type petition. Rule 185 applies only to transactions on credit between parties, in which there is a sale from the seller to a purchaser, whereby title to personal property passes from one to the other, and the relation of debtor and creditor is thereby created by general course of dealing. Williams, 264 S.W.3d at 234 (quoting Meaders v. Biskamp, 316 S.W.2d 75, 78 (Tex. 1958).

A defendant should be careful not to allow a case to be proven as a sworn account when sworn account is not the correct cause of action. Rowlands v. Unifund CCR, No. 14-05-01122-CV, 2007 WL 1395101, at *2, 3 (Tex. App.-Houston [14th Dist.] 2007, no pet.) ("Even though Unifund incorrectly pled the case as a sworn account, the evidentiary effect of the admissions alone established Unifund's entitlement to prevail based on Rowland's breach of the Account Agreement.")

Therefore, sworn account is an efficient procedure for collecting lines of credit which fall within the permitted scope of the Rule.

Quantum meruit

Quantum meruit is a cause of action that is sometimes alleged as an alternative cause of action in situations where a defendant incurs a debt but a clear, legal contract does not exist with the plaintiff. Quantum meruit is a cause of action that permits a plaintiff to recover for goods and services that were provided despite the absence of a contract where such goods and services were accepted or used by the defendant under circumstances which gave the defendant reasonable notice that the plaintiff expected to be paid for the goods and services. "Quantum meruit is an equitable remedy which does not arise out of a contract, but is independent of it." Vortt Exploration Co. V. Chevron U.S.A., Inc., 787 S.W.2d 942, 944 (Tex. 1990). "Recovery in quantum meruit will be had when non payment for the services rendered would result in an unjust enrichment" Vortt at p 944. Generally, a party may recover under quantum meruit where no express contract covering exists. Id.Quantum meruit "is based upon the promise implied by law to pay for beneficial services rendered and knowingly accepted." Campbell v. NW. Nat'l Life Ins. Co., 573 S.W.2d 496, 498 (Tex. 1978). The term quantum meruit is a Latin phrase which roughly means "the amount that it is worth". In other words, even in the absence of a contract, the plaintiff is demanding the fair value of the goods and services used by the defendant. This term would encompass the value of financial services, including money loaned. To recover under quantum meruit a claimant must prove that: (1) valuable services were rendered or materials were furnished; (2) for the person sought to be charged; (3) which services and materials were accepted by the person sought to be charged, used and accepted by him; (4) under such circumstances as reasonably notified the person sought to be charged that the claimant in performing such services was expecting to be paid by the person sought to be charged. Id.; Bashara v. Baptist Mem'l Hosp. Sys., 685 S.W.2d 307, 310 (Tex. 1985). Oral contracts are sometimes enforced by quantum meruit. The quantum meruit action, when it sounds in contract, must be brought within 4 years. Pepi v. Galliford, 254 S.W. 3d 457, 461 (Tex. App. [1st] 2007 pet. denied) (the four year statute of limitations is applicable to quantum meruit claims for debt actions, whether or not the debt is evidenced by a written contract.).

Lesser Known Causes of Action

Another cause of action for collection is to treat the debt as a chose in action. A chose in action is a right to bring an action to recover a debt, money, or thing. Black's Law Dictionary (8th ed. 2004). Jansen v. Fitzpatrick, 14 S.W.3d 426, 432 (Tex.App.-Houston [14th Dist.] 2000) held that "A chose in action is a personal right not reduced to possession, but recoverable by a lawsuit." See also In the Estate of Prater, 12-08-00008-cv (Tex.App.-Tyler 12-31-2009) An unpaid loan is a chose in action and is personal property. See Tex. Prob. Code Ann. § 3(z) (Vernon Supp. 2009); Black's Law Dictionary 275 (9th ed. 2009). Because it is property, it is assignable.

A promissory note or a check is intangible property in the nature of a "chose in action" which can only be enforced by an action in court and not by taking physical possession like other types of property. In the Matter of Guardianship of Fleckenstein, 589 S.W.2d 788, 789-790 (Tex.Civ.App.-8 Dist. 1979). (Intangible personal property follows the person, and has its situs at the domicile of the owner. Debts, being intangible, have no actual situs, they follow the person of the creditor and not of the debtor, and the creditor's domicile will prevail for purposes of venue.) Alleging the right to collect for a chose in action is useful to a creditor that wants to maintain venue in his county on a non-consumer collection matter.

Other causes of action include restitution, common law debt, assumpsit, money had [sic] and to remedy defendant's unjust enrichment. This was an alternative theory alleged in McGrew v. Citibank (S.D.), 10-07-00343-cv (Tex.App.6-17-2009). (The court did not use the theory(ies) to decide the debt was owed by defendant.)

© Stephen Niermann 2011

Editors Note: Stephen Niermann founded Niermann and Olivo with Andrew Olivo, 21 years ago in Carrollton, Texas. The firm is a general practice emphasizing business law, including creditor's rights.

Beginning at the age 14, Steve had to collect unpaid bills from farmers to enable his father's business to survive.

After earning his bachelor of science degree at Western Illinois University and then went to work for Pfizer, Inc., the pharmaceutical company. He returned to school to start an MBA at the University of Missouri-Columbia before going to law school at SMU.

He is admitted to practice before the U.S. Supreme Court, U.S. Court of Appeals, Fifth Circuit, all the U.S. District Courts and U.S. Bankruptcy Courts in Texas, the Texas Supreme Court and the Creek Indian Nation Supreme Court.

Steve is a local coordinator for financial literacy courses. He and his wife, Rebekah, and their children help sponsor a micro loan program which provides zero interest loans to empower poor women in India.

CRS Elections in Chicago

By: Nicholas D. Krawec

It is not too early to think about the Creditors' Rights Section elections to be held at the Chicago meeting in May, 2012. As 2012 is going to be an election year all over the nation, if you are interested in becoming a leader in the Creditors' Rights Section, you might as well get into the spirit of things and toss your hat into the ring. (The only thing we require, however, is that there be no name-calling, and no conspiracy theorizing against your opponents, during the "election campaign" for CRS officers). But enough humor. There will be four (4) vacancies on the Creditors' Rights Section Executive Council, as the three-year terms of four council members will expire. Additionally, there will be a vacancy for Creditors' Rights Section Secretary. If you are interested in running for one of those positions, please contact Nick Krawec, at nkrawec@bernsteinlaw.com, or call (412) 456-8103. Don't be shy. We need, and encourage, your involvement in your Section.

Editor's Note: Nicholas "Nick" Krawec is an attorney at Bernstein Law Firm, P.C. in Pittsburgh, PA. He is board certified in creditors' rights.

NEWSLETTER COMMITTEE REPORT

By: Emory Potter, Esq. and Eva Engelhart, Esq.

The newsletter is circulated three times per year electronically in the Spring, Summer and Fall (and via fax for those rare few who are not online.) Emory Potter and Eva Engelhart are the Co-Chairs of the Committee.

Members, including members of the Executive Council, are encouraged to submit articles of interest or letters to the editor for inclusion along with a short bio for publication.

Editor's Note: Emory Potter, Esq. Has been a partner in the firm of Hays & Potter PC for over 16 years where he specializes in commercial and construction litigation. He acts as a Special Master for the Superior Court of Fulton County and has acted as a municipal court judge pro hac in the city of Chamblee, Georgia. He is a graduate of Auburn University and Georgia State University College of Law and has been a member of the CLLA for 15 years.

Eva Engelhart, Esq. has been an associate with Ross, Banks, May, Cron & Cavin, PC for 13 years. She focuses her practice on commercial and business litigation, primarily commercial collections. Eva's practice includes representing clients through trial involving collection of business accounts, contract payments, note payments, and post-judgment collections. She received her J.D. from the University of Houston Law Center in 1996 and received her B.A. from Brandeis University in 1993, Magna Cum Laude.

LETTERS TO THE EDITOR

Letters or comments can be sent to eengelhart@rossbanks.com. The Free Press has instituted a "Letters to the Editor" column. If you don't want to take time out of your busy schedule to do research for a scholarly article, if you have a suggestion, recommendation, or constructive criticism to direct to the Section leadership or the Free Press editorial board, or if you just want to "vent" (in a non-abusive manner, of course), you now have a forum. You can submit a letter any time it suits your fancy, and you need not wait until just prior to the publication of an edition of the Free Press. Submissions will be kept on file for future publication.

NOMINATIONS SOUGHT FOR 2011 AWARD OF EXCELLENCE

The Creditors' Rights Section of the Commercial Law League of America is seeking nominations for its Award of Excellence, which was established to recognize outstanding contributions in the field of law affecting creditors' rights. The first recipient of this award, in 2005, was Professor James J. White who, along with Robert Summers, published the most widely recognized treatise regarding the Uniform Commercial Code. The recipient must be a lawyer, legislator, professor of law, or judge, whose work has substantially and positively made an impact on creditors' rights. The recipient will be selected for presentation of the Award at the Annual Meeting of the League held in Chicago in May, 2012. Nomination forms are available at www.clla.org.

EDITOR'S NOTE:

The CRS Newsletter apologizes to David Cook for a misprint in the title of his article, "Vacating Or Preserving Stale Judgments Bearing Inherent Defects: Setting Aside The Final Judgment" published in the Summer 2011 issue of the CRS Newsletter.

CALENDAR OF EVENTS

November 10, 2011 - November 12, 2011
91st Annual New York Meeting
NY Sheraton Hotel & Towers, New York, NY

January 19, 2012
Webinar: How the Supreme Court is Reshaping Consumer Class Action Litigation
Webinar, Chicago, Illinois

March 2, 2012
Southern Region Conference
J.W. Marriott Hotel, Houston, TX

March 20, 2012
Eastern Regional Conference and Installation Dinner
The Water Club, New York, NY

May 3, 2012 - May 6, 2012
118th National Convention
Westin Michigan Avenue, Chicago, IL

August 2, 2012 - August 5, 2012
Strategic Planning & Leadership Conference
Fountainebleu Miami Bleach, Miami, FL

November 8, 2012 - November 10, 2012
92nd Fall Meeting
Sheraton New York Hotel and Towers, New York, NY