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Things They Never Taught Us in Law School: You Can’t Get Blood from a Stone

By: Marshall R. Isaacs

Law school taught me that there are two basic elements to any civil action: (1) liability and (2) damages. Unfortunately, my ivy-league educated professors were raised on a diet rich in Fortune 500 clients. If my professors had been able to peer over their bloated bellies into the pedestrian world of close corporations, they would have discovered a small but equally important third element which I refer to as “collectability.”

With small business squabbles rarely making the syllabus, most law students don't learn about about close corporations until stumbling across them in solo practice. What young litigators fail to recognize, however, is that close corporations are very different animals from the Coca Colas and Microsofts they learned about in law school. Litigating against a close corporation can be like petting an unfamiliar dog. The consequences are obvious.

For those lawyers who have never operated a business, a quick lesson is in order: Most small businesses are closely-held companies or “close” corporations. A close corporation is not a specific business entity such as a partnership or a sole proprietorship. Close corporation simply refers to a business with only a handful of shareholders, often family members.

The success of a close corporation can be wickedly deceptive. Many close corporations which appear to be booming, in reality, operate in the red. How many times have you walked into a bustling restaurant on a Saturday night and thought to yourself, “Wow, this place is making a killing!” That’s probably not the case. Consider the following:

• The restaurant’s owner doesn’t earn a penny until he has paid for his rent, electricity, salaries, liability insurance, large appliances (e.g. ovens, refrigerators), silverware, stemware, inventory, menus, telephone, legal fees, uniforms, furniture, health code and building violations, advertising, licensing fees, signage, employee benefits, cleaning supplies, pest extermination, accounting fees, plumbing repairs and decor.

• The restaurant owner probably pays 40% of his profits towards taxes and social security. Does he pocket some cash? Not so much these days with the prevalence of credit and debit cards.

• The restaurant is completely empty on weekdays.

• When the owner isn't around, the restaurant’s bartender lets all of his friends drink for free.

• Restaurant owner’s credit is bad so he can’t get a bank loan; Restaurant owner doesn’t qualify for stimulus funds.

• Beyond his expenses, the restaurant owner still has to feed his family, pay for his kids’ private school tuition, put gas in his Beemer and cover the mortgage and balloon-payment on his depreciated mini-mansion.

In the end, many seemingly successful entrepreneurs have little or nothing. And that little or nothing gets stuffed into a plain white envelope and locked up in a dresser drawer.

What can we learn from this scenario?

If you represent a plaintiff against a close corporation and the claim is not typically covered by insurance, there may very well be no pot of gold at the end of the rainbow. Don’t automatically assume that defense counsel is bluffing when he tells you, “Sure, my client screwed your client; but where are you going to get your money from?”

You might be tempted to respond, “If the Defendant is broke, how is he paying you?” Yet, this is another misguided assumption. For example, some of my clients are friends, family or former clients whom I defend for little or nothing. Other clients can afford to pay me just enough to string the case along until they can afford to settle or until Plaintiff has died, moved away or thrown in the towel.

So how can you determine whether a defendant is broke or just bluffing?

1. Hop onto Westlaw. Westlaw has a wonderful public records database which allows you to access lawsuits, judgments, liens, bankruptcies and corporate records. Ask yourself: Is the defendant involved in multiple lawsuits? Are there unsatisfied judgments or tax warrants against Defendant? Are any of Defendant's properties involved in foreclosure proceedings? Is the defendant’s business well-established or is it new? Has defendant operated under a number of other corporate names in the past?

2. Perform a Google search. Are there negative reviews, comments or complaints about Defendant on the Better Business Bureau’s website, on RipoffReport.com or in someone’s personal blog?

3. Trust your gut. If it waddles like a duck and it quacks like a duck, it’s probably a duck.

4. Write a CYA (Cover Your Ass) letter. Write a letter to your client outlining your findings and advising that litigation may result in nothing more than a paper judgment. If the client insists on proceeding with the lawsuit, ask the Client to confirm his or her decision in writing.

5. Get out while the getting is good! Even when my clients chose to proceed, I generally opt to reject the case or ask to be relieved from pending litigation. In my opinion, paying for a paper judgment is like spending the day feeding dollar bills into a Skee-Ball machine only to be rewarded with a cheap plastic key fob.

Liability and damages are important but they don't mean anything if, as is frequently the case in this economy, a judgment isn't collectible. Do your research, litigate responsibly and never squander your client's precious retainer fees when it appears that you may be trying to get blood from a stone.

Comments (3)

Solid advice Marshall.

Do you bother with a preliminary injunctions to secure that the funds are available? If you don't, why not?

Fred,

Thanks for your feedback!

The first problem with an injunction is that it assumes a plaintiff knows where the defendant's assets are located. This is rarely the case.

To make matters more difficult, the financial resources of either party to a civil suit are irrelevant and not discoverable before trial. Dufresne v. Duemler, 108 A.D.2d 1102, 485 N.Y.S.2d 879 (3d Dept. 1985).

Even if a Plaintiff knows the whereabouts of defendant's assets, a preliminary injunction isn't available in an action seeking solely money damages. See CPLR 6301; Credit Agricole Indosuez v. Rossiyskiy Kredit Bank, 94 N.Y.2d 541, 708 N.Y.S.2d 26 (2000).

Attachment is available but it's allowed in the very limited circumstances outlined in CPLR 6201. Even then, attachment is considered a drastic remedy because it deprives defendant of its property before a determination on the merits.

As I indicated in my post, collectibility is a tricky issue and it isn't given nearly enough attention at the law school level.

Thanks for the great question!

Marshall

Excellent post and so true. I think would make a great brochure to hand out to potential clients.

However, I would be careful about how much stock one puts into BBB. They have been shown to have a bias in favor of paying members.

In any case pre-litigation asset evaluation is far from an exact science and I agree strongly with your #3 above. In these cases I push for a settlement strategy. Often something can be worked out that is more than blood from a stone, albeit less than typical client expectations.

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This page contains a single entry from the blog posted on October 25, 2010 6:17 PM.

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