Appeal from the United States District Court for the Northern District of Illinois, Eastern Division.
No. 94 C 3277 Elaine E. Bucklo, Judge.
Before POSNER, Chief Judge, and BAUER and RIPPLE, Circuit Judges.
This appeal from a judgment for the plaintiff in a diversity suit governed by Illinois law presents difficult questions concerning appellate jurisdiction, the common law of restitution, and statutes of limitations. Lawyers Title, the plaintiff, is a title insurer. Dearborn Title, now defunct and, it appears, assetless, was an escrow and closing agent and also served as Lawyers' agent for the issuance of title insurance policies in Illinois. Lawyers Title sued Dearborn to recover money that Lawyers had paid to its insureds who had incurred losses as a result of Dearborn's mishandling of real estate transactions involving those insureds. After getting a default judgment for $5.9 million against Dearborn, Lawyers Title filed supplemental proceedings under Fed. R. Civ. P. 69(a) against United Financial Mortgage Corporation, claiming that Dearborn had paid United -- a mortgage lender that was Dearborn's biggest customer -- some $654,000 by mistake, and alternatively that the payment of this money was a fraudulent conveyance. As Dearborn's judgment creditor, Lawyers Title is entitled to recover this money from United if Dearborn would have been entitled to do so. 735 ILCS 5/2-1402(c)(3); Bentley v. Glenn Shipley Enterprises, Inc., 619 N.E.2d 816, 819 (Ill. App. 1993).
The district judge granted summary judgment for Lawyers Title (without, however, addressing Lawyers' alternative ground -- fraudulent conveyance) for all but $70,000 of the money it sought, reserving that claim for trial and entering judgment under Fed. R. Civ. P. 54(b) for the balance so that United could appeal immediately. 939 F. Supp. 611 (N.D. Ill. 1996). The judge was empowered to do this only if Lawyers' claim for the recovery of the $70,000 is a separate claim from the claims she allowed. Whether it is or not is a difficult question but one that cannot be discussed intelligibly until we have set forth the facts and contentions presented in the appeal.
United Financial is a middleman in the mortgage loan market. It makes the loan to the mortgagor and then sells the loan to a bank or other financial institution. It used Dearborn as its escrow and closing agent. That is, United would deposit the money for the loan with Dearborn, which would place the money in an escrow account, handle the closing, and upon its completion disburse the money in the account to the mortgagor, refinancing bank, or seller, depending on the nature of the transaction to which the loan pertained. Lawyers Title had insured the borrower's title in some of these transactions, and so in effect had insured some of the funds deposited in Dearborn's escrow accounts. That is why it incurred losses when Dearborn lost, or more likely stole, the funds. So far as appears, United Financial did not lose any of its own money that had been deposited in Dearborn's escrow accounts.
The judgment that United Financial is appealing from is based on two checks that Dearborn gave United. One, for $87,800, was to reimburse United for advancing funds to Dearborn for transfer to a couple named Larios who were refinancing a mortgage loan they had gotten from United. United had never advanced those funds, so there was nothing for Dearborn to reimburse. Therefore, under the most elementary principles of restitution, Dearborn -- and so Lawyers Title standing in its shoes -- was entitled, at least prima facie, to the return of the $87,800, the money having been paid to United on the mistaken assumption that it was to reimburse United for the advance of a like sum to Dearborn. Allstate Life Ins. Co. v. Yurgil, 632 N.E.2d 282, 285 (Ill. App. 1994); Blue Cross & Blue Shield United v. Marshfield Clinic, 65 F.3d 1406, 1414 (7th Cir. 1995); Restatement of Restitution sec. 18 (1937). We do not understand United to be contesting Lawyers' prima facie entitlement to this money. But it seeks to retain it by way of setoff, for we shall see in a moment that United claims that Dearborn may have owed it more than $654,000.
The other check that Dearborn gave United was for $566,000. If that was money that Dearborn owed United, then United is entitled to keep it; for this is not a preference suit, which would be a suit brought by a trustee in bankruptcy. 11 U.S.C. sec. 547(b). Dearborn did not declare bankruptcy within 90 days after the check was honored, and there is no suggestion that United or any of its principals could be characterized as "insiders" of Dearborn within the meaning of 11 U.S.C. sec. 547(b)(4)(B), which allows more time for setting aside preferences for insiders. Indeed, so far as we can determine, Dearborn has never filed for bankruptcy, though it is unquestionably insolvent.
The check was not drawn in response to a bill or series of bills or any other written demand by United for payment. Extensive discovery turned up no bookkeeping entry or other documentation of debts owed United by Dearborn. Although the check was deposited in United's corporate account and cleared, the receipt of the money was nowhere recorded in United's books of account. Despite its rather grand name, United Financial Mortgage Corporation was a small company when these payments were made; and its principal, Khoshabe, claims to be a lousy bookkeeper. Dearborn's principal, Rasulis, is under criminal investigation and took the Fifth Amendment when asked to explain the basis for this large payment to United.
The irregular way in which United accounted for the check, coupled with the fact that Dearborn went bellyup several months after the check was issued, and with the halo of fraud that surrounds Rasulis and the lack of any documentation of a debt, creates an almost irresistible inference that Rasulis and Khoshabe conspired to defraud Dearborn's other creditors and the Internal Revenue Service, and that the two checks were a fraudulent conveyance by Dearborn to United. An issue critical to both of Lawyers Title's theories of liability, however (payment by mistake and fraudulent conveyance), is whether, despite appearances, the check for $566,000 discharged a liability of Dearborn to United and thus was neither mistaken nor unsupported by consideration. (The other check, the one for $87,800, was clearly paid by mistake if it was not a fraudulent conveyance.) United argues that the check was, in fact, in discharge of three distinct types of liability:
First, Khoshabe testified in his deposition that Dearborn had made an oral contract with United to pay a penalty, for every check that it gave United that bounced, equal to the face amount of the check, and that the total amount due United under this oral contract might have reached $300,000. Second, Dearborn had, again according to Khoshabe, agreed to pay United a rental fee for every closing that took place at United's offices. The fee was $100 if the mortgage lender was not United, $300 if it was. The maximum due United under this "contract" was $210,000. We are still short of $566,000, but Khoshabe testified, in the third place, that Dearborn was also liable to United in tort for costs imposed upon United by Dearborn's delays in closing United's loans, delays that sometimes thwarted advantageous sales of the loans. Khoshabe thinks that the total costs of these delays may have been as much as $140,000, in which event Dearborn owed United far more than the $566,000 that it had paid United with the second check.
Lawyers Title argues that neither the bounced-check penalty nor the extra rental fees when United was the lender were lawful, and therefore neither item represented a real debt. Illinois like all other states does not enforce penalty clauses in contracts. (For a global perspective, see Ugo Mattei, "The Comparative Law and Economics of Penalty Clauses in Contracts," 43 Am. J. Comp. L. 427 (1995).) Parties to a contract can agree on the amount of damages if there is a breach, but for such a "liquidated damages" clause to be enforceable it must be a reasonable estimate of what the promisee's losses are likely to be in the event of a breach. Bauer v. Sawyer, 134 N.E.2d 329, 333 (Ill. 1956); Saunders v. Michigan Ave. Nat'l Bank, 662 N.E.2d 602, 609 (Ill. App. 1996); Lake River Corp. v. Carborundum Co., 769 F.2d 1284, 1289-90 (7th Cir. 1985); 3 E. Allan Farnsworth, Farnsworth on Contracts sec. 12.18, pp. 283-84 (1990). This rule has come in for a lot of academic criticism, running along the following lines. A penalty clause has no effect on anyone except the parties, so why should a court refuse to enforce it, unless there is evidence of fraud or other overreaching not here argued? Penalty clauses can serve a valuable signaling device: by agreeing to a penalty Dearborn manifested a credible determination to break itself of what had become a bad habit of paying its debts to United with checks that bounced. A penalty clause makes particularly good economic sense if there is some probability that a breach will go undetected -- for example, if the seller could plausibly blame the buyer for the failure of the seller's product to perform as intended. In such a case, without a penalty clause the seller's expected damages liability will be less than the buyer's actual damages and there will be too many breaches from the standpoint of economic efficiency. It can even be argued that a penalty clause is unlikely to overcompensate the promisee if an ex ante (before the fact) perspective is employed, because the promisor would not agree to such a clause unless it was necessary to compensate the ...