Chapter IX. Litigation

JurisdictionUnited States

IX. Litigation

Despite a creditor's best efforts at settlement, litigation might be necessary to resolve a dispute with a debtor. This section discusses the procedure for filing lawsuits, then addresses common claims that creditors can raise against the defaulting debtor.

A. Procedure

1. Rules of Civil Procedure

In federal courts, the procedure for conducting civil lawsuits is found in the Federal Rules of Civil Procedure.118 The Rules are designed to "secure the just, speedy, and inexpensive determination of every action and proceeding."119 "Just," "speedy" and "inexpensive" can vary in the eye of the beholder, but every federal court aims for this goal.

State courts have their own rules of civil procedure, which, depending on the rule, may match or differ significantly from the federal rules. Generally, a court applies the rules of civil procedure of their home jurisdiction.120 If a creditor files a lawsuit in Kansas state court, the Kansas Rules of Civil Procedure apply. If a creditor files in federal court in Iowa (or any federal court), the Federal Rules of Civil Procedure apply. Procedural rules are intricate, and procedural failures can be fatal to an otherwise meritorious case. Moreover, procedural rules change, sometimes more than once each year. Creditors' counsel should stay abreast of changing rules and pay close attention to requirements and deadlines while conducting a lawsuit.

2. Litigation Process

Notwithstanding variations in procedural rules, lawsuits normally follow a formula common across all jurisdictions. To start a lawsuit, the plaintiff files a complaint or a petition,121 which explains in numbered paragraphs the identity of the parties, why the court has jurisdiction over the parties, the background facts, and the legal claims against the defendant. For example, a plaintiff seeking payment under a contract may identify its and the defendant's names and states of citizenship, explain why the court has jurisdiction over the parties, detail facts showing how and when the parties entered the contract, and assert a legal claim for breach of contract. The complaint provides the basis for the remainder of the lawsuit; essentially, if a legal claim is not addressed in the complaint, the claim is not part of the lawsuit unless the complaint is later amended to add it.

After the complaint is filed and served on the defendant — service being a particular way of notifying the defendant about the lawsuit — the defendant has a certain amount of time to file an answer or a motion to dismiss. An answer must admit or deny every allegation in the complaint, meaning the answer must address each numbered paragraph: admitting it, denying it, or stating that the defendant lacks enough information to answer truthfully (which operates as a denial).122 Any allegation that is not answered is deemed admitted.123

As an alternative to an answer, the defendant may file a motion to dismiss. While there are several bases for such a motion, the most typical basis is the complaint's failure to state a legal claim.124 A motion to dismiss for failure to state a claim argues that, even if every fact stated or implied in the complaint is true, the law does not provide any relief for a plaintiff.125 For instance, a complaint filed by a business asserting claims under consumer protection laws might be subject to dismissal because the consumer protection statute does not protect businesses. If granted, a motion to dismiss disposes of the claim(s), ends the litigation, and may prohibit the party from filing a new complaint based on the same facts.

If the case continues past the answer or motion-to-dismiss stage, parties generally enter the discovery phase of the process. Discovery allows both parties to request and exchange internal (and often confidential) documents, communications or other data relevant to the dispute. Because of the amount of documentation and the potential breadth of the claims, discovery can be an expensive, time-consuming and generally onerous process for a creditor to endure. In addition to documents, the creditor may need to prepare a witness or witnesses for oral depositions. Finally, the creditor may need to obtain expert witnesses in certain cases.

Discovery can easily turn into the costliest phase of the litigation process. In fact, "[b]y some estimates, discovery costs now comprise between 50 and 90 percent of the total litigation costs in a case."126 Because costs add up quickly during this phase, creditors should perform a cost/benefit analysis of the claim before entering discovery. A quick settlement at the beginning of litigation may generate the most revenue.

Following discovery, the parties have the option of filing a motion for summary judgment. A motion for summary judgment asks the court to decide the dispute as a matter of law. "On a motion for summary judgment, 'facts must be viewed in the light most favorable to the non-moving party only if there is a "genuine" dispute as to those facts.'"127 "Where the [factual] record taken as a whole could not lead a rational trier of fact to find for the non-moving party, there is no genuine issue for trial," so summary judgment is appropriate.128 Granting the motion operates as a judgment without the need for trial. Denying the motion allows the case to go to trial.

After discovery ends, and pending any motions for summary judgment (or other motions), the parties next prepare for trial. The trial may occur before a judge or a jury. Depending on the complexity of the case, the trial can take anywhere from a few hours to several weeks. At this point in the litigation, the parties likely have significant evidence to organize, evaluate and prepare for presentation to the judge or jury. To the extent not already prepared in prior motions, the parties must also develop legal arguments based on the available evidence. Like discovery, trial can be a costly endeavor, and the costs should be analyzed and forecasted in advance.

3. Duration of Litigation

While litigation can certainly be fast-paced at times, trials are often scheduled well into the future. The time between the complaint and judgment after trial depends on the jurisdiction. In the federal system, some courts are known to be faster than others. The Eastern District of Virginia is known as the "rocket docket" due to its reputation for disposing of cases in as little as six months. Even so, the median time to resolve a case in the Eastern District of Virginia is just over 13 months.129

Other courts' median times between complaint and trial exceed three years.130 State courts vary as well, with highly populous states like California shouldering a heavy caseload and long waits before trial. Regardless of the jurisdiction, any party entering litigation should expect an 18-monthor-longer wait before resolving the matter through trial.

B. Common Legal Claims

When filing a complaint, the most common legal claim against debtors is for breach of contract. In general, loan agreements define a default as a material breach of the agreement. A breach-of-contract action requires showing these elements: "(1) the existence of the contract, (2) plaintiff's performance or excuse for nonperformance, (3) defendant's breach, and (4) the resulting damages to the plaintiff.."131 Each state may use slightly different wording, but the basic elements are the same.132

While a breach-of-contract action seems straightforward (and even a slam-dunk with a defaulting debtor), creditors should be aware of other court requirements and contract provisions that can alter the course of litigation. Several courts require civil cases to undergo mediation before the court allows entering the trial phase before a judge.133 These procedures are taken very seriously by the courts, even requiring the in-person attendance of all parties, their attorneys and their insurers.134

Also, creditor contracts often require the arbitration of all disputes between the creditor and the debtor. While the U.S. Supreme Court has generally favored enforcement of arbitration clauses in contracts,135some states have found mandatory arbitration to be void, including in the creditor/debtor context.136 Creditors should consult with counsel in the event that the contract's arbitration clause is contested by the debtor. Finally, creditor contracts often include a forum-selection clause, which requires the litigation of any claims against or under the contract in a pre-selected court.137 If a debtor filed a lawsuit against the creditor in a different court, the lawsuit would be subject to a motion to transfer.138 Here again, a lawyer's advice on forum-selection clauses is invaluable.

C. Piercing the Corporate Veil

From time to time, a creditor may find that a business debtor in default has no assets. Without any assets, a judgment against the debtor is essentially worthless. However, in certain instances, courts allow a creditor to obtain judgment against the business debtor's owner(s), shareholder(s) or member(s). This legal theory is called piercing the corporate veil.

"The general rule ... is that a corporation exists independently of its owners, who are not personally liable for its obligations, and that individuals may incorporate for the express purpose of limiting their liability."139 "The concept of piercing the corporate veil is an exception to this general rule, permitting, in certain circumstances, the imposition of personal liability on owners for the obligations of their corporation."140 "[V]eil-piercing is usually applied to closely held corporations," but "there's no rule that publicly traded companies are exempt" from veil piercing.141

While the language of state laws varies, the underlying requirements are relatively similar. In general, a creditor must show that (1) the business entity and its owner operated as a single economic entity142 and (2) there was an overall element of injustice or unfairness.143 To determine whether the company and...

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