Kentucky and Indiana Mechanic's Liens

Article 9 of Uniform Commercial Code

“Tips, Tricks & Traps”
The Legal Collection Process

Witness Preparation

Indiana Collection Law Review

Kentucky Collection Law Review

Commercial Collection Cases: Special Issues and Concerns

Effective Use of the Credit Application

Commercial Collection Cases: Special Issues and Concerns

I. [3.1] Introduction

As compared to consumer debts, there are significant differences in the procedures employed and the applicable laws governing the collection of commercial debts. This chapter will address many of the practical and legal issues that confront the practitioner in the collection of commercial obligations. In particular, it will address the following topics: (1) proper identification of the commercial claim; (2) ethical considerations which may arise in commercial collection; (3) proper review and analysis of the commercial claim; (4) special remedies that may be available in a commercial transaction; (5) the extraordinary remedy of “piercing the corporate veil” of a corporation or limited liability company; (6) suggested procedures to be employed before filing suit; and (7) the commercial collection lawsuit.

The chapter is not intended to provide an exhaustive analysis of this subject. Rather, it is designed to assist in the proper recognition and identification of important legal and procedural issues within the context of commercial collections. In addition, the chapter is intended to assist the commercial collection practitioner in the development and improvement of streamlined handling procedures and “fast track” litigation techniques. A significant percentage of commercial collections are performed on a contingent fee agreement. In order to operate a volume contingent collection practice profitably, it is incumbent upon the collection practitioner to establish standard operating procedures to ensure the consistent and efficient handling of collection referrals. Periodic review of the various processes better ensures overhead minimization and profit maximization per collection matter.

II. [3.2] Identification of the Commercial Claim

Upon receipt of a collection matter, counsel should determine whether the case is a commercial collection as opposed to a consumer or retail collection case. Given the potential liabilities associated with the collection of retail debt, it is incumbent upon the collection practitioner to properly differentiate between these two types of collection cases. While the differences may seem obvious, and the intent of the creditor extending the credit may seem clear, ambiguities are common. Black’s Law Dictionary defines “commercial” as follows:

Relates to or is connected with trade and traffic or commerce in general; is occupied with business and commerce.

While there is no specific definition for commercial debt, “consumer debt” is defined as:

Debt incurred by an individual primarily for a personal, family, or household purpose.

The collection practitioner should adopt a conservative approach in ascertaining the nature of the debt in any given case. Probably the safest means of distinguishing commercial debt from consumer debt is to use the process of elimination in order to determine whether the debt could not be construed as a consumer transaction. The provisions of the Fair Debt Collection Practices Act, 15 U.S.C. § 1692 (1977), et. seq., (“FDCPA”), apply to consumer transactions but not to commercial transactions. The majority and prevailing view of reported decisions construing the nature of a debt under the FDCPA is to examine the nature of the underlying transaction. If the nature of the underlying transaction is for a personal, family or household purpose, the obligation to pay is a consumer debt governed by the FDCPA.

There have been some aberration opinions including Sluys v. Hand, 831 F. Supp. 321 (S.D.N.Y. 1993), wherein the court cited the FDCPA’s definition of “consumer” as meaning “any natural person obligated or allegedly obligated to pay any debt.” The court held “this definition covers business debts if incurred by a sole proprietor.” In another similar decision, Moore v. Principal Credit Corp., 1998 WL 378387 (N.D. Miss. 1998), the court determined that a proprietor can be considered a consumer when contacted by a collector at home.

However, the majority view remains that a business obligation incurred by a natural person is not subject to the FDCPA. For example, in Beaton v. Reynolds, Ridings, Vogt & Morgan, 986 F. Supp. 1360 (W.D. Okla. 1998), the court found that materials ordered by the debtor (a self-employed certified public accountant) were for use in her business. The court used the “underlying transaction” analysis and determined the debt to be commercial. The court found irrelevant the debtor’s claim that the materials were not actually used in her business.

III. [3.3] Ethical Considerations

A. [3.4] Potential Conflicts of Interest

It is not uncommon for the commercial practitioner to receive multiple collection referrals against the same debtor. Potential conflicts of interest can arise. When addressing possible conflicts, the practitioner should look to the Kentucky Rules of Professional Conduct found at Supreme Court Rule (“SCR”) 3.130. With regard to conflicts of interest, the Rules of Professional Conduct provide the following:

(a) A lawyer shall not represent a client if representation of that client will be directly adverse to another client, unless:

(1) The lawyer reasonably believes the representation will not adversely affect the relationship with the other client; and

(2) Each client consents after consultation.

(b) A lawyer shall not represent a client if representation of that client may be materially limited by the lawyer’s responsibilities to another client or to a third person, or by the lawyer’s own interest, unless:

(1) The lawyer reasonably believes the representation will not be adversely affected;

(2) The client consents after consultation. When representation of multiple clients in a single matter is undertaken, the consultation shall include explanation of the implications of the common representation and the advantages and risks involved.

SCR 3.130(1.7).

There are obviously an infinite number of examples where the specific facts of any given case could impair the lawyer’s ability to represent multiple clients against the same debtor. Of course, there will be times, after proper disclosure and consultation with each client, that common representation may be advantageous to the respective clients. However, one cannot overstate the importance of making this determination on a case-by-case basis. There may be occasions where merely seeking consent could be a violation of confidences of the initial existing client. For example, see Supreme Court Rule 3.130(1.6), which states in pertinent part:

(a) A lawyer shall not reveal information relating to representation of a client unless the client consents after consultation, except for disclosures that are impliedly authorized in order to carry out the representation . . . .

One possible scenario could include a lawyer being consulted by a creditor about the possibility of filing an involuntary petition in bankruptcy against a debtor from whom the lawyer has recently garnished funds on behalf of another client. In this instance, representation of the second client could jeopardize the rights of the original client’s recovery. In addition, attempting to seek consent could result in possible violation of confidential information. Accordingly, the collection practitioner may often find that the best and safest alternative is to simply decline employment.

B. [3.5] Unauthorized Practice of Law

Supreme Court Rule 3.020 states in pertinent part:

The practice of law is any service rendered involving legal knowledge or legal advice, whether of representation, counsel or advocacy in or out of court, rendered in respect to the rights, duties, obligations, liabilities, or business relations of one requiring the services.

It is common to employ non-lawyers in a collection practice in various capacities, including paralegals and collectors. Frequently, these individuals are actively involved in the pre-litigation collection phase of the case, such as settlement and workout agreements, as well as during the litigation and post-judgment collection process. Care should be exercised in ensuring that non-lawyers are not rendering services which may be considered the unauthorized practice of law. Supreme Court Rule 3.130(5.3) sets forth the duty to make reasonable efforts to supervise and oversee the non-lawyer’s conduct. In addition, Supreme Court Rule 3.700 is a comprehensive rule outlining the rights, duties, and responsibilities of the lawyer in regard to paralegals. Subsection 2 of Supreme Court Rule 3.700 recognizes the practical necessity of allowing paralegals to perform important functions which are specifically excluded from the unauthorized practice of law so long as the client understands the paralegal is not a lawyer and the lawyer supervises the paralegal in performing said duties. Paralegals and other non-lawyers should be clearly identified as non-lawyers in all communications with clients and other third parties.

C. [3.6] Fees

While the collection practitioner may be retained on an hourly basis, contingent fee agreements between creditors and their collection counsel are more common. Contingency fee agreements must be specific and must be in writing. Supreme Court Rule 3.130 (1.5) states in pertinent part:

(c) … a contingent fee agreement shall be in writing and should state the method by which the fee is to be determined, including the percentage or percentages that shall accrue to the lawyer in the event of settlement, trial or appeal, litigation and other expenses to be deducted from the recovery, and whether such expenses are to be deducted before or after the contingent fee is calculated. Upon recovery of any amount in a contingent fee matter, the lawyer shall provide the client with a written statement stating the outcome of the matter and showing the remittance to the client and the method of its determination.

Needless to say, contingent fee agreements should be clear and concise, thus reducing the possibility of any misunderstanding. No attorney wants to become the subject of a fee controversy which could result in time-consuming, as well as expensive, legal fee arbitration pursuant to Supreme Court Rule 3.810.

Once counsel has agreed to accept employment, an acknowledgment should be sent to the client confirming receipt of the matter, the fee agreement, and any other specific terms under which employment is being accepted. A sample initial acknowledgment letter is included in the Appendix to this chapter at Section [3.40]. A sample contingent fee agreement is also included in the Appendix at Section [3.41].

Important considerations for the collection practitioner include additional or supplemental fee arrangements in the event of affirmative defenses or counterclaims. Additional consideration should be given in the event of an appeal or in the event a preference claim may develop months after the fact.

IV. [3.7] Review and Analysis of the Commercial Claim

Without intending to oversimplify the nature of retail collection matters, the typical retail collection matter is a “point and shoot” collection mission. In the typical case, the attorney is collecting a debt based upon an installment note or credit card agreement, for a specific liquidated balance due, from a specific debtor or co-debtors. The retail case is generally supported with substantive detailed information about the debtor(s), which may include name, address, phone number, employment, social security information and other non-public information.

In contrast, the attorney in a commercial case may be supplied with little more than the name of a business (which may be a trade style or assumed name), a balance due, and perhaps a statement of account. The nature of open account commercial trade debt is such that it is common for a credit grantor to extend thousands of dollars of credit to a business entity with little, if any, specific information about the correct legal identity of the business, its ownership, or its financial stability.

Initial review of the commercial referral should include an examination of the client’s file and all documentary evidence in support of the claim. An early determination of the strengths and weaknesses of the creditor’s claim will ensure a more efficient and profitable handling of the case. The initial consultation with the creditor as well as a review of the creditor’s documentary evidence should reveal if the following are available:

(a) A written contract between the parties. This may consist of a variety of purchase orders and/or order acknowledgments. It may be as simple as an invoice and statement of account.

(b) A signed credit application.

(c) Personal guaranties executed by the principals of a corporation or other third party guarantors.

(d) Promissory notes.

(e) Payment and/or performance bonds.

(f) Lease agreement.

(g) Itemized invoices.

(h) Itemized statements reflecting debits and credits.

(i) Proofs of delivery.

(j) Copies of checks for prior partial payments received, including insufficient funds checks.

(k) Written acknowledgments of the debt from the debtor, including promises of payment.

(l) Correspondence sent by the creditor confirming prior promises of payment, disputes, and attempted resolution.

(m) Records of collection attempts and collector notes made by the credit grantor or any other third party collecting agent.

In reviewing the documentary evidence available to support the creditor’s claim, counsel should be better able to evaluate and determine the following:

(a) The prospects of collection of the claim (with or without suit), taking into account any prior experience against the debtor.

(b) The terms of the contract between the parties.

(c) The existence of known disputes or threatened counterclaims.

(d) The quantity and quality of supporting documentary evidence, as well as availability of potential witnesses in the event a lawsuit should become contested.

(e) The possibility of litigating in a hostile venue.

(f) The creditor’s expectation. Does the client want money or a “pound of flesh?”

V. [3.8] Identifying Special Remedies

While the vast majority of commercial collection referrals involve the collection of a debt on an open account for goods sold and delivered, the specific facts of any given case may entitle the creditor to special remedies that may enable greater leverage. Some of the following remedies may be covered in more detail in other chapters of this handbook. The remedies below are some of the more common confronted by the commercial practitioner. The intent in listing the remedies is to promote recognition, rather than provide a detailed analysis.

A. [3.9] Right of Repossession Pursuant to a Security Agreement

Assuming the creditor possesses a valid and enforceable security agreement against specific collateral pursuant to KRS 355.9-203 and has properly perfected that interest, the creditor is entitled to the various remedies provided to an Uniform Commercial Code Article 9 secured party, including, but not limited to, the right to take possession after default as provided in KRS 355.9-609.

B. [3.10] Reclamation

There is a potentially effective, and often overlooked, remedy available to the seller/creditor who has recently shipped goods to a buyer who is soon thereafter discovered to be insolvent. KRS 355.2-702 provides in pertinent part:

(2) Where the seller discovers that the buyer has received goods on credit while insolvent he may reclaim the goods upon demand made within ten (10) days after the receipt, but if misrepresentation of solvency has been made to the particular seller in writing within three (3) months before delivery the ten (10) day limitation does not apply. Except as provided in this subsection the seller may not base a right to reclaim goods on the buyer’s fraudulent or innocent misrepresentation of solvency or of intent to pay.

(3) The seller’s right to reclaim under subsection (2) is subject to the rights of a buyer in ordinary course or other good faith purchaser under this article (KRS 355.2-403). Successful reclamation of goods excludes all other remedies with respect to them.

However, this remedy is limited in a number of ways. First, there is the issue of whether the buyer is truly insolvent. KRS 355.1-201(23) provides that the person is insolvent when he “either has ceased to pay his debts in the ordinary course of business or cannot pay his debts as they become due or is insolvent within the meaning of the federal bankruptcy law.”

Furthermore, the seller must make a demand for return of the goods within ten days after the buyer receives them. The ten-day limitation does not apply if misrepresentations of solvency have been made to the particular seller in writing within three months before delivery. In the event the debtor should file bankruptcy within ten days of receipt of goods, written notice is required when making the demand and additionally, the creditor’s time for making the written demand, for reclamation is extended an additional ten days in this instance.

Finally, it should be understood that the rights of the reclaiming seller are subject to the rights of buyers in the ordinary course of business or other good faith purchasers. In particular, the reclaiming seller may find itself competing with the debtor’s lending institution, which commonly holds a previously perfected security interest in all goods of the debtor, including inventory. While the case law is mixed on this issue, most courts seem to favor the rights of the secured lender. A detailed analysis of the rights and limitations of the reclaiming seller can be found in the reference book titled The Uniform Commercial Code of Kentucky. David J. Leibson & Richard H. Nowka, The Uniform Commercial Code of Kentucky, § 2.6(F)(5) (2d ed. 1992).

C. [3.11] Mechanic’s Liens/Payment Bonds

If available, mechanic’s liens and possible payment bond rights can offer an excellent source of leverage in instances where the creditor has provided labor or furnished materials for erection, alteration or repair, and other improvements upon real estate. For a detailed analysis of mechanic’s liens and bond rights, see Chapter 7 herein.

Mechanic’s liens, while effective, are subject to very specific and stringent limitation. Careful analysis should be made to determine whether pre-lien notice is required. In addition to the possibility of required pre-lien notice, careful effort should be made not to miss the appropriate lien deadlines pursuant to KRS 376.010 and KRS 376.080.

Mechanic’s liens, being creatures of statute, are strictly construed by the courts. For example, in Laferty v. Wickes Lumber Co., 708 S.W.2d 107 (Ky. Ct. App. 1986), the Kentucky Court of Appeals found that statutory provisions for perfecting the lien must be strictly followed or the lien claim is lost. In Laferty, Wickes argued that the timely filing of litigation within the mechanic’s lien notice period constituted compliance with placing the debtor on written notice. The court rejected Wickes’ argument and held that a complaint, although written and served, does not substitute for or constitute the written notice required by the statute and therefore did not serve to perfect the Wickes’ lien.

Additionally, counsel should be aware that there is a completely different set of statutes relating to liens for labor and/or materials provided on public property that represent public improvements. Rather than acquiring a lien against the real estate, the claimant acquires a lien against funds due the contractor. Pertinent statutes include KRS 376.210, which defines the creation of the lien, and KRS 376.230, which details the necessary steps and extremely stringent time deadlines to properly perfect and enforce a public improvement lien. Should the property on which the improvement occurred be “public work” for the use and benefit of the United States government, counsel will need to review “The Miller Act,” found at 40 U.S.C. §§ 270a-270d-1. The Miller Act provides bond rights for the protection of persons furnishing labor and materials.

Finally, even if counsel determines that any possible mechanic’s lien rights have expired, inquiries should be made to determine the possible existence of any payment bonds. This type of bond may inure to the benefit of the client as a contemplated and intended third party beneficiary of the bond contract. Payment bonds may offer the creditor and creditor’s counsel yet another source of possible collection. Like any other contract, payment bonds are not without limitation, and efforts should be made to obtain a copy of any payment bond as quickly as possible to ensure compliance with any pre-suit notice requirements and to ensure that the claimant is within the scope of the intended protection provided by the bond.

D. [3.12] Attorney Fees

Attorney fees and collection costs are recoverable pursuant to KRS 411.195, which provides as follows:

Any provisions in a writing which create a debt, or create a lien on real property, requiring the debtor, obligor, lienor or mortgagor to pay reasonable attorney fees incurred by the creditor, obligee or lienholder in the event of default, shall be enforceable, provided, however, such fees shall only be allowed to the extent actually paid or agreed to be paid, and shall not be allowed to a salaried employee of such creditor, obligor or lienholder.

In addition to providing additional leverage during pre-suit collection, agreements that provide for the payment of attorney fees can be helpful in conjunction with settlement negotiations after the suit has been filed and during post-judgment collection. Terms incorporating payment of attorney collection fees can sometimes be incorporated into pre-suit workout agreements (as will be discussed in greater detail below in regard to workout techniques in Section [3.26]) in the event the client does not have the benefit of a credit agreement or other contract providing for payment of these expenses.

However, the collection of attorney fees and collection costs are not without limitation. In both Capitol Cadillac Olds, Inc. v. Roberts, 813 S.W.2d 287 (Ky. 1991) and Dingus vs. FADA Service Co., Inc., 856 S.W.2d 45 (Ky. Ct. App. 1993), the courts limited the attorney fees and based the award on “the time involved, the task assigned, and the degree of difficulty of work under the circumstances” in obtaining judgment against the defendants. The practical problem with using these guidelines to award attorney fees is that the assumption must be made that the losing defendants will promptly pay any judgment rendered, including any court-awarded fees. In the vast majority of cases, more time is expended effecting collection subsequent to the entry of judgment than prior thereto.

What about in those instances where the case is not contested? Many courts will still consider the circumstances of the case in awarding requested fees. Jefferson Circuit Court 404 requires any request for attorney fees to include an itemization of time expended by: date; service rendered; the nature of the service rendered; the name of the person(s) performing said service and the time they expended; total time; and a reasonable amount of compensation per hour. This is to be in the form of an affidavit, and if the request is pursuant to KRS 411.195, it should be supported with a showing that the requested fees have been paid, or have been agreed to be paid, by the party seeking enforcement.

Court-awarded collection costs and/or attorney fees can be a source of great confusion to the client. Educating the client about the enforceability of agreements for the payment of these expenses is recommended.

E. [3.13] Guaranties

Personal continuing guaranties of payment are commonly used by commercial creditors to obtain a guaranty of payment from the principals and owners of corporations and limited liability entities. Kentucky has a stringent statute regarding the enforceability of guaranties. KRS 371.065 provides the following:

(1) No guaranty of an indebtedness which is either not written on, or does not expressly refer to, the instrument or instruments being guaranteed shall be valid or enforceable unless it is in writing signed by the guarantor and contains provisions specifying the amount of the maximum aggregate liability of the guarantor thereunder, and the date on which the guaranty terminates. Termination of the guaranty on that date shall not affect the liability of the guarantor with respect to:

(a) Obligations created or incurred prior to the date; or

(b) Extensions or renewals of, interest accruing on, or fees, costs or expenses incurred with respect to, the obligations on or after the date.

Certainly, the statute makes it clear that guaranties represent an extraordinary remedy in Kentucky. Yet, the statute seems poorly written by any standard, and one must immediately wonder why the word “instrument” was used in the statute. “Instrument” is only defined in the statutes at KRS 355.3-104(2) as referring to a negotiable instrument. Given the fact that statutes are supposed to be interpreted according to the plain meaning of the words, in a narrow and conservative manner, any guaranty of an indebtedness not written on a negotiable instrument, or one which does not expressly refer to the negotiable instrument(s) being guaranteed, must contain the statutorily required maximum amount and termination date. Guaranties incorporated into credit agreements or other documents are subject to the statute.

There are few Kentucky cases that attempt to interpret KRS 371.065. Nevertheless, the Sixth Circuit Court of Appeals addressed the applicability of the statute in the context of a guaranty that included a Tennessee choice of law provision. In Wallace Hardware Co., Inc. v. Abrams, 223 F.3d 382 (6th Cir. 2000),the court, in upholding the Tennessee choice of law provision (against the Kentucky debtor and guarantors), did not find that Kentucky’s statutory restrictions on guaranties were of such fundamental interest to prevent the application of Tennessee law in enforcing the guaranty.

VI. [3.14] Piercing the Corporate Veil: Extraordinary Remedy

Frequently, the commercial collection practitioner will be faced with attempting to collect a debt from a corporation that has become insolvent. If the facts of the case warrant further inquiry, the practitioner should explore the possibility of “piercing the corporate veil” and attempting collection of the outstanding debt from the corporation’s officers and shareholders. However, this is certainly not a simple task.

The Kentucky Supreme Court has found, “[i]t is fundamental corporate law that a shareholder is not liable for the debt of the corporation unless extraordinary circumstances exist to impose liability.” Morgan v. O’Neil, 652 S.W.2d 83, 85 (Ky. 1983). The reason the law imposes such a shield is that the “[s]tockholder’s immunity from corporate obligation is fundamental to the very concept of the corporation as a separate legal entity.” Lowendahl v. Baltimore & Ohio R.R. Co., 287 N.Y.S. 62 (N. Y. App. Div. 1936), aff’d, 6 N.E.2d 56 (1936). Consequently, a court will impose liability on a shareholder only if there is a statute imposing personal liability for a corporate offense or by “piercing the corporate veil.” Morgan, 652 S.W.2d at 85.

Black’s Law Dictionary defines the phrase “piercing the corporate veil” as the judicial process whereby a court will disregard the usual immunity of corporate officers or shareholders from liability for wrongful corporate activities. Black’s Law Dictionary 1147-48 (6th ed. 1990). The approach of Kentucky courts to this process has been described as evincing “a general aversion for any disregard of the corporate entity.” See Poyner v. Lear Siegler, Inc., 542 F.2d 955 (6th Cir. 1976) (citing Rutherford B Campbell, Jr., Limited Liability for Corporate Shareholders: Myth or Matter-of-Fact, 63 Ky. L. J. 23, 48 (1975)). Nevertheless, the courts do not view the corporate persona as entirely invulnerable. “When a separate legal entity is used to justify wrong, protect fraud, or subvert public policy, then the corporate veil should be pierced and the association of persons making up the corporation should be held responsible for the corporation’s financial liabilities.” United States v. WRW Corp., 778 F. Supp. 919, 922 (E.D. Ky. 1991), aff’d, 986 F.2d 138, 143-44 (6th Cir. 1993).

The leading Kentucky case on piercing the corporate veil is White v. Winchester Land Dev. Corp., 584 S.W.2d 56 (Ky. Ct. App. 1979). In White, the plaintiff was attempting to collect on two corporate promissory notes. Id. at 59. The debtor corporation had become insolvent and had defaulted on the notes. Id. The plaintiff sought to collect the notes from the two shareholders of the corporation. In attempting to collect from the shareholders, the plaintiff argued that the corporate veil should be pierced because the corporation was a “sham” and merely the alter ego of the shareholders. Id. at 60. In deciding that it was not appropriate to pierce the corporate veil, the Kentucky Court of Appeals outlined three basic theories to utilize in determining whether to pierce the corporate veil: (1) the instrumentality theory; (2) the alter ego theory; and (3) the equity theory.

A. [3.15] Instrumentality Theory

According to the opinion in White, the following three elements must be established in order to pierce the corporate veil under the instrumentality theory: (1) that the corporation was a mere instrumentality of the shareholder; (2) that the shareholder exercised control over the corporation in such a way as to defraud or to harm the plaintiff; and (3) that a refusal to disregard the corporate entity would subject the plaintiff to unjust loss. Id. at 61.

In White, the court found that the first element of this theory was met, given that the shareholders exercised a great deal of control over the corporation insofar as they were the sole shareholders. Id. Nevertheless, the court found that the second and third elements were not met because the record was devoid of the essential elements of fraud and because the plaintiff had not suffered an unjust loss. Id. The plaintiff had not suffered an unjust loss as it could have secured the corporate loan by requiring the shareholders to sign the notes in their individual capacities. Id.

B. [3.16] Alter Ego Theory

According to White, the following two elements must be established in order to pierce the corporate veil under the alter ego theory: (1) that the corporation is not only influenced by the owners but also that there is such unity of ownership and interest that their separateness has ceased and (2) that the facts are such that an adherence to the corporation’s normal attributes, such as treatment as a separate entity, would sanction a fraud or promote injustice. Id. at 61-62.

In White, the court found that the second element was not met because there was no evidence of fraud and no great injustice existed as the plaintiff could have mitigated its losses by obtaining some type of security. Id. In addition, the first element was not met because the shareholders had complied with the “strictures” of proper corporate existence and thus “maintained the separateness of entity so vital to the legitimate corporate function.” Id.

In contrast to White, the United States district court in United States v. WRW Corp., 778 F. Supp. 919 (E.D. Ky. 1991), aff’d, 986 F.2d 138 143 (6th Cir. 1993), held that the corporate veil could be pierced under the alter ego theory. In WRW, the U.S. Justice Department attempted to pierce the corporate veil to collect civil penalties assessed against a corporation for violating the Federal Mine Safety and Health Act. Id. at 920. The court held that both elements under the alter ego theory had been met and it was thus appropriate to pierce the corporate veil. In regard to the first element, the court found that the three sole shareholders were not observing corporate formalities and that there was thus no distinction between the personality of the corporation and the personalities of the individuals. Id. at 924. In regard to the second element, the court found that, because the Mine Safety and Health Act is concerned with protecting the country’s citizens, it would be a great injustice to allow the individual shareholders to violate the act and then avoid culpability by hiding behind a corporate shield at the expense of the public’s safety. Id.

C. [3.17] Equity Theory

If the first two theories of piercing the corporate veil do not work, the corporate veil must be pierced by utilizing a balancing act under the equity theory. According to White, in determining whether the interests of justice favor piercing the corporate veil under this theory, the following factors are to be taken into consideration: (1) undercapitalization; (2) a failure to observe the formalities of corporate existence; (3) nonpayment or overpayment of dividends; (4) a siphoning off of funds by the dominant shareholder or shareholders; and (5) whether the majority of shareholders have guaranteed corporate liabilities in their individual capacities. White, 584 S.W.2d at 62.

The White court, in balancing the above factors, held that the corporate veil could not be pierced. The court found no evidence of factors (2) through (5). Id. It found evidence of undercapitalization. Id. Nevertheless, it held that undercapitalization could not justify piercing the corporate veil because Kentucky law did not require any minimum paid-in capital before incorporation. Id. 1 Furthermore, there was no innocent and unknowing party that the court was attempting to protect from undercapitalization such as an accident victim. Id. The plaintiff was a bank that had knowledge of the corporation’s shaky financial status and could have protected itself by obtaining security for the debt. Id. at 63.

In contrast to White, the court in WRW found that the factors under the equity theory weighed in favor of piercing the corporate veil. First, there was significant evidence of undercapitalization. WRW, 778 F. Supp. at 923. However, unlike White, the plaintiff, the United States, was an innocent party that could not protect itself by the granting of a security interest or a guaranty. Id. Third, there was almost a complete failure on the part of the shareholders to observe corporate formalities. Consequently, without proper corporate authorization, the shareholders imposed their will on the corporation, and their will became synonymous with the corporation’s will. Id. at 923-24. Fourth, no corporate dividends were paid out to the shareholders. Id. at 924. Fifth, there was a commingling of the corporation’s assets and the individual shareholders’ assets. Id. Finally, almost all the corporation’s debts were guaranteed by the shareholders in their individual capacity–further blurring the distinction between the corporation and the individuals. Id.

D. [3.18] Fraud Element

Notwithstanding the above discussion regarding the three theories, it is apparent that Kentucky’s courts are more likely to pierce the corporate veil when the corporate persona has been used to defraud another party to reach a result that could not otherwise have been achieved directly by the shareholder. 2 For example, in Zanone v. Standard Oil Co., 322 S.W.2d 710 (Ky. 1959), a partnership developed serious financial troubles. As a result, the partners formed a corporation, transferred their assets to the corporation, and argued that those assets could not be attached by the partnership’s creditors because the corporation had no liability to the creditors. Id. at 710-711. The court disagreed with the partners’ argument by holding that the corporation was merely a fraudulent device to do indirectly what the partnership could not do directly, avoid its creditors. Id. at 711. As such, the court pierced the corporate veil to allow the creditors to get to the assets. Id.

Nevertheless, the proposition that a corporate entity will be ignored where it serves as a shield for fraud is not absolute. There must be evidence that the individuals against whom personal liability is sought actively participated in the fraud or were aware of its existence and did nothing about it. See Commonwealth ex rel Steven Beshear v. ABAC Pest Control, Inc., 621 S.W.2d 705 (Ky. Ct. App. 1981). In ABAC Pest Control, a corporation was found liable for acts of consumer fraud. Id. at 705. The Kentucky Attorney General sought to hold the president and sole shareholder of the corporation liable for these acts by alleging that the shareholder was using the corporate entity to relieve himself from personal liability for fraudulent activity. Id. at 706. The court disagreed with the attorney general’s argument, holding that the shareholder was not personally liable because he had not personally engaged in the fraud and had not known that the corporation’s employees were perpetrating fraud. Id. at 708.

E. [3.19] Checklist of Facts and Circumstances to Consider When Attempting to Pierce the Corporate Veil

Before filing an action to pierce the corporate veil, a practitioner will have to decide whether the facts and circumstances of his or her case warrant pursuing such an action. For the practitioner wrestling with this action, the American Jurisprudence Proof of Facts series contains an excellent checklist of the facts and circumstances a practitioner should look for in determining whether an action to pierce the corporate veil is warranted. Listed below are but a few of the factors suggested:

1. Undercapitalization.

2. Failure to observe corporate formalities.

3. Absence of corporate records.

4. Nonpayment of dividends.

5. Overpayment of dividends.

6. Insolvency of corporation at time of transaction.

7. Siphoning off of funds by the dominant shareholders.

8. Shareholders guaranteeing corporate liabilities in their individual capacities.

9. Non-functioning officers or directors.

10. Lack of officers or directors.

11. Failure to issue stock.

12. Absence of consideration for stock.

13. The corporation is a facade of the operation of the dominant shareholders.

14. The corporation has an inability to meet payroll and other obligations.

15. Commingling of funds or assets.

16. Stripping the corporation of assets in anticipation of litigation.

17. Use of corporate shell to advance purely personal ends.

18. Treatment of corporate assets as personal assets.

19. Cash advances to shareholders, officers, directors.

20. Advances to the corporation by shareholders.

21. Undocumented loans.

22. The corporation’s failure to own or lease real property.

23. The corporation’s failure to maintain bank accounts.

24. Use of multiple corporations as shields for personal dealings.

25. Use of multiple corporations to circumvent statutory requirements.

26. Contracting in individual rather than corporate name.

27. Use of individual rather than corporate checks.

28. Violation of statute or public policy.

29. Misrepresentations by corporation and/or its shareholders, officers and/or directors.

30. Actual fraud.

31. Constructive fraud.

32. Preferences to shareholders, officers, or directors who are also creditors of the corporation.

45 Am. Jur. Proof of Facts 3d 1, Grounds for Disregarding the Corporate Entity and Piercing the Corporate Veil, Mark S. Cohen (1998).

VII. [3.20] The Nuts and Bolts of Pre-litigation Work-out Attempts

A. [3.21] Initial Demand

When possible, collection without a suit is immensely more profitable. Initial written demand, followed by demand by telephone seeking an amicable and voluntary payment of the debt, is certainly recommended.

Collection of the account is the desired result, and when collection can be effected without resorting to litigation, a number of risks and expenses can be avoided. In addition to providing an opportunity for amicable resolution, written demand and telephone follow-up will enable counsel to make some additional investigations and determinations.

B. [3.22] Determination of the Proper Legal Identity of the Debtor

If there is any question as to the debtor’s correct identity, initial efforts should include a check with the Kentucky Secretary of State’s office to determine if the debtor is a legally incorporated entity or limited liability company. The information can be obtained by calling the secretary of state’s office at (502) 564-7330 or, alternatively, can be accessed online at http://www.sos.state.ky.us/corporate2/entityname.asp.

The Secretary of State’s office also maintains listings of general and limited partnerships, which can be of valuable assistance in determining the correct legal identity of a business that is not a legally incorporated entity or a limited liability company. Careful effort should be taken to determine a proper match between such entities and the creditor’s account debtor. Initial complications may arise should the debtor utilize a trade style or assumed name that may not be listed with the Kentucky Secretary of State’s office or the county clerk’s office as required by KRS 365.015. If the debtor is an incorporated entity of a limited liability company, careful note should be made as to the date that the entity became incorporated as well as a determination as to whether the entity is in good standing or possibly has had its charter revoked for any number of reasons, which would principally include the failure to file annual reports.

For debts incurred prior to incorporation, KRS 271B.2-040 provides that “all persons purporting to act as or on behalf of a corporation, knowing there was no incorporation under this chapter, shall be jointly and severally liable for all liabilities created while so acting.” Moreover, after an entity has been suspended and its charter revoked, the owners/shareholders of the business may be personally responsible for the charges. KRS 271B.6-220 states in pertinent part that “[u]nless otherwise provided in the articles of incorporation, a shareholder of a corporation shall not be personally liable for the acts or debts of the corporation except that he may become personally liable by reason of his own acts or conduct.” Accordingly, if there is no longer a corporation by virtue of dissolution or revocation of the charter, the owners/shareholders may be liable as successors to the corporate entity, in their individual capacities. Kentucky courts have addressed this situation and have held that shareholders of a corporation that has been dissolved are treated as partners and held individually liable for actions taken in the name of the corporation beyond those actions necessary to wind up the corporation’s affairs. 3 SeeSteele v. Stanley, 237 Ky. 517, 35 S.W.2d 867 (1931); Ewald Iron Co. v. Commonwealth, 140 Ky. 692, 131 S.W. 774 (1910). Prudent collection practitioners would certainly want to name these individuals as well as naming the entity itself as defendants, which can still be sued pursuant to KRS 271B.14-050(2)(e). One limitation is the ability of an entity to reinstate its charter retroactively pursuant to KRS 271B.14-220 and therefore avoid the possibility of personal liability to any owners. However, this requires an affirmative response from the debtor, and the leverage of possible personal liability may be sufficient to effect collection of the underlying balance.

C. [3.23] Service of Process Upon a Corporate Entity or Limited Liability Company

When confirming information from the office of the Kentucky Secretary of State, the name and address of the process agent for the entity as well as the entity’s principal office address should be noted. Kentucky Rule of Civil Procedure (“Civil Rule”) 4.04(5) provides:

Service shall be made upon a corporation by serving an officer or managing agent thereof, or the chief agent in the county where the action is brought, or any other agent authorized by appointment or by law to receive service on its behalf.

However, where service for any reason cannot be obtained upon the resident agent or a managing agent, there is an alternate method of service available. KRS 271B.5-040 provides in pertinent part as follows:

(2) If a corporation has no registered agent or the agent cannot with reasonable diligence be served, the corporation may be served by registered or certified mail, return receipt requested, addressed to the secretary of the corporation at its principal office. Service shall be perfected under the subsection at the earliest of:

(a) The date the corporation receives the mail;

(b) The date shown on the return receipt, if signed on behalf of the corporation; or

(c) Five (5) days after its deposit in the United States mail, as evidenced by the postmark, if mailed postpaid and correctly addressed.

(3) This section does not prescribe the only means, or necessarily the required means, of serving a corporation.

The important point is that the statute does not seemingly require actual acceptance, including a signed delivery receipt as is the case with normal service via certified mail.

Assuming the creditor does not have the benefit of an executed credit application that correctly identifies the proper legal identity of the debtor, additional sources for such information may include any number of third party credit service companies. One such company is Business Credit Service, which can be accessed by telephone at (888)274-5325 or online at http://www.businessCreditUSA.com. Another source is Dun & Bradstreet. Additional clues may include copies of checks retained by the creditor from prior partial payments. Many times the checks will include the correct legal name of the business as well as the trade style used by the debtor in its day-to-day operations. Additionally, the check information could prove extremely valuable during the post-judgment collection process.

Finally, an obvious means of attempting to determine the proper legal identity of the debtor is to simply ask the debtor during the course of making a telephonic demand for payment. It cannot be overstated that in spite of the numerous technological advancements that have improved the efficiency of information-gathering techniques for the legal collection process, the telephone remains the most powerful collection tool.

D. [3.24] Determine Why the Debtor is Not Paying

Careful review of the client’s file as well as personal contact with the debtor should assist counsel in determining why the account has not been paid. Is there any record of a dispute? Has the debtor timely raised a legitimate dispute or possible defense? Should a lawsuit be filed? Effective telephone demand and negotiation can help pinpoint the existence of real versus imagined disputes for nonpayment.

It is common to periodically receive cases against the same commercial debtors. The creditors’ counsel that handles any volume of commercial collection work will recognize the “earmarks” of the perpetual stalling debtor. Many commercial debtors are sophisticated operators who may well understand the nature of the legal collection process. All debtors would like to have more time to pay off their debt. Granting more time may make sense, particularly if counsel can improve the prospects of collection in return by securing additional leverage.

The sooner counsel can determine the specific reasons for nonpayment, the more expeditiously and efficiently counsel can make an informed legal recommendation to the client as to whether a lawsuit may be required as a means of effecting quicker collection.

E. [3.25] Specific Workout Techniques/Tools

1. [3.26] Securing a Written Acknowledgment and Promise of Payment

Once counsel determines that the debtor is simply suffering cash flow problems and needs time to pay, every effort should be made to obtain a written acknowledgment from the debtor of the debt and a promise to pay. Preferably, there should be a letter or other document signed by the debtor acknowledging the outstanding balance and making a specific promise of payment. Obvious benefits include the possibility of extracting voluntary payments from the debtor and, at a minimum, posturing the case for a much speedier resolution should a lawsuit ultimately need to be filed. A debtor who has acknowledged in writing the validity of the debt and who has made a written commitment for payment is much more inclined to follow through with voluntary payment. A debtor who is unwilling to provide a written acknowledgment of an obligation in return for more time to pay is, at best, a recalcitrant debtor who has no intention of making payment on a voluntary basis and may perhaps be attempting to preserve the right to create a belated defense or dispute for nonpayment should a suit be filed.

While a signed writing from the debtor is preferred, electronic mail (“email”) is an additional method of extracting an acknowledgment and promise of payment. Additionally, should the debtor promise to provide a written acknowledgment and promise of payment and fail to follow through, it is a good idea to send the debtor a letter confirming any telephone conversations wherein the debtor has acknowledged the obligation, requesting that the letter be signed and either faxed or mailed back to counsel.

2. [3.27] Execution of a Promissory Note

Where possible, execution of a promissory note by a debtor is preferred for a number of reasons over and above a simple written acknowledgment and promise for payment of the debt. The promissory note, in addition to representing an absolute, unconditional promise of payment on a set date or over a specific interval, also offers creditor’s counsel the opportunity to obtain additional remedies and leverage for the creditor client. For instance, should the creditor not have the benefit of a signed credit application or other written contract providing for a specific rate of interest, the promissory note offers counsel the opportunity to enhance not only ultimate collection of the creditor’s claim but ensures that the creditor is obtaining additional value for the consideration of additional time and the forbearance of suit. The note also offers an opportunity to obtain a commitment for the payment of collection costs, including attorney fees, in the event that the creditor does not already possess a signed writing for the payment of such expenses.

The extension of additional time and forbearance of suit represent valuable consideration to support interest and attorney fees provisions in a promissory note. In Murphy v. Henry, 225 S.W.2d 662 (Ky. 1950), the court held, “[i]t is well settled in this state, as in others, that forbearance to prosecute a doubtful claim asserted in good faith will constitute adequate consideration for a compromise agreement.” In Hall v. Fuller, 352 S.W.2d 559 (Ky. 1962), after reviewing the three standards for determination of forbearance as valid consideration, the court held “[w]e believe the sound viewpoint to be that good faithis enough unless the claim is so obviously unfounded that the assertion of good faith would affront the intelligence of the ordinary and reasonable layman.”

Additionally, the promissory note may offer the creditor the opportunity to obtain execution of the note by the individual owner(s) (assuming the entity is a corporation or limited liability company) in the event that the creditor does not otherwise enjoy the benefit of a personal guaranty. This is something that must be negotiated on a case-by-case basis and will, in most cases, be determined by the debtor’s desire to remain in the creditor’s good graces. This may be more likely in instances where the creditor offers goods, merchandise, or services that the debtor cannot readily obtain elsewhere.

3. [3.28] Agreed Judgments

Probably the most powerful pre-suit collection tool available to collection counsel is securing a pre-suit agreed judgment from the commercial debtor. Better than a written acknowledgment of the debt or a promissory note, the agreed judgment represents an immediate, absolute, and seemingly indefensible right of collection, with all of the power of a judgment, including the right to execute.

While the concept of obtaining execution of an agreed judgment prior to filing suit may seem extraordinary, there is Kentucky law upholding and supporting such a judgment. In Ashland Armco Employees Credit Union v. Cantrell, 685 S.W.2d 559 (Ky. Ct. App. 1985), the creditor’s counsel secured an agreed judgment from the debtor providing for a specific payment arrangement. When the debtor defaulted, suit was filed and four days later the previously obtained agreed judgment was submitted to the court and entered two days later. The debtor successfully filed a motion to vacate the agreed judgment as allegedly in violation of KRS 372.140, which provides in pertinent part:

(1) Any power of attorney to confess judgment or to suffer judgment to pass by default or otherwise, any release of errors, given before an action is instituted, is void.

The court of appeals reinstated the agreed judgment, finding that the agreement entered into between the parties was, in essence, a consent judgment thereby distinguishing the judgment from an otherwise unenforceable and void cognovit note or judgment.

The important distinction is that at the time the agreed judgment is obtained, there is an existing right of action by virtue of the fact that there is a debt for a liquidated amount for which the creditor is entitled to immediate payment. This is distinguishable from the prohibited cognovit clause wherein the debtor confesses judgment prior to any default in payment and essentially waives any right to later defend.

However, careful attention should be paid to the idea that the cases allowing pre-suit agreed judgment seemingly involved consumer debts and were decided prior to the loss of exemption under the Fair Debt Collection Practices Act (“FDCPA”) for attorneys as third party collectors. It is this author’s opinion that efforts to secure pre-suit agreed judgments on consumer obligations may be hazardous. Given the “least sophisticated consumer” standard under the FDPCA, this of type collection strategy could be alleged an unfair, misleading, and/or possibly a deceptive collection practice.

VIII. [3.29] Collection Litigation

A. [3.30] Filing the Action

1. [3.31] Assimilation of Necessary Documentation

Once it has been determined that litigation will be necessary, it is recommended that counsel have available the necessary documentary evidence to establish a prima facie case for collection. However, not all of the documentation is required to be attached as exhibits to the complaint when filing the action. Generally, a single sheet statement of account will suffice to set forth the creditor’s claim pursuant to Civil Rule 8.01, which in pertinent part provides:

(1) A pleading which sets forth a claim for relief, … shall contain (a) a short and plain statement of the claim showing that the pleader is entitled to relief and (b) a demand for judgment for the relief to which he deems himself entitled. Relief in the alternative or in several different types may be demanded.

Furthermore, Civil Rule 8.05 provides in pertinent part:

(1) Each averment of a pleading shall be simple, concise, and direct. No technical forms of pleadings or motions are required.

Paragraph (2) of Civil Rule 8.05 also provides that claims may be made alternatively or hypothetically, and separate claims may be stated regardless of consistency and whether based on legal or on equitable grounds or both. All claims and filings are subject to Civil Rule 11, which provides, among other things, that the filing may not be made for “any improper purpose, such as to harass or to cause unnecessary delay or needless increase in the cost of litigation.”

While not specifically required by Kentucky law, affidavits of account can be helpful, particularly in certain Kentucky courts where sworn proof of a debt may result in the speedier entry of a default judgment should there be no defense to the claim. Generally speaking, the more concisely pled the cause of action the better, keeping in mind that counsel should plead the cause of action with enough particularity to avoid the possibility of a motion to dismiss pursuant to Civil Rule 12.02, including but not limited to subpart (f)–failure to state a claim upon which relief can be granted. A sample complaint and affidavit in support of an open account debt are included in the Appendix to this chapter at Section [3.42].

2. [3.32] Choosing the Proper Court

Pursuant to KRS 24A.120(1)(a), the jurisdiction of a district court is limited to causes of action which do not exceed $4,000 exclusive of interest and costs, except matters affecting title to real estate and matters of equity. For matters in excess of $4,000 exclusive of interest and costs, or matters involving title to real estate or equity, suit should be filed in the circuit court pursuant to KRS 23A.010.

Proper venue is equal in importance to jurisdiction. Suit should be filed in the appropriate venue to avoid the entry of a judgment that would otherwise be void and unenforceable. Kentucky statutory law addresses original venue in civil actions at KRS 452.400 et seq. This compilation of statutes designates specific types of actions and where their venue is appropriate. One of the primary venue rules is KRS 452.450. Except for certain actions, KRS 452.450 dictates that “an action against a corporation which has an office or place of business in this state, or a chief officer or agent residing in this state, must be brought in the county in which such office or place of business is situated, or in which such officer or agent resides.” Alternatively, the statute continues by stating that if “[t]he action be upon a contract, [the action must be brought] in the above named county, or in the county in which the contract is made or to be performed; or if it be for a tort, in the first named county or the county in which the tort is committed.”

KRS 452.450 has been interpreted by Kentucky courts to indicate that appropriate venue lies in a county where the designated registered office and agent are present, as specified by the corporation. Alternatively, if the action involves a security agreement and promissory note, the action can be brought in the county where the payments are to be made. Kem Manufacturing Corp. v. Kentucky Gem Coal Co., 601 S.W.2d 913 (Ky. Ct. App. 1980). Additionally, this statute permits an action against a corporation to be maintained in the county in which a contract is to be created. American Oil Co. v. Brooks, 424 S.W.2d 831 (Ky. 1967).

Kentucky statutory law also dictates where a transitory action may be brought. If such a transitory action is not required to be brought in a specific venue under the provisions of KRS 452.400 to KRS 452.475, KRS 452.480 provides that the action, “… may be brought in any county in which the defendant, or in which one (1) of several defendants, who may be properly joined as such in the action, resides or is summoned.”

Of particular interest to collection attorneys is how a preferred venue is waived to permit jurisdiction in a more convenient forum. Kentucky cases that date to 1869, as in Baker v. Louisville and N.R. Co., 67 Ky. 619 (1869), acknowledge and hold one of the most basic positions of civil procedure, namely:

[A] plea to the jurisdiction of a court after a defense to the merits of an action has been made, unless for want of jurisdiction over the subject matter of the action, comes too late since a defense to the merits of an action constitutes a waiver of the objection to the jurisdiction over the person of the defendant.

Another way that a defendant may waive the venue requirements of the Kentucky Revised Statutes is to execute a contract containing a choice of forum clause. Provided the choice of forum is fair and reasonable, Kentucky courts have held that such clauses are enforceable so long as there is no fraud in the inducement. Cline v. Allis-Chalmers Corp., 690 S.W.2d 764 (Ky. Ct. App. 1985). One issue that Kentucky courts will evaluate in deciding whether to honor a choice of forum provision is whether Kentucky has a minimal interest in the particular lawsuit. The case of Prudential Resources Corp. v. Plunkett, 583 S.W.2d 97 (Ky. Ct. App. 1979), analyzed this issue in light of a choice of forum provision selecting the State of Texas. In upholding the lower court’s decision to honor the choice of forum clause, the court of appeals stated:

[A]assuming that Kentucky has a substantial interest to protect because of a significant relationship to the transaction and to the parties, the Jackson Circuit Court would have been warranted in refusing to enforce the forum selection agreement if the application of Texas law would have subverted an important policy of Kentucky and the choice of law rule of Texas would have been in favor of its own laws.

The collection attorney may also face the decision of choosing the proper court when confronted with a non-resident defendant. For a variety of reasons, it may make more sense to file suit in the creditor’s home state where “minimum contacts” can be established. When such an instance occurs, the creditor’s attorney will normally rely on KRS 454.210 (the “long-arm statute”) for purposes of jurisdiction, service of process, and venue requirements. KRS 454.210(4) states, in pertinent part, that “when the exercise of personal jurisdiction is authorized by this section, any action or suit may be brought in the county wherein the plaintiff resides or where the cause of action or any part thereof arose.” Collection counsel will generally be relying upon subsection 2(a)(1), “Transacting any business in this Commonwealth,” to make effective use of this long-arm statute.

A distinction can be drawn between resident purchasers attempting to assert jurisdiction over a non-resident seller as opposed to resident sellers attempting to assert jurisdiction over non-resident buyers. In First National Bank of Louisville v. Shore Tire Co., Inc., 651 S.W.2d 472 (Ky. Ct. App. 1983), the Kentucky Court of Appeals considered three separate cases with very similar questions of law. In a consolidated opinion, the court made it clear that non-resident sellers who are actively promoting the sales of their products within the forum state Kentucky are invoking the benefits of that state. As such, they should be subject to the jurisdiction of Kentucky’s courts. This situation is distinguished from the non-resident buyer who enjoys no particular privilege in purchasing from the resident seller in an isolated transaction. The court found that when non-resident buyers engage in interstate transactions with resident sellers, each has transacted business in both states. The more substantial the interaction, in terms of frequency of transactions, time over which each has done business with one another, and the amount of money involved, determines if the minimum contacts test established by International Shoe Co. v. Washington, 326 U.S. 310, 66 S. Ct. 15, 90 L. Ed. 95 (1945), has been satisfied.

An important point not to be overlooked is that service via KRS 454.210 does not require a signed delivery receipt. In Haven Point Enterprises v. United Kentucky Bank, Inc., 690 S.W.2d 393 (Ky. 1985), the court found: “The statute says in part that the Secretary shall attach to the return the registry receipt, if any. The words ‘if any’ emphasize the fact that recovery of a signed, returned receipt is not vital to the completion of service pursuant to the long-arm statute.” Id. at 395. Another important point to be gleaned from Haven Point is the fact that service on the Kentucky Secretary of State under the long-arm statute (KRS 454.210) is just as valid as service upon the designated in-state process agent (formerly KRS 271A.565, now KRS 271B.5-040) as an alternate method of service. Haven Point, 690 S.W.2d at 395. The fact that the latter might arguably result in a better chance of actual notice was found unconvincing by the court when reviewing a motion for relief from the judgment pursuant to Civil Rule 60.02. Id. Finally, the courts have gone as far as holding service through the secretary of state which is returned “unclaimed” is still effective service. Davis v. Wilson, 619 S.W.2d 709 (Ky. Ct. App. 1980).

B. [3.33] Contested Cases and Discovery

Once the complaint is served, the defendant, pursuant to Civil Rules 4.02 and 12.01, has 20 days to file a responsive pleading. In addition to the standard general denial, counterclaims seem to be increasingly utilized by sophisticated debtor’s counsel to stall and delay what may otherwise appear to be a valid claim. The counterclaim also has the chilling effect of exposing the creditor to additional defense costs, including discovery expenses. This is particularly true where the counterclaim seeks affirmative relief against the creditor above set-off of the creditor’s stated claim. Aggressive and effective pre-litigation collection efforts and investigation will help reduce the odds of a nuisance answer and counterclaim that is asserted for the purpose of delay.

In the event of either a general denial or a counterclaim, creditor’s counsel is well advised to promptly serve initial written discovery to help distinguish between real and frivolous defenses. Effective written discovery may have the desirable effect of forcing the debtor to expend time and expense, thereby posturing the case for settlement. While depositions may be more effective, they are certainly more expensive and may lead to additional time delays.

The collection counsel handling large volumes of collection work should prepare well-written standardized interrogatories, requests for admissions and requests for production of documents, pursuant to Civil Rule 33, “Interrogatories to Parties,” Civil Rule 36, “Requests for Admissions,” and Civil Rule 34, “Production of Documents and Things and Entry Upon Land for Inspection and Other Purposes.” A sample set of standardized written discovery requests is included in the Appendix to this chapter at Section [3.43]. Standardized discovery requests can be a quick and effective means of moving the case closer to settlement or trial and should be edited depending upon the facts of each case. Although a deposition cannot be taken by the plaintiff pursuant to Civil Rule 30.01 until 30 days after service of the summons upon any defendant, interrogatories, requests for admissions and requests for production of documents may be served upon any party with or after service of the summons upon that party. Accordingly, counsel who anticipates defense of an action may wish to serve written discovery upon the debtor together with the summons and complaint.

The sooner that counsel initiates discovery the better. Time delays benefit only the debtor. Delay hinders the creditor for the obvious reason that the creditor bears the burden of proof in establishing its claim to collect. Collection counsel handling any volume of work will soon become familiar with the common problems associated with pursuing a disputed collection case. Problems include:

(a) Witnesses becoming unavailable, including witnesses for the plaintiff leaving the plaintiff’s employ;

(b) Inefficient file and/or document retention systems by the creditor, including missing or misplaced proofs of delivery, original invoice copies, or other important documentary evidence to prove the claim; and

(c) Creditor fatigue and/or loss of interest by the creditor in pursuing a collection claim. It is common for clients to lose interest when the time comes to produce witnesses for a deposition or trial or incur the time and expense associated with the continued prosecution of the contested collection suit.

C. [3.34] Protective Orders

Occasionally, a creditor’s counsel will be confronted with an aggressive and overzealous debtor’s attorney. An example is a debtor’s counsel seeking depositions from numerous representatives of the plaintiff for the express purpose of causing the creditor to expend substantial costs. Civil Rule 26.03, “Protective Orders,” may offer some relief in this situation. Some of the Kentucky cases offering guidance include:

• Hoffman v. Dow Chemical Co., 413 S.W.2d 332 (Ky. 1967) (protective order should be issued where the information can be obtained by interrogatories);

• Gevedon v. Grigsby, 303 S.W.2d 282 (Ky. 1957) (trial judge exercised a sound discretion in refusing to require the appearance of a nonresident witness to give his deposition); and

• Wilson v. Lamb, 125 F.R.D. 142 (E.D. Ky. 1989) (depositions of the officers of a civil defendant corporation are to be taken at the defendant’s principal place of business in Michigan where it would be very inconvenient for the officers to travel to Kentucky to be deposed, as they have no occasion to travel to the area regularly, or even sporadically on business, and where the plaintiff has not responded to the defendant’s motion for a protective order to require the depositions to be taken in Michigan).

One of the best cases on this point is Wal-Mart Stores, Inc. v. Dickinson, 29 S.W.3d 796 (Ky. 2000). In referencing protective orders issued under Civil Rule 26.03, the Wal-Mart court advised that, if a party believes numerous requests for depositions are unduly burdensome or requested for the purpose of annoyance, such party can seek a protective order citing the reasons why such requests for depositions and/or interrogatories are redundant, repetitive, oppressive, or unduly burdensome.

D. [3.35] Attempting Summary Judgment

As most creditors’ attorneys are too painfully aware, summary judgment has become elusive in the Commonwealth of Kentucky. Since 1991, when the Kentucky Supreme Court decided Steelvest, Inc. v. Scansteel Service Center, 807 S.W.2d 476 (Ky. 1991), attorneys have been hard-pressed to meet the required burden of proof to obtain summary judgment. In part, this case provides that a summary judgment should be granted when “as a matter of law, it appears that it would be impossible for the respondent to produce evidence at the trial warranting a judgment in his favor against the movant.”

Nevertheless, since Steelvest was decided in 1991, the Kentucky Supreme Court has slowly started to soften the standard for granting summary judgment. As the court held in Welch v. American Publ’g Co. of Kentucky, 3 S.W.3d 724 (Ky. 1999), summary judgment should be denied only when “from the evidence of record, facts exist which would make it possible for the nonmoving party to prevail.” Id. at 730. In the court’s analysis, the focus should be on what is in the record rather than what evidence might or could be presented at trial. Id. When there are no facts of record which would make it possible for the nonmoving party to prevail, the court’s duty is to “render a judgment forthwith [as] there is no genuine issue as to any material fact and the moving party is entitled to judgment as a matter of law.” Bennett v. Southern Bell Telephone & Telegraph Co., 407 S.W.2d 403, 405 (Ky. 1966).

Despite the court’s discernible retreat from Steelvest, most trial judges still refuse to enter summary judgment and deprive a debtor of his day in court so long as even the slightest issue in dispute exists. Counsel’s best chance of obtaining summary judgment may lie in those instances where the defendant has failed to properly respond to discovery or has failed to deny requests for admissions as provided in Civil Rule 36.02, “Effect of Admission.” In addition, where the debtor has failed to respond to discovery, Civil Rule 37 may enable counsel to seek an order to compel and/or an order to strike the debtor’s answer and enter judgment. A sample motion for summary judgment based upon a defendant’s failure to deny requests for admissions, and the deemed admission thereof, is included in the Appendix to this chapter at Section [3.44].

E. [3.36] Preparation for Trial

Assuming all pre-trial settlement efforts have been exhausted, discovery has been completed, and summary judgment has been attempted, it is time to complete all pre-trial procedures so the case can be set for trial. Civil Rule 16, “Pre-Trial Procedures; Formulating the Issues,” provides in pertinent part:

(1) In any action, the court may in its discretion direct the attorneys for the parties to appear before it for a conference to consider:

(a) the simplification of the issues;

(b) the necessity or desirability of amendments to the pleadings;

(c) the possibility of obtaining admissions of fact and documents which will avoid unnecessary proof;

(d) the limitation of the number of expert witnesses;

(e) the advisability of a preliminary reference of issues to a Commissioner;

(f) such other matters as may aid in the disposition of the action.

Counsel should inquire of the court in which the action is pending as to any local rules or other local procedural requirements regarding pre-trial procedure. Assuming the creditor is prepared to proceed to trial, a pre-trial conference not otherwise required by the presiding judge may simply lead to additional time delays. Hovever, there are some possible benefits of pre-trial conferences, which include: (1) additional pressure upon the debtor to resolve the pending litigation through settlement; (2) pressure from the court for a settlement if it appears obvious to the court that there are no genuine defenses; and (3) a final determination by the trial judge as to the total number of witnesses for trial as well as the relevant facts to be tried and any governing law. This helps assure that there will be no surprises at trial.

F. [3.37] Evidentiary Issues During Trial

As counsel prepares the matter for trial, the particular strengths and weaknesses of the case should be reviewed again. Factors will include the availability of witnesses with firsthand knowledge who are able to: (1) prove the necessary elements of the creditor’s claim; (2) refute the debtor’s allegations and defenses; and (3) authenticate the documentary evidence in support of the creditor’s claim.

Counsel should be familiar with the various evidentiary rules that will undoubtedly come into play during the course of a contested collection suit. Pertinent portions of the Kentucky Rules of Evidence (“KRE”) include Article VI - Witnesses, which states at Rule 602 that personal knowledge of each witness must be shown (experts excepted). Most commercial collection cases will not require expert testimony. Witnesses for the creditor should be prepared to testify about events of which they have firsthand knowledge. Counsel should prepare any prospective witnesses so that an appropriate foundation can be made to establish the competency of the witness to properly testify as to the facts in support of the plaintiff’s claim. Witnesses should testify as to specific facts rather than as to opinion. Generally, opinion testimony of a lay witness will be extremely limited and will result in a multitude of objections that tend to fluster the witness.

Counsel should anticipate the probability of having to attempt to establish facts from witnesses who are salespersons, credit managers or controllers with limited or incomplete firsthand knowledge of all underlying facts. Some collection practitioners attempt to utilize the debtor as the principal witness. Most would agree that attempting to make the creditor’s case utilizing the debtor as the creditor’s primary witness to prove the essential elements of the case is risky at best.

While an exhaustive review of all of the rules of evidence is beyond the scope of this chapter, creditor’s counsel can be assured that there will be objections during the course of the case based upon hearsay. One of the principal exceptions to the hearsay rule that the creditor’s counsel will rely on is provided at KRE Article VIII - Hearsay, Rule 803(6) and (7), relating to business records. In pertinent part, the rule provides:

The following are not excluded by the hearsay rules, even though the declarant is available as a witness:

…

(6) Records of regularly conducted activity. A memorandum, report, record, or data compilation, in any form, of acts, events, conditions, opinions, or diagnoses, made at or near the time by, or from information transmitted by, a person with knowledge, if kept in the course of a regularly conducted business activity, and if it was the regular practice of that business activity to make the memorandum, report, record, or data compilation, all as shown by the testimony of the custodian or other qualified witness, unless the source of information or the method or circumstances of preparation indicate lack of trustworthiness. The term “business” as used in this paragraph includes business, institution, association, profession, occupation, and calling of every kind, whether or not conducted for profit.

(A) Foundation exemptions. A custodian or other qualified witness, as required above, is unnecessary when the evidence offered under this provision consists of … business records which satisfy the requirements of KRE 902(11), or some other record which is subject to a statutory exemption from normal foundation requirements.

(B) Opinion. No evidence in the form of an opinion is admissible under this paragraph unless such opinion would be admissible under Article VII of these rules if the person whose opinion is recorded were to testify to the opinion directly.

(7) Absence of entry in records kept in accordance with the provisions of paragraph (6). Evidence that a matter is not included in the memoranda, reports, records, or data compilations, in any form, kept in accordance with the provisions of paragraph (6), to prove the nonoccurrence or nonexistence of the matter, if the matter was of a kind of which a memorandum, report, record, or other data compilation was regularly made and preserved, unless the sources of information or other circumstances indicate lack of trustworthiness.

In order to be admissible, records (with limited exceptions) must be identified and authenticated pursuant to Article IX, Authentication and Identification. Authentication is satisfied by evidence sufficient to support a finding that the matter is what its proponent claims. Illustrations provided in the rule include, but are not limited to, authentication or identification by testimony of the witness who acknowledged that the matter is what it is claimed to be.

Counsel should be prepared to introduce the business records, including statements, invoices, and any other documentary evidence in support of the creditor’s claim, through testimony of a custodian or other qualified witness. Self authentication is possible in certain instances as set forth at Article IX, Rule 902(11). This rule requires certified originals or duplicates of business records to be submitted in advance, with notice to the adverse party, and made available to the adverse party for inspection in time for the adverse party to review and challenge. For purposes of the rule, certifying for a domestic record means a written declaration under oath subject to penalty of perjury.

IX. [3.38] Endnotes

1. Other commentators view undercapitalization as a much more serious factor than the White court in determining whether the corporate veil should be pierced. Take for example the following quote:

If a corporation is organized and carries on business without substantial capital in such a way that the corporation is likely to have no sufficient assets available to meet its debts, it is inequitable that the shareholders should set up such a flimsy organization to escape personal liability. The attempt to do corporate business without providing any sufficient basis for financial responsibility to creditors is an abuse of the separate entity and will be ineffectual to exempt the shareholders from corporate debts . . . . If the capital is illusory or trifling compared with the business to be done and the risk of loss, this is a ground for denying the separate entity privilege.

Henry W. Ballantine, Ballantine on Corporations § 129, 302-03 (1946).

2. SeeWhite, 584 S.W.2d at 61 (“our courts have placed great emphasis upon fraudulent organization and have denied entity treatment upon that basis”); Dare to Be Great, Inc. v. Commonwealth, 511 S.W.2d 224 (Ky. 1974) (“generally a corporation will be looked upon as a separate legal entity but when the idea of separate legal entity is used to justify wrong, protect fraud or defend crime the law will regard the corporation as an association of persons”); Big Four Mills v. Commercial Credit Co., 307 Ky. 612, 211 S.W.2d 831 (1948) (“it is a stern but just maxim of law that fraud vitiates everything into which it enters”).

3. KRS 271B.14-050 allows dissolved corporations to continue their corporate existence to the extent that they need to wind up and liquidate their businesses. They may not conduct business that extends beyond this limited role.

X. [3.39] Appendix

A. [3.40] Sample Initial Acknowledgment Letter

LAW OFFICES
LAWYER & ATTORNEY, PLC
A PROFESSIONAL LIMITED LIABILITY COMPANY
111 Contract Road, Suite 100 Phone: (502) 555-1234
P.O. Box 55555 Facsimile: (502) 555-9876
Louisville, Kentucky 99999 Email: jlawyer@lawfirm.com
Website: www.lawfirm.com

______ ___, 200__

VIA FAX AND FIRST CLASS MAIL
Honest John Creditor
1234 Main Street
Anywhere, USA Re: Your File No. KY39253
Our File No. 1732013
Honest John Creditor Services, Inc.
vs: Don Deadbeat
$19,500.00

Dear John:

The above-captioned claim has been received. Demand was made immediately upon receipt of the transmittal papers. We are attempting to establish personal contact with the debtor to obtain payment in full. The matter is accepted as a contingent collection case for the recovery of the balance due, on the terms set forth on the contingent fee agreement attached hereto. Please sign and return the agreement as soon as possible. If there is a written contract, or other pertinent documentation not yet provided, please send any other information in support of your claim.

If you are seeking any special remedies, including but not limited to mechanic’s lien filings, notices of intent, reclamation of property, possession of property, or any other special remedies, we reserve the right to negotiate separate fees for these services. We will not attempt enforcement of any of the enumerated special remedies, and will limit our efforts to the recovery of the balance due, unless and until specifically requested and authorized to do so.

Please advance your file at this time 30 days in anticipation of an initial report. This will enable us sufficient time to attempt personal contact with the debtor so that we may make an informed legal recommendation for further handling.

Sincerely,

LAWYER & ATTORNEY, PLC

By: _______________________
John M. Lawyer
[Direct Dial (502) 555-1234]
jlawyer@lawfirm.com

OUR FEDERAL TAX ID IS 61-xxxxxxx

B. [3.41] Sample Contingent Fee Agreement

CONTINGENT FEE CONTRACT

Your firm has chosen Lawyer & Attorney, PLC for the collection of an account balance due. Lawyer & Attorney, PLC, upon beginning work, has a vested interest in the underlying collection claim pursuant to this contingency fee agreement. Our fees will be computed at the rate of ____% against all recoveries, with the exception of any costs you advance. Costs which you have advanced will be returned upon full recovery of the matter or at the conclusion of any settlement. In the event we have advanced any court costs or other expenditures authorized by your firm, we will deduct those costs from first recoveries made. Should you be entitled to special interest, collection costs, or attorney fees, every effort will be made to make a full recovery on your behalf. Please understand that while you may have an agreement for the payment of collection costs and attorney fees, our fees will be calculated upon all recoveries made, regardless of whether we are successful in collecting all collection costs or attorney fees. Our fees will be assessed against any recoveries made subsequent to our involvement, whether paid directly to your office or through this office. As funds are recovered, we will remit the net amount, less our fee, together with a voucher outlining the recovery as well as calculation of our fees and any expenses withheld.

Careful effort should be made to refer any contacts by your customer to this office. Continued contact with your customer will tend to dilute our efforts on your behalf and could impede recovery. Every effort will be made to establish contact with your customer to attempt to effect voluntary payment, unless you have instructed otherwise. We will attempt to determine if there is any dispute to the claim which could result in a defense should a lawsuit be filed. In addition, should we determine the possibility of a counterclaim, or the threat of a counterclaim, we will notify you in advance for review and investigation.

Should a counterclaim be asserted after a suit has been filed, you may elect to employ this firm for the defense of the counterclaim or retain defense counsel of your own choosing. Our normal hourly defense rate is $________ per hour. Please be aware that this includes travel time in the event that we are required to attend out-of-town depositions or court proceedings relating to the counterclaim. These charges would be billed to your firm on a monthly basis. Your firm will be billed on a time basis for time expended in the course of the defense of the counterclaim. You will not be charged for time expended with the prosecution of the underlying collection suit.

_______________________________

(Firm Signature)

Date:_______________________

C. [3.42] Sample Complaint and Affidavit in Support of an Open Account Debt

NO. 02-CI-000789 BOONE CIRCUIT COURT

HONEST JOHN CREDITOR SERVICES, INC. PLAINTIFF

vs. COMPLAINT

DON DEADBEAT DEFENDANT

* * * * * * * * *

Comes the Plaintiff, by counsel, and for its cause of action against the Defendant states as follows:

1. The Defendant is indebted to the Plaintiff in the amount of $19,500.00, as evidenced by the attachment hereto referenced as Exhibit “A.”

WHEREFORE, Plaintiff demands:

1. Judgment against the Defendant in the sum of $19,500.00;

2. Interest thereon at the rate of 19.8% per annum from March 25, 2000 and 19.8% per annum from the date of Judgment, until the Judgment is satisfied;

3. For Plaintiff’s costs herein expended, including a reasonable attorney fee as the proof may allow; and

4. For all other relief to which the Plaintiff may appear entitled.

__________________________
JOHN M. LAWYER
LAWYER & ATTORNEY, PLC
Attorneys for Plaintiff
111 Contract Road, Suite 100
P.O. Box 55555
Louisville, KY 99999
(502) 555-1234

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