HAAS BAKING COMPANY v. THE STATE OF ILLINOIS (2001)

OPINION

This claim for litigation expenses, brought under /10-55(a) of the Administrative Procedure Act (the APA) (5 ILCS 100/10-55 (a)), arises out of three rejected assessments under the Unemployment Insurance Act (820 ILCS 405) (the UI Act) by the Illinois Department of Employment Security (IDES) against Haas Baking Company of St. Louis, Missouri (Haas). This court has jurisdiction under/8(I) of the Court of Claims Act (705 ILCS 505/8 (i)).

Nature of the Claim

Haas, a St. Louis sweets baker, for many years employed drivers to distribute its goods in Illinois and paid unemployment insurance contributions to IDES for its Illinois drivers. In 1989, a former Haas employee filed for Illinois unemployment benefits, triggering an IDES audit of Haas.

Haas informed the IDES auditor that its former employee and other former Haas drivers had become independent franchisees operating their own distribution businesses and had ceased being Haas employees. Since 1985, Haas entered into franchise agreements (Distributor's Agreements) with individuals that granted them exclusive distribution rights within designated territories to sell Haas products, which they purchased from Haas. Based on those contracts, Haas maintained that it was not responsible for unemployment insurance contributions for its independent distributors.

The auditor requested a legal opinion. On June 30, 1988, the IDES legal staff issued a memorandum regarding..individuals who perform services for Haas Baking Company, and whether franchise Distributors of Haas Products are exempt under Section 212 (820 ILCS 405/212). That section, which prescribes three criteria for distinguishing between individual employees and independent contractors (for purposes of that Act), provides: /212. Service performed by an individual for an employing unit, shall be deemed to be employment unless and until it is proven in any proceeding where such issue is involved that --

A. Such individual has been and will continue to be free from control or direction over the performance of such services, both under his contract of service and in fact; and

B. Such service is either outside the usual course of business for which such service is performed or that such service is performed outside of all of the places of business of the enterprise for which such service is performed; and

C. Such individual is engaged in an independently established trade, occupation, profession or business.

D. The memo concluded that the Haas-Distributor relationship failed the criteria of all three subsections (any one of which failures defeats the exemption), and therefore is not exempt under /212.

Following the ensuing audit, IDES rejected Haas position. Its Audit Finding Letter (May 7, 1990), stated that Haas distributors did not meet the requirement of /212 to be exempt independent contractors, and were therefore being considered as Haas employees under the Act.

IDES issued three Notices of Determinations and Assessment and Demand for Payment (D&As) to Haas: (1) February 1, 1990 D&A, covering 4th Quarter 1985; (2) April 27, 1990 D&A, covering 1st Quarter 1986; and (3) May 11, 1990 D&A, covering 2nd Quarter 1986 through 3rd Quarter 1988. The D&As alleged, inter alia, that you have failed to pay contributions, interest and penalties as required by the ..Act.. for the periods set forth, and alleged specific taxable wages, unpaid UI tax contributions and demands for remittances.

Haas protested and the matters proceeded to an adjudication before an administrative hearing officer (known under the UI Act as the Director's Representative), Susan Haag.

In the administrative proceeding, the February 1, 1990 D&A was dismissed as filed beyond the statute of limitations. Ms. Haag's final Report (the Report), which was ultimately adopted by the IDES Director, set aside the two remaining D&As, finding (Report, Conclusions, at 3) (Exh.#7):

It is found that given the totality of circumstances involved, petitioner (Haas) has established that the distributors are excluded from coverage. It is not necessary to discuss whether petitioner has proven an exemption under Section 212A-C since it is found that the services performed by the distributors were not performed for the petitioner. Given the extent of their investment, the fact that they could sell their exclusive right to the territory and their ability to set their own profit margins militates against a finding that the services they performed was for the benefit of petitioner. Although petitioner may obtain a benefit from the distributors increase in sales, this benefit is based not on services performed for the petitioner, but rather on services performed by the distributors for the distributors.

Haas then demanded attorney's fees under APA/2-1 105(a); its demand was denied by the Director (April 17, 1992), who held that the D&As were issued to Haas with reasonable cause.

Haas Complaint

Haas then filed its complaint in this court seeking reimbursement of $43,010.67 expended by it in defense of the IDES assessments. Haas alleges here, in its complaint and brief, that:

(1) the February 1990 D&A was illegal because it was statutorily barred and its allegations of liability were thus false and issued without cause;

(2) the two adjudicated D&As falsely alleged liability (e.g., you have failed to pay contributions, interest and penalties as required by the (UI) Act) and by reference incorporated the liability elements of the UI Act, and thus alleged falsely:

(a) that the distributors activities were services performed for [Haas], a key element of employment as defined by UI Act/206 (820 ILCS 405/206) that was specifically rejected by the administrative decision, and

(b) that Haas paid its distributors wages within the meaning of the UI Act, when its own audit clearly reflected the fact that the distributors paid money to Haas (for purchase of goods) and with few exceptions no funds were paid by Haas to its distributors; all of which was alleged without reasonable cause;

(3) the IDES audit report was a pleading that falsely alleged UI liability of Haas and, along with IDES audit process, suffered from a series of defects that demonstrate unreasonableness and an absence of good cause.

Proceedings in this Court

This claim was tried to Commissioner Michael J. Mathis, who reported his findings to the full court and ordered post-trial briefs. Claimant filed a brief; the Respondent did not. In response to this court's order requesting submission of authorities on three issues of interpretation of the administrative expense statute. APA/10-55(a), both sides filed submissions. Neither side, however, submitted anything responsive to the court's inquiry on the legislative history and intent of/10-55.

The Statutory Elements

The statute establishes four elements for a litigation expense claim arising out of an administrative proceeding: (1) the proceeding was initiated by a state agency, (2) which made an allegations against the claimant, (3) that was found to be untrue, and (4) was made without reasonable cause. (5 ILCS 100/10-55(a).) In this case, the respondent does not dispute the first two elements. The parties focus on the untrue and without reasonable cause elements of this expense claim.

The Parties Contentions

Claimant Haas advances four distinct claims of untrue, and without reasonable cause allegations, to each of which IDES offers a rebuttal:

First is IDES February, 1990 D&A, which was undisputedly filed beyond the limitation period and was dismissed for that reason. Haas contends that this pleading was illegal and false and without cause because it was barred. IDES replies that the D&A was promptly and reasonably dismissed by it and that there was no determination on the merits or on the truth of any of the allegations in the D&A, which were not false but merely time-barred as to enforcement.

Claimant's second and third claims of false and groundless allegations concern the two D&As that were rejected on the merits. Haas contends that their liability allegations were found to be untrue and were brought without reasonable cause. Haas argues that the allegations incorporated the liability elements of the UI Act, and thus alleged falsely (2) that the distributors activities constituted services performed for an employing unit [i.e. for Haas] a key element of employment under/206 definition that is repeated in the/212 independent contractor provision and (3) that Haas paid its distributors wages within the UI Act when the audit clearly reflected the fact that the overall flow of money was from the distributors to Haas (for purchase of goods) and rather than from Haas (the alleged employer) to the distributors (the alleged employees).

Because the administrative decision found that the services performed by the distributors were not performed for [Haas], claimant now contends that the D&As allegations were found to be untrue within the import of APA/10-55(a).

The Respondent replied (at oral argument) that IDES allegations were reasonable and supported by good cause when made, in that (a) this was a case of first impression and was unique, where former employees allegedly become independent franchised distributors, (b) on the three /212 independent contractor factors, there was substantial evidence supporting the agency's position that Haas distributors were not exempt but were employees, (c) on the question of whether employees working for Haas, the evidence was mixed and there was sufficient question as to the actual practices followed by the parties and sufficient indicia of employee status, that IDES charges were supported by reasonable cause; (d) as to wages, the agency's claim that the distributors profits were effectively wages, though not the prevailing result, was a reasonable position as a matter of law, and (e) the expense statute, APA/10-55(a), is to be construed and applied strictly.

Haas fourth untrue allegation claim is based on the IDES audit report that formed the basis of the liability calculations for the D&As and IDES allegations of an employment relationship giving rise to liability. Haas asserts that the audit report was a pleading, that it falsely alleged UI liability, and that it and the audit process suffered from the following defects that demonstrate unreasonableness and an absence of good cause:

(a) The audit failed to identify the alleged employees (or distributors) whose wages were the subject of the D&As;

(b) The audit did not identify what transactions constituted the wages assessed for UI contributions, nor show any calculation of the contributions, which were unitemized;

(c) The audit was vague and failed to set forth facts that could be verified or disputed;

(d) The audit was incomplete; 17 pages of the audit report were missing and never turned over to Haas or to the hearing officer; and the calculations contained in the audit report were incomplete to the point that it would require an additional five hours of work for the IDES auditor to complete the computations, as he admitted;

(e) The auditor was biased and uncooperative in the hearing, and took 40 work days to complete his work at Haas offices;

(f) The auditor violated the administrative regulations, and demonstrated his bias, when he initiated an ex parte discussion with the hearing officer in which he urged her to back up his audit findings and made threats concerning her IDES employment;

(g) The auditor failed to interview the alleged employees (i.e., the distributors) as required by the IDES rules (56 Ill.Admin.Code 2732.200(a)).

Analysis

We take up the last issue first, as the easiest. Haas arguments that the IDES Audit Report was an adjudicated false pleading filed without reasonable cause must be rejected out of hand.

Even assuming as we do that the audit report is a pleading within the ambit of/10-55(a) in its expenses of defending against the report because: (i) its quantitative determinations, taken as allegations, were not adjudicated and cannot be said to be false, (ii) insofar as the report determined that Haas franchisee distributors were its employees and were providing services for Haas, which was adjudicated against IDES, those allegations were plainly peripheral to the report, were mere repetitions of the original liability allegations, and were not distinct allegations for purposes of a statutory expense claim; and (iii) Haas real complaints about the audit report are beyond the scope of APA/10-55(a).

We are simply not empowered by the statute to sanction state agencies for sloppy or incompetent or incomplete analysis, or for obnoxiousness, or for vexatious investigation or litigation conduct, or for unethical overreaching by a hyper-aggressive enforcement agent, which are the thrust of Haas charges against the IDES report and its author. Although Haas charges are seemingly made with good cause, we can neither adjudicate them nor remedy them under current law.

Haas defense expense claims against the two rejected D&As are more complex. First is the issue of whether the distributors were employees of Haas who provided services for Haas which were adjudicated against IDES as a factual matter and this is deemed a false allegation, Orbit Transport, Inc. v. State of Illinois, 48 Ill.Ct.C. 311 (1996) or whether the distributors were independent contractors under/212-which was the primary focus of the administrative litigation but was not adjudicated. The issue is whether the agency had reasonable grounds to allege that the distributors were providing services for Haas rather than for themselves -- and not the overlapping but not identical issue of whether those distributors are exempt independent contractors under/212.

On this issue, we conclude that IDES had reasonable grounds in the specific circumstances of this case to suspect and to allege that the Haas franchisee-distributors were not truly independent businesses and were employees in franchisee wrappings.

Whether we look to the established criteria under UI Act/212(c) on the closely pertinent independently established business issue or to the unprecedented (and very clever) change from employee to independent distributor, or to the unusual characteristics of these particular franchise agreements which at least arguably vest some control over the franchisee-distributors operations in Haas, as franchiser, and undisputedly contain some non-traditional limitations on the independent business-especially the prohibition on their hiring employee-drivers, thus limiting those businesses to their individual owner-drivers -- we are constrained to reject Haas contention that there was no reasonable basis to allege that the distributors were in fact disguised employees.

The IDES hearing officer did not accept, nor do we, Haas argument that the legal existence of the contractual franchiser-franchisee relationship between Haas and its former drivers were per se dispositive for UI Act purposes, so that IDES could not challenge their relationship based on the parties actual conduct as well as their contract. IDES lost that battle, but IDES had reasonable grounds to bring its allegations and to maintain them through trial. This was not a baseless issue.

The second wing of Haas attack on IDES reasonable cause concerns the alleged wages of the Haas franchisee-distributors. The Respondent cited no support for its argument that the distributors income or profits were their wages for purposes of the UI Act. Initially it appeared that the general absence of any cash flow downstream-from Haas down to its alleged employees-and the undisputed general pattern of money flowing upstream from the distributors to Haas (for purchase of product for resale) was itself dispositive of the UI liability allegation that Haas paid wages and that once this was established as a factual matter, by the time of the audit report, the IDES tax assessments become knowingly baseless whether or not they had been initially.

However, we must accept IDES pursuit of Haas despite the reverse flow of money between the alleged employer and its employees. In the face of our Supreme Court's expansive interpretation of wages under the UI Act in the taxicab cases, which involved leased taxis by alleged non-employees under various contractual arrangements, it is settled that a reverse flow of money does not itself defeat employment status for purposes of the UI Act and the courts will look to the underlying economic reality. Gladstone Cab Co. v Donnelly, 30 Ill. 2d 465, 197 N.E.2d 3 (1964); Myers v. Cummins, 9 Ill.2d 582, 138 N.E. 2d 491 (1956); Parks Cab Co. v Annunzio, 412 Ill. 549, 107 N.E.2d 853 (1952). Under prevailing Illinois law, IDES had reasonable grounds to allege that Haas paid wages to its distributors even though it did not issue them checks.

We thus arrive last at the first Haas claim: that it was, in effect, a per se violation of APA/10-55(a) for the agency to file an administrative action that was barred by the applicable limitation statute. Although in this case, the untimeliness of the February 1, 1990 D&A was technically adjudicated by motion, the reality was that the untimeliness was undisputed and indisputable. (we are unimpressed with IDES argument that it should be exempt from/10-55(a) liability for defense expenses as to this D&A because it promptly dismissed the clearly time-barred D&A, when it was the hearing officer who dismissed it on the Haas motion.)

We agree with Haas that the assertion of the February 1, 1990 D&A was done without reasonable cause, but that is not the test under/10-55(a). Under the statute there must be allegations that were made without reasonable cause (and were false). Here, it is not entirely clear that the allegation of liability in the February 1990 pleading was false, which is Haas burden to show in this/10-55(a) claim.

The falseness (and reasonableness) of this allegation of liability depends, at least technically, on whether the alleged liability still existed (and was merely barred) or whether it had been extinguished by the statute. That fine legal point whether a liability is extinguished or merely barred by a particular statute of limitations turns on the statutory language involved.

However, the sanctions question before us here - - whether an administrative pleading of a time-precluded liability is both false and made without reasonable cause and thus sanctionable for that reason - - is largely determined by whether the sanction statute is to be applied liberally or strictly. A liberal reading supports a sanction for both barred and extinguished actions (unless of course the agency had reasonable grounds to allege the claim was still timely), whereas a strict construction requires the underlying liability to have been extinguished in order to find a false allegation of liability and thus to support a sanction under the statute.

The limitation here is phrased as a limitation on IDES authority to issue a D&A (see, 820 ILCS 405/2207) (no determination and assessment..shall be made more than four years after ..), and thus operates on IDES standing rather that as an extinction of the underlying tax liability: enforcement is barred, but the liability apparently persists. Thus Haas wins its sanctions motion on the barred pleading if, and only if,/10-55(a) is applied liberally.

However,/10-55(a) has been consistently construed by the Illinois courts, in too many decisions to warrant citation, as paralleling the pleading sanction provisions of Supreme Court Rule 137 and its predecessor, former/2-61 1 of the code of civil procedure, and thus as a penal or punitive sanction to be applied strictly rather than liberally. Although this court recognizes that there is a strong undercurrent of remedial purpose in APA/10-55(a) which, after all, was enacted to add a remedy against the State as litigant (as were former /2-61 1 and /41), we are constrained to follow the overwhelming weight of authority to construe this administrative expense statute strictly.

This conclusion is reinforced and fairly compelled by the record of the General Assembly's original intent in enacting/10-55(a) in Public Act 82-670 in 1981. The statute was enacted over the veto of the Governor, and in both the original passage and on the veto override, it was made clear that/10-55(a) was intended to adopt the pleading sanctions standards of [former]/41 of the Civil Practice act [then still in effect, pending the effective date of the Code of Civil Procedure, which replaced it], which was later replaced by virtually identical false and unreasonable pleading language in the Code (735 ILCS 5/2-611 [repealed]) and still later in Supreme Court Rule 137.

This conclusion is reinforced and fairly compelled by the record of the General Assembly's original intent in enacting/10-55(a) in Public Act 82-670 in 1981. The statute was enacted over the veto of the Governor, and in both the original passage and on the veto override, it was made clear that/10-55(a) was intended to adopt the pleading sanctions standards of [former]/41 of the Civil Practice Act [then still in effect, pending the effective date of the Code of Civil Procedure, which replaced it], which was later replaced by virtually identical false and unreasonable pleading language in the Code (735 ILCS 5/2-611 [repealed]) and still later in Supreme Court Rule 137.

The Senate sponsor (Senator Leroy Lemke) referred to the legislation as the Equal Access to Justice Act and its purpose to conform the Administrative Procedures Act with Section 41; he explained that it allows small businessmen to collect their costs when harassed by government agencies. Transcription of Debate, 82nd Illinois General Assembly, Senate, 76th Legislative Day, 123-124 (October 15, 1981). In the House, on third reading (passage) and on the veto override, the sponsor (Rep. Judy Barr Topinka) also emphasized it pro-business and anti-abuse purpose, but in the ensuing floor debates, the remarks of Representative Harry Leinenweber, who had chaired a Judiciary Committee subcommittee on the bill, made the legislative intent clear: he explained that the subcommittee rewrote the language of what is now/10-55(a) to parallel/41 in the belief that experience under the existing/41 standard assured that the State's liability under the new statute would be fiscally manageable. Id., House of Representatives, 64th Legislative Day at 140, 143-144 (June 16, 1981) (third reading); 81st Legislative Day, at 75 (October 18, 1981) (veto override).

Applying/10-55(a) strictly, we are lead to the necessary if unsatisfying conclusion that we must deny Haas its litigation expenses in defending against the February 1990 D&A despite the quite obvious -- and undisputed -- point that IDES had no legal right to bring those charges and that IDES should have know it was too late to do so. Relief in such cases can only emanate from the General Assembly in the form of an amended statute. Under current law, this claim must be denied.

EPSTEIN, J.