Monday, January 6, 2014

We're All Alter Egos Now

Relentless Air Racing, LLC v. Airborne Turbine, LP, No. B244612 (D2d6 Dec. 31, 2013)

This last case of 2013 is a doozy. On a motion to amend a judgment to add additional judgment debtors, the court of appeal reverses the trial court to hold that the owners of a defendant limited partnership hit with a significant judgment are the alter egos of the LP as a matter of law. In doing so, it potentially significantly expands the scope of alter ego liability in California. 


Plaintiff Relentless obtained a judgment against defendant Airborne in a contract dispute involving the sale of an airplane. Unable to collect on the judgment, Relentless sought to amend the judgment to add, as alter egos, two entities that, at different times, were the general partners of Airborne, as well as Mr. and Mrs. Fulton, who were Airborne’s limited partners as well as the owners of the general partner entities.

To amend a judgment to add an alter ego as a judgment debtor, a judgment creditor must show: (1) that the new party to be added controlled the underlying litigation so as to be adequately represented in accord with due process; (2) a unity of ownership and interest; and (3) an unjust result that would result from respecting the corporate form. Here, the evidence showed that prior to the trial in the underlying case
but potentially after the case had been filed (the opinion is unclear on the timing)the Fultons had taken draws from Airborne to pay personal expenses. They also switched out Airborne’s general partner for a new entity after the trial and generally failed to abide by some corporate formalities. 

The trial court found that the Fultons were adequately represented in the underlying trial, such that it was fair to add them as judgment debtors, because they controlled Airborne. There was also a unity of ownership and interest between the Fultons and Airborne. Relentless, however, had not carried its burden to show an inequitable result, a necessary element of alter ego liability. According to the trial court, Relentless did not prove that the money taken from Airborne was improperly directed or that the switch of general partners was done for the purpose of avoiding the judgment.

The court of appeal reversed. In a very short decision, the court holds that the trial court erroneously required Relentless to establish a fraudulent intent. According to the court, only an inequitable result is required for alter ego liability. Because the Fultons had taken money out of Airborne and because the judgment would go unpaid if they were not added as debtors, the only inference possible from the evidence was that the inequitable result prong had been established.  The court further found that the circumstances permitted Relentless to add the Fultons after judgment had been entered even though it was aware of a potential alter ego relationship before or during trial. There are good policy reasons not to force plaintiffs suing corporate defendants to sue any and all potential alter egos from the outset. Because the alter ego relationship was not obvious when the case was filed, there was nothing wrong with Relentless waiting until after judgment, when it learned that it could not collect from Airborne.


Reversed.


This is a problematic opinion. It’s hard to tell if it is wrongly decided or if it just fails to fully explain the facts in context. It appears, however, to hold that a plaintiff can establish the inequitable result element of the alter ego analysis as a matter of law if: (a) a judgment would go unpaid due to principal defendant’s insolvency; and (b) the alleged alter egos have received distributions from the principal defendant at some time prior to judgment. Nothing else. That doesn’t make sense for several reasons. 


First, the opinion suggests that a decision to amend a judgment to add an alter ego should be afforded “great liberality.” That's not entirely correct. Although the discretionary procedural decision to permit a post-trial amendment might warrant a liberal treatment, the imposition of alter ego liability does not. “Because society recognizes the benefits of allowing persons and organizations to limit their business risks through incorporation, sound public policy dictates that imposition of alter ego liability be approached with caution.” Las Palmas Assocs. v. Las Palmas Ctr. Assocs., 235 Cal. App. 3d 1220, 1249 (1991). As an oft-cited California case puts it: “Alter ego is an extreme remedy, sparingly used.”  Sonora Diamond Corp. v. Superior Court, 83 Cal. App. 4th 523, 539 (2000).


Perhaps due to its mistaken belief that the doctrine applies with great liberality, the opinion further makes several statements that are inconsistent with the well-established principle that “[t]he alter ego doctrine does not guard every unsatisfied creditor of a corporation but instead affords protection where some conduct amounting to bad faith makes it inequitable for the corporate owner to hide behind the corporate form. Difficulty in enforcing a judgment or collecting a debt does not satisfy this standard.”  Sonora Diamond, 83 Cal. App. 4th at 539; “In almost every instance where a plaintiff has attempted to invoke the doctrine he is an unsatisfied creditor.” Associated Vendors, Inc. v. Oakland Meat Co., 210 Cal. App. 2d 825, 842 (1963). “The purpose of the doctrine is not to protect every unsatisfied creditor, but rather to afford him protection, where some conduct amounting to bad faith makes it inequitable, under the applicable rule above cited, for the equitable owner of a corporation to hide behind its corporate veil.” Id. There are dozens of cases that stand for this point but the court does not cite, much less distinguish, any of them. 


The opinion proceeds to conflate a settled rule—that a plaintiff need not prove “actual fraud” to establish alter ego, see Minifie v. Rowley, 187 Cal. 481, 488 (1922)—with the rule it applies to decide the case—that the alleged alter ego's “wrongful intent” is unnecessary. And indeed “beside the point.” It appears to glean the rule by closely parsing the second element in a prior case as “an inequitable result.” (emphasis original). But to the extent that the court reads “result” as being unrelated to the wrongfulness of the defendant’s conduct, it is applying a gloss based on a certain connotation of the word “result”—i.e., as an effect, rather than a cause—that is not supported in the law.


To the contrary, taking a closer look at the precedent on the issue, what the courts have traditionally meant by an “inequitable result” is that the alleged alter ego is abusing the corporate form to get away with unlawful, oppressive, bad faith, or fraudulent conduct. “[I]t would be unjust to permit those who control companies to treat them as a single or unitary enterprise and then assert their corporate separateness in order to commit frauds and other misdeeds with impunity.” Las Palmas, 235 Cal. App. 3d at 1249. Indeed, some of the earliest cases state this more or less directly. See Erkenbrecher v. Grant, 187 Cal. 7, 11 (1921) (describing the “injustice” element as something that “would aid the consummation of a wrong”). “[B]ad faith in one form or another is an underlying consideration and will be found in some form or another in those cases wherein the trial court was justified in disregarding the corporate entity.” Oakland Meat, 210 Cal. App. 2d at 838.  So while there doesn’t need to be “actual fraud” in the sense of something that fully satisfies § 1572 of the Civil Code, cases applying the doctrine invariably find that the alleged alter ego was engaged in some shenanigans from which equity will not permit it to benefit.


It’s been a slow week for me, so to prove the point, I did the research.


Compare


•    Toho-Towa Co., Ltd. v. Morgan Creek Prods., Inc., 217 Cal. App. 4th 1096, 1009 (2013) (alter ego obscured corporate structure to deprive plaintiff the benefit of license agreement);


•    Hub City Solid Waste Servs., Inc. v. City of Compton, 186 Cal. App. 4th 1114, 1123 (2010) (defendant abused corporate form by siphoning money out of contractual counterparty for purposes unrelated to the business, leaving it undercapitalized);


•    Troyk v. Farmers Grp., Inc., 171 Cal. App. 4th 1305, 1342 (2009) (insurer maintained its corporate structure in a manner that left insureds unsure with what entity they were dealing); 


 •    Crestmar Owners Ass'n v. Stapakis, 157 Cal. App. 4th 1223, 1227 (2007) (alter ego had deeded his company's property to himself without consideration to avoid conveyance to plaintiff);

•    Baize v. Eastridge Cos., 142 Cal. App. 4th 293 (2006) (alter ego shifted profits out of principal defendant and made statements that led to confusion regarding with what company plaintiff was dealing); 


•    Tran v. Farmers Grp., Inc., 104 Cal. App. 4th 1202, 1220 (2002) (insurer maintained its corporate structure in a manner that left insureds unsure with what entity they were dealing);  


•    Say & Say, Inc. v. Ebershoff, 20 Cal. App. 4th 1759, 1770 (1993) (corporation used to evade statutory obligations and engage in vexatious litigation);


•    Las Palmas, 235 Cal. App. 3d at 1250–52 (deliberate undercapitalization); 


•    NEC Elecs. Inc. v. Hurt, 208 Cal. App. 3d 772, 777–78 (1989) (depletion of assets to the detriment of creditors);


•    Jack Farenbaugh & Son v. Belmont Constr., Inc., 194 Cal. App. 3d 1023, 1034 (1987) (removal of assets from company);


•    Alexander v. Abbey of the Chimes, 104 Cal. App. 3d 39, 47 (1980) (alleged alter ego received the consideration from the sale of all of the principal defendant’s assets, which occurred during trial); 


•    Linco Servs., Inc. v. DuPont, 239 Cal. App. 2d 841, 844 (1966) (alter egos acts that effectively invited the public to do business with an unsound corporation);


•    Platt v. Billingsley, 234 Cal. App. 2d 577, 593 (1965) (alter ego defendants were “using the corporation as a facade to protect themselves against personal liability in a speculative venture”);


•    Rosen v. E. C. Losch, Inc., 234 Cal. App. 2d 324, 334-35 (1965) (alter ego transferred assets to a different personally owned corporation to avoid obligations to partner);

•    McKee v. Peterson, 214 Cal. App. 2d 515, 531 (1963) (noting that “[b]ad faith is an underlying element which will be found in the cases where the corporate entity was justifiably disregarded by the trial court” but finding that bad faith could be imputed by diversion of corporate funds for non-corporate purposes and at least negligent failures to abide by necessary formalities);


•    Wheeler v. Superior Mortg. Co., 196 Cal. App. 2d 822, 830 (1961) (upholding alter ego when separate corprations used to perpetrate and avoid liabilty for usury scheme “would indicate bad faith”);

•    Claremont Press Pub. Co. v. Barksdale, 187 Cal. App. 2d 813, 816–17 (1961) (defendant dealt with plaintiff through corporation that was never adequately formed or capitalized, obtained benefits for personal use); 


•    Minton v. Cavaney, 56 Cal. 2d 576, (1961) (second element satisfied when “there was no attempt to provide adequate capitalization”);


•    Most Worshipful Sons of Light Grand Lodge Ancient Free & Accepted Masons v. Sons of Light Lodge No. 9, 160 Cal. App. 2d 560, 568 (1958) (alter ego corporation as part of conspiracy to deprive plaintiff of its assets);


•    Bariffi v. Longridge Dev. Co., 156 Cal. App. 2d 583, 590-92 (1958)
(alter egos permitted corporation to be held out as operating entity for owning and subdividing land when it was actually created for tax purposes and had no capital to pay creditors);

•    Eng'g Serv. Corp. v. Longridge Inv. Co., 153 Cal. App. 2d 404, 413 (1957) (same facts as Bariffi);

•    Automotriz Del Golfo De Cal. S. A. De C. V. v. Resnick, 47 Cal. 2d 792, 796 (1957) (undercapitalization at a time the principal defendant was incurring significant obligations to the plaintiff; passing bad checks; misrepresenting the condition of the business);


 •    Hiehle v. Torrance Millworks, 126 Cal. App. 2d 624, 630 (1954) (alter egos made fraudulent entires in corporate books and records to obtain loan to corporation, which they used for personal enrichment);

•    Wilson v. Stearns, 123 Cal. App. 2d 472, 486 (1954) (finding alter ego because the coroprate form was “utilized for fraudulent purposes, such as a cloak or disguise for the evasion of contracts or other obligations”);


•    Kohn v. Kohn, 95 Cal. App. 2d 708, 719 (1950) (husband admitted that he was using the corporate form to shield assets from wife in divorce case);


•    Gordon v. Aztec Brewing Co., 33 Cal. 2d 514, 523 (1949) (plaintiff mislead by dealing with an identically named entity under common ownership); 


•    Duarte v. Postal Union Life Ins. Co., 75 Cal. App. 2d 557, 576 (1946) (alter ego mislead plaintiff about the nature or corporation with which he was dealing by conducting a number of sham transactions);

•    Stark v. Coker, 20 Cal. 2d 839, 848 (1942) (alter ego defendants led plaintiff to believe that they would be personally obliged);


 •    Marr v. Postal Union Life Ins. Co., 40 Cal. App. 2d 673, 677 (1940) (same facts as Duarte);

•    Sunset Farms v. Superior Court, 9 Cal. App. 2d 389, 402-03 (1935) (alter ego used corporation as part of a fraudulent scheme to avoid collection of debts)

•    D.N. & E. Walter & Co. v. Zuckerman, 214 Cal. 418, 419 (1932) (defendant tried to use post-agreement incorporation to avoid obligations under a personal guarantee);


•    Minifie, 187 Cal. at 488 (alter ego defendant tried to use the corporate form “to avoid the incidents of his fiduciary relationship” in his personal capacity);


•    Stanford Hotel Co. v. M. Schwind Co., 180 Cal. 348, 354 (1919) (alter ego used as part of a fraudulent scheme to avoid payment of predecessor's rent)

with 


•    Leek v. Cooper, 194 Cal. App. 4th 399, 418 (2011) (no alter ego liability due to lack of “some conduct amounting to bad faith”);


•     Tucker Land Co. v. California, 94 Cal. App. 4th 1191, 1202 (2001) (no inequitable result when: (1) no abuse of corporate formalities; (2) no diversion of funds; (3) no fraud);

•    Sonora Diamond, 83 Cal. App. 4th 523, 539 (2000) (subsidiary’s inability to pay debt was not inequitable result);


•    Laird v. Capital Cities/ABC, Inc., 68 Cal. App. 4th 727, 742 (1998) (declining to find parent was alter ego of subsidiary in the absence of “specific manipulative conduct” by the parent toward the subsidiary which relegates the latter to the status of merely an instrumentality, agency, conduit or adjunct of the former.” (quotations omitted)) disapproved on other ground Reid v. Google, Inc., 50 Cal. 4th 512, 524 (2010);


•    Mid-Century Ins. Co. v. Gardner, 9 Cal. App. 4th 1205, 1215–16 (1992) (no injustice even though property of corporate defendant was mistakenly insured in the name of the alleged alter ego);


•    Sammons Enters., Inc. v. Superior Court, 205 Cal. App. 3d 1427, 1434 (1988) (no alter ego liability due to lack of “[b]ad faith in one form or another”);

•    Am. Home Ins. Co. v. Travelers Indem. Co., 122 Cal. App. 3d 951, 967 (1981) (declining to find alter ego liability in the absence of “inequitable conduct”);


•    U.S. Fire Ins. Co v. Nat'l Union Fire Ins. Co., 107 Cal. App. 3d 456, 469 (1980) (reversing alter ego judgment due to lack of bad faith);

•    Westinghouse Elec. Corp. v. Superior Court, 17 Cal. 3d 259, 274 (Cal. 1976) (no alter ego liability because party asserting alter ego “faled to show the existence of an [a]lter ego arrangement” when it could not esablish that alleged alter ego established a subsidiary for manipulative purposes)

•    Pearl v. Shore, 17 Cal. App. 3d 608, 617 (1971) (“It seems to us that plaintiff's attempt to fasten corporate liabilities onto defendant must fail because of the complete lack of showing of bad faith, in any form.”);


•    Roman Catholic Archbishop v. Superior Court, 15 Cal. App. 3d 405, 412 (1971) (that principal defendant’s debt to plaintiff might go unpaid was not enough);


•    Clejan v. Reisman, 5 Cal. App. 3d 224, 239–40 (1970) (corporation potentially undercapitalized, but through no fault of alleged alter ego);


•    Tarter, Webster & Johnson, Inc. v. Windsor Devs., Inc., 217 Cal. App. 2d Supp. 875, 879 (1963) (“There is no evidence in the record that there was any bad faith on the part of the defendant or that defendant knew of facts which would indicate that the corporations were but the alter ego of the individuals.”)

•    Oakland Meat, 210 Cal. App. 2d at 838 (discussing “inequitable result” element as “designed to prevent what would be fraud or injustice, if accomplished” and noting that “bad faith in one form or another is an underlying consideration and will be found in some form or another in those cases wherein the trial court was justified in disregarding the corporate entity”);


•    Kazutoff v. Wahlstrom, 196 Cal. App. 2d 65, 69 (1963) (affirming denial of alter ego based on lack of second element when the “record on this appeal shows that the decision of the respondents to incorporate was based upon valid considerations with no implications of fraud or any attempt to avoid liability”); 


•    Cutter Labs., Inc. v. R. W. Ogle & Co., 151 Cal. App. 2d 410, 421 (1957) (isolated fact that inventor deposited one check of company funds to his own bank account was insufficient to prove bad faith or abuse of exercise of corporate control so as to disregard corporate entity);

•    Maxwell Cafe, Inc. v. Dep't of Alcoholic Beverage Control, 142 Cal. App. 2d 73, 78 (1956) (“In the absence of confusion of corporate with individual affairs, or failing to disclose to third parties the existence of the two entities, or abuse or bad faith in the exercise of corporate control, the corporate entity will not be disregarded”);


•    Shafford v. Otto Sales Co., 119 Cal.App.2d 849, 861 (1953) (no alter ego liability when “[t]here is no evidence that the corporation was used as a shield by [the alleged alter ego] Otto to cover up his activities as an individual”)'


•    Carlesimo v. Schwebel, 87 Cal. App. 2d 482, 493 (1948) (no alter ego liability, even though corporation was undercapitalized, abesent “evidence that the financial setup of the corporation is just a sham, and accomplishes injustice”);


•    Gardner v. Rutherford, 57 Cal. App. 2d 874, 881-83 (1943) (no alter ego liability because corporation was not “merely the business conduit” of the alleged alter ego; quoting rule that “[b]ad faith in one form or another must be shown before the court may disregard the fiction of separate corporate existence”);


•    Chiarello v. Axelson, 25 Cal. App. 2d 157, 160 (1938) (no alter ego liability because “defendant cannot be charged with bad faith for doing the very thing agreed upon”);


•    Hollywood Cleaning & Pressing Co. v. Hollywood Laundry Serv., 217 Cal. 124, 130-31 (1933) (declining to find alter ego liability because “[b]ad faith in one form or another must be shown before the court may disregard the fiction of separate corporate existence.”);


•    Wood Estate Co. v. Chanslor, 209 Cal. 241, 246 (1930) (no alter ego liability because the trial court found no bad faith);


•    Midwest Air Filters Pacific v. Finn, 201 Cal. 587, 597 (1927) (no alter ego liability when “[t]here is nothing in the record to challenge the good faith of the parties in the formation of the corporation”);


•    Erkenbrecher, 187 Cal. at 11 (declining to apply alter ego in “the absence of any dishonest motive or intention to accomplish a wrong”);


•    Llewellyn Iron Works v. Abbott Kinney Co., 172 Cal. 210, 213-14 (Cal. 1916) (finding that alter ego could have been established if alleged alter ego concealed facts about the nature of the corproation it was incumbent upon him to disclose in order to “escape the payment of a just debt,” but finding evidence insufficient); and
 

•    Lynch v. McDonald, 155 Cal. 704,  707 (1908) (no alter ego liability when plaintiff was fully apprised of facts regarding the relatinship between company and alleged alter ego).   

And see also

•    Hennessey's Tavern, Inc. v. Am. Air Filter Co., 204 Cal. App. 3d 1351, 1358 (1988) (without deciding merits of alter ego issue, noting that “bad faith in one form or another must be shown”); and

•    Luis v. Orcutt Town Water Co., 204 Cal. App. 2d 433, 443-44 (1962) (same).


The only case the opinion cites in its entire alter ego analysis is Greenspan v. LADT, LLC, 191 Cal. App. 4th 486 (2010). Greenspan reiterates the alter ego analysis in many of the above cases. It does not flatly state the rule that the opinion draws from it—that wrongful intent is unnecessary and beside the point. Indeed, it cites a list factors that originally appeared in the classic Oakland Meat case, which include
as relevant considerations a number of intentionally wrongful acts by an alleged alter ego. The Greenspan opinion is concerned with a host of issues, most of which are irrelevant here. Oddly, its alter ego analysis is contained in a discussion of the prejudice that resulted from the trial court’s erroneous exclusion of most of the plaintiff’s alter ego evidence.

Perhaps motivated by a lengthy procedural history that was already many years in the making, Greenspan resolved the alter ego issue in favor of the plaintiff without a remand to the trial court. Setting aside whether that was procedurally proper, Greenspan’s discussion of the conduct that gave rise to the alter ego finding—particularly when read in context with the opinion’s statement of facts—shows that the alleged alter ego was engaged in some pretty shady conduct. The evidence at least warranted an inference that the alter ego had orchestrated the sucking of $47 million out of one of the principal defendants, leaving it with only $13,000 in capital and rendering it unable to satisfy a nearly $8 million judgment. While the court never specifically says that the alter ego acted in bad faith, his acts appear to have been so clearly abusive of the corporate form to warrant such an inference, like that drawn in McKee.

Turning back to the facts of this case, there might well be evidence that would sustain an alter ego finding. But to the extent the opinion reads Greenspan to mean an unpaid judgment against Airborne, an insolvent defendant, plus the mere fact that the Fultons had previously taken distributions from Airborne is sufficient to equal an inequitable result as a matter of law, it is wrong. If Greenspan stands for that rule, it is wrong too. 


For-profit companies distribute profits to their owners. That's why they exist. That a company has paid a dividend does not, in itself, warrant piercing the corporate veil just because sometime down the road the company winds up insolvent and unable to pay a judgment. Were that the case, an “unjust result” would apply to any formerly profitable, now bankrupt company. Bankruptcy protection would be essentially useless for any companies with a single or majority owner. That’s not the law.

Of course, as the cases cited above establish, under the right circumstances, making distributions can have inequitable results. But only when other facts suggesting bad faith are shown. Thus, a company could make distributions that would render it undercapitalized in light of known or anticipated liabilities. Or the alter ego could siphon away cash to avoid obligations to creditors. Or the alter ego could have handled the company’s assets so
shambolically that an inference of bad faith is merited. Evidence of some of these facts might have been present in this case. But the opinion’s lack of clarity about the timing of the distributions vis-a-vis the litigation makes it a little hard to tell. If so, an alter ego finding might have been merited. The trial court apparently didn’t think so.

But that decision—what inferences to draw from the evidence—was for the trial court to make. See Alexander, 104 Cal. App. 3d at 46 (“[T]he conditions under which the corporate entity may be disregarded vary according to the circumstances in each case and the matter is particularly within the province of the trial court. This is because the determination of whether a corporation is an alter ego of an individual is ordinarily a question of fact.” (citations omitted)).


Indeed, the court’s finding that the trial court applied an inappropriate standard requiring bad intent might have been an effort to sidestep the deferential substantial evidence standard that is afforded to fact-finding. Frankly, it’s not even clear that the trial court was imposing the intent element the court finds erroneous—the quoted portions of the trial court ruling make it sound like the court found that Relentless just failed to carry its burden of showing that the earlier distributions were something other than ordinary dividends paid by a profitable company.

If the court thinks that the Fultons actually did something untoward warranting personal liability, it would have been much better to decide that the trial court’s ruling otherwise was unsupported by substantial evidence. If it was, however, the ruling should stand. It is one thing to say that a set of facts “presents a case upon which a trial court might decide to pierce the corporate veil,” which is probably true here. Oakland Meat, 210 Cal. App. 2d at 836.  “[B]ut looking to all of the facts . . . it is another matter to say that under these facts the corporate veil must be pierced.” Id. In any event, by ruling that an unsatisfied judgment against an insolvent company is “an inequitable result as a matter of law,” this decision ignores well-settled law and sets a dangerous precedent.

1 comment:

  1. wow what a geat article !
    much better than this one:
    http://www.lawpipe.com/california/What_Is_Alter_Ego_Doctrine_In_California_Corporate_Law.html

    now i truly understand this doctrine !
    thank you Mr Shipley !!

    ReplyDelete