Tuesday, November 15, 2016

Control, Default, and Alter Ego.

Wolf Metals v. Rand Pac. Sales Inc., No. B264002 (D2d4 Oct. 25, 2016)

Plaintiff is trying to enforce a default judgment. After a lack of success, it moves to add two new judgment creditors, one on the grounds that he was the alter ego of the debtor and the other because it was the debtor’s successor corporation. The trial court granted the request as to both, but the Court of Appeal reverses as to the alleged alter ego.

Code of Civil Procedure § 187 gives courts the authority to enter orders necessary to effectuate their jurisdiction. It has long been interpreted to permit a trial court to amend a judgment to correct the name of the debtor. (For instance, if the judgment says the debtor is X Co., Inc. but it is actually X Co., LLC.) And the power to amend a judgment to state a true name has been futher understood to include the ability to amend a judgment to add an alter ego as a judgment debtor, based on the artifice that an alter ego is just the original debtor by another name.

That, however, is only kind of true. In California, the alter ego doctrine is equitable and transactional—it expands or contracts to the point necessary to do justice, and no more. Thus, one can be a company’s alter ego in some respects while staying separate on others. As the Supreme Court has explained: 
It is not that a corporation will be held liable for the acts of another corporation because there is really only one corporation. Rather, it is that under certain circumstances a hole will be drilled in the wall of limited liability erected by the corporate form; for all purposes other than that for which the hole was drilled, the wall still stands. When it is claimed that a parent corporation should be liable because it is the alter ego of its subsidiary, equity commands that the corporate wall be breached. Yet the wall remains: the parent is liable through the acts of the subsidiary, but as a separate entity. A judgment obtained against a corporation and its alter ego is enforceable against both separately. Thus, when the plaintiff settles with only the subsidiary, the parent's liability continues. To hold otherwise would be to defeat the policy of promoting justice that lies 
Mesler v. Bragg Mgmt. Co., 39 Cal. 3d 290, 300 (1985).

That being the case, the ex post addition of another judgment debtor based on the alter ego rule can be problematic as a matter of due process and the right to a trial on the merits. That it might be just under the circumstances to call the new debtor an alter ego and breach the corporate veil does not necessarily mean that the new debtor was the
same person as the defendant that actually had an opportunity to defend itself in the underlying case. So in order to avoid this problem, to amend an existing existing judgement to add an alter ego as a new debtor, the creditor needs to show both:  (1) the new debtor is actually the alter ego of the original one; and (2) that the new debtor had actual control over the underlying litigation, such that it had motive and opportunity to litigate the merits of the liability. 

The opinion here seems somewhat confused in that it treats the second element (control over the litigation) as being unsatisfiable when the underlying judgment is entered by way of a default or a default-like order where the merits of the case are not adjudicated. And since this case was resolved in a default-like manner, the court finds that the second element wasn’t met, and reverses on that ground.

But the issue doesn’t and really shouldn’t turn on a default/merits distinction. If the debtor to be added had legitimate control over the original debtor’s decision to default, the element should be satisfied. To hold otherwise would frustrate the ability to collect on legitimate debts and frustrate the purposes of the rule permitting amendment under § 187.

On the other hand, if the case had actually gone to a full trial that the new debtor did not actually control, he can’t be added under § 187 even if he is an alter ego, because it gives rise to serious due process issues. So the resolution of the underlying case by default or otherwise is not particularly meaningful, much less dispositive. 

None of the authority cited in the opinion really suggests otherwise. Compare Schoenberg v. Benner, 251 Cal. App. 2d 154, 168 (1967) (amendment proper because alter ego had control over jury trial); Jack Farenbaugh & Son v. Belmont Constr., Inc., 194 Cal. App. 3d 1023, 1030 (1987) (amendment proper because alter ego had control over bench trial); Toho–Towa Co. v. Morgan Creek Prods., Inc., 217 Cal. App. 4th 1096, 1110 (2013) (amendment proper because there was “substantial evidence” that the purported alter ego controlled the underlying arbitration) with NEC Elecs. Inc. v. Hurt, 208 Cal. App. 3d 772, 781 (1989) (amendment improper because there was no evidence that alter ego actually controlled the litigation); Motores De Mexicali, S.A. v. Superior Court, 51 Cal. 2d 172, 175 (1958) (amendment improper because alter ego “in no way participated in the defense of the” underlying case). 

No doubt, it is more difficult to establish an alter ego’s “participation” or “control” in a case where the defendant defaults. A default, after all, arises from a defendant doing nothing or from failing show after the case is in issue, so it can be hard to show that the alter ego controlled the non-activity. That’s what happened in the Motores de Mexicali and NEC Electronics cases relied upon by the court. On the other hand, it’s far easier to show control over a trial, when one can prove that the alter ego paid or directed the lawyers or exercised other key decisions. 

Nonetheless, if the creditor can actually prove that the alter ego controlled the original debtor’s decision to take a default, I don’t see how due process requires an opportunity to re-litigate the case. For instance, if company was properly served with process as X Co., Inc., had actual notice of the litigation, and made an affirmative choice not to answer, there should be no reason why the judgment cannot be amended under § 187 to correct the name to X Co., LLC.

In any event, it does not appear that there was evidence that individual who was the alleged alter ego actually controlled the decision to default. So no harm no foul.

So far as successor corporations go, when the assets of one company pass to a second without consideration, equity can require the liabilities to follow, especially when necessary to avoid fraud or protect the rights of creditors. That’s the case here. The second company was formed by the same owner at the time the liabilities attached. The original debtor filed for BK, but never exited and had its debts discharged—it was just treated as a dead letter. But then the second company carried on basically the same business, with some of the same employees, in the same space, and using some of the same equipment. Under the circumstances, it wasn’t inequitable to find that the second company took on the liabilities of the first one.

Reversed in part.

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