Friday, October 22, 2010
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Court Allows Creditors to Pursue Bankrupt’s Shareholders
By STEVEN M. ELLIS, Staff Writer
The Ninth U.S. Circuit Court of Appeals yesterday rejected arguments that creditors of a corporation in bankruptcy are precluded from suing shareholders in California state court on an alter ego theory.
A federal judge in San Francisco had ruled that a Chapter 11 trustee had exclusive standing to bring a general alter ego claim against two owners of a Northern California farm that filed for bankruptcy, barring a creditor’s attempt to pierce the corporate veil.
But a three-judge panel—noting that state law determines whether a claim belongs to the trustee or a creditor—held on appeal that California law does not recognize a freestanding general alter ego claim or cause of action that will allow a corporation and its shareholders to be treated as alter egos for purposes of all of the corporation’s debts.
Writing for the panel, Senior Judge J. Clifford Wallace said that meant that there was no reason why United Kingdom-based Ahcom Ltd could not rely on an alter ego theory to sue Hendrik and Lettie Smeding individually to confirm an arbitration award and for breach of contract.
Ahcom sued the Smedings, who operated Nuttery Farms Inc. in St. Helena, after the business allegedly failed to deliver on a contract to provide Almonds to Ahcom.
Pursuant to the contract, Ahcom brought an arbitration action against Nuttery Farms before a tribunal in Hamburg, Germany and prevailed. Ahcom then sued in California state court to collect the award, but it named the Smedings as defendants rather than Nuttery Farms, which had petitioned for bankruptcy protection soon after the arbitration award.
Ahcom sought to pierce Nuttery Farms’ corporate veil in order to direct its arbitration confirmation and breach of contract claims against the Smedings. It asserted that they controlled the business as an alter ego, diverting funds and other assets to their own uses to the detriment of creditors, including Ahcom.
The Smedings removed the suit to the U.S. District Court for the Northern District of California and argued that the company was asserting a claim that harmed not just Ahcom but all creditors. Senior U.S. District Judge Samuel J. Conti agreed with the Smedings that such a claim was the exclusive property of the trustee, and he dismissed the complaint.
But the Ninth Circuit reversed, with Wallace reasoning that the Smedings were incorrect in arguing that the California Court of Appeal’s 1977 ruling in Stodd v. Goldberger 73 Cal.App.3d 827 created a general alter ego claim that a trustee can assert on behalf of all creditors.
In Stodd, a bankruptcy trustee sued the debtor’s shareholders on an alter ego theory to establish personal liability for all of the debtor’s debts, but the Court of Appeal affirmed a trial court’s dismissal. The court reasoned that a trustee could not maintain an action on an alter ego theory without some allegation of injury to the corporation giving rise to a right of action in it against the shareholders, and that if no such allegation was present, the asserted cause of action belonged to each creditor individually, not the trustee.
The U.S. Bankruptcy Court for the Central District of California and the Ninth Circuit Bankruptcy Appellate Panel subsequently relied on Stodd to conclude that California permitted a corporation to bring a general alter ego claim against its owners if some injury to the corporation was alleged.
Wallace, however, said those courts misread the opinion.
“Stodd was not, as the Smedings maintain, creating a ‘general alter ego claim,’ ” he wrote. “Instead, Stodd was attempting to distinguish established ‘right[s] of action’ that are properly brought by the trustee (fraudulent conveyance, conversion, and theft…) from those that are not. Under Stodd, the trustee can sue for the former but not for the latter.”
Judges Susan P. Graber and M. Margaret McKeown joined Wallace in his opinion.
The case is Ahcom, Ltd. v. Smeding, 09-16020.
Copyright 2010, Metropolitan News Company