Altered Egos – The Ninth Circuit Weighs in (Again) On Whether Individual Creditors Can Pursue Their Own “Alter Ego” Claims Against a Bankrupt Entity’s PrincipalsMonday, October 25th, 2010
Whenever a troubled business seeks bankruptcy protection, unsecured creditors are often left scrambling to find other sources of recoveries for their claims.
In addition to individual, contractually negotiated protections such as personal guarantees and letters of credit, alter ego claims against the debtor’s principals can provide such creditors with additional pockets from which to seek payment. To do so, however, such creditors must often address the objection that they are without standing to pursue such claims, because alter ego claims are often “general” ones, by which all creditors were injured – and from which all creditors are entitled to benefit. As a result, goes the objection, only the trustee – and not individual creditors – may pursue alter ego claims against the debtor’s principals.
The idea that alter ego claims may be prosecuted only by the debtor’s bankruptcy trustee on behalf of all creditors has been endorsed by at least one Circuit Court of Appeals: The 11th Circuit has affirmed as much in Baille Lumber Company, LP v. Thompson, 413 F.3d 1293 (11th Cir. 2005).
But this view is not universally held. In fact, the 9th Circuit has long held a contrary view, as has the 8th Circuit. See Williams v. California 1st Bank, 859 F.2d 664, 667 (9th Cir. 1988) (“[N]o trustee . . . has the power under . . . the [Bankruptcy] Code to assert general causes of action, such as [an] alter ego claim, on behalf of the bankrupt estate’s creditors.”). See also In re Ozark Restaurant Equipment Co., Inc., 816 F.2d 1222, 1228 (8th Cir. 1987); Estate of Daily v. Title Guar. Escrow Services, Inc., 187 B.R. 837, 842-43 (D. Haw. 1995), aff’d. 81 F.3d 167 (9th Cir. 1996).
Despite the Ninth Circuit’s guidance, however, several lower courts in California have continued to permit bankruptcy trustees to “glom onto” alter ego claims. See, e.g., In re Advanced Packaging and Products Co., 2010 WL 234795 (C.D. Cal. 2010) (permitting a trustee in bankruptcy to settle an alter ego claim brought against the bankrupt corporation’s parent entity because the claim was “general” rather than “particularized”).
Last week – for what appears to be the third time in as many decades – the Ninth Circuit revisited this issue in Ahcom, Ltd. v. Smeding.
Ahcom‘s facts are relatively straightforward: Ahcom, a UK-based corporation, contracted for almonds with California-based Nuttery Farms, Inc. (NFI). After NFI allegedly failed to deliver the almonds, Ahcom commenced arbitration in Europe, then sued in the US to collect on the arbitrator’s award – but not before NFI had filed for bankruptcy protection. Undeterred, Ahcom directly sued NFI’s non-debtor principals, Hendrik and Lettie Smeding, seeking to pierce NFI’s corporate veil. The Smedings removed the action to US District Court for the Northern District of California and successfully dismissed the action on the grounds that Ahcom’s alter ego claims were “general” in nature – and, therefore, property of NFI’s bankruptcy estate.
On appeal, the Ninth Circuit reversed, noting that in California, “there is no such thing as a substantive alter ego claim at all . . . .” (citing Hennessey’s Tavern, Inc. v. Am. Air Filter Co., 251 Cal.Rptr. 859, 863 (Ct. App. 1988)). The panel then went further to explain that California law on this issue has been misread by bankruptcy courts and by the Bankruptcy Appellate Panel for the Ninth Circuit.
As a result, “California law does not recognize an alter ego claim or case of action that will allow a corporation and its shareholders to be treated as alter egos for purposes of all the corporation’s debts. Just because NFI’s trustee could not bring such a claim against the Smedings under California law, there is no reason why Ahcom’s claims against the Smedings could not proceed.”
A circuit split worthy of resolution by the Supreme Court? Perhaps. An alternate means of recovery for unsecured creditors who can allege the right facts? Most definitely.