Memorandum Decision re Contempt for Attempt to Prosecute Alter Ego Claim
Original Filed August 9, 1999
The court issued an order to show cause re contempt to Lisa Michaels, Jill Weiss, and their counsel Abramson & Smith, LLP, (collectively, "Respondents") for an alleged violation of the automatic stay under 11 U.S.C. § 362(a)(3). The trustee ("Trustee") alleged Respondents violated the stay by attempting to amend a state court judgment against the debtor, International Cab Co. ("International") to include the names of National Cab Co. ("National") and James O'Connor ("O'Connor") as alter ego judgment debtors.
The court has considered the Trustee's Motion for Order to Show Cause Re Contempt; Respondents' Response to the Motion ("Response"); Respondents' Supplemental Response ("Supplemental Response"), to which the Trustee has declined the opportunity to respond in writing; and the arguments of counsel at hearings on June 30, and July 30, 1999. For the reasons that follow, the court finds Respondents violated the automatic stay and are in civil contempt. The court has discretion under 11 U.S.C. § 105(a) to impose sanctions for civil contempt for automatic stay violations. The Trustee shall be awarded $1,000 against Respondents as partial compensation for the Trustee's costs and fees in filing and prosecuting the motion for the Order to Show Cause.
On September 3, 1997, Lisa Michaels and Jill Weiss obtained a state court judgment against International for personal injuries sustained in an accident while passengers in a taxicab owned by International. At that time, International's insurance company was in insolvency proceedings and was unable to satisfy any insurance claims. International petitioned the state court for a two month stay of execution of the judgment. During this period, O'Connor incorporated National and immediately transferred International's assets to National, while leaving all liabilities in International. O'Connor is the sole shareholder and president of both companies. International filed a Chapter 7 bankruptcy petition approximately four months later. Under 11 U.S.C. § 362(a), the petition stayed Respondents from enforcing their judgment against International.
Respondents then filed a fraudulent transfer action in state court based upon the transfer of International's assets to National. Fraudulent transfer claims are property of the estate and can only be asserted by the Trustee.(1) The Trustee notified Respondents of the automatic stay violation and requested that Respondents dismiss their suit, which they did.
The Trustee then reached a settlement with O'Connor and National which released each of them from any further claims by the Trustee or the estate. Respondents objected to the settlement, and a hearing was held in which Respondents' objections were overruled. At the hearing, Respondents were informed that any alter ego claim based upon the fraudulent transfer was property of the estate. Following the settlement, Respondents filed a motion to amend ("Motion to Amend") their state court judgment for personal injuries to include National and O'Connor as alter ego judgment debtors under California Code of Civil Procedure section 187.
III. Issues Presented
May Respondents assert an alter ego claim against National or O'Connor?
Have Respondents violated the automatic stay by filing the Motion to Amend?
If the automatic stay has been violated, can Respondents be held in contempt and thereby ordered to pay damages to the Trustee?
A. The Alter Ego Doctrine
The alter ego doctrine is used to establish the direct liability of a shareholder or owner when that shareholder or owner improperly uses the corporate entity to commit acts which harm the corporation itself, or third persons involved with the corporation. State law determines who has standing to assert an alter ego claim when the corporate entity which has been abused subsequently files bankruptcy. CBS, Inc. v. Folks (In re Folks), 211 B.R. 378, 385 (9th Cir. BAP 1997) ("Folks"). Both International and National are incorporated in California. O'Connor is a resident of California. Therefore, California law is controlling on the issue of standing to bring an alter ego claim in this case.
The California Supreme Court has described the use of the alter ego doctrine as follows:
The alter ego doctrine arises when a plaintiff comes into court claiming that an opposing party is using the corporate form unjustly and in derogation of the plaintiff's interests. (6 Witkin, Summary of Cal. Law (8th ed. 1974) Corporations, § 5, p.4318.) In certain circumstances the court will disregard the corporate entity and will hold the individual shareholders liable for the actions of the corporation: "As the separate personality of the corporation is a statutory privilege, it must be used for legitimate business purposes and must not be perverted. When it is abused it will be disregarded and the corporation looked at as a collection or association of individuals, so that the corporation will be liable for acts of the stockholders or the stockholders liable for acts done in the name of the corporation." (Comment, Corporations: Disregarding Corporate Entity: One Man Company (1925) 13 Cal.L.Rev. 235, 237.)
Mesler v. Bragg Management Co., 39 Cal. 3d 290, 300, 702 P.2d 601, 216 Cal. Rptr. 443 (1985).
The case of Automotriz Del Golfo De California v. Resnick, 47 Cal. 2d 792, 306 P.2d 1 (1957) earlier set forth two prerequisites for the application of the alter ego doctrine. They are "(1) that there be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist and (2) that, if the acts are treated as those of the corporation alone, an inequitable result will follow." Id. at 796.
B. Generalized Alter Ego Claims
California law distinguishes two types of alter ego claims: generalized and particularized. Folks, 211 B.R. at 385, 387. Generalized claims are those which derive from harm to the corporation and could be asserted by any creditor of the corporation. Id. at 387. In other words, the corporation itself is injured in such a way that each of its creditors is injured vicariously through the injury to the corporation. The corporation is the initial target of the injury. Where the injury is to the corporation itself, the claim for that injury is for the benefit of the corporation, and is therefore the property of the estate. Id. at 387, 388. "[O]nly the Debtor or Trustee has standing to assert the alter ego claim where injury to the corporation is alleged." In re Davey Roofing Inc., 167 B.R. 604, 608 (Bankr. C.D. Cal. 1994).
The resolution of the standing issue depends upon whether the alter ego claim is the property of the estate or instead belongs to a particular creditor. Folks, 211 B.R. at 387. If the alter ego claim is property of the estate, then it can only be asserted by the Trustee. Davey Roofing, 167 B.R. at 606. Alternatively, if it is not estate property, then the creditor may assert the claim. The Trustee "may not enforce rights of action which belong to the creditors individually because they are not rights in which the bankrupt claims an interest and are not assets of the estate in bankruptcy." Stodd v Goldberger, 73 Cal. App. 3d 827, 835, 141 Cal. Rptr. 67 (1977).
In Davey, creditor S-G Wholesale filed a state court claim against Donald Davey as the alter ego of Davey Roofing, Inc. S-G Wholesale alleged that Davey had abused the corporate entity by commingling corporate funds with personal funds, which Davey then withdrew for personal use. S-G Wholesale alleged that Davey Roofing was unable to pay its debt due to the transfer of funds. Davey Roofing then filed a Chapter 11 petition and requested the bankruptcy court to determine whether S-G Wholesale's alter ego claim was property of the estate.
The Davey court determined that the alter ego claim was property of the estate because injury to the corporation had been alleged. The court stated:
In the case at bar, S-G alleges that Debtor's principal misappropriated for his own benefit assets belonging to the bankrupt corporation, to the detriment of the estate and all of Debtor's creditors, rather than any individual creditor. Thus, Debtor [or the Trustee in bankruptcy] is the proper party to assert alter ego claims, and all of Debtor's creditors are bound by the outcome of the estate's action.
Davey,167 B.R. at 608.
Similarly, in Folks, creditor CBS Inc., alleged that Byron Folks, as the alter ego of BYCA , Inc., had "failed to observe any corporate formalities with respect to BYCA and used bank accounts and funds of BYCA for personal and family expenditures. This is a general claim because all creditors are affected and no particularized injury to CBS exists." Folks, 211 B.R. at 387.
C. Particularized Alter Ego Claims
Particularized alter ego claims are distinguished by direct harm to a creditor and do not derive from general harm to the corporation. If a claim is particularized, then it is not property of the estate because it only benefits that particular creditor. Folks, 211 B.R. at 387. The trustee cannot assert the claim because he can only assert claims which benefit the entire estate. In that situation, the individual creditor is the proper person to assert the claim. "In California, only a creditor with a particularized injury has standing to assert an alter ego claim." Id. at 385.
The case of Variable-Parameter Fixture Development Corporation v. Morpheus Lights, Inc. and John Richardson, 945 F. Supp. 603 (S.D.N.Y. 1996) provides an example of an alter ego claim based upon a particularized injury.(2) Variable involved a claim of patent infringement against Morpheus, and against Richardson as the alter ego of Morpheus. Richardson was the sole shareholder and president of Morpheus. Variable claimed that Richardson had "actively participated in the willful infringement of the ...patent and [was] personally liable for the damages arising from his tortuous conduct." The patent infringement suit was subsequently stayed when Morpheus filed a bankruptcy petition. Variable, 945 F.Supp. at 605, 606.
The court in Variable determined that although the bankruptcy petition stayed the suit against Morpheus, it did not stay the suit against Richardson. Id. at 608. The court reasoned that the alter ego claim against Richardson was for a particularized injury and was therefore not property of the bankruptcy estate, and not subject to the automatic stay. Id. This reasoning was based upon the fact that Richardson's alleged patent infringement had not harmed the debtor corporation, Morpheus, but had instead caused harm directly to Variable. The Variable court explained that the basis of the alter ego claim was that Richardson had:
directly and actively participated in ... willful infringement [of the patent]. Variable claims that as the alter ego of Morpheus, Richardson caused harm directly to Variable. In other words, Variable has alleged a "particularized injury" and not solely injury to the corporation. Accordingly, the claims do not fall within the ambit of the automatic stay applicable to Morpheus.
D. Respondents' Alter Ego Claim
In their Response, Respondents state: "The purpose of the Motion to Amend Judgment in the state court is to add the names of the defendants, National Cab Company, Inc. and James E. O'Connor, both of which are nondebtors, pursuant to California's alter ego doctrine, in the personal claims of Lisa Michaels and Jill Weiss for damages for personal injury." (Response, page 2, lines 4-7.) This statement assumes that Respondents can assert a particularized alter ego claim based on their personal injuries.
To assert a particularized alter ego claim, Respondents must allege direct injuries caused by an abuse of the corporate entity. The abuse of the corporate entity in this case relates only to the fraudulent transfer, not to the personal injuries. Injury resulting from the fraudulent transfer is not a direct injury particularized to Respondents. Instead, the fraudulent transfer injured International directly, and each of its creditors indirectly. At the second hearing, Respondents conceded that any contract creditor of International could have stated a claim based on the fraudulent transfer. Therefore, an alter ego claim arising out of the fraudulent transfer is generalized.
In the Motion to Amend, Respondents state:
James E. O'Connor manipulated the assets of International and this taxicab business so that he and National would continue to benefit from the assets now maintained by National while the liabilities remained with International. Once James E. O'Connor singlehandedly accomplished the transfer of all International's assets to National, he drove the undercapitalized corporation into bankruptcy with $1.6 million in debts. Clearly, the transfers of International's assets to National were to the detriment of International's creditors.
Motion to Amend, page 9, lines 26-28, page 10, lines 1-3.
This passage provides the basis for a generalized alter ego claim, not a particularized alter ego claim. All of International's creditors were harmed by the actions of O'Connor, not just Respondents. Respondents have not been harmed directly by O'Connor's abuse of the corporate entity, but rather indirectly through his transfer of assets which caused International to be unable to satisfy Respondents' judgment. The harm caused to Respondents is that International cannot pay its debts to Respondents and other creditors. This is the same harm caused to all of International's creditors. Respondents have suffered no particularized injury.
Respondents assert that their claims are particularized because Respondents suffered direct personal injuries while there was no "personal" injury to International. This argument focuses on the state court personal injury claims. As stated previously, no alter ego claim can be stated based upon the personal injuries. Respondents have not alleged that O'Connor used International in a manner that caused the personal injuries.
In the Supplemental Response, Respondents rely upon Caplin v. Marine Midland Grace Trust Co., 406 U.S. 416, 92 S. Ct. 1678, 32 L. Ed.2d 195 (1971) and Williams v. California First Bank, 859 F.2d 664 (9th Cir. 1988) to support the proposition that the Trustee does not have standing to assert an alter ego claim based upon Respondents' personal injuries because the personal injury judgment is not recoverable on behalf of the estate. While Caplin and Williams do stand for the proposition that a trustee may not assert claims on behalf of individual creditors, the facts of the instant case are distinguishable from Caplin and Williams.
The issue here is not what actions the trustee may bring but what actions Respondents (or any other creditors of this estate) may not bring. Caplin involved an attempt by a trustee under former Chapter X of the Bankruptcy Act to sue an indenture trustee for the debtor's debentures based upon the indenture trustee's alleged failure to fulfill obligations under the indenture. The Supreme Court rejected the trustee's contentions, holding that nothing in the Bankruptcy Act (and certainly nothing similar exists under the Bankruptcy Code today) authorizes a trustee to collect money not owed to the estate. Caplin, 406 U.S. at 428. Further, the debenture holders themselves could pursue claims directly against their indenture trustee and a suit by the trustee on behalf of the indenture holders might be inconsistent with independent actions they might be allowed to bring themselves. Id. at 431, 432.
In Williams, the Ninth Circuit followed Caplin and rejected an attempt by a trustee to prosecute claims that individual creditors held against a third party and assigned to the trustee. Williams, 859 F.2d at 667.
The Trustee in the instant case has settled a fraudulent transfer claim which benefits all of International's creditors. The issue of National's and O'Connor's liability for the generalized injury to the estate has already been resolved. What remains for Trustee concerns payment of the settlement debt; this affects all of International's creditors, and was resolved by the Trustee's settlement of the fraudulent transfer. The Trustee in not attempting to assert a personal injury claim which belongs to Respondents.
Respondents make the additional argument that their injuries are particularized because the fraudulent transfer, and therefore, the alter ego liability, was in response to their personal injury judgments. No case law has been found, and none has been offered, to suggest that the type of alter ego claim may be determined by the alleged alter ego's motivations. Respondents' aggressive pursuit of the state court judgment may have been the reason that O'Connor acted, but still the harm is to the corporation. Even if the fraudulent transfer was a specific effort to avoid Respondent's judgment, the alter ego claim is determined by the injury directly caused by the fraudulent transfer. International has been directly harmed by the fraudulent transfer. Therefore, Respondents cannot assert a particularized alter ego claim based upon the personal injuries, or upon the fraudulent transfer.
E. The Automatic Stay
Respondents argue that they are not in violation of the automatic stay because they are not attempting to amend their judgment to include the name of the debtor, International. In their Response, Respondents state "[t]he automatic stay applies only to the debtor, International Cab Company, Inc. and it does not apply to any person or entity except the debtor." (Response, page 2, lines 14-15.) While the automatic stay does not apply to claims against nondebtors, it does apply to claims against property of the estate under 11 U.S.C. § 362(a)(3). The facts which provide the basis for Respondents' state court amendment are the same facts used by the Trustee to assert the fraudulent transfer. In the Motion to Amend, Respondents state:
Said motion is made pursuant to Code of Civil Procedure Section 187, on the grounds that plaintiffs obtained a judgment against International Cab Company, Inc.; after the entry of said judgment International Cab Company, Inc. transferred all of its assets to National Cab Company, Inc. for inadequate consideration and for the purpose of fraudulently avoiding plaintiff's judgment against it.Motion to Amend, page 1, lines 24-28.
Respondents are essentially reasserting the fraudulent transfer claim. Because Respondents are in effect pursuing the fraudulent transfer claim, although under a different name, they are attempting to enforce a claim which is property of the estate.
The Trustee's settlement of the fraudulent transfer included the release of O'Connor and National from any further claims based on that cause of action. The settlement is property of the estate under 11 U.S.C. § 541 (a)(1) because it is derived from the fraudulent transfer claim which is property of the estate. Respondents are interfering with this property because the Motion to Amend, if granted, would jeopardize the release of O'Connor and National agreed to in the settlement. 11 U.S.C. § 362 (a)(3) provides that the filing of a bankruptcy petition operates as a stay of "any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate[.] Respondents' attempt to interfere with the terms of the settlement is an attempt to exercise control over property of the estate.
Respondents' interference with the settlement, in a larger sense, prospectively undermines the Trustee's ability to settle general alter ego claims. If individual creditors are subsequently allowed to take actions which argue the same claims that the Trustee is empowered to settle, the ability of the Trustee to settle such claims is weakened. The Trustee must be able conclusively to release parties from future claims as part of a settlement. All creditors claiming through a generalized alter ego claim must abide by the settlement negotiated by the Trustee. Davey Roofing, 167 B.R. at 608.(3)
The Trustee negotiated a settlement under which the estate is currently receiving payments secured by the assets of National. The Trustee contends that the Motion to Amend could jeopardize the ability of National to continue making these payments, thus damaging the estate. In addition, if Respondents are allowed to amend the state court judgment, nothing would prevent International's other creditors pursuing O'Connor and National in a similar manner. This potential scenario violates one of the main objectives of the automatic stay. That is, the ability of the Trustee to administer the assets of the estate in an orderly and equitable manner.
The automatic stay is one of the fundamental debtor protections provided by the bankruptcy laws. ... The automatic stay also provides creditor protection. Without it, certain creditors would be able to pursue their own remedies against the debtor's property. Those who acted first would obtain payment of the claims in preference to and to the detriment of other creditors. Bankruptcy is designed to provide an orderly liquidation procedure under which all creditors are treted equally.
Harsh Investment Corp. v. Bialac (In re Bialac), 712 F.2d 426, 431 (9th Cir. 1983), citing H.R. Rep. No. 95-595, 95th Cong., 2d Sess. at 340 (1977).
F. Sanctions for Contempt of the Automatic Stay
Violations of the automatic stay are normally sanctioned under 11 U.S.C. § 362(h) which states: "An individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys fees, and, in appropriate circumstances, may recover punitive damages." Although a trustee is not an "individual" who may recover damages for violation of the automatic stay under 11 U.S.C. § 362(h), a bankruptcy court may award sanctions to a trustee under its contempt power. Havelock v. Taxel (In re Pace), 67 F.3d 187, 193 (9th Cir. 1995).
The Trustee has requested that Respondents be sanctioned in this matter. The court has discretion under 11 U.S.C. § 105(a) to impose sanctions for contempt for violation of the automatic stay. Id. Section 105(a) provides:
The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.
The Ninth Circuit has stated that "[section 105(a) is broad enough to provide relief to those entities that are injured by willful violations of the automatic stay, but cannot recover under § 362(h)." State of California Employment Development Dept. v. Taxel (In re Del Mission Limited), 98 F.3d 1147, 1152 (9th Cir. 1996). A violation of the automatic stay may be considered willful even in the absence of any intent to violate the stay. The violation is willful if "the defendant knew of the automatic stay and ... the defendants's actions which violated the stay were intentional." Goichman v. Bloom (In re Bloom), 875 F.2d 224, 227 (9th Cir. BAP 1989). Respondents were clearly aware of the automatic stay, and their actions in filing the motion to amend the state court judgment were intentional.
Respondents have been advised twice that any claim based on a fraudulent transfer is property of the estate: once when the Trustee requested that Respondents dismiss their state court fraudulent transfer action, and again at the hearing on approval of the Trustee's settlement with National and O'Connor. Therefore, it may be inferred that Respondents have chosen to disregard the instructions of the court, and are therefore in contempt.
For the foregoing reasons, Respondents have violated the automatic stay and are in contempt. The court acknowledges that the issues raised by this controversy are difficult and not always clear to practitioners not familiar with the applicable bankruptcy doctrines at play. Because it is a particularly obtuse area of the law, and further because the court is satisfied that Respondents seemed to have made a good faith effort to attempt to avoid the reach of 11 U.S.C. § 362(a), including their consultation with bankruptcy counsel, the court does not regard the violations as malicious or in bad faith. That being said, Respondents will have to get the message once and for all that they may not interfere with the Trustee's rights. They were warned once by the Trustee when they attempted to prosecute their fraudulent transfer action; they were admonished by the court at the hearing on the settlement. Thus today's decision, while not in the nature of injunctive relief (as none was sought) should constitute a severe warning to Respondents to put this entire matter behind them as difficult as that may be. The court will temperate sanctions based upon the foregoing reasons and further because of the very difficult situation Ms. Michaels and Ms. Weiss have encountered after suffering personal injuries. If there is any further disregard for these bankruptcy principles, however, the court will not be so considerate.
Attorney's fees and costs are appropriate as a basis for awarding damages for violation of the automatic stay under 11 U.S.C. § 105(a). In re Pace at 192. Therefore, the court will order that within ten days of service of the order to be presented, Respondents shall pay $1,000 to the Trustee as partial compensation for the Trustee's costs and fees in filing and defending the motion to show cause re contempt for violating the automatic stay.
The Trustee should submit a form of order consistent with the foregoing and shall comply with B.L.R. 9021-1 and 9022-1.