Wolf Metals Inc. v. Rand Pac. Sales, Inc., 4 Cal. App. 5th 698
Wolf Metals Inc. v. Rand Pac. Sales, Inc., 4 Cal. App. 5th 698 (2016), a published California Court of Appeals decision, the California Court of Appeal held that a judgment creditor could not amend a default judgment to add an additional individual judgment debtor under an “alter ego” theory, because doing so would violate that person’s due process rights, although adding a successor corporation to the judgment was permissible. Judgment creditors often want to add a nondebtor individual to a state court default judgment, because the corporation the judgment is against files bankruptcy, or is otherwise “uncollectible”.
FACTS: Wolf Metals filed a complaint against Rand Pacific Sales, Inc. (“RPS”) for open book account, account stated and breach of contract after RPS did not pay for solid sheet metal that Wolf Metals sold to RPS.
RPS answered the complaint, but then filed for bankruptcy under chapter 7. The state action was stayed. Wolf Metals asserted an unsecured claim in the bankruptcy proceedings. The case was fully administered and RPS, as a corporate debtor, did not receive any discharge.
After the bankruptcy case was closed, the trial court authorized Wolf Metals to resume the state court litigation. RPS’s counsel repeatedly failed to appear at hearings. Ultimately the trial court struck RPS’s answer and entered a default judgment against RPS. Wolf Metals conducted a debtor’s examination of RPS’s president, Donald Koh, and RPS’s secretary and treasurer, Koh’s wife. Following motions to compel responses, sanctions and another debtor’s examination, Wolf Metals filed a motion under California Code of Civil Procedure section 187 to amend the default judgment to name Koh and South Gate Steel, Inc. (“SGS”), another company that Koh operated, as additional judgment debtors under alter ego and successor corporation theories. Concluding that Koh was RPS’s alter ego and that SGS was RPS’s successor corporation, the court amended the default judgment naming Koh and SGS as additional judgment debtors.
On appeal, the California Court of Appeal reversed the amended judgment as to Koh, and affirmed as to SGS.
REASONING: Under the California Supreme Court’s precedent in Motores De Mexicali, S.A. v. Superior Court, 51 Cal. 2d 172 (1958) (“Motores”), adding Koh as an additional judgment debtor under an alter ego theory violated Koh’s due process rights because the initial judgment against Wolf Metals was obtained by default.
California Code of Civil Procedure section 187 authorizes a trial court to amend a judgment to add additional judgment debtors. In some circumstances, it may be proper to add an additional judgment debtor under an alter ego theory. For example, when an individual abuses the corporate form to perpetrate a fraud, courts will ignore the corporate entity and adjudge the wrongful acts to be those of the persons controlling the corporation.
However, courts are sensitive to the application of the alter ego theory in connection with default judgments because it raises due process concerns. “[T]o amend a judgment to add a defendant, thereby imposing liability on the new defendant without trial, requires both (1) that the new party be the alter ego of the old party and (2) that the new party … controlled the litigation, thereby having had the opportunity to litigate, in order to satisfy due process concerns. The due process considerations are in addition to, not in lieu of, the threshold alter ego issues.” Triplett v. Farmers Ins. Exchange, 24 Cal. App. 4th 1415, 1421 (1994) (emphasis in original).
The court noted that it was bound by the rule first established over fifty years ago in Motores. There, the plaintiff obtained a default judgment against a corporation and sought to add as alter egos the three individuals who formed the corporation. In rejecting the request, the Motores court cited Fourteenth Amendment due process concerns, particularly because the individuals had no duty to participate in that action since no claims had been made against them personally. Likewise, in NEC Electronics, Inc. v. Hurt, 208 Cal. App. 3d 772 (1989) (“NEC”), the court relied on Motores to reverse the lower court’s decision adding the defendant’s CEO as an additional judgment debtor. The NEC court explained that there was no defense for the defendant’s CEO to control because the corporate defendant did not appear to defend at trial.
This case is the same as Motores. Both the individuals behind the corporate defendants here and in Motores dominated their respective companies. However, in both cases, the corporate defendants offered no evidence-based defenses and the judgments against the corporate entities were entered by default. The cases upon which Wolf Metals relied were distinguishable, because they did not follow defaults. In those cases, the defendants presented evidence-based defenses before the court amended the judgment to add additional alter ego defendants. Thus, those cases involved defenses that the proposed alter ego judgment debtor potentially could control. In contrast, despite having filed its answer, which was later stricken, RPS did not present any evidence-based defense before default judgment was entered against it, and Koh was not proposed as an alter ego defendant before default judgment was entered. Thus, bound by Motores, the court reversed the lower court’s decision as it applied to Koh.
Contrast the reversal of the trial court’s alter ego decision with the portion of the decision affirming that the amended judgment could include SGS as a successor corporation. Due process is not contravened by amending the judgment to include a corporation that is the debtor defendant’s “mere continuation.” See McClellan v. Northridge Park Townhome Owners Ass’n, 89 Cal. App. 4th 746 (2001). The evidence presented to the trial court established that SGS was a mere continuation of RPS, because they shared the same officers, business location, employees, agent for service of process and equipment, the companies’ funds and assets were commingled, and SGS did not pay adequate consideration for RPS’s assets.
COMMENT from 2/6/17 enewsletter
Wolf Metals highlights the due process problem of adding an additional individual debtor to a default judgment under an alter ego theory. The lesson is that plaintiffs should consider whether an alter ego theory applies before moving forward to obtain a default judgment, and make sure to add the relevant individuals as additional named defendants before moving forward with a prove-up. Adding those individuals in advance may enable the plaintiff to obtain default judgments against them or may at least prompt the individuals to appear and respond (of course, where – as here – the defendants are not forthcoming with information about various relationships, it may be difficult for a plaintiff to determine in advance whether it should name additional defendants). Conversely, debtor-defendants should consider the advantages of defaulting when only a corporate defendant is named in the pleadings. As Wolf Metals demonstrates, waiting until after the default judgment is obtained against the entity forecloses the plaintiff’s opportunity to obtain an amended judgment against an individual on an alter ego theory.
[as reported in State Bar of California, Business Law Section, Insolvency Law Committee e-newsletter of 2/6/17]