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JPV I L.P. v. Koetting

On Behalf of | Mar 7, 2023 | Firm News

In JPV I L.P. v. Koetting, (No. A163491, 2023 Cal. App. LEXIS 89 (Ct. App. Feb. 7, 2023)) (“Koetting”) the California Court of Appeals in the First District, Division Three determined that the trial court incorrectly interpreted and applied the required elements to add a judgment debtor liable on an alter ego theory. Under both California and Delaware law, the alter ego doctrine extends to LLCs and generally requires that the proponent demonstrate: (1) a unity of interest and ownership such that the separate personalities of the corporation and the individual do not exist; and (2) an inequitable result if the corporate identity is not disregarded. In order to prevail in a motion to add judgment debtors under alter ego doctrine, the judgment creditor must also show that (1) the parties to be added as judgment debtors had control of the underlying litigation and were virtually represented in that proceeding. In determining whether these elements are met, a non-exhaustive list of factors that courts consider include: (1) one individual’s ownership of all stock in a corporation; (2) use of the same office or business location; (3) commingling of funds and other assets of the individual and the corporation; (4) an individual holding out that he is personally liable for debts of the corporation; (5) identical directors and officers; failure to maintain minutes or adequate corporate records; (6) disregard of corporate formalities; (7) absence of corporate assets and inadequate capitalization; and (8) the use of a corporation as a mere shell, instrumentality or conduit for the business of an individual. No single factor is determinative, rather, courts examine all circumstances to determine whether to apply the alter ego doctrine.

In Koetting, the plaintiff appealed the trial court’s failure to join a judgment debtor under alter ego theory. The trial court’s order reflects that the following factors were considered in evaluating whether alter ego doctrine applied: the LLCs’ failure to observe corporate formalities “for meetings”, which the trial court determined was inconsequential because there was no evidence that the LLCs’ articles or operating agreements required such formalities; declarations of accountants that established that the LLCs were adequately capitalized and complied with the law for LLCs, including maintaining current registration; and lastly, the trial court found that there was no personal use of LLC assets.

On appeal, the Court looked to the trial court’s determination that defendants complied with California and Delaware law for LLCs, including maintaining current registration. The evidence was undisputed that defendants failed to maintain valid registration in Delaware from July 2015 through September 2018. Defendants did not cure the registration defect until arbitration proceedings in this action commenced. Further, the Appellate Court opined that even if the trial court believed that maintaining compliance with registration requirements precluded alter ego liability, this was a legally erroneous assumption. The alter ego inquiry focuses on whether the corporate form was used inequitably, not whether the corporation was in good standing. Therefore, the Appellate Court concluded that, the trial court’s finding was not supported by the substantial evidence. Further, the trial court rested its determination that defendants did not personally use any of the subject LLC’s assets based on declarations prepared by the LLC’s accountants. The Appellate Court found that the evidence overwhelmingly demonstrated that defendants used the LLC email addresses and client lists, which contradicted the trial court’s conclusion that defendants did not use any of the LLC’s assets.

The Appellate Court also addressed the issue of the trial court’s finding that the plaintiff failed to prove that defendants operated the LLC at issue with bad faith. The Appellate Court opined that under California law, alter ego liability is not limited to circumstances in which the corporate entity was a sham, operated in bad faith, or was created with intent to defraud. Rather, the Court declared, whether the corporate form was used to further fraud, circumvent a statute, or accomplish some other wrongful or inequitable purpose should be evaluated. Thus, the Court determined that the trial court erred in reaching its conclusion.

The Appellate Court concluded that the trial court failed in its analysis for several of the aforementioned reasons, and, as such, the resulting decision was inequitable as a matter of law due to the misapplication of alter ego theory.