Alter Ego Claims — Beware Attorney Fee Liability

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One of the essential purposes of forming an entity and conducting business through that entity is to limit the owners’ personal liability. California law generally views the entity and its owners as separate and legally distinct.

The “alter ego” doctrine is an exception to this rule. A successful alter ego claim allows a party to “pierce the corporate veil” and hold the entity’s owners liable for the entity’s debt. For more background on the alter ego doctrine, see the prior Money and Dirt post: Seven Critical Mistakes Real Estate LLCs Make (and How to Avoid Them) — Mistake #4: Stepping into “Alter Ego” Liability.

But pursuing an alter ego claim can be risky. If the contract underlying the dispute contains an attorney fee clause, then the court can award attorney fees even where the alleged “alter ego” is not a party to the contract.

An opinion recently published by California’s Third Appellate District — Westwood Homes, Inc. v. AGCPII Villa Salerno Member, LLC — illustrates the point.

Facts: judgment against developer; unsuccessful motion to amend judgment to add “alter egos”

A property owners association and other parties (hereafter, “association”) obtained judgments against a real estate developer (Westwood Montserrat, Ltd.) on claims arising from the CC&Rs for a planned residential community in Placer County. After the developer’s unsuccessful appeal of the judgments, the parties returned to the trial court and the association filed a motion to amend the judgments to include third parties affiliated with the developer — Westwood Homes and Lucille Westwood Limited Partnership — as “alter egos.” The trial court denied the motion.

Westwood Homes and Lucille Westwood Limited Partnership then filed a motion to recover over $34,000 in attorney fees incurred in defeating the alter ego motion under Civil Code section 1717. The trial court denied the motion, and the appeal followed.

Court of Appeal: party who defeats “alter ego” claim is entitled to fees

The Court of Appeal reversed, holding that an award of fees was proper.

The court recapped the development of case law applying Civil Code section 1717 not just to contracting parties, but also their alleged “alter egos.” There are three procedural devices commonly used to impose alter ego liability:

  1. sue the alter ego directly (usually along with the contracting party) in an action for breach of contract
  2. first obtain a judgment for breach of contract against the contracting party, followed by a motion to amend the judgment to add the alter ego (which the association pursued in this case)
  3. after obtaining a judgment against the signatory, file an independent action against the alter ego

As to the first option (suing the alter ego directly in the main action), a 1979 California Supreme Court opinion — Reynolds Metals Co. v. Alperson — confirmed that an award of attorney fees was appropriate in favor of successful defendants who had not signed the contract, but had been sued as the “alter egos” of the contracting party. This result ensures “mutuality of remedy” — i.e., if the plaintiff had succeeded on its alter ego claims, it would have been entitled to an award of fees, so it was only fair for the successful “alter ego” defendants to obtain a fee award after defeating the plaintiff’s claims.

As to the third option (filing an independent action against the alter ego after judgment against the signatory), two recent court of appeal opinions (MSY Trading Inc. v. Saleen Automotive, Inc. and 347 Group, Inc. v. Philip Hawkins Architect, Inc.) extended the reasoning of the Reynolds Metals case and held that an award of fees was proper after the alleged alter ego prevailed.

As to the second option (filing a motion to amend a prior judgment), which was pursued by the association in this case, the court ruled there should be no difference in the outcome.

The court observed: “These different procedural vehicles, however, are identical in substance: in all three, the proof of alter ego is the same.” Regardless of the procedural device used, all “alter ego claims proceed from the theory that, in the eyes of the law, the alter ego was a party, albeit by a different name.”

As such, the court determined that Westwood Homes and Lucille Westwood Limited Partnership were entitled to recover their attorney fees for defeating the alter ego motion.

Lesson

When the contract at issue contains an attorney fee clause, think carefully before asserting a claim for alter ego liability, regardless of the procedural device used. A party who unsuccessfully asserts alter ego might end up owing attorney fees to the alleged alter ego.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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