Court Boldly Goes Where No Court Has Gone Before While Navigating the Nuances of Attorney’s Fees and the Alter Ego Doctrine

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Nothing triggers nerdy excitement within the legal community quite like a freshly decided case that claims to address an issue “which appears to be a question of first impression.”[1]  This is the court’s way of proclaiming in its best Captain Kirk voice that it has decided “to boldly go where no [Court] has gone before.”

Recently, the California Court of Appeal decided MSY Trading Inc. v. Saleen Automotive, Inc., which answers an important question—whether an alleged alter ego defendant is entitled to attorney’s fees after successfully defending an alter ego claim, when the underlying litigation involved a contract with an attorney’s fees provision.  For the first time, the court answered “yes.”

MSY TRADING CASE SUMMARY

In a separate lawsuit, Plaintiff, MSY Trading, obtained a judgment for breach of contract against certain entities not parties to the case before the court of appeal.  The contract contained an attorney’s fees provision, so MSY Trading’s judgment included an award for attorney’s fees.  After obtaining that judgment, MSY Trading filed an enforcement action against Steve Saleen, among others, on the basis that Mr. Saleen was an alter ego of the judgment debtors.  Mr. Saleen successfully defeated the alter ego claim and moved for his own attorney’s fees award based on the contract in the underlying action.  The trial court awarded Mr. Saleen’s attorney’s fees and MSY Trading appealed.

On appeal, MSY Trading argued that the alter ego action was not an action “on a contract” (in contrast with MSY Trading’s underlying breach of contract action); therefore, attorney’s fees were not awardable to the prevailing party.  Generally, in California, where a contract allows for an award of attorney’s fees to the prevailing party in a lawsuit, reasonable attorney’s fees are awarded for any action “on a contract.”[2]

The appellate court rejected MSY Trading’s argument.  The court explained that MSY Trading could have included its alter ego allegations against Mr. Saleen in the underlying breach of contract action.  In that situation, “undoubtedly [Mr. Saleen] would have been entitled to contractual attorney fees ….”  The fact that alter ego allegations may be brought prejudgment or postjudgment was too arbitrary of a consideration on which to base the right to attorney’s fees.  Accordingly, the appellate court concluded that when a judgment creditor (such as MSY Trading) attempts to add a party to a contract judgment, the alter ego action is “on the contract” for purposes of an attorney’s fees award, even though the alleged alter ego was never a party to the contract.

LESSONS

MSY Trading emphasizes the importance of understanding the nuances of the alter ego doctrine and contract attorney’s fees provisions.  Either or both of those issues can dramatically affect litigation strategy regardless of the underlying claims’ merits.  Focusing on the perspective of the plaintiff in MSY Trading, we see the difficult strategy decisions that breach of contract plaintiffs may be confronted with.  MSY Trading had successfully proved its breach of contract case and was awarded its attorney’s fees.  After the judgment debtors were unable to satisfy MSY Trading’s breach of contract judgment, MSY Trading’s only hope of satisfying its judgment was to pursue the judgment against alter egos.  However, pursuing alter ego has its own independent risks.  After losing the alter ego action, which is an “extreme remedy, sparingly used,”[3] not only was MSY Trading denied the opportunity to collect on its own judgment, but it was now responsible for an attorney’s fee award to Mr. Saleen—a seemingly unfair result after proving its breach of contract case in the underlying action.

It is easy to see how this scenario can arise in the real estate context.  In real estate, single purpose entities (typically LLCs or partnerships) are often utilized to pursue projects involving a particular piece of property, funded by separate individuals or entities.  Imagine, for example, Party A contracts with a single purpose entity to pursue a joint venture and includes an attorney’s fees provision in the contract.  After the project fails, the single purpose entity has little or no capital, but its investors are motivated to roll the dice and fund litigation in an attempt to pin blame on Party A for the project’s failure.  Party A successfully defends itself but incurs substantial attorney’s fees in the process.  Even if Party A obtains an attorney’s fees award, the single purpose entity may have no funds to pay the judgment.  Therefore, like in MSY Trading, Party A has to decide whether to accept never collecting on its attorney’s fees judgment or run the risk of possibly owing attorney’s fees, despite winning the underlying contract case, if it ultimately goes after the single purpose entity’s investors as alter egos and fails.

It will be interesting to see if subsequent decisions address the potential unfairness of some of these loopholes, including whether it makes courts more sympathetic to alter ego claims.  In the meantime, real estate investors, and their attorneys, should consider early on what role alter ego and attorney’s fees contract provisions may have in any pending  or potential future litigation.

[1] MSY Trading Inc. v. Saleen Automotive, Inc. (June 26, 2020) 2020 WL 3481424, *1.

[2] California Civil Code § 1717.

[3] Sonora Diamond Corp. v. Superior Court (2000) 83 Cal.App.4th 523, 539.

[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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