A recent wave of vessel seizures premised on alter-ego theories has swept through various U.S. federal courts. These cases present significant risks for vessel owners and ship managers, even if the underlying claims are ultimately defensible. Plaintiffs employ Supplemental Admiralty Rule B as the procedural device to seize vessels as an asset of the target defendant. Rule B requires a prima facie showing that the defendant is not present within the district to satisfy the existence of general-personal jurisdiction. The Supreme Court’s general jurisdiction ruling in Daimler AG v. Bauman, 134 S.Ct. 746 (2014), has made it much easier to meet Rule B’s requirement because such jurisdiction is now predicated upon proof that the defendant’s systematic and continuous contacts render it essentially at home within the district, effectively requiring its principal place of business to lie within the district. Given the peripatetic existence of merchant ships and their ownership—often by single ship-owning companies incorporated within flag-of-convenience countries—satisfying Rule B’s “presence within the district” standard now is nearly automatic.
Plaintiffs couple Rule B’s easy compliance with alter-ego allegations that the ship manager or ship-owning group are dominated and controlled by a single individual or entity to the disadvantage of the plaintiffs and that the target defendant is but a corporate extension of the company with whom the plaintiffs’ real dispute exists (and that dispute may have absolutely no connection with the United States). Supplemental Admiralty Rule E(4)(f) permits a defendant whose property has been seized to an immediate post-seizure hearing. While the federal courts are not aligned as to the standard that applies at such a hearing, it is fair to say that plaintiffs are required, at minimum, to meet the probable-cause test, which equates to reasonable grounds for supposing the allegations are well founded.
So, despite the fact that an ex-parte pre-judgment seizure of property is an extraordinary procedure and piercing the corporate veil of separately incorporated companies is an extraordinary remedy, plaintiffs have engineered a relatively easy litigation vehicle to bring considerable commercial pressure to bear upon shipowners and managers. By satisfying the probable-cause standard, plaintiffs open the door to the discovery of documents and witness testimony that often entail considerable time (years), expense, and inconvenience by vessels’ interests to respond. And, either the vessel remains under seizure during the intervening period or substitute security is posted for its release. The Supplemental Admiralty Rules permit security up to 200 percent of the amount of the plaintiffs’ claim, though often the amount does not exceed 150 percent. Nevertheless, that amounts to a substantial premium added to the plaintiffs’ claim and security from the vessel’s protection and indemnity (“P&I”) club may not be available for breach of contract claims, which often lie at the heart of these alter-ego cases.
Fraud Challenges and Processes
The challenge for vessel interests at the Rule E(4)(f) stage is to contest the fundamental premise of the alter-ego claim, which is that the target defendant engaged in fraudulent activity or intended to circumvent statutory or contractual obligations. Under federal practice, fraud must be alleged with particularity—who did it, what was done, when was it committed, where was it committed, and how was it carried out. Are such allegations set forth in the plaintiffs’ original verified complaint? Also, close attention must be paid to the verification accompanying the complaint and whether it truly verifies the allegations set forth therein. Federal courts examine a laundry list of factors, which differ slightly between circuit courts, for purposes of assessing whether the ostensibly controlling corporation exercised complete domination and control over the purported subservient corporation. These factors often include the following:
- disregarding corporate formalities such as, for example, issuing stock, electing directors, or keeping corporate records;
- capitalization that is inadequate to ensure that the business can meet its obligations;
- putting funds into or taking them out of the corporation for personal, not corporate, purposes;
- overlap in ownership, directors, officers, and personnel;
- shared office space, address, or contact information;
- lack of discretion by the allegedly subservient entity;
- dealings not at arms-length between the related entities;
- the holding out by one entity that it is responsible for the debts of another entity; and
- the use of one entity’s property by another entity as its own.
See Pacific Gulf Shipping v. Vigorous Shipping & Trading S.A., et al, 992 F.3d 893, 898 (9th Cir. 2021).
Once discovery is unleashed, the focus shifts to the nitty-gritty details of inter-corporate relationships and delving into the factors above. The process is daunting and entails enormous effort compiling the group’s relevant corporate documents and vetting witnesses in preparation for invariably long depositions. Yet, overlap in corporate activities and operations and activities is not enough. There must be some evidence of wrongdoing. The gist of corporate fraud invariably involves the misuse of monies. Using a forensic accounting expert to examine the defendant’s financial books may yield the best defense. For example, in Pacific Gulf Shipping, the Ninth Circuit noted that:
The auditor found no intermingling of funds and no raiding of bank accounts. Even the few potential irregularities that Pacific Gulf points to in Vigorous's bank statements (three payments to Giorgio Armani) were identified as payments on behalf of the master of the Vigorous, whose salary was reduced by those same amounts. Pacific Gulf points to no specific evidence disputing the probity of Blue Wall and Vigorous's books, so we deem that fact undisputed.
Observations and Recommendations
What we have observed about corporate structures internationally versus domestically within the United States is that special purpose vehicle (“SPV”) structures often do not meet the rigors of corporate separateness required in the States, which makes them more susceptible to the veil-piercing argument at the outset of the case. U.S. federal courts apply the corporate-formality requirements of their respective circuits, and not those employed by the country of incorporation. Also, the use of common officers, directors, offices, contact details, and common financial and operational management, while certainly more economical and efficient, makes it simpler for the plaintiffs to argue that the group structure at issue is dominated and controlled by one or two key individuals or parent company. Moreover, U.S. federal judges are not familiar with the role of ship managers and how they operate and manage their vessel fleets, nor are they familiar with how vessel-owning groups are constructed as investment vehicles for institutional investors. Consequently, there is much confusion that plaintiffs can create by showing how daily financial management and operational decisions are made by relatively few individuals to create the appearance of domination and control.
Vessel interests that regularly engage in commerce with the United States would be well served to closely examine the ownership, management, and corporate structure of their vessel-owning entities and beef-up the corporate walls that separate them.