The Ninth Circuit Bankruptcy Appellate Panel holds that a discharge injunction does not bar an alter ego claim against a non-debtor where, under applicable law, the result of an alter ego finding is not to deem the entities as one and the same, but to hold one liable for the other’s debts.
- A discharge in bankruptcy does not extinguish a debt but releases a debtor from personal liability on the debt. The debt still exists and may be collected from a co-obligor, guarantor and, in certain circumstances, a debtor’s alter ego.
- Where a creditor is not seeking any recovery from the debtor, a discharged debtor still has the same obligations as any witness to participate in discovery or attend trial, and requiring such participation is not a violation of the discharge injunction.
- A complaint alleging alter ego should be carefully drafted to avoid asserting discharged claims or naming the debtor as a defendant, so as not to run afoul of the discharge injunction.
In RS AIR, LLC v. NetJets Aviation, Inc. (In re RS AIR, LLC), 2023 Bankr. LEXIS 1453, 2023 WL 3774652 (9th Cir. BAP June 2, 2023), the Ninth Circuit Bankruptcy Appellate Panel (BAP) concluded that a discharge injunction is not violated by an alter ego claim against a non-debtor that alleges that the debtor and non-debtor defendant are one and the same. The BAP reasoned that a discharge only protects a debtor from personal liability, not any other person or entity (such as a co-obligor or guarantor) that is liable with a debtor, and affirmed an order denying the debtor’s motion for contempt for violations of the discharge injunction.
NetJets Aviation Inc., NetJets Sales, Inc., and NetJets Services Inc. (collectively, “NetJets”) sell and lease fractional interests in private jets. Before bankruptcy, RS Air LLC (RS Air) purchased an interest in two aircraft from NetJets and entered into certain management agreements, NetJets sued RS Air for breach of contract, and RS Air counterclaimed. On the eve of trial, RS Air filed its chapter 11 case under subchapter V in the U.S. Bankruptcy Court for the Northern District of California.
During RS Air’s bankruptcy case, NetJets moved for standing to pursue alter ego claims against RS Air’s founder and sole managing member, Stephen Perlman, and certain entities owned or controlled by Mr. Perlman. The Bankruptcy Court denied the motion for failure to allege facts sufficient to permit NetJets to pierce the corporate veil. NetJets appealed the decision to the BAP.
While the appeal was pending, the Bankruptcy Court confirmed RS Air’s chapter 11 plan. On appeal, the BAP affirmed the Bankruptcy Court’s confirmation order, vacated the order denying NetJets’ motion for standing to pursue alter ego claims, and remanded to the Bankruptcy Court.
Before entry of RS Air’s discharge in the bankruptcy case, NetJets filed a new lawsuit against Mr. Perlman, individually and as trustee of the Perlman Trust, and Rearden LLC, a related entity owned and controlled by Mr. Perlman (together, the “Non-Debtor Defendants”) in federal district court. Notably, the complaint did not name RS Air as a defendant.
The Non-Debtor Defendants filed a motion to dismiss in the District Court, and with RS Air, a motion for contempt against NetJets in the Bankruptcy Court. The District Court found that there was no alter ego liability as to Rearden LLC, but denied the motion to dismiss as to Mr. Perlman and the Perlman Trust. Meanwhile, the Bankruptcy Court denied the contempt motion, concluding that there was a “fair ground of doubt” whether the discharge injunction applied to the complaint. In response to a motion for clarification and reconsideration, the Bankruptcy Court clarified its ruling and expressly held that NetJets did not violate the discharge injunction.
Effect of Discharge
Section 524(a)(2) of the Bankruptcy Code protects a debtor from a subsequent suit, or any other act to collect, by a creditor whose claim has been discharged in a bankruptcy case. Section 524(e) provides that, with certain exceptions, a debtor’s discharge does not affect the liability of any other entity on, or the property of any other entity for, the discharged debt.
Alter Ego Allegations
In ruling that NetJets’ alter ego allegations did not violate the discharge injunction as to RS Air, the BAP first looked to the plain language of section 524 and determined that under sections 524(a)(2) and (e), the discharge only protects the debtor from liability and does not affect the liability of non-debtors for such debt.
The BAP then turned to examine whether the alter ego allegations in NetJets’ complaint concerned RS Air’s “personal liability” under section 524. The BAP noted that there was no dispute that the complaint did not name RS Air as a defendant, nor did it seek any relief specifically against RS Air.
During oral argument, counsel for Mr. Perlman argued that section 524(e) was inapplicable because the complaint sought to hold RS Air liable as an entity that is one and the same as the Non-Debtor Defendants. The BAP found this argument unpersuasive because—as the parties previously agreed—Delaware law controlled the alter ego analysis and, under Delaware law, the result of veil piercing is not that the entities are deemed one and the same, but instead that one entity is held liable for the other’s debts.
As additional support for its conclusion, the BAP pointed to the Ninth Circuit’s historical and categorical prohibition against third-party releases. See Resorts Int’l v. Lowenschuss (In Re Lowenschuss), 67 F.3d 1394 (9th Cir. 1995); Blixseth v. Credit Suisse, 961 F. 3d 1074 (9th Cir. 2020). As such, the result in RS Air may be different in a jurisdiction that permits third-party releases where the applicable chapter 11 plan releases the debtor’s alleged alter ego.
Finally, the BAP parsed the cases relied on by RS Air, including In re Ostrander, Case No. 11-33801, 2022 WL 999680 (Bankr. N.D. Ohio Apr. 1, 2022) and In re Torres, 594 B.R. 890 (Bankr. C.D. Cal. 2018).
Like RS Air, In re Ostrander involved alter ego claims, but there the court found the discharge injunction was violated. At least one cause of action alleged that the corporations were the debtor’s alter egos and sought to hold the debtor personally liable for the entities’ acts. The Ostrander court thus concluded that the “overall effect” of the complaint was a violation. In reaching this conclusion, the court noted that the confusing drafting of the complaint made it difficult to separate the permissible and impermissible claims.
In re Torres also involved alter ego claims. The Torres court similarly found the discharge injunction was violated. The court reasoned that, under California law, the judgment could be amended to add the defendant’s alter egos as judgment debtors, and the most likely outcome “in the normal course of events” was that the creditor would be successful in adding the discharged debtor to a default judgment against the business. The BAP in RS Air disagreed with the Torres court’s reasoning, stating that a discharge violation does not exist whenever a creditor might later seek a judgment against the discharged debtor. The BAP determined it would not protect the Non-Debtor Defendants from liability because NetJets “might” in the future claim that RS Air and the Perlman parties were one and the same.
Participation in Discovery
The Non-Debtor Defendants also argued that merely requiring RS Air to participate in discovery in the District Court violated the discharge injunction. But the BAP, citing to its prior rulings, held that a discharged debtor’s obligation to participate in discovery does not violate the discharge injunction—the discharge injunction only enjoins personal collection of a discharged debt; it does not “relieve a discharged debtor from all forms of imposition or inconvenience.”
The BAP’s decision reaffirms that a discharge does not extinguish a debt, but rather, releases a debtor from personal liability on the debt. The debt still exists and may be collected from a co-obligor, guarantor and—at least where non-debtor releases are prohibited and when Delaware law controls—an alter ego. The BAP’s decision in RS Air demonstrates that creditors should not be quick to conclude that their recoveries are limited. Instead, creditors should consider other potential paths for recovery, including alter ego claims, when warranted