Piercing the Corporate Veil and Alter Ego US and Mexican Law

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1 Piercing the Corporate Veil and Alter Ego US and Mexican Law Panelists: Hon. Louise D. Adler, Judge of the U.S. Bankruptcy Court Ali Mojdehi, Cooley LLP Manuel Perez-Freyre, Baker McKenzie Mary R. Robberson, Higgs, Fletcher & Mack

2 Alter Ego 1. Background of Alter Ego Meaning (Latin, "the other I"). In law, a doctrine by which a court of law holds individual shareholders liable for a corporation's debts if the corporation is deemed to be nothing more than an "alter ego" of the corporation's owners. Also referred to as piercing the corporate veil. Veil piercing" may take place when a company is set up for fraudulent purposes, or where it is established to avoid an existing obligation. Utility: An equitable doctrine used to address fraud and to ensure the interests of justice are served. 2. Context and where it is applicable Corporations exist in part to shield the personal assets of shareholders from personal liability for the debts or actions of a corporation. Piercing the corporate veil typically is most effective with smaller privately held business entities (close corporations) in which the corporation has a small number of shareholders, limited assets, and recognition of separateness of the corporation from its shareholders would promote fraud or an inequitable result. 2

3 Legal Principles U.S. Law In the United States, different theories, most important "alter ego" or "instrumentality rule", attempted to create a piercing standard. Mostly, they rest upon three basic prongs namely: "unity of interest and ownership": the separate personalities of the shareholder and corporation cease to exist, "wrongful conduct": wrongful action taken by the corporation, and "proximate cause": as a reasonably foreseeable result of the wrongful action, harm was caused to the party that is seeking to pierce the corporate veil. Alter Ego is a question of state law. In determining whether or not the corporate veil may be pierced, the courts are required to use the laws of the corporation's home state. 3

4 Legal Principles U.S. Law (continued) Factors that a U.S. court may consider when determining whether or not to pierce the corporate veil include the following: Absence or inaccuracy of corporate records; Concealment or misrepresentation of members; Failure to maintain arm's length relationships with related entities; Failure to observe corporate formalities in terms of behavior and documentation; Intermingling of assets of the corporation and of the shareholder; Manipulation of assets or liabilities to concentrate the assets or liabilities; Non-functioning corporate officers and/or directors; Significant undercapitalization of the business entity (capitalization requirements vary based on industry, location, and specific company circumstances); Siphoning of corporate funds by the dominant shareholder(s); Treatment by an individual of the assets of corporation as his/her own; and Was the corporation being used as a "façade" for dominant shareholder(s) personal dealings 4

5 Legal Principles Mexican Law 1. Background of Alter Ego and Piercing the Corporate Veil in Mexico: Recently in Mexico the theory of Alter Ego and Piercing the Corporate Veil has been recognized by means of a series of precedents issued by the Collegiate Circuit Courts. In Mexico mercantile entities are ruled by Federal Laws and therefore, the criteria for piercing the corporate veil is determined in accordance with such laws. 2. Relevant cases include: The Coca Cola Export Corporation Case (November 2008). Importadora y Distribuidora Ucero Case (November 2012). Spectrasite Communications Case (August 2013). In one of the precedents the Court stated that all actions against the contractual good faith are considered to be an illicit act. 5

6 Legal Principles Mexican Law 3. Factors that a Mexican Court may consider when determining whether or not to pierce the corporate veil include the following: Actions/acts undertaken by the Company: committing fraud against third parties; or violating the application of the law; avoiding the application of the law; avoiding obligations; and in general, implementing actions for illicit purposes. If the company carries out activities in violation of the contractual good faith; To discover the illegality of the acts carried out in the companies; 6

7 Legal Principles Mexican Law Preliminary legal aspects for the Case Study: 1. Relevant aspects for the recognition and enforcement of foreign judgments in Mexico 1 : Mexican Courts have exclusive competence in matters relating to lands and waters located in Mexico. The judgments have not been rendered as a consequence of the exercise of a action in rem; That the judge or the court had jurisdiction. That the defendant had been summoned or serviced in a personal manner (right to a hearing). To be res judicata in the country rendered. That the obligation requested to be carried out is not contrary to the public order in Mexico. 1. Article 568 of the Federal Code of Civil Procedures and Article 1,347-A Commercial Code. 7

8 Case Study

9 Case Study Merits Appeal: Kismet Acquisition, LLC v. Diaz-Barba et al. (In re Icenhower), 757 F.3d 1044 (9th Cir. 2014) Appeal from the United States District Court for the Southern District of California, Barry T. Moskowitz, District Judge, Presiding. D.C. Lead Case No. 3:08 cv BTM BLM Sanctions Appeal: Kismet Acquisition, LLC v. Diaz-Barba et al. (In re Icenhower), 755 F. 3d 1130 (9th Cir. 2014) Appeal from the United States District Court for the Southern District of California, Barry T. Moskowitz, District Judge, Presiding. D.C. Lead Case No. 3:08 cv BTM BLM 9

10 Background and Facts The Icenhowers (the Debtors ) purchased an interest in Vista Hermosa, a coastal villa in Jalisco, Mexico from the Lonies (the Original Owners ). The investment was purchased in a fideicomiso trust an arrangement wherein a Mexican bank holds title to a coastal property and a foreign national is granted the right to use it. The Original Owners sued Debtors in the Southern District of California, on a note, seeking, inter alia, a determination of the parties' respective rights and interests in the Villa interest and injunctive relief. On November 24, 2003, the district court entered judgment for the Original Owners, directing Debtors either to pay damages of $1,356, or to return the Villa interest. 10

11 The Players Original Owners sue Debtor on a note regarding Villa Debtor sets up H&G to avoid summary judgment in litigation by Lonies H&G takes ownership of Villa Original Owners obtain judgment against Debtor Debtor files bankruptcy in San Diego H&G sells the Villa to D&B (Mexican citizens residing in San Diego) Bankruptcy Trustee sues Debtor & H&G for fraudulent transfer Trustee finds out about postbankruptcy sale to D&B and sues D&B Kismet purchases the Litigation from Bankruptcy Trustee 11

12 Factual Background On March 4, 2002, while the Original Owners' action against him was pending, Debtor purchased H&G, a shell company created by Laughlin International, Inc. The same day, Debtor agreed to transfer, inter alia, the Villa interest to H&G for $100,000 and H&G's assumption of $140,000 of debt. The bankruptcy court later found: [N]o evidence that H&G paid any of the recited consideration; After the sale, Debtor retained absolute control over the operation of the Villa Property and the right to all rental income from the villa; H&G was not capitalized beyond the $3,424 contributed by Debtor; Craig Kelley, H&G s president and sole officer and director, served in a purely titular capacity and took orders from Debtor; and H&G had no real corporate existence apart from [Debtor] and had no business purpose other than as a sham company to hold the Debtors' assets. 12

13 Factual Background Debtor filed for bankruptcy protection on December 15, In a closing ceremony in San Diego on June 7, 2004, H&G sold the Villa interest to D&B (Mexican citizens residing in San Diego) for $1.5 million. Although H & G was represented by Mr. Kelley, the closing was controlled by Debtor. Prior to the closing, numerous red flags had arisen, including: Although the Villa interest was purportedly sold by H&G, Debtor was able to lower the purchase price to account for a debt he personally owed D&B. D&B were on notice of Debtor s bankruptcy and of the possibility of litigation to avoid Debtor s transfer of the Villa interest to H&G and to tie Debtor to H&G. The Villa interest comprised substantially all of H&G's assets, but its sale was not authorized by a shareholder resolution, as required by Nevada law and H&G's Articles. The Debtor instructed D&B to pay most of the consideration to entities other than H&G, including an entity associated with Debtor. 13

14 Procedural History In January 2004, Debtors disclosed to their creditors their March 2002 sale of the Villa interest to H&G. On August 23, 2004, the bankruptcy trustee filed an avoidance action, alleging that the sale by Debtor to H&G was a fraudulent prepetition transfer (the Fraudulent Conveyance Action ). On August 3, 2006, the trustee filed an avoidance action, alleging that H&G was Debtor s alter ego and the sale from H&G to D&B was an unauthorized post-petition transfer (the Post-petition Transfer Action ). H&G did not appear in either action. On November 30, 2006, Kismet purchased the estate's assets and was substituted for the trustee in both actions. 14

15 Procedural History Following a bench trial, on June 2, 2008, the bankruptcy court issued consolidated findings of fact and conclusions of law in the two actions. In the Post-petition Transfer Action, the court ruled for Kismet, concluding: H&G was Debtor s alter ego and substantively consolidated H&G with Debtor s bankruptcy estate, such that the Villa interest was part of the estate nunc pro tunc as of the petition date. As a result of the alter ego finding, the transfer of the interest to D&B was an unauthorized post-petition transfer avoidable under 549(a). D&B had no defense to avoidance under 549(c) since D&B were aware of Debtor s bankruptcy prior to the closing. As initial transferees of the interest, D&B were strictly liable under 550(a)(1) to return the interest or its value to the estate. 15

16 Procedural History Alternatively, in the Fraudulent Conveyance Action, the court ruled for Kismet, concluding: Pursuant to 544(b)(1) and California law, Debtor s transfer of the Villa interest to H&G was avoidable as a fraudulent transfer. Because D&B were not good-faith purchasers, Kismet could recover the Villa interest from D&B under 550(a)(2), as subsequent transferees of H&G. 16

17 Conflict of Laws Issues California law governed the determination of D&B s good faith. The Ninth Circuit, affirming the bankruptcy court, ruled that the judgment was not contrary to Mexican law. First, fideicomiso trusts are explicitly permitted under Mexican law. Second, the bankruptcy court did not require the Mexican government to approve the trust or to recognize or enforce its judgment. The Ninth Circuit also ruled that Congress intended extraterritorial application of the Bankruptcy Code as it applies to property of the estate. Because H&G was Debtors alter ego and its substantive consolidation of H&G with the bankruptcy estate, the Villa interest was property of the estate as of the petition date. 17

18 The Impact of Alter Ego on the Procedural Posture Bankruptcy filing Debtor H&G D&B H&G found to be the alter ego of Debtor & is substantively consolidated with the Icenhower bankruptcy estate, nunc pro tunc therefore... Villa Is Property of the Bankruptcy Estate at the time of the post bankruptcy transfer to D&B! 18