As most litigators will tell you a plaintiff in a civil lawsuit needs to be able to prove both liability and damages to win a case. That is, you need to show both that the defendant is liable under the law and that you have suffered damages as a result. Proving one but not the other and you’ll lose the case.
But there’s one other consideration that is just as important, albeit often elusive, and that is, collectability. Even if you win the case, if you can’t collect on the judgment, you might as well have lost.
The following case, Wolf Metals, Inc. v. Rand Pacific Sales, Inc., California Court of Appeals for the Second District, Case No. B264002 (October 25, 2016), describes some of the remedies available, procedures to follow, and difficulties confronted when obtaining a default judgment against a judgment-proof defendant.
Wolf Metals, Inc. v. Rand Pacific Sales, Inc.
In December 2009, material supplier Wolf Metals, Inc. (“Wolf”) filed a complaint against Rand Pacific Sales, Inc. (“RPS”) in the Los Angeles County Superior Court for unpaid sheet metal supplied by Wolf to RPS pursuant to an oral agreement. Wolf contended that RPS owed it $292,055.93.
Two months later, in February 2010, RPS answered Wolf’s complaint, but in June 2010, RPS filed for bankruptcy under Chapter 7 of the U.S. Bankruptcy Code. As a result of the bankruptcy proceeding, Wolf’s action in the superior court was subject to the Bankruptcy Code’s “automatic stay” and Wolf was unable to proceed with its complaint.
In July 2011, the U.S. Bankruptcy Court ordered the case closed. In connection with that order the docket for the bankruptcy proceeding stated, “no discharge.”
In September 2011, Wolf resumed its action in the superior court against RPS. After RPS counsel repeatedly failed to attend scheduled hearings, the court ordered that RPS’s answer to Wolf’s complaint be stricken and entered the default of RPS. In July 2012, the superior court entered a default judgment against RPS, awarding $292,055.93 in damages, $70,400.00 in prejudgment interest, and $430.00 in costs.
When RPS failed to satisfy the judgment, Wolf arranged for a debtors examination of RPS’ President, Donald Koh, and his wife, who was RPS’ Secretary and Treasurer. After initially refusing to answer any questions, Koh and his wife were examined and excused. Later, Wolf served written discovery to RPS seeking its records. In response, Koh replied that he had no records, stating that the documents sought had either been transferred to the bankruptcy trustee or discarded. In September 2014, Wolf filed a motion to compel further responses, which the superior court granted, as well as sanctions against RPS totaling $1,245.00.
In January 2015, Wolf conducted a second debtor examination of Koh. During the second debtor examination, Koh testified that:
- RPS’ board of directors consisted only of he and his wife, and that the sole shareholder of RPS was his family trust.
- RPS was engaged in the business of “[s]teel purchase and sales,” including the purchase of steel coil from suppliers, like Wolf, which was then cut and sold as a finished product.
- RPS had always conducted its operations from a single location and had 10 to 20 employees.
- Koh and his wife also operated a company called South Gate Steel, Inc. (“SGS”), which supplied steel to RPS and cut steel on behalf of RPS. Koh, however, denied that SGS engaged in the same business as RPS.
- Koh and RPS made loans to one another. At some point, RPS secured a loan from Koh, and discharged the loan by transferring equipment to him valued at 29,000.00. According to Koh, no document expressly established the existence of the loan.
- In 2010, after RPS filed for bankruptcy, RPS stopped doing business and sold its remaining inventory. Koh described the current status of RPS as “nothing,” that RPS had been “thrown away,” and that SGS had taken possession of RPS’ remaining furniture and other items, which he described as “abandoned.”
- When asked whether SGS employed any of RPS’ employees, Koh replied, “Yes.” Koh further testified that RPS would neither satisfy the judgment nor pay the discovery sanctions owed to Wolf because RPS was “no longer there” and that he was “not [RPS] anymore.”
Following the second debtor examination, Wolf filed a motion to amend the default judgment to name both Koh and SGS as additional judgment debtors under Code of Civil Procedure section 187, which provides that “the trial court has jurisdiction to modify a judgment to add additional judgment debtors.” Specifically, Wolf contended that Koh and SGS were the alter egos of RPS and that SGS was a mere continuation of RPS.
In support of its motion, and in addition to the testimony given by Koh during the second debtors examination, Wolf submitted evidence that:
- SGS was engaged in the same business as RPS and that Koh served as the agent for service of process for both SGS and RPS.
- Photos showing that SGS conducted business out of the same building as RPS.
- Photos showing that the front sign of the building that used to display RPS’ name, two phone numbers, and a description of its services as “[s]pecialist on narrow cut slit coils, [m]ax capacities ¼ thick to ½ width, round edged flat bars & coils” was unchanged, except that RPS’ name was now absent.
- Images of SGS’ website showing that its listed services closely tracked the advertisement on the building’s front sign.
Koh and SGS’ opposition, while arguing that it was legally improper to name Koh and SGS as additional judgment debtors and that Wolf had failed to act with due diligence in seeking its amendments, neither disputed Wolf’s evidentiary showing nor offered any new evidence. The superior court granted Wolf’s motion, finding that Koh and SGS were alter egos of RPS and that SGS was a successor corporation of RPS.
Koh and SGS appealed.
On appeal, Koh and SGS argued that: (1) the bankruptcy proceedings discharged RPS’ debt to Wolf; (2) SGS was improperly named as an additional judgment debtor as a successor corporation; and (3) Koh was improperly named as an additional judgment debtor as an alter ego of RPS.
No Discharge Under Bankruptcy Proceeding
On appeal, Koh and SGS argued that the superior court’s order contravened the bankruptcy proceedings and, specifically, the bankruptcy trustee’s final report prior to the case being closed which stated:
I have made a diligent inquiry into the financial affairs of the debtor . . . there is no property available for distribution from the estate over and above that exempted by law . . . I hereby certify that the estate of the above-named debtor(s) has been fully administered. . . . Claims scheduled to be discharged without payment . . . $286,469.47.
Although the bankruptcy court’s docket reflected that the proceeding closed with “no discharge,” Koh and SGS argued that the bankruptcy trustee’s final report established that Wolf’s claims against RPS were “to be discharged without payment.”
The Court of Appeals disagreed, explaining that unlike individual Chapter 7 cases, corporations are not discharged in Chapter 7 bankruptcies. Rather, explained the Court, 11 USC 727(a)(1) states “[t]he court shall grant the debtor a discharge unless . . . the debtor is not an individual.”
As such, explained the Court of Appeals, bankruptcy proceedings do “not dissolve a corporation – which must be accompanied under state procedures – [and] corporate debts and liabilities survive the closing of the bankruptcy proceeding.” “For that reason, responsibility for those debts and liabilities may be imposed on other parties under ‘alter ego’ and ‘successor corporation’ theories” and, thus, held the Court the “bankruptcy proceeding did not preclude the amendment of the judgment to include appellants as judgment debtors.”
Default Judgment Was Properly Amended to Name SGS Under Successor Corporation Theory
Under the successor corporation theory, explained the Court of Appeals, corporations cannot escape liability by a mere change of name or a shift of assets when and where it is shown that the new corporation is, in reality ,but a continuation of the old. This is particularly true where actual fraud or the rights of creditors are involved, in which case, courts have uniformly held the new corporation liable for the debts of the former corporation. And here, held the Court:
The evidence established that although SGS’ creation predated RPS’s bankruptcy proceeding, SGS merely continued RPS’s business operation under a different name. According to Wolf Metals’s showing, Koh “ran” both corporations, which share the same president, secretary, treasurer, business location, and agent for service. After the bankruptcy proceeding closed, RPS was never dissolved. SGS took possession of RPS’s remaining assets and offered services identical to those provided by RPS, using RPS’s employees. Koh testified that RPS had been “thrown out” and was “no longer there,” and that he was “not [RPS] anymore.” Wolf Metals’s evidence also showed that prior to RPS’s bankruptcy, Koh obtained RPS’s equipment as the purported repayment of a loan to RPS. As the trial court observed, at the January 2015 judgment debtor examination, Koh was unable to explain his transactions with RPS and SGS “whereby the funds and assets of [RPS] were com[m]ingled with [those] of [SGS] and his own personal finances.” In view of this evidence, the court reasonably concluded that SGS was a mere continuation of RPS.
Default Judgment Was Not Properly Amended to Name Koh Under Alter Ego Theory
So far so good for Wolf.
But not all tales have a happy ending.
On the issue of whether Koh was properly named as an additional judgment debtor under an alter ego theory, the Court of Appeals held that he was not.
Relying on the California Supreme Court’s decision in Motores De Mexicali v. Superior Court, 51 Cal.2d 172 1958), in which the supreme court held that due process considerations under the 14th Amendment to the U.S. Constitution require that a defendant have an opportunity to be heard and to present his defense, the Court of Appeals held that naming Koh as an alter ego of RPS was improper since “RPS offered no evidence-based defense in the underlying action, and the judgment against RPS was entered by default.”
In a footnote to the opinion, the Court of Appeals recognized the potential unfairness to the plaintiffs but held that it was bound by the decision of the California Supreme Court:
Wolf Metals argues that declining to recognize Koh as a judgment debtor would encourage alter egos of corporations to avoid corporate liabilities by ensuring that the corporations default in actions against them. While we recognize the merits of that policy consideration, the rule established in Morales over a half a century ago is binding on us.