It is commonplace to see a company’s wholly-owned subsidiary or sole shareholder sued under an alter ego theory to recover for the alleged wrongdoing of the company, particularly when the company itself lacks sufficient funds to satisfy a judgment. But plaintiffs are increasingly using a variation of the alter ego doctrine known as the “single-enterprise rule” to pursue claims against companies that are related to the main target through interlocking boards, shared ownership, or affiliate relationships. This post examines the genesis of the single-enterprise rule and the types of cases where it has been applied.
The Las Palmas Decision and Birth of the Single-Enterprise Rule
Las Palmas Associates v. Las Palmas Center Associates, 235 Cal. App. 3d 1220 (1991) is often cited as the first instance in which the alter ego doctrine was extended to a sister corporation. The cross-complainants in Las Palmas were three buyers (“Buyers”) who had sued three sellers (“Sellers”) for breaches of lease guaranties and fraud. Id. at 1234. Buyers planned to purchase a shopping center being developed by one of the Sellers, Hahn Devcorp but wanted to exclude from the purchase two “problem tenants” who had stopped making payments on their multi-year leases. Id. at 1231. To address Buyers’ concern, Sellers had Hahn Devcorp guarantee the stores’ two leases. Id. at 1231-32.
When Hahn Devcorp failed to honor its lease guarantee, Buyers sued Sellers for fraud, alleging that Sellers had misrepresented their intent to honor the guaranties in order to induce the Buyers into consummating the sale. Id. at 1234. At trial, Buyers argued (and the jury found) that Hahn Devcorp was the alter ego of another entity called Ernest Hahn, Inc. Id. at 1237. On appeal, Ernest Hahn, Inc. argued that the record did not support a finding that Hahn Devcorp was its alter ego, because Ernest Hahn, Inc. had no ownership interest in Hahn Devcorp at the time the lease guarantees were created, having transferred all of its shares of Hahn Devcorp to another entity (“Trizec”) the year before. Id. at 1248.
The Las Palmas court disagreed, finding instead that because the alter ego doctrine is an equitable one, “the conditions under which a corporate entity may be disregarded vary according to the circumstances of each case.” Id. Although alter ego liability is generally reserved for the parent-subsidiary relationship, “under the single-enterprise rule, liability can be found between sister companies.” Id. at 1249. The court described the rule as follows:
though there are two or more personalities, there is but one enterprise: and … this enterprise has been so handled that it should respond, as a whole, for the debts of certain component elements of it.
Id. at 1249-51. At trial, Buyers argued – and the appellate court agreed – that a single-enterprise existed with Trizec at the top, Ernest Hahn, Inc. in the middle, and Hahn Devcorp at the bottom. Id. at 1249. This finding was supported by evidence that Ernest Hahn, Inc. had guaranteed $43.2 million in loans and loan commitments to Hahn Devcorp, in addition to guaranteeing the lease payments for one of the problem tenants after Ernest Hahn, Inc. had divested its ownership interest in Hahn Devcorp. Id. at 1250. These guaranties demonstrated that Hahn Devcorp’s survivability as a developer was intertwined with its dependence on Ernest Hahn, Inc. Id. at 1250-51. In addition, two individuals sat on the boards of both entities. And when Hahn Devcorp’s board fired the corporation’s executives and staff, Ernest Hahn, Inc. used its employees to continue to manage the business. Id. at 1251.
Cases Post-Las Palmas Applying Single-Enterprise Rule
Since its inception, the single-enterprise rule has been applied by numerous California state and federal courts. As a practical matter, the single-enterprise rule differs in name only from the alter ego doctrine. Courts addressing applicability of the single-enterprise rule consider the same factors evaluated for a traditional alter ego analysis, including: inadequate capitalization; disregard of corporate formalities (such as stock issuance, keeping of minutes, election of officers and directors, segregation of corporate records); identical directors and officers; commingling of funds and other assets; identical equitable ownership in the two entities; the holding out by one entity that it is liable for the debts of the other; use of the same offices and employees; and use of one as a mere shell or conduit for the affairs of the other. Willig v. Exiqon, Inc., No. SA CV 11-399 DOC RNB, 2012 WL 10375, at *9 (C.D. Cal. Jan. 3, 2012). See also Oakley, Inc. v. Trimera Mil. Tech., Inc., No. SACV141649DOCDFMX, 2016 WL 8794459, at *10 (C.D. Cal. Jan. 22, 2016); Cal-Star Prod., Inc v. Fencepost Prods., Inc., No. LACV1804490JAKEX, 2019 WL 13038581, at *2–3 (C.D. Cal. Apr. 18, 2019) (same).
In applying the single-enterprise rule, courts tend to place particular importance on evidence of “such domination of finances, policies and practices that the controlled corporation has, so to speak, no separate mind, will or existence of its own and is but a business conduit for its principal.” Toho-Towa Co., LTD. v. Morgan Creek Prods., Inc., 217 Cal. App. 4th 1096, 1107 (2013). Here are just a few examples of instances in which the single-enterprise rule has been successfully applied.
In Toho-Towa, the appellate court ruled that substantial evidence existed for the trial court’s finding that plaintiff could enforce a $5.7 million judgment against Morgan Creek Productions (“MCP”) that had been awarded against two MCP-affiliated companies: Morgan Creek International B.V. (“B.V.”) and Morgan Creek International Ltd. (“Ltd.”) based on the single-enterprise rule where:
The three entities were all owned by the same person, who was the sole decision-maker for all of the Morgan Creek entities;
The three entities exploited the same assets;
The “work” of B.V. and Ltd. was performed by the employees of MCP; and
Although B.V. entered into contracts which required that monetary payments be made to them, no money was remitted, but rather was transferred directly to Ltd.’s lender.
217 Cal. App. 4th at 1100, 1109 (2013).
In Conde v. Sensa, the Court found the plaintiff had adequately alleged grounds for treating defendants IBH and JustFab as part of a “single enterprise” run by other Sensa Entities where:
All three were headquartered in the same building, and made intercompany loans that generally had no formal agreements, bargained for consideration, or loan payment schedule;
IBI released JustFab of nearly $20 million in debt for no consideration;
IBI provided $10 million to IB Holding to purchase JustFab shares;
JustFab and IB Holding prepared consolidated financials and filed a unitary tax return with IBI in 2012; and
Ownership was largely (but not fully) consolidated between all of the entities: IBI owned 90% of Sensa Products, and IB Holding partially owned IBI and JustFab.
259 F. Supp. 3d 1064, 1072 (S.D. Cal. 2017).
In Troyk v. Farmers Grp., Inc., the appellate court found there was substantial evidence to support the trial court’s finding that defendants FGI, FIE, and Prematic acted as a single enterprise and therefore, FGI and FIE could be liable for restitution of Prematic’s violation of California’s unfair competition law where:
Prematic was a wholly owned subsidiary of FGI, and all of its directors are officers or employees of FGI;
Prematic performed most of its billing and forwarding activities by using FGI's equipment and personnel and paid FGI for such use; and
FGI, as FIE’s managerial agent and attorney-in-fact, designed and effected a scheme whereby any FIE insured who elected a one-month term policy would be required by FIE to execute an agreement with Prematic, requiring the insured to pay to Prematic not only the stated premium but also a service charge for paying in full that stated premium.
171 Cal. App. 4th 1305, 1342 (2009). The holding in Troyk is somewhat unique in that FIE did not control or own any shares of stock of Prematic. Id. at 1342. Nonetheless, the court of appeal held that the trial court could reasonably infer that FGI’s managerial and administrative control over FIE’s activities as FIE’s attorney-in-fact allowed FGI to control the activities of both FIE and Prematic, effectively making FIE and Prematic sister—or at least affiliated—entities for the purpose of applying the single enterprise doctrine to FGI’s scheme to require the class members to pay service charges that were not disclosed in their policies. Id.
Conclusion
Plaintiffs who seek to recover from a party that was part of a multi-party effort to commit wrongdoing should consider whether the evidence supports the existence of a single-enterprise. Did the entity assuming financial responsibility within the enterprise ever have enough capital to operate their business? Have adequate records of loans and other business transactions between the entities been kept and adequate procedures observed? If these conditions are not met, the plaintiff may have a path to recover from another party within the enterprise.
For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.
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