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New Case Provides a Template (and a Warning) for Avoiding "Alter Ego" Status

The United States District Court for the Southern District of California has recently provided practitioners with a roadmap for avoiding having the activities (and the assets) of one entity conflated into a sister entity by means of the "alter ego" theory. Failure to prove "alter ego" is particularly crippling to a creditor if there is personal jurisdiction over one entity but no jurisdiction over the sister entity that has the deep pocket.

In Stone v. Advance America 2009 WL 765665 (S.D. Cal., 2009) Advance America of California LLC ("Advance California") is a Delaware limited liability company that makes "payday" loans in San Diego. Customers obtain the loans by visiting a local Advance California office. Customers can, however, obtain a loan by visiting an interactive website. Advance America Centers Inc ("Centers") is a Delaware corporation with its principal place of business in South Carolina. Centers is the parent of Advance California. It operates the website out of South Carolina. The plaintiff brought a California class action against Advance California and Centers alleging inter alia, violations of the California Deferred Deposit Transaction Law. It is undisputed that there was personal jurisdiction against Advance California, since the plaintiff dealt directly and personally with Advance California in San Diego in order to obtain the loan. The issues were whether Centers was the "alter ego" of Advance California and, if not, whether Center's own activities in California were sufficient to render it personally subject to jurisdiction in California. It is obvious from a reading of Stone v. Advance America that personal jurisdiction over Centers was critical to the plaintiff, since Centers was the deep pocket and Advance California was relatively judgment proof. Indeed, it is likely that Advance California and Centers was structured with this result in mind.

In support of a finding of alter ego status, the plaintiff showed that (1) both entities have the same officers; (2) both entities share the same administrative offices in South Carolina; (3) both entities share the same website for the purpose of soliciting loans; (4) Advance California prosecutes lawsuits in California on behalf of Centers, and (5) Centers drafted loan agreements for use by Advance California.

In opposition to a finding of alter ego status, the defendant showed that (1) Advance California is sufficiently capitalized, (2) maintains separate corporate books, (3) holds separate corporate meetings, (4) files separate tax returns and (5) Advance California does not transfer money to Centers unless proper documentation has been made. That last point is especially interesting. Centers did not allege that Advance California did not remit its revenues to Centers, nor could it have, since the whole point of this parent-subsidiary relationship was to feed the parent and starve the sub. Centers merely alleged that it documented the transfers.

The allegation was sufficient. The court held that there was no general personal jurisdiction over Centers, because Centers is not the alter ego of Advance California. For alter ego status to apply, a plaintiff:

"must make out a prima facie case (1) that there is such unity of interest and ownership that the separate personalities [of the two entities] no longer exist and (2) the failure to disregard [their separate entities] would result in fraud or injustice."

Doe v. Unocal Corp., 248 F.3d 915 (9th Cir. 2001).

Based upon Center's showing that it maintained all of the corporate formalities, Centers was held not to be the alter ego of Advance California.

If there is no general jurisdiction, could there be specific personal jurisdiction, i.e. did Centers, not by virtue of being the alter ego of Advance California but by its own conduct have sufficient contacts with California so as to bring it within the California long arm statute? In the 9th Circuit, a plaintiff must prove all of the following:

  1. The defendant purposefully directed his activities or consummated some transaction with the forum state, or performed some act within the state invoking the benefits and protections of the state's laws; and
  2. The claim must arise out of or relate to the defendant's forum-related activities; and
  3. The exercise of jurisdiction must comport with fair play and substantial justice.

In support of the personal jurisdiction claim, the plaintiff relied upon three "activities" on Center's part. First, the plaintiff showed that Centers had brought fifty prior Small Claims Court actions in San Diego County against other debtors since 2000, and that Advance California assisted Centers in prosecuting these claims. However, none of these prior actions pertained to this claim, and the plaintiff could not show that any of those other lawsuits had any effect upon the class plaintiff or any other member of the class. In dismissing this factor, the court set an almost impossibly high standard. It ruled that for this factor to apply, the plaintiff would have to show that but for these 50 other lawsuits, the class plaintiff would not have suffered any injury. In other words, a showing of other conduct whereby the defendant avails itself of the jurisdiction is not sufficient. The other conduct must directly effect the plaintiff.

Second, the plaintiff showed that Centers maintained an interactive website. California residents could – and many did -- obtain a loan by using the website. However, the class plaintiff did not use the website to make the loan; the plaintiff was a walk-in customer. Indeed, there was no evidence that the class plaintiff was even aware of the existence of the website. Once again, the court set a very high standard, holding:

"Plaintiff has failed to allege or submit any evidence to demonstrate that Plaintiff would not have suffered the injuries alleged in the Complaint but for Center's soliciting and taking cash advance applications From California residents through its websites."

Finally, the plaintiff showed that Centers drafted the agreement that contains an unconscionable clause. But the plaintiff could not show that the clause was specifically directed against this plaintiff. Once again, a general activity that did not directly harm this plaintiff was deemed insufficient to render Centers personally liable in California.

If Stone v. Advance America tells us anything, it is that, at a very minimum, every entity desiring to avoid being deemed the alter ego of another entity must maintain the corporate formalities. It must maintain separate books of account, maintain separate bank accounts, and file separate tax returns. It must be sufficiently capitalized when it enters into business to operate its intended business. Loans or other capital transactions between entities should be memorialized. In other words, brother-sister or parent-sub entities should treat each other – to the greatest extent possible – in the same manner as if they were entities dealing at arm's length. In hindsight, the fact that Centers and Advance California had the same officers occupying the same offices was a mistake that invited trouble. Surely Centers could have arranged Advance California to have at least some different officers.

What is most troubling about Stone v. Advance America is the court's focus on Center's interactive website. Increasingly, retailers of all kinds make sales by means of interactive websites. There was no finding in Stone v. Advance America that Center's web server was located in California or that anyone associated with Centers maintained the website in California. The sole focus was on whether the plaintiff used the website in California. If that is the sole criterion, the defendant's victory was more an accident than anything. Presumably, the law firm that brought this class action will next time not choose as its class representative a debtor who was a walk-in customer. Whether a class representative who deals solely with an out-of-state retailer of goods or services by means of an interactive website can obtain personal jurisdiction over any foreign retailer merely by using that retailer's website remains to be seen.

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Robert F. KluegerJD, LLM 
Mr. Klueger is one of the very few private attorneys in America who has argued a tax case before the United States Supreme Court, [United States v. Brockamp, 519 US 347 (1997)], which resulted in a change in the tax law regarding tax refund claims filed by disabled taxpayers....

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Mr. Stein is one of California’s best known attorneys and AV rated by Martindale-Hubbell (highest possible rating). He lectures dozens of legal seminars each year on the subjects of asset protection and advanced tax planning....
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